Money & Market situations

1. Unit II
Market Structure
Perfect Competition
Imperfect competition
Monopoly, Monopolistic Competition,
Oligopoly and Duopoly
Price determination and various market
conditions
Prepared by:-
Dr. Waqar Ahmad
Asstt. Professor
Allenhouse Business School

2. What is a Market?
Market is defined as a place or point at
which buyers and sellers negotiate their
exchange of well-defined products or
services.
Market is a place where buyer and seller
meet, goods and services are offered for
the sale and transfer of ownership
occurs.

3. Definition of Market
Market is any area over which buyers and
sellers are in close touch with one another,
either directly or through dealers, that the
price obtainable in one part of the market
affects the prices paid in other parts.
- Benham

4. As seen from the definition of market, the
components of a market are:
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
COMPONENTS
AND
MARKET STRUCTURE

5. COMPETITIVE BASED MARKET
STRUCTURE
The less the power an individual firm has to
influence the market in which it operates, the
more competitive that market is.
Types of Competition are..
I. Perfect Competition Markets
II. Imperfect Competition Markets

6. Market Structures Based on
Competition

7. WHAT IS
PERFECT COMPETITION
MARKET
A market structure in which all
firms in an industry are price
takers and in which there is
freedom of entry into and exit from
the industry is called Perfect
Competition.

8. FEATURES OF
PERFECT COMPETITON MARKET
• A Large Number of Buyers and Sellers
• Price Taker (market price)
• Homogeneous Products (same product)
• The firms are Free to Entry or Exit
• No Individual Preferences (buyer/seller)
• Each buyer and seller operates under the
conditions of certainty
• Mobility of Factors of Production – move
freely from industry to industry and firm to
firm

9. • Perfect knowledge
• A firm is price taker
• No govt. interference
• Perfectly elastic curve
• Revenue curve under perfect competition
• Producer equilibrium
FEATURES OF
PERFECT COMPETITON MARKET
Cont……

10. IMPERFECT COMPETITION
In this market there are small no of firms. Having
Large number of buyers and sellers with product
differentiation
It covers three types of market are…
1. Monopoly Market
2. Monopolistic Market
3. Oligopoly Market
4. Duopoly Market

11. MONOPOLY
A pure monopoly exists if one and only one
firm produces and sells a particular
commodity in the market.
The single firm producing the product is itself
both the firm and the industry.
E.g.: Railways.

12. FEATURES OF MONOPOLY
COMPETITIVE MARKET
• Large number of buyers
• Only One seller
• Price Discrimination
• Full Restrictions
• Imperfect Knowledge
• Price Maker
• Demand Curve (Less elastic)
• Revenue Curve
• Producer Equilibrium

13. CAUSES OF MONOPOLY
 Patent Rights give legal monopoly
 Govt. policies such as granting licenses
 Ownership and control of some strategic
raw materials.
 Exclusive knowledge of technology by the
firm.
 Size of the market may accommodate only
a single firm
 Limit pricing policy adopted to prevent new
entrants.

14. MONOPOLISTIC COMPETITION
Monopolistic competition is a
market situation in which there
are large number of buyers and
seller which buys and sellers
differentiated goods

15. Monopolistic Competition refers to a situation
where there are many sellers of a
differentiated product.
There is competition which is not perfect,
between many firms making very similar
products which are close but not perfect
substitutes.
Monopolistic market exhibits characteristic of
both perfect competition and monopoly

16. FEATURES OF MONOPOLISTIC
COMPETITION
1. Large number of buyers
2. Large number of sellers/producers
3. Product Differentiation (Tooth paste)
4. Imperfect knowledge (Buyers)
5. Higher selling cost (Promotion cost)
6. Few Restrictions (Copyright, Patent right etc.)
7. Freedom of entry and exist
8. Demand Curve (Price sensitivity market)
9. Revenue Curve under monopolistic competition
10. Producers equilibrium

17. OLIGOPOLY
It is a market in which large number of
buyer but only few sellers of the product
it is know as Oligopoly.
If there is a competition among a few
sellers, oligopoly is said to exist.

18. FEATURES OF OLIGOPOLY
1. Large number of buyers
2. Few number of sellers/producers
3. Inter dependence in decision making
4. High barriers
5. Huge advertisement expenses (80%)
6. In-determinant demand curve
7. Restriction on the entry and exit of firms.
8. Price rigidity.
9. Complicate market structure.

19. S.NO.
TYPES OF
MARKETS
SITUATION
SIZE
OF
SELLERS
SIZE
OF
BUYERS
EXAMPLES
1 Monopoly
Single
Seller
Large
Buyers
Ex:
Indian Railways
2 Oligopoly Few Sellers
Large
Buyers
Ex: LPG Gas,
Cement Market,
Pizza Market
3 Duopoly Two Sellers
Large
Buyers
Ex:
Soft drinks

20. Total Revenue, Average Revenue
and
Marginal Revenue
Total Revenue is the revenue earned by producing
and selling ‘n’ units
TR = P * Q
Average Revenue is the revenue earned per unit sold
AR = TR / Q
Marginal Revenue is the change in revenue by
producing and selling one more unit
MR = P

21. EQUILIBRIUM POINT
Equilibrium point refers to the position
where the firm enjoys maximum profits and
it has no incentive either to reduce or
increase its output level.
Equilibrium based on two conditions
1. MR = MC
2. MC curve should cut the MR curve from
below

22. SHIFT IN EQUILIBRIUM
1. Change in Demand
Change in Demand shows that increases in demand the equilibrium
price rises and equilibrium output increases. On the other hand if the
demand decreases equilibrium output decreases.
Y S
D’
N D P
Price N’ P
S D’
D
O M M’ X
Output

23. SHIFT IN EQUILIBRIUM
1. Change in Supply
Change in Supply that an increase in Supply, equilibrium price falls
while equilibrium output increase. On the other hand with a
decreases in supply, equilibrium price rise and equilibrium output
also decreases.
Y D’ S
S
N P
Price N’ P
S D’
S
O M M’ X
Output

24. Average Revenue and Marginal Revenue
of the firm under Perfect Competition
No. of units sold AR or Price
Marginal income
(MR)
TR=P*Output
1 4 -- 4
2 4 4 8
3 4 4 12
4 4 4 16
5 4 4 20
6 4 4 24
7 4 4 28

25. PRICE DETERMINATION OR
OUTPUT UNDER PERFECT
COMPETITION
OR
EQUILIBRIUM POINT OF THE FIRM
UNDER PERFECT COMPETITION
Two Equilibrium are under (PC)
1. Short run equilibrium of the
industry
2. Long run equilibrium of the
industry

26. 1. Short run equilibrium of the industry
Industry equilibrium is attained at the point where the total market
demand for a product is equal to the total supply of the
product.
E
S
S
D
D
Y
XO
Price P
Q

27. SHORT RUN EQUILIBRIUM OF THE FIRM
• No entry or exit of any firm.
• Firm will be in equilibrium where MR=MC.
• In short run equilibrium will be coming in three
situation are….
a) Super normal profit situation
b) Normal profit situation
c) Loss situation

28. SUPER NORMAL PROFIT
Price,RevenueandCost
Output
MC
AC
Q
N
MR= AR
0
profit
P
R
MR=MC
S
ES= Avg. Profit
Firm earning super normal profits

29. NORMAL PROFIT
Price,RevenueandCost
Output
LMC
LAC
Q
N
MR= AR
0
P
E
Firm earning normal profits
AC

30. LOSSES
Price,RevenueandCost
Output
MC
AC
X
N
MR= AR
0
Losses
P
R
S
Firm Facing Lose
Y

31. SUTDOWN POINT
The point where price is below AVC & as soon as firm attains this point
should stop production so that loss = FC only.
Price,RevenueandCost
Output
MC
AC
AVC
Q
P5
Q5*0
loss
P5= MR5= AR5
At P5, min AVC
(AR) = (AVC).
Therefore the firm
should shut down.
S

32. 2. Long run equilibrium of the industry
Equilibrium of the industry is obtained similarly to as it is obtained the
short run period. i.e. at the point where total demand is equal to
the total supply of a product. At this point , equilibrium price is
obtained which is taken by all the firms in the industry.
E
S
S
D
D
Y
XO
Price P
Q

33. Long run equilibrium of the firms
under perfect competition
In long run all the firms in the industry earn normal
profit
• No Super normal profit in long run
• No firm bearing losses in long run
• Price = Minimum average cost – marginal cost

34. Long run equilibrium of the industry
Under perfect competition
P=AR=LMC=LAC
LMC
LAC
P
COST
Q
E
Price and output under perfect competition in Long Run
FIRM OUTPUT
O

35. Price and Out put
Discrimination
under Monopoly

36. Average Revenue and Marginal
Revenue of the firm under Monopoly
No. of units sold AR or Price TR=P*QS
MR(Additional
made to the TR)
1 35 35 ---
2 34 68 33
3 32 96 28
4 30 120 24
5 28 140 20
6 26 156 16

38. SUPER NORMAL PROFIT
Price,RevenueandCost
Output
MC
AC
X
o
P
Firm earning super normal profits under Monopolist
AR
MR
E
Y
S R
Q

39. NORMAL PROFIT
Price,RevenueandCost
Output
MC
AC
X
o
P
Firm earning Normal profits under Monopolist
AR
MR
E
Y
S
E

40. LOSSES
Price,RevenueandCost
Output
SMC
SAC
X
o
P
Firm bearing losses under Monopolist
AR
MR
E
Y
Losses
R
Q
S

41. LONG RUN EQUILIBRIUM OF THE INDUSTRY
UNDER MONOPOLY
Under the long run the monopolist firm can change the size of
his plant according to his needs. Thus in the long run the
monopolist will set his plant size such that to maximize
his profit or to earn super normal profit.
Price,RevenueandCost
Output
LMC
LAC
Xo
P
Firm earning super normal profits under Monopolist
AR
MR
E
Y
S R
Q
SMC
SAC

42. Price and Out put
Discrimination
under Monopolist
competition

43. SUPER NORMAL PROFIT
Price,RevenueandCost
Output
MC
AC
X
o
P
Firm earning super normal profits under Monopolist
AR
MR
E
Y
T T
P

44. LOSSES
Price,RevenueandCost
Output
SMC SAC
X
o
P
Firm Losses under Monopolist
AR
MR
E
Y
T
P”
T”

45. NORMAL PROFIT
Price,RevenueandCost
Output
LMC
LAC
X
o
Firm earning normal profits under Monopolist
AR
MR
E
Y
P
P”

46. LONG RUN EQUILIBRIUM OF THE INDUSTRY
UNDER MONOPOLISTIC COMPETITION
• In long run the new firm can easily enter in the group or
industry seeing the super normal profit earned by already
existing firm in the group.
• The entry of the new firms will make the super normal profit
disappear with the entry of the new firms.
• The firms can easily exit from industry (Shutdown) because of
losses.
• In long run no firm bear lose.

47. • The firm in group, earn, supernormal profit, it will attract the
new firms to enter into the industry.
• The new entries will increase the no. of the firms in the group.
• Then it increase the demand of inputs, factors of
production(Land, Labor, machinery, raw materials etc.) by the
group.
• Then it increase the supply of the factors and price.
• Then it increase the Avg. Cost of the firms. (for the sake of
super normal profit).
LONG RUN EQUILIBRIUM OF THE INDUSTRY
UNDER MONOPOLISTIC COMPETITION

48. • It means avg. cost continuously shifting upwards till it
became tangent to the avg. revenue.
• AV=AR
• Then the new firms entry stops
• Now the all the firm earns only normal profit.
LONG RUN EQUILIBRIUM OF THE INDUSTRY
UNDER MONOPOLISTIC COMPETITION

49. LONG RUN GROUP EQUILIBRIUM
Price,RevenueandCost
Output
LMC
LAC
X
o
Firm earning normal profits under Monopolist
AR
MR
E
Y
P
P”

50. OLIGOPOLY
It is a market in which large number of
buyer but only few sellers of the product
it is know as Oligopoly.
If there is a competition among a few
sellers, oligopoly is said to exist.

51. Introduction
• Derived from Greek word: “oligo” (few) “polo” (to sell)
• A few dominant sellers sell differentiated or homogenous
products under continuous consciousness of rivals’ actions.
• Oligopoly looks similar to other market forms; as there can be
many sellers (like in monopolistic competition), but a few
very large sellers dominate the market.
• Products sold may be homogenous (like in perfect
competition), or differentiated (like in monopolistic
competition).

52. • Entry is not restricted but difficult due to requirement of
investments.
• One aspect which differentiates oligopoly from all other
market forms, is the interdependence of various firms: no
player can take a decision without considering the action (or
reaction) of rivals.

53. Duopoly
• Duopoly is that type of oligopoly in which only
two players operate (or dominate) in the
market.
• Used by many economists like Cournot,
Stackelberg, Sweezy, to explain the equilibrium
of oligopoly firm, as it simplifies the analysis.

54. Price and Output Decisions
No single model can explain the determination of
equilibrium price and output.
Difficult to determine the demand curve and hence the
revenue curve of the firm. Tendency of the firm to
influence market conditions by various activities like
advertisement, and fear of price war resulting in price
rigidity.

55. Cournot’s Model
• Augustin Cournot illustrated with an example of two firms
engaged in the production and sale of mineral water.
• Each firm owns a spring of mineral water, which is available
free from nature.
Assumptions
•Each firm maximizes profit.
•Cost of production is nil because the springs are
available free from nature, i.e. MC=0.

56. •Market demand is linear; hence the demand curve
is a downward sloping straight line.
•Each firm decides on its price assuming that the
other firm’s output is given (i.e. the other firm will
continue to produce and sell the same amount of
output in next period).
•Firms sell their entire profit maximizing output at
the price determined by their demand curves.

57. Cournot’s Model
Period 1: Firm A: ½ (1) = ½
Firm B: ½ (1/2)= 1/4
Period 2: Firm A: ½ (1-1/4)= 3/8
Firm B: ½ (1-3/8) =5/16
Period 3: Firm A: ½ (1-5/16)=11/32
Firm B: ½ (1-11/32)= 21/64
Period 4: Firm A: ½ (1-21/64) = 43/128
Firm B: ½ (1-43/128)=85/256 ………
Period N: Firm A: ½ (1-1/3) =1/3
Firm B: ½ (1-1/3) = 1/3
Thus A’s output is declining progressively (with ratio=1/4), whereas B’s
output is increasing at a declining rate.
•A’s equilibrium output=1/3
•B’s equilibrium output=1/3

58. Cournot’s Model
Quanti
ty
Price,
Reven
ue,
Cost
O
A
D
P
A
P
B
B
Q
B
Q
A
MR
A
M
RB
D
*
• Firm A produces profit maximising
output at MR=MC=0 and sells half of
the total market demand (equal to
OD*).
• Point A is the mid point of DD*.
• Firm B assumes A will continue to
produce OQA ,so considers QAD* as
the market available to it and AD* as
its demand curve. Its MR curve will be
MRB.
• B maximizes profit and produce QB.
• A and B together supply to three
fourths of the total market, while one
fourth remains unattended.

59. Stackelberg’s Model
• Developed by German Economist H. V. Stackelberg
• Popularly known as the Leader Follower Model.
• An extension of the model of Cournot.
• One of the players is sufficiently sophisticated to recognize
that the rival firm acts.
• The sophisticated firm is able to determine the reaction curve
of the rival and is also able to incorporate it in its own profit
function. Thus it acts as a monopolist.
• Naïve firm will act as follower.

60. Stackelberg’s Model
RA
RA RB
RB
E
Output of Firm A
Output of
Firm B
O
XA
XB
Firm A’s reaction
function
Firm B’s reaction
function
a
X’B
X’A
b
• If firm A is the sophisticated firm, it
will try to produce that output at
which it can maximize its profit, at
point “a”.
• A will produce OXA and B will be
contended with OXB.
• B will act as a follower and accept
the leadership of A.
• If firm B is the sophisticated firm,
will be at equilibrium at point “b”,
producing OXB.
• A will act as the follower and
accept B’s leadership will produce
only OXA.
RARA: Reaction function of A
RBRB: Reaction function of B
Cournot’s equilibrium= E

61. Kinked Demand Curve
• Paul Sweezy (1939) introduced concept of kinked demand
curve to explain ‘price stickiness’.
Assumptions
– If a firm decreases price, others will also do the same.
So, the firm initially faces a highly elastic demand
curve.
– A price reduction will give some gains to the firm
initially, but due to similar reaction by rivals, this
increase in demand will not be sustained.

62. - If a firm increases its price, others will not follow. Firm will
lose large number of its customers to rivals due to substitution
effect.
- Thus an oligopoly firm faces a highly elastic demand in case of
price fall and highly inelastic demand in case of price rise.
• A firm has no option but to stick to its current price.
• At current price a kink is developed in the demand curve
• The demand curve is more elastic above the kink and less elastic
below the kink.

63. Kinked Demand Curve
(price and output determination)
• Discontinuity in AR (D1KD2)
creates discontinuity in the MR
curve.
• At the kink (K), MR is constant
between point A and B.
• Producer will produce OQ,
whether it is operating on MC1 or
MC2, since the profit maximizing
conditions are being fulfilled at
points S as well as T.
• If MC fluctuates between A and
B, the firm will neither change its
output nor its price.
• It will change its output and price
only if MC moves above A or
below B.
• D1K = highly elastic portion of the
demand curve when rival firms do
not react to price rise
• KD2 = less elastic portion, when
rival firms react with a price
reduction.
• Kink is at point K.
D1
D2
K
A
B
MR
Quantity
O
MC1
MC2
P
Q
S
T
Price,
Revenue,
Cost

64. Collusive Oligopoly
• Rival firms enter into an agreement in mutual interest
on various accounts such as price, market share, etc.
• Explicit collusion: When a number of producers (or
sellers) enter into a formal agreement.
• Tacit collusion: A collusion which is not formally
declared.
.

65. Cartel
•A formal (explicit) agreement among firms on price and
output.
•Occurs where there are a small number of sellers with
homogeneous product.
•Normally involves agreement on price fixation, total industry
output, market share, allocation of customers, allocation of
territories, establishment of common sales agencies, division
of profits, or any combination of these.
•Immediate impact is a hike in price and a reduction in supply.
•Two types: centralized cartels & Market sharing cartels

66. Centralized Cartels
P
O
Q
MR
AR=D
∑MCMCAMCB
QAQB
Price,
Cost,
Revenue
Quantity
• MCA = Firm A’s marginal cost
• MCB = Firm B’s marginal cost
• ∑MC = industry marginal cost
• OQ = profit maximizing output
because (MR=∑MC).
• OQA = A’ output, OQB = B’s
output
• OQ=OQA + OQB; OQA > OQB.
• OP = price at which both firms
can sell their output. Price will be
determined by summation of all
firms’ costs and demand.
• An individual firm is thus just a
price taker.

67. Market Sharing Cartels
Output
Price,
Cost,
Revenue
O
QA
PA
ARA
MRA
ACMC
ARB
PB
MRB
QB
• Firms decide to divide the market
share among them and fix the
price independently.
• All firms have the same cost
functions because they are
producing a homogenous product.
• Due to different demand
functions, at equilibrium total
output (OQ)=OQA+ OQB, where
OQA> OQB.
• The quantity of output produced
and sold would depend upon the
terms of agreement among the
firms.

68. Factors Influencing Cartels
• Number of firms in the industry: Lower the number of firms in the industry,
the easier to monitor the behaviour of other members.
• Nature of product: Formed in markets with homogenous goods rather than
differentiated goods, to arrive at common price. But if goods are
homogeneous, an individual firm may gain larger market share by cheating,
i.e. by lowering the price.
• Cost structure: Similar cost structures make it easier to coordinate.
• Characteristics of sales: Low frequency of sales coupled with huge amounts
of output in each of these sales make cartels less sustainable, because in
such cases firms would like to undercut the price in order to gain greater
market share.
– with large number of firms and small size of the market some firms may
deviate from the cartel price and thus cheat other members.

69. Informal and Tacit Collusion
• Formed when firms do not declare a cartel, but informally
agree to charge the same price and compete on non price
aspects.
• Sometimes this agreement involves division of the market
among the players in such a way that they may charge a price
that would maximize their profit without fear of retaliation.
• Also seen in case of highly skilled human resource.
• It is as damaging to consumers as formal cartels, because it
makes an oligopoly act like a monopoly (in a limited sense)
and deprives consumers of the benefits of competition.

70. Price Leadership
• Dominant Firm: a leader in terms of market share, or presence in all
segments, or just the pioneer in the particular product category.
– May be either a benevolent firm or an exploitative firm.
• Benevolent leader
– Allows other firms to exist by fixing a price at which small firms
may also sell.
• so that it does not have to face allegations of monopoly
creation;
• Earns sufficient margin at this price and still retains market
leadership

71. •Exploitative leader: fixes a price at which small inefficient players
may not survive and thus it gains large share of the market.
•Barometric Firm: has better industry intelligence and can
preempt and interpret its external environment in an effective
manner.
No single player is so large to emerge as a leader, but there
may be a firm which has a better understanding of the
markets.
Acts like a barometer for the market.

72. Thank you