BUSINESS ECONOMICS

(22MBACC102)

Dr. Salma Begum

BUSINESS ECONOMICS
Module-3
Market Structures
 Meaning of Market

▪ Market is generally understood to mean a particular place

or locality where buyers & sellers meet together and deal
with their business transaction.
▪ For example, Bombay market, Delhi market, Calcutta
market, Bangalore market, Mangalore market & Mysore
market etc.
▪ However, in economics, the term market, it is not a
particular place/locality where goods are bought and sold.
▪ The idea of a particular locality or geographical place is not
necessary to the concept of the market.
 Classification of Market

Area Time Commodities Competition

Bullion Perfect Imperfect

Local Market Period Market Competitio Competitio
n n

Share
Regional Short Period
Market Monopoly

Money Duopoly
National Long Period
Market

Oligopoly
Very Long Capital
International Market Monopolistic
Period
Competition
 Classification of Market Structure
Perfect competition and Imperfect competition

1. Perfect Competition
market, where there is a large number of producers (firms)
producing a homogeneous product, homogeneous price
existence.

2. Imperfect competition
It is an important market category where in individual firms
exercise control over the price of commodity.
Imperfect competition has several sub-markets -
1) Monopolistic competition
2) Pure Oligopoly
3) Differentiated Oligopoly
4) Monopoly
 Forms of Market Competition

Barriers to
Models of Number of Number of Nature of
entry and
Competition buyers sellers products
exit
Perfect Identical
Very large Very large None
competition products
Single
Monopoly Very large One Very large
product
Monopolistic Minimum
Very large Large None
competition differences
Large
Oligopoly Very large Very few Large
differences
 Perfect Competitive Market
Features of perfect competitive market

1.Large number of buyers and sellers

2.Homogeneous product
3.Free entry and exist conditions
4.Perfect knowledge about market
5.Perfect mobility of factors of production
6.Absence of transport cost
 Perfect Competition-
Price and Output Determination
▪ Price under perfect competition is determined by
the interaction of the two forces – demand and
supply.
▪ Though individuals cannot change the price, but
aggregate forces of demand and supply can change.
▪ Demand side – marginal utility of commodity to
the buyers
▪ Supply side – cost of production – producers
▪ The interaction of demand and supply is called the
equilibrium price.
▪ Equilibrium price is that price at which quantity
demanded is equal to the quantity supplied at given
price – both buyers and sellers are satisfied
 Equilibrium between demand and
supply
Price of Demand Supply Pressure on
commodities price

5 12 1
Excess
10 10 2
Demand
15 08 4
20 06 6 Equilibrium
25 04 8
Excess Supply
30 02 10
35 01 12
Price and Output Determination
 Perfect Competition- Short run
What is
economic
profit?

Firms are price takers.

Horizontal Demand
curve.
Marginal revenue
equals to average
revenue and the price

https://www.investopedia.com/terms/e/economicprofit.asp
Perfect Competition- Short run
Long period price determination-Perfect Competition

▪Long period is a period of many

years 5, 10, 15 20 & above.
▪In this period supply conditions are
fully able to meet the new demand
conditions.
▪In the long run no fixed & variable
factors all the factors treated as
variable factors.
▪New plants/new firms can enter into
the market & old firms can leave
the market.
 Perfect
Competition- You mean I
cannot earn
super-norm
Short run al profit?

Theory- In Perfect
Competition, the seller
ends up with normal profit.

Video-https://www.youtub
e.com/watch?v=Z9e_7j9W
zA0
Features of Monopoly
Why Monopoly?
Price-output determination under Monopoly
 Can Monopoly incur loss in long-run?

Price-maker
MR=MC (Profit maximization)
MC=AR (Socially optimal
quantity or allocative
efficiency)
Q= min AC (Productive
efficiency)
P = AC (non profitable)
 Watch the Video and Practice Diagram

Video-https://www.youtube.com/
watch?v=ZiuBWSFlfoU
 Monopolistic Competition

▪In the real world, neither perfect

competition nor monopoly
exists, but it is only an imperfect
competition like monopolistic
competition does exist.
▪The credit for the development
of monopolistic competition
goes to Joan Robinson of UK &
Chamberlin of USA in 1933.
▪Mrs. Joan Robinson published
her book on “The Economy of
Imperfect Competition & Prof
Edward. H. Chamberlin on “The
theory of Monopolistic
competition” in 1933.
 Monopolistic Competition

▪Monopolistic competition
refers to competition
among a large number of
sellers producing close
substitute but not perfect
substitutes.
▪Further, in this market
condition there is freedom
of entry into & exist from
the industry.
 Features of Monopolistic Competition
1. A large number of
firms
2. Product
differentiation
3. Free entry & exists of
firms
4. Advertisement
expenditure/ Selling
Cost
5. Non-price
competition
6. Product variation
 Nature of Demand curve
▪Under monopolistic competition
enjoys some control over the price of
its product – since its product is
somewhat differentiated from others.
If a firm raises the price of its product
it will find some of its customers
going away to buy other products. As
a result, the quantity demanded of its
product will fall and vice versa.
▪Therefore, demand curve facing an
individual firm under monopolistic
competition slopes downward. If a
firms wants to increase the sales of its
product, it must lower the price.
Short period - Price and output determination
Short period - Price and output
determination
 Monopolistic Competition-Long run
price-output determination
▪Monopolistic competitors differentiate
products to exploit short-run profit
opportunities, and would like their profits to
persist.
▪These hopes are usually frustrated because
typical monopolistic competitors earn only
normal profits in the long run
▪the long-run industry adjustments parallel
those for pure competition. Entry of new firms
seeking profits cannot be prevented, which
may increase production costs.
▪Profits are also dissipated because prices fall
when new competitors expand output and take
customers from existing firms.
Long-Run Adjustments
 Long-Run Adjustments
▪ This shrinks the demand for a successful firm's products. When new firms
enter the market, the demand curves of established firms shift leftward and
become more elastic, ultimately leaving all firms in an equilibrium of the
sort shown in Figure
▪ Marginal revenue equals marginal cost at point a, and the long-run average
total cost (LRATC) curve is just tangent to the demand curve at point b.
▪ This tangency allows the firm to sell its output at a price just equal to
average cost (Pe = ATCe), yielding only normal profits in the long run.
Product differentiation allows the prices of comparable goods to vary in
monopolistic competition, but only within a narrow range.
 Oligopoly
▪ The term Oligopoly derived from two Greek words ‘Oligos’
means a few & Pollein – to sell.
▪ It is a competition among few big sellers each one of them
selling either homogenous or heterogeneous products.
▪ Thus, oligopoly refers to that form of imperfect competition
where there will be only a few sellers producing either a
homogeneous product or products which are close substitutes
but not perfect substitutes.
▪ Oligopoly is also referred as “Competition among the few”
as a few big firms will be producing & competing in the
market.
 Features of Oligopoly

1. A few sellers
2. Market Interdependence
3. Kinked Demand curve-
Indeterminate demand
curve
4. Importance of advertising
5. Group Behaviour
6. Element of Monopoly
7. Self created entry barriers
8. Price Rigidity
Examples of Oligopoly
 Classification of Oligopoly

Price
Product Entry of firms Agreement
Leadership

Collusive Non-collusive
Perfect Imperfect Oligopoly Oligopoly
Oligopoly Oligopoly

Open Closed Partial

Full Oligopoly
Oligopoly Oligopoly Oligopoly
 Oligopoly Classified
There may be many firms
in the market. However,
the market share remains
with a few.
e.g. Banking Industry,
Airline/Aviation industry
etc.
There may be different
products under different
brand names but they
belong to a particular large
firm.
e.g. Nestle, Patanjali,
P&G, HUL etc.
 Video-Oligopoly

https://www.youtube.com/w
atch?v=0Gb4t1L2MH0
https://www.youtube.com/w
atch?v=9Vi8LBXPg2I
 Kinked Demand Curve
▪In 1939, Prof Paul Sweezy has introduced the Kinked
Demand Curve – determination of equilibrium in oligopoly
market.
▪He used the kinked demand curve model – explain about price
rigidity under oligopoly market.
▪Demand curve facing an oligopolist has a kink at the
prevailing price.
▪If he lowers the price below the prevailing level his
competitors will follow him & will lower their prices.
▪But if he increases his price above the prevailing level his
competitors will not follow his increase in price.
▪Upper segment of the demand curve is relatively elastic and
the lower portion is relatively inelastic.
 Assumptions

1. There is an established market price at which all the sellers

are satisfied.
2. Each sellers attitude depends on the attitude of his rivals.
3. An attempt of every seller to push up his sales by reducing
the price will be counteracted by other sellers.
4. If the seller raises the price, other will not follow him rather
they will stick to the prevailing price.
 Kinked demand curve
▪dKd is the kinked demand curve of
an oligopolistic firm.
▪OP is the prevailing market price
& OM is the equilibrium level of
output. Y
▪If an oligopolistic seller (firm) More Elastic

increases the price of the product

above OP, this will reduce his d MC
K
sales – because the rivals are not P
expected to follow his price.
▪This is because the dk portion of
the kinked demand curve is elastic A
Less elastic
& the corresponding dA portion of D/AR
the MR curve is positive. B
▪If the seller reduces the price of O M X
the product below OP, his rivals MR
will also reduce their price. quantity
 Kinked demand curve
▪Though he increase's his sales,
his profits would be less than
before.
▪The reason is that kd portion of
the kinked demand curve below
OP is less elastic & MR curve
below B is negative.
▪Thus in both the price-rising &
price reducing situations – the
oligopolistic seller will be the
loser.
▪Therefore, he will stick to the
prevailing market price OP
which remains rigid.
▪A kinked demand curve is said
to occur when there is a sudden
change in the slope of the
demand curve.
 Price and output determination –
Oligopoly

▪ There is no one system of pricing under oligopoly

market.
▪ Price policy followed by a firm depends on the nature
of oligopoly & rival reactions.
▪ Therefore, there are three types of pricing under
oligopoly.
1. Independent Pricing
2. Pricing under Collusion
3. Pricing under Price Leadership
1. Independent Pricing or (Non-collusive oligopoly)
Homogeneous Product
▪ When goods produced by different oligopolists are more or less similar or
homogeneous in nature.
▪ There will be a tendency for the firms to fix a common pricing – “Going
Price” – accepting price.
▪ So that firm earns adequate profits at this price.
Non-homogeneous Product or Different Product
▪ When goods produced by different firms are different in nature, each firm
will be following an independent price policy – like monopoly.
▪ Due to product differentiation, each firm has some monopoly power.
▪ Price war between different firms & each firm may fix price at the
competitive level.
▪ A firm tend to change prices even below the variable costs, the other firms
are also cutting the price as same as them – cut throat competition.
▪ Independent pricing in reality leads to antagonism, friction, rivalry,
infighting, price-wars etc.
2. Pricing under Collusion

▪ The term collusion means - to play together in economics. It

means that the firms co-operation between the competing
firms in pricing their products.
▪ Three main reasons for collusion
1. Oligopoly firms wants to reduce competition & increasing profits.
2. Collusion helps them to reduce uncertainty.
3. To prevent the entry of new firms into the industry.
▪ Collusion based on oral agreements or written agreements.
▪ Oral agreements – “Gentlemen’s agreement – it does not
consist of any records.
▪ Written agreements are called as CARTELS.
▪ Two kinds of collusion
▪ 1. Perfect Collusion &
▪ 2. Imperfect Collusion
1. Perfect collusion (centralized cartel)
▪ The firms surrender all their rights to a central authority
when sets prices, output & quotas for each firm, distributes
profits etc.
▪ The cartel are similar to a monopoly, where entire oligopoly
industry is controlled & directed by the central agency.
2. Imperfect collusion
▪ Refers to a secret or informal agreement under which the
colluding firms in the oligopoly industry seek to fix prices &
outputs of their products.
▪ Price leadership is an outstanding example of imperfect
collusion.
 Price Leadership under oligopoly

▪ When price is determined by one big firms in the industry & this price is
accepted by all the other firms (small firms).
▪ Price fixation is generally the result of tacit understanding rather than of a
formal agreement.
▪ The big firms – scale of production, most senior/experienced firms etc.
▪ In America, price leadership industries are – biscuits, cement, cigarettes,
flower, fertilizers, petroleum, milk, steel etc.
 Game Theory
• Game theory helps us understand oligopoly and other
situations where “players” interact and behave strategically.
• Players can be anyone – firms, individuals, countries etc.
• Game is a situation where the players interest and respond to
each other’s moves with an objective in mind.
• Strategy is an action plan to win the game, taking into
consideration the behaviour and likely responses from the
opponent player (s).
Application of Game Theory to Oligopolistic
Strategy

https://www.youtube.com/watch?v=
PCcVODWm-oY
 Whether or not to increase ad-expenditure?
There are two firms- A and B (Duopoly).
•In Oligopoly, the firms have to decide their strategy by
anticipating the other player’s move. This can happen by
anticipating different possible moves by the rival.

Example of Ad-expenditure,
i)Counter moves by the rival firm (B) in response to increase in
ad-expenditure by this firm (A).
ii)The pay-off of this strategy when the rival firm (B) does not
react, and the rival firm does make a counter move by increasing
its ad-expenditure.
 Dominant strategy
• The best possible strategy is dominant strategy. A dominant
strategy is one that gives optimum pay-off, no matter what the
opponent does.
• Thus, the basic strategy to arrive at the dominant strategy.
 Pay-off matrix of Ad-Game

B’s Option
Increase Ad Doesn’t increase
Increase A B A B
A’s Ad 20 10 30 0
Option Doesn’t A B A B
increase 10 5 15 5
(increase in Sales in million Rs.)
 Dominant strategy for firm A

Dominant strategy for firm A is to increase ad expenditure.

 Pay-off matrix of Ad-Game
(No dominant strategy for firm A)

B’s Option
Increase Ad Doesn’t increase
Increase A B A B
A’s Ad 20 10 30 0
Option Doesn’t A B A B
increase 10 5 25 5
(increase in Sales in million Rs.)
 NASH EQUILIBRIUM

• In real life situations, there is continuous action, reaction, and

counteractions.
• John Nash, an American mathematician has developed a
technique called as “NASH EQUILIBRIUM.’
• Each firm does the best it can, given the strategy of its
competitors. Nash Equilibrium is the one in which none of the
firms can increase its pay-off given the strategy of rival firm.

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7399618/
 Pay-off matrix of Ad-Game
B’s Option
Increase Ad Doesn’t increase
Increase A B A B
A’s Ad 20 10 30 0
Option Doesn’t A B A B
increase 10 5 25 5
(increase in Sales in million Rs.)
 Case Study: Game Theory in Indian
E-commerce
There's a message for competitors every time Amazon announces a big-ticket investment
The seeds were sown early this year. On 15 January, the world’s richest man and Amazon founder
Jeff Bezos said the online retailer would invest $1 billion in India over 5 years, bringing 10 million
small and mid-size local businesses online. While US companies are known to be tight-lipped about
their investment plans, there is a reason why Amazon keeps announcing them. In it, there always is
an inherent message for its competitors. This time, it was for Reliance Industries which had, just a
month back in December, rolled out an early version of JioMart -- its much-anticipated online retail
service, saying it will use its technology platform to tap into India’s vast network of small
neighbourhood stores known as kiranas. Bezos’ appeal then to woo such businesses could be
understood.
Game theory is about how you make moves in competitive situations where the outcome depends
critically on your competitor’s moves. Here, signaling is just as critical as the actual action. That was
Bezos’ turn. Now Reliance has come back with a $5.7 billion deal with Facebook that gives the
Mark Zuckerberg company a 9.9% stake in RIL subsidiary Jio Platforms. RIL gets a lot money to
lengthen its runway and secondly it makes sure that it mentions in the joint news release, unleashing
‘JioMart’ on the mammoth 450 million user base of Facebook-owned Whataspp to turbocharge
‘kiranas’. All eyes on Amazon now on its next move, which should not be undermined in anyway.
And while all this happens, we have now entered the second round of Indian e-commerce wars.
 The network effects will impact all spaces – payments, content, distribution, currency and of course
commerce. The prize is enormous.
The second round brings Amazon face-to-face with Jio which is well versed with such playbook:
Jio’s entry has shaken the telecom business model – free voice calls, disruptive packages and
freebies. Result: stiff losses, value erosion, mergers and even bankruptcies. In other words, throw
money to control consumers, ‘monopoly leveraging’ and raise prices at will.
Source-
https://www.livemint.com/news/india/opinion-game-theory-in-indian-e-commerce-115881695860
72.html

QUESTIONS
1.Evaluate why Amazon Chief announced their investment plans for Amazon India, well ahead of
time.
2.According to the Game Theory model, with a diagram, analyse the choices the competitor Jio-Mart
would have.
3.Substantiate with features of the market, what sort of market this makes the e-commerce space