Market Structure

Market?
Components of Market
Sellers Buyers Product Price Exchange
Market is set of conditions in which buyers and sellers contact each other and conduct exchange transactions.

Classification of Market
Based on
Area (Local, Regional, National,) Nature of Transactions (spot Mkt, Future Mkt) Volume of business (Wholesale & Retail) Time (short period, long period,) Status of sellers (Producers, C & F Agents, Wholesalers, Retailers,) Regulations (Regulated and Un-regulated) Competition (Perfect,..,Monopoly)

Classifying Markets
Classifying markets (by degree of competition)
number of firms freedom of entry to industry
free, restricted or blocked?

nature of product
homogeneous or differentiated?

nature of demand curve

degree of control the firm has over price

Alternative Market Structures

Different market structures
Perfect competition

Imperfect competition
Monopoly Duopoly Monopolistic competition Oligopoly
With product differentiation
Without product differentiation

Features of the four market structures

Type of market Number of firms Freedom of entry Nature of product Examples Implications for demand curve faced by firm Horizontal: firm is a price taker Downward sloping, but relatively elastic Downward sloping. Relatively inelastic (shape depends on reactions of rivals) Downward sloping: more inelastic than oligopoly. Firm has considerable control over price

Perfect competition Monopolistic competition

Very many Many / several

Unrestricted

Homogeneous (undifferentiated)

Cabbages, carrots (approximately) Builders, restaurants Cement cars, electrical appliances Local water company, train operators (over particular routes)

Unrestricted

Differentiated

Undifferentiated Oligopoly Few Restricted or differentiated

Monopoly

One

Restricted or completely blocked

Unique

Features of the four market structures

Type of market Number of firms Freedom of entry Nature of product Examples Implications for demand curve faced by firm Horizontal: firm is a price taker Downward sloping, but relatively elastic Downward sloping. Relatively inelastic (shape depends on reactions of rivals) Downward sloping: more inelastic than oligopoly. Firm has considerable control over price

Perfect competition Monopolistic competition

Very many Many / several

Unrestricted

Homogeneous (undifferentiated)

Cabbages, carrots (approximately) Builders, restaurants Cement cars, electrical appliances Local water company, train operators (over particular routes)

Unrestricted

Differentiated

Undifferentiated Oligopoly Few Restricted or differentiated

Monopoly

One

Restricted or completely blocked

Unique

Features of the four market structures

Type of market Number of firms Freedom of entry Nature of product Examples Implications for demand curve faced by firm Horizontal: firm is a price taker Downward sloping, but relatively elastic Downward sloping. Relatively inelastic (shape depends on reactions of rivals) Downward sloping: more inelastic than oligopoly. Firm has considerable control over price

Perfect competition Monopolistic competition

Very many Many / several

Unrestricted

Homogeneous (undifferentiated)

Cabbages, carrots (approximately) Builders, restaurants Cement cars, electrical appliances Local water company, train operators (over particular routes)

Unrestricted

Differentiated

Undifferentiated Oligopoly Few Restricted or differentiated

Monopoly

One

Restricted or completely blocked

Unique

Features of the four market structures

Type of market Number of firms Freedom of entry Nature of product Examples Implications for demand curve faced by firm Horizontal: firm is a price taker Downward sloping, but relatively elastic Downward sloping. Relatively inelastic (shape depends on reactions of rivals) Downward sloping: more inelastic than oligopoly. Firm has considerable control over price

Perfect competition Monopolistic competition

Very many Many / several

Unrestricted

Homogeneous (undifferentiated)

Cabbages, carrots (approximately) Builders, restaurants Cement cars, electrical appliances Local water company, train operators (over particular routes)

Unrestricted

Differentiated

Undifferentiated Oligopoly Few Restricted or differentiated

Monopoly

One

Restricted or completely blocked

Unique

Features of the four market structures

Type of market Number of firms Freedom of entry Nature of product Examples Implications for demand curve faced by firm Horizontal: firm is a price taker Downward sloping, but relatively elastic Downward sloping. Relatively inelastic (shape depends on reactions of rivals) Downward sloping: more inelastic than oligopoly. Firm has considerable control over price

Perfect competition Monopolistic competition

Very many Many / several

Unrestricted

Homogeneous (undifferentiated)

Cabbages, carrots (approximately) Builders, restaurants Cement cars, electrical appliances Local water company, train operators (over particular routes)

Unrestricted

Differentiated

Undifferentiated Oligopoly Few Restricted or differentiated

Monopoly

One

Restricted or completely blocked

Unique

Features of the four market structures

Type of market Number of firms Freedom of entry Nature of product Examples Implications for demand curve faced by firm Horizontal: firm is a price taker Downward sloping, but relatively elastic Downward sloping. Relatively inelastic (shape depends on reactions of rivals) Downward sloping: more inelastic than oligopoly. Firm has considerable control over price

Perfect competition Monopolistic competition

Very many Many / several

Unrestricted

Homogeneous (undifferentiated)

Cabbages, carrots (approximately) Builders, restaurants Cement cars, electrical appliances Local water company, train operators (over particular routes)

Unrestricted

Differentiated

Undifferentiated Oligopoly Few Restricted or differentiated

Monopoly

One

Restricted or completely blocked

Unique

Pure Competition

Monopoly

Duopoly

Oligopoly (undifferentiated)

Oligopoly (differentiated)

Monopolistic Firms

Perfect Market

Features of Perfect Competition

Large number of buyers and sellers
Seller is a price taker

Homogeneous Product
Identical, Perfect substitutes

Pure Market

Free entry and exit

Profit-firms will enter the market and vice-versa

Perfect knowledge of the market

Buyers & Sellers are completely aware of prices

Perfect mobility of factors of production

Factors of production can be easily move in & move out

Absence of transport cost

Price equilisation of commodity and factors geographically

Existence of a single and uniform price

Both buyers and sellers cannot influence the price

Non-intervention of Government
Market economy

Price Determination under Perfect Competition

Price per metre (in Rs) 50 40 30 20

Quantity demanded 10 15 20 25

Quantity supplied (mn meters)

25 23 20 15

Pressure on Price Falling Falling Neutral Raising

10

30

10

Raising

Short-run equilibrium of industry and firm under perfect competition

P
S

Pe

O
Q (millions)

Industry

Behaviour of price, while supply remains the same

P
S
P1

P
P2 D1 D2

M2 M M1

Q (millions)

Behaviour of price, while demand remains the same

S2 P1 P P2

S3

M1

M2

Q (millions)

Industry

The Price Taker Assumption

P
Pe

P D

D Qe
Market Supply and Demand

Qmilk
Demand for Milk

Qmilk

Marginal Revenue
Q 0 P 6 TR 0 MR 6 6 6 6 6 6

1
2 3 4 5 6 7

6
6 6 6 6 6 6

6
12 18 24 30 36 42

Demand = Marginal Revenue

P P = D = MR

D Qe
Market Supply and Demand

Qmilk
Contented Cow Dairys Demand

Qmilk

The Supply Curve for a Price-taking Firm

MC 5 Rs. per nut 4 E1 3 E0 2 E2 E3 p3 p2 AVC p1 3 5 4

p0

q0 Output [i] Marginal cost and average variable cost curves

q1 q2 Quantity [ii] The supply curve

q3

Perfect Competition
Short-run equilibrium of the firm
Price
given by market demand and supply

Output
where P = MC

Profit
(AR AC) Q possible supernormal profits

Equilibrium of industry and firm under perfect competition

P
S

Rs

Pe

AR Equilibrium Point -MC=MR=Price - MCD cut MR from below & O after MC must be raising Equilibrium Point

D = AR = MR

O
Q (millions)

Qe Q (thousands)

(a) Industry

(b) Firm

Short-run equilibrium of industry and firm under perfect competition

Super Normal Profit Rs (AC < Price)

P
S

MC

AC

Pe

AR AC

D = AR = MR

O
Q (millions)

Qe Q (thousands)

(a) Industry

(b) Firm

Loss minimising under perfect competition

Loss (AC > Price)

P
S

Rs

MC

AC

AC P1 AR1

D1 = AR1 = MR1

O
Q (millions)

Qe Q (thousands)

(a) Industry

(b) Firm

Normal Profit
Normal Profit MC = MR RsAC = AR

P
S

MC AC

P2 D2

AR2

D2 = AR2 = MR2

O
Q (millions)

O
Q (thousands)

(a) Industry

(b) Firm

Short-run shut-down point

P
S

Rs

MC

AC

AVC

P2 D2

AR2

D2 = AR2 = MR2

O
Q (millions)

O
Q (thousands)

(a) Industry

(b) Firm

Perfect Competition
Short-run equilibrium of the firm (cont.)
short-run supply curve of firm
the MC curve

Short-run supply curve of industry

sum of supply curves of firms

Consumers and Producers Surplus

Price

Consumer surplus

E Market price

p0
Producers surplus

D
Total variable cost

q0 Quantity

Consumers and Producers Surplus

Consumers surplus is the area under the demand curve and above the market price line. The equilibrium price and quantity are p0 and q0. The total value that consumers place on q0 units of the product is given by the sum of the dark yellow, light yellow, and light blue areas. The amount that they pay is p0q0, the rectangle that consists of the light yellow and light blue areas. The difference, shown as the dark yellow area, is consumers surplus.

Consumers and Producers Surplus

Producers surplus is the area above the supply curve and below the market price line. The receipts of producers from the sale of q0 units are also p0q0. The area under the supply curve, the blue-shaded area, is total variable cost, which is the minimum amount that producers must receive to induce them to supply the output. The difference, shown as the light yellow area, is producers surplus

The Allocative Efficiency of Perfect Competition

S 1 E p0 4 2 D 3

Competitive market price

q1

q0

q2

Quantity

The Allocative Efficiency of Perfect Competition

At the competitive equilibrium E consumers surplus is the dark yellow area above the price line Producers surplus is the light yellow area below the price line. Reducing the output to q1 but keeping price at p0 lowers consumers surplus by area 1. It lowers producers surplus by area 2. Assume that producers are forced to produce output q2 and to sell it to consumers, who are in turn forced to buy it at price p0. Producers surplus is reduced by area 3 (the amount by which variable costs exceed revenue on those units). Consumers surplus is reduced by area 4 (the amount by which expenditure exceeds consumers satisfactions on those units). Only at the competitive output, q0, is the sum of the two surpluses maximized.

Perfect Competition
The long run
long-run equilibrium of the firm
all supernormal profits competed away

Long-run equilibrium under perfect competition

Profits return Supernormal profits New firms enter to normal
P
S1 Se LRAC P1 PL AR1 D1 DL

Rs

ARL

O
Q (millions)

QL Q (thousands)

(a) Industry

(b) Firm

Perfect Competition
The long run
long-run equilibrium of the firm
all supernormal profits competed away
LRAC = AC = MC = MR = AR

Long-run equilibrium of the firm under perfect competition

Rs
(SR)MC (SR)AC

LRAC

DL AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

Short-run and Long-run Equilibrium of a Firm in Perfect Competition

SRATC0 MC0

p0
MC*

c0
SRATC*

LRAC

p*

q0

q*

Short-run and Long-run Equilibrium of a Firm in Perfect Competition

The firms existing plant has short-run cost curves SRATC0 and MC0 while market price is p0 . The firm produces q0, where MC0 equals price and total costs are just being covered. Although the firm is in short-run equilibrium, it can earn profits by building a larger plant and so moving downwards along its LRAC curve.

Short-run and Long-run Equilibrium of a Firm in Perfect Competition

Thus the firm cannot be in long-run equilibrium at any output below q*, because average total costs can be reduced by building a larger plant. If all firms do this, industry output will increase and price will fall until long-run equilibrium is reached at price p*. Each firm is then in short-run equilibrium with a plant whose average cost curve is SRATC* and whose short-run marginal cost curve, MC*, intersects the price line p at an output of q*. Because the LRAC curve lies above p* everywhere except at q*, the firm has no incentive to move to another point on its LRAC curve by altering the size of its plant. Thus a perfectly competitive firm that is not at the minimum point on its LRAC curve cannot be in long-run equilibrium.

Perfect Competition
The long run
long-run equilibrium of the firm
all supernormal profits competed away

LRAC = AC = MC = MR = AR

long-run industry supply curve

Perfect Competition
The long run
long-run equilibrium of the firm
all supernormal profits competed away

LRAC = AC = MC = MR = AR

long-run industry supply curve incompatibility of economies of scale with perfect competition

Does the firm benefit from operating under perfect competition?

Long-run Industry Supply Curves

S0 Price S0

Quantity

D0

Quantity

Quantity

Long-run Industry Supply Curves

Price D0
E0

S0

D0
E0

S0

p0

q1 Quantity S0 D0

q1 Quantity

p0

E0

q1 Quantity

Long-run Industry Supply Curves

D1 Price D0 D1
E1 E0

S0

D0
E1

S0

p0

E0

q1 Quantity D0

D1
E1 E0

q1 S0 Quantity

p0

q1 Quantity

Long-run Industry Supply Curves

D1 Price D0 D1
E1 E0 E2

S0 p0 LRS

D0
E1

S0
E2

LRS
E0

p0

q1

q2 D0

D1
E1 E0

q1 S0

q2

(i)

Quantity

(ii)

Quantity

p0 p0

E2

LRS

(iii)

q1 Quantity

q2

(i) A constant long-run industry supply curve

The initial curves are at D0 and S0. Equilibrium is at E0 with price p0 and quantity q0. A rise in demand shifts the demand curve to D1, taking the short-run equilibrium to E1. New firms now enter the industry, shifting the shortrun supply curve outwards. Price is pushed down until pure profits are no longer being earned. At this point the supply curve is S1. The new equilibrium is E2 with price at p2 and quantity q2. The curves shift so that price returns to its original level, making the long-run supply curve horizontal.

(ii) A Rising long-run industry supply curve

The initial curves are at D0 and S0. Equilibrium is at E0 with price p0 and quantity q0. A rise in demand shifts the demand curve to D1, taking the short-run equilibrium to E1. New firms now enter the industry, shifting the short-run supply curve outwards. Price is pushed down until pure profits are no longer being earned. At this point the supply curve is S1. The new equilibrium is E2 with price at p2 and quantity q2. Profits are eliminated and entry ceases before price falls to its original level, giving the LRS curve a positive slope.

(iii) A falling long-run industry supply curve

The initial curves are at D0 and S0. Equilibrium is at E0 with price p0 and quantity q0. A rise in demand shifts the demand curve to D1, taking the short-run equilibrium to E1. New firms now enter the industry, shifting the shortrun supply curve outwards. Price is pushed down until pure profits are no longer being earned. At this point the supply curve is S1. The new equilibrium is E2 with price at p2 and quantity q2. The price falls below its original level before profits return to normal, giving the LRS curve a negative slope.

PERFECT COMPETITION: A SUMMARY

PERFECT COMPETITION

Market Structure and Firm Behaviour Competitive behaviour refers to the extent to which individual firms compete with each other to sell their products. Competitive market structure refers to the power that individual firms have over the market - perfect competition occurring where firms have no market power and hence no need to react to each other. Elements of the Theory of Perfect Competition The theory of perfect competition is based on the following assumptions: firms sell a homogenous product; customers are well informed; each firm is a price-taker; the industry can support many firms, which are free to enter or leave the industry.

PERFECT COMPETITION

Short-run Equilibrium
Any firm maximises profits producing the output where its marginal cost curve intersects the marginal revenue curve from below - or by producing nothing if average cost exceeds price at all outputs. A perfectly competitive firm is a quantity-adjuster, facing a perfectly elastic demand curve at the given market price and maximising profits by choosing the output that equates its marginal cost to price. The supply curve of a firm in perfect competition is its marginal cost curve, and the supply curve of a perfectly competitive industry is the sum of the marginal cost curves of all its firms. The intersection of this curve with the market demand curve for the industrys product determines market price.

PERFECT COMPETITION
The Allocative Efficiency of Perfect Competition Perfect competition produces an optimal allocation of resources because it maximises the sum of consumers and producers surplus by producing equilibrium where marginal cost equals price. Long-run Equilibrium Long-run industry equilibrium requires that each individual firm be producing at the minimum point of its LRAC curve and be making zero profits. The long-run industry supply curve for a perfectly competitive industry may be [i] positively sloped, if input prices are driven up by the industrys expansion, [ii] horizontal, if plants can be replicated and factor prices remain constant, or [iii] negatively sloped, if some other industry that is not perfectly competitive produces an input under conditions of falling long-run costs.

Thank You