Market Structures PDF

Market Market Structures Structures Features of the four market structures Doctors Soft Drink Railways , IRCTC (India)  ALTERNATIVE MARKET STRUCTURES Classifying markets by degree of competition – numbe...

Market Market Structures Structures Features of the four market structures Doctors Soft Drink Railways , IRCTC (India)  ALTERNATIVE MARKET STRUCTURES Classifying markets by degree of competition – number of firms – freedom of entry to industry – nature of product – nature of demand curve The four market structures – perfect competition – monopoly – monopolistic competition – Oligopoly Structure conduct performance  Market Structure Perfect Competition Competitive Less Monopolistic Competition Competitive Oligopoly Monopoly More What is the market structure of traditional potato farming?  Top Countries in Potatoes Production - Source FAO Source: https://www.potatonewstoday.com/2023/01/21/global-potato-statistics- latest-fao-data-published/ Comparative Analysis  PERFECT COMPETITION Assumptions – Many Many buyers buyers and and sellers sellers – Firms (sellers) sellers) and and buyers buyers are are price price takers takers – freedom of entry – Product Product is is homogeneous homogeneous -- identical products – perfect knowledge – Example: Example: Agricultural Agricultural markets markets (Close (Close to to Perfect Perfect Competition)* Competition)*  ASSUMPTIONS/ Characteristics 1. Large numbers of sellers and buyers The industry or market includes a large number of firms (and buyers), so that each individual firm, however large, supplies only a small part of the total quantity offered in the market. Under these conditions each firm alone cannot affect the price in the market by changing its output. For example, there are 107,000 U.S. soybean farmers. If a typical grower drops out of the market, market supply falls by only 1/107,000 = 0.00093%, which would not affect the market price. Similarly, perfect competition requires large number of buyers as well- no single buyer will effect the market price too. Example, if firms sell to only a single buyer—such as producers of weapons that are allowed to sell to only the government—then the buyer can set the price and the market is not perfectly competitive.  2. Product homogeneity Firms in a perfectly competitive market sell identical or homogeneous products_ there is no way a buyer could differentiate among the products of different firms. Most agricultural products are homogeneous: Oil, gasoline, and raw materials such as copper, iron, cotton, and sheet steel are also fairly homogeneous. When products are homogeneous — no firm can raise the price of its product above the price of other firms without losing most or all of its business. In contrast, if the product were differentiated the firm would have some discretion in setting its price without losing all of its sales. In the automobile market—which is not perfectly competitive—the products are differentiated or heterogeneous - characteristics of a BMW 5 Series and a Honda Civic differ substantially. Honda Civics would not be very effective in preventing BMW from raising its price. Premium ice creams (Amul) can be sold at higher prices because THESE have different ingredients and is perceived by many consumers to be a higher-quality products than normal ones. Product homogeneity is important because it ensures that there is a single market price of the product.  3. Firm is a Price taker The assumptions of large numbers of sellers and product homogeneity imply that the individual firm has no power to determine the price and accepts the price decided in the market. Because each individual firm sells a sufficiently small proportion of total market output, its decisions have no impact on market price. Each firm takes the market price as given- it is a price-taker (Light Bulb Distributor)  3. Firm is a Price taker Why would a competitive firm be a price taker? Because it has no choice! At the given market price, the firm can sell as much as it wants at that price, so it has no incentive to lower its price. If a firm were to try to charge more than the market price, it would be unable to sell any of its output because consumers would buy the good at a lower price from other firms in the market. The assumption of price taking applies to consumers as well as firms. In a perfectly competitive market, each consumer buys such a small proportion of total industry output that he or she has no impact on the market price, and therefore takes the price as given. 4. Free Entry and Exit Free entry (or exit), means that there are no special costs that make it difficult for a new firm either to enter an industry and produce, or to exit if it cannot make a profit. The special costs that could restrict entry are costs which an entrant to a market would have to bear, but which a firm that is already producing would not. The ability of firms to enter and exit a market freely leads to a large number of firms in a market and promotes price taking. If barriers exist the number of firms in the industry may be reduced so that each one of them may acquire power to affect the price in the market. Pharmaceutical Industry and Aircraft Industry are not competitive due to restricted entry/entry costs. Free exit is also important: If firms can freely enter a market but cannot exit easily if prices decline, they might be reluctant to enter the market in response to a short-run profit opportunity in the first place. Free Entry & Exit also eliminates possibility of making excess profits. 5. Profit maximization The goal of all firms is profit maximization. No other goals are pursued. 6. No government regulation There is no government intervention in the PC market (tariffs, taxes, subsidies, ceilings, floor, and so on are ruled out). The market structure in which the above assumptions are fulfilled is called pure competition. It is different from perfect competition, which requires the fulfilment of the following additional assumptions.  7. Perfect mobility of factors of production Raw materials and other factors are not monopolized and labor is not unionized. The factors of production are free to move from one firm to another throughout the economy. It is also assumed that workers can move between different jobs, which implies that skills can be learned easily. There is perfect competition in the markets of factors of production.  8. Perfect knowledge/Full Information It is assumed that all sellers and buyers have complete knowledge of the conditions of the market. If buyers know that different firms are producing identical products and they know the prices charged by all firms, no single firm can unilaterally raise its price above the market equilibrium price. If it tried to do so, consumers would buy the identical product from another firm. If consumers are unaware that products are identical or they don’t know the prices charged by other firms, a single firm may be able to raise its price and still make sales. Information is free and costless. Under these conditions uncertainty about future developments in the market is ruled out. 9. Negligible Transaction Costs Perfectly competitive markets have very low transaction costs. Buyers and sellers do not have to spend much time and money finding each other or hiring lawyers to write contracts to execute a trade. If transaction costs are low, it is easy for a customer to buy from a rival firm if the customer’s usual supplier raises its price. In contrast, if transaction costs are high, customers might absorb a price increase from a traditional supplier. For example, because some consumers prefer to buy milk at a local convenience store rather than travel several miles to a supermarket, the convenience store can charge slightly more than the supermarket without losing all its customers. Revenue Concepts for a Price-taking Firm: Calculate TR, AR, MR Quantity sold Price (Units) (q) (£p) 10 3.00 11 3.00 12 3.00 13 3.00  Revenue Concepts for a Price-taking Firm: Calculate TR, AR, MR Quantity sold Price TR = p*q AR = TR/q MR = TR/q (Units) (q) (£p) (£) (£) (£) 10 3.00 30.00 3.00 3.00 11 3.00 33.00 3.00 3.00 12 3.00 36.00 3.00 3.00 13 3.00 39.00 3.00  Short-run equilibrium of industry and firm under perfect competition P Rs S Pe D O O Q (millions) (a) Industry  Short-run equilibrium of industry and firm under perfect competition P Rs S D= Pe AR AR P = MR D O O Q (millions) Q (thousands) (a) Industry (b) Firm  Short-run equilibrium of industry and firm under perfect competition P Rs S MC D= Pe AR AR= MR D O O Qe Q (millions) Q (thousands) (a) Industry (b) Firm  PERFECT COMPETITION Short-run equilibrium of the firm – P = MC – possible supernormal profits  Short-run equilibrium of industry and firm under perfect competition P Rs S MC AC D= Pe AR AR= MR AC D O O Qe Q (millions) Q (thousands) (a) Industry (b) Firm  Short-run equilibrium of industry and firm under perfect competition P Rs S MC AC D= Pe AR AR= MR AC D O O Qe Q (millions) Q (thousands) (a) Industry (b) Firm  Perfect Competition: Short-Run Equilibrium Firm’s Demand Curve = Market Price = = Average Revenue = Marginal Revenue Firm’s Supply Curve = Marginal Cost where Marginal Cost > Average Variable Cost  PERFECT COMPETITION Short-run equilibrium of the firm – P = MC – possible supernormal profits – short-run supply curve of firm  Short-Run Profit Maximization by a Competitive Firm Choosing Output in the Short Run Any perfectly competitive firm maximizes its profit at the output where its Total profit is Max or marginal profit is zero or where its marginal cost equals its marginal revenue. Because it faces a horizontal demand curve, a competitive firm can sell as many units of output as it wants at the market price, p. Thus, a competitive firm’s revenue, R(q) = pq, increases by p if it sells one more unit of output, so its marginal revenue equals the market price: MR(q) = d(pq)/dq = p. i.e.  Short-Run Profit Maximization by a Competitive Firm Choosing Output in the Short Run That is, because a competitive firm’s marginal revenue equals the market price, a profit-maximizing competitive firm produces the amount of output q* at which its marginal cost equals the market price MC(q*) = p.  For the quantity determined by above Equation to maximize profit, the second-order condition must hold - Because the firm’s marginal revenue, p, does not vary with q, dp/dq = 0. Thus, the second-order condition requires that MC must have a steeper slope than the MR curve or the MC must cut the MR curve from below.: This Equation requires that the marginal cost curve be upward sloping at q*. Canadian lime manufacturing industry- firm’s short- run decision The lime plant’s estimated average cost curve, AC, and MC functions are given in figure. If the market price of lime is p = $8 per metric ton, the competitive firm faces a horizontal demand curve (marginal revenue curve) at $8. The MC curve crosses the firm’s demand curve (or price or marginal revenue curve) at point e, where the firm’s output is 284 units (where a unit is a thousand metric tons). At a market price of $8, the competitive firm maximizes its profit by producing 284 units. If the firm produced fewer than 284 units, the market price would be above its marginal cost. The firm could increase its profit by expanding output because the firm earns more on the next ton, p = $8, than it costs to produce it, MC. If the firm were to produce more than 284 units, the market price would be below its marginal cost, MC , and the firm could increase its profit by reducing its output.  At 284 units, the firm’s profit is π in panel a can be calculated as area of shaded rectangle. The length of the rectangle is the number of units sold, q = 284,000 (or 284 units). The height of the rectangle is the firm’s average profit per unit. Because the firm’s profit is its revenue, R(q) = pq, minus its cost, π(q) = R(q) - C(q), its average profit per unit is the difference between the market price (or average revenue), p = R(q)/q = pq/q, and its average cost, AC = C(q)/q: At 284 units, the lime firm’s average profit per unit is $1.50 = p - AC(284) = $8 - $6.50, and the firm’s profit is π = $1.50 * 284,000 = $426,000. Panel b shows that this profit is the maximum possible profit because it is the peak of the profit curve.  Excess Profits or Losses in SR Firm in (short-run) equilibrium does not necessarily mean that it always makes excess profits. Whether the firm makes excess profits or losses depends on the level of the A TC at the short- run equilibrium. If the ATC is below the price at equilibrium (figure a) the firm earns excess profits (equal to the area PABe). If the ATC is above the price (figure b) the firm makes a loss (equal to the area FPeC).  Deriving the short-run supply curve P S Rs MC a D1 = MR1 P1 D1 O O Q1 Q (millions) Q (thousands) (a) Industry (b) Firm  Deriving the short-run supply curve P S Rs MC a D1 = MR1 P1 b D2 = MR2 P2 D1 D2 O O Q2 Q (millions) Q (thousands) (a) Industry (b) Firm  Deriving the short-run supply curve P S Rs MC a D1 = MR1 P1 b D2 = MR2 P2 c D3 = MR3 P3 D1 D2 D3 O O Q3 Q (millions) Q (thousands) (a) Industry (b) Firm  Deriving the short-run supply curve P S Rs S a D1 = MR1 P1 b D2 = MR2 P2 c D3 = MR3 P3 D1 D2 D3 O O Q (millions) Q (thousands) (a) Industry (b) Firm  PERFECT COMPETITION Short-run supply curve of industry Long-run equilibrium of the firm – all supernormal profits competed away  Perfect Competition: Long-Run Equilibrium Quantity is set by the firm so that short-run: Price = Marginal Cost = Average Total Cost Economic Profit < or > 0 At the same quantity, long-run: Price = Marginal Cost = Average Cost Economic Profit = 0 Questions  Consumers’ and Producers’ Surplus S Price E Consumer surplus Market price p0 Producers surplus D Total variable cost 0 q0 Quantity  Consumers’ and Producers’ Surplus  Consumers’ surplus is the area under the demand curve and above the market price line.  The equilibrium price and quantity are p0 and q0.  The total value that consumers place on q0 units of the product is given by the sum of the dark yellow, light yellow, and light blue areas.  The amount that they pay is p0q0, the rectangle that consists of the light yellow and light blue areas.  The difference, shown as the dark yellow area, is consumers’ surplus.  Consumers’ and Producers’ Surplus  Producers surplus is the area above the supply curve and below the market price line.  The receipts of producers from the sale of q0 units are also p0q0.  The area under the supply curve, the blue-shaded area, is total variable cost, which is the minimum amount that producers must receive to induce them to supply the output.  The difference, shown as the light yellow area, is producers’ surplus.  The Allocative Efficiency of Perfect Competition S Price 1 E Competitive market price p0 3 4 2 D 0 q1 q0 q2 Quantity  The Allocative Efficiency of Perfect Competition  At the competitive equilibrium E consumers’ surplus is the dark yellow area above the price line.  Producers’ surplus is the light yellow area below the price line.  Reducing the output to q1 but keeping price at p0 lowers consumers surplus by area 1.  It lowers producers’ surplus by area 2. The Allocative Efficiency of Perfect Competition  Assume that producers are forced to produce output q2 and to sell it to consumers, who are in turn forced to buy it at price p0.  Producers’ surplus is reduced by area 3 (the amount by which variable costs exceed revenue on those units).  Consumers’ surplus is reduced by area 4 (the amount by which expenditure exceeds consumers’ satisfactions on those units).  Only at the competitive output, q0, is the sum of the two surpluses maximized.