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Dr. Gopalakrishna B.V., Faculty in MBA, SDM, Mangalore
Meaning of Market
• Market in general – mean particular place or locality where goods are sold and purchase. • In economics, the term market we do not mean any particular place/locality in which goods are bought and sold. • Buyers and sellers contact through personal contact, exchange of letters, telegrams, telephones and e-mail etc. • For example trade between America and India.
Meaning of Market……
In the words of Cournot – market not any particular market place in which things are bought and sold but the whole of any region in which buyers and sellers are in such free interact with one another. Thus, essential of market are – a) Commodity which is dealt with b) The existence of buyers and sellers c) A place, be it a certain region/country/world d) Price prevailing for the commodity.
Classification of Market Structure
Perfect competition and Imperfect competition 1. Perfect Competition market, where there is a large number of producers (firms) producing a homogeneous product, homogeneous price existence. 2. Imperfect competition It is an important market category where in individual firms exercise control over the price of commodity. Imperfect competition has several sub-markets
1) 2) 3) 4) Monopolistic competition Pure Oligopoly Differentiated Oligopoly Monopoly
Prof Chamberlin and Mrs. Joan Robinson were developed monopolistic competition in 1933. Chamberlin’s in his work “The Theory of Monopolistic Competition” and Mrs. Robinson “The Economic Imperfect Competition” in 1933. The firm produces differentiated product but some how close substitute each other. Sellers are numerous but not as much of perfectly competitive market. A wide range of consumer goods like toothpastes, soaps, cigarette, radio’s, TVs, Scoters, Commercial vehicle – large degree of product differentiation. This market condition characterized by mixture of perfect competitive and a certain degree of monopoly power.
Forms of Market Competition
Models of Competition Perfect competition Monopoly Number of buyers Very large Very large Number of sellers Very large One Large Very few Nature of products Identical products Single product Minimum differences Large differences Barriers to entry and exit None Very large None Large
Monopolistic Very large competition Oligopoly Very large
Perfect Competitive Market Features of perfect competitive market 1. Large number of buyers and sellers 2. Homogeneous product 3. Free entry and exist conditions 4. Perfect knowledge about market 5. Perfect mobility of factors of production 6. Absence of transport cost
1. Large Number of buyers and sellers
There will be a large number of buyers and sellers existed in the market. Any single producer or consumers influences demand and prices - drop of water put into sea like.. Individual firm is only a price taker and not price-maker.
2. Homogeneous Product
Commodities produced by all the firms is homogenous and identical in all respects. There is no changes in terms of quality, size, taste etc between the firms. No. one firms influences prices either increase/decrease in the market.
3. Free entry and exists There are no artificial restrictions either preventing the entry of new firms into market or compelling the existing firms to continue. The firms have full liberty to choose either to continue or go out of the industry. 4. Perfect knowledge on the part of buyers and sellers Both buyers and sellers got good knowledge about market conditions – price of commodities. Due to perfect knowledge by both buyers and sellers, there need not be any advertisement. 5. Perfect mobility of factors of production The factors like labour & capital should be freely mobile place to place and region to regions 6. Absence of transport cost If transport costs are incurred, prices should be differentiated in different sectors of the market.
Price and Output Determination
Price under perfect competition is determined by the interaction of the two forces – demand and supply. Though individuals cannot change the price, but aggregate forces of demand and supply can change. Demand side – marginal utility of commodity to the buyers Supply side – cost of production – producers The interaction of demand and supply is called the equilibrium price. Equilibrium price is that price at which quantity demanded is equal to the quantity supplied at give price – both buyers and sellers satisfied
Equilibrium between demand and supply
Price of Demand commodities 5 10 15 20 25 30 35 12 10 08 06 04 02 01 Supply 1 2 4 6 8 10 12 Excess Supply Excess Demand Equilibrium Pressure on price
Price and Output Determination
Elements of time – price theory Alfred Marshall was the first economists to introduced “Time Factor” – price determination. He divided time period into three ways –
1. Market Period 2. Short Period and 3. Long Period
1. Market Period
Market period are also called as very short period. The supply of a commodity is almost fixed and the demand will play a decisive role in determining the price of products. This market period may be an hour, a day, or few days or even a few weeks – depends on nature of commodities. Types of commodities are –
1. Perishable commodities 2. Non-perishable commodities
Fish, milk, vegetables, flowers, meat and butters etc are perishable commodities. Supply is limited in the existing stocks. The fundamental features of this period – supply of the commodity is absolutely fixed and therefore, the supply curve of each firm will be a vertical straight line. Demand factors more important than supply in determining price.
Y D D1 S
P1 Price P P2
Durable goods are those which can be reproduced or those can be stored. Like perishable goods, the supply of durable goods is not vertical throughout the length. Firms selling such goods have a minimum reserve price – they will not sell goods at less than reserve price – wheat, soap & oil etc.
Factors affecting Reserve Price
1. 2. 3. 4. Price in future – if seller expects that a high price will prevail in future. Liquidity preference – if the seller is in urgent need of money his reserve price will be low & vice-versa. Future cost of production – if the seller expects that in future the cost of production will fall, his reserve price will be lower & vice-versa. Storage Expenses – if the seller finds that the storage expenses are higher & the time for which the stocks have to be held are longer, his reserve price will be lower & vice-versa. Durability of commodity – more durable commodity is higher will be the reserved price. 6. Future demand
Future demand of a commodity also influences the reserve price of the producer. If the producer expects a higher demand in future, his reserve price will also be higher.
Short period – Price determination
• Short period refers to that period in which supply can be adjusted to a limited extent. • Stigler in his word short period is a period in which the rate of production, change by change in variable with existence of fixed inputs. • In short period fixed factors – machinery, plant, building etc cannot be altered and variable factors may be increased or decreased according to the change in demand. • In short period, price is determined by the interaction of two forces – demand and supply. • Demand factors were more dominated factors in short period.
Short period price determination
D1 P E1 D E S D1 D M M1 Out put E2 S
Long period price determination
• Long period is a period of many years 5, 10, 15 20 & above. • In this period supply conditions are fully able to meet the new demand conditions. • In the long run no fixed & variable factors all the factors treated as variable factors. • New plants/new firms can enter into the market & old firms can leave the market.
Long run Price determination
Y MPSC SPSC E2 LPSC E
• Monopoly is a market situation in which there is only one seller/producer who controls the entire market supply. • There are no close substitutes for his product & there are barriers to the entry of rival producers. • The term monopoly has originated from the two Greek words “Mono” – single & “poly” – seller, thus, monopoly means single seller existence. • Thus, monopoly market model is – opposite extreme of perfect competition. • The degree of competition in monopoly market structure is nil or extremely small.
Features of Monopoly
1. One seller & large number of buyers
the monopolist’s firm is the only firm – it is an industry. But the number of buyers is assumed to be large. There shall not be any close substitutes for the product sold by the monopolist. The cross elasticity of demand between the product of the monopolist and others must be negligible or zero. There are either natural or artificial restrictions on the entry of firms into the industry, even when the firm is making abnormal profits. Under monopoly there is only one firm which constitutes the industry. Difference between firm and industry comes to an end. Monopolistic has full control over the supply of the commodity But due to large number of buyers, demand of any one buyer constitutes an infinitely small part of the total demand.
2. No close substitutes
3. Difficulty of entry of new firms
4. Monopoly is also an industry
5. Price Maker
Nature of Demand curve
• Demand curve of the monopoly market is sloping downwards. • If he wants to increase the sale of his good, he must reduce the price or • he can raise the price by reducing his level of output.
Nature of Demand curve
Price and output determination
– The goal of the monopolist is to maximise profits – rational behavior. – Profit maximisation of monopoly firms depends on demand & cost conditions. – If he raises the price of his product, the quantity demanded of it will fall & if he lowers the price the quantity demanded of his product will increase. – He will therefore choose price-output combination which maximises his profits. – Profit are maximised at the level of output at which MR=MC & MC cuts MR from the below.
Price & output determination Monopoly
P Economic Profit
MR Quantity of output
• In the real world, either perfect competition or monopoly does not existed, but it only an imperfect competition like monopolistic competition. • The credit for the development of monopolistic competition goes to Joan Robinson of UK & Chamberlin of USA in 1933. • Mrs Joan Robinson her book “The Economic of Imperfect Competition & Prof Edward. H. Chamberlin “The theory of Monopolistic competition” in 1933. • Thus, monopolistic competition refers to competition among a large number of sellers producing close substitute but not perfect substitutes. • Further, in this market condition there is freedom of entry into & exist from the industry. • It defined as the form of market structure in which there is a large number of firms producing differentiated products which are close substitutes of each other.
• • • • • • • • The products of various sellers under this market conditions are fairly similar but not perfect/close substitutes of each other. Every seller has a monopoly of his own product variety but he has to face a stiff competition from his rival sellers, selling close substitutes of his product. Bathing soap – which produce different brands such as Lux, Human, Godrej, jai, dove etc. Shampoo – Sunsilk, Clinic plus, Head & Shoulders etc. Blade – Swiss, Wilkinson, Sword & 7.0 clock etc. Tooth paste – Colgate, close-up, promise, Pepsudent etc. Two wheeler bike – Hero Honda, Pulsor, TVS Victor, Yamaha etc. Cool drinks – Pepsi, coco-cola, sprite, 7up, Mirinda, Maza slice etc.
Features of Monopolistic Competition 1. 2. 3. 4. 5. 6. A large number of firms Product differentiation Free entry & exists of firms Selling cost Non-price competition Product variation
large number of firms There are a relatively large number of firms existed in the market. Because of large number of firms, there is stiff competition between them. Unlike perfect competition these large number of firms do not produce identical but they have perfect substitutes between them. The size of each firm will be relatively small. 2. Product differentiation Products produced by various firms are not identical but are slightly different • from each others – close substitutes of each other. Therefore, their prices cannot be very much different from each other. • Their products are similar & close substitutes of each others. • Product differentiated – differences in the quality, tastes, preferences, • workmanship, durability, size, shape, design, colour, fragrance, packing etc.
3. Freedom of entry & exist • New firms to enter & existing firms to leave industry. • If industry making super-normal profits new firms can enter it – which leads to the expansion of output. • Exist firms can leave industry – if they incurs losses. 4. Product variation • Product variation under monopolistic competition exists because there is differentiation of products of various firms. • The variation of product refers to a change in the quality of the product itself, technical change, design, better materials package etc. 5. Non-price competition
• • • • Selling cost & advertisement expenditure is an unique feature of monopolitic competition. The firms incur a considerable expenditure on advertisements & selling cost to promote the sales of heir products. The advertisement & other selling outlays – change he demand for its product Firms maximising profits through advertisement & selling cost.
• • •
Nature of Demand curve Under monopolistic competition enjoys some control over the price of its product – since its product is somewhat differentiated from others. If a firm raises the price of its product it will find some of its customers going away to buy other products. As a result, the quantity demanded of its product will fall. On the contrary if it lowers the price, it will find that buyers from other varieties of the product will start purchasing its product & as a result the quantity demanded of its product will increase. Therefore, demand curve facing an individual firm under monopolistic competition slopes downward. If a firms wants to increase the sales of its product, it must lower the price.
Nature of Demand curve
Nature of Demand curve…….
• Demand curve facing a firm will be his average revenue curve (AR). • Thus, average revenue curve of the monopolistic competitive firm slopes downward throughout its length. • Since average revenue curve slopes downward, marginal revenue (MR) curve lies below it. • The implication of MR curve lying below AR curve is that the MR will be less than the price or average revenue. • If the firm wants to sell more, the price of its product fall MR therefore must be less than the price.
• Price & output determination under monopolistic competition was developed by Edward H. Chamberlin – in the early 1930s. • Monopolistic competition refers to large number of sellers sell differentiated products, which are close to each other. • The price and output determination – are similar to monopoly market condition. • Demand curve sloping downward like monopoly AR & MR. • Various firms producing differentiated product, which are close to each other. • In the short run, firms incurring super normal profits, normal profits & economic losses, it depends upon the nature of average cost & average revenue
Short period - Price and output determination
Super normal profit and economic losses
Y (a) SMC SAC Dollars H G P H
(b) SAC MC SMC
40 Total Loss
E AR/D D O M OutputMR X
D O M Output MR X
Price and Output Determination – short period – Normal Profits
D 10,000 MR 30,000
Lieberman & Hall; Introduction to Economics, 2005
Monopolistic Competition in the Short Run
• In the short-run, a monopolistically competitive firm will produce up to the point where MR = MC.
• This firm is earning positive profits in the short-run.
Monopolistic Competition in the ShortRun
• Profits are not guaranteed. Here, a firm with a similar cost structure is shown facing a weaker demand and suffering short-run losses.
Monopolistic Competition in the LongRun
• The firm’s demand curve must end up tangent to its average total cost curve for profits to equal zero. This is the condition for long-run equilibrium in a monopolistically competitive industry.
The term Oligopoly derived from two Greek words ‘Oligos’ – a few & Pollein – to sell. Thus, oligopoly refers to that form of imperfect competition where there will be only a few sellers producing either a homogeneous product or products which are close substitutes but not perfect substitutes. Oligopoly is also referred as “Competition among the few” as a few big firms will be producing & competing in the market. Oligopoly market is different from monopoly, duopoly, monopolistic competition and perfect competition, it is sometimes called limited competition, incomplete monopoly or multiple monopoly. Oligopoly market are generally found in modern capitalist countries. Earlier it is called as pure or perfect oligopoly & the latter it is called as imperfect or differentiated oligopoly.
Classification of Oligopoly
1. Pure or perfect oligopoly & differentiated or imperfect oligopoly • If the firm producing/competing identical/homogeneous product it is called as pure/perfect oligopoly. for example – Cement & Aluminum Industries. • While, the firm producing & competing different commodities/close substitute & not perfect substitution called different/imperfect oligopoly. 2. Open and Closed oligopoly • Open oligopoly refers to new firms can enter the market & compete with the existing firms. • Closed Oligopoly – no freedom to entry & exist of firms to industry.
3. Collusive and non – collusive Oligopoly • Collusive means co-operation between the competing firms in pricing their products • All the existing firm acts independently in the determination of prices. • There is no insecurity, uncertainty in the oligopoly industry. • Where as non-collusive oligopoly each firms undertaken independent decision making with regard to price & output of the commodity (lack of understanding between the firms & competing within themselves). 4. Partial and Full Oligopoly • Partial oligopoly market one of the dominant firms undertake decision-making of price & output & other firms follows it – price leadership. • Where as, full oligopoly – the market will be conspicous by the absence of price leadership.
Features of Oligopoly Market
1. Interdependence 2. Indeterminate demand curve 3. Importance of advertising & selling costs 4. Group Behaviour 5. Element of Monopoly 6. Price Rigidity
1. Interdependece • The price & output decisions of one firm will affect the other firms & any decision can be arrived at only after deep consideration of the possible reaction of the rival firms in the group. • As the number of firms are few, a change in price & output by a firm will directly affect the fortunes of its rivals. • Decision-making is closely connected with the price output policies of other firms. 2. Indeterminate Demand Curve • No firm in oligopoly market can forecast with some degree of certainty about the nature & position of its demand curve. • The firm cannot make an estimate of sales of its product if it were to cut the price by a certain percentage. • Hence the demand curve or the revenue curve of the firm is indeterminate.
3. Importance of advertisement & selling cost
• Due to indeterminate demand curve leads to the condition of aggressive advertisement to bring more customers into the fold of the firm. • A direct effect of interdependence & indeterminate demand of various firms – firms incurs the enormous selling & advertisement cost. • Therefore, there is a great importance of advertising & selling costs under conditions of oligopoly market. • Prof Baumol rightly says that “it is only under oligopoly market advertising comes fully into its own”. • The firms under oligopoly recognize their interdependence & realise the importance of mutual cooperation. • Therefore, there is a tendency among them for collusion. • Collusion as well as competition prevail in the oligopolistc market leading to uncertainty and indeterminateness.
4. Group Behaviour
5. Price Rigidity • Prices tend to be sticky or rigidity under oligopoly market – product differentiation. • The price will be kept unchanged due to fear of retaliation & counter-action from other firms – sticky & inflexible. • No firm would indulge in price cutting, as it would eventually lead to a price war. • Price War - if any one firm introduces a price cut it will attract to customers, the rival firms will retaliate by cutting down their prices No benefit to rivals • The price may be kept constant even without any collusion or agreement
Kinked Demand Curve
• In 1939, Prof Paul Sweezy has introduced the Kinked Demand Curve – determination of equilibrium in oligopoly market. • He used the kinked demand curve model – explain about price rigidity under oligopoly market. • Demand curve facing an oligopolist has a kink at the prevailing price. • If he lowers the price below the prevailing level his competitors will follow him & will lower their prices. • But if he increases his price above the prevailing level his competitors will not follow his increase in price. • Upper segment of the demand curve is relatively elastic and the lower portion is relatively inelastic.
Assumptions 1. There is an established market price at which all the sellers are satisfied. 2. Each sellers attitude depends on the attitude of his rivals. 3. An attempt of every seller to push up his ales by reducing the price will be counteracted by other sellers. 4. If the seller raises the price, other will not follow him rather they will stick to the prevailing price.
Kinked Demand Curve
d More Elastic
Less Elastic D/AR
A B O M MR
• dKd is the kinked demand curve of an oligopolistic firm. • OP is the prevailing market price & OM is the equilibrium level of output. • If an oligopolistic seller (firm) increases the price of the product above OP, this will reduce his sales – because the rivals are not expected to follow his price. • This is because the dk portion of the kinked demand curve is elastic & the corresponding dA portion of the MR curve is positive. • If the seller reduces the price of the product below OP, his rivals will also reduce their price. • Though he increase's his sales, his profits would be less than before. • The reason is that kd portion of the kinked demand curve below OP is less elastic & MR curve below B is negative. • Thus in both the price-rising & price reducing situations – the oligopolistc seller will be the loser. • Therefore, he will stick to the prevailing market price OP which remains rigid. • A kinked demand curve is said to occur when there is a sudden change in the slope of the demand curve.
Price and output determination Oligopoly
• There is no one system of pricing under oligopoly market. • Price policy followed by a firm depends on the nature of oligopoly & rival reactions. • Therefore, there are three types of pricing under oligopoly. 1. Independent Pricing 2. Pricing under Collusion 3. Pricing under Price Leadership
1. Independent Pricing or (Non-collusive oligopoly) Homogeneous Product When goods produced by different oligopolists are more or less similar or homogeneous in nature. There will be a tendency for the firms to fix a common pricing – “Going Price” – accepting price. So that firm earns adequate profits at this price. Non-homogeneous Product or Different Product When goods produced by different firms are different in nature, each firm will be following an independent price policy – like monopoly. Due to product differentiation, each firm has some monopoly power. Price war between different firms & each firm may fix price at the competitive level. A firm tend to change prices even below the variable costs, the other firms are also cutting the price as same as them – cut throat competition. Independent pricing in reality leads to antagonism, friction, rivalary, infighting, price-wars etc.
2. Pricing under Collusion • The term collusion means - to play together in economics. It means that the firms co-operation between the competing firms in pricing their products. • Three main reasons for collusion
1. Oligopoly firms wants to reduce competition & increasing profits. 2. Collusion helps them to reduce uncertainty. 3. To prevent the entry of new firms into the industry.
• • • • • •
Collusion based on oral agreements or written agreements. Oral agreements – “Gentlemen’s agreement – it does not consist of any records. Written agreements are called as CARTELS. Two kinds of collusion 1. Perfect Collusion & 2. Imperfect Collusion
1. Perfect collusion (centralized cartel) The firms surrender all their rights to a central authority when sets prices, output & quotas for each firm, distributes profits etc. The cartel are similar to a monopoly, where entire oligopoly industry is controlled & directed by the central agency. 2. Imperfect collusion Refers to a secret or informal agreement under which the colluding firms in the oligopoly industry seek to fix prices & outputs of their products. Price leadership is an ou5tstanding example of imperfect collusion.
Pricing under collusion
MC1 P Q1 Q2 Q3
Price & Cost
MR M1 M2 Output M3
• ID industry’s demand curve & MD – marginal revenue curve. • The marginal cost of the cartel (IMC) is the sum-total of the marginal cost curves of the two firms in the industry. • At point Q, the aggregate marginal cost of the industry (IMC) is equal to the marginal revenue. • Therefore, the cartel will naturally produce OM3 output for the industry & fix PM3 price for the product. • Because, it is at this output & price that the cartel is able to maximise the profits of the industry. • There are two oligopoly firms in the industry named as A & B. • The marginal cost curve of the firm ‘A’ is MC1 & of the firm B is MC2. • The output of each firm will be fixed on the basis of its efficiency. • The efficiency of A firms lower than B firms. • OM1 quantity of output with MC1 marginal cost of firm A, while firm B produces OM2 of output with MC2 marginal cost. • Thus, the output of A firm is OM. B firm is OM2 & total output is OM3 & the price at which this output is old is PM3.
• When price is determined by one big firms in the industry & this price is accepted by all the other firms (small firms). • Price fixation is generally the result of tacit understanding rather than of a formal agreement. • The big firms – scale of production, most senior/experienced firms etc. • In America, price leadership industries are – biscuits, cement, cigarettes, flower, fertilizers, petroleum, milk, steel etc.
3. Price Leadership under oligopoly
Price leadership under oligopoly
Y Figure 1
e nu t e ev Cos R
AR = D mrket a
AR = D leader MR leader
• ID represents the total industry’s demand at OP price, the industry sells OM of output. • The average revenue curve of the smaller firms is a horizontal straight line – because they accepted price fixed by dominant firm. • We have taken three smaller firms as A, B & C. • The price is OP1 & therefore, the AR curve is a horizontal straight line. • Therefore, their MR curve is also the same as AR curve. • Each firms have their own separate marginal cost curves. MCA of A MCB of B & MCc of C firms. • Q1 is the point at which the marginal cost of the firm A is equal to its marginal revenue & therefore, it produces OM1 output. • Q2 is the point at which the marginal cost of the firm B is equal to its marginal revenue & therefore, it produces OM2 output. • Similarly, the firm C produces OM3 output. The total output of the industry is OM & therefore, the output of the dominant firm would be OM = (OM1 + OM2 + OM3). • The dominant firm can determine its price & output by the quality of its marginal cost & marginal revenue.