Module_III

Market Structure
3.1Perfect Competition :Features
3.2 Monopoly :Features ,Sources of monopoly power
3.3 Monopolistic Competition : Features, Selling Cost
3.4 Oligopoly: Features

Perfect competition Market

As the name itself suggests, perfect competition refers to the market situation where the competition among the
buyers and sellers will be in the most perfect form. As a market situation it is quite distinct from other types and
exhibits certain distinct peculiarities of its own. One thing which has to be noted is that the perfect competition
market situation is only a theoretical concept and it is not found practically anywhere in the world. It is only a
myth. The important characteristics /features of perfect competition may be listed out as follows:

1. Large number of buyers and sellers:

This is an important characteristic of perfect competition. Since there are a large number of buyers and sellers in

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the market, each buyer buys so little and each seller sells so little that none of them are in a position to influence the
price in the market. Individual seller or buyer’s contribution to the total demand or supply is negligible. Both have
to sell and buy the goods at the prevailing prices.Hence in the perfect competition price is determined by the
combined actions of all the buyers and sellers in the market.
2. Existence of homogeneous product:
This characteristic implies that the product being sold by all the sellers in the market are identical from the buyer’s
point of view. The products are homogeneous/identical in the sense that they are perfect substitutes. Hence no seller
can charge a price even slightly above the ruling market price. If he does so, he will lose all his customers. This
condition ensures a single /uniform price for a particular product throughout the market.

3. Free entry and free exit of firms:

This characteristic implies that there should be absolute freedom for the firms either to enter or to exit. If the
industry is making supernormal profit then new firms will enter and on the other hand few firms will quit the
industry if there are losses. Hence in the perfect competition, firms can enjoy only normal profit in the long run.
4. Perfect knowledge of the market:
All the sellers and buyers have the perfect knowledge of the market. The buyers and the sellers are fully aware of
the prices that are being offered and accepted in different parts of the market. Hence there is no necessity of
incurring any expenditure on publicity or advertising. This condition ensures a single uniform price throughout the
market.
5. Perfect mobility of the factors of production:
Perfect competition implies perfect mobility of the factors of production in between places and employment, which
they consider profitable and highly remunerative. This perfect mobility ensures uniform cost of production, which
inturn ensures a single uniform price throughout the market.
6. Absence of transport costs:
This condition becomes very essential in order to have a single uniform price. A single uniform price cannot exist
under perfect competition, if transport costs are taken into account. Sometimes a distinction is observed between
pure competition and perfect competition.
A firm in the short run under a perfect competition market may enjoy super or abnormal profit (AR>AC), Normal
profit (AR=AC) or could even incur losses also (AR<AC). But due to free entry and free exit features, in the long
run, a firm always lands up earning only normal profit. In case, if existing firms are earning super normal profit, it
would attract the entry of new firms into an industry, which further triggers the competition amongst them due to
which customers get divided.

As a result, sales reduces and consequently, super normal profit reduces to the level of normal profit. Similar is the
case with loss. In case of loss, few firms may decide to quit the industry. As a result, competition reduces and
customers increase. This increases sales and as a result, loss gets converted into normal profitability. Hence a firm
in the long run under a perfect competition market always earns normal profit. When all firms are earning normal
profit, even the entire industry also will be earning normal profit in the long run too.

Imperfect competition market

As discussed earlier, a perfect competition market is a myth. Hence Imperfect competition in the market is the
reality. There are six types of imperfect competition
markets viz.,
Monopoly: Existence of single seller in the market
Duopoly: Existence of two sellers in the market.
Oligopoly: Existence of few sellers in the market.

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Monopsony: Existence of single buyer in the market
Duopsony: Existence of two buyers in the market.
Oligopsony: Existence of few buyers in the market.
Oligopoly Market:
Oligopoly is an important form of imperfect competition. It is often described as ‘competition among a few’. When
there are a few sellers in a market, oligopoly is said to exist. Prof. Stigler defines oligopoly as “that situation in
which a firm bases its market policy in part on the expected behaviour of a few close rivals.” Example - Cold drink
industry, automobile industry

Characteristics /features of oligopoly

•Few sellers- In the oligopoly market there are few sellers. The number of sellers is not more than 10. In case there
are more than ten sellers, few sellers are dominant and others are insignificant.

•Homogeneous or differentiated products- goods which are sold under oligopoly are either homogeneous or
differentiated. Differentiation is in the form of brand name, design, color etc.

•Entry is possible but difficult- In case of oligopoly a new firm can enter the market but in reality, it is difficult
because of the technological, financial and other barriers

•Interdependence- as there are few firms under oligopoly, a single firm is not in a position to take any decision
about price and output independently. Any decision taken by one firm has the reactions from the rival firms or
competitive firms. Different firms will have different decisions. Thus the firms are interdependent. Therefore it is
necessary for the firm to take in to consideration the possible reactions of the rival firms.

•Uncertainty- as the firms are interdependent for deciding the price and output, it creates the atmosphere of
uncertainty. If one seller increases his output to capture large share of the market, others will react in the same way.
If one seller increases the price of his product, others will not follow him due to the fear of losing the market. On
the other hand if one seller reduces the price, others will also reduce their prices. But how much price reduction
they will do is uncertain. This means that an oligopolist is uncertain about the reactions of the competitive firms.
•Indeterminateness of the demand curve-. In case of oligopoly due to interdependence of firms and the uncertainty
aspect Demand curve does not have a definite shape. It loses its determinateness.

The demand curve under oligopoly is kinky as shown in the following diagram.
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Price rigidity- kinked demand curve model

Kinky demand curve model or kinked demand curve hypothesis was given by an American economist Paul M.
Sweezy and Oxford economist Hall and Hitch.

Interdependence and uncertainty aspect of oligopoly leads to indeterminateness of the demand curve. In case of
oligopoly price is rigid or inflexible because oligopolists are not interested in changing their price even though
economic conditions undergo a change.

As shown in Diagram 12.2 above there are two demand curves DD of firm A and D1D1 of firm B. Demand curve
DD is more elastic where as demand curve D1D1 is less elastic. These two demand curves intersect at point K.
Thus the prevailing price is OP and quantity is OQ. As shown in the diagram the demand curve faced by an
oligopolist is DKD1. This demand curve has a kink at point K because the upper segment of demand curve
(segment DK is more elastic) and the lower segment of the demand curve (segment KD1) is less elastic. This
difference in elasticities is because of the reactions of the competitive firms.
An oligopolists believes that if he reduces the price below prevailing price, his competitors will also reduce their
prices and if he increases the price above prevailing price, his competitors will not increase their prices.

•Increase in price- If an oligopolistic increases the price above prevailing price his competitors will not increase
their price. Therefore, demand for his goods will fall substantially. This is because due to increase in price his
customers will go to his competitors who have not increased their prices. Due to this the demand curve above
prevailing price is more elastic.

•Reduction in price- If an oligopolistic reduces the price below prevailing price, his competitors will follow him
and also reduce their prices due to the fear of losing their customers. Due to quick reactions of the oligopolists,
whoever reduces the price, demand for his goods increases by a very little amount. Therefore the demand curve
below prevailing price is less elastic.

Therefore DKD1 is the kinked demand curve under oligopoly. Due to differences in elasticity, a demand curve has
a kink at point K. Thus the demand curve under oligopoly is called kinky demand curve.

Rigid price- With an increase in price, there is a fear of losing the market and there is a very little benefit by
reducing the price. Therefore an oligopolist is not interested in changing their price. Thus price remains rigid or
sticky under oligopoly.

M.R
Monopolistic competition

Dr.
In real life perfect competition and monopoly are rarely found. What we find in real life is a mixture of two
markets, namely Monopolistic competition. The concept of monopolistic competition was introduced by Prof. E. H.
Chamberlin of USA in his famous book ‘The Theory of Monopolistic Competition’. Monopolistic competition
market situation is a peculiar blend or combination of both Monopoly and Perfect competition. It is a market
situation where a group of monopolists are in competition. Hence in this kind of market situation
“Large numbers of small sellers are selling differentiated products which are close but not perfect substitutes”. For
example: Market for soaps and detergents, cosmetics, clothing industry etc.,

The features of monopolistic competition:

1.Existence of large number of firms: In Monopolistic competition, the number of firms producing a product will
be large, but the size of each firm will be small. Each firm follows an independent price-output policy. No firm’s
action influences the other in any significant manner.

2.Product differentiation: In monopolistic competition, by adopting different techniques one firm will be trying to
show that its products are different from other firms. Those different techniques may be in the form of: (a)
differences in the quality of raw materials used (b) offering supplementary and other services to customers like
offering gifts, free home delivery, after sales services etc.
3.Free entry and exit of firms: New firms will have complete freedom to enter into an industry or to leave the
industry. There will be no entry barriers and in the same no restriction on coming out of the industry like in the
perfect competition.

4.It is a combination of monopoly and competition: Monopolistic competition is a peculiar combination of both
monopoly and competition. Large number of small sellers produce differentiated products which are close
substitutes but can’t be perfect substitutes. A small group of monopolists are in competition to sell their goods.
5.Selling costs: All those expenses, which are incurred on sales promotion of a product are called selling costs.
These selling costs include the cost of advertisements, free gifts, decoration of shops, demonstrations etc. All these
costs are necessary for the sales promotion because many sellers are selling products which are close substitutes.
So to induce buyers to buy their products, selling costs are necessary.

6.Definite preference of the consumers: The consumers will have definite preference for a particular product, due
to its special features. The demand curve in the monopolistic competition will be more elastic. It implies that with a
small increase in prices the demand may be reduced drastically. Hence, in monopolistic competition, the sellers
compete with each other through product differentiation or selling, but not with price.

Monopoly:

M.R
Dr.
The term ‘Monopoly’ is derived from two Greek words namely: Mono meaning ‘Single’ and Poly meaning Seller.
If there is only one seller in the market, it is called a monopoly. This market situation is at the opposite pole of
perfect competition market. Monopoly can be defined as “A market situation, where there is only one seller, who
controls the entire supply of his product, which has no close substitutes”. Pure monopoly is never found in practice.
However in public utilities such as Railway transport, water supply and electricity etc. we generally find
monopoly. This market situation represents absence of competition. Therefore, it is known as ‘single firm industry’.

Features of the monopoly market:

1. A single seller: As earlier discussed, monopoly means the existence of a single seller. It may be a person or a
group of persons united together in the form of cartels, pools, trusts, syndicates, associations etc., For example:
OPEC (organization of petroleum exporting countries). This monopolist will have complete control over the supply
of his product, which is crude oil. Hence the monopoly market is known as “Single firm industry”. In the case of
monopoly market, the difference between firm and industry disappears. Because entire industry consists of only one
firm.

2. No close substitutes: There will be no close substitutes for the products of the monopolist. The cross elasticity of
demand for the monopolist product is zero. The consumers will not have any other alternatives under monopoly.
They must buy the product or service only from the monopolist, that too by paying the price charged by him.
Hence in Monopoly, there will be absence of competition.

3. He is the price–maker: The Monopolist is the price-maker. He decides the price of his good or service. Since he
is the only seller and there is no close substitute. Hence he decides the price. The consumers are either to buy the
goods and services at the price fixed by the monopolist or to go without it. A monopolist has dual power – both a
price maker and output adjuster. But he cannot exercise both these powers simultaneously, as he has no control over
the market demand.
4. Existence of Entry barriers: The entry of other firms is highly restricted in monopoly market situation. Some of
the important factors which acts as entry barriers are: Natural factors: The nature itself has differentiated in
allocating resources. For example: petroleum products are available only in Arab countries, Jute growth is good
only in Bangladesh.
● Legal restrictions: Some companies, through Law, posses the monopoly. For example: Possessing Patents,
Trademarks and Copyrights etc. In India, Reserve Bank of India has the monopoly over printing of
currency notes.

● Business formation: Some business firms through forming business organizations like Cartels, Pools,
Syndicates, Trusts creates monopoly markets. Competition can be converted into cooperation. For
example: assume there were three doctors in the city. Those three doctors enter into some contract and
decide to start a common hospital. All three doctors agree to practice in the same hospital and share the
money at the end of the day. In this case initial competition has been converted into co-operation.

● Investment factors: Some large players through their massive investments create monopoly. For instance:
TATA and MITTAL have made huge investments in the production of iron and steel. Any new firm that
wants to enter in that field, will not be able to invest on par with them. Similar is the case with Indian
Railways.

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5. Existence of super normal profit: In monopoly, the seller always enjoys the super-normal profit. The price
charged by him will always be more than the average cost of production. Hence, he always enjoys the super-normal
profit
6. Price discrimination: A monopolist in order to attract all range of consumers, practices price discrimination.
Charging different prices to the different buyers for a similar kind of product or service is called as price
discrimination. For example: A doctor may charge Rs. 300 for richer patients and Rs. 100 for poorer patients for
the same treatment. Discriminating price is more profitable than a single uniform price.

7.Monopoly is an extreme form of imperfect competition with a single seller of a product which has no close
substitute. Monopolist, is the price maker and earns supernormal profit, not only during the short run but also in the
long run.

SOURCES OF MONOPOLY POWER

The monopoly has numerous factors which gives monopoly
power to the monopolist.
1. Natural monopoly power: Some monopolist gets monopoly power naturally by the product they produce which
is naturally available to them. A natural monopoly is a type of monopoly that exists due to the high start-up costs of
conducting a business in a specific industry. A company with a natural monopoly might be the only provider or a
product or service in an industry or geographic location in the whole market which gives him the monopoly power
naturally. Natural monopolies are allowed when a single company can supply a product or service at a lower cost
than any potential competitor in the market.
2. Product differentiation: The product which is being sold in the monopoly market is differentiated product which
has no close substitute in the market. In a perfectly competitive market, every product is perfectly homogeneous
and a perfect substitute for any other product in the market. With a monopoly, there is great to absolute product
differentiation in the sense that there is no available substitute for a monopolized good. The monopolist is the sole
supplier of the commodity in the market.
3. Legal protection: Legal is an artificial power which a firm has to protect this product from various market
competition and make a product unique or different. Legal protection is in the form of copyrights, patent rights,
trade marks etc. which gives the firm the monopoly power and make his product different from the other product in
the market.
4. Barriers to Entry: Barriers to entry are factors and circumstances that prevent entry into market by would-be
competitors and limit new companies from operating and expanding within the market. Monopolies have relatively
high barriers to entry due to its natural and artificial barriers. The barriers must be strong enough to prevent or
discourage any potential competitor from entering into the market.
5. Control over the resources: As the firm is the only seller in the market, he has sole control over the resources
which are used for production of the product. The source of control comes either from the natural or legal power.

Comparison
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