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									Market Structures




                    1
         Market Structures
Market structure refers to the competitive
  environment in which buyers and sellers of
  a product operate.
Major Types-
• Perfect competition
• Monopoly
• Monopolistic competition
• Oligopoly
                                           2
        Perfect Competition
• Large number of undifferentiated buyers
  and sellers
• Each one is so small as to be insignificant
  to influence the market
• The seller is a price-taker
• Homogeneous products
• No barriers to entry and exit- survival of
  the fittest
                                                3
        Perfect Competition
• Well organised and continuous markets
• Flexible market prices to keep responding
  to changing conditions of supply and
  demand
• Perfect Knowledge on market condition,
  product and present and future prices,
  costs and economic opportunities-
  eliminates price differences
                                              4
         Perfect Competition
• Perfect mobility of factors of production
  (raw materials, labour and capital)-this
  results in factor price equalisation.

• No Government interference: No rationing,
  administered prices, subsidies etc.



                                              5
         Perfect Competition
Presumption that free market operates in social
  interest-
• “Invisible hand” and self-regulatory mechanism
• Provides an effective check on the power of the
  sellers, safeguards consumer and makes it
  unnecessary for the State to intervene
• Stock market is the closest example of a
  perfectly competitive market


                                                    6
       Equilibrium Under Perfect
              Competition
Note:
 Equilibrium is at the point of intersection between
   MC and MR
MC cuts AC from below at its lowest point
Firm may make profits, losses or break even in the
   short run- depends on its cost of production
If firm makes abnormal profit, more firms will enter-
   Increase in supply- lower price and profit
Opposite in case of losses
                                                    7
Firm Making Profit in Short Run
                                   P=AR=MR as
 Y                                 represented by the
             MC                    horizontal line
                                   OP and OQ are
                    AC             equilibrium price and
         E                         output.
 P                         AR=MR
                                   OPEQ represents Total
 A           C                     Revenue
                                   OACQ is total cost.
     O                         X   Here, TR>TC
         Q                   O
                  Output     u     PECA is the short run
                             t     supernormal profit.
                             p
                             u
                             t                             8
    Firm Breaking Even in Short Run

                   MC               Firm breaks even
Cost/Revenue




                                    where AC curve is
                                    tangent to AR. TR
                            AC      and TC are the
                                    same and given by
                                    rectangle OPEQ.
                            AR=MR   There is neither
P                                   loss, nor profit
               E




   O
               Q   Output

                                                        9
Firm Making Loss in Short Run

                                    Total Revenue=OPEQ
                MC
                       AC           Total Cost=OBCQ
     C                              Loss= BCEP
B

P                           AR=MR
          E




OO
      Q
              Output
                                                         10
Case of Exit or Shut Down Point
• If prevailing market price is more than
  average variable cost (AVC) of production,
  the firm will continue production.
• If prevailing market price is less than
  average variable cost (AVC) of production,
  the competitive firm will shut down
  production


                                           11
Firm Making Loss in Short Run

               MC      SAC           Total Revenue=OPEQ

B     A                              TVC= OKLQ
                       SAVC
      L                              TR < TC at price OP
K
                                     TFC= LKAB (Lost
P                            AR=MR   entirely)
          E                          Operating Loss=
                                     OKLQ-OPEQ = PKLE
                                     At OP price, firm
                                     decides to shut down.

OO
      Q
              Output
                                                             12
          Perfect Competition
Key lessons of perfect competition for
  managers
• Important to enter the market as far ahead of the
  competitors as possible - when supply is low and
  price is high- this requires entrepreneurial skill
• A firm earning an economic profit (as
  distinguished from normal profits) can not afford
  to be complacent because economic profit will
  attract new entrants
• Only way for a firm to survive is to keep costs as
  low as possible

                                                  13
        Perfect Competition
• With growing globalisation, new
  competitive cost pressures are being felt
  by firms around the world
• Indian companies have the advantage of
  low –cost labour but disadvantage of
  technology lag
• (Obama on outsourcing)


                                              14
Global Competitiveness Index
  Market Distortions

    – Efficiency of legal framework
    – Extent and effect of taxation
    – Number of procedures required to
      start a business
    – Time required to start a business




                                          15
Global Competitiveness Index
  Competition
    Intensity of local competition
    Effectiveness of antitrust policy
    Imports
    Prevalence of trade barriers
    Foreign ownership restrictions




                                        16
                   QUIZ
• Elasticity of demand for a perfectly
  competitive firm is equal to _____.
• Free entry and exit of firms is responsible
  for ________ _____           in the long run.
• A perfectly competitive firm has all the
  following features EXCEPT: a) Price Taker
      b) Quantity adjuster C) Perfectly
  informed d) Price discriminator
                                              17
• Elasticity of demand for a perfectly
  competitive firm is equal to infinity
• Free entry and exit of firms is responsible
  for normal profits in the long run
• A perfectly competitive firm has all the
  following features EXCEPT: a) Price Taker
      b) Quantity adjuster C) Perfectly
  informed d) Price discriminator
                                            18
                   QUIZ
• In a perfectly competitive market, a firm in
  the long run operates at:
A) AC=MC             B) AR=MR
C)MR=MC              D) P=AR=MR=AC=MC




                                             19
                  QUIZ
TRUE OR FALSE?
• The government sets the price of the
  product in a perfectly competitive market.
• A perfectly competitive firm produces a
  substantial portion of the aggregate
  output.
• There is no cost for entering a perfectly
  competitive market.
• Factors of production can freely move in 20
  and out of the industry.
• The government sets the price of the
  product in a perfectly competitive market.F
• A perfectly competitive firm produces a
  substantial portion of the aggregate
  output. (F)
• There is no cost for entering a perfectly
  competitive market. (T)
• Factors of production can freely move in
  and out of the industry. (T)
              MONOPOLY
Features of Monopoly:
• Single seller of a particular good or service
• No difference between firm and industry
• Large number of buyers
• No close substitutes -cross elasticity of
  demand is zero
• High entry barriers
• Monopolist is a price setter/maker
                                              22
• Strength of a monopolist’s power depends
  on how much he can raise the price
  without losing all his customers- this
  depends on elasticity of demand, which in
  turn, depends on availability of substitutes
• Before liberalisation, in India telephones,
  electricity, post& telegraph, oil &gas,
  railways were all monopolies.

                                             23
Causes and Forms of Monopoly
Barriers to entry-
• Legal: Result of statutory regulation by government:
  Copy right, trade marks, government regulation, licence,
  tariffs and non-tariff barriers against import of goods
• Technical; Technical know-how is available with only
  one person
• Natural: Control over supply of raw materials or natural
  resources such as minerals, (De Beers produced 90% of
  entire world’s diamonds)
• High costs of capital investment or economies of
  scale


                                                         24
Causes and Forms of Monopoly
• Joint Monopoly: Through voluntary agreement,
  business companies jointly acquire monopoly
  power. e.g., Trusts, syndicates, cartels
• Public Monopoly: Created for the welfare of the
  public- e.g., public utilities like water supply,
  electricity, railways, telephones
• Private Monopoly: Owned an operated by
  private individuals or organisations- objective is
  profit maximisation

                                                   25
Causes and Forms of Monopoly
• Simple Monopoly: Charges uniform or single
  price for a product to all the consumers- no
  discrimination between buyers or uses.
• Discriminating Monopoly : Act of selling the
  same commodity produced under single control,
  at different prices to different buyers or different
  uses at the same time- not related to difference
  in cost of production


                                                     26
• Regional Monopoly-
• Geographical Indication under WTO
  creates a barrier for global competitors
• Covers plants, seeds, herbs etc




                                             27
    Pricing& Output Decisions Under
               Monopoly
                                   Monopolist’s demand curve is
Y                                  downward sloping (AR=D).
                       SMC         MR curve is below AR curve.
                             SAC   Equilibrium tis MR=MC (at E)
                                   An ordinate drawn from E to X
                                   axis determines profit
           L                       maximising output t OQ
P
                                   Given the demand curve AR,
                                   output OQ can be sold at a
K                                  given time only at one price,
          M
                                   ie., QL (= OP)
                   E
                             AR    Thus determination of
                                   outputsimultaneously
                             =D    determines the price.
                       MR
                                   PLMK is the profit
O                             X
               Q
       Monopolist’s Profit
Whether a monopolist makes a supernormal
  or economic profit depends on:
• Its cost and revenue conditions
• Threat from potential competitors
• Government policy.
• If monopoly firm operates at MC=MR, its
  profit depends on the relative levels of AR
  and AC
          Monopolist’s Profit

• if AR>AC, there is economic profit
• if AR= AC, there is normal profit
• if AR<AC, theoretical possibility of the
  monopoly firm making losses
   Measuring Monopoly Power
• Number of firms criterion- Simplest- Fewer the
  number, higher the degree of monopoly power
• Excess Profit Criterion- here, opportunity cost
  of the owner’s capital and a margin for risk are
  deducted from the actual profit made by the firm.
• Triffin’s cross elasticity criterion - lower the
  cross elasticity of the product of the firm, greater
  the monopoly power.
   Measuring Monopoly Power
• Concentration ratio of an industry is used
  as an indicator of monopoly power -
  relative size of firms in relation to the
  industry as a whole.
• Cn is the percentage of market output
  generated by the n largest firms in the
  industry
• Herfindahl- Hirschman Index(HHI) is a
  measure of the amount of competition in
  an industry
                                          32
  Herfindahl- Hirschman Index
              (HHI)
• Measure of the size of firms in relation to
  the industry
• Indicator of the amount of competition
  among them.
• An economic concept widely applied in
  competition law and antitrust laws.



                                                33
   Measuring Monopoly Power
• The index involves taking the market
  share of the respective market
  competitors, squaring it, and adding them
  together.




                                              34
       Herfindahl- Hirschman
             Index(HHI)
• It can range from 0 to 10,000, moving from
  a huge number of very small firms to a
  single monopolistic producer.
Interpretation of H- index:
• Below 0.10 (or <1,000): No concentration
• Between 0.10 to 0.18 (or 1,000 to 1,800):
  Moderate concentration.
• Above 0.18 (> 1,800) : High concentration
• .                                         35
• The United States uses the Herfindahl index to
  determine whether mergers are equitable to
  society;
• The Antitrust Division of the Department of
  Justice considers Herfindahl indices as
  discussed above.
• As the market concentration increases,
  competition and efficiency decrease and the
  chances of collusion and monopoly increase.
   Measuring Monopoly Power

• While the threshold is considered to be
  "0.18" in the US, the EU prefers to focus
  on the level of change.
• Increases in the HHI generally indicate a
  decrease in competition and an increase
  of market power, whereas decreases
  indicate the opposite.
                                              37
• In Europe, concern is raised if there's a "0.025"
  change when the index already shows a
  concentration of "0.1".
• E.g., if in a market , company B (with 10%
  market share) suddenly bought out the shares of
  company C (which also has 10%) then if this
  new market concentration makes the index jump
  to "0.172".
• This would not be relevant for merger law in the
  U.S. (being under 0.18) but would in the EU
  (because there's a change of over 0.025)         38
           Monopoly Power
The usefulness of this statistic to detect and
  stop harmful monopolies is directly
  dependent on a proper definition of a
  particular market
E,g., If we were to look at a hypothetical
  financial services industry as a whole, and
  found that it contained 6 main firms with
  15 % market share each, then the industry
  would look non-monopolistic….
                                             39
            Monopoly Power
But suppose that one of those firms handles 90 %
  of the savings accounts and physical branches
  (and overcharges for them because of its
  monopoly), and the others primarily do
  commercial banking and investments.
• In this scenario, people would be suffering due
  to a market dominance by one firm; the market
  is not properly defined because savings
  accounts are not substitutable with commercial
  and investment banking.
                                                40
          Monopoly Power
• The problems of defining a market work
  the other way as well.
• For example, one cinema may have 90%
  of the movie market, but if movie theatres
  compete against video stores, pubs and
  nightclubs, then people are less likely to
  be suffering due to market dominance of
  the cinema.

                                               41
            Monopoly Power
• Another typical problem in defining the market is
  choosing a geographic scope.
• For example, 5 firms may have 20% market
  share each, but may occupy five areas of the
  country in which they are monopoly providers
  and thus do not compete against each other.
• A service provider or manufacturer in one city is
  not easily substitutable with a service provider or
  manufacturer in another city

                                                   42
     Case of New York City Taxi
              Industry
Market Value of Monopoly Profits
• Like most US cities, New York city requires a
  medallion (license) to operate a taxi.
• Medallions are limited in number and this
  confers monopoly power to owners.
• Value of owning a medallion is equal to the
  present discounted value of the future stream of
  earnings from the ownership of a medallion.


                                                 43
Market Value of Monopoly Profits in
   New York City Taxi Industry
• No of medallions in New York city remained at
  11,787 from 1937 to 1996 when it was increased
  by only 400 to 12,187. Value of medallion rose
  from $10 to $250000 by 1999 or 18% per year.
• Proposals to increase the number of medallions
  was blocked by the taxi industry lobby. If
  licenses to operate were freely granted, then the
  price of medallions would drop to zero.


                                                 44
Market Value of Monopoly Profits in
   New York City Taxi Industry
• Instead of doing that, New York city allowed a
  sharp growth in the number of radio cabs, which
  can respond only to radio calls and can’t cruise
  the streets for passengers.
• This sharply increased the competition in NY taxi
  industry and reduced profits to the taxi owners
  from 33% in 1993 to 11% in 1999
   - from Wall Street Journal quoted in Salvatore


                                                 45
   Discriminating Monopoly/ Price
           Discrimination
3 forms:
• 1st Degree: Different rate for every unit of
  output- discrimination between buyers /
  between units
• Monopolist forces every consumer to part
  with his entire consumer surplus-Full
  benefit of trade goes to trader.
(Auction is one example, but it is for special
  products)
                                             46
    2nd degree Discrimination
• 2nd Degree: Buyers are divided into
  different blocks or groups and then
  different rates charged for each block or
  group:
• Here, consumers enjoy a part of the
  consumer surplus and monopolist is also
  able to get a part of the surplus;
E.g., electricity charges, Quantity discounts
                                                47
     3rd degree Discrimination
• 3rd degree: Most common type-Seller divides his
  buyers into sub-markets and charges a different
  price for each market-
• Dumping is an example: High price in domestic
  market and low in international market.
• Reasons: To dispose off surplus; to remove
  rivals; to take advantage of increasing returns to
  scale; to create new demand abroad.
• As demand is elastic in international market, he
  has to reduce price but charges a higher price in
  the domestic market as domestic demand is
  inelastic
                                                   48
   When is Price Discrimination
            Possible?
Conditions of Price Discrimination ( When is
   Price discrimination possible?)
1. Consumers are unaware of the difference in
   prices charged
2. Price difference so small that consumers don’t
   bother
3. Price illusion/ irrationality
4. Markets are situated far from one another and
   so it is expensive to transfer goods from one
   market to another (Geographical distance)

                                                    49
         Conditions of Price
           Discrimination
5) When elasticities of demand in the two
   markets are different: higher price for low
   elasticity market and lower price for high
   elasticity market.
6) Direct personal services such as those of
   doctors and lawyers where resale is not
   possible
7) Legal sanction provided by government:
   e.g., lower prices in army canteen
                                             50
  Forms of Price discrimination
• Personal Discrimination: Occurs when
  different prices are charged to different
  consumers – doctors and lawyers may charge
  different fees for the rich and the poor
• Local Discrimination: Lower prices in one
  locality and higher in another. e.g., dumping by
  charging higher prices in domestic market and
  lower prices in foreign markets
• Trade Discrimination: Charging different rates,
  based on use e.g., electricity charges for
  domestic/ industrial/agricultural uses
                                                 51
Forms of Price Discrimination
• Quality Discrimination: Hard cover
  editions being sold at higher prices than
  paper back editions of books; business
  class travel vs economy class in air travel
• Time Discrimination: Different charges
  for the same commodity at different points
  of time- off-season air tickets; happy hours
  in restaurants

                                             52
Indian Railway & Price Discrimination
• On the basis of passenger categories:
  senior citizens, children, students,
  handicapped, escorts, employees---
• Class of Travel (Basis: Comfort)
• Category of Train:9 categories- rajdhani,
  superfast, mail, Garib Rath, passenger,
  shuttle (Basis: time taken for travel)
                                              53
                   QUIZ
• TRUE OR FALSE?
• Charging different prices for similar goods
  is pure price discrimination.
• Difference in elasticities is a necessary
  condition for price discrimination.
• Tatkal facility provided by Indian Railways
  is an example of ----------degree price
  discrimination.
                                            54
                   QUIZ
• Charging different prices for similar goods
  is pure price discrimination (F. same, not
  similar)
• Difference in elasticities is a necessary
  condition for price discrimination.(T)
• Tatkal facility provided by Indian Railways
  is an example of second degree price
  discrimination.
                                            55
• In comparison with a perfectly competitive
  market, a monopoly market would usually
  generate
• A) Higher output at higher price
• B) Higher output at lower price
• C) Lower output at higher price
• D) Lower output at lower price

                                           56
• In comparison with a perfectly competitive
  market, a monopoly market would usually
  generate
• C) Lower output at higher price




                                           57
• A monopoly is
• A) One of the few producers of a
  homogeneous product
• B) A single producer of a single product
• C) One of the many producers of a
  homogeneous product
• D) One of the many producers of a
  differentiated product
                                             58
59
    Monopolistic Competition

Chamberlin and Joan Robinson

In reality, monopoly and competition are not
  mutually exclusive, but markets have both
  elements in differing degrees
Most economic situations are composites of
  both competition and monopoly
                                           60
   Characteristics of Monopolistic
           Competition
Large no of firms/ sellers -Consequently no
  individual has any significant control over the
  market
Absence of interdependence: (Independent
  decision Making) -Since the number is large and
  size of each firm is small, no firm can influence
  or is influenced by others in the market.
Example of FMCG product market
Freedom of entry: No barriers to entry- this leads
  to occurrence of only normal profits in the long
  run

                                                  61
 Characteristics of Monopolistic
         Competition
• In Monopolistic Competition firms compete
  with each other mainly not on the basis of
  price but on the basis of non price
  elements
• Product differentiation and selling costs
  are known as non-price competition



                                           62
   Characteristics of Monopolistic
           Competition
Product Differentiation: Core of monopolistic
   competition- Different firms produce similar,
   but not homogeneous products.
Even minor changes in the same generic product ,
   by which a seller can charge a different price
   e.g., tooth paste, tooth brush
Cross elasticity of demand for products is very
   high (not infinite) in this market



                                                63
Product differentiation may relate to
A) Quality, design, packaging, trade names,
   raw materials used

B) Conditions surrounding sale of the
   product- courteous approach, efficiency,
   credit availability, after-sale service etc


                                                 64
 Characteristics of Monopolistic
         Competition
Product differentiation gives firms some
  monopoly power i.e., power to control the
  price in a narrow circle, but in the wider
  circle the firm faces competition from rival
  producers.
• Firms in effect are competing monopolies



                                                 65
   Characteristics of Monopolistic
           Competition
Selling Costs: Expenditure incurred on
   changing the demand and preference of
   the consumers - Expenditure on
   advertising, promotion, displays, salaries
   of salesmen, free samples etc.-
• Unique to monopolistic competition
..


                                                66
• Imperfect knowledge- about cost, quality,
  prices .
• As Joan Robinson puts it: “ the imperfect
  market is characterised by distortions of
  market conditions by sellers”




                                              67
• Identification of product groups:
• A product group comprises of products
  that are “good” but no perfect subsitutes
  of each other.
• E.g., Lux, Lifebuoy. Dove, Cinthol can be
  classified as the product group of “soaps”
• Ariel, surf, Nirma and Tide can be
  classified as the product group of
  “detergents”
                                               68
   Monopolistic Competition &
         Advertising
• Advertising: No need in monopoly and
  perfect competition
• In this situation, makes sense for the firm
  to attract customers through advertising
  than by lowering prices




                                                69
    Monopolistic Competition
Wastes of Monopolistic Competition
1. Competitive advertising ( as opposed to
  constructive advertising) to attract
  consumers to pay a premium for a
  particular brand




                                         70
• Criticised by several economists because:
• Advertising induces customers to spend more
  money because of name, rather than rational
  factor
• Adds no value to the product being offered
• Leads to brand confusion in the consumers
  minds
• Ads by rivals may even cancel out each other,
  leading to increase in the AC of each firm,
  without corresponding increase in sales.
                                                  71
2. Excess capacity- resources are not fully
  utilised, leading to higher costs




                                              72
                      QUIZ
• Slope of DD curve for a monopolistic competition
  is flatter than that of a monopoly firm. (T)
• A firm in monopolistic competition can not
  practice price discrimination. (F)
• Firms under monopolistic competition will have
  limited discretion over price because of
  Customer loyalty.
• If a firm in monopolistic competition increases its
  price slightly it will lose some customers.

                                                   73
 Oligopoly: Definition and Features
• Few Sellers : Naturally each seller has a
  sizeable share of market-
• Homogeneous or differentiated products
• Close Interdependence- decision of a single
  firm to expand or contract output affects entire
  market- moves and counter moves- need to
  predict and analyse every possible reaction of
  rivals before a firm takes decisions
• Automobiles, steel, consumer electronics

                                                     74
 Oligopoly: Definition and Features
• Indeterminate demand curve: because
  of extreme interdependence
• Price Rigidity- Price remains stuck at a
  certain level-No desire for a departure
  from prevailing price in either direction-
  price cutting will be followed by rival but
  price hike may not be and hence “sticky”
  prices

                                                75
          Oligopolistic Pricing
Oligopolistic pricing can take 3 different forms:
1. Independent Pricing
2. Collusion Model
3. Price Leadership
1.Independent Pricing: Method of pricing its
    differentiated product – result of the fact that
    each firm has a certain monopoly power, but
    there is fear of retaliation by rivals
- Various possibilities occur: Price wars and price
    rigidity
                                                       76
         Collusive Oligopoly
2. Collusion Model:
• When there are only a small no of firms in a
  market, they have a choice between cooperative
  and non cooperative behaviour.
• Tacit or explicit collusion
• A Cartel agreement represents the most
  complete form of collusion among oligopolists-
  here firms are in a cooperative mode and
  minimise competition among themselves- due to
  explicit agreement between firms –

                                               77
          Collusive Oligopoly
• Joint decisions on output / price / market share
  or quotas-
• Example of OPEC- decides on output rather
  than price-Has a board of control which
  determines the market share of each member
• Sometimes tacit collusion occurs between firms
  without explicit agreement- Here firms quote
  identical prices
• Example: Indian cement and steel markets

                                                     78
          Collusive Oligopoly
Barriers to Collusive Oligopoly:
• Considered illegal as it converts oligopoly into
  monopoly
- Firms may cheat by giving secret price
  concessions and thereby increasing the market
  share
• Slow and lengthy process of cartel negotiations
• Rigidity of negotiated prices
- Some cartel members may be political rivals
  such as Iraq, Kuwait and Iran in OPEC
                                                     79
           Price Leadership
3. Price Leadership: It is an informal position in
   most oligopolistic markets.
It may emerge spontaneously due to technical
   reasons such as size, efficiency, economies of
   scale, brand image or the firm’s ability to
   forecast market conditions accurately
• Typically, leadership role is played by a
   dominant firm (largest in the industry) and
   smaller ones follow-(Example- Bajaj scooter,
   Camlin ink)

                                                     80
           Price Leadership
• Sometimes price leadership is barometric-Here
  one of the firms (not necessarily the dominant
  one) takes lead in announcing a price change,
  especially when a change is due but is not
  implemented due to uncertainty in the market –
  The barometric firm is supposed to have a better
  knowledge of the changing environment of the
  market than others
• Price leadership often serves as a means to
  price discipline and price stabilisation
                                                 81
       Kinked Demand Curve
• Once a general pricing decision is taken under
  any of the above models, it remains fixed for an
  extended period.
• Kinked demand curve theory by Paul Sweezy
  explains price rigidity under oligopoly
• 2 parts of demand curve of a firm have different
  elasticities- one for price increase and another
  for price decrease- Former is more elastic than
  latter

                                                     82
                   Kinked Demand Curve

                                                      The AR curve or
                                                      demand curve has a
                                                      kink at the point K at
   D                    K                             which it operates
   P                              MC1                 and price is OP.
                                    M
                                    MC2               DK: Demand is more
                        M
Cost/Revenue




                                    C                 elasic. Raising price
                        M           1                 above OP will cause
                                                      sizeable decline in
                                                      demand
                                        D1            KD1: Inelastic
                             MR                       segment. Price cut
O                            M
                                             output   will be followed by
               O    Q        R
                                                      rivals
                             M
                            M1                                              83
      Kinked Demand Curve
• MR Curve is discontinuous as a result of
  kink in AR curve
• MC passes through the dotted portion of
  the MR curve. Hence , a change in MC
  has no effect on price and output




                                             84
 Industrial Concentration in US
Industry                Four Firm Ratio
Cigarettes                    93
Breakfast cereals             85
Household Refrigerators      82
Newspapers                    25
Men’s clothing               18
Women’s Dresses               11

                                          85
            Game Theory
• First systematic attempt was made by von
  Neumann and Morgenstern
• Martin Shubik is considered the most
  prominent proponent of game theory




                                         86
• Nature of the problem faced by an
  oligopolistic firm is best explained by
  Prisoner’s Dilemma:
• A and B are arrested by CBI on suspicion
  of involvement in a crime and interrogated
  separately by the CBI, with the following
  conditions disclosed to them:


                                           87
1. If you confess your involvement in the crime,
  you will get 5 years imprisonment.
2. If you deny your involvement and your partner
  denies it too, you will be set free for lack of
  evidence.
3. If one of you confesses and turns approver, and
  the other does not, then the one that confesses
  will get 2 years imprisonment and one who does
  not confess gets 10 years imprisonment .

                                                 88
• Given the conditions, each suspect has 2
   options-
 i) To confess
ii) Not to confess
• Both have a dilemma
• While taking a decision both have a
   common objective- to minimise the period
   of imprisonment
                                              89
              Game Theory
• Game Theory models include players, strategies
  and payoffs
• Players : Decision makers
• Strategies: Choices to change price, develop
  new products, undertake new advertising
  campaigns etc
• Payoff: Outcome or consequence of a strategy
• Payoff Matrix: Table giving the payoffs from all
  the strategies open to the firm and the rival’s
  responses

                                                 90
•   A firm needs to anticipate-
•   Counter moves by rivals
•   Pay-off when
•   a) rival firm does not react
•   B) rival makes a counter move by raising
    its ad expenditure


                                               91
  OPEC’s Price Making Power
• 12 members- Saudi largest producer
• The Organization of Petroleum Exporting
  Countries (OPEC) is a cartel of twelve countries
  made up of Algeria, Angola, Ecuador, Iran, Iraq,
  Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the
  United Arab Emirates, and Venezuela. The
  organization has maintained its headquarters in
  Vienna since 1965, and hosts regular meetings
  among the oil ministers of its Member Countries.
  Indonesia 's membership from OPEC was
  voluntarily suspended recently as it became a
  net importer of oil.

                                                 92
• During 1970s undisputed power-In 1980s OPEC
  was accused of behaving like a “clumsy cartel” –
• Non cooperative behaviour from members with
  lower reserves such as Qatar, Indonesia and
  Venezuela. Because of their lower reserves and
  intention of making quick profits, these often
  produced in excess of the stipulated individual
  quota


                                                 93
  OPEC’s Price Making Power
• When prices nosedived abnormally in
  1998, OPEC successfully executed 2
  successive production cuts
- But since then erosion of OPEC’s
  monopoly power as a price maker
-Surge in non OPEC production and



                                        94
  OPEC’s Price Making Power

• Core problem is price of oil is no more
  fixed in the spot market where physical
  trading takes place but on futures market
  where only paper barrels are traded
• Only an insignificant part of oil traded on
  NYMEX is ever physically delivered.


                                                95
  OPEC’s Price Making Power

• Many players are involved in futures
  trading that are not involved in physical
  trading of crude (true of all commodities)-
  floor traders, fund managers, refiners,
  producers, financial institutions and
  speculators- complicates process of
  decision making within OPEC

                                                96
   OPEC’s Price Making Power
OPEC’s ability to influence prices depends on-
• Its ability to influence so many players, including
  level of stocks and inventories that the refineries
  are holding
• Size of speculative positions
• Flow of hedge funds in and out of the market
• Traders’ bearish or bullish sentiments
• Existence or erosion of spare capacity

                                                    97
   Comparison of different Market
            Structures
Feature     Perfect     Monopoly   Monopolisti
            competition            c
                                   competition
No of       Many       One         Large
sellers
Nature of   Homogene Homogene Differentiat
goods       ous      ous      ed

Entry       Free       Barriers    Unrestricte
                                   d
                                              98
Degree of   Zero       Absolute    Limited
   Comparison of different Market
            Structures
Feature     Perfect     Monopoly      Monopolisti
            competition               c
                                      competition
Cost        Production   Production   Production
Elements    cost         cost         cost+
                                      Selling cost

Long run    Normal       Super-       Normal
Profits                  normal
Nature of   Elastic      Inelastic    Relatively   99
Demand                                inelastic
Feature   Perfect     Monopoly        Monopolisti
          competition                 c
                                      competition
Pricing   Price taking Price-         Price-
                       making:        making:
                       i) Uniform     Uniform
                       ii) Price      price
                       discriminati
                       on
                                                100

								
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