INSTITUTE OF MANAGEMENT SCIENCES

Assignment of Managerial Economics

Market Structure in Decision making

Submitted To: Sir Wahid Shah Submitted By: Saleha Ahmed Madiha Amin Hira Yasmin Sohaib Iftikhar BB-09-12 BB-09-68 BB-09-70 BB-09-124

Date: 19-12-2011

Market Structure

Definition of Market:
A market is a set of conditions in which buyers and sellers meet each other for the purpose of exchange of goods and services for money.

Elements of Market:
The essentials of a market are: y Presence of goods and services to be exchanged. y Existence of one or more buyers and sellers. y A place or a region where buyers and sellers of a good get in close touch with each other.

Market Structure
The interconnected characteristics of a market, such as the number and relative strength of buyers and sellers anddegree of collusion among them, level and forms of competition, extent of product differentiation, and ease of entry into and exit from the market. Market structure is best defined as the organizational and other characteristics of a market. We focus on those characteristics which affect the nature of competition and pricing but it is important not to place too much emphasis simply on the market share of the existing firms in an industry. It is also defined simply as the number of firms producing identical products Traditionally, the most important features of market structure are:
y y y

The number of firms (including the scale and extent of foreign competition) The market share of the largest firms (measured by the concentration ratio) The nature of costs (including the potential for firms to exploit economies of scale and also the presence of sunk costs which affects market contestability in the long term) The degree to which the industry is vertically integrated - vertical integration explains the process by which different stages in production and distribution of a product are

y y y

under the ownership and control of a single enterprise. A good example of vertical integration is the oil industry, where the major oil companies own the rights to extract from oilfields, they run a fleet of tankers, operate refineries and have control of sales at their own filling stations. The extent of product differentiation (which affects cross-price elasticity of demand) The structure of buyers in the industry (including the possibility of monophony power) The turnover of customers (sometimes known as market churn ) i.e. how many customers are prepared to switch their supplier over a given time period when market conditions change. The rate of customer churn is affected by the degree of consumer or brand loyalty and the influence of persuasive advertising and marketing.

Types of Market/Market Model:

Markets are classified according to the number of firms in the market and by the commodity to be exchanged. The economists on the basis of variation in the features of market describe four market models: y y y y Perfect Competition. Monopoly. Monopolistic Competition. Oligopoly.

Quick Reference to Basic Market Structures:

Market structure Perfect Competition Monopoly Monopolistic Competition Oligopoly Seller entry barriers No Yes No Yes Seller number Many One Many Few Buyer entry barriers No No No No Buyer number Many Many Many Many

In the analysis of each market model, it is examined as to what determines the equilibrium price, output and profit levels for the individual firm and for the industry.

Perfect Competition: Definition:

The concept of perfect competition was first introduced by Adam Smith in his book "Wealth of Nations". Later on, it was improved by Edgeworth. However, it received its complete formation in Frank Kight's book "Risk, Uncertainty and Profit" (1921). Leftwitch has defined market competition in the following words: "Prefect competition is a market in which there are many firms selling identical products with no firm large enough, relative to the entire market, to be able to influence market price". According to Bllas: "The perfect competition is characterized by the presence of many firms. They sell identically the same product. The seller is a price taker". The main conditions or features of perfect competition are as under:

Features/Characteristics or Conditions:
y Large number of firms. The basic condition of perfect competition is that there are large numbers of firms in an industry. Each firm in the industry is so small and its output so negligible that it exercises little influence over price of the commodity in the market. A single firm cannot influence the price of the product either by reducing or increasing its output. An individual firm takes the market price as given and adjusts its output accordingly. In a competitive market, supply and demand determine market price. The firm is price taker and output adjuster. Large number of buyers. In a perfect competitive market, there is very large number of buyers of the product. If any consumer purchases more or purchases less, he is not in a position to affect the market price of the commodity. His purchase in the total output is just like a drop in the ocean. He, therefore, too like the firm, is a price taker.

In the figure (15.1) PK is the market price determined by the market forces of demand and supply. The price taker firm has to adjust and sell its output at Price PK or OE.

Diagram/Figure:

The product is homogeneous. Another provision of perfect competition is that the good produced by all the firms in the industry is identical. In the eyes, of the consumer, the product of one firm (seller) is identical to that of another seller. The buyers are indifferent as to the firms from which they purchase. In other words, the cross elasticity between the products of the firm is infinite. No barriers to entry. The firms in a competitive market have complete freedom of entering into the market or leaving the industry as and when they desire. There are no legal, social or technological barriers for the new firms (or new capital) to enter or leave the industry. Any new firm is free to start production if it so desires and stop production and leave the industry if it so wishes. The industry, thus, is characterized by freedom of entry and exit of firms. Complete information. Another condition for perfect competition is that the consumers and producers possess perfect information about the prevailing price of the product in the market. The consumers know the ruling price, the producers know costs, the workers know about wage rates and so on. In brief, the consumers, the resource owners have perfect knowledge about the current price of the product in the market. A firm, therefore, cannot charge higher price than that ruling in the market. If it does so, its goods will remain unsold as buyers will shift to some other seller. Profit maximization. For perfect competition to exist, the sole objective of the firm must be to get maximum profit.

Importance:
Perfect competition model is hotly debated in economic literature. It is argued that the model is based on unrealistic assumptions. It is rare in practice. The defenders of the model argue that the theory of perfect competition has positive aspect and leads us to correct conclusions. The concept is useful in the analysis of international trade and in the allocation of resources. It also makes us understand as to how a firm adjusts its output in a competitive world.