ch11(Forms of Market)

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Chapter 11 Forms of Markets:

Chapter 11 Forms of Markets

Introduction:

Introduction Essential features of a market: Commodity must exist Buyers and sellers There must be an area for interaction Is the internet a market?

Alternative Forms of Markets:

Classifying markets by degree of competition Number of firms Nature of product Degree of freedom to enter and exit an industry The four market structures Perfect competition Monopoly Monopolistic competition Oligopoly Structure Conduct Performance Alternative Forms of Markets

Perfect Competition:

Perfect Competition Features Very large number of buyers and sellers Homogenous products Freedom of entry and exit to the industry Perfect knowledge of market Perfect mobility of factors of production Absence of transport costs

Very Large Number of Buyers & Sellers:

Very Large Number of Buyers & Sellers Firm is the price taker Each firm forms an insignificant part of the market No firm can influence the market price Firm is a price taker Industry is the price maker Price is given exogenously to the firm – Price Line

Firm is a Price Taker under perfect competition:

Firm is a Price Taker under perfect competition O O S D (a) Industry Quantity (millions) Quantity (thousands) Price Revenue

Firm is a Price Taker under perfect competition:

Firm is a Price Taker under perfect competition O O S D (a) Industry P e (b) Firm Quantity (millions) Quantity (thousands) Price Revenue

Firm is a Price Taker under perfect competition:

Firm is a Price Taker under perfect competition O O S D (a) Industry P e (b) Firm AR D = AR = MR Quantity (millions) Quantity (thousands) Price Revenue Price Line

Homogenous Product:

Homogenous Product Product sold by different firms are identical Product of one firm is exactly the same as product of another firm Products are perfect substitutes Demand is perfectly elastic

Freedom to Entry & Exit:

Freedom to Entry & Exit No costs attached to enter or exit industry Distinction between short and long run Short-run equilibrium of the firm P = MC Firm can earn supernormal profits Firm can incur losses Long run equilibrium of the firm Firm can earn only normal profits

Short-run equilibrium of industry and firm under perfect competition:

Short-run equilibrium of industry and firm under perfect competition O O S D (a) Industry P e (b) Firm AR D = AR = MR MC Q e Quantity (millions) Quantity (thousands) Price Revenue / Costs

Short-run equilibrium of industry and firm under perfect competition:

Short-run equilibrium of industry and firm under perfect competition O O S D (a) Industry P e (b) Firm AR D = AR = MR MC Q e AC AC Quantity (millions) Quantity (thousands) Price Revenue / Costs

Short-run equilibrium of industry and firm under perfect competition – Super Normal Profits:

Short-run equilibrium of industry and firm under perfect competition – Super Normal Profits O O S D (a) Industry P e (b) Firm AR D = AR = MR MC Q e AC AC Quantity (millions) Quantity (thousands) Price Revenue/ Costs Supernormal Profits

Short-run equilibrium of industry and firm under perfect competition:

Short-run equilibrium of industry and firm under perfect competition O O S D (a) Industry Quantity (millions) Quantity (thousands) Price Revenue / Costs

Short-run equilibrium of industry and firm under perfect competition:

Short-run equilibrium of industry and firm under perfect competition O O S D (a) Industry P e Quantity (millions) Quantity (thousands) Price Revenue / Costs

Short-run equilibrium of industry and firm under perfect competition:

Short-run equilibrium of industry and firm under perfect competition O O S D (a) Industry P e (b) Firm AR D = AR = MR Quantity (millions) Quantity (thousands) Price Revenue/ Costs

Short-run equilibrium of industry and firm under perfect competition:

Short-run equilibrium of industry and firm under perfect competition O O S D (a) Industry P e (b) Firm AR D = AR = MR MC Q e Quantity (millions) Quantity (thousands) Price Revenue / Costs

Short-run equilibrium of industry and firm under perfect competition:

Short-run equilibrium of industry and firm under perfect competition O O S D (a) Industry P e (b) Firm AR D = AR = MR MC Q e AC Quantity (millions) Quantity (thousands) Price Revenue / Costs AC

Short-run equilibrium of industry and firm under perfect competition – Abnormal Losses:

Short-run equilibrium of industry and firm under perfect competition – Abnormal Losses O O S D (a) Industry P e (b) Firm AR D = AR = MR MC Q e AC AC Quantity (millions) Quantity (thousands) Price Revenue/ Costs Abnormal Losses

Perfect Competition:

Long-run equilibrium of the firm All supernormal profits competed away All abnormal losses are nullified All firms earn only normal profits Perfect Competition

Long Run Equilibrium under Perfect Competition:

O O D (a) Industry P 1 (b) Firm LRAC AR 1 S 1 D 1 LMC Quantity (millions) Quantity (thousands) Price Revenue / Costs Long Run Equilibrium under Perfect Competition

Long Run Equilibrium under Perfect Competition:

O O S 1 D (a) Industry P 1 (b) Firm AR 1 S 2 D 1 Quantity (millions) Quantity (thousands) Price Revenue / Costs LRAC LMC Long Run Equilibrium under Perfect Competition

Long Run Equilibrium under Perfect Competition:

O O S 1 D (a) Industry P 1 (b) Firm AR 1 P L AR L Q L S 2 D 1 D L Quantity (millions) Quantity (thousands) Price Revenue / Costs LRAC LMC Long Run Equilibrium under Perfect Competition

Long Run Equilibrium under Perfect Competition:

O O D (a) Industry P 1 (b) Firm AR 1 S 1 D 1 Quantity (millions) Quantity (thousands) Price Revenue / Costs LRAC LMC Long Run Equilibrium under Perfect Competition

Long Run Equilibrium under Perfect Competition:

O O S 1 D (a) Industry P 1 (b) Firm AR 1 S 2 D 1 Quantity (millions) Quantity (thousands) Price Revenue/ Costs LRAC LMC Long Run Equilibrium under Perfect Competition

Long Run Equilibrium under Perfect Competition:

O O S 1 D (a) Industry P 1 (b) Firm AR 1 P L AR L Q L S 2 D 1 D L Quantity (millions) Quantity (thousands) Price Revenue/ Costs LRAC LMC Long Run Equilibrium under Perfect Competition

Long-run equilibrium of the firm under perfect competition:

Long-run equilibrium of the firm under perfect competition Quantity O AR = MR (SR)AC LRAC (SR)MC D L LRAC = (SR)AC = (SR)MC = MR = AR Revenue/ Costs

Perfect Knowledge:

Perfect Knowledge Perfect knowledge exists between buyers and sellers Ensures uniform market price

Perfect Mobility of Factors of Production:

Perfect Mobility of Factors of Production Factors can move freely in and out of the industry No transportation costs Results in uniform price across all firms

Shape of the AR and MR Curves of a firm:

Shape of the AR and MR Curves of a firm O O S D (a) Industry P e (b) Firm AR D = AR = MR Quantity (millions) Quantity (thousands) Price Revenue Horizontal curves Parallel to x- axis

Demand & Supply Curves:

Demand & Supply Curves Demand curve is horizontal to the x- axis Reflects demand is perfectly elastic Supply Curve Upward sloping part of the marginal cost curve

Equilibrium Output of a Firm:

INDUSTRY FIRM Price Demand Supply Price Quantity TR AR MR MC Per unit Sold 2000 1000 60 15 900 60 60 50 40 1800 1500 60 16 960 60 60 60 60 1600 1600 60 17 1020 60 60 70 80 1400 1800 60 18 1080 60 60 80 Equilibrium Output of a Firm Equilibrium output is where P=MC Industry equilibrium at Price = Rs 60

Equilibrium Output of a Firm:

INDUSTRY FIRM Price Demand Supply Price Quantity TR AR MR MC perunit Sold 2000 1000 60 15 900 60 60 50 40 1800 1500 60 16 960 60 60 60 60 1600 1600 60 17 1020 60 60 70 80 1400 1800 60 18 1080 60 60 80 Equilibrium Output of a Firm Equilibrium output is where P=MC Different firms will produce different levels of output based on their cost structures

Monopoly:

Defining monopoly Single seller No close substitutes Barriers to entry Think of some examples of monopolies in India Monopoly

Single Seller:

Single Seller Sole seller of the commodity Firm constitutes the industry Firm is a price maker Considerable influence on market price

Absence of Close Substitutes:

Absence of Close Substitutes Consumer can not get another commodity that is closely related to the monopolist’s product Eg: no close substitutes to electricity or potable water Demand is relatively inelastic

Barriers to Entry:

Barriers to Entry Types of barriers Ownership of strategic raw materials or exclusive knowledge of production techniques Patent rights Government licensing Natural Monopolies Ensures monopolist can earn supernormal profits in the long run Can earn supernormal profits or abnormal losses in the short run

Price Discrimination:

Price Discrimination When the same product is sold at different prices to different buyers To practice price discrimination Markets to be sub – divided into different demand elasticities No interaction between different buyers

Shape of AR & MR Curves:

Units sold Price TR AR MR 1 5 5 5 5 2 4 8 4 3 3 3 9 3 1 4 2 8 2 - 1 Shape of AR & MR Curves MR 0 Output Revenue AR Downward sloping curves MR is less than AR

Equilibrium Output :

Equilibrium Output Equilibrium price and output MC = MR Q O MC Q m MR Cost / Revenue

Equilibrium Output :

Equilibrium Output Equilibrium price and output MC = MR Q O MC Q m MR AR Cost / Revenue a AR

Equilibrium Output :

Equilibrium Output Equilibrium price and output MC = MR Q O AC MC AR AC Q m MR AR Cost / Revenue a b

Equilibrium Output :

Equilibrium Output Equilibrium price and output MC = MR Q O AC MC AR AC Q m MR AR Cost / Revenue Supernormal Profits

Monopolistic Competition:

Monopolistic Competition Features of monopolistic competition Large number of buyers & sellers Differentiated product Selling Costs exist Freedom of entry and exit Examples Soap industry: Lux, Medimix, Cinthol, Margo etc Fan industry: Crompton Greaves, Bajaj, Usha, Orient etc

Features of Monopolistic Competition:

Features of Monopolistic Competition Large number of buyer & sellers Not as large as perfect competition Firm has marginal influence over price of product Product Differentiation Products are closely similar to each other Colour, size, shape, taste etc Creates an impression in the minds of the buyer that the product is different to that sold by other firms

Features of Monopolistic Competition:

Features of Monopolistic Competition Selling Costs Introduced by Edward Chamberlain Selling expenses incurred to create product differentiation Could be in terms of: Sales promotion gimmicks Packaging Advertising Could be: Constructive: provides useful information Combative: attempts to lure customers from competition

Features of Monopolistic Competition:

Features of Monopolistic Competition Free entry and exit Short run Firms can earn supernormal profits Firms can incur abnormal losses Long run Firms can earn only normal profits Equilibrium output produced by a firm MR = MC

Short run equilibrium of the firm under monopolistic competition:

Short run equilibrium of the firm under monopolistic competition Q O AC MR AR / D P s Q s MC Cost / Revenue (Rs)

Short run equilibrium of the firm under monopolistic competition:

Short run equilibrium of the firm under monopolistic competition Q O AC MR AR / D P s Q s MC AC s Cost / Revenue (Rs)

Short run equilibrium of the firm under monopolistic competition:

Short run equilibrium of the firm under monopolistic competition Q O AC MR AR / D P s Q s MC AC s Cost / Revenue (Rs) Supernormal Profits

Short run equilibrium of the firm under monopolistic competition:

Short run equilibrium of the firm under monopolistic competition Q O AC MR AR / D P s Q s MC AC s Cost / Revenue (Rs)

Short run equilibrium of the firm under monopolistic competition:

Short run equilibrium of the firm under monopolistic competition Q O AC MR AR / D P s Q s MC AC s Cost / Revenue (Rs) Abnormal Losses

Long run equilibrium of the firm under monopolistic competition:

Q O LRAC MR L AR L / D L P L Q L LRMC Long run equilibrium of the firm under monopolistic competition Cost / Revenue (Rs) E

Monopolistic Competition:

Monopolistic Competition Demand Curve Downward sloping Relatively Elastic due to large number of close substitutes Q O D Price D

Oligopoly:

Oligopoly Key features of oligopoly Few firms Interdependence of firms Barriers to entry & exit Price Rigidity Price wars Tacit Collusion Group Behaviour Firms behave as if they were one firm Retain their individuality Examples: Cartels: OPEC Price Leadership: Cement Industry