Module 4 Market Structure and Pricing Practices: 12 Hours

4.1 Different Market structure, features:

Market Structure:

Contents :
1. Meaning of Market
2. Characteristics of Market
3. Market Structure
4. Forms of Market Structure
 
4.1 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:
 
(i) Presence of goods and services to be exchanged.
(ii) Existence of one or more buyers and sellers.
(iii) A place or a region where buyers and sellers of a good get in close touch with
each other.
    

Market Structure: Meaning, Characteristics and Forms | Economics

Market structure refers to the nature and degree of competition in

the market for goods and services. The structures of market both
for goods market and service (factor) market are determined by
the nature of competition prevailing in a particular market.

Meaning of Market:
Ordinarily, the term “market” refers to a particular place where goods are purchased
and sold. But, in economics, market is used in a wide perspective. In economics, the
term “market” does not mean a particular place but the whole area where the buyers
and sellers of a product are spread.
This is because in the present age the sale and purchase of goods are with the help of
agents and samples. Hence, the sellers and buyers of a particular commodity are
spread over a large area. The transactions for commodities may be also through
letters, telegrams, telephones, internet, etc. Thus, market in economics does not refer
to a particular market place but the entire region in which goods are bought and sold.
In these transactions, the price of a commodity is the same in the whole market.
According to Prof. R. Chapman, “The term market refers not necessarily to a place
but always to a commodity and the buyers and sellers who are in direct competition
with one another.” In the words of A.A. Cournot, “Economists understand by the
term ‘market’, not any particular place in which things are bought and sold but the
whole of any region in which buyers and sellers are in such free intercourse with one
another that the price of the same goods tends to equality, easily and quickly.” Prof.
Cournot’s definition is wider and appropriate in which all the features of a market are
found.

4.2 Characteristics of Market:

The essential features of a market are:
(1) An Area:
In economics, a market does not mean a particular place but the whole region where
sellers and buyers of a product ate spread. Modem modes of communication and
transport have made the market area for a product very wide.
(2) One Commodity:
In economics, a market is not related to a place but to a particular product.
Hence, there are separate markets for various commodities. For example, there are
separate markets for clothes, grains, jewellery, etc.
(3) Buyers and Sellers:
The presence of buyers and sellers is necessary for the sale and purchase of a product
in the market. In the modem age, the presence of buyers and sellers is not necessary
in the market because they can do transactions of goods through letters, telephones,
business representatives, internet, etc.
(4) Free Competition:
There should be free competition among buyers and sellers in the market. This
competition is in relation to the price determination of a product among buyers and
sellers.
(5) One Price:
The price of a product is the same in the market because of free competition among
buyers and sellers.
On the basis of above elements of a market, its general definition may be
as follows:
The market for a product refers to the whole region where buyers and sellers of that
product are spread and there is such free competition that one price for the product
prevails in the entire region.
4.3 Market Structure:
Meaning:
Market structure refers to the nature and degree of competition in the market for
goods and services. The structures of market both for goods market and service
(factor) market are determined by the nature of competition prevailing in a
particular market.
Determinants:
There are a number of determinants of market structure for a particular good.
They are:
(1) The number and nature of sellers.
(2) The number and nature of buyers.
(3) The nature of the product.
(4) The conditions of entry into and exit from the market.
(5) Economies of scale.
They are discussed as under:
1. Number and Nature of Sellers:
The market structures are influenced by the number and nature of sellers in the
market. They range from large number of sellers in perfect competition to a single
seller in pure monopoly, to two sellers in duopoly, to a few sellers in oligopoly, and to
many sellers of differentiated products.
2. Number and Nature of Buyers:
The market structures are also influenced by the number and nature of buyers in the
market. If there is a single buyer in the market, this is buyer’s monopoly and is called
monopsony market. Such markets exist for local labour employed by one large
employer. There may be two buyers who act jointly in the market. This is called
duopsony market. They may also be a few organised buyers of a product.
This is known as oligopsony. Duopsony and oligopsony markets are usually found for
cash crops such as rice, sugarcane, etc. when local factories purchase the entire crops
for processing.
3. Nature of Product:
It is the nature of product that determines the market structure. If there is product
differentiation, products are close substitutes and the market is characterised by
monopolistic competition. On the other hand, in case of no product differentiation,
the market is characterised by perfect competition. And if a product is completely
different from other products, it has no close substitutes and there is pure monopoly
in the market.
4. Entry and Exit Conditions:
The conditions for entry and exit of firms in a market depend upon profitability or
loss in a particular market. Profits in a market will attract the entry of new firms and
losses lead to the exit of weak firms from the market. In a perfect competition
market, there is freedom of entry or exit of firms.
But in monopoly and oligopoly markets, there are barriers to entry of new firms.
Usually, governments have a monopoly in public utility services like postal, air and
road transport, water and power supply services, etc. By granting exclusive
franchises, entries of new supplies are barred. In oligopoly markets, there are
barriers to entry of firms because of collusion, tacit agreements, cartels, etc. On the
other hand, there are no restrictions in entry and exit of firms in monopolistic
competition due to product differentiation.
5. Economies of Scale:
Firms that achieve large economies of scale in production grow large in comparison
to others in an industry. They tend to weed out the other firms with the result that a
few firms are left to compete with each other. This leads to the emergency of
oligopoly. If only one firm attains economies of scale to such a large extent that it is
able to meet the entire market demand, there is monopoly.
4.4 Forms of Market Structure:
On the basis of competition, a market can be classified in the following
ways:
1. Perfect Competition
2. Monopoly
3. Duopoly
4. Oligopoly
5. Monopolistic Competition
1. Perfect Competition Market:
A perfectly competitive market is one in which the number of buyers and sellers is
very large, all engaged in buying and selling a homogeneous product without any
artificial restrictions and possessing perfect knowledge of market at a time. In the
words of A. Koutsoyiannis, “Perfect competition is a market structure characterised
by a complete absence of rivalry among the individual firms.” According to R.G.
Lipsey, “Perfect competition is a market structure in which all firms in an industry
are price- takers and in which there is freedom of entry into, and exit from, industry.”

Characteristics of Perfect Competition:

The following are the conditions for the existence of perfect competition:

(1) Large Number of Buyers and Sellers:

The first condition is that the number of buyers and sellers must be so large that
none of them individually is in a position to influence the price and output of the
industry as a whole. The demand of individual buyer relative to the total demand is
so small that he cannot influence the price of the product by his individual action.
Similarly, the supply of an individual seller is so small a fraction of the total output
that he cannot influence the price of the product by his action alone. In other words,
the individual seller is unable to influence the price of the product by increasing or
decreasing its supply.
Rather, he adjusts his supply to the price of the product. He is “output adjuster”.
Thus no buyer or seller can alter the price by his individual action. He has to accept
the price for the product as fixed for the whole industry. He is a “price taker”.
(2) Freedom of Entry or Exit of Firms:
The next condition is that the firms should be free to enter or leave the industry. It
implies that whenever the industry is earning excess profits, attracted by these
profits some new firms enter the industry. In case of loss being sustained by the
industry, some firms leave it.

(3) Homogeneous Product:

Each firm produces and sells a homogeneous product so that no buyer has any
preference for the product of any individual seller over others. This is only possible if
units of the same product produced by different sellers are perfect substitutes. In
other words, the cross elasticity of the products of sellers is infinite.

No seller has an independent price policy. Commodities like salt, wheat, cotton and
coal are homogeneous in nature. He cannot raise the price of his product. If he does
so, his customers would leave him and buy the product from other sellers at the
ruling lower price.

The above two conditions between themselves make the average revenue curve of the
individual seller or firm perfectly elastic, horizontal to the X-axis. It means that a
firm can sell more or less at the ruling market price but cannot influence the price as
the product is homogeneous and the number of sellers very large.

(4) Absence of Artificial Restrictions:

The next condition is that there is complete openness in buying and selling of goods.
Sellers are free to sell their goods to any buyers and the buyers are free to buy from
any sellers. In other words, there is no discrimination on the part of buyers or sellers.
Moreover, prices are liable to change freely in response to demand-supply
conditions. There are no efforts on the part of the producers, the government and
other agencies to control the supply, demand or price of the products. The movement
of prices is unfettered.

(5) Profit Maximisation Goal:

Every firm has only one goal of maximising its profits.

(6) Perfect Mobility of Goods and Factors:

Another requirement of perfect competition is the perfect mobility of goods and

factors between industries. Goods are free to move to those places where they can
fetch the highest price. Factors can also move from a low-paid to a high-paid
industry.

(7) Perfect Knowledge of Market Conditions:

This condition implies a close contact between buyers and sellers. Buyers and sellers
possess complete knowledge about the prices at which goods are being bought and
sold, and of the prices at which others are prepared to buy and sell. They have also
perfect knowledge of the place where the transactions are being carried on. Such
perfect knowledge of market conditions forces the sellers to sell their product at the
prevailing market price and the buyers to buy at that price.

(8) Absence of Transport Costs:

Another condition is that there are no transport costs in carrying of product from one
place to another. This condition is essential for the existence of perfect competition
which requires that a commodity must have the same price everywhere at any time.
If transport costs are added to the price of the product, even a homogeneous
commodity will have different prices depending upon transport costs from the place
of supply.

(9) Absence of Selling Costs:

Under perfect competition, the costs of advertising, sales-promotion, etc. do not arise
because all firms produce a homogeneous product.
Perfect Competition vs Pure Competition:
Perfect competition is often distinguished from pure competition, but they differ only
in degree. The first five conditions relate to pure competition while the remaining
four conditions are also required for the existence of perfect competition. According
to Chamberlin, pure competition means, competition unalloyed with monopoly
elements,” whereas perfect competition involves perfection in many other respects
than in the absence of monopoly.” The practical importance of perfect competition is
not much in the present times for few markets are perfectly competitive except those
for staple food products and raw materials. That is why, Chamberlin says that perfect
competition is a rare phenomenon.”
Though the real world does not fulfil the conditions of perfect competition, yet
perfect competition is studied for the simple reason that it helps us in understanding
the working of an economy, where competitive behaviour leads to the best allocation
of resources and the most efficient organisation of production. A hypothetical model
of a perfectly competitive industry provides the basis for appraising the actual
working of economic institutions and organisations in any economy.
3. Duopoly:
Duopoly is a special case of the theory of oligopoly in which there are only two
sellers. Both the sellers are completely independent and no agreement exists between
them. Even though they are independent, a change in the price and output of one will
affect the other, and may set a chain of reactions. A seller may, however, assume that
his rival is unaffected by what he does, in that case he takes only his own direct
influence on the price.
If, on the other hand, each seller takes into account the effect of his policy on that of
his rival and the reaction of the rival on himself again, then he considers both the
direct and the indirect influences upon the price. Moreover, a rival seller’s policy may
remain unaltered either to the amount offered for sale or to the price at which he
offers his product. Thus the duopoly problem can be considered as either ignoring
mutual dependence or recognising it.
4. Oligopoly:
Oligopoly is a market situation in which there are a few firms selling homogeneous or
differentiated products. It is difficult to pinpoint the number of firms in ‘competition
among the few.’ With only a few firms in the market, the action of one firm is likely to
affect the others. An oligopoly industry produces either a homogeneous product or
heterogeneous products.
The former is called pure or perfect oligopoly and the latter is called imperfect or
differentiated oligopoly. Pure oligopoly is found primarily among producers of such
industrial products as aluminium, cement, copper, steel, zinc, etc. Imperfect
oligopoly is found among producers of such consumer goods as automobiles,
cigarettes, soaps and detergents, TVs, rubber tyres, refrigerators, typewriters, etc.

Characteristics of Oligopoly:
In addition to fewness of sellers, most oligopolistic industries have
several common characteristics which are explained below:

(1) Interdependence:
There is recognised interdependence among the sellers in the oligopolistic market.
Each oligopolist firm knows that changes in its price, advertising, product
characteristics, etc. may lead to counter-moves by rivals. When the sellers are a few,
each produces a considerable fraction of the total output of the industry and can have
a noticeable effect on market conditions.
He can reduce or increase the price for the whole oligopolist market by selling more
quantity or less and affect the profits of the other sellers. It implies that each seller is
aware of the price-moves of the other sellers and their impact on his profit and of the
influence of his price-move on the actions of rivals.
Thus there is complete interdependence among the sellers with regard to their price-
output policies. Each seller has direct and ascertainable influences upon every other
seller in the industry. Thus, every move by one seller leads to counter-moves by the
others.
(2) Advertisement:
The main reason for this mutual interdependence in decision making is that one
producer’s fortunes are dependent on the policies and fortunes of the other
producers in the industry. It is for this reason that oligopolist firms spend much on
advertisement and customer services.
As pointed out by Prof. Baumol, “Under oligopoly advertising can become a life-and-
death matter.” For example, if all oligopolists continue to spend a lot on advertising
their products and one seller does not match up with them he will find his customers
gradually going in for his rival’s product. If, on the other hand, one oligopolist
advertises his product, others have to follow him to keep up their sales.
(3) Competition:
This leads to another feature of the oligopolistic market, the presence of competition.
Since under oligopoly, there are a few sellers, a move by one seller immediately
affects the rivals. So each seller is always on the alert and keeps a close watch over
the moves of its rivals in order to have a counter-move. This is true competition.
(4) Barriers to Entry of Firms:
As there is keen competition in an oligopolistic industry, there are no barriers to
entry into or exit from it. However, in the long run, there are some types of barriers
to entry which tend to restraint new firms from entering the industry.
They may be:
(a) Economies of scale enjoyed by a few large firms; (b) control over essential and
specialised inputs; (c) high capital requirements due to plant costs, advertising costs,
etc. (d) exclusive patents and licenses; and (e) the existence of unused capacity which
makes the industry unattractive. When entry is restricted or blocked by such natural
and artificial barriers, the oligopolistic industry can earn long-run super normal
profits.
(5) Lack of Uniformity:
Another feature of oligopoly market is the lack of uniformity in the size of firms.
Finns differ considerably in size. Some may be small, others very large. Such a
situation is asymmetrical. This is very common in the American economy. A
symmetrical situation with firms of a uniform size is rare.
(6) Demand Curve:
It is not easy to trace the demand curve for the product of an oligopolist. Since under
oligopoly the exact behaviour pattern of a producer cannot be ascertained with
certainty, his demand curve cannot be drawn accurately, and with definiteness. How
does an individual seller s demand curve look like in oligopoly is most uncertain
because a seller’s price or output moves lead to unpredictable reactions on price-
output policies of his rivals, which may have further repercussions on his price and
output.
The chain of action reaction as a result of an initial change in price or output, is all a
guess-work. Thus a complex system of crossed conjectures emerges as a result of the
interdependence among the rival oligopolists which is the main cause of the
indeterminateness of the demand curve.
If the oligopolist seller does not have a definite demand curve for his product, then
how does he affect his sales. Presumably, his sales depend upon his current price and
those of his rivals. However, a number of conjectural demand curves can be
imagined.
For example, in differentiated oligopoly where each seller fixes a separate price for
his product, a reduction in price by one seller may lead to an equivalent, more, less or
no price reduction by rival sellers. In each case, a demand curve can be drawn by the
seller within the range of competitive and monopoly demand curves.
Leaving aside retaliatory price movements, the individual seller’s demand curve
under oligopoly for both price cuts and increases is neither more elastic than under
perfect or monopolistic competition nor less elastic than under monopoly. It may still
be indefinite and indeterminate.
This situation is shown in Figure 1 where KD1 is the elastic demand curve and MD is
the less elastic demand curve. The oligopolies’ demand curve is the dotted kinked
KPD. The reason is quite simple. If a seller reduces the price of his product, his rivals
also lower the prices of their products so that he is not able to increase his sales.

Price and Output Determination under Oligopoly

Price and Output Determination under Oligopoly!
A diversity of specific market situations works against the development of a single,
generalized explanation of how an oligopoly determines price and output.
Pure monopoly, monopolistic competition and perfect competition, all refer to rather
clear cut market arrangements; oligopoly docs not.
It consists of the ‘tight’ oligopoly situation in which two or three firms dominate the
entire market and the ‘loose’ oligopoly situation where six or seven firms occupy the
maximum share of the market.
Other firms share the balance. It includes both differentiation and standardization. It
encompasses the cases in which firms are acting in collusion and in which they are
acting independently. Therefore, the existence of various forms of oligopoly prevents
the development of a general theory of price and output. The element of mutual
interdependence in oligopolistic market further complicates the determination of
price and output.

In-spite of these difficulties, two interrelated characteristics of

oligopolistic pricing stand out:
1. Oligopolistic prices tend to be inflexible or Sticky Price change less frequently in
Oligopoly than they happen under other competitions like perfect, competition,
monopoly and monopolistic competition.
2. When oligopolistic prices change, firms are likely to change their prices together
they act in collusion in setting and changing prices.
Keeping these facts in mind, the price and output determination under
oligopoly is in the following situations:
1. Price Determination in Non-Collusive Oligopoly:
In this case, each firm follows an independent price and output policy on the basis of
its judgment about the reactions of his rivals. If the firms are producing
homogeneous products, price war may occur. Each firm has to fix the price at the
competitive level. On the contrary, in case of differentiated oligopoly, due to product
differentiation, each firm has some monopoly control over the market and therefore
charge near monopoly price.
Thus the actual price may fall between the two limits:
(i) The Upper Limit of Monopoly Price and,
(ii) The Linear limit of Competitive Price.
Practically, there is every possibility to determine the exact price within
these limits. However there may be the following possibilities:
(i) There may be complete price instability in the market which results in price war.
(ii) The price may settle down at intermediate level due to the working of the market
forces.
(iii) The firm may accept the prevailing price and adjust itself according to prevailing
price.
So long as the firm earns adequate profits at the prevailing price, it may not try to
change it. Any effort to change it may create uncertainties in the market. A firm will
stick to that price to avoid uncertainties. Thus the price tends to be rigid where
oligopolist takes independent action.
B. Equilibrium under Collusion:
The modern economists are of the view that independent price determination cannot
exist for long in oligopoly. It leads to uncertainty and insecurity and to overcome
them there is a tendency among oligopolists to act collectively by tacit collusion. In
addition, the firms can gain the economics of production. All the firms in oligopoly
tend to enlarge their size and lower their costs of production per unit and capture
maximum share of the market.
Collusive oligopoly is a situation in which firms in a particular industry decide to join
together as a single unit for the purpose of maximising their joint profits and to
negotiate among themselves so as to share the market.
The former is known as:
(i) The joint profit maximisation cartel and
(ii) The latter as the market-sharing cartel. There is another type of collusion, known
as leadership, which is based on tacit agreements.
Under it, one firm acts as the price leader and fixes the price for the product while
other firms follow it. Price leadership is of three types: low-cost firm, dominant firm,
and barometric.

4.2 determination of price under perfect competition and equilibrium in the

short run and the long run:

Price and Output Determination under Perfect Competition

Perfect competition refers to a market situation where there are a large number of
buyers and sellers dealing in homogenous products.

Moreover, under perfect competition, there are no legal, social, or technological

barriers on the entry or exit of organizations.

In perfect competition, sellers and buyers are fully aware about the current market
price of a product. Therefore, none of them sell or buy at a higher rate. As a result,
the same price prevails in the market under perfect competition.

Under perfect competition, the buyers and sellers cannot influence the market price
by increasing or decreasing their purchases or output, respectively. The market price
of products in perfect competition is determined by the industry. This implies that in
perfect competition, the market price of products is determined by taking into
account two market forces, namely market demand and market supply.
In the words of Marshall, “Both the elements of demand and supply are required for
the determination of price of a commodity in the same manner as both the blades of
scissors are required to cut a cloth.” As discussed in the previous chapters, market
demand is defined as a sum of the quantity demanded by each individual
organizations in the industry.

On the other hand, market supply refers to the sum of the quantity supplied by
individual organizations in the industry. In perfect competition, the price of a
product is determined at a point at which the demand and supply curve intersect
each other. This point is known as equilibrium point as well as the price is known as
equilibrium price. In addition, at this point, the quantity demanded and supplied is
called equilibrium quantity. Let us discuss price determination under perfect
competition in the next sections.

Demand under Perfect Competition:

Demand refers to the quantity of a product that consumers are willing to purchase at
a particular price, while other factors remain constant. A consumer demands more
quantity at lower price and less quantity at higher price. Therefore, the demand
varies at different prices.

Figure-1 represents the demand curve under perfect competition:

As shown in Figure-1, when price is OP, the quantity demanded is OQ. On the other
hand, when price increases to OP1, the quantity demanded reduces to OQ1.
Therefore, under perfect competition, the demand curve (DD’) slopes downward.

Supply under Perfect Competition:

Supply refers to quantity of a product that producers are willing to supply at a
particular price. Generally, the supply of a product increases at high price and
decreases at low price.

Figure-2 shows the supply curve under perfect competition:

In Figure-2, the quantity supplied is OQ at price OP. When price increases to OP1,
the quantity supplied increases to OQ1. This is because the producers are able to earn
large profits by supplying products at higher price. Therefore, under perfect
competition, the supply curves (SS’) slopes upward.

Equilibrium under Perfect Competition:

As discussed earlier, in perfect competition, the price of a product is determined at a
point at which the demand and supply curve intersect each other. This point is
known as equilibrium point. At this point, the quantity demanded and supplied is
called equilibrium quantity.

Figure-3 shows the equilibrium under perfect competition:

In Figure-3, it can be seen that at price OP1, supply is more than the demand.
Therefore, prices will fall down to OP. Similarly, at price OP2, demand is more than
the supply. Similarly, in such a case, the prices will rise to OP. Thus, E is the
equilibrium at which equilibrium price is OP and equilibrium quantity is OQ.

4.3 Monopoly - features, equilibrium condition, Price discrimination:

2. Monopoly Market:
Monopoly is a market situation in which there is only one seller of a product with
barriers to entry of others. The product has no close substitutes. The cross elasticity
of demand with every other product is very low. This means that no other firms
produce a similar product. According to D. Salvatore, “Monopoly is the form of
market organisation in which there is a single firm selling a commodity for which
there are no close substitutes.” Thus the monopoly firm is itself an industry and the
monopolist faces the industry demand curve.
The demand curve for his product is, therefore, relatively stable and slopes
downward to the right, given the tastes, and incomes of his customers. It means that
more of the product can be sold at a lower price than at a higher price. He is a price-
maker who can set the price to his maximum advantage.

However, it does not mean that he can set both price and output. He can do either of
the two things. His price is determined by his demand curve, once he selects his
output level. Or, once he sets the price for his product, his output is determined by
what consumers will take at that price. In any situation, the ultimate aim of the
monopolist is to have maximum profits.

Characteristics of Monopoly:
The main features of monopoly are as follows:

1. Under monopoly, there is one producer or seller of a particular product and there
is no difference between a firm and an industry. Under monopoly a firm itself is an
industry.

2. A monopoly may be individual proprietorship or partnership or joint stock

company or a cooperative society or a government company.

3. A monopolist has full control on the supply of a product. Hence, the elasticity of
demand for a monopolist’s product is zero.

4. There is no close substitute of a monopolist’s product in the market. Hence, under

monopoly, the cross elasticity of demand for a monopoly product with some other
good is very low.

5. There are restrictions on the entry of other firms in the area of monopoly product.

6. A monopolist can influence the price of a product. He is a price-maker, not a price-

taker.

7. Pure monopoly is not found in the real world.

8. Monopolist cannot determine both the price and quantity of a product
simultaneously.

9. Monopolist’s demand curve slopes downwards to the right. That is why, a

monopolist can increase his sales only by decreasing the price of his product and
thereby maximise his profit. The marginal revenue curve of a monopolist is below the
average revenue curve and it falls faster than the average revenue curve. This is
because a monopolist has to cut down the price of his product to sell an additional
unit.

Price and Output Determination under Monopoly

Monopoly refers to a market structure in which there is a single producer or seller
that has a control on the entire market.

This single seller deals in the products that have no close substitutes and has a direct
demand, supply, and prices of a product.

Therefore, in monopoly, there is no distinction between an one organization

constitutes the whole industry.

Demand and Revenue under Monopoly:

In monopoly, there is only one producer of a product, who influences the price of the
product by making Change m supply. The producer under monopoly is called
monopolist. If the monopolist wants to sell more, he/she can reduce the price of a
product. On the other hand, if he/she is willing to sell less, he/she can increase the
price.

As we know, there is no difference between organization and industry under

monopoly. Accordingly, the demand curve of the organization constitutes the
demand curve of the entire industry. The demand curve of the monopolist is Average
Revenue (AR), which slopes downward.

Figure-9 shows the AR curve of the monopolist:

In Figure-9, it can be seen that more quantity (OQ2) can only be sold at lower price
(OP2). Under monopoly, the slope of AR curve is downward, which implies that if the
high prices are set by the monopolist, the demand will fall. In addition, in monopoly,
AR curve and Marginal Revenue (MR) curve are different from each other. However,
both of them slope downward.

The negative AR and MR curve depicts the following facts:

i. When MR is greater than AR, the AR rises

ii. When MR is equal to AR, then AR remains constant

iii. When MR is lesser than AR, then AR falls

Here, AR is the price of a product, As we know, AR falls under monopoly; thus, MR is

less than AR.

Figure-10 shows AR and MR curves under monopoly:

In figure-10, MR curve is shown below the AR curve because AR falls.

Table-1 shows the numerical calculation of AR and MR under monopoly:

As shown in Table-1, AR is equal to price. MR is less than AR and falls twice the rate
than AR. For instance, when two units of
Output are sold, MR falls by Rs. 2, whereas AR falls by Re. 1.
 Monopoly Equilibrium:
Single organization constitutes the whole industry in monopoly. Thus, there is no
need for separate analysis of equilibrium of organization and industry in case of
monopoly. The main aim of monopolist is to earn maximum profit as of a producer
in perfect competition.
Unlike perfect competition, the equilibrium, under monopoly, is attained at the point
where profit is maximum that is where MR=MC. Therefore, the monopolist will go
on producing additional units of output as long as MR is greater than MC, to earn
maximum profit.
Let us learn monopoly equilibrium through Figure-11:

In Figure-11, if output is increased beyond OQ, MR will be less than MC. Thus, if
additional units are produced, the organization will incur loss. At equilibrium point,
total profits earned are equal to shaded area ABEC. E is the equilibrium point at
which MR=MC with quantity as OQ.

It should be noted that under monopoly, price forms the following

relation with the MC:

Price = AR
MR= AR [(e-1)/e]
e = Price elasticity of demand
As in equilibrium MR=MC
MC = AR [(e-1)/e]
Exhibit-2:
Determining Price and Output under Monopoly:
Suppose demand function for monopoly is Q = 200-0.4Q
Price function is P= 1000-10Q
Cost function is TC= 100 + 40Q + Q2
Maximum profit is achieved where MR=MC
To find MR, TR is derived.
TR= (1000-10Q) Q = 1000Q-10Q2
MR = ∆TR/∆Q= 1000 – 20Q
MC = ∆TC/∆Q = 40 + 2Q
MR = MC
1000 – 20Q = 40 + 2Q
Q = 43.63 (44 approx.) = Profit Maximizing Output
Profit maximizing price = 1000 – 20*44 = 120
Total maximum profit= TR-TC= (1000Q – 10Q2) – (100+ 40Q+Q2)
At Q = 44
Total maximum profit = Rs. 20844

Monopoly Equilibrium in Case of Zero Marginal Cost:

In certain situations, it may happen that MC is zero, which implies that the cost of
production is zero. For example, cost of production of spring water is zero. However,
the monopolist will set its price to earn profit.

Figure-12 shows the monopoly equilibrium when MC is zero:

In Figure-12, AR is the average revenue curve and MR is the marginal revenue curve.
In such a case, the total cost is zero; therefore, AR and MR are also zero. As shown in
Figure-12, equilibrium position is achieved at the point where MR equals zero that is
at output OQ and price P.We can see that point M is the mid-point of AR curve,
where elasticity of demand is unity. Therefore, when MC = 0, the equilibrium of the
monopolist is established at the output (OQ) where elasticity of demand is unity.
Short-Run and Long-Run View under Monopoly:
Till now, we have discussed monopoly equilibrium without taking into consideration
the short-run and long- run period. This is because there is not so much difference
under short run and long run analysis in monopoly.
In the short run, the monopolist should make sure that the price should not go below
Average Variable Cost (AVC). The equilibrium under monopoly in long-run is same
as in short-run. However, in long-run, the monopolist can expand the size of its
plants according to demand. The adjustment is done to make MR equal to the long
run MC.
In the long-run, under perfect competition, the equilibrium position is attained by
entry or exit of the organizations. In monopoly, the entry of new organizations is
restricted.
The monopolist may hold some patents or copyright that limits the entry of other
players in the market. When a monopolist incurs losses, he/she may exit the
business. On the other hand, if profits are earned, then he/she may increase the plant
size to gain more profit.
4.4. Monopolistic Competition: Features, Pricing Under monopolistic
competition :

Definition: Monopolistic competition is a market structure which

combines elements of monopoly and competitive markets. Essentially a
monopolistic competitive market is one with freedom of entry and exit,
but firms can differentiate their products. Therefore, they have an inelastic
demand curve and so they can set prices. However, because there is
freedom of entry, supernormal profits will encourage more firms to enter
the market leading to normal profits in the long term.
A monopolistic competitive industry has the following features:

 Many firms.
 Freedom of entry and exit.
 Firms produce differentiated products.
 Firms have price inelastic demand; they are price makers
because the good is highly differentiated
 Firms make normal profits in the long run but could make
supernormal profits in the short term
 Firms are allocatively and productively inefficient.

Diagram monopolistic competition short run

In the short run, the diagram for monopolistic competition is the same as
for a monopoly.
The firm maximises profit where MR=MC. This is at output Q1 and price P1,
leading to supernormal profit

Monopolistic competition long run

Demand curve shifts to the left due to new firms entering the market.

In the long-run, supernormal profit encourages new firms to enter. This

reduces demand for existing firms and leads to normal profit. I

Efficiency of firms in monopolistic competition

 Allocative inefficient. The above diagrams show a price set

above marginal cost
 Productive inefficiency. The above diagram shows a firm not
producing on the lowest point of AC curve
 Dynamic efficiency. This is possible as firms have profit to
invest in research and development.
 X-efficiency. This is possible as the firm does face competitive
pressures to cut cost and provide better products.
Examples of monopolistic competition
 Restaurants – restaurants compete on quality of food as much
as price. Product differentiation is a key element of the
business. There are relatively low barriers to entry in setting
up a new restaurant.
 Hairdressers. A service which will give firms a reputation for
the quality of their hair-cutting.
  Clothing. Designer label clothes are about the brand and
product differentiation
 TV programmes – globalisation has increased the diversity of
tv programmes from networks around the world. Consumers
can choose between domestic channels but also imports from
other countries and new services, such as Netflix.
Limitations of the model of monopolistic competition

 Some firms will be better at brand differentiation and

therefore, in the real world, they will be able to make
supernormal profit.
 New firms will not be seen as a close substitute.
 There is considerable overlap with oligopoly – except the
model of monopolistic competition assumes no barriers to
entry. In the real world, there are likely to be at least some
barriers to entry
 If a firm has strong brand loyalty and product differentiation –
this itself becomes a barrier to entry. A new firm can’t easily
capture the brand loyalty.
 Many industries, we may describe as monopolistically
competitive are very profitable, so the assumption of normal
profits is too simplistic.
Key difference with monopoly
In monopolistic competition there are no barriers to entry. Therefore in
long run, the market will be competitive, with firms making normal profit.

Key difference with perfect competition

In Monopolistic competition, firms do produce differentiated products,
therefore, they are not price takers (perfectly elastic demand). They have
inelastic demand.

New trade theory and monopolistic competition

New trade theory places importance on the model of monopolistic

competition for explaining trends in trade patterns. New trade theory
suggests that a key element of product development is the drive for
product differentiation – creating strong brands and new features for
products. Therefore, specialisation doesn’t need to be based on traditional
theories of comparative advantage, but we can have countries both
importing and exporting the same good. For example, we import Italian
fashion labels and export British fashion labels. To consumers, the
importance is the choice of goods.

4.5 Oligopoly: Features, Kinked demand Curve, Cartels, Price leadership.,

4.6 Game theory-types, static and dynamic games
4.7 Pricing Approaches: Full cost pricing, Product line pricing,
4.8 Pricing Strategies: Price Skimming, Penetration Pricing, Loss leader
pricing, Peak Load pricing.