Market Behaviour PDF

MARKET BEHAVIOUR  Market  It refers to the interaction between sellers and buyers of a good or service at a mutually agreed upon price  Interaction may be  At a particular place  Over telephone  Through internet  Market may be a place, or a function, or a process  Characteristics o...

MARKET BEHAVIOUR  Market  It refers to the interaction between sellers and buyers of a good or service at a mutually agreed upon price  Interaction may be  At a particular place  Over telephone  Through internet  Market may be a place, or a function, or a process  Characteristics of Market 1. Nature of competition  Number, size and distribution of sellers  Very large number of small sellers  Only one large player without competitor 2. Nature of product  Homogeneous product or  Differentiated product  Characteristics of Market 3. Number and Size of buyers  Very large number of small buyers  Evenly balanced market  Small number of large buyers  Market driven by buyer’s preferences  Characteristics of Market 4. Freedom to enter into or exit from the market  Very difficult to enter  Financial restrictions  Legal compulsions  Technological restrictions  Very easy to enter without any restrictions  PERFECT COMPETITION  Homogeneous product  Freedom of entry and exit  Perfect knowledge of the market  Perfectly elastic demand curve  Perfect mobility of factors of production  No government intervention  Firm is a price taker  Price and revenue under perfect competition  Price is constant  Marginal revenue and average revenue will be identical and constant  Short-run equilibrium  New firms cannot be established  Firms cannot expand output  New production techniques cannot be introduced  Output decisions are not influenced by fixed cost  Firms should recover variable cost  In the short-run, a competitive firm may get  Abnormal profit  Abnormal loss  Normal profit or break-even  Equilibrium in the long run  No restriction on entry or exit of firms  Inefficient firms leave the market  Profit of existing firms attract new firms  Price will fluctuate  Profits will vanish and firms will break-even  MONOPOLY  A monopoly is a market in which a single seller sells a product (or service) which has no substitute  Pure monopoly  It is that market situation in which there is absolutely no substitute of the product  The entire market is under control of a single firm  Features of monopoly  Single seller  Single product  No difference between firm and industry  Independent decision making  Restricted entry  Reasons for monopoly  Restriction by law  Control over key raw materials  Specialised know-how  Economies of scale  Small market size  Types of monopoly  Legal monopoly A legal monopoly is created when the government restricts entry of other players in a particular market in order to keep total control in its hands  Economic monopoly An economic monopoly is one which is created whenever competition is eliminated due to economic inefficiency of other players, or due to superior efficiency of a particular player  Types of monopoly  Natural monopoly A natural monopoly is formed when the size of the market is so small that it can accommodate only one player  Regional monopoly  The regional monopoly is formed due to geographical or territorial boundaries  Demand curve for a monopoly firm  The monopoly firm has a normal demand curve with a negative slope It can sell more units only when it reduces the price of its product  The demand curve is highly inelastic, but also not perfectly inelastic Reason: Pure monopoly does not exist in real life  AR curve is downward sloping  MR curve is downward sloping It lies below AR curve It would lie halfway between AR curve and price axis  Price and output decisions in the short run  Supernormal profits  Normal profits  Subnormal profit (loss)  Price and output decisions in the long run  Supernormal profits  Normal profits  Price Discrimination  It is the practice of discriminating among buyers on the basis of the price charged for the same good or service  Prerequisites to price discrimination  Market control Monopolist is a price maker Market imperfection leads to price discrimination  Division of market Whole market can be divided into various segments Segregate customers on the basis of  Needs  Paying capacity  Geography  Demography, etc.  Different price elasticities of demand in different markets High price is charged if price elasticity is low Low price is charged if price elasticity is high  To make price discrimination possible, these three conditions must coexist  Bases of price discrimination 1. Personal  Seller has direct contact with its customers  Seller knows about paying capacity of customers and intensity of their needs Demography: Concession in train fare for children, senior citizens Paying capacity: Doctors treat poor patients for concessional fee Need: Lawyer charges high fee for criminal cases and low for petty cases 2. Geographical  Different prices for different regions Crude oil prices Edible oils Automobile, etc. 3) Time  It depends on which time of the day or month or year the product is being purchased Discounts during festive season Online shopping 4. Purpose of use  Electricity charges: different for domestic users and industrial purpose  Bank loans: different interest rates for different types of loans  Degrees of price discrimination 1. First degree  Price discrimination of first degree is when the seller is able to charge different prices for different units of the same product from the same customer 2. Second degree  Price discrimination of second degree is when the seller divides consumers in groups on the basis of their paying capacities and discriminates on the basis of consumer surplus 3. Third degree  Price discrimination of third degree is when the seller manages to take away only a small portion of consumer surplus  MONOPOLISTIC COMPETITION  It is a market situation in which a relatively large number of producers offer similar but not identical products  Features of both perfect competition and monopoly  Features of monopolistic competition 1. Large number of buyers and sellers  There are large number of sellers, but not as large as in perfect competition  Each firm produces a small portion of industry output  Each buyer purchases a very small part of the industry output 2. Heterogeneous products  Firms sell differentiated products  Minor changes in product Colour Packaging Brand name  Enjoys some degree of uniqueness in the mindset of customers Sellers can charge different prices 3. Selling costs  Promotion costs  Attractive packaging  Higher commissions to distributors  Sales promotion  Advertisements  Other incentives 4. Independent decision making  Firms decide price and output of their own products (monopoly)  Based on individual demand and cost  Do not consider the possible reactions of rival firms 5. Imperfect knowledge  Information about cost, quality, price, etc. is not uniformly available to all buyers and sellers 6. Unrestricted entry and exit  Mobility of resources is unrestricted  New firms can enter and loss making firms can leave the market  Demand and marginal revenue curves  A firm has a normal demand curve with a negative slope  Heterogeneity of products  Demand is highly elastic  If a firm increases price slightly, it will lose some, but not all of its customers  If it lowers the price slightly, it will gain some, but not all of the rival’s customers  If price reduction is large, it may acquire more customers of rival firms The slope of demand curve is flatter  Demand and MR Curves of a Firm Price, Revenue AR MR Quantity  Price and output decisions in short run  Supernormal profits (due to negative slope of demand curve)  Normal profits  Subnormal profits (losses)  Price and output decisions in long run  Supernormal profits attract new firms  Adds competition  MR curve shifts downwards – indicates decrease in market share  Aggregate demand remains same  All firms would earn normal profits  OLIGOPOLY  Oligopoly is a market where a few dominant sellers sell differentiated or homogeneous products under continuous consciousness of rivals’ actions  Features of Oligopoly 1. Few sellers  Small number of large firms 2. Product  Differentiated or homogeneous 3. Entry barriers  There are no legal barriers, but various economic barriers  Huge investment requirements  Strong customer loyalty for existing brands  Economies of scale 4. Interdependent decision making  One firm cannot take any decision independent of other firms  Firms continuously watch each step of their rivals 5. Non price competition  Each firm avoids incidence of price wars  If one firm resorts to price reduction, other rivals retaliate Hence, firms will not resort to price changes 6. Indeterminate demand curve  Each firm faces two demand curves  One is highly elastic and the other one less elastic This is due to different types of reactions by rival firms in response to a move to change its price by one firm  Nature of demand curve  Kinked demand curve A E Price, Cost, Revenue K D (AR) L 0 Output Q MR  Demand curve has a kink at ‘E’  Price = EQ  Output = OQ  Demand curve above EQ is AE  Demand curve below EQ is ED  If a firm increase price above EQ Rival firms will not react  If a firm decreases price below EQ Other firms will react by decreasing price to the same extent  Firm keeps the price rigid at EQ  ‘MR’ curve is discontinuous corresponding to the kink  Two segments of MR curve ‘AK’ corresponds to upper part of demand curve ‘L’ corresponds to lower part of demand curve MR curve is discontinuous between K and L  The gap depends on the elasticity of demand above and below the kink  Price determination  Objective is to maximize profits  MR = MC  A E MC1 MC2 Price, Cost, MC3 Revenue K P1 D (AR) P2 P3 L 0 Output Q MR  Equilibrium points at P1, P2, P3 at the kink  Profit is maximized  As long as MC curves intersects MR curve in the discontinuous portion – price remains constant (Price rigidity)  At left of the kink  MC < MR  At right of the kink  MC > MR  Oligopoly price under leadership  One of the firm is a leader (dominant firm)  Price is fixed by leader  Other firms follow the leader MCA A MCB Price, Cost, R Revenue M EA D EB d MR 0 QA QB Quantity  Price determination under collusion  Formation of cartel  Small number of firms  Similar cost conditions for all the firms  Minimal product differentiation  Inelastic demand  High barriers to entry of new firms  No excess capacity, etc.  MC P Price, Cost, E Revenue AR MR 0 Q Quantity Thank You