Market Analysis

Market Analysis

Structure Conduct - Performance

Structure Conduct - Performance

Market Structure

Number of firms.
Industry concentration.
Technological and cost conditions.
Demand conditions.
Ease of entry and exit.

Conduct

Pricing.
Advertising.
R&D.
Merger activity.

Performance

Profitability.
Social welfare.

'Herfindahl-Hirschman Index HHI

A commonly accepted measure of market
concentration.
It is calculated by squaring the market share of
each firm competing in a market, and then
summing the resulting numbers.
The HHI number can range from close to zero
to 10,000. The HHI is expressed as:
HHI = s1^2 + s2^2 + s3^2 + ... + sn^2
(where sn is the market share of the ith firm).

'Herfindahl-Hirschman Index HHI

The closer a market is to being a monopoly, the higher
the market's concentration (and the lower its
competition).
If, for example, there were only one firm in an industry,
that firm would have 100% market share, and the HHI
would equal 10,000 (100^2), indicating a monopoly. Or,
if there were thousands of firms competing, each would
have nearly 0% market share, and the HHI would be
close to zero, indicating nearly perfect competition.
The U.S. Department of Justice uses the HHI for
evaluating mergers.

Lerners Index -Measurement of

Monopoly Power

Degree of monopoly power = P MC/P

Where P denotes price and MC denotes marginal cost at
the equilibrium level of output.
Under perfect competition, Lerners index of monopoly
power = (P MC/P) = 0/P = 0. On the other hand, when
the monopolised product entails no cost of production,
that is, when the product is a free good whose supply is
controlled by one person, the marginal cost will be equal
to zero and Lerners index of monopoly power (P-MC/P)
would be equal to one or unity. Thus when MC is equal
to zero P MC/P = P 0/P = P/P = 1

The Degree of Competition

Classifying markets

number of firms
freedom of entry to industry
nature of product
nature of demand curve

The four market structures

perfect competition
monopoly
monopolistic competition
oligopoly

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

Features of the four market structures

The Degree of Competition

Classifying markets

number of firms
freedom of entry to industry
nature of product
nature of demand curve

The four market structures

perfect competition
monopoly
monopolistic competition
oligopoly

Perfect Competition
Assumptions
firms are price takers
freedom of entry
identical products
perfect knowledge

Short-run equilibrium of the firm

price, output and profit

Short-run equilibrium of industry and

firm under perfect competition
P

MC

D = AR
= MR

AR
AC

Pe

D
O

O
Q (millions)

(a) Industry

AC

Qe
Q (thousands)

(b) Firm

Loss minimising under perfect

competition
P

AC
P1

AC

MC

D1 = AR1

AR1

= MR1

D
O

O
Q (millions)

(a) Industry

Qe
Q (thousands)

(b) Firm

Perfect Competition
Assumptions

firms are price takers

freedom of entry
identical products
perfect knowledge

Short-run equilibrium of the firm

price, output and profit

The short-run supply curve of the firm

Deriving the short-run supply curve

MC = S
a

P1
P2

b
c

P3

D1 = MR1
D2 = MR2
D3 = MR3

D1
D3
O

Q (millions)

(a) Industry

D2
O

Q (thousands)

(b) Firm

Perfect Competition
Long-run equilibrium of the firm
all supernormal profits competed away
LRAC = AC = MC = MR = AR

Long-run equilibrium under Profits

perfect
return
Supernormal
New firms enter
competition
to normalprofits
P

S1
Se

LRAC
P1

AR1

D1

PL

ARL

DL

D
O

O
Q (millions)

(a) Industry

QL
Q (thousands)

(b) Firm

Long-run equilibrium of the firm under perfect

(SR)MC
competition
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

Perfect
Competition
Benefits of perfect competition
price equals marginal cost
prices kept low
firms must be efficient to survive

Perfect competition

The market demand and supply equations for Plywood are given by

Qs = 20,000 + 30P
Qd = 40,000 20P
1.Determine the equilibrium price and quantity
The Plywood industry is perfectly competitive, and the marginal cost
equation for one firm, Greenply,is given by
MC = 200 + 4Q
2.What is the short-run output rate for Greenply?
Average Cost is given by
AC= 1000/Q +200 + 2Q
4.In the short-run , how much economic profit will the firm earn?

 In a perfectly competitive market

supply and demand functions are
Qs = 1000P + 500
Qd = 5000 500P
If variable cost function of a firm is
VC = 103Q 0.5Q2
1. Profit maximizing output for the firm
2. Economic profit?

XYZ Ltd., operating in a perfectly competitive

market, sells a stationery item at Rs.10 per
unit. The cost function is given as
TC = 4,000 + 4Q + 0.02Q2
1.The profit maximizing output for the firm?

Softy Cereals Inc. (SCI) produces and markets Tasties, a

popular ready-to-eat breakfast cereal. The
demand and supply functions of Tasties are as follows:
QD = 150 3P
QS = 50 +10P.
If excise tax of Rs.3 is imposed on Tasties, what is the
proportion of tax that will be borne by the consumers ?

 Demand and supply functions for a product

are:

Qd = 10,000 4P

Qs = 2,000 + 6P
If the government imposes a excise tax of
Rs.100 per unit, what will be the new
equilibrium price? What is the proportion of tax
shared by the producers and consumers

Monopoly
Defining monopoly
Barriers to entry

economies of scale
economies of scope
product differentiation and brand loyalty
lower costs for an established firm
ownership/control of key factors
ownership/control over outlets
legal protection
mergers and takeovers
aggressive tactics

 Pure monopoly is the form of market

organization in which a single firm
sells a commodity for which there are
no close substitutes. Monopoly is at
the opposite extreme from perfect
competition in the spectrum or range
of market organisation.

Features

Single seller
No close substitutes
Entry is blocked
No difference between firm and industry
Price discrimination
Downward sloping demand curve( less elastic)

Monopoly
The monopolists demand curve
downward sloping
MR below AR

Equilibrium price and output

Equilibrium output, where MC = MR
MR = P (1+1/e)


Profit
maximising under
MC monopoly

MR
O

Qm

Monopoly
The monopolists demand curve
downward sloping
MR below AR

Equilibrium price and output

Equilibrium output, where MC = MR
Equilibrium price, found from demand
curve


Profit
maximising under
MC monopoly

AC

AR

AC

AR
MR
O

Qm

Monopoly
The monopolists demand curve
downward sloping
MR below AR

Equilibrium price and output

Equilibrium output, where MC = MR
Equilibrium price, found from demand curve

Profit
Measuring profit


Profit
maximising under
MC monopoly

Total profit

AC

AR

AC

AR
MR
O

Qm

Monopoly
The monopolists demand curve
downward sloping
MR below AR

Equilibrium price and output

Equilibrium output, where MC = MR
Equilibrium price, found from demand curve

Profit
Measuring profit
Supernormal profit can persist in long run

Monopoly
Disadvantages of monopoly
high prices / low output: short run

Equilibrium of industry under perfect

competition and monopoly: with the same MC

curve
MC
Monopoly
P1

AR = D

MR
O

Q1

Equilibrium of industry under perfect

competition and monopoly: with the same MC

curve
MC ( = supply under
perfect competition)

Comparison with
Perfect competition

P1
P2

AR = D

MR
O

Q1

Q2

Monopoly
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run

Monopoly
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run
lack of incentive to innovate

Monopoly
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run
lack of incentive to innovate

Monopoly
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run
lack of incentive to innovate

Advantages of monopoly

Monopoly
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run
lack of incentive to innovate

Advantages of monopoly
economies of scale

Equilibrium of industry under perfect

competition and monopoly: with different MC

curves
MCmonopoly

P1

AR = D
MR
O

Q1

Equilibrium of industry under perfect

competition and monopoly: with different MC

MC ( = supply)perfect competition
curves
MCmonopoly
P2
P1

P3

AR = D
MR
O

Q2

Q1

Q3

Monopoly
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run
lack of incentive to innovate

Advantages of monopoly
economies of scale
profits can be used for investment

Monopoly
Disadvantages of monopoly
high prices / low output: short run
high prices / low output: long run
lack of incentive to innovate

Advantages of monopoly
economies of scale
profits can be used for investment
high profits encourage risk taking

Monopoly Control
Promoting competition
Government Regulation
Public Ownership
Legal Action
Fiscal Measures
Promotion of Co-operation
Publicity Drive
Consumer Awareness

Demand and cost functions of a

monopolist are
P = 800 10Q
TC =300Q + 2.5Q2
1.What is the Profit maximizing
output and price for the monopolist?
2.What is the economic profit earned
by the Monopolist?

 For a monopolist the total revenue

function is given as TR = 6,400Q
80Q2 . The marginal cost of the firm is
Rs.160. What is the profit maximizing
output and price?

Monopolistic Competition
Assumptions of monopolistic
competition

Large no. of firms

Easy Entry

Product differentiation

Selling costs

Equilibrium of the firm

short run

Short-run equilibrium of the firm

under monopolistic competition

MC
AC

Ps
ACs

AR D
MR
O

Qs

Monopolistic Competition
Assumptions of monopolistic
competition
Equilibrium of the firm
short run
long run

Long-run equilibrium of the firm

under monopolistic competition

LRMC
LRAC
PL

ARL DL
MRL
O

QL

Monopolistic Competition
Assumptions of monopolistic
competition
Equilibrium of the firm
short run
long run
underutilisation of capacity in the long
run

Long run equilibrium of the firm under perfect

and

monopolistic
competition
LRAC
P1
P2

DL under perfect
competition

DL under monopolistic
competition
O

Q1

Q2

Monopolistic Competition
Assumptions of monopolistic
competition
Equilibrium of the firm
short run
long run
underutilisation of capacity in the long
run

Non-price competition

Monopolistic Competition
Assumptions of monopolistic
competition
Equilibrium of the firm
short run
long run
underutilisation of capacity in the long run

Non-price competition
The public interest

Monopolistic Competition
Assumptions of monopolistic competition
Equilibrium of the firm
short run
long run
underutilisation of capacity in the long run

Non-price competition
The public interest
comparison with perfect competition

Monopolistic Competition
Assumptions of monopolistic competition
Equilibrium of the firm
short run
long run
underutilisation of capacity in the long run

Non-price competition
The public interest
comparison with perfect competition
comparison with monopoly

Oligopoly
Key features of oligopoly
barriers to entry
interdependence of firms

Competition versus collusion

Collusive oligopoly: cartels
equilibrium of the industry

 barriers to entry
interdependence of firms
Competition versus collusion
Collusive oligopoly: cartels

Cartels
A cartel is formal organisation of producers of a
commodity. Its purpose is to coordinate the
policies of the member firms so as to increase
profits. Cartels are illegal
Centralised cartels ( allocate output and profit
or agreeing on price)
Market sharing Cartels ( each firm operates
only in one area)

Cartels often fail?

Difficult to organize all the producers if there
are more than few producers
It is difficult to reach agreement among the
members on how to allocate output and profit
when firms face different cost curves
There is strong incentives for each firm to
remain outside the cartel or cheat on the cartel
by selling more than its quota at the higher
price
Monopoly profits are likely to attract other
firms into the industry and undermine the
cartel agreement

Oligopoly
Tacit collusion
price leadership:
dominant Price leadership
Barometric Price leadership

Oligopoly
Tacit collusion
price leadership: dominant firm
price leadership: barometric

Kinked
demand for a firm under

oligopoly
Current price
and quantity
give one point
on demand curve

P1

Q1

Kinked
demand for a firm under

oligopoly

D
P1

D
O

Q1

Oligopoly
Non-collusive oligopoly: the kinked
demand curve theory
Assumptions of the model

1.

If a firm raises prices, other firms wont follow and the firm loses a lot
of business. So demand is very responsive or elastic to price increases.

2.

If a firm lowers prices, other firms follow and the firm doesnt gain
much business. So demand is fairly unresponsive or inelastic to price
decreases.

stable prices

Stable price under conditions of a kinked

demand
curve

MC2
MC1

P1

D AR

b
O

Q1

MR

Oligopoly
Non-collusive oligopoly: the kinked
demand curve theory
assumptions of the model
stable prices
limitations of the model

Oligopoly
Non-collusive oligopoly: the kinked
demand curve theory
assumptions of the model
stable prices
limitations of the model

Oligopoly and the public interest

Oligopoly
Non-collusive oligopoly: the kinked
demand curve theory
assumptions of the model
stable prices
limitations of the model

Oligopoly and the public interest

advantages

Oligopoly
Non-collusive oligopoly: the kinked
demand curve theory
assumptions of the model
stable prices
limitations of the model

Oligopoly and the public interest

advantages
disadvantages

 Product research and development

Better quality package and
appearance
Easier credit terms
Home delivery

After sale service

Non-price
competition
Longer period of guarantee
Advertisement and promotions

 Oligopolists have greater ability to invest in R&D which

leads to increased economies of scale, improved product
quality and new product
Oligopolists are more amenable to government control as
compared to a large number of small producers.
Within some limits, increase in costs will not affect the
price and output of oligopolists when they are facing
kinked demand curve
Advertisement is useful as it informs the customers,
when produce differentiated products, too much may be
spent on advertising and model changes.
Some product differentiation has the economic value of
satisfying consumers desire for variety and choice.

Factors involved in pricing

Cost of production
Demand and competition
Consumers Psychology
Government policy
Nature of market

Objectives of Pricing

Survival
ROI
Service
Profit Maximization
Sales Maximization
Market Share
Competition
Market leader

Methods of Pricing

Cost plus or mark-up pricing

Target rate of return price
Going rate price
Psychological price
Administered pricing
Skimming pricing
Penetration pricing

Loss-leader pricing
Limit pricing
Transfer pricing
Peak-load pricing
Two-part tariff

Price Discrimination
Meaning of price discrimination
First degree
Second degree
Third degree (the most common form)

Third-degree
price discrimination
P
Revenue from
a single price

P1

200

Third-degree
price discrimination
P
Increased revenue
from price
discrimination
A higher
discriminatory
price is now introduced

P2
P1

150

200

Price Discrimination
Meaning of price discrimination
First degree
Second degree
Third degree (the most common form)

Conditions necessary for price

discrimination

Price Discrimination
Meaning of price discrimination
First degree
Second degree
Third degree (the most common form)

Conditions necessary for price

discrimination
Advantages to the firm

Price Discrimination
Profit maximising prices and output
under price discrimination

Profit-maximising output under

third degree price discrimination
MC
8
6
5

DY
DX

O 1000

MRY
O

MRX

(a) Market X

2000

(b) Market Y

MRT
O

3000

(c) Total
(markets X + Y)

Price Discrimination
Profit maximising prices and output
under price discrimination
Price discrimination and the public
interest
competition

Price Discrimination
Profit maximising prices and output
under price discrimination
Price discrimination and the public
interest
competition
profits

 Demand functions of a monopolist in two effectively

segmented markets are:
Qa = 1,000 50Pa
Qb = 800 25Pb
Total cost function of the monopolist is TC = 500 + 10Q.
If the monopolist does not practice price discrimination,
what is the sales maximizing price ?

Price Discrimination

A firm sells in two markets and has constant marginal costs of

production equal to $2 per unit. The demand and demand and
marginal revenue equations for the two markets are as follows:
Market 1
P1 = 14 2Q1
2Q2

Market 2
P 2 = 10 Q2
MR 1 = 14 4Q1

MR 2 = 10

Using third-degree price discrimination, what are the profitmaximizing prices and quantities in each market? Show that greater
profits result from price discrimination than would be obtained if a
uniform price were used.