Market Structures Prof.

Tarun Das, IILM, New Delhi

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Contents of this presentation
1. Different Market Structures 2. Perfect competition 3. Monopoly and Monopolistic competition 4. Market Power and Lerner Index 5. Structure-conduct-performance (SCP) approach

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• • • a) b) c) d)

1.1 Different market structures A market is an arrangement through which

buyers and sellers exchange their goods and services, anything of value. Market structure is a set of characteristics that determine business environment under which firms operate. Market structure is determined by: Number of sellers and buyers, Degree of product differentiation, Procedures for entry and exit of firms, Degree of contestability and rivalry of firms.

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1.2 Different market structures Markets Number of Number of
sellers buyers Many Perfect Many competition Monopoly Mono (single) Duopoly Duo (two) Oligopoly Oligo (a few) Monopolistic A few competition

Poly (many) Poly (many) Poly (many) A few

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• • • • • • • •

Many sellers and many buyers. Perfectly competitive firms are price-takers. They sell homogeneous/standardized product Perfect knowledge of buyers and sellers about the market. No restrictions on entry and exit of firms Price is determined by free market forces of supply and demand. Despite the term “competitive”, firms do not contest others and donot act as rivals. Perfect competition is an utopia- real market is neither perfect nor competitive.

2.1 Perfect CompetitionBasic characteristics

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2.2 Perfect CompetitionEquilibrium Conditions
1. Objective Function- Maximize Profits Π = Total Revenue – Total Cost = TR – TC= PQ – TC(Q) 2. First order condition, d Π /dQ= 0 ⇒ P-MC=0 ⇒ P=AR=MR=MC 3.The second order and sufficient condition: 2nd derivative should be negative i.e. d2 Π /dQ2 < 0, -d(MC)/dQ <0 implying d(MC)/dQ >0, i.e. MC must be rising, MC>ATC 4. Break even point:P=MR=ATC= AVC+AFC 5. Shut down point: P=MR=AVC

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2.3 Perfect Competitionequilibrium
200 COST (Rupees) 150 100 50 0 11 13 15 OUTPUT (Q) AVC ATC MC 17 1 3 5 7 9

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2.4 Perfect Competition- assignment-1
1. A firm with AVC = 10 - 0.03Q + 0.00005Q² and fixed cost Rs.600 operates in a perfectly competitive market, and faces a market price of Rs.10 per unit. (a) Find out the profit-maximizing output and the level of profit. (b) At what market price, will the firm break even? And At what market price, will it shut down? What are levels of loss at these points? Source: Ch-11, Q-11, p.465, Thomas and Morris. Answer: pp.726-727, Thomas and Morris.

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2. A firm with MC = 80 - 0.1Q + 0.0001Q² operates in a perfectly competitive market, and faces a market price of Rs.75 per unit. (a) Find out the profit-maximizing output, average cost and the level of profit. (b) At what other level of output, does MC equal market price? Is this output level optimal? If not, why? Source:Ch-11,Q-12, p.465, Thomas and Morris. Answer: p.727, Thomas and Morris.

2.5 Perfect Competition- assignment2

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3.1 Monopoly and Monopolistic Competition 1. Monopoly- Single Firm but many buyers. Unlike in the perfect competition, price is variable and is determined by the monopolist. Entry is restricted. Equilibrium condition MR = MC 2. Monopolistic Competition- existence of large number of small firms supplying differentiated products to many consumers. Entry and exit of firms, as in the case of perfect competition, is freeonly difference is the product differentiation. Equilibrium condition MR=MC for all
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1. A Monopoly Firm faces the following demand and average cost functions: Q = 2600 – 100P + 0.2 Y –500 Pr AVC = 20 – 0.07 Q + 0.0001Q² Where Q=output, P=Price of the product, Y=consumers income=Rs.20,000 Pr=Price of related good=Rs.2 AVC= Average variable cost. (a) Derive MR and MC functions. (b) Find out optimal level of production, price and profits. Source:Ch-12, Q-15 and Q-18,pp.512-513, Thomas and Maurice. Answer: pp.729
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3.2 Monopoly and Monopolistic Competition- Assignment

4.1 Market power and Lerner Index
1. Market power is the ability of the pricesetting firm to raise their prices without loosing their market share. 2. Lerner Index =(P-MC)/P = (P-MR)/P = [P-P(1+1/Ep)]/P = 1- (1+1/Ep)/P = -1/ Ep 3. Market power varies inversely with price elasticity of demand, and equals zero under perfect competition.

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4.2 Determinants of Market power

1. Strong barriers to entry due to government licensing, investment and franchise policies. 2. Existence of very large firms with economies of scale. 3. Input barriers 4. Loyalties to brand names/ trade marks 5. Consumers lock-in due to large switching cost caused by installation and other costs. 6. Network externalities
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5.1 Strategy-Conduct-Performance (SCP) Analysis - Market strategy of different markets Market No. of Entry Product firms Type Perfect Very competition large Monopoly Oligopoly One Few Free Standardized

Differentiated Impeded Both Differentiated

Blocked

Monopolisti Many Easy c Market Structures by Prof. Tarun Das competition

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5.2 Strategy-Conduct-Performance (SCP) Analysis – Conduct of different markets Market Price Product R&D and strategy strategy advertising Type Perfect None competition Indepen dent None

Monopoly Indepen Indepen dent dent Oligopoly Indepen Indepen dent dent Monopolisti Indepen Indepen Market Structures by Prof. Tarun Das c dent dent

Light Heavy Heavy
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5.3 Strategy-Conduct-Performance (SCP) Analysis – Performance of different markets Market Profit Technical Progreefficiency ssiveness Type Perfect Normal competition Monopoly Excessive Oligopoly Excessive Monopolisti Fair Good Good

Poor Poor Good

Poor Poor Fair
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5.4 Strategy-Conduct-Performance (SCP) Analysis – Performance and Equilibrium Conditions Market Equity and Equilibrium employmen conditions Type t Perfect competition Monopoly Oligopoly Monopolisti c competition Good MC=MR=P=AR

Poor Poor Fair

MC=MR=P(1-1/Ep) MC=MR for all MC=MR=P(1-1/Ep)
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Market Structures by Prof. Tarun Das

5.5 Critique of SCP Approach
1. The structure-conduct-performance (SCP) approach argues that behavior and therefore the performance of firms is determined by the industrial structure in which firms operate. But, SCP approach has been criticized by many economists: (a) Complex Relations- The causality from structure to conduct to performance is not uni-directional and is much more complex. (b) Contestable Markets- SCP emphasizes the role of price setting for making profits. But Baumol argues that profits actually depend on the degree of contestability i.e. the ease with which the firms can enter and exit.

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5.5 Critique of SCP Approach
© Chicago school (Milton Friedman)- There is no significant degree of monopoly power. In the long run, markets will bring competition in the absence of government intervention. (d) The Austrian school - Like Chicago school, it criticizes government intervention as it leads to non-optimal and inefficient allocation of resources. But it concludes that monopoly power is a reality and not a bad thing as it encourages cost-effectiveness and innovations and promotes growth. It says that SCP analysis is too static.

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5.6 Market Power and SCP Approach- Assignments
1. What is meant by market power? What are the factors influencing market power? Explain Lerner Index to measure market power. What is the value of Lerner Index for the perfectly competitive market? 2. Provide a structure-conduct-performance (SCP) analysis, in a tabular form, for perfect competition, monopoly, oligopoly and monopolistic competition. What are the criticisms by Baumol, Chicago school and Austrian school against the SCP analysis? Do you agree with their views?  

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Thank you Have a Good Day

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