Business Economics

Session 9: Market Structure Analysis - I

Faculty: Prof. Sunitha Raju

Session Date:
 EPGDIB 2020-21

Preview Questions
Business Economics
1. How to explain and predict changes in prices and output
consequent to changes in economic conditions and policies

2. How do changes in market demand and supply factors

influence an individual firm’s profits?

3. How does competition influence an individual’s firm’s profits?

4. Does profit maximisation underlie the current pricing

practices
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Demand - Supply Framework

Business Economics

 Changes in Demand factors induces changes in

market prices

 Demand expansion causes price hikes

 Demand contraction leads to price falls

 Changes in Supply factors induces changes in

market prices

 Supply expansion leads to price falls

 Supply contraction leads to price increases
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Demand Analysis: A Review

Business Economics
 Demand curve defines how consumers respond to changes in price
P

Q
 Revenue implications of demand curve is given in TR and MR curves
TR

MR Q

Q
MR
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Supply Analysis: A Review

Business Economics
 Cost implications of increasing supply is given by supply curve
P

 MC curve above the AVC is the supply curve which defines the
incremental cost for increasing supply by one unit

 MC curve is derived from the production and cost relationships

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Profit Maximization
Business Economics
 Demand and Supply factors together determine profits earned
TC
TR

TC TR

Q* Q
 Profit Maximisation
= TR - TC
d( ) = d(TR) - d(TC) Any change in demand and
dQ dQ dQ supply condition will
= MR - MC = 0 influence profits earned by
= MR = MC
the firm
MR > MC Q
MR < MC Q
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Market Structure
Business Economics

 Changes in Demand & Supply condition translates

into changes in behaviour by various firms

 This behaviour is also influenced by how firm relate

to other firms in the market.
“Competition”

 Issues
 Why does competition between products differ
 What determines competition
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Basic Characteristics of Various

Market Structures
Business Economics

Market Number of Type of Barriers to Power of Non-price

Structure Producers Product entry Firm over competition
Price

Perfect Many Standardized Low None None

Competition

Monopolistic Many Differentiated Low Some Advertising

and Product
differentiation

Oligopoly Few Standardized High Some Advertising

or and Product
Differentiated differentiation

Monopoly One Unique Very High Considerable Advertising

Product
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Market Structure and Competition

Business Economics

Competition Increases
Perfect Competition
Competition reduces

Monopolistic
Oligopoly
Monopoly
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Perfect Competition : Assumptions

Business Economics

 Many buyers and sellers

 Buyers and sellers are price takers
 Product is homogeneous
 Perfect mobility of resources
 Economic agents have perfect knowledge
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Competitive Market : Pricing

Decisions
Business Economics

 Who sets price

 How much freedom do firms have in the
setting the price
 Industry vs Firm
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Competitive Market : Nature of
Demand Curve
Business Economics
1. Demand curve : Industry level
P
AR

 Downward sloping as P↓, Q↑

 Slope depends on the nature of the product i.e.
price elastic (luxury), price inelastic goods
(Necessities)
Contd…
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Determination of Equilibrium
Quantity and Price : Short run
Business Economics
2. Industry level
P D S

P*

Q* Q

 Interaction between Demand and Supply factors

determines P* and Q*
 Market demand = OQ*. Firms to decide how much of
OQ* to supply
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Determination of Equilibrium
Quantity and Price : Short run
Business Economics
3. Firm level
 Industry equilibrium price is the Firm’s given price
 Profits maximized at MR = MC
PI PF MC
D S

AR = MR = P
*
P

Q* QI Q*F QF
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Competitive Market : Nature of
Demand Curve
Business Economics
Demand curve : Firm level
P

AR

 Price taker : Single firm cannot influence market

price.
 Can sell any Q at a given Price (P)
 Product is standardized large number of
substitutes available. Hence, demand curve is
perfectly elastic.
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Relationship between P, AR, MR

Business Economics

P Q TR AR ( TR
Q
) MR ( TR
Q
)

5 1 5 5 -
5 2 10 5 5
5 3 15 5 5
5 4 20 5 5
5 5 25 5 5
5 6 30 5 5
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Business Economics
3. Firm’s Profits

Firm A Firm B Firm C

MC
MC MC
AC
AC AC

. P = MR
. P =AR =MR

Q*A Q*B Q*C

Depends on firm’s cost structure

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Competitive Market :
Long Run Equilibrium
Business Economics
1. Shifts in Supply Curve SI MC AC
S3
S2
PI . PI
P3 .
P2 . P3
P2

Q* Q2 Q1
* *

 Entry / Exit conditions being easy,

→ Profits induce entry of more firms into the industry market
supply expand shifts
→ Losses induce exit of firms from the industry market
supply contracts.
 Equilibrium P = AC = MC only normal profits
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Perfect Competition Model:
Implications
Business Economics
1. Existence of powerful Market forces
 Tend to drive price where firms earn only normal profits
 More than normal profits induce new firms to join
 Prices are flexible downward

2. Firms produce at the lowest possible average cost

3. Firms are ‘Price takers’ and ‘Quantity adjusters’
 No market power- only discretionary judgment is how much to
produce at the prevailing market price
 Discretion over output erodes in the long run
4. Output is responsive to changes in demand
5. Competitive struggle to respond to changing
market conditions and remain price efficient
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Monopoly : Market Characteristics

Business Economics

 Single seller and many buyers

 No close substitutes for product
 Significant barriers to resource mobility
– Control of an essential input
– Patents or copyrights
– Economies of scale: Natural monopoly
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Monopoly Market
Business Economics
 Does a Monopolist have complete freedom in setting
price?

P P P
D2 D3
D1

Q Q Q
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Monopoly Market : Pricing

Business Economics
1. Nature of Demand Curve
P
D

 Slope of the demand curve determined by the

nature of the product
 Demand curve for firm same as industry
 Downward sloping demand curve
firm can fix either price or quantity
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Monopoly Market : Pricing

Business Economics
2. Equilibrium Price and Quantity
P
MC
P* AC

.
P
=
AR
MR

Q* Q

 Profits maximized at MR = MC
 Supernormal profits at P* & Q*
 Operates on the falling part of AC curve excess
capacity conditions.
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Competitive and Monopoly

Markets
Business Economics

MC
MC AC

P* P*
AC
P = AR=MR

P
=
AR
MR
Q* Q*

 Production efficiency and profit margin

 R & D and Product development patents
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Pricing Behaviour : Monopoly

Business Economics
(i) Market Price
 Downward sloping demand curve
can fix either Price or Quantity

 “under produces”

(ii) Economic profits continue

 High entry barriers no threat of competition

(iii) Monopoly exists if Economies of Scale are

pronounced
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Pricing Behaviour : Monopoly

Business Economics

(i) Does a Monopolist charge the highest price

possible?

(ii) Given an inelastic demand curve and the objective of

profit maximisation, price and output decisions will
fall in what part of the demand curve?

(iii) Does a monopolist reap exorbitant profits always?

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Monopoly Market : Pricing

Business Economics
3. Can a Monopoly firm be an efficient producer?
MC
MC
AC
P* P* AC

. P
=

P
AR

=
AR
MR
MR
Q* Q*

Profits earned depends on

 Cost structure and cost efficiency of a monopolist
 Nature of the product
→ Price elastic products induces a monopolist to
operate efficiently
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Monopoly Market : Pricing

Business Economics
4. Does a Monopolist always earn profits?
MC
*
P
MC
P* AC
AC
. P
.

P
=

=
AR

AR
MR
MR
Q* Q*
 Cost structure determines the profits of a Monopolist
 Entry / Exit conditions difficult
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Monopoly Firm: Constraints to
Market Behaviour
Business Economics

1. Government Intervention and Regulation

 Monopolist limits price and profits

2. Limits profits to discourage potential competition

 Limit pricing depends on how effectively entry is blocked
 Forego short run profit maximisation to enhance long
run profits.

3. Countervailing power on the buying side

 Monopsony