Module 3
§ Market is a term which is commonly used for a particular place or locality where goods are
bought and sold. According to Prof. Samuelson, “A market is a mechanism by which buyers
and sellers interact to determine the price and quantity of a good or service.” Based on
competition, the market structure has been classified into two broad categories:
§ 1. Perfectly competitive. (Perfect Competition)
§ 2. Imperfectly competitive. (Monopoly, Monopolistic competition and Oligopoly)
§ Perfect competition is defined as a market structure in which an individual firm
producing homogenous commodities cannot influence the prevailing market price of
the product on its own.
§ Perfect competition is a market structure characterized by complete absence of
rivalry among individual firms.
§ 1. Very Large Number of Buyers and Sellers
There are so many buyers and sellers that no individual buyer or seller can
influence the price of the commodity in the market. He is a price-taker having no bargaining
power in the market.
2. Homogeneous Product
Firms in the market produce a homogeneous product. Homogeneity of a product implies that one unit of the
product is a perfect substitute for another.
3. Free Entry or Exit of Firms
The industry is characterized by freedom of entry and exit of firms. In a perfectly competitive market, there
are no barriers to entry or exit of firms. Entry or exit may take time, but firms have freedom of movement
in and out of an industry.
4. Perfect Knowledge
Firms have all the knowledge about the product market and the factor market. Buyers also have perfect
knowledge about the product market.
5. Perfect Mobility of Factors of Production
The factors of production can move easily from one firm to another. Workers can move between
jobs and between places.
6. Absence of Transportation Cost
All goods are produced locally. Transportation costs are zero.
7. Perfectly elastic demand curve
At existing price seller can sell any amount of commodity.
:: Imaginary or hypothetical market situation ::
Under any market situation a firm is in equilibrium when it gets maximum profit.
There are two approaches to find the profit maximizing level of output.
1. TC, TR Approach. 2. MC, MR Approach.
TC, TR Approach.
ü A market situation in which a single seller controls the entire supply of a commodity.
ü The monopolist has full control over price and output. E.g. Indian Railway.
Is Luxottica – a Monopoly ?
ü single seller: single seller controls entire production
and distribution—no competition, any price can be
charged—firm itself is the industry
ü no close substitutes
ü barriers to entry: entry to market is restricted—legal
restrictions, exclusive ownership of resources,
technical knowhow not available to other firms
ü price maker
ü -downward sloping demand curve: consumer still
decides whether he should buy or not
§ Increasing competition with Antitrust Laws
-these are statutes to protect consumers from monopoly
practices and ensure fair competition
-Antitrust laws allow govt. to prevent mergers, and to breakup
companies
MRTP Act in India (Monopolies and Restrictive Trade Practices)
controls monopolies
§ Regulation
-regulatesprice e.g. electricity, power
-does not allow companies to charge any price they wish
§ Public ownership
-govt. becomes the owner
A monopolist can sell a larger quantity only at a
lesser price. Hence the MR curve of a monopolist
will be downward sloping. As MR curve is
downward sloping AR curve also will be downward
sloping.
Equilibrium under Monopoly
Under monopoly, for the equilibrium and price
determination there are two different conditions
which are:
1. Marginal revenue must be equal to marginal cost.
2. MC must intersect MR from below
ü It means a monopolist sells his product at a higher price in the home
market and lower price in the international market.
ü lt is the act of charging different prices for the same product from different
consumers.
ü For example, a doctor charges different fees from poor and rich patient
ü for electricity low rates are charged for domestic consumption and high
rate for commercial consumption.
A market situation in which there are large number of buyers and sellers dealing in a
differentiated product
§ Combination of perfect competition and monopoly
§ Products produced by different sellers are not identical but close substitutes
e.g. different brands of soap
§ Product of each seller has a unique feature, so he has a monopoly on his product,
but products are close substitutes and there are large no. of buyers and sellers
§ Large no. of buyers and sellers: Not as large as in perfect competition- each buyer
represents an insignificant part of total
§ Product differentiation: Each product has a unique feature that gives it monopoly – colour,
shape, quality, packing .
§ Selling cost: close substitutes => acute competition, thus expenditure on advertisement and
sales promotion is high
§ Freedom of entry and exit: new firms can enter, loss making firms can leave industry at any
time
§ Imperfect knowledge: info about market conditions –price, quality, cost not uniformly
available
Market situation in which there are few sellers selling either a homogenous or
differentiated product
e.g. aviation industry, telecommunication industry
§ Few sellers: Few sellers dominate the entire industry; influence price of each other
§ Homogenous/differentiated product: products may be homogenous in some cases e.g.
petrol, and differentiated in others e.g. automobiles
§ Barriers to entry: No legal barriers, but economic barriers like huge investment
requirement, strong consumer loyalty to existing brands, etc
§ Mutual interdependence: influenced by each other’s decision
§ Existence of price rigidity: Firms prefer not to change price, as it will not be
beneficial
§ Indeterminate demand curve: Uncertain behaviour patterns. Demand is not stable
as each firm keeps an eye on its rivals to change strategies
§ Developed by Paul M Sweezy
§ Explains price rigidity under oligopoly
Assumptions:
- If a firm increases its price others will not
- If a firm decreases its price, others will
• The kink at point A creates a
discontinuity in the MR curve
• MR remains unchanged
between points B and C
• Even if cost increases and MC
shifts from MC2 to MC1, there
will be no change in
equilibrium price and
quantity
To avoid price war and loss, firms enter into an agreement regarding uniform price
and output. This is known as collusion.
A situation in which two or more firms jointly set their prices or output, divide the
market among them or make the business decisions
- helps preventing uncertainties, entry of new firms, strengthens bargaining power of
firms against buyers
- Collusion can be formal/tacit
§ Oligopoly involves tight competition
§ Trying to increase market share through price leads to price war; not effective
§ Thus, resort to non-price competition to increase sales
Competition between companies that focuses on benefits, extra services, good
workmanship, product quality, etc.
§ It is a marketing strategy that includes sales staff, sales promotions, free gifts,
coupons, advertising
§ Two main branches of non-price competition
- product differentiation (packing, colour, smell, quality)
- advertising (advertising, branding, PR)
e.g.
Loyalty card, subsidised delivery, aftersales services, advertising, cultivating good
reviews
Perfect competition Monopoly Monopolistic Oligopoly
competition
Large no. buyers and Single seller, large no. Large no. of buyers Few sellers and large
sellers of buyers and sellers no. of buyers
Homogenous product Single product with Differentiated product Homogenous/differen
no close substitutes tiated
Freedom of entry/exit Restricted entry Freedom of Barriers to entry
entry/exit
No selling cost No selling cost Selling cost Selling cost
Perfectly elastic Downward sloping, Downward sloping, Indeterminate
demand curve less elastic demand more elastic demand demand curve
curve curve
§ Right price is one which would keep all participants (consumer, seller, shareholders)
happy
§ Objective of firm also important
§ Cost of the product
§ Government policy regarding tax/subsidy
Some important pricing strategies are:
§ Cost plus/markup pricing
§ Target return pricing
§ Penetration pricing
§ Predatory pricing
§ Under this, price is the sum of cost and a profit margin
§ Normally AC is used for this, thus also called Average cost pricing/Full cost pricing
§ Price=AC+m, where m is the percentage of markup
-markup is fixed arbitrarily; often determined at 10%
-varies from industry to industry depending on availability of substitutes, degree
of competition
§ Limitation: not suitable when there is tough competition/ threat of entry of new
firms
§ Similar to cost plus pricing
§ Main difference-margin is decided by producer rationally depending on
experience of firm, consumer’s paying capacity, risks involved and other factors
§ To enter a market already dominated by existing firms, just one option:
charge less than existing price – called penetration price
e.g. Reliance’s entry in mobile phone industry
The method can be adopted in the short term and success largely depends on
elasticity of demand
§ A dominant firm sets prices too low for a
sufficient period so that competitors leave
the market and others are deterred from
entering
§ Expectation is that the losses incurred can be
compensated by future gains
§ Predatory pricing causes harm to consumers
and is considered anti-competitive
§ Following the prevailing market price instead of a separate marketing strategy
§ Prices are mostly fixed by dominant firm & others accept it
§ Adopted when the products sold by other sellers are close substitutes and cross
elasticity is very high
§ Used when product has reached maturity and become generic i.e. the buyer will
now not ask for a specific brand , but just ask for the product in general e.g. mineral
water
§ High price is charged at introduction of product and a lower price during maturity
§ Producers aware that high income consumers want to be among the first owners
(status symbol)
§ Sellers skim the market and earn a very high profit at launch
§ Once established, and reached
maturity, charge lower price to
attract lower income group