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MOD - 3
 CONTENTS
Perfect and imperfect competition – monopoly, regulation of monopoly, monopolistic
completion (features and equilibrium of a firm) – oligopoly –
Kinked demand curve – Collusive oligopoly (meaning) – Non-price competition –
Product pricing – Cost plus pricing – Target return pricing – Penetration pricing –
Predatory pricing – Going rate pricing – Price skimming.
Market
Market is a term which is commonly used for a particular place or locality where goods are bought and
sold. According to Prof. Samuelson, “A market is a mechanism by which buyers and sellers interact to
determine the price and quantity of a good or service.” Based on competition, the market structure has been
classified into two broad categories:
1. Perfectly competitive. (Perfect Competition)
2. Imperfectly competitive. (Monopoly, Monopolistic competition and Oligopoly)

Imperfect competition
If any of the features of perfect competition is absent in a market, that market situation is known as
imperfect competition. In other words, imperfect competition refers to any economic market that does not
meet the rigorous assumptions of a hypothetical perfectly competitive market. The important forms of
imperfect competition are monopoly, oligopoly, monopolistic competition etc.
Perfect Competition
• Perfect competition is defined as a market structure in which an individual firm producing homogenous
commodities cannot influence the prevailing market price of the product on its own.
• It is a market structure characterized by complete absence of rivalry among individual firms.

Features of Perfect Competition

1. Very Large Number of Buyers and Sellers---
There are so many buyers and sellers that no
individual buyer or seller can influence the price of
the commodity in the market. The price-taker have
no bargaining power in the market.

The demand curve facing a firm is derived from the market equilibrium. In a perfectly competitive market,
price of the commodity is determined by the intersection of the market demand and supply curves of the
commodity. This occurs at point E where DD = SS.
2. Homogeneous Product --- Firms in the market produce a homogeneous product. Homogeneity of a
product implies that one unit of the product is a perfect substitute for another.
3. Free Entry or Exit of Firms ------ The industry is characterized by freedom of entry and exit of firms. In a
perfectly competitive market, there are no barriers to entry or exit of firms. Entry or exit may take time, but
firms have freedom of movement in and out of an industry.
4. Perfect Knowledge ---- Firms have all the knowledge about the product market and the factor market.
Buyers also have perfect knowledge about the product market.
5. Perfect Mobility of Factors of Production ---- The factors of production can move easily from one firm to
another. Workers can move between jobs and between places.
6. Absence of Transportation ------ Cost All goods are produced locally. Transportation costs are zero
The MC curve must intersect the MR curve from below
and after the intersection lie above the MR curve.
In simpler terms, the firm must keep adding to its output
as long as MR>MC. This is because additional output
adds more revenue than costs and increases its profits.
Further, if MC=MR, but the firm finds that by adding to
its output, MC becomes smaller than MR, then it must
keep increasing its output.

Since it is a perfectly competitive market, the demand for the product of the firm is perfectly elastic.
Further, it can sell all its output at the market price. Therefore, its demand curve runs parallel to the
X-axis throughout its length and its MR curve coincides with the AR curve.
Monopoly
Monopoly is a market in which a single seller sells a product which has no substitutes . E.g. RBI , Rail transport

Features of Monopoly
1. High barriers of entry: Competitors are unable to break into the market due to a single company's control of it.
2. Price maker: The Company that operates the monopoly can determine the price of its product without the risk of
a competitor undercutting its price. A monopoly can raise prices at will.
3. Profit maximizer: a monopoly maximizes profits. Due to the lack of competition a firm can charge a set price
above what would be charged in a competitive market, thereby maximizing its revenue.
4. No Close Substitutes for the commodity. The product sold by monopolist has no close substitute.
5. High barriers to entry: other sellers are unable to enter the market of the monopoly.
6. Single seller: in a monopoly one seller produces all of the output for a good or service.
7. Price discrimination: in a monopoly the firm can change the price and quantity of the good or service. It is the act
of charging different prices for the same product from different consumers.
Demand Curve under Monopoly
The monopolist produces all the output in a particular
market. The monopolist is a ‘price-maker’. It does not mean
that monopolist can fix both price and the quantity demanded.
If he fixes a high price, less commodity will be demanded. The
result is a downward sloping demand curve. The demand curve
is a constraint facing a monopoly firm. Demand curve is also
the price line and the AR curve. Since AR is downward
sloping, MR lies below AR curve and is twice as steep as the
AR curve.
Equilibrium under Monopoly
Under monopoly, for the equilibrium and price determination there are
two different conditions which are:
1. Marginal revenue must be equal to marginal cost.
2. MC must cut MR from below.

SAC and SMC are the short run average cost and marginal cost curves
respectively while AR and MR are the average revenue and marginal revenue curves respectively. The
monopolist is in equilibrium at point E because at point E both the conditions of equilibrium are fulfilled i.e.,
MR = MC and MC intersects the MR curve from below. At this level of equilibrium the monopolist will
produce OQ1 level of output and sells it at CQ1 price which is more than average cost DQ1 by CD per unit.
Therefore, in this case total profits of the monopolist will be equal to shaded area ABDC.
Dumping
• It means a monopolist sells his product at a higher price in the home market and lower price in the

international market.

Regulation of Monopoly
1. Promote competition. In some industries, it is possible to encourage competition, and therefore
there will be less need for government regulation.
2. Quality of service. If a firm has a monopoly over the provision of a particular service, it may have
little incentive to offer a good quality service. Government regulation can ensure the firm meets
minimum standards of service.
3. Prevent excess prices. Without government regulation, monopolies could put prices above the
competitive equilibrium. This would lead to allocative inefficiency and a decline in consumer
welfare.
Monopolistic Competition
Monopolistic competition is a type of imperfect competition such that many producers sell products
that are differentiated from one another. It is a market structure at which large number of sellers dealing
with differentiated commodities. The main feature of monopolistic competition is Product Differentiation
Product Differentiation means commodities marketed by each seller can be distinguished from the products
marketed by other seller in the form of size, shape, brand, color etc..

Features of Monopolistic Competition

Freedom of entry and exit. Firms produce differentiated products.
Firms have price inelastic demand; they are price makers because the good is highly differentiated
Large number of sellers Product Differentiation
Freedom for entry and exit Advertisement and selling cost
Lack of Perfect Knowledge
Price – Output determination under monopolistic competition.

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.
Oligopoly
An oligopoly is a market characterized by a small number of firms who realize they are interdependent in
their pricing and output policies. The number of firms is small enough to give each firm some market power.
It is a market with few sellers dealing with homogenous and differentiated commodities. In oligopoly one
firm’s action will cause its competitors to react. This shows that firms has interdependence under oligopoly.

Features of Oligopoly
1. Few Firms with Large Market Share --- A market may have thousands of sellers, but if the top 5 firms have
a combined market share of over 50 percent, it can be classified as an oligopolistic market. This is because
the power is concentrated between a few sellers who are able to exercise power over the market.
2. High Barriers to Entry --- Oligopolistic firms maintain their position through a number of barriers to entry.
For instance, brand loyalty, patents, and high start-up costs are but to name a few. These make it difficult for
new entrants to build a presence in the market and attract customers.
3. Interdependence --- Any action a firm takes in an oligopolistic market will strongly affect the actions of its
competitors.
4. Nature of the Product --- The firms under oligopoly may produce homogeneous or differentiated product.
5. Indeterminate Demand Curve --- Under oligopoly, the exact behaviour pattern of a producer cannot be
determined with certainty. So, demand curve faced by an oligopolistic is indeterminate (uncertain)

Price – Output determination under oligopoly

The Kinked demand curve model was developed by Paul M Sweezy in 1939. The kinked demand curve
is distinctive of an oligopolistic market. It shows how, at higher and lower prices, the elasticity of demand
changes. As a result, prices remain relatively rigid. As competitors keep their prices stable, the firm that
increases prices will lose customers to cheaper rivals. At the same time, reducing prices won’t increase
demand. This is because price decreases will be met with fierce competition. In an oligopoly, when one firm
reduces its prices, the others follow. In turn, any real gains in demand will be negligible.
Diagram of kinked demand curve
Collusive Oligopoly
Collusive Oligopoly Sometimes, firms may try to remove uncertainty related to acting independently
and enter into price agreements with each other. This is collusion. Collusion is either formal or informal.
It can take the form of cartel or price leadership.
A cartel is an association of independent firms within the same industry which follow the common
policies relating to price, output, sale, profit maximization, and the distribution of products. Price
leadership is based on informed collusion.
Under price leadership, one firm is a large or dominant firm and acts as the price leader who fixes the
price for the products while the other firms allow it. According to Samuelson “Collusion denotes a
situation where two or more firms jointly set their prices or output, divide the market among them, or
make the business decisions”
Non – Price Competition
Non-price competition involves ways that firms seek to increase sales and attract custom through
methods other than price. Non-price competition can include quality of the product, unique selling point,
superior location and after-sales service.

Forms of non-price competition

• Loyalty card – Some big business have invested considerably in loyalty cards which give ‘rewards’ or
money back to customers who build up points/spending.
• Subsidized delivery - Amazon has been successful at pushing Prime Delivery accounts. This promises
free next day delivery. Amazon is offering this delivery service as a loss leader. The cost of delivery is
often higher than what a customer is actually paying.
• Advertising/brand loyalty - Firms spend billions on advertising because repeated exposure to famous
brands can make consumers more likely to buy ‘trusted’ brands.

• After-sales service –
For some goods, like TVs and car, offering free after-sales service can be a factor in encouraging
customer trust. It can also be a profitable aspect of the business.
For example, Apple Care offers a three-year warranty, but it is priced at a good margin.

• Coupons and free gifts- Some sellers provide coupons and free gifts along with product.
Product Pricing
By product pricing presents an opportunity to set the right price for the by products of the main core
product so as to earn incremental revenue. It is very important to set the right price for the by product so that
it can be sold.

Mark-up Pricing
Markup pricing or cost-plus pricing is a pricing strategy where the price of a product or service is
calculated by adding together the cost of the products and a percentage of it as a markup. The percentage or
markup is decided by the company usually fixed at the required rate of return.

Price = Cost (AC) + m (Margin)

Going rate pricing

It is when a business sets the price of its product or service based on the market price. The Going-Rate
Pricing is a method adopted by the firms wherein the product is priced as per the rates prevailing in the
market especially on par with the competitors.
Target Return Pricing
It is a pricing method in which a formula is used to calculate the price to be set for a product to return
a desired profit or rate of return on investment assuming that a particular quantity of the product is sold.

Penetration Pricing
Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or
service by offering a lower price during its initial offering. The lower price helps a new product or service
penetrate the market and attract customers away from competitors.
Market penetration pricing relies on the strategy of using low prices initially to make a wide number of
customers aware of a new product.
The goal of a price penetration strategy is to entice customers to try a new product and build market share
with the hope of keeping the new customers once prices rise back to normal levels.
Predatory pricing
It is a method of pricing in which a seller sets a price so low that other suppliers cannot compete and are
forced to exit the market. Predatory pricing involves charging very low prices, the aim being to get rid of
competitors so that the supplier can charge considerably higher prices later. The predator is willing to sell at a
loss – below cost – for a period, in the hope that its rivals either go bust or decide stop selling that product.
When competing companies have left the market, the predator pushes prices back up.

Price skimming
Price skimming is a product pricing strategy by which a firm charges the highest initial price that
customers will pay and then lowers it over time. As the demand of the first customers is satisfied and
competition enters the market, the firm lowers the price to attract another, more pricesensitive segment of the
population. The skimming strategy gets its name from "skimming" successive layers of cream, or customer
segments, as prices are lowered over time.
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