Market structure

-Sowmya S
-Faculty,BIMS,UOM
 Market structure
• Market structure, in economics, refers to how
different industries are classified and
differentiated based on their degree and
nature of competition for goods and services.
• It is based on the characteristics that influence
the behavior and outcomes of companies
working in a specific market.
 Factors or features determine the market
structure
• The industry’s buyer structure
• The turnover of customers
• The extent of product differentiation
• The nature of costs of inputs
• The number of players in the market
• Vertical Integration extent in the same industry
• The largest player’s market share
 Perfect Competition

• Perfect competition occurs when there is a large number of small companies

competing against each other. They sell similar products (homogeneous), lack
price influence over the commodities, and are free to enter or exit the market.
• Consumers in this type of market have full knowledge of the goods being sold.
• This market is unrealistic as it faces some significant criticisms described below.
• No incentive for innovation: In the real world, if competition exists and a
company holds a dominant market share, there is a tendency to increase
innovation to beat the competitors and maintain the status quo. However, in a
perfectly competitive market, the profit margin is fixed, and sellers cannot
increase prices, or they will lose their customers.
• There are very few barriers to entry: Any company can enter the market and
start selling the product. Therefore, incumbents must stay proactive to maintain
market share.
Features of Perfect Competition
 Diagram for perfect competition-Short run

IN CASE OF LOSS
IN CASE OF NORMAL PROFIT
 Diagram for perfect competition-Short run

In case of No profit no loss

 Diagram for perfect competition-Long run

In case of Normal profit- same as no profit no loss of short run

 Conclusions of perfect competition

• Firms will be allocate efficient

• Firms will be productive efficient
• Firms have to remain efficient otherwise they
will go out of business.
• Firms are unlikely to be dynamical
efficient because they have no profits to invest
in research and development.
 Monopoly Market
• The Monopoly is a market structure characterized by a single seller, selling
the unique product with the restriction for a new firm to enter the market.
• Simply, monopoly is a form of market where there is a single seller selling
a particular commodity for which there are no close substitutes.
 One seller dominating the market
 Differentiated market
 Firm is a price maker
 High barriers to entry and exist
 Imperfect information
 Firm is a profit maximizer
 Features of Monopoly Market
• Under monopoly, the firm has full control over
the supply of a product. The elasticity of demand
is zero for the products.
• There is a single seller or a producer of a
particular product, and there is no difference
between the firm and the industry. The firm is
itself an industry.
• The firms can influence the price of a product
and hence, these are price makers, not the price
takers.
• There are barriers for the new entrants.
• The demand curve under monopoly market is
downward sloping, which means the firm can
earn more profits only by increasing the sales
which are possible by decreasing the price of a
product.
• There are no close substitutes for a monopolist’s
product.
monopoly power in the market in the short-
run
• The diagram for a monopoly is
generally considered to be the same in
the short run as well as the long run.
• Profit maximization occurs where
MR=MC. Therefore the equilibrium is
at QM, Pm. (point M)
• This diagram shows how a monopoly
is able to make supernormal profits
because the price (AR) is greater than
AC.
• Usually, supernormal profit attracts
new firms to enter the market, but
there are barriers to entry in
monopoly, and this enables the
monopoly to keep supernormal
profits.
 Welfare loss to society

• In a competitive market, the

output will be at Pc and Qc.
(point C)
• In a monopoly, the output
will be QM and PM – causing
a fall in consumer surplus.
• Monopoly also causes a fall
in producer surplus (less is
sold).
• The blue triangle shows the
net loss of consumer and
producer surplus to society.
 Efficiency and monopoly
• Allocative Efficiency: Monopolies set a price greater than MC
which is not allocative efficiency (not lowest point on AC
curve)
• Productive efficiency: By producing at left of AC, the
monopoly is productive inefficient .(Higher prices with the
lower output)
• X-Efficiency: With less competition, a monopoly has fewer
incentives to cut costs and therefore will be X-inefficient.
(Excess cost-producing the above average curve)
• Dynamic efficiency: Barriers to entry, Long run super normal
profits(Reinvested), Imperfect information, Greater
economies of sale, Cross subsidization
 Monopolistic Competition
• Under, the Monopolistic Competition, there are a large number of firms that produce differentiated
products which are close substitutes for each other. In other words, large sellers selling the products
that are similar, but not identical and compete with each other on other factors besides price.
• The monopolistic competition is also called as imperfect competition
• Key difference with monopoly
• In monopolistic competition there are no barriers to entry. Therefore in long run, the market will be
competitive, with firms making normal profit.
• Key difference with perfect competition
• In Monopolistic competition, firms do produce differentiated products, therefore, they are not price
takers (perfectly elastic demand). They have inelastic demand.
 Features of Monopolistic Competition
1. The products being slightly different from each other remain close substitutes of each other
and hence cannot be priced very differently from each other.
2. Unlike the perfect competition, the firms produce the differentiated products which are
substitutes for each other, thus make the competition among the firms a real and a tough
one.
3. With an intense competition among the firms, the entity incurring the loss can move out of
the industry at any time it wants.
4. Under the monopolistic competition, an individual firm is not a price taker but has some
influence over the price of its product.
5. A huge cost on advertisements and other selling costs to promote the sale of their products.
6. To meet the needs of the customers, each firm tries to adjust its product accordingly.
 Monopolistic Competition-Short run
• AR>AC in
supernormal profit
• In the short run, the
diagram for
monopolistic
competition is the
same as for a
monopoly.
• The firm maximizes
profit where
MR=MC. This is at
output Q1 and price
P1, leading to
supernormal profit
 Monopolistic Competition-Long Run
• Normal Profit: AR=AC
• Demand curve shifts
to the left due to
new firms entering
the market.
• In the long-run,
supernormal profit
encourages new
firms to enter. This
reduces demand for
existing firms and
leads to normal
profit.
 Efficiency of firms in monopolistic
competition
• Allocative inefficient: The above diagrams show a
price set above marginal cost therefore no allocative
efficiency
• Productive inefficiency: The above diagram shows a
firm not producing on the lowest point of AC curve
• Dynamic efficiency: This is possible as firms have
profit to invest in research and development.
• X-efficiency: This is possible as the firm does face
competitive pressures to cut cost and provide better
products.
 Oligopoly
• An oligopoly is a market structure where a few large firms collude and dominate a
particular market segment. Due to minimal competition, each of them influences
the rest through their actions and decisions.
• Market players in an oligopolistic market focus on non-price competition, ensure
their brands are uniquely identifiable and apply hidden advertising tactics.
• Raised barriers to entry, price-making power, non-price competition, the
interdependence of firms, and product differentiation are all oligopoly
characteristics.
 Definition-Oligopoly
• Definition: The Oligopoly Market characterized by few sellers, selling
the homogeneous or differentiated products. In other words, the
Oligopoly market structure lies between the pure monopoly and
monopolistic competition, where few sellers dominate the market and
have control over the price of the product.
• Examples of oligopolies
• Petrol retail – see below.
• Pharmaceutical industry
• Coffee shop retail – Starbucks, Costa Coffee, Cafe Nero
• Newspapers – In the UK market share is dominated by tabloids Daily
Mail, The Sun, The Mirror, The Star, Daily Express.
• Book retail – In the UK market share is dominated by Waterstones,
Amazon and smaller firms like Blackwells.
 Features of Oligopoly Market
1. Few Sellers: Few firms dominating the market
enjoys a considerable control over the price of
the product.
2. Interdependence: there is a complete
interdependence among the sellers with
respect to their price-output policies.
3. Advertising: Under Oligopoly market, every
firm advertises their products on a frequent
basis
4. Competition: Every seller keeps an eye over
its rival and be ready with the counterattack.
5. Entry and Exit Barriers: The firms can easily
exit the industry whenever it wants, but has
to face certain barriers to entering into it.
6. Lack of Uniformity: There is a lack of
uniformity among the firms in terms of their
size, some are big, and some are small.
 Types of Oligopoly Market
1. Open Vs Closed Oligopoly: This classification is made
on the basis of freedom to enter into the new
industry.
2. Partial Vs Full Oligopoly: The partial Oligopoly refers
to the market situation, wherein one large firm
dominates the market and is looked upon as a price
leader. Whereas in full Oligopoly, the price leadership
is conspicuous by its absence.
3. Perfect (Pure) Vs Imperfect (Differential)
Oligopoly: The Oligopoly is perfect or pure when the
firms deal in the homogeneous products. Whereas
the Oligopoly is said to be imperfect, when the firms
deal in heterogeneous products
4. Syndicated Vs Organized Oligopoly: Firms with
common interest/Firms with associations for better
understanding
5. Collusive Vs Non-Collusive Oligopoly: Collusive is
understanding between firms and non collusive is
lack of understanding
Kinked Demand Curve-In Oligopoly

Developed by Paul M Sweezy

The kinked demand curve makes certain assumptions:

Explains the price rigidity •Firms are profit maxi misers.
in Oligopoly market •If one firm increases the price, other firms won’t follow
suit. Therefore, for a price increase, demand is price
If a firm reduces the
elastic.
price competitions follow it •If one firm cuts price, other firms will follow suit
and neutralizes the because they don’t want to lose market share.
expected gain Therefore, for a price cut, demand is price inelastic.
If the price raised then
the competitors do not
However, the kinked demand curve has limitations:
follow
It doesn’t explain how the price was arrived at in the
first place.
Firms may engage in price competition.
 Kinked Demand Curve Diagram
•In the kinked demand curve model, the firm maximizes profits at Q1, P1 where
MR=MC.
•Thus a change in MC, may not change the market price. It suggests prices will be
quite stable.

The elastic response to the price

rise results from rivals not changing
their price in response,
 whereas the inelastic response to a
price drop results in rivals being forced
to 'follow suit' given that rivals would
experience a considerable fall in
market share if they did not reduce
price.
Due to the kink in the demand
curve of the oligopolist, MR curve is
discontinuous at the level of output
corresponding to the kink.
Economies of scale for Oligopolies or conclusion

• Economies of scale: Larger firms can

benefit from economies of scale This
enables lower average costs with
increased output.
• Allocative efficiency? If oligopolies are
competitive then prices will be lower and
more allocative efficient.
• Dynamic efficiency? Firms in an oligopoly
have profits they can use for investment in
new products. Also, competitive pressures
encourage them to innovate.
 Game Theory
• Propounded by:
• John Von Neumann and Oskar Morgenstern (1943)
• John Nash generalised these theories and provided the
basis of the modern field

John Forbes Nash Jr

 Game Theory
• Meaning:
• Game theory is the science of interactive
decision making. When you think carefully before
you act, you are said to be behaving rationally.
• Game Theory is a body of knowledge which is
concerned with the study of decision making in
situation where two or more rational opponents
are involved under condition of competition and
conflicting interests.
 Game Theory
• Essential Features of Game Theory:
• Finite number of competitors.
• Finite number of action.
• Knowledge of alternatives.
• Outcome or Gain.
• Choice of opponent.
 Game Theory
• Terms used:
• Two Person Zero-sum game
• It is the situation which involves two persons or players and
gains made by one person is equal to the loss incurred by the
other.
• n-persons game: A game involving n persons is called a n-
person game.
• Pay offs - Outcome of a game due to adopting the different
courses of actions by competing players in the form of gains
or losses for each of the players is known as pay offs.
 Game Theory
• Pay off matrix – In a game, the gains or losses, resulting from
different moves and counter moves, when represented in the
form of a matrix are known as pay off matrix.
• Maximin Criteria – The maximizing player lists his minimum
gains from each strategy and selects the strategy which gives
the maximum out of these minimum gains.
• Minmax Criteria – The minimizing player lists his maximum
loss from strategy and selects the strategy which gives him
the minimum loss out of these maximum losses.
• Value of Game – The maximum guaranteed gain to the
maximizing player if both the players use their best strategy.
 Zero sum game in-Game Theory
• Zero Sum Games:
• Zero-sum is a situation in game theory in which one person's gain is equivalent to
another's loss, so the net change in wealth or benefit is zero.
• - one player’s winnings are the others’ losses.
• - Player interests in complete conflict.
• - Players are dividing up any fixed amount of possible gain.
• Most economic and social games are not zero-sum.
• Example: Trade offers scope for deals that benefit everyone.
Zero sum vs Non Zero sum game
 Game Theory
Uses of Game Theory:
• Helps answer the “why did
that happen?” questions.
• Prediction
• Advice or prescription
Limitations of Game Theory
• Infinite number of strategy
• Knowledge about strategy
• Zero outcomes
• Risk & uncertainty
• Finite number of
competitors
• Certainty of Pay offs
• Rules of game.
 Nash Equilibrium
• In game theory, the Nash equilibrium, named after the mathematician
John Forbes Nash Jr
• It is the most common way to define the solution of a non-cooperative
game involving two or more players.

• Advantages:
• It is a well-defined quantitative approach for decision making in a competitive
situation.
• It helps in the assessment of the competitors’ reactions.
• It is a management tool that helps in policymaking.
• Disadvantages:
• The determination of the optimal solution becomes difficult with the increase in the
number of participants.
• It is more of a logical strategy and not a winning strategy.
• The concept fails to account for uncertainties that are encountered in real-life
business situations.
• The theory expects the participants to act rationally, which is not always the case.
 Nash Equilibrium
• Example: Let us take the example of two rival companies –
• Company X and Company Y, to illustrate the concept of Nash equilibrium
in game theory. Both companies intend to determine whether it is the
right time to expand their production capacity. If both companies expand
their capacities now, each can increase their market share by 10%.
• However, if only one of them decides to expand, then it can increase its
market share by 20%, while the other one will not gain any market share.
On the other hand, if both the companies give up the idea of expansion,
then neither of them will gain any market share.
• The below table indicates the payoff in this case.
• So, in this case, the Nash equilibrium is achieved when both the
companies expand their production capacities as it offers better payoff
overall.
Prisoner’s Dilemma & Nash Equilibrium
 Prisoner’s Dilemma & Nash Equilibrium
• We can also apply Nash Equilibrium to the popular prisoner’s dilemma.
• In this, police arrests two criminals – A and B – and put them in two separate cells.
As both are kept in different cells they have no way to communicate with each other
and jointly decide the action plan. Police have no proof against them, so it offers
them options to either testify that the other was part of the crime or do not speak
anything.
• likely outcomes:
• Both testify against each other and each serves a five-year prison. If A speaks up
against B, but B chose not to say anything, then A gets no prison and B gets a 10-
year prison or vice versa. Lastly, in case both of them do not speak or remain silent,
then both will get a jail term of one year.

• As in this situation, it would have been better and would have been in the best
interest of both A and B, that both of them keep mum and serve one year in
prison. Rather than both speaking and both getting prison for a longer-term.
 Cartels and non price competition
• Cartels are competitors in the same industry and seek to reduce
that competition by controlling the price in agreement with one another.
• cartels tend to arise in markets where there are few firms and each firm
has a significant share of the market.
• The organization of petroleum‐exporting countries (OPEC) is perhaps the
best‐known example of an international cartel.
• Oligopolistic firms join a cartel to increase their market power, and
members work together to determine jointly the level of output that each
member will produce and/or the price that each member will charge.
 Cartel Theory in Oligopoly
• The cartel price is determined by market
demand curve at the level of output
chosen by the cartel.
• The cartel's profits are equal to the area of
the rectangular box labeled abcd in Figure .
• Note that a cartel, like a monopolist, will
choose to produce less output and charge
a higher price than would be found in a
perfectly competitive market.
• The oil‐producing firms form a cartel like
OPEC to determine their output and price,
they will jointly face a downward‐sloping
market demand curve, just like a
monopolist.