CHAPTER-07:

MARKET STRUCTURE
AND PRICING DECISION
 MARKET STRUCTURE
• Market structure is the complete array of industry characteristics that directly affect the
price/output decisions made by firms.
• Market structure describes the competitive environment in the market for any good or service.
• Market structure is typically characterized on the basis of four important industry
characteristics:
i) the number and size distribution of active buyers and sellers and potential entrants,
ii) the degree of product differnetiation,
iii) the amount and cost of information about product price and quality, and
iv) conditions of entry and exit.
• The effects of market structure are measured in terms of the prices paid by consumers,
availability and quality of output, employment and career advancement opportunities, and the
pace of product innovation, among other factors.
TYPES OF MARKET STRUCTURE
 PERFECT COMPETITION
• Definition: Perfect competition is a market setting in which there are a large number of sellers of a homoenous product.
Perfect competition is an uncommon phenomenon in the real business world. However, the actual markets that approximate to
the condiitons of perfectly competitive model include the share markets, securities and bond markets, and agricultural product
markets, e.g., local vegetable markets.
• Features of Perfect competition:
• 1. A large number of sellers and buyers.
• 2. Homogenous products.
• 3. Perfect mobility of factors of production.
• 4. Free entry and exit of firms.
• 5. Perfect knowledge
• 6. Absence of confusion or artificial restraint.
• 7. No governmnet intervention.
 MONOPOLY
• Definition: The term pure monopoly signifies an absolute power to produce and sell a product which has no close sustitute.
In other words, a monopoly market is one in which there is only one seller of a product having no close substitute. The cross
elasticity of demand for a monopoly product is either zero or negative. A monopolized industry is a single—firm industry. In
the opinion of Joel Deal, a monopoly market is one in which a product of lasting distictiveness is sold. E. H. Chamberlin
envisages monopoly as the control of all goods and services by the monopolist. In the opinion of some authors, any firms
facing a sloping demand curve is a monopolist.
Public utility sector, postal, telegraph and telephone services, generation and distribution of electricity, railways, airlines etc.,
are public monopolies.
• Features of Monopoly:
• 1. Single seller.
• 2. Unique product.
• 3. Blockaded entry and exit.
• 4. Imperefct dissemination of information.
 MONOPOLISTIC COMPETITION
• Definition: Monopolistic competition is defined as market setting in which a large number of sellers sell
differentiated products.
Retail trade and service sectors, clothing, fabric, footwear, paper, sugar, vegetable oils, coffee, spices
etc. have the characteristics of monopolistic competition.
• Features of Monopolistic Competition:
• 1. Large number of sellers.
• 2. Free entry and free exit.
• 3. Perfect factor mobility.
• 4. Complete dissemination of market information.
• 5. Differentiated product.
 OLIGOPOLY
• Definition: Oligopoly is defined as a market structure in which there are a few sellers selling a homogenous or differentiated products.
Where oligopoly firms sell a homogenous product, it is called pure o homogenous oligopoly. Where firms of an oligopoly industry sell
differntiated products, it is called differentiated or heterogenous oligopoly.
 Pure or Homogenous Oligopoly: Industries producing bread, cement, steel, petrol, cooking gas, chemicals, aluminium and sugar.
 Differentiated or Heterogenous Oligopoly: Automobiles, telivision sets, soaps and detergents, refrigerators, soft drinks, computers,
cigarettes, etc.
• Features of Oligopoly:
• 1. Few sellers.
• 2. Homogenous or unique product.
• 3. Bloackaded entry and exit.
• 4. Imperfect dissemination of information.
• 5. Interdependence of decision-making.
• 6. Indeterminate price and output.
 PRICE DETERMINATION UNDER
PERFECT COMPETITION
• Market price in a perfectly competitive market is determined by the market forces—market demand and market supply.
• Market demand refers to the sum of the quantity demnaded by each individual consumer at different prices.
• Market supply is the sum of quantity supplied by the individual firms in the industry.
• The market price is determined for the industry and is given for each individual firm and each buyer.
• Thus a seller in a perfectly competitive market is a ‘price-taker’ not a ‘price-maker’.
• In a perfectly competitive market, the main problem for a profit maximizing firm is not to determine the price of its product but to
adjust its output to the market price so that profit is maximum.
• The mode of price determination –price level and its variation –depends on the time taken by the supply position to adjust itself to
the changing demand conditions.
• Price determination under perfect competition is analysed under three different time periods:
i) market period or very short run
ii) short run, and
iii) long run.
 PRICE DETERMINATION UNDER
PERFECT COMPETITION
• i) Pricing in Market Period: Market period or very
short run refers to a time period in which quantity
supplied is absolutely fixed, i.e, supply response to price
is nil. Since the stock of goods is fixed, the supply curve
is perfectly inelastic. In this situation, price is
determined solely by the demand condition. Supply
remains an inactive agent. Daily fish market, stock
markets, daily milk market, certain essential medicines
during epidemics are the examples of very short markets.
 PRICE DETERMINATION UNDER
PERFECT COMPETITION
• Ii) Pricing in the Short Run: In a short run, firms can
neither change their size nor quit, nor can new firms enter
the industry. In the short run, supply curve is elastic.
• Price determination for the industry by the demand curve
DD and supply curve SS, at price OP1 or PQ. This price is
fixed for all the firms in the industry. The firms are
required to adjust their output to the price PQ so that they
maximize their profit. Profit is maximum where MR =
MC. Firm’s upward sloping MC curve inersects AR=MR
at point E, where MR= MC. This point E is the
equilibrium point. It determines the profir maximizing
output ON. The total maximum profit has been shown by
the area P1TME. This is the maximum supernormal profit.
But if AR < AC, the firm incurs loss at point E’.
 PRICE DETERMINATION UNDER
PERFECT COMPETITION
• Iii) Pricing in the Long Run: In the
long run, the firms can adjust their
size or quit the industry or new
firms can enter the industry. Firms
adjust their output to point M, where
OP1 = AR’ = MR’ =LMC. Firms
make economic profit. At the output
ON, firms are in a position to make
only normal profit, since at this
output, OPo = AR= MR = LMC
=LAC (=EN). No firm is in a
position to make economic profit,
nor does any firm make losses.
 PRICING UNDER PURE MONOPOLY: SHORT-RUN
•• A  monopoly market is one in which there is only one seller of a product having no close
substitute. A monopolized industry is a single firm industry. In a monopoilized industry,
equilibrium of the monopoly firm signifies the equilibrium of the industry.
• Pricing and output decision under monopoly are based on revenue and cost conditions. AC and
MC curves are identical. But AR and MR curves are different under monopoly because, a
monopoly firm faces a downward sloping demand curve. When a demand curve is sloping
downward, MR curve lies below the AR curve and the slope of the MR is twice that of AR.
• A profit maximizing monopoly firm chooses a price-output combination at which MR = SMC.
MR and SMC intersect each other at point E. At profit maximiziing output OQ, MR = SMC.
Given the demand curve AR = D, the output OQ can be sold per time unit at only one price, i.e.,
AQ(=OP1). Thus the determination of output simultaneuosly determines the price for the
monopoly firm.
• At output OQ and price AQ, the monopoly firm maximizes its unit and total profits. Its per unit
monopoly or economic profit (AR- SAC) equals (per AQ- BQ) = AB. Its total profit, , = PB x AB
= area as shown by the shaded area. Since,in the short run, cost andd revenue conditions
are not expected to change, the equilibrium of the monopoly firm will remain stable.
 Does A Monopoly Firm Always Earn
Economic Profit
• Whether a monopoly firm earns economic profit or normal profit or incur loss depends on
i) its cost and revenue conditions;
ii) threat from potential competitors; and
iii) government policy in respect of monopoly.
• If a monopoly firm operates at the level of output where MR = MC, its profit depends on
the relative levels of AR and AC.
• Given the level of output, there are three possibilities:
i) if AR > AC, there is economic profit for the firm,
ii) if AR = AC, the firm earns only normal profit, and
iii) if AR < AC, though only a theoritical possibility, the firm makes losses.
 Monopoly Pricing and Output Decision in the
Long Run
• In the long run, a monopolist gets an opportunity to expand the size of its firm
with a view to enhance its long-run profits. The expansion of the plant size may
be subject to such conditions as a) size of the market, b) expected economic
profit, and c) risk of inviting legal restrictions.
• The AR and MR curves show the market demand and marginal revenue
conditions faced by the monopoly firm. The LAC and LMC show the long run
cost conditions. Monopoly’s LMC and MR intersect at point E, where output is
OM. This is the profit maximizing output. Given the AR curve, the price at
which the total output OM can be sold is AM. This output price combination
maximizes the monopolist’s long run profit. The total monopoly profit is shown
by the area NABP.
 Price Discrimination Under Monopoly
• Price discrimination means selling the same or slightly differentiated product to different sections of
consumers at different prices not commensurate with the cost of differentiation.
• Consumers are differentiated on the basis of their income or purchasing power, geographical location, age, sex,
colour, marital status, quantity purchased, time of purchase, etc.
• There is another kind of price discriminatin, the same price is charged from the consumers of different areas
while cost of produciton in two different plants located differently is not the same.
• Some common examples of price discrimination are:
i) physicians and hospitals, lawyers, consultants, etc., charge their customers at different rates mostly on the
basis of the latter’s ability to pay.
ii) merchandise sellers sell goods to relatives, friends, old customers etc. at lower prices than to others and off-
season discounts for the same set of customers.
iii) railways and airlines charge lower fares from the children and students, and for different class of travellers.
iv) different prices in domestic and foreign markets,
v) differential rates for cinema shows, musica concerts, etc.
Necessary Conditions for Price Discrimination

• First, different markets must be seperable for a seller to be able to practice

discriminatory pricing. Markets are seperated by i) geographical distance involving
high cost of transportation, i.e., doemstic versus foreign markets, ii) exclusive use of
the commodity, e.g., doctor’s services, iii) lack of distribution channels, e.g., transfer
of electricity from domestic use to industrial use.
• Second, the elasticity of demand must be different in different markets.
• Third, there must be imperfect competition in the market.
• Fourth, profit maximizing output is much larger than the quantity demanded in a
single market or section of consumers.
 Price Discrimination by Degrees
• First degree: The first degree of price discrimination is the limit of discriminating
prices. When a seller is in a position toknow the price each consumer or consumer
group is willing to pay, he sets the price accordingly and tries to extract the whole
consumer surplus. After extracting the consumer surplus for the first unit of
commodity, he gradually lowers down the price, so that the cnsumer surplus of the
users of the second unit is extracted. The process is continued until the whole
consumer’s surplus available at a price where MC = MR., is extracted. A doctor who
knows or can guess the paying capacity of his patients can charge the highest
possible fee from presumably the richest patient and lowest fee from the poorest
patient.
 Price Discrimination by Degrees
• Second Degree: Where market size is very large, perfect discrimination is
neither feasible nor desirable. In that case, a monopolist uses second degree
priec discrimination or block pricing method. The monopolist divides the
potential buyers into blocks, e.g., rich, middle class and poor, and sells the
commodity in blocks—first at the higest price to the rich, then at a lower price
to the middle class, and so on.
• The second degree price discrimination is feasible where i) the number of
consumers is large and price rationing can be done, and ii) demand curve for all
the consumers is identical, iii) a single rate is applicable for a large number of
buyers.
• By adopting a block pricing system, a monopolist maximizes his revenue at
TR = (OQ1. AQ1) + (Q1Q2 . BQ2) + (Q2Q3 . CQ3)
 Price Discrimination by Degrees
• Third Degree: When a profit maximizing
monopolist sets different prices in different
markets having demand curves with
different elasticities, he is practising the
third degree price discrimination. It
happens quite often that a monopolist has to
sell his goods in two or more markets,
completely separate from one another, each
having a emand curve with different
elsticity. The monopolist is therefore,
required to find different price-quantity
combinations that can maximize his profit
in each market. For this, he equates MC
and MR in each market and fixes prices
accordingly.
 Pricing and Output Decisions Under
Monopolistic Competition
• Price and Output Decisions under Short Run: The model of proce and
output determination under monopolistic competition was developed by
Edward H. Chamberlin in the early 1930s. A firm under monopolistic
competition faces a downward sloping demand curve. This kind of demand
curve is the result of i) a strong preference of a section of consumers for the
product, and ii) the quasi-monopoly of the seller over the supply. The strong
preference or brand loyalty of the consumers gives the seller an opportunity
to raise the price and yet retain some customers. And, since each product is
a substitute for the other, the firms can attract the consumers of other
products by lowering their prices. Firm’s MR intersects its MC at point E.
This point fulfiils the necessary condition of profit maximization at output
OQ. At the output OQ and price AQ, the firm earns a maximum monopoly
or economic profit AB per unit of output and total monopoly profit shown
by the rectangle PABC.
 Pricing and Output Decisions Under
Monopolistic Competition
• Price and Output Determination in the Long Run: The supernormal profit brings about in
the long run two important changes in a monopolistically competitive market.
First, the supernormal profit attracts new firms to the industry. As a result, the existing firms
lose a part of their market share to new firms. Consequently their demand curve shifts
downward to the left until AR is tangent to LAC.
Second, the incresing number of firms intensifies the price competition between the firms.
Price competition increases because losing firms try to regain or retain their market share by
cutting down price of their product. And, new firms in order to penetrate the market set
comparatively low prices for their product. The price competition increases the slope of the
firm’s demand curve, or, in other words, it makes the demand curve more elastic. LMC
intersects MR2 at point T where firm’s long run equilibrium output is determined at OQ2 and
price at P2Q2. Price at P2Q2 equals the LAC. It means that under monopolistic competition,
firms make only normal profit in the long run. Once all the firms reach this stage, there is no
attraction for the new firms to enter the industry, nor there is any reason for the existing firms
to quit the industry. This signifies the long run equilibrium of the inudstry.
 Exercise
• Ptoblem-01:A monopoly firm has to supply two markets with two different demand functions
as given below:
P1=32-2Q1
P2=22-Q2
• Where P1 and P2 are prices and Q1 and Q2 are quantities in two markets, respectively. Firms
total cost function is given as:
TC =10+2Q+Q²
• Find: i) Profit maximizing output, ii) Allocation of output between the two markets, iii) Prices
for two markets and iv) Total profit at profit maximizing output level.
•• Solution-01:
  i) Profit,
• Total reveneue equals the sum of revenue from the two markets.
.+.
• = (32-2Q1). + (22-Q2).
-+ -

• = - + - (10+2Q+Q²)
= - + - - 10 – 2Q - Q²
For profit to be maximum, Q must be equal to profit maximizing sales in markets A and B.
Therefore, +
2( + ) - +
2- - - .
+ - - . -10
For profit to be maximum, marginal profit must be equal to zero.
Marginal profit for Market A : = 30 - 6- =0
Marginal profit for Market B : = 20 - - 4=0

• = 4, = 3.
Profit maximizing outpus are 4 units for Market A. and 3 units for Market B. = (4+3) units = 7 units.
•  iii) Price for market A = 32-2Q1 = 24
• Price for market B = 22-Q2 = 19
• iv) Profit + - - . -10
= 30(4) + 20(3) -3(16) -2(9) -2(12) -10
= 120+ 60- 48 -18 -24-10 = 180-100 = 80
Total profit = Taka 80.
This is the maximum profit.
 Exercise
•  Problem-02: Suppose demand and total cost functions for a monopoly
firm are given as follows:
P = 500- 5Q
TC = 50+
Find the profit maximizing output and price for monopoly.
 Exercise
• Problem-03:
  Suppose that the demand curve for the firms under monopolistic
competition is given as: = 100 -0.5P
• And the total cost function is given as: +
When some new firms enter the industry, the demand function for each firm
changes to = 98.75 -
i) Find whether there was any motivation for the new firms to enter the industry
in the long run.
ii) What is the equilibrium price and output in the long run?
Iii) Prove that in the long run AR = LAC.
• Therefore,
• Solution-03: Demand Fuction, = 100 -0.5P
  100 –Q1 = 0.5P1 or, P1 = 200 – 2Q1
TR1 = P1 x Q1 = (200 – 2Q1 )Q1 = 200Q1 -

• +
= = +5-Q+
LMC = 5 – 2Q +

• = 5 – 2Q +

• + 2Q1 -195 = 0
+ 40Q1 – 3900 = 0 [ multiplid by 20]
or, Q1 =
or, Q1 = 30.
So, Profit maximizing output in the short run is 30.
• P1 = 200 – 2Q1 or, P1 = 200 – 2x30 = 140
LAC = + 5 - Q + = 72.08
Short run equilibrium output =30
P1 (=AR1 ) = 140
LAC = 72.08
Supernormal profit = AR1 – LAC = 140-72.08 =67.92 (per unit of output).
The existence of supernormal profit attracts new firms to the industry in the long run.
•
• = 98.75 - or, P2 = 98.75 – Q2
 
• TR = P2xQ2
= (98.75 – Q2)Q2 = 98.75Q2 -

• The long run equilibrium output can be obtained by equating MR2 with the LMC function. For the sake of uniformity, we
designate Q in the LMC function as Q2.
• The long run equilibrium output is MR2 = LMC
= 5 – 2Q +

• AR or P2 must be equal to LAC for long run equilibrium.

• AR2 = LAC

• 98.75 – Q2 = + 5 - Q + = 73.75
For, Q2 =25, we get 98.75 -25 = 73.75
• And, + 5 - Q + = 73.75
It is thus proved that in the long run AR = LAC and it earns only normal profit.