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E-Notes
Class : BBALL.B 1st Semester
Paper Code : BBALLB 115
Subject : Managerial Economics
UNIT IV
MARKET STRUCTURE
Market is a place where people can buy and sell commodities. It may be vegetables market, fish
market, financial markets or foreign exchange markets. In economic language market is a study
about the demand for and supply of a particular item and its consequent fixing of prices, example
bullion on market and foreign exchange market or a commodity market like food grains market
etc. Market is classified into various types based on the characteristic features. They are
classified on the basis of:
Area: Local, regional, national and international
Time: Very short period, short period, long period, very long period
Commodity: Produce exchange, bullion market, capital market, stock market
Nature of Transaction: Spot market, forward market, futures market
Volume of business: Wholesale market, retail market
Importance: Primary market, secondary market, territory market
Regulation: Regulated market, unregulated market
Economics: Perfect market and imperfect market.
In Economics, market implies:
1. Presence of buyers and sellers of the commodity
2. Establishment of contact between the buyer and seller
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3. Similarity of the product
4. Exchange of commodity for a price
Classification of Market Structure based on the nature of competition:
1. Perfect market
2. Imperfect market - The imperfect market in turn can be classified as
a. Monopoly market
b. Duopoly market
c. Oligopoly market
d. Monopolistic market
PERFECT COMPETITION
Perfect competition is a market structure characterized by a complete absence of rivalry among
the individual firms. A perfectly competitive firm is one whose output is so small in relation to
market volume that its output decisions have no perceptible impact on price. No single producer
or consumer can have control over the price or quantity of the product.
Features of perfect market:
1. Large number of buyers and sellers
2. Homogeneous product
3. Perfect knowledge about the market
4. Ruling prices
5. Absence of transport cost
6. Perfect mobility of factors
7. Profit maximization
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8. Freedom in decision making
In perfect market, the price of the commodity is determined based on the demand for and
supply of the product in the market. The equilibrium price and output determination is as
shown in the graph.
Graph - Price and Output Determination in the Perfect Market
The demand curve (D) and the supply curve (S) intersect each other at a particular point which is
called the equilibrium point. At the equilibrium point ‘E’ the quantity demanded and the quantity
supplied are equal (that is OQ quantity of commodity is demanded and the same level is supplied
etc). Based on the equilibrium the price of the commodity is fixed as OP. This is the fundamental
pricing strategy followed in the perfect market.
When the price at which quantity demanded is equal to quantity supplied, buyers as well as
sellers are satisfied. If price is greater than the equilibrium price, some sellers would not be able
to sell the commodity. So they would try to dispose the unsold stock at a lower price. Thus the
price will go on declining till they get equalized (Qd = Qs). The various possible changes in
Demand and supply are expressed in the following graphs to understand the price fluctuations in
the market.
When the firm is producing its goods at the maximum level, the unit cost of production or
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managerial cost of the last item produced is the lowest. If the firm produces more than this, the
managerial cost will rise. If that firm produces less than that level of output, it is not taking
advantage of the economics of the large scale operation. When the firm produces largest level of
output and sells at the managerial cost, it is said to be in equilibrium position. There is no
temptation to produce more or produce less level of output. Likewise, when all the firms put
together or the industry produces the largest amount of output at the lowest marginal cost, the
industry is also said to be in the equilibrium
Let us assume that the demand equal to supply Qd = Qs and the equilibrium point ‘E’ determines
the price as OP. In the short run the demand for the commodity increases but the supply remains
the same. Then the demand curve shifts to the right and the new demand curve.
D1D1 is derived. The demand has increased from OM quantity to OM1. The new demand curve
intersects the supply curve at the new equilibrium point ‘E1’ and the price of the commodity is
increased from OP to OP1. Therefore it is clear that when demand increases without any change
in supply this leads to price rise in the market.
Graph – Price and Quantity Variability When Increase In Demand
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Graph – Price And Quantity Variability When Increase In Price
If the firm changes its supply due to increase in demand then the possible fluctuations in the price
is explained below. Let us assume that the firm increased its supply 10% , the demand has also
increased but not in the same proportion – it increased only 2% ( ΔQd < ΔQs). From the graph
we can understand that the equilibrium point ‘E’ has changed into E1’ which reduced the price of
the commodity from OP to OP1.
Graph – Price And Variability When Change In
Demand Is Less Than Change InSupply
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On the other hand when there is 10% increase in the demand and the supply has increased only
to 2%, the new demand curve D1D1 and the new supply curve S1S1 intersect each other at the
new equilibrium point E1’.The price of the commodity is OP at ‘E’ and it increases from P to P1
and becomes OP1.i.e. When the demand increases more than the supply ( ΔQd > ΔQs ) the price
of the commodity will increase.
Graph – Price and Quantity Variability when change in Demand is more than the change
in supply
The following graph explains clearly that both the demand for the commodity and the supply
increases in the same proportion (i.e. ΔQD =ΔQS).The shift in supply curve and the shift in
demand curve are in the same level and the new equilibrium point ‘E1’ determines the same
price OP level. There is no change in the price when the demand and supply are equal.
Graph – Price And Quantity Variabilty When Change In Demand And Supply Equally
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PROFIT MAXIMIZATION UNDER PERFECT COMPETITION
The primary objective of any business is to maximize the profit. Profit can be increased either
by increasing total revenue (TR) or by reducing the total cost (TC). The profit is nothing
but the difference between the revenue and the cost. The total profit = TR – TC
Let us assume that whatever produced is sold in the market. TR = Quantity sold x price
To increase the revenue, it is better to either increase the quantity sold or increase the price.
Therefore while increasing the revenue or minimizing the total cost of production over a period
of time with attendant economies of scale will widen the difference to gain more profit.
In perfect market, the firm’s Marginal cost, Average cost, Average revenue, Marginal revenue
are equal to the price of the commodity. The cost is measured as average cost and marginal cost
.When the firm is in equilibrium, producing the maximum output i.e. cost of the last item
produced is known as marginal [Link] total cost divided by the number of goods produced will
give the average cost. When the firm is operating in perfect market MC = AC.
In the same way the revenue available to the firm through selling goods is called as total revenue.
The last item sold is the marginal revenue. The total revenue divided by the number of items sold
is the average revenue and when the firm is working in the perfect market the MR shall be equal
to AR.
Therefore the MC = MR = AR = AC = P in the short run.
The size of the plant is fixed only with the variable factors and the price is fixed by the demand
and supply.
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Perfect Market Price Determination
The demand for the commodity is expressed in the demand curve (D) and the supply (S) curve is
known as S curve. The point of intersection of the D curve and S Curve is the equilibrium point
(E) where the price is determined as OP. (Rs.10) The average revenue per unit is also Rs.10
expressed in graph (b) along with the marginal cost (MC) and average cost (AC) curves. The MC
and AC intersect at point ‘K’ which is equal to the price OP / AR / MR. Therefore we can say
that P=AR=AC=MR=MC at this level. At this equilibrium point buyers and sellers are satisfied
with their price. The price of the commodity includes the normal profit through the average cost.
The average cost consists of implicit and explicit costs. That means the organizers knowledge,
time, idea and effort is also considered in the cost of production. Let us assume that in the short
run the demand for the commodity increases, then the change in price and profit are explained in
the graph below.
Graph - Short Run Profit Maximization Under Perfect Competition
From the above graph we can understand that in the short run demand curve DD and the short
period supply curve SPSC intersects at ‘E’ and the price of the commodity is determined as OP.
The right side graph indicates the cost and revenue curves. The average revenue (AR) and
marginal revenue (MR) are equal to the price of the commodity OP. The short period marginal
cost (SMC) and short period average cost (SAC) are also depicted in the graph. The minimum
average cost is selected based on the equilibrium point Q which produces optimum quantity of
OM. The marginal cost curve and average cost curve intersects at the point Q that means QM
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amount (rupees) is spent as marginal as well as average cost. The SAC is tangential to AR/MR at
this point therefore we can conclude that the price of the commodity is equal to the average cost,
average revenue, marginal cost and marginal revenue ( P = AR = MR = AC = MC )
If the demand increases in the market then the new demand curve D1D1 intersects the SPSC at
the new equilibrium point ‘E1’ and the price increases from OP to OP1. Therefore the average
revenue also increases from AR to AR1. At this situation P1 = AR1 = MR1 but the SMC curve
intersects at Q1 ie., new equilibrium point and the OM quantity has increased from OM to OM1
in the ‘X’ axis. The average cost has increased as M1R.
Profit = Total Revenue (TR) – Total Cost (TC)
TR = quantity sold x price
TC = average cost x quantity produced
TR = OM1 x OP1 = OM1Q1P1
TC = M1R x OM1 = OM1RS
Profit = OM1Q1P1 - OM1RS = P1Q1RS
In the above graph, the shaded portion of P1Q1RS is the total profit earned by the firm in the
short run but in the long run the organization will increase the production and will supply more
of the commodity. Ultimately both the demand and the supply gets equalized and the short run
abnormal profit becomes normal. Therefore we can conclude that even in the perfect market it is
possible to earn profit in the short period.
It indicates clearly that in the short run, in any perfect market, the increase in demand will
increase the profit to the businessmen. The normal profit will be there until it gets equalized with
the demand i.e. new D1D1 with the increased supply of S1S1.
This economic profit attracts new firms into the industry and the entry of these new firms
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increases the industry supply. This increased supply pushes down the price. As price falls, all
firms in the industry adjust their output levels in order to remain in profit maximizing
equilibrium. New firms continue to enter the industry and price continues to fall, and existing
firms continue to adjust their outputs until all economic profits are eliminated. There is no longer
an incentive for the new firms to enter and the owners of all firms in the industry will earn only
what they could make through their best alternatives.
Economic losses motivate some to exit (shut down) from the industry. The exit of these firms
decreases industry supply. The reduction in supply pushes up market price and all the firms shall
adjust their output in order to maximize their profit.
Shut Down Point:
If the market price for the product is below minimum average variable cost, the firm will cease to
produce, if this appears to be not just a temporary phenomenon. When the price is less than
average variable cost it will neither cover fixed cost nor a part of the variable costs. Then the
firm can minimize losses up to total fixed costs only by not producing. It is therefore regarded as
the shut down point. In the short run, a firm can be in equilibrium at various levels depending
upon different cost and market price conditions. But these are temporary equilibrium points.
Thus at this unstable equilibrium point the firm gets excess profits or normal profit and
sometimes incur loss also.
Monopoly Market
Mono means single, poly means seller and hence monopoly is a market structure where only one
sells the goods and many buyers buy the same. Monopoly lies at the opposite extreme from
perfect competition on the market structure continuum. A firm produces the entire supply of a
particular good or service that has no close substitute.
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Characteristic Features:
1. A single seller in the market
2. There are no close substitutes
3. There is a restriction for the entry and exit for the firms in the market
4. Imperfect dissemination of information
This does not mean that the monopoly firms are large in size. For example a doctor who has a
clinic in a village has no other competitor in the village but in the town there may be more
doctors. Therefore the barrier to the entry is due to economies of scale, economies of scope, cost
complementarities, patents and other legal barriers.
Profit maximization under Monopoly Competition
For monopolist there are two options for maximizing the profiti.e. maximize the output and the
limit the price or limit the production of the goods and services and fix a higher price (market
driven price). In monopoly competition, the demand curve of the firm is identical to the market
demand curve of that product. In monopoly the MR is always less than the price of the
commodity.
Profit Maximization Rule:
Produce at that rate of output where MR = MC. From the graph we can understand the profit
maximization under monopoly. ‘X’ axis indicates the output and ‘Y’ the price/cost and revenue.
The marginal revenue curve is denoted as MR. The average revenue curve is AR which is also
the demand curve. MC is the marginal cost curve, It looks like a tick mark and average cost
curve AC is boat shape.
Graph- Profit Maximization Under Monopoly Market
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From the above graph it is seen that the demand curve D and average revenue curve AR are
depicted as a single curve. The marginal revenue curve MR also slopes the same but the MR
curve is below the AR curve. The short run marginal cost curve SMC looks like a tick mark and
the boat shaped average cost curve SAC is also seen in the graph.
The profit maximization criteria of MR=MC is followed in the monopoly market and the
equilibrium point ‘E’ is derived from the intersection of MR and SMC curves in the short run.
i.e. MC curve or SMC here intersects the MR curve from below. Based on the equilibrium point,
the output is the optimum level of production i.e., at OM quantity. The price of the commodity is
determined as OP. On an average the firm receives MQ amount as revenue. The total revenue of
selling OM quantity gives OMQP amount of total revenue (OM quantity x OP price). The firm
has spent MR as an average cost to produce OM quantity and the total cost of production is
OMRS (OM quantity x MR cost per unit)
Profit = TR – TC = OMQP - OMRS
= PQRS (the shaded portion in the graph)
In the short run the monopoly firm will earn profit continuously even with various returns.
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Graph- Monopoly Profit With Increasing Cost
From the above graph it can be understood that the cost of production (MC, AC) is increasing
along with the output but even with the increasing scale the firm earns PQRS as profit which is
the shaded portion in the graph.
The graph given below explains clearly that the firms cost curves of Marginal cost (MC) and
Average cost (AC) are declining with this slope.
The organization earns PQRS profit but the profit is comparatively lesser than the previous
situation.
Graph – Monopoly Profit Under Decreasing Cost
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The third situation explains that the organizations’ marginal cost and average cost curves are
horizontal and parallel to the X axis. Even with the constant scale, the firms earns profit as
PQRS.
Graph – Monopoly Profit Under Constant Cost
Therefore we can conclude by saying that under monopoly market structure the firm will earn
profit even under different cost conditions and profit maximization takes place. They follow the
price determination condition as MC=MR and never incur loss.
DIFFERENT MARKET STRUCTURES AT A GLANCE:
Points of Perfect Monopoly Monopoly Oligopoly Duopoly
Difference Competition
No. of sellers Very large One Large A few Two
Product Homogeneous One Product Product Product Similar of
differentiation differentiation product
differentiation
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Price Uniform Single Price Different Different Similar orDifferent
and Price
discrimination
Entry Free entry Restricted Not Not absolute Not restrictedand
absolute freedom absolute freedom
freedom
Mobility Perfect Partial Partial Partial Partial
Price Perfectly Highly Less elastic Less elastic Less elastic orinelasti
elasticy inelastic
of
demand
Knowledge Perfect knowledge Partial knowledge Partial Partial Partial knowledge
ofthe knowl knowledge
market edge
Selling cost NIL NIL Exist Exist May or maynot exist
AR & MR Horizontal Both are Both aredifferent
AR is AR > MR Downward sloping
and Different indeterminate AR>MR
AR = MR AR> MR
Transportation NIL Exist Exist Exist Exist
Cost
Price By industry By firm but Firms Counter Uniformity
determinati equilibrium firm and themse pricing
on industry is lves
same
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PRODUCT DIFFERENTIATION
Product differentiation is simply the characteristics that define your product and make it unique
to customers. You may hear it called the unique selling proposition or abbreviated as the USP.
Why is product differentiation important?
For brands, the field of competition is more crowded than ever. When faced with too many
choices, consumers can be overwhelmed, and often walk away rather than make a difficult
decision. That is why it is imperative to find a way for your product to stand out and be
considered uniquely [Link] want it to be crystal clear to your customers what you are
offering and how your product compares to competitors. If you have other products, you also
want to make sure each product has a clearly defined identity to eliminate confusion for
customers. Creating a differentiated product which appeals to your target market can help to
build your competitive advantage over other brands.
What are some ways to differentiate your products?
You do not want to be different just for the sake of being different. Instead, consider what
matters most to your customers, and let that drive your decisions on how to differentiate your
product. Your product differentiation should arise after careful study, and should be part of your
larger strategy for the product. With that said, here are some common ways that a product can
stand out:
Benefits
What value can customers expect to gain from using your product compared to others? What
problem is the product going to solve? How is it going to make their lives better? For example,
yours may be the only brand offering a mobile app that saves actual time from an activity that
parents must do (but do not like) every day.
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Design
Does the product have a different design that distinguishes it from the rest? For example, your
product is sleek while your competitors' offerings appear clunky or dated. This distinction may
help customers connect with your brand. For example, think about the modern design sensibility
of the Nest thermostat. Instead of copying the rectangular shape of other thermostats, the
company opted for a simple circle with an easy-to-read, color-changing display. This fresh take
on an old idea helps the company sets their product apart and gain a competitive advantage.
Price
Is your product priced lower or higher than your competitors' products and other products you
offer? Your price should reflect the overall value that you are offering in the product. For
example, you can justify a higher price if customers recognize that the product offers
unsurpassed quality. This is how a luxury brand like Ferrari can command a top asking price for
their cars. Ask too low of a price, however, and customers may not see your product as truly
valuable.
Quality
Does your product simply work better than your competitors' products? Do you offer some
functionality that your competitors do not? Can users expect the product life to last longer than
other products? Your product's competitive advantage may indeed prove to be superior
construction and dependability.
Customer service
Your product may be similar to others in many ways. However, you can differentiate your whole
offering — and build your competitive advantage — by assembling a stand-out support team and
earning a reputation for being ultra- responsive to customers' needs.
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For example, the #1 core value for Zappos is "Deliver wow through service," and they succeed
— even though Zappos does not always have the lowest price. A customer who orders by
midnight may receive their package by the next morning. This emphasis on customer service
pays off — judging by the fact that 75% of their sales are reportedly from repeat customers.
PRICE RIGIDITY
The Kinked Demand Curve is also known as Paul M. Sweezy Model. The oligopolistic price that
remain stable over a period of time is known as price rigidity. It is such a situation when there is
a change in cost of production and demand conditions there is no change in the price of the
goods and services from the firm's side. As the price of the durable goods do not change
throughout the year say fan, radio, television, watch etc.
Reasons for Price Rigidity:
There are the following reasons which are responsible for price rigidity under oligopolistic
market.
(1) When the Oligopolists might happen to understand the basic element that it is futile to
exercise price war as price war does favour none.
(2) The oligopolists may be self content with the current prices so as to avoid uncertainty,
insecurity, antagonism etc.
(3) The oligopolists may stick to prevailing price so as to discourage the entry of the new firms.
(4) If any price is fixed through collusion or an agreement, no firm is going to change it so as to
avoid the fear of price war.
(5) As high selling cost is involved no firm is ready to change its price.
(6) The firm may increase their profits by sales maximisation rather than cutting down the
prices. So, price rigidity is maintained.
(7) Finally, the shape of the Kinked Demand Curve goes in support for price rigidity in
oligopolistic market structure.
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Assumptions:
The kinked demand curve hypothesis of price rigidity is based on the following
assumptions:
(1) There are few firms in the oligopolistic industry.
(2) The product produced by one firm is a close substitute for the other firms.
(3) The product is of the same quality. There is no product differentiation.
(4) There are no advertising expenditures.
(5) There is an established or prevailing market price for the product at which all the sellers
are satisfied.
(6) Each seller’s attitude depends on the attitude of his rivals.
(7) Any attempt on the part of a seller to push up his sales by reducing the price of his product
will be counteracted by the other sellers who will follow his move.
(8) If he raises the price, others will not follow him. Rather they will stick to the prevailing
price and cater to the customers, leaving the price-raising seller.
(9) The marginal cost curve passes through the dotted portion of the marginal revenue curve
so that changes in marginal cost do not affect output and price.
The analysis of price rigidity can be explained with the help of Kinked Demand Curve asunder with
the help of diagram
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The diagram explains that the firm is starting at a point P with the corresponding current price
equal to OP1. The diagram shows that KPD is the Kinked demand curve and P is the Kinkey
point on the Kinked demand curve KPD, therefore OP1 is the prevailing price in the oligopolistic
market with OQ level of output and MR is the discontinuous Marginal Revenue curve, the
portion AB shows its discontinuity and MC is the marginal cost curve faced by an oligopolist.
Starting from point P with corresponding prevailing prince OP1 any increase in the price will
reduce its sales for the firm and rival may or may not follow the same, then the firm will reduce
its sales and profit will be limited. It is because of the KP portion of the Kinked demand curve
being elastic and the corresponding portion of KA of the Marginal revenue curve is positive.
Thus, any increase in price is liable to reduce its sales and revenue frontiers and then profit to
decline.
On the contrary, if the firm or seller reduces its price below OP1 its rival firm will also reduce
the price of its product which may lead to an increase in its sales but the profit would be less than
before. The reason is very clear that PD portion of Kinked demand curve is less elastic and the
corresponding part of marginal revenue curve below B is negative. Thus, in both the situations
either price increases or price decreases and the oligopolist remains the loser. Thus, the
oligopolist would stick to the prevailing market price OP1 which remains rigid. Hence the
rigidity is maintained at Kinky point P of the Kinked Demand curve under oligopolistic market.
This is such a situation in which the oligopolistic firm does not want to have a change in its
price, maintaining rigidity at the Kinky point of the Kinked demand curve. Thus price rigidity is
always maintained at the Kinky point on the Kinked demand curve under oligopolistic market.
The demand curve KPD with P as Kinky point on it presents a discontinuity in marginal revenue
curve equal to the portion AB and beyond B the marginal revenue curve is negative. The
elasticity of Kinked demand curve determines the size of discontinuity in the marginal revenue
curve. The more elastic the demand curve is to the left of the Kinky point P and more inelastic to
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right of the Kinky point, the more will be discontinuity in the marginal revenue curve under
oligopolistic market in the price rigidity analysis. If the angle, KPD becomes a right angle
the gap or discontinuity (AB) will be the widest. Thus, the price will be stable and rigid till
marginal cost curve cuts marginal revenue curve, somewhere between the discontinuity portion
AB. The Theory of Kinked demand curve has its drawbacks.
(i) The gap or discontinuity or Marginal Revenue Curve (MR) may be unstable.
(ii) The theory does not tell us how the initial price OP1 is maintained.
(iii) Price determination is illusionary as it does not follow the market behaviour.
(iv) It is doubtful about the stability of price under oligopoly as actual sales price in case of
many products is not possible.
(v) Kinked theory follows a price cut but does not follow a price rise but Stigler remarked that
a price rise has not been taken into consideration.
ADVERTISING
Advertising is always present, though people may not be aware of it. In today's world,
advertising uses every possible media to get its message through. It does this via television, print
(newspapers, magazines, journals etc), radio, press, internet, direct selling, hoardings, mailers,
contests, sponsorships, posters, clothes, events, colours, sounds, visuals and even
people (endorsements). The advertising industry is made of companies that advertise,
agencies that create the advertisements, media that carries the ads, and a host of people like copy
editors, visualizers, brand managers, researchers, creative heads and designers who take it the
last mile to the customer or receiver. A company that needs to advertise itself and/or its products
hires an advertising agency. The company briefs the agency on the brand, its imagery, the ideals
and values behind it, the target segments and so on. The agencies convert the ideas and concepts
to create the visuals, text, layouts and themes to communicate with the user. After approval
from the client, the ads go on air, as per the bookings done by the agency's media buying unit.
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School of Law
An ISO 9001:2015 Certified Quality Institute
(Recognized by Govt. of NCT of Delhi, Affiliated to GGS Indraprastha University, Delhi)
ADVERTISING IN MONOPOLISTICALLY
The importance of advertising in monopolistic industries is readily apparent. Advertising
highlights real or perceived product differences between and among products of firms in the
industry. Advertising creates and reinforces customer loyalty, which gives the firm limited
market power. The effect of successful advertising by firms in monopolistically competitive
firms is illustrated in Figure.
In Figure the demand curve for the firm’s product shifts from D0 to D1 as a result of the firm’s
advertising expenditures. The costs of advertising are illustrated by the shifts in the marginal and
average total cost curves from MC0 to MC1 and ATC0 to ATC1, respectively. These changes
result in an increased unit sales and prices. In the situation depicted the Figure, the firm is clearly
better off as a result of its presumably successful advertising campaign. This is seen by the
increase in profits from p0 to p1.
How much advertising is optimal? In principle, the optimal level of advertising expenditure
maximizes the firm’s profits from having spent that money. As a general rule, the firm will
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Chanderprabhu Jain College of Higher Studies
&
School of Law
An ISO 9001:2015 Certified Quality Institute
(Recognized by Govt. of NCT of Delhi, Affiliated to GGS Indraprastha University, Delhi)
maximize its profits from advertising by producing at an output level at which marginal
production cost (including incremental advertising expenditures) equals marginal revenue.
CONDITIONS OF ENTRY AND EXIT
The ease with which firms are able to enter and exit a particular industry is also crucial in
determining the nature of a market. When it is difficult for firms to enter into an industry,
existing firms will have much greater influence in their output and pricing decisions than they
would if they had to worry about increased competition from new comers, attracted to the
industry by high profits. In other words, managers can make pricing decisions without worrying
about losing market share to new entrants. Thus if a firm owns a patent for the production of a
good, this effectively prohibits other firms from entering the market. Such patent protection is a
common feature of the pharmaceutical industry. Exit conditions from the industry also affect
managerial decisions.
Suppose that a firm had been earning below-normal economic profit on the production and sale
of a particular product. If the resources used in the production of that product are easily
transferred to the production of some other good or service, some of those resources will be
shifted to another industry. If, however, resources are highly specialized, they may have little
value in another industry.
In this and the next two chapters we will examine four basic market structures: perfect
competition, monopoly, oligopoly, and monopolistic competition.
For purposes of our analysis we will assume that the firms in each of these market structures are
price takers in resource markets and that they are producing in the short run. The result of these
assumptions is that the cost curves of each firm in these industries will have the same general
shape as those presented earlier.
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Chanderprabhu Jain College of Higher Studies
&
School of Law
An ISO 9001:2015 Certified Quality Institute
(Recognized by Govt. of NCT of Delhi, Affiliated to GGS Indraprastha University, Delhi)
Firms differ in the proportion of total market demand that is satisfied by the production of each.
This is illustrated in Figure 8.1. At one extreme is perfect competition, in which the typical firm
produces only a very small percentage of total industry output. At the other extreme is
monopoly, where the firm is responsible for producing the entire output of the industry.
The percentage of total industry output produced is critical in the analysis of profit maximization
because it defines the shape of the demand curve facing the output of each individual firm. The
market structures that will be examined in this and the next chapter can be viewed as lying along
a spectrum, with the position of each firm defined by the percentage of the market
Finally, as in perfect competition, it is relatively easy for new firms to enter the industry, or for
existing firms to leave it.
Definition: Monopolistic competition is a market structure that is characterized by buyers and
sellers of a differentiated good or service and in which it is relatively easy to enter the industry or
to leave it.
For either duopolies or oligopolies to persist in the long run, there must exist conditions that
prevent the entrance of new firms into the industry. There is disagreement among economists
over just what these conditions are. Bain (1956) has argued that these conditions should be
defined as any advantage that existing firms hold over potential competitors, while Stigler (1968)
argues that these barriers to entry comprise any costs that must be paid by potential competitors
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Chanderprabhu Jain College of Higher Studies
&
School of Law
An ISO 9001:2015 Certified Quality Institute
(Recognized by Govt. of NCT of Delhi, Affiliated to GGS Indraprastha University, Delhi)
that are not borne by existing firms in the industry. Many of the barriers to entry erected by
oligopolists are the same as those used by monopolists.
Oligopolist also can control the industry supply of a product and enhance its market power
through the control of distribution outlets, such as by persuading retail chains to carry only its
product. Persuasion may take the form of selective discounts, long term supply contracts, or
gifts to management. Devices such as product warranties also serve as an effective barrier to
entry. New car warranties, for example, typically require the exclusive use of authorized parts
and service. Such warranties limit the ability of potential competitors from offering better or less-
expensive products.
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