Module-3

Market Structures
• Market structures refer to the organizational and competitive
characteristics of a market that influence the behavior of firms and
their pricing strategies. The structure of a market is determined by
several factors, including the number of firms in the market, the type
of products they sell, the ease of entry and exit, and the degree of
competition.
Perfect Competition
• market structure characterized by a large number of small firms, homogeneous
products, perfect information, and no barriers to entry or exit. In this market, no
single firm has significant market power, and prices are determined by supply and
demand.
• Key Features:
• Many buyers and sellers
• Homogeneous (identical) products
• Free entry and exit
• Perfect information
• Free Entry and Exit
• Price Takers
• No Transaction Costs

• Example: Agricultural markets, such as those for wheat or rice.Individual farmers sell a standardized
product, and no single farmer can influence the market price.
Monopoly
• where a single seller or producer controls the entire supply of a
product or service, leading to significant market power. Monopolies
can set prices above the equilibrium level, resulting in higher profits.
• Key Features:
• Single seller
• Unique product with no close substitutes
• High barriers to entry (e.g., legal, technological)
• Example: water or electricity
 Monopolistic Competition
• a large number of firms that sell similar but differentiated products. In this type of market, each firm has
some degree of market power, allowing them to set prices above marginal cost. Unlike perfect competition,
firms in monopolistic competition can differentiate their products, which gives them some control over
pricing.
• Key Features:
1. Many Sellers:
The market consists of numerous firms, each with a relatively small market share. No single firm can dominate the market.
2. Product Differentiation:
Firms offer products that are similar but not identical. This differentiation can be based on quality, branding, features, or
customer service.
3. Some Market Power:
Because products are differentiated, firms have some degree of market power. They can set prices based on their unique
offerings rather than being price takers.
4. Free Entry and Exit:
There are low barriers to entry, allowing new firms to enter the market easily when they see potential profits. Similarly,
firms can exit the market if they are not profitable.
5. Non-Price Competition:
Firms often compete through advertising, marketing, and product differentiation rather than solely on price. This can
enhance brand loyalty among consumers.
Examples?
Oligopoly
• a small number of firms that dominate the market. These firms have
significant market power and can influence prices and production levels.
Oligopolistic firms may engage in collusion or competition, leading to
various pricing strategies.
• Key Features:
• Few large firms
• Products may be homogeneous or differentiated
• Significant barriers to entry
• Interdependence among firms
• Example: The automobile industry is a prominent example of oligopoly,
where a few large companies (like Ford, General Motors, and Toyota)
dominate the market.
 Comparison of Market Structures
Perfect Monopolistic
Feature Oligopoly Monopoly
Competition Competition

Number of Firms Many Many Few One

Homogeneous or
Type of Products Homogeneous Differentiated Unique
Differentiated

Significant Complete (Price

Control over Price None (Price taker) Some
(Interdependence) maker)

Barriers to Entry None Low High Very High

Clothing, Utilities (e.g.,

Examples Agricultural products Cars, Airlines
Restaurants electricity)
 Why does the demand curve of a firm facing
perfect competition is perfectly elastic?
• Because market price = individual Price
• Homogeneous Products
• all firms sell identical or homogeneous products. This means that consumers view the products from different firms as perfect
substitutes. If one firm tries to raise its price above the market equilibrium price, consumers will switch to other firms that sell
the same product at the lower price.
• Large Number of Sellers:
• There are many firms in a perfectly competitive market. Each firm has a very small market share relative to the
entire market. As a result, no single firm can influence the market price.
• Price Taker:
• Firms in perfect competition are "price takers." This means they accept the market price determined by the forces
of supply and demand. They have no control over the price and must sell their products at the prevailing market
price. If they attempt to charge a higher price, they will sell nothing, as consumers will buy from competitors.
• Perfect Information:
• Consumers have complete knowledge of prices and product quality in perfect competition. If a firm raises its price,
consumers will quickly find out and shift their purchases to other firms offering the same product at the market
price. This leads to a perfectly elastic demand for the individual firm.
Monopoly:

● The monopolist maximizes profit where MR = MC.

● The price is set on the demand curve at the
corresponding quantity.
● The monopolist produces less output and charges a
higher price compared to a competitive firm.

Monopolistic Competition:

● Firms maximize profit in the short run where MR = MC.

● In the long run, entry and exit of firms lead to zero
economic profit. Firms break even as the demand
curve shifts due to competition, and the price equals
average total cost (ATC).
Price – Output determination under
oligopoly
• In an oligopoly, where firms are highly interdependent, they often avoid
price wars to maintain profitability and instead engage in non-price
competition. This type of competition focuses on increasing market share
through methods other than lowering prices.
• Product Differentiation
• Advertising and Marketing
• Sales Promotions
• Customer Service
• Product Innovation
• Packaging and Branding
• Quality and Features
• After-Sales Service
 kinked demand curve model under oligopoly
- Why price is rigid under oligopoly?
• The kinked demand curve is a model used to explain
price rigidity in an oligopoly, where firms are reluctant
to change prices due to the asymmetric reactions of
competitors.
• If a firm raises its price, competitors will not follow,
causing the firm to lose a significant share of its
customers.
• If a firm lowers its price, competitors will match the price
reduction to maintain their market share, leading to only a
small increase in the firm’s customers.
• As a result, the demand curve for the firm is:
• Elastic for price increases (upper part of the demand
curve).
• Inelastic for price decreases (lower part of the
demand curve). The firm faces a "kink" at the current
market price, leading to price rigidity, where prices
tend to remain stable even when costs fluctuate.
 Collusive oligopoly
• Collusive oligopoly refers to a situation in which firms in an oligopolistic market collaborate or cooperate with
one another, rather than competing, to maximize their joint profits. This type of behavior reduces competition
and allows firms to act as a monopoly, setting prices and output levels that benefit all members of the collusion.
• Types of Collusion:
1. Explicit Collusion (Cartels):
1. Firms openly agree to coordinate their pricing and production strategies.
2. The most formal type of collusion is a cartel, where firms sign agreements to fix prices, control output, or divide markets.
3. Example: The Organization of Petroleum Exporting Countries (OPEC) is a well-known cartel, where member countries coordinate their
oil production levels to influence global oil prices.
2. Tacit Collusion:
1. Firms do not have a formal agreement, but they indirectly cooperate by following each other’s pricing strategies or output levels. This is
often referred to as price leadership, where one firm (usually the dominant firm) sets the price, and other firms follow.
2. Example: In the airline industry, a dominant airline might increase ticket prices, and other airlines would follow without any formal
agreement. This maintains high prices across the market without direct communication or agreement.
• How Collusive Oligopoly Works:
• Firms agree on key aspects like:
• Price fixing: Setting a common price to avoid price competition.
• Output quotas: Limiting production to ensure prices remain high.
• Market division: Dividing regions or customer groups to avoid competition.
Demand Curve, Average Revenue (AR), and
Marginal Revenue (MR) Curve Under Monopoly
• Demand Curve:
• downward sloping, meaning that as the price
decreases, the quantity demanded increases. it
reflects the lack of close substitutes and the
monopolist’s market power.
• Average Revenue (AR):
• In a monopoly, AR is equal to the price of the
product. The AR curve is also the same as the
demand curve because it shows the price at which
different quantities can be sold.
• Marginal Revenue (MR):
• In a monopoly, the MR curve is below the AR curve.
This is because to sell an additional unit, the
monopolist must lower the price for all previous
units sold. Therefore, the MR increases at a
decreasing rate.
Equilibrium under Monopoly
• Under monopoly, for the equilibrium and price
determination there are two different conditions
which are:
• Marginal revenue must be equal to marginal cost.
• MC must cut MR from below.
• The monopoly will produce up to the level where
MC=MR. This limit will indicate equilibrium output.
• The monopolist is in equilibrium at point E
because at point E both the conditions of
equilibrium are fulfilled i.e., MR = MC and MC
intersects the MR curve from below. Therefore, in
this case total profits of the monopolist will be
equal to shaded area ABDC.
 Equilibrium
Comparison: Monopoly vs. Monopolistic 1.Monopoly:
Competition 1. Diagram:
1. The monopolist sets output where MC = MR
2. The firm earns supernormal profits in the
Aspect Monopoly Monopolistic Competition long run, represented by the shaded area
between Price and Average Cost (AC).
2. Key Features:
Number of Firms One firm dominates the Many firms with 1. No competition.
market differentiated products.
2. Price is higher and output lower than in a
Product Differentiation No close substitutes, unique Differentiated products competitive market.
product. (branding, quality). 2.Monopolistic Competition:
1. Diagram:
Market Power Price maker, full control over Some control over price due
market price. to product differentiation. 1. Firms set output where MC = MR, just like a
monopoly
2. In the short run, firms may earn supernormal
Barriers to Entry High barriers (legal, Low to moderate, easier for profits, but in the long run, as new firms
technological, etc.). new firms to enter. enter the market, profits are eroded to
Long-run Profits Supernormal profits possible Only normal profits in the normal profits.
in the long run. long run due to competition. 3. The equilibrium price is found on the
Demand (AR) curve.
2. Key Features:
Demand Curve Downward sloping inelastic. Downward sloping, elastic 1. In the long run, firms only earn normal
due to substitutes. profits.
2. The firm operates at excess capacity, as it
Advertising Not significant, no direct Important for differentiation
competition and brand loyalty does not produce at the minimum point on
the Average Cost (AC) curve.
 pricing and methods used for pricing
• Pricing decisions take into account factors like production costs, market demand, competition,
consumer behavior, and overall business goals.
• 1. Cost-Based Pricing
• Cost-Plus Pricing (Markup Pricing)
• The price is set by adding a fixed percentage (markup) to the total cost of producing or acquiring the
product.
• Price = Cost + (Cost × Markup Percentage)
• 2. Competition-Based Pricing
• The price is based on the average market price or the price charged by major competitors.
• 3. Value-Based Pricing
• Psychological Pricing
• Dynamic and Demand-Based Pricing
• Skimming Pricing
• firm sets a high initial price for a new or innovative product and then gradually lowers it over time.
 pricing and methods used for pricing
• Mark-up Pricing
• A pricing strategy where a firm adds a set amount or percentage to the cost of a product to determine its
selling price.
• Selling Price=Cost Price+(Cost Price×Mark-up Percentage)
• If the cost of producing a smartphone is $300, and the firm applies a 30% mark-up:Selling Price=300+(300×0.30)=300+90=390
• Target Return Pricing
• firm sets prices to achieve a specific return on investment (ROI) or target profit.
• Price=Fixed Costs+Variable Costs+Target Profit​/Number of Units Sold
• Penetration Pricing
• sets a low initial price for a new product to quickly attract customers and gain market share.
• Predatory pricing
• firm deliberately sets prices extremely low, often below production costs, to eliminate or weaken competitors.
Once competitors are driven out of the market, the firm can raise prices and enjoy greater market control
• Amazon
• Going rate pricing
• firm sets the price of its product or service based on the prevailing market rates or competitor
pricing.
Forms of non-price competition
• Non-price competition involves strategies to increase market share
without altering prices.
• Product Differentiation, Features, Quality, Design: Firms make their products
stand out through unique features, higher quality, or innovative design.
• Advertising and Marketing
• Branding, Promotions, Sponsorships:
• Customer Service
• Support, Warranty, After-sales Service
• Loyalty Programs
• Rewards, Discounts for Repeat Purchases