19O306 – ECONOMICS FOR ENGINEERS DR K.P.

RADHIKA
▪ To define the concept of market and classify them.

▪ To explain the features of the various market structures.

▪ To examine the price, output and profit determination

under various market structures.

▪ To compare the different types of market structures.

▪ A market is an arrangement that facilitates buying and selling of goods and

services.

▪ Market structure refers to the number and distribution size of buyers and

sellers in the market for particular goods and services.

▪ It helps in understanding the characteristics of the buyers and sellers.

▪ It also explains the power of a firm in determining price and outputs.

1. Sellers (Producer)
2. Buyers (Customers)
3. Nature of product (Types of Product)
4. Conditions of entry and exit
5. Negotiation (Price)
6. Transfer of Ownership and Product
7. Transfer of Money or Equal Value
▪ Markets are classified based on their components as a criterion.

▪ This helps distinguish the market structures to better understand its functioning.

▪ The fundamental criterion used to classify market structures are

▪ Degree of competition (seller and buyer)

▪ Nature of competition ( number of firms)

▪ Product characteristics

▪ Individual seller’s control over supply and price of the products and services.
The less the power an individual firm has to influence
the market in which it operates, the more competitive
that market is.
▪ A market structure where there is infinite number of buyers and sellers with freedom of entry and

exit of firms is called perfect competition.

▪ FEATURES OF PERFECT COMPETITION

▪ Large number of buyers and sellers

▪ Seller is the price taker.

▪ Non-price competition (gifts, discounts, advertising)

▪ Perfect mobility of factors of production.

▪ There is absence of transport costs (sellers are close to each other)

▪ Homogenous or Identical products are being sold.

▪ There is no restriction on entry and exit of firms. (no government interference)

▪ There is perfect knowledge of the market.

▪ Firms are price takers. They cannot influence the market price as it is determined by the
industry.

▪ PRICE : In the short run therefore the market price which is the short run equilibrium price of
the industry is taken by the firms.

▪ REVENUE: A firm earns revenue by selling the good that it produces in the market.

▪ The average revenue ( AR ) of a firm is defined as total revenue per unit of output.

▪ Recall that if a firm’s output is q and the market price is p, then TR equals p × q.

▪ Hence AR = TR/ Q = (P*Q)/Q = P

▪ In other words, for a price-taking firm, average revenue equals the market price.
▪ The profit maximization rule under perfect competition is
▪ MR = MC

▪ Given this equilibrium, a firm in perfect competition will possibly enjoy three types of profits
▪ SUPER NORMAL PROFIT (economic profits) :
▪ a firm earns super normal profit when the total revenue is greater than the total cost or when
price is greater than the average total cost.
▪ AC < AR or MR

▪ NORMAL PROFIT (breakeven profit):

▪ normal profits occur when the total revenue equals total cost, where no profit or no loss in
incurred.
▪ This is the profit necessary for a firm to stay in business.
▪ AC = AR or MR

▪ SUBNORMAL PROFT (economic losses) :

▪ This situation occurs when the price is lower than the average total cost.
▪ AC > AR or MR
 SUPER NORMAL PROFIT
MR=MC MC
Price, Revenue and Cost

AC

R
MR= AR
P profit • The firm is in
equilibrium at point
S R.
• The price charged is
P.
• The firm earns super
normal profits shown
Q in the area PRSX,
N
0 since AR exceeds AC
Output

Firm earning super normal profits

 NORMAL PROFIT
MC
Price, Revenue and Cost

AC

E
MR= AR
P • The firm is in
equilibrium at point
R.
• The price charged is
P.
• The firm earns
normal profits as AR
Q = AC.
N
0
Output

Firm earning normal profits

 SUB-NORMAL PROFIT MC
AC
Y • The firm is in equilibrium
at point R.
• The price charged is P.
• The firm incurs economic
Price, Revenue and

Economic Loss loss as shown in the area

R PQRT, since AR is less
P MR= AR
than AC
• When a firm incurs loss it
can continue or shut down.
• When the price is less than
the AVC, the firm will stop
its production. This is
Cost

called Shut down point.

X
N
0
Output

Firms with sub-normal profit

▪ In the long run the firms have time to make changes in the production process.

▪ All inputs are variable in the long run. The equilibrium of firms in the industry will be when

the long run MC = long run MR. (MR=MC rule)

▪ Firms in perfect competition will only earn normal profits in the long run due to the

feature of free entry and exit.

▪ ENTRY AND EXIT INFLUENCE

▪ The influx of firms will cause increase in market supply, leading to reduction in price and

hence individual firms will only earn normal profits.

▪ The exit of firms will cause a decrease in market supply, which will raise the prices, thereby

leading individual firms to again earn only normal profits.

 Price, profit and output under perfect competition in Long Run

LMC
COST

LAC

E
P P=AR= MR

O
FIRM OUTPUT Q
▪ Perfect knowledge among buyers and sellers and hence firms cannot act like a monopolist.

▪ There is no need for advertising because of perfect knowledge and selling of unbranded goods.

▪ There is possibility for consumer surplus.

▪ Consumers have adequate choice due to large number of sellers.

▪ CONCLUSION

▪ Very few markets or industries in the real world are perfectly competitive.

▪ Commodity markets, such as coffee and tea, exhibit many of the characteristics of perfect competition,
such as the number of individual producers that exist, and their inability to influence market price.

▪ For other markets in manufacturing and services, the model is a useful yardstick by which economists
and regulators can evaluate levels of competition that exist in real markets.
• Existence of a single seller in the market producing a product that has no substitutes is
termed as monopoly market structure.
• The single firm producing the product is itself both the firm and the industry.
• Examples ????????????????
• FEATURES OF MONOPOLY
• One seller and large number of buyers.
• Product has no close substitutes.
• The seller is the price maker with power to control the price in the market.
• Strict barriers to entry of new firms.
• Advertisement depends on nature of product (luxury – requires advertising, whereas
public utilities like water, electricity do not require)
• Imperfect knowledge of the market is prevalent.
• Demand is less elastic in nature.
BARRIERS TO ENTRY AND TYPES OF MONOPOLY

▪ Control over raw material (DeBeers in South Africa – 80% of raw diamonds)

▪ Patent and copyright (owner has monopoly over the particular product)

▪ Cost of establishing an efficient plant ( public utilities by government)

▪ Government franchises (government gives exclusive rights to firm (irctc)

▪ TYPES OF MONOPOLIES FORMED

▪ Natural/ Geographical Monopoly : Jute, Diamonds, Microsoft

▪ Technological monopoly

▪ Legal Monopoly : Railways, BSNL until Privatisation, Coal India, Hindustan Aeronauticals

▪ Coercive Monopoly : legal and illegal (private organizations and crony capitalism)
▪ The firm’s demand curve represents the industry demand due to presence of one single seller.

▪ The demand curve in monopoly is a downward sloping curve as consumers respond to price changes.

▪ The monopolist therefore sets price based on the elasticity of demand during a particular time.

The seller is the price

maker in the monopoly.

The law of demand

operates and therefore
the AR and MR curves
are downward sloping
with MR below the AR
in the short run during
equilibrium.
▪ In the short-run, a monopolist has some of his inputs fixed and hence he tries to earn maximum profits or suffer minimum loss by

taking control of his average and marginal costs.

▪ Besides cost control, a firm under monopoly also practices the method of price discrimination as a strategy to maximize profits.

▪ Price discrimination refers to the charging of different prices to different buyers for the same good.

▪ The three degrees of price discrimination generally followed are:

▪ First degree price discrimination : different prices for each unit sold,

as in the case of auctions, bids. (highest bidder gets the product)

Criterion used is consumer’s purchasing power.
▪ Second degree price discrimination : the products are grouped into blocks

and each block is charged different price. Example : EB charges as per slab
parking for first few hours etc. Criterion used is quantity of purchase.
▪ Third degree price discrimination : Here the monopolist divides the markets

into sub-markets or sub-groups. Example: different groups of consumers

like adults, children charged different for a movie, transportation,
entertainment parks etc. Criterion used is age, sex, income, etc.

.
 SUPER NORMAL PROFIT
Y The profit maximization condition
in monopoly during short-run is
MC MR = MC rule.
In the figure E denotes the short-
run equilibrium with MR=MC.
Price, Revenue and

AC At the equilibrium with A as

Q
P output, if the AC curve lies below
the AR, or AC<AR, the firm
S R makes super normal profits.
The shaded portion PQRS
denotes the Super-normal profit
E zone of the monopolist.
AR
Cost

MR
X
o
Output
Firm earning super normal profits under Monopoly
 NORMAL PROFIT
Y The profit maximization condition
in monopoly during short-run is
MC MR = MC rule.
AC In the figure D denotes the short-
run equilibrium with MR=MC.
Price, Revenue and

At the equilibrium with A as

E
P output, if the AC = AR, the firm
makes normal profits.
In the figure AC=AR at point E.
The portion PE denotes the
Normal profit zone of the
D monopolist, also known as
AR
Cost

breakeven zone.
MR
X
o
Output
Firm earning Normal profits under Monopoly
 SUB-NORMAL PROFIT
SMC
Y SAC The profit maximization condition
in monopoly during short-run is
MR = MC rule.
In the figure E denotes the short-
R
S run equilibrium with MR=MC.
Price, Revenue and

Losses At the equilibrium with A as

Q output, if the AC > AR, the firm
P makes sub-normal profits or
economic loss.
In the figure SAC is above the AR
curve.
E The portion PQRS denotes the
AR
Cost

loss zone of the firm under

monopolist.
MR
X
o
Output

Firm incurring losses under Monopoly

 ▪ In the long run the firm can adjust its inputs

used in production.
Price, Revenue and Cost

Y ▪ The equilibrium point is where MR = MC.

▪ A firm under monopoly sets his plant size

LMC
such that he maximizes his profit. This is

LAC possible as he is a single seller dominating

P Q
the market and also the price maker.

S R ▪ Hence a seller in monopoly in the long will

earn super normal profits because the firm

E
has crossed all barriers to entry and is
AR
MR dominant in the industry.
o Output X
▪ Monopoly generally denotes absence of competition, which leads to higher prices always owing to the profit motive.

▪ Degree of monopoly power exerted varies across economies and organizations and this affects various consumption

and investment patterns. (telecommunication in India)

▪ Monopolies face diseconomies of scale in long-run and can cause spill over effect on the economy.

▪ Monopolies in many economies have been forcefully gaining political power, which is a term called (crony

capitalism). This leads to inequalities in the allocation of resources and society at large, widening the gap between
haves and have nots. There is a growing concern over the influence of Facebook, Google and Twitter because they
influence the diffusion of information in society.

▪ Environmental concerns also rise with monopoly in sectors like oil, telecommunications and certain natural resource

based industries.

▪ The best way out is the government needs to have regulations to control the firm in monopoly.
▪ Monopolistic market structure is one in which there are large number of small sellers.

▪ They sell close substitute products. Hence they are a combination of perfect and monopoly market

structure. Classic examples are : retail industry – books, paste, soaps, ice-creams, chocolates…

▪ FEATURES OF MONOPOLISTIC MARKET

❖ Large number of sellers who have small magnitude of business.

❖ No individual firm can influence price, but they follow independent price-output policy.

❖ Product differentiation is done through labelling, packaging, designing, brand names, advertising.

❖ Free entry and exit but imperfect knowledge of the market.

❖ Non price competition practices used are discounts, gifts, after sales services etc.

❖ Presence of high selling cost like advertising and these are included in cost of production.
▪ The demand curve is downward sloping due to the presence of product differentiation.

▪ Elasticity of demand is high as firms in industry produce close substitutes.

▪ As the demand curve is highly elastic and downward sloping, the AR and MR curves slope

downwards, with MR curve lying below the AR or demand curve, as shown in the figure
below:
 SUPER NORMAL PROFIT
Y The profit maximization condition
in monopolistic during short-run is
MC MR = MC rule.
In the figure E denotes the short-
run equilibrium with MR=MC.
Price, Revenue and

AC At the equilibrium with A as

Q
P output, if the AC curve lies below
the AR, or AC<AR, the firm
S R makes super normal profits.
The shaded portion PQRS
denotes the Super-normal profit
E zone of the monopolistic.
AR
Cost

MR
X
o
Output
Firm earning super normal profits under Monopolistic
 NORMAL PROFIT
Y The profit maximization condition
in monopolistic during short-run is
MC MR = MC rule.
AC In the figure D denotes the short-
run equilibrium with MR=MC.
Price, Revenue and

At the equilibrium with A as

E
P output, if the AC = AR, the firm
makes normal profits.
In the figure AC=AR at point E.
The portion PE denotes the
Normal profit zone of the
D monopolistic, also known as
AR
Cost

breakeven zone.
MR
X
o
Output
Firm earning Normal profits under Monopolistic
 SUB-NORMAL PROFIT
SMC
Y SAC The profit maximization condition
in monopolistic during short-run is
MR = MC rule.
In the figure E denotes the short-
R
S run equilibrium with MR=MC.
Price, Revenue and

Losses At the equilibrium with A as

Q output, if the AC > AR, the firm
P makes sub-normal profits or
economic loss.
In the figure SAC is above the AR
curve.
E The portion PQRS denotes the
AR
Cost

loss zone of the firm under

monopolistic market.
MR
X
o
Output

Firm incurring losses under Monopolistic

 Long run equilibrium of monopolistic market
In the long-run when more firms enter
Y because of boom, the supply will
LRMC increase causing existing firms to only
LRAC have normal profits. If the industry is in
recession, many firms exit causing the
Price, Revenue and

supply to reduce and thereby allowing

E only for normal profits for existing
P
firms.
In the figure D denotes the short-run
equilibrium with LRMR=LRMC.
At the equilibrium with A as output, if
D the LRAC = LRAR, the firm makes
LRAR normal profits.
Cost

In the figure LRAC=LRAR at point E.

LRMR The portion PE denotes the Normal
X
o profit zone of the monopolistic, also
known as breakeven zone.
Output
Firm earning only Normal profits under Monopolistic in long-run
▪ A few firms in the industry producing either identical or differentiated products in the
market form an oligopoly.
▪ Entry of new firms is very difficult in this type of market structure.
▪ Duopoly is a special form of oligopoly with presence of only two sellers in the market.
▪ Example: Visa and Master Card; Boeing and Airbus, Pepsi and Coco Cola

▪ Features of Oligopoly
▪ Few firms in number with large size operations.
▪ Homogenous or differentiated products.
▪ Mutual interdependence of rival firms in deciding price, sales and business strategies.
▪ Barriers to entry are tough with stringent rules for patents, copyrights, mergers, and policies.

▪ Examples : Accounting oligopoly (KPMG, PWC, Delloite, EY)

Give examples in these sectors along with their market share -
Airlines, Cement, Steel, oil, drugs, diamonds?
 Types of Oligopoly

Type of oligopoly Distinctive feature

Pure or perfect Oligopoly Produce homogenous products

steel, oil etc
Imperfect or differentiated Produce differentiated products
oligopoly Soft drinks, cars

Collusive and Non-collusive Firms cooperate on determining

oligopoly price and output in collusive or
cooperative oligopoly
(they form cartels-OPEC)
When firms compete with each
other they form non-collusive
oligopoly.
PRICE RIGIDITY AND KINKED DEMAND CURVE
▪ Price rigidity explains the behavior of a firm in oligopoly that has no incentive to
increase or decrease the price.
▪ Price rigidity is distinct in oligopoly because of the two assumptions
1. If an oligopolist reduces the price, his rivals will follow and reduce the price too, so
as to avoid losing customers.
2. If an oligopolist increases the price, his rivals will not increase, thereby gaining
customers from firms that increase their price.
▪ Because of the prevalence of price rigidity, each oligopolistic firm will face an
kinked demand curve. This was introduced by Professor Sweezy to explain
price rigidity.
▪ The demand is elastic above the “kink” where an increase in price will lead to
large drop in quantity demanded as consumers switch to rival firms.
▪ The demand is inelastic below the “kink” where decreasing price will only
reflect a small increase in quantity as other firms also decrease the price.
▪ The graph below explains this concept.
KINKED DEMAND CURVE OF OLIGOPOLY MARKET

Firms in an oligopoly do not

Elastic often change prices, certainly not
demand for minor changes in costs, but
they will change
prices if cost changes are
substantial.

InElastic
demand
 PRICE LEADERSHIP MODEL OF OLIGOPOLY
▪ A pricing strategy in oligopoly where firms in oligopoly follow the price set by the lead firm.
▪ Price leadership is a form of collusion, as there is no formal agreement.
▪ Two types of price leaderships that are formed are
▪ Dominant price leadership:
▪ the largest firms may dominate the overall industry.
▪ they can keep costs low and hence can forecast the market accurately.
▪ The dominant firm acts like a monopoly and sets its price to maximize profits.
▪ Other firms will follow this dominant firm.
▪ When products are homogenous, other firms are forced to adjust output and cost to equal
the price of the leader.
▪ Barometric Price Leadership
▪ One firm will initiate to first announce the price change.
▪ The firm need not be a dominating firm.
▪ Other firms follow the initiator firm.
▪ A cartel is an agreement or arrangement among firms in oligopoly to cooperate
with each other and act together as a monopoly.
▪ A cartel is a group of firms who limit the scope of competitiveness in the market.
▪ The firms want to eliminate uncertainty and improve profits, by stabilizing market
shares and prices.
▪ The world famous cartel is OPEC (??)
▪ Cartels have capability with unity to behave like monopoly and earn super normal
profits.
▪ The firms in cartel also divide the profits on the basis of individual level of
production.
▪ The essence of their success lies in developing a strong supply chain and a great
brand name, with adequate marketing tactics.
TO CONCLUDE
▪ An oligopoly may end up looking more like a monopoly or a competitive market,
depending on the number of firms.

▪ There is no certainty in how firms will compete in Oligopoly; it depends upon

▪ the objectives of the firms,

▪ the contestability of the market and

▪ the nature of the product.

▪ The pricing is done by proper agreement between the firms.

▪ The product differentiation may or may not present.

▪ The firms spend heavy on the advertising campaign and keep a close look at the
advertising of other companies and response accordingly.