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In classical economics, market pricing is primarily determined by the interaction of supply and demand. Price is interrelated with both of these measures of value. The relationship between price and supply is generally negative, meaning that the higher the price climbs, the lower amount of the supply is demanded. Conversely, the lower the price, the greater the supply is demanded. Price, the amount of goods for which a product is sold, may be seen as a financial expression of the value of the product. Setting the right price is an important part of effective marketing, being the only part of the marketing mix that generates revenue, as product, promotion, and place are all about marketing costs. Price is also the marketing variable that can be changed most quickly. For a consumer, price is the monetary expression of the value to be enjoyed/benefits of purchasing a product, as compared with other available items. A customer’s motivation to purchase a product comes firstly from a need and a want. The second motivation comes from a perception of the value of a product in satisfying that need/want. The perception of the value of a product varies from customer to customer, because perceptions of benefits and costs vary. Perceived benefits are often largely dependent on personal taste. In order to obtain the maximum possible value from the available market, businesses try to segment the market – that is to divide up the market into groups of consumers whose preferences are broadly similar – and to adapt their products to attract these customers. In general, a products perceived value may be increased in one of two ways – either by increasing the benefits that the product will deliver or by reducing the cost. For consumers, the price of a product is the most obvious indicator of cost hence the need to get product pricing right.
This report focuses on Natural Price, Market Price and the relationship between them. It also discusses standard market forms – Monopoly, Oligopoly and Perfect
Competition. In economics Natural price is the price for a good or service that is equal to the cost of production whereas market price is the economic price for which a good or service is offered in the marketplace. It is of interest mainly in the study of microeconomics. There are four basic types of market structures by traditional economic analysis: perfect competition, monopolistic competition, oligopoly and monopoly. A monopoly is a market structure in which a single supplier produces and sells a given product. An oligopoly is a market dominated by a few large suppliers. In economic theory, perfect competition describes
markets such that no participants are large enough to have the market to set the price of a homogeneous product.
2. NATURAL PRICE AND MARKET PRICE
2.1. NATURAL PRICE There is in every society an ordinary or average rate both of wages and profit in every different employment of labour and stock. This rate is naturally regulated, partly by the general circumstances of the society, their riches or poverty, their advancing, stationary, or declining condition; and partly by the particular nature of each employment. Similarly there is an average rate of rent, which is regulated, partly by the general circumstances of the society or neighbourhood in which the land is situated, and partly by the natural or improved fertility of the land. These average rates may be called the natural rates of wages, profit, and rent, at the time and place in which they commonly prevail. When the price of any commodity is neither more nor less than what is sufficient to pay the rent of the land, the wages of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market, according to their natural rates, the commodity is then sold for what may be called its natural price. The commodity is then sold precisely for what it is worth, or for what it really costs the person who brings it to market. It does not comprehend the profit of the person who is to sell it again, if he sells it at a price which does not allow him the ordinary rate of profit in his neighbourhood, he is evidently a loser by the trade, as by employing his stock in some other way he might have made that profit. His profit, besides, is his revenue, the proper fund of his subsistence. As he is preparing and bringing the goods to market, he advances to his workmen their wages, or their subsistence; so he advances to himself, in the same manner, his own subsistence, which is generally suitable to the profit which he may reasonably expect from the sale of his goods. Unless they yield him this profit, they do not repay him what they may have really cost him. Though the price, therefore, which leaves him this profit, is not always the lowest at which a dealer may sometimes sell his goods, it is the lowest at which he is
from the greater difficulty of producing it. and in every society this rate varies according to their circumstances. with the fall in their price. this is more than counterbalanced by the improvements in machinery. they are enhanced in real value. or declining condition. necessaries. at least where there is perfect liberty. stationary. according to their riches or poverty. which that money will purchase.The power of the labourer to support himself. the improvements in agriculture. 4 . the discovery of new markets. therefore. but on the quantity of food. The natural price of labour is that price which is necessary to enable the labourers. and may even occasion their natural price to fall. The natural price itself varies with the natural rate of each of its component parts. by the better division and distribution of labour. The natural price of labour. With a rise in the price of food and necessaries. necessaries. However. The natural price of all commodities. and the family which may be necessary to keep up the number of labourers. may for a time counteract the tendency to a rise in the price of necessaries. and conveniences required for the support of the labourer and his family. and conveniences become essential to him from habit. does not depend on the quantity of money which he may receive for wages. in the progress of wealth and population. their advancing. to subsist and to perpetuate their race. has a tendency to become dearer.likely to sell them for any considerable time. profit. has a tendency to fall. the natural price of labour will rise. both in science and art of the producers. depends on the price of the food. of wages. from the rise in the natural price of the raw material of which they are made. because one of the principal commodities by which its natural price is regulated. on one hand. or where he may change his trade as often as he pleases. so will the same causes produce the correspondent effects on the natural price of labour. With the progress of society the natural price of labour has always a tendency to rise. the natural price of labour will fall. except raw produce and labour. and rent. and by the increasing skill. Though.
and profit. Rather than want it altogether. and their demand the effectual demand. or below. as the commodity can never be brought to market in order to satisfy it. Some part must be sold to those who are willing to pay less.2. or the whole value of the rent. all those who are willing to pay the whole value of the rent. which must be paid in order to bring it. When the quantity of any commodity which is brought to market falls short of the effectual demand. and the low price which they give for it must reduce 5 . some of them will be willing to give more. MARKET PRICE The actual price at which any commodity is commonly sold is called its Market price. When the quantity brought to market exceeds the effectual demand. wages. The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought to market. It may either be above. Among competitors of equal wealth and luxury the same deficiency will generally occasion a more or less eager competition. according as either the greatness of the deficiency. Such people may be called the effectual demanders. but his demand is not an effectual demand.2. and the demand of those who are willing to pay the natural price of the commodity. labour. or exactly the same with its natural price. The wealth and want on luxury of the competitors happen to animate more or less the eagerness of the competition. according as the acquisition of the commodity happens to be of more or less importance to them. he might like to have it. wages. it cannot be all sold to those who are willing to pay the whole value of the rent. A very poor man may be said in some sense to have a demand for a coach and six. which must be paid in order to bring it to market. and profit. and profit. A competition will immediately begin among them. cannot be supplied with the quantity which they want. and the market price will rise more or less above the natural price. since it may be sufficient to effectuate the bringing of the commodity to market. It is different from the absolute demand. which must be paid in order to bring it .
The quantity of every commodity brought to market naturally suits itself to the effectual demand. labour is dear when it is scarce. The market price will sink more or less below the natural price. the interest of the labourers in the one case. The quantity brought to market will soon 6 . some of the component parts of its price must be paid below their natural rate. However much the market price of labour may deviate from its natural price. and cheap when it is plentiful. a tendency to conform to it. will prompt them to withdraw a part of their labour or stock from this employment. like commodities. and cannot be disposed of for more. and no more. If at any time it exceeds the effectual demand. or as nearly the same with the natural price. labour. or according as it happens to be more or less important to them to get immediately rid of the commodity. according as the greatness of the excess increases more or less the competition of the sellers. or stock. in bringing any commodity to market.3. If it is rent. and of their employers in the other. but does not oblige them to accept of less. the market price naturally comes to be either exactly. from the natural operation of the proportion of the supply to the demand. The competition of the different dealers obliges them all to accept of this price. that the quantity never should exceed the effectual demand and it is the interest of all other people that it never should fall short of that demand. The whole quantity upon hand can be disposed of for this price. it has.the price of the whole. the interest of the landlords will immediately prompt them to withdraw a part of their land and if it is wages or profit. RELATIONSHIP BETWEEN NATURAL PRICE AND MARKET PRICE When the quantity brought to market is just sufficient to supply the effectual demand. The market price of labour is the price which is really paid for it. 2. It is the interest of all those who employ their land.
to which the prices of all commodities are continually gravitating. All the different parts of its price will soon sink to their natural rate. and sometimes force them down even somewhat below it. When the market price of labour exceeds its natural price. The quantity brought will soon be sufficient to supply the effectual demand. When. by the encouragement with high wages give to the increase of population. and therefore to rear a healthy and numerous family. When the market price of labour is below its natural price. Different accidents may sometimes keep them suspended a good deal above it. that he has it in his power to command a greater proportion of the necessaries and enjoyments of life. that the market price of labour will rise to its natural price. the quantity brought to market should at any time fall short of the effectual demand. and the whole price to its natural price. if it is wages or profit. some of the component parts of its price must rise above their natural rate. All the different parts of its price will rise to their natural rate. is the central price. on the contrary. the number of labourers is increased. the interest of all other landlords will naturally prompt them to prepare more land for the raising of this commodity. If. the interest of all other labourers and dealers will soon prompt them to employ more labour and stock in preparing and bringing it to market. 7 . that the condition of the labourer is flourishing and happy. The natural price therefore.be no more than sufficient to supply the effectual demand. or the demand for labour has increased. and the whole price to its natural price. wages again fall to their natural price. however. the condition of the labourers is most wretched. Poverty deprives them of those comforts which custom renders absolute necessaries. and indeed from a reaction sometimes fall below it. and that the labourer will have the moderate comforts which the natural rate of wages will afford. If it is rent. But whatever may be the obstacles which hinder them from settling in this centre of repose and continuance. It is only after their privations have reduced their number. they are constantly tending towards it.
Oligopoly. Economists assume that there are a number of different buyers and sellers in the marketplace. For almost every product there are substitutes. This is termed monopolistic competition. cannot maximize his or her total utility and has have very little influence over the price of goods. one entity has the exclusive rights to a natural resource. there are no substitutes and there is no competition. so if one product becomes too expensive. This means that we have competition in the market. Entry into such a market is restricted due to high costs or other impediments.3. In a market that has only one or few suppliers of a good or service. both the consumer and the supplier have equal ability to influence price. If there is a single seller in a certain industry and there are not any close substitutes for the product. the single business is the industry. meaning that a consumer does not have choice. such as electricity. there are many sellers in an industry and/or there exist many close substitutes for the goods being produced. For example. a buyer can choose a cheaper substitute instead. In a market with many buyers and sellers. social or political. the producer(s) can control price. whereas by oligopoly the companies interact strategically. which allows price to change in response to changes in supply and demand. A monopoly is a market structure in which there is only one producer/seller for a product. Perfect competition and Monopolistic competition. In some industries. STANDARD MARKET FORMS There are four basic types of market structures by traditional economic analysis: Monopoly. a government can create a monopoly over an industry that it wants to control. A monopoly is a market structure in which a single supplier produces and sells a given product. Another reason for the barriers against entry into a monopolistic industry is that oftentimes. Sometimes. In other words. in Saudi Arabia the 8 . For instance. then the market structure is that of a "Pure Monopoly". which may be economic. but nevertheless companies retain some market power.
many products that are similar in nature and. a monopoly is a single seller. that is. Thus. there are only a few firms that make up an industry. for instance. There are two extreme forms of market structure: monopoly and.1. Monopolies are thus characterized by a lack of economic competition to produce the good or service and a lack of viable substitute goods. Although monopolies may be big businesses. if any. the power. many substitutes. In economics. 9 . Monopoly A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity. causing any firm that increases its prices to lose market share and profits. Perfect competition is characterized by many buyers and sellers. to charge high prices. in a perfectly competitive market. This select group of firms has control over the price and like a monopoly. barriers to entry for new companies. For example. an oligopoly has high barriers to entry. In an oligopoly. A monopoly may also form when a company has a copyright or patent that prevents others from entering the market. size is not a characteristic of a monopoly.government has sole control over the oil industry. A small business may still have the power to raise prices in a small industry (or market). In law. had a patent on Viagra. The verb "monopolize" refers to the process by which a company gains the ability to raise prices or exclude competitors. The products that the oligopolistic firms produce are often nearly identical and therefore the companies which are competing for market share are interdependent as a result of market forces. Pfizer. its opposite. producers in a perfectly competitive market are subject to the prices determined by the market and do not have any leverage. perfect competition. the consumers can just turn to the nearest competitor for a better price. should a single firm decide to increase its selling price of a good. Perfect competition means there are few. and prices are determined by supply and demand. as a result. 3. a monopoly is a business entity that has significant market power.
by contrast. Patents. but they rarely provide market power. A government-granted monopoly or legal monopoly. prices or sale of goods. is sanctioned by the state. Holding a dominant position or a monopoly of a market is not illegal in itself. The government may also reserve the venture for itself. a monopoly may also have monopsony control of a sector of a market. in which there is only one buyer of a product or service. be considered abusive and therefore incur legal sanctions. In many jurisdictions. and trademarks are sometimes used as examples of government granted monopolies. Likewise. High Barriers to Entry: Other sellers are unable to enter the market of the monopoly. monopolies typically maximize their profit by producing fewer goods and selling them at higher prices than would be the case for perfect competition. Monopolies can be established by a government. or form by integration. Monopolies. often to provide an incentive to invest in a risky venture or enrich a domestic interest group.A monopoly is distinguished from a monopsony. a monopoly should be distinguished from a cartel (a form of oligopoly). When not coerced legally to do otherwise. thus forming a government monopoly Characteristics of monopoly Profit Maximizer: Maximizes profits. however certain categories of behaviour can. suppliers (monopsony) and the other companies (oligopoly) in ways that leave market interactions distorted. 10 . competition laws restrict monopolies. Price Maker: Decides the price of the good or product to be sold. monopsonies and oligopolies are all situations such that one or a few of the entities have market power and therefore interact with their customers (monopoly). when a business is dominant. form naturally. in which several providers act together to coordinate services. copyright.
Formation of monopolies Monopolies can form for a variety of reasons. characters. including the following: I. sounds or names. There are three major types of barriers to entry. If a firm has exclusive ownership of a scarce resource. there is one seller of the good that produces all the output. Price Discrimination: A monopolist can change the price and quality of the product. economic. images. which was given monopoly status by Oliver Cromwell in 1654. legal and deliberate. the whole market is being served by a single company. such as a song writer having a monopoly over their own material. A monopoly could be created following the merger of two or more firms. such as Microsoft owning the Windows operating system brand. 11 . such as with the Post Office. it has monopoly power over this resource and is the only firm that can exploit it. Sources of monopoly power Monopolies derive their market power from barriers to entry – circumstances that prevent or greatly impede a potential competitor's ability to compete in a market. Given that this will reduce competition. Single seller: In a monopoly. giving them exclusive rights to sell a good or service. IV. Producers may have patents over designs. II. such mergers are subject to close regulation and may be prevented if the two firms gain a combined market share of 25% or more. III. Therefore. when the market was opened up to competition. He sells more quantities charging fewer prices for the product in a very elastic market and sells less quantities charging high price in a less elastic market. Governments may grant a firm monopoly status. The Royal Mail Group finally lost its monopoly status in 2006. or copyright over ideas.
Monopolies are often in a position to reduce prices below a new entrant's operating costs and thereby prevent them from continuing to compete. It also can play a crucial role in the development or acquisition of market power. Technological superiority: A monopoly may be better able to acquire. This is the network effect. The absence of substitutes makes the demand for the good relatively inelastic enabling monopolies to extract positive profits. Decreasing costs coupled with large initial costs give monopolies an advantage over would-be competitors. integrate and use the best possible technology in producing its goods while entrants do not have the size or finances to use the best available technology. There is a direct relationship between the proportion of people using a product and the demand for that product. One large company can sometimes produce goods cheaper than several small companies. or large research and development costs or substantial sunk costs limit the number of companies in an industry. Economies of scale: Monopolies are characterised by decreasing costs for a relatively large range of production. No substitute goods: A monopoly sells a good for which there is no close substitute. Capital requirements: Production processes that require large investments of capital. The most famous current example is the market dominance of the Microsoft operating system in personal computers. capital requirements. Network externalities: The use of a product by a person can affect the value of that product to other people. This effect accounts for fads and fashion trends. Large fixed costs also make it difficult for a small company to enter an industry and expand. In other words the more people who are using a product the greater the probability of any individual starting to use the product. Economic barriers: Economic barriers include economies of scale. Control of natural resources: A prime source of monopoly power is the control of resources that are critical to the production of a final good. cost advantages and technological superiority. 12 .
A natural monopoly suffers from the same inefficiencies as any other monopoly. potential competitors are excluded from 13 . it is always cheaper for one large company to supply the market than multiple smaller companies. An early market entrant that takes advantage of the cost structure and can expand rapidly can exclude smaller companies from entering and can drive or buy out other companies. in fact. and force. Fragmenting such monopolies is by definition inefficient. absent government intervention in such markets. Government-granted monopoly A government-granted monopoly is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or company to be the sole provider of a commodity. Intellectual property rights. A natural monopoly occurs where the average cost of production "declines throughout the relevant range of product demand". Regulation of natural monopolies is problematic. Types of monopolies I. lobbying governmental authorities. including patents and copyrights. Legal barriers: Legal rights can provide opportunity to monopolise the market of a good. The most frequently used methods dealing with natural monopolies are government regulations and public ownership. give a monopolist exclusive control of the production and selling of certain goods. The relevant range of product demand is where the average cost curve is below the demand curve. Deliberate actions: A company wanting to monopolise a market may engage in various types of deliberate action to exclude competitors or eliminate competition. II. When this situation occurs. will naturally evolve into a monopoly. Natural monopoly A natural monopoly is a company that experiences increasing returns to scale over the relevant range of output and relatively high fixed costs. Such actions include collusion.
where the buyer (the United States Navy) is the only one demanding the product. A peculiar one exists in the market for nuclear-powered aircraft carriers in the United States. consent must be obtained from more than one agent in order to obtain the good. IV. if the two agents do not cooperate. one good is still of value even if the other good is not obtained. Complementary goods are a less extreme form of this effect. Bilateral monopoly In a bilateral monopoly there is both a monopoly (a single seller) and monopsony (a single buyer) in the same market. III. The solution is for one agent to purchase all sections of the road. Complementary monopoly In a complementary monopoly. regulation. An example of a bilateral monopoly would be when a labor union (a monopolist in the supply of labor) faces a single large employer in a factory town (a monopsonist). or other mechanisms of government enforcement. In this case. This can be seen in private toll roads where more than one operator controls a different section of the road. overhaul. This leads to a reduction in surplus generated relative to an outright monopoly. Because the monopolist ultimately forgoes transactions with consumers who value the product or service more than its cost. market price and output will be determined by forces like bargaining power of both buyer and seller. In such. Monopoly and efficiency According to the standard model. or decommission. and there is only one seller (Huntington Ingalls Industries) by stipulation of the regulations promulgated by the buyer's parent organization (the United States Department of Defense. the monopolist will sell a lesser quantity of goods at a higher price than would companies by perfect competition. in which a monopolist sets a single price for all consumers. which has thus far not licensed any other firm to manufacture. monopoly pricing creates a deadweight loss referring to potential gains 14 .the market by law.
that went neither to the monopolist nor to consumers. the monopoly setting is less efficient than perfect competition. becoming "complacent". aircraft manufacturer holding company forced to divest itself of airlines in 1934. or provide incentive for research and investment into new alternatives. in 2001.S. created as a legal trading monopoly in 1600. U. a legal monopoly in China formed in 758. Standard Oil. the combined surplus (or wealth) for the monopolist and consumers is necessarily less than the total surplus obtained by consumers by perfect competition. fined 493 million euros by the European Commission in 2004 which was upheld for the most 15 . because they do not have to be efficient or innovative to compete in the marketplace. settled anti-trust litigation in the U. Given the presence of this deadweight loss.S. The British Honourable East India Company. anti-trust prosecution failed in 1911. American Telephone & Telegraph. Western Union was criticized as a "price gouging" monopoly in the late 19th century. Netherlands East India Company. It is often argued that monopolies tend to become less efficient and less innovative over time. created as a legal trading monopoly in 1602. telecommunications giant broken up in 1984. Sometimes this very loss of psychological efficiency can increase a potential competitor's value enough to overcome market entry barriers. Where efficiency is defined by the total gains from trade. two of its surviving "child" companies are ExxonMobil and the Chevron Corporation. United Aircraft and Transport Corporation. Microsoft. Steel. Examples of monopolies Global The salt commission. broken up in 1911.
The fine was 1. 2002. Pursuant to the recommendations of this committee. This Act provides for different notifications for making different provisions of the Act effective. Operation of bus transportation within many cities. The Government had appointed a committee in October 1999 to examine the existing MRTP Act for shifting the focus of the law from curbing monopolies to promoting competition and to suggest a modern competition law. 1969 is the first enactment to deal with competition issues and came into effect on 1st June 1970. They can benefit from economies of scale. Land line telephone service in most of the country is provided only by the government run BSNL Laws in India against monopoly India has been very conscious about the competition in the market place and has been vigilant to frame laws curtailing monopolies and restrictive trade practices The Monopolies & Restrictive Trade Practices Act. Indian Indian Railways has monopoly in Railroad transportation State Electricity board have monopoly over generation and distribution of electricity in many of the states. was enacted on 13th January 2003. ADVANTAGES OF MONOPOLIES Monopolies can be defended on the following grounds: I. Hindustan Aeronautics Limited has monopoly over production of aircraft. and may be ‘natural’ monopolies.35 Billion USD in 2008 for noncompliance with the 2004 rule. the Competition Act. protect the interests of the consumers and ensure freedom of trade. The objectives of the Competition Act are to prevent anti-competitive practices.part by the Court of First Instance of the European Communities in 2007. so it may be argued that it is best for them to remain monopolies to avoid the 16 . There is Government monopoly over production of nuclear power. promote and sustain competition.
The result is lower price and higher output in the long run. Reducing consumer surplus and economic welfare. earning a country valuable export revenues. VI. VIII. IV. otherwise. II. 17 .wasteful duplication of infrastructure that would happen if new firms were encouraged to build their own infrastructure. costs are reduced via process innovation. High profit levels boost investment in R&D. DISADVANTAGES OF MONOPOLY TO THE CONSUMER Monopolies can be criticised because of their potential negative effects on the consumer. that is. It has been consistently argued by some economists that monopoly power is required to generate dynamic efficiency. If some of the profits are invested in new technology. Charging a higher price than in a more competitive market. VII. II. Restricting output onto the market. technological progressiveness. Innovation is more likely with large enterprises and this innovation can lead to lower costs than in competitive markets. Domestic monopolies can become dominant in their own territory and then penetrate overseas markets. A firm needs a dominant position to bear the risks associated with innovation. V. III. Firms need to be able to protect their intellectual property by establishing barriers to entry. including: I. III. there will be a free rider problem. Reducing consumer sovereignty. This is because: IV. Restricting choice for consumers. V. This is certainly the case with Microsoft.
Product differentiation: There is zero product differentiation in a perfectly competitive market. There are distinctions. Every product is perfectly homogeneous and a perfect substitute for any other. PC markets have free entry and exit. The barriers must be strong enough to prevent or discourage any potential competitor from entering the market. however. Both monopolies and perfectly competitive companies minimize cost and maximize profit. Both are assumed to have perfectly competitive factors markets. Excess Profits: Excess or positive profits are profit more than the normal expected return on investment. Monopolies have relatively high barriers to entry. some of the more important of which are as follows: Marginal revenue and price: In a perfectly competitive market. The shutdown decisions are the same. price is set above marginal cost. Number of competitors: PC markets are populated by an infinite number of buyers and sellers. Barriers to Entry: Barriers to entry are factors and circumstances that prevent entry into market by would-be competitors and limit new companies from operating and expanding within the market. In a monopolistic market. There are no barriers to entry.MONOPOLY VERSUS COMPETITIVE MARKETS While monopoly and perfect competition mark the extremes of market structures there is some similarity. Monopoly involves a single seller. With a monopoly. A customer either buys from the monopolizing entity on its terms or does without. price equals marginal cost. The cost functions are the same. exit or competition. which can enter the market 18 . there is great to absolute product differentiation in the sense that there is no available substitute for a monopolized good. A PC company can make excess profits in the short term but excess profits attract competitors. The monopolist is the sole supplier of the good in question.
freely and decrease prices. the optimum price at which to sell products or services. Game theory may be applied in situations in which decision makers must take into account the reasoning of other decision makers.which economists seek to model through the use of game theory. a large % of the market is taken up by the leading firms). for example. A monopoly can preserve excess profits because barriers to entry prevent competitors from entering the market.e. the best site for a manufacturing plant. In a monopolistic market no such supply relationship exists. Firms within an oligopoly produce branded products (advertising and marketing is an important feature of competition within such markets) and there are also barriers to entry. to determine the formation of political coalitions or business conglomerates. OLIGOPOLY An oligopoly is a market dominated by a few large suppliers. A monopolist cannot trace a short term supply curve because for a given price there is not a unique quantity supplied. Economics is much like a game in which the players anticipate one another's moves. Another important characteristic of an oligopoly is interdependence between firms. It has been used. 19 . The degree of market concentration is very high (i.2. This means that each firm must take into account the likely reactions of other firms in the market when making pricing and investment decisions. eventually reducing excess profits to zero. Supply Curve: in a perfectly competitive market there is a well-defined supply function with a one to one relationship between price and quantity supplied. This creates uncertainty in such markets . and even the behaviour of certain species in the struggle for survival. 3.
access to expensive and complex technology. Entry and exit: Barriers to entry are high. and strategic actions by incumbent firms designed to discourage or destroy nascent firms. CHARACTERISTICS Profit maximization conditions: An oligopoly maximizes profits by producing where marginal revenue equals marginal costs.The on-going interdependence between businesses can lead to implicit and explicit collusion between the major firms in the market. The most important barriers are economies of scale. Long run profits: Oligopolies can retain long run abnormal profits. Product differentiation: differentiated (automobiles). Each firm is so large that its actions affect market conditions. Collusion occurs when businesses agree to act as if they were in a monopoly position. patents. Ability to set price: Oligopolies are price setters rather than price takers. Buyers have only imperfect knowledge as to price. Interdependence: The distinctive feature of an oligopoly is Product may be homogeneous (steel) or interdependence. Therefore the 20 . High barriers of entry prevent side-line firms from entering market to capture excess profits. cost and product quality. Additional sources of barriers to entry often result from government regulation favouring existing firms making it difficult for new firms to enter the market. Number of firms: "Few" – a "handful" of sellers. There are so few firms that the actions of one firm can influence the actions of the other firms. Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Oligopolies are typically composed of a few large firms. Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of various economic factors can be generally described as selective.
there are no competitors to be concerned about. The variety and complexity of the models is because you can have two to 10 firms competing on the basis of price. 21 . For example. Non-Price Competition: Oligopolies tend to compete on terms other than price. This high degree of interdependence and need to be aware of what other firms are doing or might do is to be contrasted with lack of interdependence in other market structures. and product differentiation are all examples of non-price competition. All firms in a PC market are price takers. there are a series of simplified models that attempt to describe market behaviour under certain circumstances. it may want to know whether other firms will also increase prices or hold existing prices constant. marketing. Some of the better-known models are the dominant firm model. technological innovations. This means that in contemplating a market action. Loyalty schemes. In a monopoly. each firm's effects on market conditions are so negligible as to be safely ignored by competitors. quantity. a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves. MODELING There is no single model describing the operation of an oligopolistic market. In a monopolistically-competitive market. Fortunately. Or if the firm is considering a price increase. an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous price war. the Cournot-Nash model. the Bertrand model and the kinked demand model. In a perfectly competitive (PC) market there is zero interdependence because no firm is large enough to affect market price. It is very much like a game of chess or pool in which a player must anticipate a whole sequence of moves and countermoves in determining how to achieve his or her objectives.competing firms will be aware of a firm's market actions and will respond appropriately. as current market selling price can be followed predictably to maximize short-term profits. advertisement. advertising and reputation.
Key Features of Oligopoly A few firms selling similar product Each firm produces branded products Likely to be significant entry barriers into the market in the long run which allows firms to make supernormal profits. Businesses have to take into account likely reactions of rivals to any change in price and output THEORIES ABOUT OLIGOPOLY PRICING There are four major theories about oligopoly pricing: I. Oligopoly firms collaborate to charge the monopoly price and get monopoly profits II. Non-price competition focuses on other strategies for increasing market share. Oligopoly prices and profits are "indeterminate" because of the difficulties in modelling interdependent price and output decisions IMPORTANCE OF PRICE AND NON-PRICE COMPETITION Firms compete for market share and the demand from consumers in lots of ways. Consider the example of the highly competitive UK supermarket industry where non-price competition has become very important in the battle for sales Mass media advertising and marketing Store Loyalty cards 22 . Oligopoly firms compete on price so that price and profits will be the same as a competitive industry III. Interdependence between competing firms. We make an important distinction between price competition and non-price competition. Oligopoly price and profits will be between the monopoly and competitive ends of the scale IV. Price competition can involve discounting the price of a product (or a range of products) to increase demand.
Monopoly is defined by the dominance of just one seller in the market. oligopoly is an economic situation where a number of sellers populate the market. Banking and other Financial Services (including travel insurance) In-store chemists / post offices / crèches Home delivery systems Discounted petrol at hyper-markets Extension of opening hours (24 hour shopping in many stores) Innovative use of technology for shoppers including self-scanning machines Financial incentives to shop at off-peak times Internet shopping for customers PRICE LEADERSHIP IN OLIGOPOLISTIC MARKETS When one firm has a dominant position in the market the oligopoly may experience price leadership. COMPARISON BETWEEN MONOPOLY AND OLIGOPOLY Monopoly and oligopoly are economic market conditions. 23 . We see examples of this with the major mortgage lenders and petrol retailers. The firms with lower market shares may simply follow the pricing changes prompted by the dominant firms.
either due to technology. Long Island Rail Road etc. book publishing. productivity suites). A monopoly usually exists when Barriers to entry barriers to entry are very high . Google (web Examples search. Moderate/fair pricing due to competition Meaning A single firm controls a large market Characteristics share in the industry. few firms in the industry. beer (Anheuser-Busch and MillerCoors). 24 . media (TV broadcasting. Health insurers. But much higher than perfect competition(where there is a large number of buyers and sellers) Market making ability because of very Sources of Power Market making ability by virtue of being virtually the only viable seller in the industry.COMPARISON CHART Domains Monopoly An economic market condition where one seller dominates the entire market.DeBeers (diamonds) . wireless carriers. search advertising). Barriers to entry are very high as it is difficult to enter the industry because of economies of scale. patents. Microsoft (Operating systems. A small number of firms dominate the industry. Monsanto (seeds). government regulation or capital-intensive nature of the industry. thereby gaining the ability to set price. distribution overheads. price. customer service etc. movies) etc. These firms compete with each other based on product differentiation. Each firm can therefore significantly influence the market by setting price or production quantity. Oligopoly An economic market condition where numerous sellers have their presence in one single market. Prices High prices may be charged since there is no competition in market.
take-overs and acquisitions. A decision taken by one seller in an oligopolistic market has a direct effect on the functioning of other sellers. lobbying governmental authorities etc. Oligopoly markets on the other hand. The seller here has the power to influence market prices and decisions. Though an oligopolistic market does not have any sources of power. Competition in turn ensures moderate prices and numerous choices for consumers. legal and deliberate. is a market condition where numerous sellers coexist in the market place. ensure competitive hence fair prices for the consumer. A monopolistic entity will use the position it is in to its advantage and drive out competitors either by reducing prices to such an extent that survival for another seller may become impossible or by virtue of economic conditions like large capital requirement for start-up companies. Since there is no other competitor to fear from. This market condition usually arises from mergers. Deliberate attempts for monopolistic markets would include collusion. This market situation is very consumer-friendly because it induces competition amongst sellers. The monopolist asserts all the power while the consumer is left with no choice.CHARACTERISTICS Monopolistic markets are controlled by one seller only. on the other hand. the sellers will use their status of dominance and maximize their profits. Oligopoly. Prices A monopolistic market may quote high prices. SOURCES OF POWER A monopolistic market derives its power through three sources: economic. 25 . Consumers have limited choices and have to choose from what is supplied. Legal barriers like intellectual property rights also help a monopolistic entity retain its power. it comes into existence solely due to the accommodating nature of other sellers.
Perfect competition theory. there are few if any perfectly competitive markets. Simon & Schuster and Holtzbrinck Four breakfast cereal manufacturers . Still. General Mills. Because the conditions for perfect competition are strict.Random House.Examples Four music companies control 80% of the market . Pearson. each of whom has little or no control over the market price . Sony Music Entertainment. unless subject to some form of direct regulation by the government. Warner Music Group and EMI Group Six major book publishers . Perfect competition serves as a benchmark against which we can measure real-life and imperfectly competitive markets. The spectrum of competition ranges from highly competitive markets where there are many sellers. Post and Quaker Two major producers in the beer industry . buyers and sellers in some auction-type markets say for commodities or some financial assets may approximate the concept.3. In many sectors of the economy markets are best described by the term oligopoly where a few producers dominate the majority of the market and the industry is 26 . The degree to which a market or industry can be described as competitive depends in part on how many suppliers are seeking the demand of consumers and the ease with which new businesses can enter and exit a particular market in the long run.Universal Music Group. HarperCollins.Kellogg.Anthem and Kaiser Permanente 3.to a situation of pure monopoly where a market or an industry is dominated by one single supplier who enjoys considerable discretion in setting prices. Hachette.Anheuser-Busch and MillerCoors Two major providers in the healthcare insurance market . perfect competition (sometimes called pure In economic competition) describes markets such that no participants are large enough to have the market to set the price of a homogeneous product.
quality and production methods of products. 27 . as well as what rights are conferred on the buyer.The qualities and characteristics of a market good or service do not vary between different suppliers. Zero transaction costs . Homogenous products .All consumers and producers are assumed to have perfect knowledge of price. Non-increasing returns to scale . and infinite producers with the willingness and ability to supply the product at a certain price.Buyers and sellers do not incur costs in making an exchange of goods in a perfectly competitive market. utility.Firms are assumed to sell where marginal costs meet marginal revenue. Specific characteristics may include: Infinite buyers and sellers – An infinite number of consumers with the willingness and ability to buy the product at a certain price.The lack of increasing returns to scale (or economies of scale) ensures that there will always be a sufficient number of firms in the industry.Well defined property rights determine what may be sold. BASIC STRUCTURAL CHARACTERISTICS Generally. Profit maximization . In a duopoly two firms dominate the market although there may be many smaller players in the industry. Property rights .highly concentrated. where the most profit is generated. Zero entry and exit barriers – A lack of entry and exit barriers makes it extremely easy to enter or exit a perfectly competitive market. a perfectly competitive market exists when every participant is a "price taker". Perfect factor mobility – In the long run factors of production are perfectly mobile. and no participant influences the price of the product it buys or sells. allowing free long term adjustments to changing market conditions. Perfect information .
as output will always occur where marginal cost is equal to marginal revenue (MC=MR). An identical output produced by each firm – in other words. In the long run. other factor inputs) and 28 . In perfect competition. Many suppliers each with an insignificant share of the market – this means that each firm is too small relative to the overall market to affect price via a change in its own supply – each individual firm is assumed to be a price taker. very specific conditions such as that of monopolistic competition. any profit-maximizing producer faces a market price equal to its marginal cost (P=MC). It allows for derivation of the supply curve on which the neoclassical approach is based. perfectly competitive markets are both allocatively and productively efficient. This implies that a factor's price equals the factor's marginal revenue product. there will be a large substitution effect away from this firm IV. II. All firms (industry participants and new entrants) are assumed to have equal access to resources (technology. The abandonment of price taking creates considerable difficulties for the demonstration of a general equilibrium except under other. Consumers perceive the products to be identical III. perfectly-competitive markets are not productively efficient as output will not occur where marginal cost is equal to average cost (MC=AC). They are allocatively efficient. Consumers have perfect information about the prices all sellers in the market charge – so if some firms decide to charge a price higher than the ruling market price. ASSUMPTIONS BEHIND A PERFECTLY COMPETITIVE MARKET I. This is also the reason why "a monopoly does not have a supply curve".In the short run. the market supplies homogeneous or standardised products that are perfect substitutes for each other.
The long run equilibrium for a perfectly competitive market occurs when the marginal firm makes normal profit only in the long term VI. There are assumed to be no barriers to entry & exit of firms in long run – which means that the market is open to competition from new suppliers – this affects the long run profits made by each firm in the industry. price P1 is the market-clearing price and this price is then taken by each of the firms.improvements in production technologies achieved by one firm can spillover to all the other suppliers in the market V. Because the market price is constant for each unit sold. No externalities in production and consumption so that there is no divergence between private and social costs and benefits SHORT RUN PRICE AND OUTPUT FOR THE COMPETITIVE INDUSTRY AND FIRM In the short run the equilibrium market price is determined by the interaction between market demand and market supply. A firm maximises profits when 29 . In the diagram shown above. the AR curve also becomes the Marginal Revenue curve (MR).
This causes an increase in market price and quantity traded. At the profit maximising level of output. the profit-maximising output is Q1. In the diagram below. Higher prices cause an expansion along the supply curve. the firm is making an economic loss (or sub-normal profits) EFFECTS OF CHANGE IN MARKET DEMAND In the diagram below there has been an increase in market demand (ceteris paribus). Some firms may be experiencing subnormal profits because their average total costs exceed the current market price.e. An inward shift in market demand would have the 30 . The area shaded is the economic (supernormal profit) made in the short run because the ruling market price P1 is greater than average total cost.marginal revenue = marginal cost. The firm's average revenue curve shifts up to AR2 (=MR2) and the profit maximising output expands to Q2. Other firms may be making normal profits where total revenue equals total cost (i. they are at the break-even output). total profits have increased. Not all firms make supernormal profits in the short run. Their profits depend on the position of their short run cost curves. the firm shown has high short run costs such that the ruling market price is below the average total cost curve. Following the increase in demand. The firm sells Q1 at price P1. In the diagram above. Notice that the MC curve is the firm's supply curve.
Think also about the effect of a change in market supply . This is shown in the diagram below. 31 . LONG RUN ADJUSTMENT PROCESS If most firms are making abnormal profits in the short run there will be an expansion of the output of existing firms and we expect to see the entry of new firms into the industry. The addition of new suppliers causes an outward shift in the market supply curve. Firms are responding to the profit motive and supernormal profits act as a signal for a reallocation of resources within the market.opposite effect.perhaps arising from a cost-reducing technological innovation available to all firms in a competitive market.
At the profit-maximising output level Q3 only normal profits are being made. At this point each firm is making normal profits only. higher market supply will reduce the equilibrium market price until the price = long run average cost. Thus a long-run equilibrium is established. price is equal to marginal cost (P=MC) and therefore allocate efficiency is achieved – the price that consumers are paying 32 .Making the assumption that the market demand curve remains unchanged. There is no further incentive for movement of firms in and out of the industry and a long-run equilibrium has been established. Does perfect competition lead to economic efficiency? Perfect competition is used as a yardstick to compare with other market structures (such a monopoly and oligopoly) because it displays high levels of economic efficiency. There is no incentive for firms to enter or leave the industry. The entry of new firms shifts the market supply curve to MS2 and drives down the market price to P2. In both the short and long run.
product characteristics. There is of course another form of economic efficiency – dynamic efficiency – which relates to aspects of market competition such as the rate of innovation in a market. the ease with which firms may enter and exit the market. and production techniques. The long run of perfect competition. they take into account the structure of the market in which the firm is operating. firms should be able to enter and exit the market easily. exhibits optimal levels of static economic efficiency. none of which is large in terms of its sales. First. and the amount of information available to both buyers and sellers regarding prices. Second. all firms and consumers in the market have complete information about prices. product quality. Price-taking behaviour:-A firm that is operating in a perfectly competitive market will be a price-taker. A price-taker cannot control the price of the good it sells. and production techniques.in the market reflects the factor cost of resources used up in producing / providing the good or service. Third. Productive efficiency occurs when price is equal to average cost at its minimum point. it 33 . This is not achieved in the short run – firms can be operating at any point on their short run average total cost curve. each firm in the market produces and sells a nondifferentiated or homogeneous product. therefore. but productive efficiency is attained in the long run because the profit maximising output is achieved at a level where average (and marginal) revenue is tangential to the average total cost curve. the quality of output provided over time. Fourth. Four characteristics or conditions must be present for a perfectly competitive market structure to exist. The structure of the market is determined by four different market characteristics: the number and size of the firms in the market. the degree to which firms' products are differentiated. CONDITIONS FOR PERFECT COMPETITION When economists analyse the production decisions of a firm. there must be many firms in the market.
34 . homogeneous product.g. since consumers will just go to another bookie. When placing bets. a stock exchange resembles this. and so no one bookie can offer worse odds than those being offered by the market as a whole. Furthermore. such as a license and the capital required setting up. there are many firms and each firm is small in size. and some barriers to entry exist. When there are many firms. investment banks) may solely influence the market price. violates the condition that "no one seller can influence market price". with the only differences between individual bets being the pay-off and the horse. of course. This. Because each firm in the market sells the same. This makes the bookies pricetakers.simply takes the market price as given. a number of approximations exist: Perhaps the closest thing to a perfectly competitive market would be a large auction of identical goods with all potential buyers and sellers present. It is also impossible for a single firm to affect the market price by changing the quantity of output it supplies because. The conditions that cause a market to be perfectly competitive also cause the firms in that market to be price-takers. competition forces each firm to charge the same market price for its good. Of course. all producing and selling the same product using the same inputs and technology. The flaw in considering the stock exchange as an example of Perfect Competition is the fact that large institutional investors (e. there are not an infinite amount of bookies. Horse betting is also quite a close approximation. no single firm can increase the price that it charges above the price charged by the other firms in the market without losing business. EXAMPLES Though there is no actual perfectly competitive market in the real world. consumers can just look down the line to see who is offering the best odds. the product on offer is very homogeneous. by assumption. not as a complete description (for no markets may satisfy all requirements of the model) but as an approximation. By design.
Free software works along lines that approximate perfect competition as well. in addition to consumers/sellers possessing perfect information of the product in question. A firm will receive only normal profit in the long run at the equilibrium 35 . It is often the case that street vendors may serve a homogenous product. In the long run. both demand and supply of a product will affect the equilibrium in perfect competition. In the short run. This is so since relatively few barriers to entry/exit exist for street vendors. All code is freely accessible and modifiable. equilibrium will be affected by demand. there are often numerous buyers and sellers of a given street food. Free software may be bought or sold at whatever price that the market may allow. Furthermore. EQUILIBRIUM IN PERFECT COMPETITION Equilibrium in perfect competition is the point where market demands will be equal to market supply. A firm's price will be determined at this point. and individuals are free to behave independently. Some believe that one of the prime examples of a perfectly competitive market anywhere in the world is street food in developing countries. in which little to no variations in the product's nature exist. Anyone is free to enter and leave the market at no cost.
Secrets of this kind. can seldom be long kept. Market economies are assumed to have many buyers and sellers. it must be acknowledged. keep up the market price. however. in many commodities. When by an increase in the effectual demand. a good deal above the natural price.4. Perfect competition represents an economy with many businesses competing with one another for consumer interest and profits. and perhaps for some time even below it. may. the market price of some particular commodity happens to rise a good deal above the natural price. and the extraordinary profit can last very little longer than they are kept. yet sometimes particular accidents. the effectual demand being fully supplied. towards the natural price. and may so long enjoy their extraordinary profits without any new rivals. CONCLUSION The market price of every particular commodity is continually gravitating. sometimes natural causes. If the market is at a great distance from the residence of those who supply it. those who employ their stocks in supplying that market are generally careful to conceal this change. and sometimes particular regulations of police. If it was commonly known. they may sometimes be able to keep the secret for several years together. their great profit would tempt so many new rivals to employ their stocks in the same way that. Oligopolies are industries with a few interdependent companies. high competition and many substitutes. the market price would soon be reduced to the natural price. 36 . for a long time together. Monopolies characterize industries in which the supplier determines prices and high barriers prevent any competitors from entering the market.
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