Unit 8

Market Structures

Objectives:
After going through this unit, you will be able to explain:
The concept and significance of the structure of the market
Types of market structures
Difference between competitive and non-competitive markets
Behavior of firms in various market structures
Equilibrium conditions in various market forms

Structure:
1.1 Introduction
1.2 Structure Conduct Performance (S-C-P) model
1.3 Structure of the market
1.4 Competitive and Non-competitive markets
1.5 Perfect competition
1.6 Firm behavior in perfect competition
1.7 Monopoly
1.8 Limits to monopoly power
1.9 Monopoly equilibrium
1.10 Sources of monopoly
1.11 Monopolistic competition
1.12 Features of monopolistic competitive firm
1.13 Equilibrium for a monopolistically competitive firm in the short and long
run
1.14 Benefits of monopolistic competition
1.15 Oligopoly
1.16 Models of oligopoly
1.17 Comparison of various market structures
1.18 Summary
1.19 Key words
1.20 Self-assessment questions
1.1 Introduction
The concept of market form is central to economics. This is because in decision-making
analysis, market structure has an important role through its impact on the decision-
making environment. The extent and characteristics of competition in the market affect
choice behavior among the operating firms. In economics, markets are classified
according to the structure of the industry serving the market. Industry structure is
categorized on the basis of market structure variables which are, further, believed to
determine the extent and characteristics of competition.

1.2 Structure Conduct Performance (S-C-P) Model

The performance of an industry or a firm is determined by the behavior of buyers and

sellers in the market, which in turn is determined by the structural attributes of the market
in which it operates. This thought is propounded through the Structure Conduct
Performance(S-C-P) theory which links elements or attributes defining the structure or
form of the market to business policies and performance in industrial economies.

The basic tenet of the S-C-P paradigm is that the economic performance of a firm is a
function of its conduct which, in turn, is a function of the industry structure to which the
firm belongs (Mason, 1939; Bain, 1956). While the structure of the market is explained at
length in the following sections, conduct and performance can be explained:

Conduct refers to the activities and behavior of the sellers in the market. Sellers
activities include installation and utilization of capacity, promotional and pricing policies,
research and development, and inter-firm competition or cooperation, product decisions,
operational decisions, resource planning etc.

Economic performance is the outcome of firms conduct and policies. It can be

measured in terms of resource utilization, profit margins, growth, market share,
competitiveness among rivals, turnover etc.
Consider the following figure which describes the relation between the structure of the
market and its impact of firm behavior and performance.

Structure of the Market

Number of firms
Product differentiation
Entry/exit conditions
Mobility of resources
Dissemination of information

Conduct/behavior of the firm

Strategic decisions
Pricing policy
Product decisions
Operational decisions
Resource planning
Research and development

Performance of the firm

Profitability
Growth
Market share
Competitive ability
Sales turnover
Equity
1.3 Structure of the market

Knowing and understanding market structure has an important bearing on the firms
conduct and performance and is, hence, vital for a business. It can be defined in terms of
the following elements,
a) Number of firms
b) Product differentiation
c) Entry/exit conditions
d) Mobility of resources
e) Dissemination of information
Each of the above elements defines the degree of competition in the market. Consider the
following table:

S. Element of the Description Degree of

N. market structure competition in the
market
a) Number of firms This defines the number of competing More the number
firms in the market. of competitors
higher is the
competition.
b) Product The differentiation of goods along key Successful
differentiation features is an important strategy for firms differentiation
to establish their brands as distinct from strategy reduces
other brands in the same product category. competition.
c) Entry/exit If the market is characterized by barriers By creating
conditions then there exist obstacles on the way of barriers in the
potential new entrant to enter the market market firms
and compete with the existing firms. The restrict
barriers can be strategic, natural, and competition.
regulatory.
d) Mobility of This is more in terms of access to If firms have
resources resources and resource advantage that resource advantage
 some firms may over other firms in the they build
market competitive ability
e) Dissemination of Flow of information among buyers and Greater ease in
information sellers regarding various issues in the flow of
market such as price, offers, strategy etc. information
increases
competition.

1.4 Competitive and non-competitive markets

Based on the above attributes market forms can be classified as competitive and non-
competitive as shown in the following figure,

Market
Forms

Competitive Markets Non-competitive

markets

Perfect Monopoly
Competition
Monopolistic
Competition
Oligopoly

A firm is the smallest unit of production. The objective of a firm is to maximize profits.
This it can achieve by minimizing cost of production, or maximizing total revenue. The
prospects of profit for a firm are further guided by market conditions. As shown in the
above diagram the market forms can be broadly competitive and non-competitive. Within
this broad categorization markets are defined in terms various attributes signifying
varying degrees of competition. Consider the following figure,

Competition decreases

Perfect Monopolistic Oligopoly Monopoly

Competition Competition

Competition increases

The above figure shows that as on moves from perfect competition to monopoly
competition in the market reduces. On the other hand as one moves from monopoly to
perfect competition in the market increases. The following section discusses in detail the
features of and firm behavior in various market forms.

1.5 Perfect Competition

Traditionally perfect competition is considered as an ideal form of market. This market

structure is a golden rule. As it is understood today, the Classical Competitive Model is
hypothetical in nature; it is not based on actual market conditions. Such a competitive
market is supposed to provide maximum justice to a maximum number of buyers and
sellers. Following features characterize this market structure:
a) Large number of buyers and sellers: There are large number of buyers and
sellers. In that case the idea is that the individually each seller and buyer are too
 small relative to the size of the market, so that no one of them can control price
fixation. Instead they regard the price as being determined by the market and
beyond their ability to influence. In other words, for buyers and sellers in this
market form price is given.

b) Product homogeneity: Firms in the market produce homogeneous products that

are perfect substitutes for each other. There are no real or perceived differences
between products. This leads to each firm being price takers and facing a perfectly
elastic demand curve for their product.

c) Entry/exit conditions: There is free entry or exit for any firm. Free entry means
that new firms can set up in business to compete with established companies
whenever the new competitors feel that the profits are high enough to justify the
investment. Similarly, if operating firms find it commercially discouraging to
continue in the perfectly competitive market they can quit as and when they want.
In other words there are no barriers to entry or exit.

d) Mobility of resources: All firms have access to resources. Even if there are
resource advantages that some firms may enjoy over other firms in the market in
the short run, in the long run the resource mobility ensures that this advantage is
killed.

e) Dissemination of information: In practice, this feature implies that each buyer

and seller knows all about her or his opportunities to make deals, that is, knows
the terms on which other market participants will buy and sell. Perfect
dissemination of information would mean that all sellers and consumers know all
things, about all products, at all times, and therefore always make the best
decision regarding sale or purchase.

These features consolidate competitive force and rule out the influencing capacity of
individual firms. When market conditions are perfectly understood there is no chance of a
higher price being charged or paid. When factors of production are freely mobile, entry or
exit of firms is facilitated. Proximity to the market further ensures that there is no extra
transport cost, which may otherwise cause a small variation in the price.

1.6 Firm behavior in perfect competition

Many economists have questioned the validity of studying perfect competition. However
the theory does yield important predictions about what might happen to price and output
in the long run if competitive conditions hold good. The investigative outcome of a
competitive market, derived from the characteristics of competition, is as follows,

a) Identical Prices: In a competitive market, an individual firm has no capacity to

influence market conditions. Therefore it has to take market price as given,
constant and uniform in nature. The price of a good is also known as the
Average Revenue (AR) of the firm. Consider the following figure,
Price

P AR=MR =D

0
Quantity

Since Average Revenue or Price and Marginal Revenue are identical, when the
former is constant the latter is also constant. Moreover, the Average Revenue
curve of a firm is the same as the individual demand curve. Hence, the
competitive demand curve is a horizontal straight line parallel to the quantity axis.
This has been shown in the above figure. The quantity of output produced and
sold is shown on the x-axis and Price is measured along the y-axis. The firm
cannot charge a higher or lower price than the OP. If it attempts to charge a
somewhat higher price assuming competition, the firm will be able to sell nothing.
 On the other hand, if it charges a somewhat lower price the firm will
unnecessarily suffer losses. Because of the large number of competing firms,
individual firm faces highly elastic demand curve and any rise in price will lead to
a large fall in demand and total revenue.

b) Competitive equilibrium in the short run: In the short run, it is possible for
an individual firm to make more than the normal profit. This situation is shown
in the following diagram; the firm gets the price P from the equilibrium in the
market. P is above the average cost denoted by C. The volume of economic
profit is shown by the arrow.

Market Firm
Price Price
D S MR
Economic
Profit
AR

e
P
C AR=MR
=D

0
Qe
Quantity Quantity

c) Competitive equilibrium in the long run: In the long run, economic profit
cannot be sustained. Freedom of entry causes the arrival of new firms in the
market which further causes the demand curve of each individual firm to shift
downward, bringing down at the same time the price, the average revenue and
marginal revenue curve. The final outcome is that, in the long run, the firm will
make only normal profit (or zero economic profit). Its horizontal demand curve
will touch its average total cost curve at its lowest point, as shown in the
following figure.
 In a competitive market, a firm will be in equilibrium at a point where all the four
variables are equal.
d) MR = MC = AR = AC.
A firm in such equilibrium earns only normal profit.

d) Economic efficiency due to competition: Competition will ensure that firms

attempt to minimize their costs and move towards productive efficiency. The threat
of competition should lead to a faster rate of technological development and process
efficiency, as firms have to be responsive to the needs of consumer.

1.7 Monopoly
Monopoly is the market condition in which there is only one provider of a particular
commodity. Such a situation is beneficial for the firm as it enjoys lack of market
competitors. The customer has no alternatives for the available goods and services and
has to buy them at given facilities for the dictated price.

The primary characteristics of monopoly market form include the following:

a) Single Seller: For a pure monopoly to take place, only one firm can be selling the
good. A company can have a monopoly on certain goods and not on other goods.
 b) No close substitutes: A monopolists product is perceived as non-substitutable in
the market.

c) Price maker: Monopolist exercises market power and is hence called a price
maker. This market power is reflected by the firms control in the market through,
(i) Product differentiation, and
(ii) Supply
d) Very high barriers to entry: In a monopoly market structure, because there is a
single seller selling a product with no close substitutes, there exist very high
barriers to entry making it difficult for other firms o enter the market. These
barriers can be of three types:
(i) Strategic barriers such as control on source of the raw material
(ii) Legal barriers such as patents, government granted permits and licenses
(iii) Economies of scale and natural monopolists

1.8 Limits to the Monopoly Power

From the above features it would seem that monopolists enjoy unlimited power in the
market. This may not be true however. A monopolist may have complete freedom in
determining his own price, yet there are some limits to his power. These are:
(i) The demand curve of a monopolist slopes downwards, as shown in the
following figure:
 Price

AR=D

Quantity

A downward sloping demand curve faced by a monopolist implies that a

monopolist cannot choose both price and quantity of output to be sold. He has
to determine one of these. If he chooses to exercise monopoly power by
charging a higher price he will be able to sell lower quantity and if prefers to
sell larger quantities he can do so only for lower prices.
(ii) Another constraint on monopoly power arises out of the income and
willingness of consumers. Even though a monopolist has complete freedom
to charge any price this freedom is restricted by the consumers ability to
purchase goods which is further limited by his income..
(iii) Finally, monopoly power also depends upon elasticity of the demand curve.
If the demand curve is rigid or less elastic the monopolist has a greater
degree of control. As the demand curve becomes more flexible or flatter the
monopolists control starts declining as shown in the following diagram,
 Price

D2
D1

Quantity

This is explained with the help of above figure. In the figure there are two
demand curves. D1 is rigid or less flexible showing greater monopoly control.
D2 is flatter or more flexible and depicts a lower degree of monopoly control.
In case of a flexible demand curve there is a danger that even at a higher price,
the total revenue of a monopolist may be smaller.

1.9 Monopoly Equilibrium: In order to study equilibrium under monopoly let us draw
the demand and supply or cost curves of a monopolist.

Price

MC AC
R
P

C AR
S

MR

O Q
Quantity
In the above figure AR and MR are the demand and marginal revenue curves of a
monopolist. AC and MC are the respective cost or supply curves. The usual equilibrium
of MR=MC is equally applicable to the monopolist. At equilibrium, the monopolist
produces and supplies output quantity Q. This is the only profit-maximizing condition for
the monopolist. Under the given demand-cost structure no other level of output can help
to enhance his profit.

At equilibrium the monopolist charges price P which is determined by a corresponding

point R on the average revenue curve. The total revenue of the monopolist is then,

TR = OQ X P = OQRP

Similarly the total cost of the monopolist is governed by a point on the average cost
curve. S or C is the average cost of producing output Q in which the total cost will be,

TC = OQ XAC = OQSC

The profits of the monopolist as the difference between TR and TC are,

Profits = TR - TC = OQRP - OQSC = CSRP

Hence CSRP are the monopoly profits. These profits look similar to economic profits
under competition.

Monopoly profits differ in two respects:

(i) Monopoly profits are permanent and enjoyed in the short as well as long
run. There is no fear of monopoly profits being competed away.
(ii) Monopoly profits arise out of control over conditions in the market. The
monopolist follows restrictive policies and charges a higher price. This is the
source of his profits
1.10 Sources of Monopoly
Traditionally monopoly is considered as an evil form of market. Restrictive practices of
the monopolist cause prices to be higher and supply of goods to be smaller than what
would normally be available. But sometimes monopoly is unavoidable. These
circumstances are called sources of monopoly. They are:

(i) There are some natural resources such as land with specific properties,
mines, oil deposits, fields, etc. the supply of each of which is absolutely
limited. When such products are essential and not available anywhere else
the owners of the resources automatically acquire natural monopoly powers.
(ii) In some enterprises, large amount of capital is required to be invested right
from the beginning. Steel production, railway construction etc. are examples
of such enterprises. Those who possess such capital resources enjoy
monopoly powers. Other small investors cannot compete with them and the
monopoly survives unrivaled.
(iii) In certain enterprises, specialized technical resources are required to be
employed. Ship building, aeronautics, space research are examples of these
enterprises. Those who possess such technical resources will have monopoly
power.
(iv) In modern times certain legal provisions create monopoly rights. These are
in the form of intellectual property rights (IPR) leading to monopoly power.
(v) Finally there are monopolies in the form of public utilities. Road
construction, postal services, water supply, telecommunications, etc. are
some of the examples. In the case of such services it is necessary to maintain
a high quality and a uniformity of products or services. This results in
monopoly power.

In all such cases monopoly form of the market becomes unavoidable. Though there are
certain evils of the monopoly market form these have to be suffered and tolerated. In
absence of monopoly production and supply of these goods and services the society will
be totally deprived of certain benefits.
1.11 Monopolistic competition

Monopolistic competition refers to a market structure that is a traverse between the two
extremes of perfect competition and monopoly. The model retains many features of
perfect competition but depicts a market form having competition which is imperfect. As
a result, the model offers a somewhat more realistic depiction of many common
economic markets. The model best describes markets in which numerous firms supply
products which are each slightly different from that supplied by its competitors.
Examples include automobiles, toothpaste, furnaces, restaurant meals, motion pictures,
romance novels, wine, beer, cheese, shaving cream and many more.

1.12 Features of Monopolistic Competition

Monopolistic competition is a modern form of the market. A large variety of goods are
sold in such a market. Its main features can be stated as follows:

a) Many sellers: The number of firms operating under monopolistic competition is

sufficiently large implying a great degree of competition.

b) Product Differentiation: Under monopolistic competition products are

differentiated. This is one of the most important features of this form of market.
Product differentiation may be real or perceived.
(i) Real differentiation implies an evident distinctiveness about the product
one that can be maintained in some physical or chemical composition of the
product or in the taste and appearance of that product.
(ii) Perceived differences refer to the product distinctiveness that is created in
the consumers mind primarily through advertising or promotion, although
the product itself may not be really different.
When products are differentiated more buyers are likely to be attracted. Thereby t
he firm gains extra control over demand and market conditions.
 c) Selling Cost: Selling Cost is another important feature of a monopolistically
competitive market. This is primarily in the form of advertisement expenditure.
Whenever a product is differentiated it is necessary to inform buyers; and
advertisement is a medium through which buyers can be told about superiority of
that product. Selling Cost is inevitable if products are differentiated. Infact, many
a times, advertising itself is used a strategy to create product differentiation. For
example using celebrities in product endorsements etc.

d) Entry/exit conditions: There is freedom of entry. There are no quantitative

restrictions or differences in market conditions. However qualitative differences
may create some barriers in the short run. In the long run, all such barriers may
not exist.

e) Resource Mobility: There is a great degree of resource mobility allowing firms

to have access and minimizing resource advantages.

f) Dissemination of information: In monopolistic competition, buyers do not know

everything, but they have relatively complete information about alternative prices.
They also have relatively complete information about product differences, brand
names, etc. Each seller also has relatively complete information about production
techniques and the prices charged by their competitors.

1.13 Equilibrium for a monopolistically competitive firm in the short and long run
The equilibrium for a monopolistically competitive firm in the short run is shown the
following diagram:
 Price

MC AC
R
P

C AR
S

MR

O Q
Quantity

A monopolistically competitive firm acts like a monopolist in that the firm is able to
influence the market price of its product by altering the rate of production of the product.
In the short-run, the monopolistically competitive firm can exploit the heterogeneity of its
brand so as to reap positive economic profit. As shown in the above diagram the firm
earns economic profit equal to CPRS. In the long run, however, freedom of entry,
mobility of resources, and ease of flow of information may nullify the short run economic
profit.
The equilibrium for a monopolistically competitive firm in the long run is shown the
following diagram.
As shown in the above figure, in the long run, whatever distinguishing characteristic that
enables one firm to reap monopoly profits will be duplicated by competing firms. This
competition will drive the price of the product down and, in the long run, the
monopolistically competitive firm will make zero economic profit.

1.14 Benefits of monopolistic competition

Monopolistic competition has several advantages which are:

(i) Monopolistic competition creates more variety for the consumer.

(ii) The price of every variety sold in the market will be lower. This is because
of competition. Competition in the industry, forces each firm towards
efficiency improvements whose benefits are passed along to the consumers
in the form of lower prices.
(iii) The improvement in productive efficiency for each firm may lead to a
reduction in the use of resources in the industry as well as efficient
utilization of the existing resource base.

1.15 Oligopoly
Oligopoly denotes a market situation where there are few sellers for a product or service.
It exhibits the following features:

a) Few interdependent firms: Interdependence means that firms must take into
account likely reactions of their rivals to any change in price, output or forms of
non-price competition.

b) Product branding: Each firm in the market is selling a branded or differentiated

product.

c) Entry barriers: Significant entry barriers into the market prevent the dilution of
competition in the long run which maintains economic profits for the dominant
firms.
 d) Non-price competition: Non-price competition is a consistent feature of the
competitive strategies of oligopolistic firms. Examples of non-price competition
include:
(i) Free deliveries and installation
(ii) Extended warranties for consumers and credit facilities
(iii) Longer opening hours (e.g. supermarkets and petrol stations)
(iv) Branding of products and heavy spending on advertising and marketing
(v) Extensive after-sales service
(vi) Expanding into new markets + diversification of the product range

1.16 Models of Oligopoly

There is no single theory of how firms determine price and output under conditions of
oligopoly. Some models of oligopoly describing firm behavior and pricing and output
decisions are:
a) Collusions and cartels
b) Price leadership
c) Game theory
d) Kinked demand curve

a) Collusions and cartels

It is often observed that when a market is dominated by a few large firms, there is
always the potential for businesses to seek to reduce market uncertainty and
engage in some form of friendly behavior. When this happens the existing firms
decide to engage in price fixing agreements or cartels. The aim of this is to
maximize profits mutually and act as if the market is a pure monopoly. This
behavior is deemed illegal by the competition authorities of many countries. But it
is hard to prove that a group of firms have deliberately joined together to raise
prices.
Collusion is often explained by a desire to achieve mutual profit maximization
within a market or prevent price and revenue instability in an industry. Price
fixing represents an attempt by suppliers to control supply and fix price at a level
close to the level we would expect from a monopoly. To fix prices, the producers
in the market must be able to exert control over market supply.

The distribution of the cartel output may be allocated on the basis of an output
quota system or another process of negotiation. Although the cartel as a whole is
maximizing profits, the individual firms output quota is unlikely to be at their
profit maximizing point. For any one firm, within the cartel, expanding output and
selling at a price that slightly undercuts the cartel price can achieve extra profits.

Unfortunately if one firm does this, it is in each firms interest to do exactly the
same. If all firms break the terms of their cartel agreement, the result will be an
excess supply in the market and a sharp fall in the price. Under these
circumstances, a cartel agreement might break down.

(i) Collusion in a market or industry is easier to achieve when:

(ii) There are only a small number of firms in the industry and barriers
to entry protect the monopoly power of existing firms in the long
run.
(iii) Market demand is not too variable i.e. it is reasonably predictable
and not subject to violent fluctuations which may lead to excess
demand or excess supply.
(iv) Demand is fairly inelastic with respect to price so that a higher
cartel price increases the total revenue to suppliers in the market -
this is clearly easier when the product is viewed as a necessity by
the majority of final consumers.
 (v) Each firms output can be easily monitored - this enables the cartel,
more easily, to control total supply and identify firms who are
cheating on output quotas

Most cartel arrangements experience difficulties and tensions and some producer
cartels collapse completely. Several factors can create problems within a collusive
agreement between suppliers:

(i) Enforcement problems: The cartel aims to restrict total

production to maximize total profits of members. But each
individual member of the cartel finds it profitable to raise its own
production. It may become difficult for the cartel to enforce its
output quotas. There may be disputes about how to share out the
profits. Other firms who may be not members of the cartel, may
opt to take a free ride by producing close to but just under the
cartel price.
(ii) Falling market demand: An economic slowdown or recession
creates excess capacity in the industry and puts pressure on
individual firms to cut prices to maintain their revenue.
(iii) The successful entry of non-cartel firms into the industry: This
undermines a cartels control of the market.
(iv) The exposure of illegal price fixing by market regulators: Such
legal pressures may also cause the cartel to breakdown.

b) Price leadership

Another type of oligopoly behavior is explained by Price Leadership. This

is when one firm has a clear dominant position in the market and the firms
with lower market shares follow the pricing changes prompted by the
dominant firm. If most of the leading firms in a market are moving prices
 in the same direction, it can take some time for relative price differences to
emerge which might cause consumers to switch their demand.

c) Game theory
A game is a situation in which the fate of a player in a game depends not
only on the actions of that player but also on the other players involved in
the game. Game theory is mainly concerned with predicting the outcome of
games of strategy in which the participants have incomplete information
about the others intentions. Game theory analysis has direct relevance to the
study of the conduct and behavior of firms in oligopoly market, for instance
the decisions that firms must take over pricing, and how much money to
invest in research and development spending. Costly research projects
represent a risk for any business - but if one firm invests in R&D, can
another rival firm decide not to follow? They might lose the competitive
edge in the market and suffer a long term decline in market share and
profitability. The dominant strategy for both firms is probably to go ahead
with R&D spending. If they do not and the other firm does, then their profits
fall and they lose market share. However, there are only a limited number of
patents available to be won and if all of the leading firms in a market spend
heavily on R&D, this may ultimately yield a lower total rate of return than if
only one firm opts to proceed.

d) Kinked demand curve

The demand or average revenue curve used in this analysis is kinked. It has
a Kink or a knot. The demand curve is not a smooth straight line but has two
segments with a varying degree of flexibility or slope. Let us begin with its
underlying assumptions.

(i) If the firm reduces its price the producer expects other competitors
to introduce a similar price cut; the market demand will increase but the
share of the firm will remain unaltered.
 (ii) If the firm raises the price then other competing firms will not follow the
price rise. There will be a very small rise in demand but a significant
reduction in the sales of the firm.
The two assumptions suggest that neither a fall nor a rise in price would benefit
the firm. Oligopoly price is rigidly fixed. Moreover, such price rigidity causes a
kink in the demand curve with its lower segment steeper or inelastic and its upper
segment flatter and more flexible. Consequently there is no incentive to alter price
under oligopoly. This will be clearer when explained with the help of a figure.

In the above figure, there are two demand curves, DED, which is flatter and more
flexible and D1ED1, which is steeper and less flexible. The two demand curves
interest at point E which itself is a point of kink. The upper portion of the flatter
demand curve DE and the lower portion of the steeper demand curve ED1
together make up the Kinked Demand Curve. Under the above stated assumptions
the lower portion of the flatter demand curve ED and the upper portion of the
steeper demand curve D1E are not operative. Taking into account only relevant
segments of the two demand curves a kinked demand curve DED1 has been
formed and presented in the following figure,
 Once we locate the point of Kink there is no further problem in oligopoly
analysis. The point of Kink, E, is itself an equilibrium point. At such point
equilibrium output produced is Q and price charged is P.

Once a kink in the demand curve is known and given, oligopoly equilibrium
automatically follows. The point of kink such as E is itself an equilibrium point.
Moreover, such equilibrium is rigid and stable. There is no incentive on the part of
the oligopoly firm to move away from the point of kink. Any attempt on his part
either to lower or raise the price will not be to his advantage. This can be
explained with the help of the following figure,

The lower segment ED1 of the demand curve is steeper. Even with a significant
fall in price from P to P1 increase in the quantity demanded QQ1 is very small.
Reduction in price will then result in smaller total revenue for the firm. On the
other hand, any attempt to cause a small rise in price as PP2 on the flatter portion
ED of the demand curve causes a significant fall in the quantity demanded from Q
to Q2. This again will cause total revenue of the firm to be smaller at higher price.
The firm is rigidly fixed at E, the point of kink with P as the price. This therefore
is also called sticky price solution.

1.17 Comparison of various market structures

We have established that the structure of the market and its attributes has an important
bearing on the firms behavior and its pricing and output decisions. The following table
compares and contrasts various market forms:
 Element of Market forms
Perfect Monopolistic Oligopoly Monopoly
the market
competition Competition
structure
Number of Large Many Few One
firms
Product Homogenous Slightly Slightly or Highly
differentiation product differentiated highly differentiated
product differentiated product with no
product close substitutes
Entry Complete Relative Slight or high Very high barriers
conditions freedom of freedom of restrictions in to entry
entry entry entry of new
firms
Mobility of Perfect Relative Slight or high Restriction in
resources mobility of mobility of restrictions in mobility of
resources resources mobility of resources
resources
Dissemination Free flow of Slight Slight or high Restriction in flow
of information restrictions in restrictions in of information
information flow of flow of
information information
Profit Economic Economic Indeterminate Economic profits
potential profits in the profits in the in the short run and
short run but short run but long run
only normal only normal
profits in the profits in the
long run long run
Demand Perfectly Relatively Indeterminate Relatively inelastic
curve elastic elastic

1.18 Summary
In this unit we have highlighted the important bearing that the structure of the market has
on a firms pricing and output decisions. The structure of the market can be described in
terms of number of buyers and sellers, product differentiation, entry conditions, mobility
of resources, and flow of information. Based on these criteria we have analyzed four
market forms perfect competition, monopoly, monopolistic competition, and oligopoly.
A comparison of them brings about the existence of varying degrees of competition in the
market and the consequent impact on a firms decisions.

1.19 Key words

a) Structure Conduct Performance (S-C-P) Model: Economic performance of a

firm is a function of its conduct which, in turn, is a function of the industry
structure to which the firm belongs.
b) Market structure: The structure of the market can be described in terms of
number of buyers and sellers, product differentiation, entry conditions, mobility
of resources, and flow of information.
c) Product differentiation: The differentiation of goods along key features to
establish brands as distinct from other brands in the same product category.
d) Barriers to entry: Obstacles on the way of potential new entrant to enter the
market and compete with the existing firms.
e) Perfect competition: Ideal markets form with a very high degree of competition
so that a single seller or buyer is too small relative to the size of the market and no
one of them can individually control market or its conditions.
f) Monopoly: Market condition in which there is only one provider of a particular
commodity.
g) Monopolistic competition: Markets in which numerous firms supply products
which are each slightly different from that supplied by its competitors.
h) Oligopoly: A market situation where there are few interdependent sellers for a
product or service.
i) Collusions: Covert interdependence between competing oligopoly firms for
pricing and output decisions.
 j) Cartel: Overt and contractual interdependence between competing oligopoly
firms for pricing and output decisions.
k) Price leadership: One firm has a clear dominant position in the oligopoly market
and the firms with lower market shares follow the pricing changes prompted by
the dominant firm.
l) Game theory: A proposition according to which the fate of a firm in the market
depends not only on its own actions but also on the other firms, as in a game
where the fate of a player depends on all the players involved in the game.

1.20 Self-assessment questions

1) Explain the importance of the structure of the market based on the S-C-P model.
2) What are the various elements that describe the market structure? Discuss
3) Explain Perfect Competition. How does a firm arrive at equilibrium in such a
market?
4) How can a monopoly be created? Discuss the advantages of a monopoly situation
in the market?
5) Explain monopolistic competition. Discuss firms behavior in such a market.
6) Write a note on models of oligopoly.
7) Economic performance of a firm is a function of its conduct which, in turn, is a
function of the
a) Industry structure to which the firm belongs.
b) Government policy
c) Size of the firm
d) Goods and services
8) The structure of the market can be described in terms of number of buyers and
sellers, product differentiation, entry conditions, mobility of resources, and flow
of information.
a) True
b) False
c) Cant say
 d) None of the above
9) Product differentiation can be
a) Real
b) Perceived
c) Both a) and b)
d) Cant say
10) Barriers to entry can be
a) Natural
b) Regulatory
c) Strategic
d) All of the above
11) Fill in the blanks:
a) The differentiation of goods is done along ______________features to
establish______________ as distinct from other______________ in the
same product category.
b) ______________ are obstacles on the way of potential new entrant to
enter the market and compete with the existing firms.
c) ______________ is an ideal markets form with a very high degree of
competition so that a single seller or buyer is too small relative to the size
of the market and no one of them can individually control market or its
conditions.
d) ______________ is a market condition in which there is only one provider
of a particular commodity.
e) ______________ is a market in which numerous firms supply products
which are each slightly different from that supplied by its competitors.
f) Oligopoly is a market situation where there are few
______________sellers for a product or service.
g) ______________ are covert interdependence between competing
oligopoly firms for pricing and output decisions.
h) ______________ is an overt and contractual interdependence between
competing oligopoly firms for pricing and output decisions.
i) When one firm has a clear dominant position in the oligopoly market and
the firms with lower market shares follow the pricing changes prompted
by the dominant firm it is called ______________.
j) ______________ is a proposition according to which the fate of a firm in
the market depends not only on its own actions but also on the other firms,
as in a game where the fate of a player depends on all the players involved
in the game.
k) A demand curve which is not a smooth straight line but has two segments
with a varying degree of flexibility or slope to explain behavior of an
oligopoly firm is called______________.