UNIT 3

LESSON 16
MARKET STRUCTURES

Learning outcomes

After studying this unit, you should be able to:

Define Market
Know different types of market structure
Distinguish between perfect competition, monopoly, and monopolistic
competition
Relate national income and economic welfare
Know per capita as an indicator of economic welfare

INTRODUCTION:
Now we are starting the third unit. This unit will give you all the details of the
different market structure. After reading this unit you will be able to know about the
different types of markets.
The number of firms and the level of product differentiation are useful parameters for
classifying various market structures. The level of competition also gets influenced by
product and production related factors, potential competitors, number of buyers and their
behaviour and the governmental policies.
We are now ready to analyze the various market
forms in greater detail. That will be attempted in the subsequent units in this block.

Meaning of market:
A market is a group of people and firms which are in contact with
one another for the purpose of buying and selling some product. It is not necessary that
every member of the market be in contact with each other.

Markets and competition
While all of us often use the word-'Market, we-do' Do not
realize that very few, markets possess a well defined place in a geographical area or have
a postal address. The Bombay, Stock Exchange is, one such market with a building and
an area earmarked for transacting shares.
The central phenomenon in the functioning of any market is competition. Competitive
behavior is molded by the market structure of the product under consideration. It is
therefore necessary to have a thorough understanding of this concept.

Meaning of Market structure:
A simple definition of this concept can be found in
Pappas and Hirschey (1985).
According to them "Market structure refers to the number and size distribution of buyers
and sellers in the market for a good or service. The market structure for a product not
includes firms and individuals currently engaged in Buying and selling but also the
potential entrants.

CLASSIEFICATION OF MARKET STRUCTURES:
Markets are traditionally classified
into four basic types. These are :

Perfect competition is characterized by a large number of buyers and sellers of an
essentially identical product. Each member of the market, whether Buyer or seller, is so
small in relation to the total industry volume that he is unable to influence the price of the
product. Individual buyers' and sellers are essentially price takers. At the ruling price a
firm can sell any quantity. Since there is free entry and free exit, no firm can
earn excessive profits in the long run.

Monopoly: In this situation there is just one producer of a product. The firm has
substantial control over the price: Further, if product is differentiated and if there are no
threats of new firms entering the same business, a monopoly firm can manage to earn
excessive profits over along period.

Monopolistic competition : It is coined by E.M. Chamberlin implies a market structure
with a large number of firms selling differentiated products. The differentiation may be
real or is perceived so by the customers. Two brands of soaps may just be identical but
perceived by customers as different on some fancy dimension like freshness. Firms in
such--a market structure have some control over price! By and large they are unable to
earn excessive profits in the long run. Since the whole structure operates on perceived
product differentiation entry of new firms cannot be prevented. Hence, above normal
profits can be earned only in the short run.

Oligopoly is a market structure in which a small number of firms account for the whole
industry's output. The product mayor may not be differentiated. For example only 5 or 6
firms in India constitute 100% of the integrated steel industry's output. All of, them
market almost identical products. On the other hand, passenger car industry with only
three firms is characterized by marked differentiation in products The .nature of products
is such that very often one finds entry of new firms difficult. Oligopoly is characterized
by vigorous competition where firms manipulate both prices and volumes in an attempt
to outsmart their rivals. No generalization can be made about profitability scenarios.

PARAMETERS OF MARKET STRUCTURES:
Now its clear that all the market
structures use only two parameters as distinguishing factors-number of firms and
degree of product differentiation. Other factors like product characteristics and entry of
new firms are also important but these determine the level of competition in a given
market structure.

In the real situation we will only find the imperfect market situation, and other market
situations like perfect competition, monopoly, and oligopoly are all myth. From the
above it is also clear that all these market structures can be classified in only two
fundamental forms-Perfect Competition and Imperfect Competition. Under this
classification Monopoly, Oligopoly and Monopolistic Competition are treated as special
cases of markets which are less than perfect. Thus these forms illustrate the degree of
imperfection in a market by using the number of firms and product differentiation as
basic criteria.

A convenient and effective classification scheme depicting types of competitive market
structures is shown in the diagram. A close look at the diagram reveals that most real
world markets are neither perfectly competitive or perfectly monopolistic. Most
industries that we come across can be classified in the realm of imperfect competition.




Types of Competition
Kind of Competition Number of
Producers and
Degree of
Product Dif-
ferentiation
Part of
Economy
Where
Prevalent.

Degree of
Control
Over Price
Methods of
Marketing

Perfect competition Many
producers:
identical
products

A few
agricultural
industries

None

Market
exchange or
auction

Imperfect competition:
Many differentiated
sellers
Many
producers:
many real or
fancied
differences in
product

Toothpastes,
retail trade;
conglo-
merates

Oligopoly

Few
producers:
little or no
difference in
product Few
producers:
some
differentiation
of products

Steel,
aluminum

Autos,
machinery




some



Advertising
and quality
rivalry:
administered
prices
Complete monopoly

Single
producer:
Unique
A few
utilities

Considerable

Promotional
and
"institutional"
product
without close
Substitutes
public-
relations
advertising

FACTORS DETERMINING THE NATURE OF COMPETITION

As we have seen that the number of firms and product differentiation are extremely crucial
in determining the nature of competition in a market. It has been tactically assumed that
there are a large number of buyers. What would happen if there are several firms
producing a standardized product but only one buyer? Obviously,' the buyer would
control the price, he will dictate how much to buy from whom. The entire price volume
decision takes on a different qualitative dimension. Similarly, product features and
characteristics the nature of production system the possibility of new entrants in a market
have profound impact on the competitive behavior of firms in a market. Since the 'entry'
of new entrants has special relevance in business behavior we reserve it to the next
section and deal with other issues in the present one.

Effect on buyer
We have already referred to the case where there is only one buyer. Such
situation is defined as monopoly. For example, there are just six firms in India
manufacturing railway wagons all of which supply to just one buyer The Railways. Such
a situation can also exist in a local labor market where' a single large firm is the only
provider of jobs for the people in the vicinity. A recent example is the new petro-
chemicals complex that is coming up in the rural parts of coastal Maharashtra.

More frequently encountered in the Indian markets is a case of a few large buyers,
defined as Oligopoly. The explosives industry which makes detonators and commercial
explosives has three major customers Coal India Ltd. (CIL), Department of Irrigation and
various governmental agencies working on road building activities of these, just one
customer, CIL takes nearly 60% of the. industry's output. There are about 10 firms. In the
industry which negotiate prices and quantities 'with CIL to finalize their short term-plans.
Most industries manufacturing heavy engineering equipment are typified in India by a
few manufacturers and few buyers with the Government being the major one. Price and
volume determination in such products often takes the form of negotiation across table
rather than the operation of any market forces. Since the members in the whole, market
inclusive of buyers and sellers are not many very often they know each other. In other
situations like the consumer goods firms have no direct contact with their customers.

Production Characteristics
Minimum efficient scale of production in relation to the overall industry output and
market requirement sometimes playa major role in shaping the market structure. Why
there are no more than say , 5 or 10 integrated steel plants even in an advanced country
like the U.S.A. can be partly explained by this factor. Since the minimum economic size
of such a steel plant is a few million tones, the entire world steel industry can have no
more than JOO efficient and profitable firms. Thus every country has only a handful of
steel plants. On the other hand, when one comes to re-rolling mills which take the steel
billets or bars as input, the minimum efficient size comes down considerably, and given
the existing demand, several firms can be seen to operate.

Further, the minimum size does not remain constant but changes drastically with
technological advancements, When technical changes push up the economic size of a
plant one notices that the number of firms decline over time. This can be noticed in some
process industries like synthetic fibre. Conversely, technological innovations may make it
possible for smaller sized. plants to become economically viable. In such a case a lot of
new entrants come and soon the market becomes highly competitive. Notice the personal
computers entry in India.

Apart from minimum plant size factors like availability of the required raw material,
Skilled labour etc. can also mould the market structure. Presently only one Indian source
(IPCL) provides all the raw material for plastic products. Like wise, enough skilled
people are not available work on the sophisticated machines. These factors sometimes
restrict output and push up prices even though adequate market potential for expansion
exists.

Product Characteristics

The above example referred to market situations with CTV and detergent powder as
product examples. Both these markets have many firms and the products are
differentiated. But in case of CTV, there are no close substitutes (BWTV) being a poor
one, whereas, there are many substitutes to a detergent powder (bar soaps; chips, cakes).
Therefore one notices more violent competition in the detergent Market than in the CTV.
market. In the CTV industry firms are competing with each other's products but in the
detergent market the firms are competing with other substitute products as well. Of
course you may remind us of the customer income constraint but even with that there
should be no difficulty in appreciating the differences in the degree of c6mpet1tiveriess
in these two markets. Similarly when two locations are connected by road and rail, firms
engaged in passenger bus service are not only computing with themselves but also with
an alternate mode of transport. . .
The physical characteristics or a product can also influence the competitive structure of
its market. If the distribution cost is a major element in the cost of a product, competition
would tend to get localised. Within a given region firms would compete and make
attempts to set up several plants around all the major markets in a bid to show there
presence in all the territories. Similarly, for perishable products, the competition is
invariably local

Conflict between physical characteristics and minimum economic size,

An interesting question arises in the case of a product like cement . for reason of
minimizing the transport costs on raw materials, most cement plants in the country are
located near mine sites. A large efficient plant near a mine site can manufacture cement at
the optimum cost, but the local demand is never large enough. If such a plant has to sell
In far away markets (from Gujarat to Kerala, for example) the transport costs can be quite
high. Customers located in such areas will always buy cement at a much higher price.
The government partly offsets this by using the mechanism of levy price which is the
same throughout the country.


BARRIERS TO ENTRY

In a classic book J .S. Bain (1956) analyzed the character and significance of the
condition of entry in manufacturing industries. Till that time, most analyses of how
competition works gave little. emphasis to the force of the potential or threatened
competition of possible new competitors. The attention was simply focused on the
competition among firms already established in an industry. Lately, however the
meaning of competition is inclusive of potential entrants.
The existence or otherwise of 'entry barriers' in a given industry has profound impact on
its performance and the behavior of firms in it.

If has been found that the firms in an industry are always worried about the possibility of
a new entrant. If the existing number is few then the degree of insecurity will be
correspondingly higher. To be sure, the existing firms, especially in an oligopoly, have ..
some advantages over the potential, entrant. But, because of the threat of new entrants,
the existing members cannot, exploit these advantages (by raising prices continuously)
beyond a point. What that point is and when the new entrants would find it profitable to
break the entry barriers are also not known. One thing is clear, that this potential
competition always puts a check on the pricing strategies of oligopolists.
What can act as an entry barrier?

Anything that retains the competitive advantages of the existing firms in an industry can
act as a barrier to those' desirous of entering it. Some of the commonly encountered
aspects are indicated below.

High Initial Investment
A new passenger car plant with a capacity to assemble say 50,000 automobiles per
annum can cost around Rs.1O0,crores. You know that not many firms have the capacity
to mobilize resources of that order. Naturally, there are high entry barriers to the
automobile market due to high level of initial investment. For similar reasons, one does
not find too many integrated steel plants coming up too often. On the other hand, it takes
only a few lakhs of rupees to set up a biscuit making unit. The barrier on account of
investment is quite low in such industries.

Economies of Scale in Non-production Activities
Scale economies are not restricted to manufacturing. These extend to distribution,
marketing and advertising. Consumer products like soaps, toothpastes display
considerable economies of scale in marketing and distribution. A nation-wide presence in
these industries presupposes an efficient and penetrating distribution network, high order
of brand related marketing skills and ability to service a fairly differentiated product line.
Thus, one may find numerous local soap makers but there are substantial entry barriers to
a new national brand penetrating the market.

Technology, Patents and Research
The ability to possess and commercially exploit certain specialized technology is one
more source of entry barrier. Specially chemicals, drugs, plastics are some of the
industries where the difficulty of developing a new. product or a process is well
understood. These are knowledge related factors. It is very difficult to penetrate an
industry where a few existing firms have a strong research base and a large pool of
product related patents. New entrants in such industries are often the employees of the
existing firms breaking away to form a new entity.

Switching Costs
Take an industry like earthmoving machinery. For such an industry each firm has a few
large customers like contractors, project authorities or coal mines. Consider that a
customer has a fleet of say 10 machines of a given brand. When he replaces one machine
or augments his fleet, more likely the choice would fall on the same brand. For him it
means a familiar machine, known operational details, already trained operators and a host
of other things like spare parts stocks. Thus, the cost of switching to a new brand can be
fairly high,' These costs can act as entry barriers. Along with earthmoving machines the
customer also has related equipment like loaders and dump trucks which he had
purchased on the ground of compatibility with a given brand of the main machine.
.
Take the case IBM. Why does every other personal computer.(PC) that one come as
across claims to be an IBM compatible. It has to be so, because all the software is
developed by using IBM standards. The PC cannot work without software. By
developing industry level standards, IBM has created 'high switching costs' in an attempt
to create entry barriers.
You will have notice a that' in oligopoly situations, firms should strive towards creating
high entry barriers, if the industry does not possess those necessary characteristics. This
is precisely what happens. If there are low entry barriers, new firms enter soon and the
profitability of the existing firms drops. Notice the state of the pocket calculator industry.
There, are virtually no entry barriers and with the existence of cheap smuggled products,
it is impossible to create them. As a result, most large firms are almost out of this market
leaving it open for the small scale units.

Activity 7

The table below lists some industries Indicate in column 3 whether the entry barriers are
high or low. Give reasons in column 4.
S.No. Name of the Industry Entry Barriers Reasons
1 Computer Software
2 Mainframe computers
3 Oil-field chemicals
4 CNC machine tools
5 Breakfast cereals
6 Aluminium
7 Ball-point pens
8 Colour Television Sets


THE ROLE OF GOVERNMENT POLICY

,All governments, whether in India or abroad, impose taxes and duties. What is special
about the Indian governmental policies is their ability to control price, ,quantity of
production, distribution choice of product, location and almost every business decision of
a firm. Some reference to these have been made in the previous sections. Presently we
shall see the role of government policy in a synoptic way. Later, a full unit in Block No.
5 will talk about the regulatory environment in detail.
,"
Through its industrial licensing policies the Central Government has control over the
following business decisions:
1 Choice of the product
2 Scale of production (capacity)
3 Location of production
4 Choice of technology

The policy on foreign collaborations also regulates the aspects pertaining to choice of
technology. Import policies can have significant impact on the types and quantities of raw
materials that would become available for production. Choice of machinery is also guide
by the import regulations in force.
Through levy of customs and excise duties, the price of the end products as well as the
raw materials gets affected. Some industries like sugar aluminum, steel, edible. oils,
cement are subject to price controls. These are administered through various Acts and,
the job of determining prices is often entrusted to the Bureau of Industrial Costs and
Prices under the Ministry of Industry. Firms in these industries are thus partly guided by
market forces and partly by the Ministry in regard to their pricing decisions.

Apart from these, several state governments have their regulations for promoting (or
restricting ) 'the growth bf certain industries. All things considered, the job of the
business manager is made quite difficult in the Indian environment. Ironically,
government steps ill to correct certain imperfections in the market but in the process
adds a few of its own. The existence of many industries with only few firms is mainly
attributable to the government policies which have acted as entry barriers for a long
period of time. The picture is changing rapidly. There are fair chances that in the future
market related forces would operate more on the price volume decisions of the firms,
than the government, policy related factors.



FOR SELF-ASSESSMENT TEST

1. List and explain the factors that determine the element of competition in a market for
either a product or a factor.
2. in the nature of prevailing competition that decides the classification of a market into
perfect and imperfect. Based on your analysis, comment on the degree of perfection
in the following markets
a) Labour market in Dubai
b) Capital market in India,
c) Computer market in India
d) Bombay stock market
e) Wholesale vegetable market in a city like Delhi

3 What do you mean by the term -"barriers to entry"? State and explain the factors that
cause such barriers.
4 In theory, we talk about barriers to entry' in practice ( in India ) we have barriers to
exit' our sick units are not allowed to die a natural death. Comment.
5 In what ways, does monopolistic competition differ from perfect competition? Give
real world examples to illustrate your answer. (You may re-do the same question when
you have run down the entire reading
material of the present Block.)
6 Review your understanding of the following terms:
a) .Cut-throat-competition .
b) Oligopoly / Duopoly
c) Bilateral monopoly
d) Duopsony/Oligopsony
e) Product differentiation
f ) Price volume decision
7 Write a lucid essay on the "Determinants of Price-Output Decisions".

Activity

a) Identify monopoly industries in the public sector and private sector manufacturing
and services sectors.

..


b) The table below gives information on some Indian industries which exhibit
"different degrees of imperfection in their market structures. Fill in the last
column by specifying the type of competition that is most likely to prevail in these
industries.

S.No. Name of Industry Number of firms 'Type of competition
1 Tractor 10
2 Vanaspati (ghee) . 22
3 Edible oil 3600
4 Sugar 326
5 Cigaretts 5
6 Caustic soda 24
7 Passenger cars 3
8 Commercial vehicles 11
9 Cement 40
10 Earthmoving equipment 10
11 Soaps 20
12 Synthetic detergents 16
Sources: Centre for Monitoring Indian Economy, Bombay

c) All the' firms in the sugar and cement industries produce almost identical products and
there are many firms. Price control prevails in these industries. Each firm in the industry
must sell a part of the output at a price determined by the government. In what way the
performance of these industries would differ from say the caustic soda industry where no
such price control exists?
-

..
..



A ) Obtain information about the Freight Equalis31ion Scheme in steer and analyse its
impact on the price of various steel products in different locations.

B ) Describe compitetive situation in the market for a product with one dominant buyer
and one dominant seller.



POINTS TO PONDER

MARKET
a market is a group of people and firms which
are in contact with one another for the
purpose of buying and selling some product.
It is not necessary that every member of the
market be in contact with every other

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Market structure
Market structure refers to the number and size
distribution of buyers and sellers in the
market for a good or service.

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Types of market
Traditionally markets are classified into four
types:
Perfect competition
Monopoly competition
Monopolistic competition
Oligopoly competition

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Perfect competition
Perfect competition is characterized by a large
number of buyers and sellers of an
essentially identical product. Each member of
the market, whether Buyer or seller, is so
small in relation to the total industry volume
that he is unable to influence the price of the
product. Individual buyers' and sellers are
essentially price takers. At the ruling price a
firm can sell any quantity. Since there is free
entry and free exit, no firm can earn
excessive profits in the long run.

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Monopoly
In the monopoly situation there is just one
producer of a product. The firm has
substantial control over the price: Further, if
product is differentiated and if there are no
threats of new firms entering the same
business, a monopoly firm can manage to
earn excessive profits over along period.

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Monopolistic competition
Monopolistic competition a term coined by
E.M. Chamberlin implies a market structure
with a large number of firms selling
differentiated products. Firms in such--a
market structure have some control over
price! By and large they are unable to earn
excessive profits in the long run

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Oligoply
Oligopoly is a market structure in which a small
number of firms account for the whole
industry's output.

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