Managerial

Economics
UM15MB501
Unit 5 : Market Structures
Dr. Sangeeta Meholia
Christ university

(All the contents in this PPT are sourced from various webpages)
(Copyrights of the content belongs to the respective authors)
Lecture 32
• Market structure and pricing practices: Perfect Competition,
Features, Determination of price under perfect competition under
market period

2
Market Structure
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.

Structures are classified in term of the presence or absence of competition.  When competition is absent, the
market is said to be concentrated. There is a spectrum, from perfect competition to pure monopoly.

There are several market structures in which firms can operate. The type of structure influences the firm’s
behaviour, whether it is efficient, and the level of profits it can generate. Neo-classical theory of the firm
distinguishes a number of market structures, each with its own characteristics and assumptions. The structure
of a market refers to the number of firms in the market, their market shares, and other features which affect the
level of competition in the market. Market structures are distinguished mainly by the level of competition that
exists between the firms operating in the market.
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Types of Market Structure
• Perfect Competition – many firms, freedom of entry, homogeneous
product, normal profit.
• Monopoly – One firm dominates the market, barriers to entry, possibly
supernormal profit.
• Monopolistic Competition – Freedom of entry and exit, but firms have
differentiated products. Likelihood of normal profits in the long term.
• Oligopoly – An industry dominated by a few firms, e.g. 5 firm
concentration ratio of > 50%

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Lecture 33
• Determination of price under perfect competition under short-run and
Long -run

5
Perfect Market Structure
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.”

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Characteristics 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”.

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(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.

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(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.

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(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 compe­
tition 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.
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 Equilibrium in perfect competition
In the short run
The single firm takes its price from the industry, and is,
consequently, referred to as a price taker. The industry is
composed of all firms in the industry and the market price
is where market demand is equal to market supply. Each
single firm must charge this price and cannot diverge from
it.

Under perfect competition, firms can make super-normal

profits or losses.

The industry price is determined by the interaction of

Supply and Demand, leading to a price of P. The individual
firm will maximise output where MR = MC at Q

In the long run firms will make normal profits.

If supernormal profits are made new firms will be attracted

into the industry causing prices to fall. If firms are making a
loss then firms will leave the industry causing price to rise.
The features of perfect competition are very rare in the real
world. However perfect competition is as important
economic model to compare other models. It is often argued
that competitive markets have many benefits which stem 11
from this theoretical model.
 Equilibrium in perfect competition
In the Long run
However, in the long run firms are attracted into the
industry if the incumbent firms are making
supernormal profits. This is because there are no
barriers to entry and because there is perfect
knowledge.
The effect of this entry into the industry is to shift
the industry supply curve to the right, which drives
down price until the point where all super-normal
profits are exhausted.  If firms are making losses,
they will leave the market as there are no exit
barriers, and this will shift the industry supply to
the left, which raises price and enables those left in
the market to derive normal profits.
The super-normal profit derived by the firm in the
short run acts as an incentive for new firms to enter
the market, which increases industry supply and
market price falls for all firms until only normal
profit is made.
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 Changes in long Run equilibrium
1. The effect of an increase in demand for the industry.

If there is an increase in demand there will be an increase in price Therefore the Demand curve and hence AR will shift
upwards. This will cause firms to make supernormal profits. This will attract new firms into the market causing price to fall
back to the equilibrium of P

2. An increase in firms costs

The AC curve will increase therefore AR< AC. Firms will now start making a loss and therefore firms will go out of business.
This will cause supply to fall causing prices to increase

Efficiency of perfect competition

1. Firms will be allocatively efficient P=MC

2. Firms will be productively efficient. Lowest point on AC curve

3. Firms have to remain efficient otherwise they will go out of business.

4. Firms are unlikely to be dynamically efficient because they have no profits to invest in research and development.

5. If there are high fixed costs, firms will not benefit from efficiencies of scale 13
Examples of perfect competition
In the real world it is hard to find examples of industries which fit all the criteria of ‘perfect
knowledge’ and ‘perfect information’. However, some industries are close.
• Foreign exchange markets. Here currency is all homogeneous. Also traders will have access to
many different buyers and sellers. There will be good information about relative prices. When
buying currency it is easy to compare prices
• Agricultural markets. In some cases, there are several farmers selling identical products to the
market, and many buyers. At the market, it is easy to compare prices. Therefore, agricultural
markets often get close to perfect competition.
• Internet related industries. The internet has made many markets closer to perfect competition
because the internet has made it very easy to compare prices, quickly and efficiently (perfect
information). Also, the internet has made barriers to entry lower. For example, selling a popular
good on internet through a service like e-bay is close to perfect competition. It is easy to compare
the prices of books and buy from the cheapest. The internet has enable the price of many books
to fall in price, so that firms selling books on internet are only making normal profits.

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Lecture 34
• Monopoly: Features, Pricing under monopoly – Short & Long Run.

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Monopoly
• A pure monopoly is defined as a single seller of a product, i.e. 100% of market share.
• 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.

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Characteristics of Monopoly:
• 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.
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HOW Does a Monopoly come into existence?
• Economic barriers: Economic barriers include economies of scale, capital requirements, cost advantages and
technological superiority.

• Economies of scale: Monopolies are characterised by decreasing costs for a relatively large range of production.
Decreasing costs coupled with large initial costs give monopolies an advantage over would-be competitors. Monopolies
are often in a position to reduce prices below a new entrant's operating costs and thereby prevent them from continuing
to compete. Furthermore, the size of the industry relative to the minimum efficient scale may limit the number of
companies that can effectively compete within the industry. Capital requirements: Production processes that require
large investments of capital, or large research and development costs or substantial sunk costs limit the number of
companies in an industry. Large fixed costs also make it difficult for a small company to enter an industry and expand.

• Technological superiority: A monopoly may be better able to acquire, integrate and use the best possible technology in
producing its goods while entrants do not have the size or finances to use the best available technology. [9] One large
company can sometimes produce goods cheaper than several small companies.

• No substitute goods: A monopoly sells a good for which there is no close substitute. The absence of substitutes makes
the demand for the good relatively inelastic enabling monopolies to extract positive profits.

• Control of natural resources: A prime source of monopoly power is the control of resources that are critical to the
production of a final good.

• Legal barriers: Legal rights can provide opportunity to monopolise the market of a good. Intellectual property rights,
including patents and copyrights, give a monopolist exclusive control of the production and selling of certain goods.
Property rights may give a company exclusive control of the materials necessary to produce a good.

• Deliberate actions: A company wanting to monopolise a market may engage in various types of deliberate action to
exclude competitors or eliminate competition. Such actions include collusion, lobbying governmental authorities, and
force 18
Monopoly Pricing under Short run
• 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. In addition, in monopoly, AR curve and Marginal Revenue (MR) curve are different
from each other. However, both of them slope downward.
• 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.
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Contd…

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.

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.

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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

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Monopoly Pricing under Long run

In the Long run, the monopoly further consolidates

his position by investing further in R&D, using
mass production techniques and lowering his Cost
of production. By increasing his scale of production
his short term cost curves shift downwards from
SAC1 to SAC2. Thus giving him further scope to
increase his profit maximizing output level, and also
reducing the price from OJ to OL.

Thus the super normal profits can be increased from

JKTP1 to SMLP2

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Lecture 35
• Price Discrimination – First, Second and Third Degree

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Price Discrimination in Monopoly
Price discrimination is the practice of charging a different price for the same good or service.
There are three types of price discrimination – first-degree, second-degree, and third-degree
price discrimination.
In monopoly, there is a single seller of a product called monopolist. The monopolist has
control over pricing, demand, and supply decisions, thus, sets prices in a way, so that
maximum profit can be earned.
The monopolist often charges different prices from different consumers for the same product.
This practice of charging different prices for identical product is called price discrimination.
According to Robinson, “Price discrimination is charging different prices for the same product
or same price for the differentiated product.”
According to Stigler, “Price discrimination is the sale of various products at prices which are
not proportional to their marginal costs.”

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Necessary Conditions for Price Discrimination
It is possible under the following conditions:
1. Existence of Monopoly: Implies that a supplier can discriminate prices only when there is monopoly.
The degree of the price discrimination depends upon the degree of monopoly in the market.
2. Separate Market: Implies that there must be two or more markets that can be easily separated for
discriminating prices. The buyer of one market cannot move to another market and goods sold in one
market cannot be resold in another market.
3. No Contact between Buyers: Refers to one of the most important conditions for price discrimination.
A supplier can discriminate prices if there is no contact between buyers of different markets. If buyers
in one market come to know that prices charged in another market are lower, they will prefer to buy it
in other market and sell in own market. The monopolists should be able to separate markets and avoid
reselling in these markets.
4. Different Elasticity of Demand: Implies that the elasticity of demand in the markets should differ
from each other. In markets with high elasticity of demand, low price will be charged, whereas in
markets with low elasticity of demand, high prices will be charged. Price discrimination fails in case of
markets having same elasticity- of demand.

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Types of Price Discrimination
Three degrees of price discrimination are

i. First-degree Price Discrimination: Refers to a price discrimination in which a monopolist charges

the maximum price that each buyer is willing to pay. This is also known as perfect price discrimination
as it involves maximum exploitation of consumers. In this, consumers fail to enjoy any consumer
surplus. First degree is practiced by lawyers and doctors.

ii. Second-degree Price Discrimination: Refers to a price discrimination in which buyers are divided
into different groups and different prices are charged from these groups depending upon what they are
willing to pay. Railways and airlines practice this type of price discrimination.

iii. Third-degree Price Discrimination: Refers to a price discrimination in which the monopolist
divides the entire market into submarkets and different prices are charged in each submarket.
Therefore, third-degree price discrimination is also termed as market segmentation. In this type of
price discrimination, the monopolist is required to segment market in a manner, so that products sold
in one market cannot be resold in another market. Moreover, he/she should identify the price elasticity
of demand of different submarkets. The groups are divided according to age, sex, and location. For
instance, railways charge lower fares from senior citizens. Students get discount in cinemas, museums,
and historical monuments.
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 First degree Price Discrimination
First Degree discrimination, alternatively known
as perfect price discrimination, occurs when a firm
charges a different price for every unit consumed.
The firm is able to charge the maximum possible
price for each unit which enables the firm
to capture all available consumer surplus for itself.
In practice, first-degree discrimination is rare.
Consumer surplus is derived whenever the price a
consumer actually pays is less than they are
prepared to pay. A demand curve indicates what
price consumers are prepared to pay for a
hypothetical quantity of a good, based on their
expectation of private benefit.

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Second degree Price Discrimination
Second-degree price discrimination means charging a different price for
different quantities, such as quantity discounts for bulk purchases. Refers
to a price discrimination in which buyers are divided into different groups
and different prices are charged from these groups depending upon what
they are willing to pay. Railways and airlines practice this type of price
discrimination.
Some differentiation happens in terms of service provided to them..

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Third degree Price Discrimination
• Third-degree price discrimination means charging a different price to
different consumer groups. For example, rail can be subdivided into
commuter and casual travellers, and cinema goers can be subdivide into
adults and children. Splitting the market into peak and off peak use is
very common and occurs with gas, electricity, and telephone supply, as
well as gym membership and parking charges. Third-degree
discrimination is the commonest type.
• Different consumer groups must have elasticities of demand. E.g.
students with low income will be more price elastic.

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Advantages of Price Discrimination
1. Firms will be able to increase revenue. This will enable some firms to stay in
business who otherwise would have made a loss. For example price discrimination
is important for train companies who offer different prices for peak and off peak.
2. Increased revenues can be used for research and development which benefit
consumers
3. Some consumers will benefit from lower fares. E.G. old people benefit from lower
train companies, old people are more likely to be poor.
Disadvantages of Price Discrimination
4. Some consumers will end up paying higher prices. These higher prices are likely to
be allocatively inefficient because P > MC.
5. Decline in consumer surplus.
6. Those who pay higher prices may not be the poorest. E.g. adults could be
unemployed, OAPs well off.
7. There may be administration costs in separating the markets.
8. Profits from price discrimination could be used to finance predatory pricing.
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Lecture 36
• Monopolistic Competition: Features, Pricing Under monopolistic
competition

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Monoloplistic Competition
• Monopolistic competition refers to a market situation where there are
many firms selling a differ­entiated product. “There is competition which
is keen, though not perfect, among many firms making very similar
products.” No firm can have any perceptible influence on the price-
output policies of the other sellers nor can it be influenced much by
their actions. Thus monopolistic competition refers to competition
among a large number of sellers producing close but not perfect
substitutes for each other.

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Characteristics of Monopolistic competition
1) Large Number of Sellers:
• In monopolistic competition the number of sellers is large. They are “many and small
enough” but none controls a major portion of the total output. No seller by chang­ing its
price-output policy can have any perceptible effect on the sales of others and in turn be
influenced by them. Thus there is no recognised interdependence of the price-output
policies of the sellers and each seller pursues an independent course of action.
(2) Product Differentiation:
• One of the most important features of the monopolistic competi­tion is differentiation.
Product differentiation implies that products are different in some ways from each other.
They are heterogeneous rather than homogeneous so that each firm has an absolute
monopoly in the production and sale of a differentiated product. There is, however, slight
difference between one product and other in the same category.
• Products are close substitutes with a high cross-elasticity and not perfect substitutes.
Product “differentiation may be based upon certain characteristics of the prod­ucts itself,
such as exclusive patented features; trade-marks; trade names; peculiarities of package or
container, if any; or singularity in quality, design, colour, or style. It may also exist with
respect to the conditions surrounding its sales.”

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(3) Freedom of Entry and Exit of Firms:
• Another feature of monopolistic competition is the freedom of entry and exit of firms. As firms
are of small size and are capable of producing close substitutes, they can leave or enter the
industry or group in the long run.
(4) Nature of Demand Curve:
• Under monopolistic competition no single firm controls more than a small portion of the total
output of a product. No doubt there is an element of differentiation neverthe­less the products
are close substitutes. As a result, a reduction in its price will increase the sales of the firm but it
will have little effect on the price-output conditions of other firms, each will lose only a few of
its customers.
• Likewise, an increase in its price will reduce its demand substantially but each of its rivals will
attract only a few of its customers. Therefore, the demand curve (average revenue curve) of a
firm under monopolistic competition slopes downward to the right. It is elastic but not
perfectly elastic within a relevant range of prices of which he can sell any amount.
(5) Independent Behaviour:
• In monopolistic competition, every firm has independent policy. Since the number of sellers is
large, none controls a major portion of the total output. No seller by changing its price-output
policy can have any perceptible effect on the sales of others and in turn be influenced by them.

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(6) Product Groups:
• There is no any ‘industry’ under monopolistic competition but a ‘group’ of firms
producing similar products. Each firm produces a distinct product and is itself an
industry. Chamberlin lumps together firms producing very closely related
products and calls them product groups, such as cars, cigarettes, etc.
(7) Selling Costs:
• Under monopolistic competition where the product is differentiated, selling
costs are essential to push up the sales. Besides, advertisement, it includes
expenses on salesman, allowances to sellers for window displays, free service,
free sampling, premium coupons and gifts, etc.
(8) Non-price Competition:
• Under monopolistic competition, a firm increases sales and profits of his product
without a cut in the price. The monopolistic competitor can change his product
either by varying its quality, packing, etc. or by changing promotional
programmes.
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36

Monopolistic Price determination in Short run

Under monopolistic competition, the firm will be in equilibrium position when marginal revenue is equal to
marginal cost. So long the marginal revenue is greater than marginal cost, the seller will find it profitable to
expand his output, and if the MR is less than MC, it is obvious he will reduce his output where the MR is equal to
MC. In short run, therefore, the firm will be in equilibrium when it is maximising profits, i.e., when MR = MC.
In the above diagram, the short run average cost is MT and short run average revenue is MP. Since the AR curve is
above the AC curve, therefore, the profit is shown as PT. PT is the supernormal profit per unit of output. Total
supernormal profit will be measured by multiplying the supernormal profit to the total output, i.e. PT × OM or
PTT’P’ as shown in figure (a). The firm may also incur losses in the short run if it is facing AR curve below the AC
curve. In figure (b) MP is less than MT and TP is the loss per unit of output. Total loss will be measured by
multiplying loss per unit of output to the total output, i.e., TP × OM or TPP’T’.
 Monopolistic Price determination in Long run
• Under monopolistic competition, the supernormal
profit in the long run is disappeared as new firms are
entered into the industry. As the new firms are
entered into the industry, the demand curve or AR
curve will shift to the left, and therefore, the
supernormal profit will be competed away and the
firms will be earning normal profits. If in the short
run firms are suffering from losses, then in the long
run some firms will leave the industry so that
remaining firms are earning normal profits.
• The AR curve in the long run will be more elastic,
since a large number of substitutes will be available
in the long run. Therefore, in the long run,
equilibrium is established when firms are earning
only normal profits. Now profits are normal only
when AR = AC. It is further illustrated in the following
diagram: 37
Lecture 37
• Product differentiation. Oligopoly: Features

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Product Differentiation
• product differentiation (or simply differentiation) is the process of
distinguishing a product or service from others, to make it more
attractive to a particular target market. This involves differentiating it
from competitors' products as well as a firm's own products.
• Product differentiation can be achieved in many ways. It may be as
simple as packaging the goods in a creative way, or as elaborate as
incorporating new functional features. Sometimes differentiation does
not involve changing the product at all, but creating a new advertising
campaign or other sales promotions instead.
• This differentiated product image can promote brand loyalty

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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.
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Characteristics of Oligopoly:

(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.

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(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.

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Lecture 38
• Sweezy’s Kinked demand Curve Model

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Sweezy’s Kinked-Demand Model
• Consider a firm in an oligopoly that wants to change its price. How will the other firms react?
There are 2 possibilities: they can either match the price changes or ignore them. But what the
other firms will actually do will probably depend on the direction of the price change. If one firm
raises its price, the others probably will not follow, since that will allow them to take market share
from the price changer. This makes the demand curve more elastic, since as the firm raises its
price, then many of its customers will buy from the other firms, lowering the revenue of the
higher-priced firm.
• If the firm lowers its price, then the other firms would surely follow, to prevent any loss of market
share. This part of the demand curve is much more inelastic, since all of the firms are acting in
concert. This creates a kink in the demand curve, where the change in demand goes from very
elastic at higher prices to inelastic at lower prices. Since the marginal revenue curve depends on
prices, the marginal revenue curve is also kinked. At lower prices, the marginal revenue curve
drops downward creating a gap. The marginal cost curves of both scenarios will intersect the same
quantity being produced by the oligopoly, represented by the vertical line in the graph; therefore,
there is no change in quantity produced as prices are lowered, as long as the change in marginal
cost is within the marginal revenue gap.

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 Continued……

• The kinked-demand curve explains why firms in an oligopoly resist

changes to price. If one of them raises the price, then it will lose
market share to the others. If it lowers its price, then the other firms
will match the lower price, causing all of the firms to earn less profit.

• Critics of the kinked-demand model point out that while the model
explains why oligopolies maintain pricing, it doesn't explain how its
products were initially priced. The other thing it doesn't explain is that
when the economy changes significantly, especially when there is high
inflation, then the firms of an oligopoly do change prices often. In
some cases, oligopolistic firms may engage in a price war, where each
firm charges a successfully lower price to gain market share.
In the Diagram, P1 = Product Price of the Oligopoly. If a firm raises its price (D 1), but the others do not match the
increase, then revenue will decline in spite of the price increase. If the firm lowers its price (D2), then the other firms
will match the decrease to avoid losing market share. Because there is a kink in the demand curve, there is a gap in the
marginal revenue curve (MR1 -MR2). Since firms maximize profit by producing that quantity where marginal cost
equals marginal revenue, the firms will not change the price of their product as long as the marginal cost is
betweenMC1 and MC2, which explains why oligopolistic firms change prices less frequently than firms operating under
other market models.

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Lecture 39
• Cartels – Collusion Model

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 Cartels
• Cartel is an agreement between competing firms to control prices or exclude entry of a new competitor in a
market. It is a formal organization of sellers or buyers that agree to fix selling prices, purchase prices, or
reduce production using a variety of tactics. Cartels usually arise in an oligopolistic industry, where the
number of sellers is small or sales are highly concentrated and the products being traded are
usually commodities. Cartel members may agree on such matters as setting minimum or target prices (price
fixing), reducing total industry output, fixing market shares, allocating customers, allocating territories, bid
rigging, establishment of common sales agencies, altering the conditions of sale, or combination of these.
The aim of such collusion (also called the cartel agreement) is to increase individual members' profits by
reducing competition. If the cartelists do not agree on market shares, they must have a plan to share the
extra monopoly profits generated by the cartel.
• One can distinguish private cartels from public cartels. In the public cartel a government is involved to
enforce the cartel agreement, and the government's sovereignty shields such cartels from legal
actions. Inversely, private cartels are subject to legal liability under the antitrust laws now found in nearly
every nation of the world. Furthermore, the purpose of private cartels is to benefit only those individuals
who constitute it, public cartels, in theory, work to pass on benefits to the populace as a whole.
• Competition laws often forbid private cartels. Identifying and breaking up cartels is an important part of
the competition policy in most countries, although proving the existence of a cartel is rarely easy, as firms
are usually not so careless as to put collusion agreements on paper
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Contd….
• Sometimes firms in an oligopoly try to form a cartel by agreeing to fix prices or to divide the market
among themselves, or to restrict competition some other way. The primary characteristic of the Cartel
Model is collusion among the oligopolistic firms to fix prices or restrict competition so that they can
earn monopoly profits.
• If the dominant firms in an oligopoly can successfully collude to fix prices, then they can be certain of
each other's output, which will allow to maximize their profits by producing that quantity of output
where marginal revenue equals marginal cost, just as it would be for a monopoly. However, if any of the
firms cheat, then a price war may ensue, lowering the profits of all firms, and maybe even causing them
to operate a loss. In most modern economies, collusion is generally against the law, however there are
certain countries that engage in collusion to maximize their profits from their natural resources.
• The best example of a cartel today is the Organization of Petroleum Exporting Countries, otherwise
known as OPEC, which comprises 12 oil-producing nations that supply 60% of all oil traded
internationally. Prices are maintained by restricting each country of the OPEC cartel to a
specific production allocation. The OPEC cartel is largely responsible for the large fluctuations in
gasoline prices that have occurred in the United States since 1973, although recently, speculation in the
commodity markets has also increased volatility.

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49
Lecture 42
• PRESENTATION ON MARKET STRUCTURES WITH RESPECT TO
INDIAN MARKETS – by Students

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