Market structure
- 1. MARKET STRUCTURE BY: ABHISHEK KUMAR PANDEY
- 2. MARKET • “market” refers to a particular place where goods are purchased and sold. But, in economics, market is used in a wide perspective. In economics, the term “market” does not mean a particular place but the whole area where the buyers and sellers of a product are spread.
- 3. CHARACTERISTICS OF MARKET: The essential features of a market are: (1) An Area: In economics, a market does not mean a particular place but the whole region where sellers and buyers of a product ate spread. Modem modes of communication and transport have made the market area for a product very wide. (2) One Commodity: In economics, a market is not related to a place but to a particular product. Hence, there are separate markets for various commodities. For example, there are separate markets for clothes, grains, jewellery, etc.
- 4. (3) Buyers and Sellers: The presence of buyers and sellers is necessary for the sale and purchase of a product in the market. In the modem age, the presence of buyers and sellers is not necessary in the market because they can do transactions of goods through letters, telephones, business representatives, internet, etc. (4) Free Competition: There should be free competition among buyers and sellers in the market. This competition is in relation to the price determination of a product among buyers and sellers. (5) One Price: The price of a product is the same in the market because of free competition among buyers and sellers.
- 5. DETERMINANTS: There are a number of determinants of market structure for a particular good. They are: (1) The number and nature of sellers. (2) The number and nature of buyers. (3) The nature of the product. (4) The conditions of entry into and exit from the market. (5) Economies of scale.
- 6. TYPES OF MARKET: On the basis of competition, a market can be classified in the following ways: 1. Perfect Competition 2. Monopoly 3. Duopoly 4. Oligopoly 5. Monopolistic Competition
- 10. PERFECT COMPETITION Perfect competition happens when numerous small firms compete against each other. Firms in a competitive industry produce the socially optimal output level at the minimum possible cost per unit.
- 11. FEATURES OF PERFECT COMPETITION • Many firms. • Freedom of entry and exit; this will require low sunk costs. • All firms produce an identical or homogeneous product. • All firms are price takers, therefore the firm’s demand curve is perfectly elastic. • There is perfect information and knowledge.
- 13. DIAGRAM FOR PERFECT COMPETITION
- 14. • THE INDUSTRY PRICE IS DETERMINED BY THE INTERACTION OF SUPPLY AND DEMAND, LEADING TO A PRICE OF PE. • The individual firm will maximise output where MR = MC at Q1. • In the long run firms will make normal profits.
- 15. EXAMPLES OF PERFECT COMPETITION • Foreign exchange markets. Here currency is all homogeneous. Also traders will have access to many different buyers and sellers. There will be good information about relative prices. When buying currency it is easy to compare prices • Agricultural markets. In some cases, there are several farmers selling identical products to the market, and many buyers. At the market, it is easy to compare prices. Therefore, agricultural markets often get close to perfect competition. • Internet related industries. The internet has made many markets closer to perfect competition because the internet has made it very easy to compare prices, quickly and efficiently (perfect information). Also, the internet has made barriers to entry lower. For example, selling a popular good on internet through a service like e-bay is close to perfect competition. It is easy to compare the prices of
- 16. MONOPOLY • A monopoly is a firm that has no competitors in its industry. It reduces output to drive up prices and increase profits. By doing so, it produces less than the socially optimal output level and produces at higher costs than competitive firms.
- 17. A monopoly maximises profits where MR=MC (at point m). It sets a price of Pm and quantity Qm.
- 18. PROBLEMS OF MONOPOLY • Higher prices. Firms with monopoly power can set higher prices (Pm) than in a competitive market (Pc). (Red area is supernormal profit) • Allocative inefficiency. A monopoly is allocatively inefficient because in monopoly (at Qm) the price is greater than MC. (P > MC). In a competitive market, the price would be lower and more consumers would benefit from buying the good. A monopoly results in dead-weight welfare loss indicated by the blue triangle. (this is net loss of producer and consumer surplus) • Productive inefficiency A monopoly is productively inefficient because the output does not occur at the lowest point on the AC curve. • X – Inefficiency. – It is argued that a monopoly has less incentive to cut costs because it doesn’t face competition from other firms.Therefore the AC curve is higher than it should be. • Supernormal Profit. A monopolist makes Supernormal Profit Qm * (AR – AC ) leading to an unequal distribution of income in society. • Higher prices to suppliers – A monopoly may use its market power (monopsony power) and pay lower prices to its suppliers. E.g. supermarkets have been criticised for paying low prices to farmers. This is because farmers have little alternative but to supply supermarkets who have dominant buying power. • Diseconomies of scale – It is possible that if a monopoly gets too big it may experience dis-economies of scale. – higher average costs because it gets too big and difficult to coordinate. • Lack of incentives. A monopoly faces a lack of competition, and therefore, it may have less incentive to work at product innovation and develop better products. • Lack of choice. Consumers in a monopoly market face a lack of choice. In some markets – clothing, choice is as important as price
- 19. HOW MONOPOLIES CAN DEVELOP • Horizontal Integration. Where two firms join at the same stage of production, e.g. two banks such as TSB and Lloyds • Vertical Integration. Where a firm gains market power by controlling different stages of the production process. A good example is the oil industry, where the leading firms produce, refine and sell oil. • Legal Monopoly. E.g. Royal Mail or Patents for producing a drug. • Internal Expansion of a firm. Firms can increase market share by increasing their sales and possibly benefiting from economies of scale. For example, Google became a monopoly through dominating the search engine market. • Being the first firm e.g. Microsoft has created monopoly power by being the first firm.
- 20. REGULATION OF MONOPOLIES Governments can regulate monopolies. This, in theory, can enable the best of both worlds. Economies of scale and lower prices. Monopoly regulation can include: • Price capping RPI-X to limit price increases • Prevent mergers • Windfall tax on monopoly profit. • Investigating abuse of monopoly power, e.g. collusion.
- 21. . DUOPOLY: • Duopoly is a special case of the theory of oligopoly in which there are only two sellers. Both the sellers are completely independent and no agreement exists between them. Even though they are independent, a change in the price and output of one will affect the other, and may set a chain of reactions. A seller may, however, assume that his rival is unaffected by what he does, in that case he takes only his own direct influence on the price.
- 22. OLIGOPOLY • An oligopoly is an industry with only a few firms. If they collude, they reduce output and drive up profits the way a monopoly does. However, because of strong incentives to cheat on collusive agreements, oligopoly firms often end up competing against each other.
- 23. THE MAIN FEATURES OF OLIGOPOLY: • An industry which is dominated by a few firms. • UK definition of an oligopoly is a five firm concentration ratio of more than 50% (this means the five biggest firms have more than 50% of the total market share) See also: Concentration ratios • Interdependence of firms – companies will be affected by how other firms set price and output. • Barriers to entry, but less than monopoly. • Differentiated products, advertising is often important. • Oligopoly is the most common market structure
- 24. FIRMS IN OLIGOPOLY There are different possible ways that firms in oligopoly will compete and behave this will depend upon: • The objectives of the firms; e.g. profit maximisation or sales maximisation? • The degree of contestability; i.e. barriers to entry. Government regulation. • There are different possible outcomes for oligopoly: • Stable prices (e.g. through kinked demand curve) – firms concentrate on non-price competition • Price wars (competitive oligopoly) • Collusion for higher prices.
- 25. THE KINKED DEMAND CURVE MODEL This model suggests that prices will be fairly stable and there is little incentive for firms to change prices. Therefore, firms compete using non-price competition methods. • This assumes that firms seek to maximise profits. • If they increase the price, then they will lose a large share of the market because they become uncompetitive compared to other firms. Therefore demand is elastic for price increases. • If firms cut price then they would gain a big increase in market share. However, it is unlikely that firms will allow this. Therefore other firms follow suit and cut price as well. Therefore demand will only increase by a small amount. Therefore demand is inelastic for a price cut. • Therefore this suggests that prices will be rigid in oligopoly
- 26. • The diagram above suggests that a change in marginal cost still leads to the same price, because of the kinked demand curve. Profit
- 27. EVALUATION OF KINKED DEMAND CURVE • In the real world, prices do change. • Firms may not seek to maximise profits, but prefer to increase market share and so be willing to cut prices, even with inelastic demand. • Some firms may have very strong brand loyalty and be able to increase price without demand being very price elastic. • The model doesn’t suggest how prices were arrived at in the first place.
- 28. PRICE WARS • Firms in oligopoly may still be very competitive on price, especially if they are seeking to increase market share. In some circumstances, we can see oligopolies where firms are seeking to cut prices and increase competitiveness. • A feature of many oligopolies is selective price wars. For example, supermarkets often compete on the price of some goods (bread/special offers) but set high prices for other goods, such as luxury cake.
- 29. COLLUSION • Another possibility for firms in oligopoly is for them to collude on price and set profit maximising levels of output. This maximises profit for the industry. • Collusion is illegal, but tacit collusion may be hard to spot. • For collusion to be effective, there need to be barriers to entry. • A cartel is a formal collusive agreement. For example, OPEC is a cartel seeking to control the price of oil.
- 30. MONOPOLISTIC COMPETITION: • In monopolistic competition, an industry contains many competing firms, each of which has a similar but at least slightly different product. Restaurants, for example, all serve food but of different types and in different locations. Production costs are above what could be achieved if all the firms sold identical products, but consumers benefit from the variety.
- 31. A MONOPOLISTIC COMPETITIVE INDUSTRY FEATURES: • Many firms. • Freedom of entry and exit. • Firms produce differentiated products. • Firms have price inelastic demand; they are price makers because the good is highly differentiated • Firms make normal profits in the long run but could make supernormal profits in the short term • Firms are allocatively and productively inefficient.
- 32. In the short run, the diagram for monopolistic competition is the same as for a monopoly. The firm maximises profit where MR=MC. This is at output Q1 and price P1, leading to supernormal profit
- 33. MONOPOLISTIC COMPETITION LONG RUN In the long-run, supernormal profit encourages new firms to enter. This reduces demand for existing firms and leads to normal profit.
- 34. EXAMPLES OF MONOPOLISTIC COMPETITION • Restaurants – restaurants compete on quality of food as much as price. Product differentiation is a key element of the business. There are relatively low barriers to entry in setting up a new restaurant. • Hairdressers. A service which will give firms a reputation for the quality of their hair-cutting. • Clothing. Designer label clothes are about the brand and product differentiation • TV programmes – globalisation has increased the diversity of tv programmes from networks around the world. Consumers can choose between domestic channels but also imports from other countries and new services, such as Netflix.
- 35. LIMITATIONS OF THE MODEL OF MONOPOLISTIC COMPETITION • Some firms will be better at brand differentiation and therefore, in the real world, they will be able to make supernormal profit. • New firms will not be seen as a close substitute. • There is considerable overlap with oligopoly. Except the model of monopolistic competition assumes no barriers to entry. In the real world, there are likely to be at least some barriers to entry • If a firm has strong brand loyalty and product differentiation – this itself becomes a barrier to entry. A new firm can’t easily capture the brand loyalty. • Many industries, we may describe as monopolistically competitive are very profitable, so the assumption of normal profits is too simplistic.
- 36. KEY DIFFERENCE WITH MONOPOLY • In monopolistic competition there are no barriers to entry. Therefore in long run, the market will be competitive, with firms making normal profit. • Key difference with perfect competition • In Monopolistic competition, firms do produce differentiated products, therefore, they are not price takers (perfectly elastic demand). They have inelastic demand.
- 37. NEW TRADE THEORY AND MONOPOLISTIC COMPETITION • New trade theory places importance on the model of monopolistic competition for explaining trends in trade patterns. New trade theory suggests that a key element of product development is the drive for product differentiation – creating strong brands and new features for products. Therefore, specialisation doesn’t need to be based on traditional theories of comparative advantage, but we can have countries both importing and exporting the same good. For example, we import Italian fashion labels and export British fashion labels. To consumers, the importance is the choice of goods. •