Market Structures

Market Structures-Revised Prof. Tarun Das, IILM, New Delhi

Market Structures by Prof. Tarun Das

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

Market Structures by Prof. Tarun Das

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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

Perfect Many competition

Many

Monopoly Mono (single) Duopoly Duo (two) Oligopoly Oligo (a few) Monopolistic Large competition

Poly (many) Poly (many) Poly (many) Large

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1.3 Different Market Structures Markets

Product

Entry and Contestability & rivalry Exit

Perfect competition

Standardized

Free

Nonexistent

Monopoly

Blocked

Nil

Duopoly

Differen tiated Both

Restricted

Exists

Oligopoly

Both

Impeded

High

Monopolistic competition

Differen tiated

Easy

High

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• • • • • • • •

2.1 Perfect CompetitionBasic characteristics

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.

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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=MC=Min (ATC) 5. Shut down point: P=MC= Min (AVC) Market Structures by Prof. Tarun Das

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200 150 100

17

15

13

9

7

5

3

0

11

50

1

COST (Rupe e s)

2.3 Perfect Competition equilibrium

OUTPUT (Q) AVC

ATC

Market Structures by Prof. Tarun Das

MC

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2.4 Review Question on PC 1. (a) What are the basic characteristics of a perfectly competitive market? What are the conditions for profit maximization under perfect competition? Explain graphically equilibrium conditions and shut down and break-even points? (b) Does perfect competition exist in reality? Discuss Peteraf’s model for existence of monopolistic competition.

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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 Market Structures by Prof. Tarun Das

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3.2 Monopolistic Competition 1. Monopolistic competition lies in between two extreme market structures- perfect competition and monopoly. 2. In fact, monopolistic competition combines features of both monopoly and competitive markets with varying degrees. 3. Like perfect competition, there are large numbers of buyers and sellers, and there is free entry for new firms. 4. However, products are not homogeneous and firms are not independent decision makers regarding prices, products, sale services.

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3.3 Monopolistic Competition 5. In monopolistic competition, products are differentiated by brand names, trade marks, designs, color and shape, packaging, prompt after-sale services, credit terms etc. Despite differentiation, products are close substitutes. 6. Firms enjoy quasi monopoly powers. Like monopoly, firms are price makers but do not have as much market power as the monopolist. Firms face intense competition, contestability and rivalry and produce large number of imperfect substitutes. Market Structures by Prof. Tarun Das

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3.4 Monopolistic Competition

7. Firms resort to non-price competition like advertisement, free insurance, free samples and gifts etc.

Review Question

1. (a) What are the basic characteristics of a monopolistic competition? (b) What are the features of a monopoly and a competitive market coexisting in monopolistic competition? What is the basic difference between monopolistic competition and perfect competition? (c ) What is the equilibrium competition for a monopolistic competition? Market Structures by Prof. Tarun Das

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3.5 Peteraf’s Model on Cornerstones of Monopolistic Competition 1. Heterogeneity in factor endowments. 2. Ex-post limits to perfect competition – non-existence of perfect substitutes and perfect imitable products and services 3. Imperfect mobility and tradability of resources and factors of production 4. Ex ante limits to competitionAdvantage of locations and sites.

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4.1 Strategy-Conduct-Performance (SCP) Analysis - Market strategy of different markets Market No. of Entry Product firms Type Perfect Very competition large Monopoly Oligopoly

One

Free

Standardized

Blocked

Differentiated A Few Impeded Both

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

Differentiated

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4.2 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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4.3 Strategy-Conduct-Performance (SCP) Analysis – Performance of different markets Market Profit Technical Progreefficiency ssiveness Type Perfect Normal competition

Good

Good

Monopoly Excessive

Poor

Poor

Oligopoly Excessive

Poor

Poor

Monopolisti

Market Structures by Prof. Tarun Das

Fair

Good

Fair

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4.4 Strategy-Conduct-Performance (SCP) Analysis – Performance and Equilibrium Conditions Market Equity and Equilibrium employmen conditions Type t Perfect competition

Good

MC=MR=P=AR

Monopoly

Poor

MC=MR=P(1-1/Ep)

Oligopoly Monopolisti c competition

Poor Fair

MC=MR for all MC=MR=P(1-1/Ep)

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4.5 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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4.5 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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4.6 Review Question -SCP Approach 1. (a) Provide a structure-conductperformance (SCP) analysis, in a tabular form, for perfect competition, monopoly and monopolistic competition. (b) What are the criticisms by Baumol, Chicago school and Austrian school against the SCP analysis? Do you agree with their views? Market Structures by Prof. Tarun Das

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Thank you Have a Good Day

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