welcome back to the foundation course in managerial economics uh in the previous week we uh studied
the production function we saw the relationship between output and inputs and how that translates
into cost uh we looked at short run costs the nature of costs in the short run the nature
of cost in the long run and how it changes how the cost decisions change from short run
to long run we discussed about fixed cost and variable cost and how that relates to
long run and short run uh so in in this week what we are going to do
is we are going to see how the firm decides having known that uh the production function
having known its own production function that is how much output can be produced through
what combinations of inputs and costs uh how does the firm basically decide how much output
to produce and what price to charge because uh if you may remember we said that the objective
of the firm firm is to maximize profit and profit is the difference between revenue and
cost so we have developed our understanding about
cost and this week we are going to uh look at how the revenue is determined by a firm
so revenue consists of 2 parts price and quantity so the price and quantity gets determined
by the firm in different kinds of market structures differently so this is what we are going to
study this week so uh lets proceed .
we are going to discuss about various market structures and we are going to assume that
uh the objective of all firms uh is basically to maximize profit so profit is total revenue
minus total cost and costs behave in similar ways for all producers and the cost curves
all also look similar basically uh in the previous week the cost curves that we developed
we looked at the marginal cost the average cost uh how they change overtime how the average
cost is a u shaped cost curve how the marginal cost when it is decreasing it is below the
average cost curve and when its increasing it is above the average cost curve
so all these the nature of the cost curves they do not change from firm to firm so basically
the for all the firms whether they are in a competitive market structure or they are
in a monopolistic market structure they all have similar kinds of cost curves so all that
we need to understand now is how does price and quantity decision change for different
kinds of market structures so coming back to the slides so total revenue
is uh price into quantity and this would depend on what price the firm charges and what level
of output it decides to produce so how does the firm decide what price to charge and what
level of output to produce so all this depends on the market structure in which the firm
operates . so the demand for different goods the demand
the prices the quantity produced all these will vary according to the structure of the
market a firm is operating in so variations in market structure basically arises due to
certain characteristics of the product that the firm is selling so we are going to see
that the market structures are basically different because of some some characteristic of nature
of the product its inherent in the product itself which decides what kind of market structure
the product will be sold in so broadly very broadly we are going to see
that market structures differ from one each other on the basis of the following the market
structures will be different uh depending on the number of sellers theyll be different
for number of sellers the substitutability of the product that is if the uh if there
are alternatives which are available in the market that is going to determine what kind
of market structure the product will be available in
ease of entry and exit ease of entry into the market and ease of exit from the market
uh if it is very difficult to enter the market then obviously the number of sellers will
be low or if it is very difficult to exit the market say for example you are stuck with
a very high cost you incur a very high cost of setting up a business for that product
in the market and you are stuck with for a stuck with it for a long time
in that case we would say that there is a very high exit cost so in that case also certain
firms like the number of firms in the market maybe very low market power of individual
seller now market power of individual seller this i am going to elaborate later when i
discuss individually the different uh market structures but as is as you might uh already
have uh kind of understood what market power of individual seller means
it basically means how much control the seller has on price if the seller is able to determine
what price to charge in the market so and that is indirectly that that is kind of like
whether the seller has a market power or not is highly related to the all the other 3 factors
that we have listed above that is the number of sellers substitutability of the product
so if the number of sellers is low obviously the market power of the individual seller
will be high if the substitutability of the product if the product is easily substitutable
like if it is possible to have it is possible to have alternatives of the this product in
the market then the individual seller cannot have too much power over the market or too
much power to control prices in the market ease of entry and exit from the market again
if it is easy to enter or exit the market so the individual seller will always be faced
with a large number of uh competitor so in that case the seller will probably not have
too much uh market too much market power uh in that kind of market structure
so these are broadly the the basis on which the market structures vary from each other
and in this course we are going to focus primarily on 4 kinds of market structures which i am
going to and how they differ from one another let me just elaborate on the board .
so there can be 4 kinds of market structures on one extreme so so on one extreme we have
what we call perfect competition we have perfect competition so in perfect competition the
all the 4 categories by which we say the market structures differ from each other so in under
perfect competition firstly large number of sellers so this is in case of perfect competition
there are large number of sellers in the market and secondly substitutability of the product
basically products are homogeneous when i say products are homogeneous that basically
means the products are all very similar to each other not only very similar they are
exactly similar to each other uh when i say exactly similar that does not mean that uh
you know like uh literally they are exactly similar what that means is to the consumer
they are deemed similar so whether the product has been purchased from seller number 1 or
seller number 2 uh the to the buyer it does not make any difference
so its very difficult to differentiate the products from each other and that is what
i mean by uh mean when i say that the products are homogenous a very uh the perfectly competitive
market example is not uh we dont have a exactly perfectly competitive market for any product
uh its its more theoretical concept but something which comes very close to perfectly competitive
market is the agricultural products market say for example the vegetables are sold or
food grains are sold in the market the wholesale market so there all the products are very
similar to each other and the price is determined in the market depending on the amount that
the sellers have bought the amount that the buyers are uh willing to purchase so the the
demand and supply uh framework that we discussed in the earlier weeks that kind of setup determines
what prices to is going to be charged in the market and basically all the buyers they accept
that price and they just sell their products at that price
so basically the all the products are very homogeneous or they are very similar to each
other so the example is agricultural products so products are homogenous to each other and
thirdly ease of entry and exit from the market so again the example of agricultural products
so basically farm products so its not very difficult to enter this market if someone
wishes to grow uh vegetables or food grains or do farming its not something very uh difficult
to do there is not too much high barrier of entry to it and similarly there is no too
uh high cost of exit from the market if someone wishes to stop producing agricultural product
he may just stop and maybe sell off his land or use it to or put it to some other alternative
use so the barrier to of entry and exit from the market is very low so basically uh this
is this is the barrier of entry exit is low fourth is the market power of individual seller
the market power of individual seller uh as we have already seen that there are large
number of sellers the products are homogenous there is no barrier to of entry or exit in
the market so basically all the sellers in this market they are all price takers so basically
market power of individual seller is almost nil so they are all price takers so they are
all price takers . so on the other extreme we have almost the
opposite situation of perfect competition which is the monopoly which is the monopoly
which most of know that monopoly is basically there is one single seller in the market so
we have one seller okay one more thing is
when i am describing all these market structures i am assuming that the number of buyers is
many in all the market structures there could be situation where we have something
like monopsony where there is one single buyer and many sellers in the market so we are not
going into the buyer side of the market yet we will be discussing mostly about the sellers
perspective if he is the sole supplier in the market or he is one of few or he is one
of many or he is one of a huge number of sellers so this is what we are doing here uh substitutability
of the product the product is unique the product is unique the product is unique in the sense
that there is one seller in the market so he is the one who is selling this product
and this itself that there is one seller in the market itself kind of uh implies that
whatever he is producing no one else is producing that
so to give an example this situation of monopoly could arise due to a lot of things it could
arise because the fixed cost of setting up this business could be very high so we are
going to go into the details of what causes natural monopoly in what situation a monopoly
arises and all that when we discuss about monopoly in the later weeks but it suffices
to give some example here that one example of monopoly is basically patented medicines
so pharmaceutical company which has patented a particular drug say a lifesaving drug that
this particular company can produce and no one else can is a that patent causes a high
barrier to entry barrier of entry in this market and he is the uh this pharmaceutical
company is the single seller in the market and the product is unique
another example is say for example the indian railways indian railways this is the one single
organization which is catering to the railway requirement of the entire huge country of
india so barrier of barrier of entry is high because it is not easy to setup a railway
network a parallel railway network given that one is already existing so that would be extremely
costly and may not make sense actually so again we are going to discuss those in
details later so basically the examples are patents which create barrier to entry and
there are natural barriers to entry in case of because of very huge fixed cost say in
case of railways or water supply or uh setting up of power plants etc so these are situations
of monopoly so ease of entry barrier to entry barrier
of entry or exit is very high okay and market power of individual seller
so all these 3 characteristics of the market itself determines that the market power of
the individual seller is very high basically the individual seller gets to decide at what
price he is going to sell the product so he is basically a price maker he is not a price
taker but he is a price maker . so this is about monopoly so we have perfect
competition in one extreme and we have monopoly in the other extreme and we have 2 more market
structures which we are going to discuss later they fall within these extreme 2 categories
one is the called the monopolistic competition one is the monopolistic competition and here
like perfect competition there are large number of sellers
how is it different from competition products are not homogeneous products are not homogenous
although there are large number of sellers who are selling this product products are
not homogenous but they are very similar to each other so to give an example say for example
fmcg products say for example toothpaste now there are there can be whole lot of companies
who are producing toothpaste there can be number of brands different types of products
of toothpaste but they are at the end of the day they are all toothpaste so they are substitutable
but there could be minor differences between the the toothpaste because of which the people
can have preference for one variety over other so there is some amount of product differentiation
here and the products are not exactly homogenous so product differentiation happens here product
differentiation is there and the barrier of entry is not very high its not too difficult
to set up business in this market structure so barrier of entry is not too high
and the monopoly in monopolistic competition the firm has some control or some market power
that is the firm has some control over setting up of price of the product
because the products are differentiated so the firm knows that there is some amount of
loyal customers who would probably not shift to other products if the price change is a
little bit so but even then since the products are at the end of the day they are substitutable
so they cannot change the price too much so this is the situation where they are uh they
have some amount of market power so some market power is there for the seller .
another and another the last type of market structure that we are going to discuss is
the oligopoly so in case of oligopoly there are few sellers in case of oligopoly there
are few sellers in the market products whether the products are homogenous or they are differentiated
well in this in oligopoly the products could be homogenous perfectly substitutable or they
could be differentiable say for example the opec oil producing oil
exporting countries they form a oligopoly of oil producers or oil exporters and there
are few of them so in the world market so that is a oligopoly and oil crude oil is perfect
substitute if not like not going into technical details but crude oil is kind of homogenous
and on the other hand we have the car companies or airlines so there the airline services
differentiated uh then car companies different kinds of car manufactures different models
uh they are highly differentiated products so in oligopoly you can have both types of
producer surplus possible barrier to entry is kind of high barrier to entry is kind of
high and that is the reason we have few sellers
in the market and the barrier of entry is high we have few sellers in the market they
are catering to the huge population of consumers who are looking for this product and the firms
have substantial amount of market power but one thing interesting about oligopoly is in
the rest of all kinds of market structures the firms in these market structures they
decide how much output to produce what prices to charge and that is not dependent on what
other firms are doing in none of the market structures the firm
is concerned about what other firms or its rivals are doing but in case of oligopoly
since there are few sellers in the market every sellers decision is dependent on the
decision of its rivals so this is a special kind of situation and
here different kinds of scenarios could emerge where the the sellers could be competing on
the basis of the output they produce or they could be competing on the basis of prices
that they charge so these are the different kinds of market structures that we are going
to discuss during this week and one more to end the discussion one more interesting thing
here is what is the role of advertisement in all of these market structures
now in case of perfect competition since products are homogenous since products are homogenous
it does not make sense for a firm to advertise its products because they are all similar
so by advertising it is just going to increase its own cost so it does not make sense however
in case of perfect competition the industry level advertisement is possible which is going
to shift the demand curve to the right so to take an example say for example in uh
we have advertisement for eggs or milk so you generally want people to increase their
consumption of eggs or increase their consumption of milk and it doesnt matter you dont care
who they purchase it from which of the dairies they purchase it from or which of the poultries
they purchase it from you just want the industry demand curve to shift to the right
so the the role of advertisement is at industry level in this case of perfect competition
same is the case in monopoly in in monopoly the seller is can advertise to basically increase
the consumption to basically to shift the demand curve to the right but obviously it
does not have any uh requirement or any need to attract the consumers to uh to itself because
it is the only seller in the market uh in case of monopolistic competition advertisement
pays the maximum role because in case of monopolistic competition the products are highly substitutable
the product differentiation that can be created can be created in the minds of the consumers
and that is the reason that in case of monopolistic competition the firms are going to spend a
lot on advertisement because they can attract the consumers to itself and in case of oligopoly
also depending on whether its a differentiated product uh if it is a differentiated product
they may go for advertisement if it is a undifferentiated product homogenous product they are not going
to go for advertisement so this was our broad discussion about market
structure and every week we are going to take up each of these market structures and discuss
about them thank you