Perfect Competition, Monopoly,

Monopolistic Competition and

Oligopoly
MARKET STRUCTURES
• Perfect competition is a market structure
characterized by complete absence of rivalry
among individual firms
• Perfect competition is defined as a market
structure in which there are large number of
buyers and sellers of homogeneous commodity.
• A good example of perfect competition is the
agriculture market. Otherwise it is ideal situation
which rarely exists in the real world.
Perfectly competitive markets are rare, however
close examples include:
• Foreign currency – homogenous product, each
trader is relatively small in the market and the
trader has to take the given price.
• Fruits and vegetables – homogenous product,
firms are price takers, large number of buyers
and sellers…etc.
 Features of perfect competition
• There is said to be perfect competition in an
industry when certain conditions are satisfied.
• These conditions are divided in two groups:-
• Conditions of pure competition among the
producers
• Conditions of perfect market for the
commodity
 Conditions of Pure Competition
1. Large number of buyers and sellers
2. Homogeneous product
3. Free entry or exit of firms
 Conditions of Perfect Market
The market for a commodity is said to be perfect
if at any given time the commodity sells at
the same price in all parts of the market.
Four conditions of perfect market are:
1. Perfect Knowledge
2. Perfect mobility of factors of production
3. Absence of transportation cost
4. Absence of selling cost
 Price Determination under perfect
competition
• Meaning of Industry: In economics, industry
consists of large number of firm, producing the
homogeneous products. For example, when we
say’ Shoe Industry of India’ then we are dealing
with all firms of India, producing shoes.
• Equilibrium Point: An industry will be in
equilibrium, when
• The Total supply of the industry = The total
demand of the industry
Industry and The Firm
When the firm is a price taker, there is little percentage
difference in prices within the market. But most firms
sell at the prevailing, ruling market price.
Case of supernormal profits
Case of Normal Profit
Case of losses
 Monopoly
• Monopoly is a market structure in which there
is a single firm producing all for output.
• Example: State has the monopoly in providing
water supply ,railways, postal services, etc
• Example: Microsoft, De Beers, etc.
 Features of Monopoly
• A single firm
• No close substitutes-Price Maker
• Barriers to entry
• Perfect knowledge
 Dumping
• "dumping" is a kind of predatory pricing,
especially in the context of international
trade. It occurs when manufacturers export a
product to another country at a price either
below the price charged in its home market,
or in quantities that cannot be explained
through normal market competition.
• A standard technical definition of dumping is the
act of charging a lower price for the like goods in
a foreign market than one charges for the same
good in a domestic market for consumption in
the home market of the exporter. This is often
referred to as selling at less than "normal value"
on the same level of trade in the ordinary course
of trade. Under the World Trade
Organization (WTO) Agreement, dumping is
condemned (but is not prohibited) if it causes or
threatens to cause material injury to a domestic
industry in the importing country.
 Monopolistic Competition
• Monopolistic Competition(as given by
Chamberlin) or Imperfect Competition(as
given by Robinson) is defined as a market
structure in which there are many firms selling
closely related but unidentical commodities.
• Examples:
detergents,automobiles,textiles,soft drinks,TV
sets,etc
Features of Monopolistic Competition
• Large number of buyers and sellers
• Product differentiation
• Free entry or exit of firms
• Imperfect Knowledge
• Selling cost
• High transportation cost
• An oligopoly market exists when barriers to
entry result in a few mutually dependent
companies controlling a substantial portion of
a market.
 Oligopoly
• Oligopoly is defined as a market structure in which there
are a few sellers of the homogeneous or differentiated
products. The number of sellers depends on the size of the
market. If there are two sellers, then it is called a duopoly.
• Types of Oligopoly
1. Pure Oligopoly: It occurs if the product is homogeneous.
Examples: Industries producing cement, steel, chemicals,
cooking gas and basic metal, etc.
2. Differentiated Oligopoly: It occurs if the products are
differentiated. Examples: Automobiles, refrigerators,
computers, microwave,etc.
 Features of Oligopoly
1. Few sellers
2. Homogeneous or differentiated products
3. Barriers to entry
4. Mutual interdependence
5. Selling Cost
 Concentration Ratio

• Concentration ratios are usually used to show the

extent of market control of the largest firms in the
industry and to illustrate the degree to which an
industry is oligopolistic.
• A concentration ratio is a measure of the total output
produced in an industry by a given number of firms in
the industry. The most common concentration ratios
are the CR4 and the CR8, which means the four and the
eight largest firms.
•
• LOW CONCENTRATION
• 0% to 50%. This category ranges from perfect
competition to oligopoly.
• MEDIUM CONCENTRATION
• 50% to 80%. An industry in this range is likely an
oligopoly.
• HIGH CONCENTRATION
• 80% to 100%. This category ranges from oligopoly
to monopoly.
Collusive and non-collusive oligopoly

• Collusive and non-collusive oligopoly

• Many a times, firms under oligopoly collude in
order to coordinate prices, limit competition
between them and to reduce uncertainties.
This is known as collusive oligopoly. This
results in firms acting like a monopoly and
thus making abnormal profits.
 Collusive Oligopoly

There are two types of collusion:

• FORMAL COLLUSION
• It is a formal agreement among firms to undertake planned actions
to prevent competition. It is also known as a cartel.
• It might include
• o Setting production quotas to control output
• o Price fixing
• o Dividing markets among each other on geographical basis or
other factors
• Formal collusion is considered illegal in most of the countries which
have strict competition/anti-trust laws to prevent and control
formal collusion. However, Formal collusion between governments
may be permitted. Example, OPEC (Organisation of Petroleum
Exporting Countries).
 DIFFICULTIES IN MAINTAINING
CARTELS
• There are a number of difficulties or obstacles in forming and
maintaining cartels. Some of them are discussed below:
• Different firms may have different cost curves: Since, in a cartel
the price fixed is common, it might lead to different levels of profits
for different firms. Firms with higher AC will have lower profits,
whereas firms with lower AC will enjoy higher profits.
• Number of firms: An industry with large number of firms will have
less chances of having a cartel as it is always difficult to bring them
all on consensus in terms of price and output.
• Different firms may face different demand curves: Demand curve
for a firm depends on the level of market share and product
differentiation it commands. This makes it difficult for firms with
different demand curves to arrive at a common price.
•
• Incentive to cheat: Colluding firms have an incentive to cheat on
the agreement as it might lead to higher profits. This may be in the
form of secretly offering lower prices or other concessions. This
might lead to the collapse of cartel.
• Economic conditions: During recessions, it is difficult to run cartels
as the firms may want to lower prices in order to attract more sales.
This would also lead to price war and the collapse of a cartel.
• Cartels depend of high barriers to entry: Abnormal profits attract
more firms to the industry which in turn lowers the industry prices.
However, in order to sustain a cartel in the long run, there should
be high barriers to entry so that potential new entrants are blocked
from entering the industry.
• Legal barriers: Most of the countries round the world have strong
competitive/anti-trust laws to restrict cartels.
 INFORMAL/TACIT COLLUSION

• A collusive situation where the firms are again charging

same price and limiting competition, however without any
formal agreement.
• Types of informal collusion
• Price leadership: This occurs when one firm has a clear
dominant position in the market and the firms with lower
market shares follow the pricing changes driven by the
dominant firm.
• Limit pricing: It occurs where firms informally agree to set a
price that is lower than the profit maximising price. Firms
experience lower profits than the highest possible profits
and therefore discourage new firms from entering the
industry.
 Non Collusive Oligopoly

• In a non collusive oligopoly the firms do not

collude however, they this requires them to be
aware of the reactions of the other firms while
making pricing decisions.
• A non collusive oligopoly will experience price
rigidity as the firms are always conscious of
the competitors' actions while making price
decisions. This can be explained with the
helped of a kinked demand curve.
 Kinked Demand Curve

• Kinked Demand curve was devised by Paul Sweezy, an

American economist in the 1930s. The Kinked Demand
curve gives an explanation to underlying reason why an
oligopolistic market experiences price rigidity.
• Lets assume that a firm is selling at price P.
• The firm as three options
• If the firm increase the Price: If the firm increase the price
above its present price P, it is more likely that other firms
will not increase their prices. The firm will end up losing
customer to other firms. The firm will lose relatively large
demand as compared to the price increase. Thus, a firm will
face a relatively elastic demand curve above the point 'a'.
• If the firm lowers the Price: If the firm lowers the
price, it will start a price war and other firms will lower
their prices too. It is more likely that the competitors
will set their prices even lower than the firm. The firm
will not see much increase in its demand even with a
relatively high price cut. Thus, the firm will face less
elastic demand below the point 'a'.
• It should therefore not change the price and should
continue to sell at price 'P'.
• If we combine both the demand curves we will get a
demand curve kinked at point 'a'.
• The MR curve will be twice as steeply sloping.
 What does Kinked Demand Curve
explain?
• Kinked demand curve explains the price inflexibility of
oligopolistic firms that do not collude.
• If the firm lowers its prices the competitors will lower
their prices even further and the firm will lose demand
and if the firm increase its price, the competitors will
not follow by increasing their prices and thus the firm
will again lose demand. Therefore, the best strategy is
to stick to the existing price level.
• In order to avoid a price war firms will compete on
other factors rather than price. This is known as non-
price competition.