What is a Market

 The determination of Price and Output of

various products depends upon the type of
market structure in which the goods are sold and
produced.

 A Market is a whole of a region where buyer and

seller interact with each other and price of the
same good tends to be in equity.

 Essentials of a Market
- Commodity which is dealt
- Existence of Buyer and seller
- a Place
- Communication(direct or indirect) between buyer and
seller that only one price should prevail.
 Market:

 Benham stated market ‘’as

any area over which buyers
and sellers are in close touch
with one another either directly
or through dealers , that the
price obtained in one part of
market affects the price paid in
other”
 Stonier and Hague explains
the term market as'' any  the only essential for a market is
organisation whereby buyers that all buyers and sellers
and sellers of good are kept in should be in constant touch with
close contact with each each other , either because they
other…there is no need to for are in the same building or
a market to be in a single because or they are able to
building… contact through telephone or
internets.
MARKET
MORPHOLOGY/STRUCTURE
 Classification of Market forms

 Market structure are classified on:

1) Number of firms producing a product

2) The nature of product produced by the firm
3) The ease at which the new firms can be a part of
the existing Industry.
4) Degree of control over price.
5) Nature of competition.
 Classification of Market forms
Market No. of Nature of Control Entry ep
Structure Firms Product over Condition
price
a) Perfect Large Homogeneous None Free entry, exit Infinite
Competition
b) Imperfect
Competition
i) Monopolistic Large Differentiated Some Barrier – Large
Competition (close product
substitute) differentiation

ii) Oligopoly Few Homogeneous/ Some Barriers –firms Small

(pure & Firms Differentiated dominating
differentiated)
iii)Duopoly Two

C) No One Unique Very Barriers Very

Competition (No substitute) Large Small
Monopoly
 Pure/Perfect Competition

Many buyer/sellers +

Identical Products
 PERFECT COMPETITION
 Definition of Perfect competition:
 A market in which there are many small firms,
all producing homogeneous goods.
 No single firm has influence on the price of the
product it sells.
 Perfect Competition
 Demand curve for the single firm will be infinite (perfectly elastic)
The maximum output an individual firm can produce is small.
Products are standardized commodities

 No single firm can influence the price of the product

(price taker)

 Many small sellers

 More sellers, more substitutes the consumer has
 Market power is none

 Homogenous product
 the substitutes are "perfect substitutes."

 Sufficient knowledge
 When customers know the prices offered by other
sellers, they will be better able to switch – increasing
elasticity further.
Perfect Competition
 Free entry
 companies may even enter the market to provide still
more substitutes

 Long-run economic profit (above normal) is none

 No Government intervention

 Example:
Agricultural products, Precious metals, Financial
instruments like shares, unskilled labours
ep = ∞

P D

Q
 Imperfect Competition

 Individual firm exercise control over the price

 Can be caused by
- Fewness of firms
- Product differentiation

 Sub- categories
Monopoly
 Monopolistic Competition

 Pure Oligopoly
 Differentiated Oligopoly
i) Monopoly
 Existence of a single producer
 Has no close substitutes P
 Large control over prices P’ ep < 1
 Market power : High
 Long run economic profit : High
Q Q’

 Kind of business
Govt. sanctioned regulated monopolies
Public utilities, Telephones, Electricity
 The expansion and contraction of output will
have a effect on the prices of the product
i) Monopolistic Competition
P ep > 1
 Large no of Firms
 Relatively easy barrier P’ D
 Product differentiation which are close substitutes
 Start up capital is low Q Q’

 Market power – low to high

 Long run economic profit : normal
 Kind of Business
Small business- retail and services
Boutiques, shoe store, restaurants, laundries

 Demand curve of a firm is going to be highly elastic,

firm has some control over price.,
ii) Oligopoly
 Competition among few large firms producing
 Homogenous – Pure Oligopoly
 Products differentiation – Differentiated Oligopoly

 Fewness of firms / size of the firm ensures that each of them

have some control over the price
 Market entry: Difficult
 Market Power : Low to High
 Long run economic profit : Low to high
 Pricing behaviour is of mutual interdependence
(Each seller is setting its price on the basis of reaction from the
competitor)
 Demand curve slopes downwards and ep is small
( Relatively Inelastic)
 Kind of firms:
 Manufacturing sector-, oil refineries, tobacco, steel
automobile, soft drinks
 AR and MR under
Perfect competition
 Demand curve is perfectly elastic
 Price is beyond the control of the firm
 AR remains constant
 If price or AR remains the same , then MR = AR
 As with addition of one more unit, price does not fall
No of Price TR MR
Units (AR) P*Q
Q
1 16 16 16
2 16 32 16
3 16 48 16
4 16 64 16
5 16 80 16
 AR and MR under
Perfect competition
 The price or average remain the same at OP level
 TR slopes upwards
TR

Revenue P P=AR = MR

O output
AR and MR under No of Price TR MR
Imperfect competitionUnits Q (AR) P*Q

1 16 16 16
 Demand curve is
2 15 30 14
downward sloping
 Firm increases 3 14 42 12
production and sale of 4 13 52 10
its product, price starts
5 12 60 8
falling
 AR starts falling 6 11 66 6
 MR falls more rapidly 7 10 70 4
 MR is +ve as long as 8 9 72 2
TR is increasing
9 8 72 0
 MR is -ve when TR
starts declining 10 7 70 -2
AR and MR under
Imperfect competition
P
AR

O Q M MR

M
TR
 AR and MR under Imperfect
competition

 In all forms of imperfect competition

 AR curve of a firm slopes downwards

i.e If firms lowers the price of the product, the

quantity demanded and sales would increase

 MR is zero TR is maximum
Equilibrium of the
Firm and Industry
under Perfect
Competition
 Meaning and Condition of Perfect
Competition
*Large Number of Firms
- Individual firm exercises no control over the prices
- Output constitutes a very small fraction of total output
- Price taker and output adjuster
*Homogenous Product
- Perfect substitutes
- Cross elasticity is Infinite
*Free entry and Exit
 - If firms are making super normal profit in short run, in long run
 new firms will enter and compete away the profits
 - If firms are making losses in the short run, some of the existing
 firm will leave the industry in the long run and the firms left will
 make normal profit.
 *No governmental interference
 * Profit Maximisation
 Meaning and Condition of Perfect
Competition

 Perfect Information about the prevailing Price

- Buyer and seller are fully aware about the price in the market
- Buyer would shift if seller increase the price
 Seller are aware and will not charge less price.

 *Perfect mobility of factors of production

 *Firm is a price taker
 Which of the following among them is not a
condition of perfect competition?
 A large number of firms.
 Perfect mobility of factors.
 Informative advertising to ensure that
consumers have good information.
 Freedom of entry and exit into and out of the
market.
CONDITION OF PROFIT MAX-
 Equilibrium of the Firm -
Short Run
 In short run perfect competition we are assuming that

 All firms are working under identical cost condition

 Shapes of AR and MR curve are same
 All firms are of equal efficiency
 The MC= Price to attain SMC
equilibrium output E
F
 At point F the firm can further
increase its profits as MR > MC AR =-MR
 At point E, MC = MR
 MC cuts MR from below

O M
 How much profit does the firm
earn in the short run?
 Profit per unit of output = AR – AC

 It should produce at that level of output at which the additional

revenue received from the last unit is equal to the additional cost of
producing that unit.
 MC = MR

 It depends upon the average cost curve ( AC)

 Which determine whether the firm earns

 Super normal profit
 Normal profit
 Losses
 Shut down
Perfect Competition: Supernormal
Profit/ AbnormalProfit(AR<AC)
 a) Super Normal Profit

 Equilibrium output of OM
 Average Revenue = ME
 Average Cost = MF
SAC
 Profit per unit is EF
( AC- AR) Super Normal Profit SMC
 Total profit is HFEP
 Super normal profit in short run E
P
 As normal profits are included in AR = MR
average cost H F

O M
 b) Normal Profit

 When AC is tangent to AR and MR curve SAC

i.e AR = AC
 Then firm makes normal profit

SMC

E
P
AR =-MR
H

O M
 c) Losses
 If the AR and MR curve lies below the AC curve
 Firm would be making a loss since AR < AC
SAC
 Loss is of PEFH
SMC
AVC

F
H
Losses AR =-MR
E
P

O M
 PROFIT MAXIMIZATION IN LONG
EFFECT RUN
OF ENTRY Firms that earn supernormal profits
in the short run will only be able to
The economic profit attracts The price is determined by earn normal or zero profits in the
newcomers to the industry. As a the intersection of the long run due to entry of
result, many firms will enter the market supply curve and newcomers.
market and this will lead to an the market demand curve.
increase in supply. The competitive firm sells 60 kg of
chicken and earns an economic
Price (RM) Price (RM)
Supply curve will shift to the right profit shown by the shaded area.
and equilibrium market price will fall
to RM15.
MC
SS AC
SS1
20 20 PROFI P = MR = AR

15
T P1 = MR1 = AR1

DD

Quantity Quantity
Q* 60

Market Firm
 PROFIT MAXIMIZATION IN LONG
The price is
RUN (cont.) EFFECT OF EXIT
The losses in short run forces
determined by the those sellers who cannot The competitive firm sells 60 kg of chicken and
intersection of the cover their AVC or TVC to suffers losses shown by the shaded area.
market supply curve leave the market. As many
and the market firms exit the market, this will
demand curve. Firms that suffer losses in the short
lead to a decrease in the run can still continue their operation
market supply. as in the long run they are able to
Price (RM)
Price (RM) earn normal or zero profits due to
Supply curve will shift to left and equilibrium exit of the firms.
market price will rise to RM15.
SS1 MC
AC

SS
15
15 P1 = MR1 = AR1

10 10
LOSSES
P = MR = AR

DD

Quantity Quantity
Q* 60

Market Firm
 Will the firm decide to
shut down?

 Why do they not suspend production if they are making loss?

 The firm cannot dispose of the fixed capital equipment in the short run
 The firm has to incur losses equal to fixed cost
 So if the firm shuts down it can avoid only variable cost

 Therefore if the firm earn revenue which covers variable cost as well
as part of fixed cost, its quite rational for to be in business

 Two instances in which it can operate

 If AVC curve lies below the Price
 If AVC = P
 i) When AVC = Price

 If the AVC = Price

 The firm is able to recover its variable cost of OMEP
SAC
 No Fixed cost (PEFH) is recovered
 The firm should operate and bear SMC
AVC
losses equal to its fixed cost

F
H
AR =-MR
P
E

O M
 ii) When AVC is below the Price

 The firm is able to recover its variable cost of OMBA

SAC
 And a part of Fixed cost of ABEP
 The firm should operate and bear SMC
AVC
losses of PFEH

F
H
AR =-MR
E
P
A
B

O M
 d) Shut Down
 If the price falls below the AVC.
 Then it makes losses greater than total fixed cost
 It will be rational for the firm to close down SAC
 As the firm is not able to recover even SMC
its variable cost AVC

F
H
AR =-MR
P

O M
 Long Run
 It is a period of time which is sufficient to allow firm to have a
change in all the factors of production.

 Long run the market price will settle at the point where the firms
earn Normal profit.

 Price that enable firm to earn above normal profit would induce
other firms to enter the market

 Whereas prices below the normal level would cause firms to leave
the market.

 Price = MC= MR= AC=AR

 Long Run Equilibrium
 Price = LMC = LAC= SMC=SAC
LMC

LAC

P AR = MR

OUTPUT
 Long run equilibrium is established at the minimum point of the long
run average cost curve.

 i.e working a the minimum efficient scale.

 With utmost technical efficiency and the resources are used

efficiently.
 Why to competitors stay in
business if they make Zero
economic profit
 The producers are earning fair rate of return in the long run

 Earlier the firm enters a market, the better the chance of earning
above normal profit.

 Firms can innovate to earn positive economic profit

 Or to survive firms must find ways to produce at the lowest possible

cost or atleast at cost levels below those of their competitors.
 Mathematical derivation of equilibrium
of firm
 Firm aims at profit maximization
  = R-C
 R=f’(X) and C=f”(X), given price.
 A) The FOC-
 d/dX=dR/dX-dc/dX =0
 dR/dX=dC/dX (slope of TR & TC)
 MR=MC
 Second Order Condition (SOC)
 d2/dX2 = d2R/dX2 - d2C/dX2
 This must be negative if the function has
been maximized, i.e.
 d2R/dX2 < d2C/dX2
Slope of MR < Slope of MC
 Thus MC must have a steeper slope than the
MR curve. Or
 MC must cut the MR curve from below.
 Example
Market demand equation for a perfectly competitive market is as given
QD = 2000 – 100P
The market supply equation is
Qs=1200 + 150P
 
What does the demand equation say?
1. Quantity demanded increases by 100 every 1 unit rise in the price

2. Quantity demanded decreases by 100 every 1 unit rise in the price

3. Quantity demanded remains fixed to 2000 every 1 unit rise in the price

4. None of the above

 
What does the supply equation say?
5. Quantity supplied increases by 150 every 1 unit rise in the price

6. Quantity supplied decreases by 150 every 1 unit rise in the price

7. Quantity supplied remains fixed to 1200 every 1 unit rise in the price

8. None of the above

 Example contd…
 
What is the equilibrium price for the above scenario?
1. 3

2. 3.1

3. 3.2

4. 3.3

 
What is the equilibrium quantity for the above scenario?
5. 1660

6. 1680

7. 1700

8. 1720
Equilibrium of the
Firm and Industry
under Monopoly
 Meaning

 Monopoly is said to exist when one firm is the sole producer or

seller of a product which has no close substitutes.

- One single producer

- No close substitutes should be available in the market.
- Strong barriers to the entry into the industry.

That is there is NO COMPETITION.

 Sources / Reasons of
Monopoly Power

1. Patent / Copyright
For a certain period of time, firm can attain a patent right on the new
product from the government.

2. Control over an essential Raw – material.

3. Grant of Franchise by the Government

A firm is granted the exclusive legal rights by the Government to
produce a given product. Government keep with itself the right to
regulate its price and quality.
 Sources / Reasons of
Monopoly Power

4. Advertising and Brand Loyalties of the established Firms.

Strong loyalties to the brands of the established firms . And their
heavy advertising campaigns, to enhance the market power of the
producer and prevent the entry of potential competitors.

5. Economies of Scale: Natural Monopoly

When significant economies of scale are present, the AC of production
goes on falling over a wide range of output, which (output) meets the
demand of entire market.
Natural monopoly are regulated by the Government so that the Firm
does not charge a high prices and exploit the consumers.
 MONOPOLY (cont.)
 Barriers to Entry
 Barriers to entry refer to restriction that prevents other sellers
from entering into a market
1. Control over raw material – a monopoly status can also be maintained through
control over the supply of raw material
2. Patent and Copyright – a patent is an exclusive right to the production of an
innovative product. A copyright is an exclusive right to the author of a book or
composer of a music or producer of a movie
3. Cost of establishing an efficient plant – natural monopoly exists when one
firm can meet the entire market demand with lower price compared to two or
more firms
4. Government Franchises – the government will give exclusive rights to a firm to
sell a certain goods and services in a certain area
 Monopolies are regulated by the Federal
Government through anti-trust laws. However
there are 3 types of monopolies that exist in
America:
 1. Natural Monopoly: because the monopoly’s
large size, it benefits from economies of scale,
thus the government allows the monopoly to
operate since it is cheaper than allowing
competition. (example: Tennessee Valley
Authority (TVA) provides power to much of the
south, it is too expensive for another electric
provider to compete with the TVA, thus the
government allow the TVA to continue to operate
as a monopoly)
 2. Technological Monopoly: firms that request
patents and trademarks cannot have their
products duplicated by any other competing firm,
thus they are protected monopolies (example:
Microsoft’s copyright protect on its products;
Apple’s patents of the design of all its products)
3. Government Monopoly: government
controlled business (example: country water
provider, sale of nuclear material, Canadian
healthcare system (ran by the Canadian
government)
 Nature of MR and AR Curve

 Both AR and MR curve are Downward sloping

 MR curve lies below the AR curve. As when the monopolist sells

more, the price of the product falls and the MR would be less than
the price.

 Monopolist has to choose a price –quantity combination which

yields him maximum possible profits.

 Monopolist ability to set its price is limited by the demand curve of

its product i.e Price elasticity of demand for its product.
Nature of MR and AR Curve

AR

O
Q M MR
 Monopoly Equilibrium and
Price Elasticity of Demand
 Monopolist ability to set price is limited by the demand curve for its
product i.e the price elasticity of demand.

 The price elasticity of demand indicates how much more or less

people are willing to buy in relation to price decrease or increase.

 Monopolist will never be in an equilibrium at a point on demand

curve where price elasticity of demand is less than one.

 As when price elasticity is less than one, marginal revenue is

negative.

 Monopoly equilibrium will always lie where price elasticity is greater

than one if marginal cost is positive.
Monopoly Equilibrium and
Price Elasticity of Demand
e >1
e=1
P
e<1
AR
O
M MR

M TR
 Price – Output Equilibrium
under Monopoly
Short Run

 Monopolist will go on producing as long as MR > MC

 Profits will be maximum at which MR = MC

 The price under perfect competition is equal to marginal cost

 But price under monopoly is greater than marginal cost

 In Monopoly equilibrium
 MR = MC
 P > MC
 Price – Output Equilibrium
under Monopoly

Q P TR TC AC MC MR Remarks Profit or
Loss
0 200 0 100 - - - -
1 200 200 250 250 150 200 MR > MC -50
2 180 360 350 175 100 160 MR > MC +10
3 160 480 420 140 70 120 MR > MC +60
4 140 560 500 125 80 80 MR = MC +60
5 120 600 600 120 100 40 MR < MC 0
6 100 600 720 120 120 0 MR < MC -80
7 80 560 870 120 150 -40 MR < MC -20
Price / Output Equilibrium
a) Super Normal Profits
Price / Output Equilibrium
b) Losses
 Long Run Equilibrium under
Monopoly
 In long run monopolist make adjustments to the plant size

 The monopolist would choose that plant size which is most

appropriate with particular level of demand.

 In the Long run the equilibrium would be at the level of output where
given MR cuts the long run MC curve

 The firm will operate where LAC is tangent to SAC

 MR = LMC = SMC
 SAC = LAC
 P > LAC
 As the price cannot fall below LAC, in long run the monopolist will
quit the industry if it is not even able to make normal profits.
Long Run Equilibrium under
Monopoly

SMC
LMC LAC

P G SAC
F
H

AR

O
Q
MR
 Difference

Perfect Competition Monopoly

1. In equilibrium 1. In equilibrium
P= MC P > MC
2. In long run 2. In long run equilibrium
MR / P= MC= minimum AC Average cost is still declining
3. In long run they make normal 3. In long run they can also make
profits super normal profits
4. Price Discrimination is not there 4. Price Discrimination is there if
elasticity's of demand are different in
different market.
5. In equilibrium price and output are 5. In equilibrium price is higher and
determined by demand and supply curve output smaller
 In his opinion on the Microsoft antitrust case, Judge
Jackson wrote: Three main facts indicate that Microsoft
enjoys monopoly power. First, Microsoft's share of
market for Intel-compatible PC operating systems is
extremely large & stable. Second, Microsoft dominant
market share is protected by high barrier to entry. Third,
and largely as a result of that barrier, Microsoft's
customers lack a commercially viable alternative to
Windows."
 Are these elements related to monopoly? Why? Are all
these necessary? If not, which one is crucial? Explain
your reasoning in context to the case discussed in the
class.
Is there Price Discrimination
in Monopoly?
Yes
 Meaning
 It refers to the practice of a seller selling the same product at different
prices.

 Sellers does this when it is possible and profitable.

 i.e
“ Sales of technically similar products at prices which are not
proportional to Marginal cost”.
 Types
 First Degree – Personal
When the monopolist is able to sell each separate unit of output at
different prices

 Second Degree - Local

When monopolist is able to charge separate prices for different blocks
or quantities of commodity from buyers.

 Third Degree - According to use or Trade

When the seller divides his buyers into two or more than two sub-
market depending upon the price elasticity of demand
( A manufacture who sells his product at a higher price at home and at
a lower price abroad)
 When is Price
Discrimination Possible?
 If its not possible to transfer any unit of the product from one market to
another.

 It should not be possible for the buyer in the dearer market to transfer
themselves into the cheaper market to buy the product at lower price.

 The nature of the commodity ( Surgeon or lawyer)

 Long distance / Tariff Barrier (Distance increases the cost)
 Legal Sanction ( Electricity supplied at different prices in
Residential / Commercial areas)
 Ignorance of Buyers
 Preferences & prejudices of Buyers
 Same service for differentiated commodities
 When Price Discrimination
is profitable?
 P.D Is profitable only if Ed in one market is different from Ed in the
other.
 Monopolist will charge different prices in different sub- markets.

 Which is on the basis of differences in price elasticity of demand.

 Monopolist can divide his total market into several sub – market.

 For example
 Two market – Relatively Elastic and Relatively Inelastic
 Higher price in relatively inelastic market, so profit margin high
 Lower price relatively elastic market, so profit margin are low
 So putting it together higher profits collectively by Price
discrimination
 Managerial Decision Making in
Monopoly
 Monopoly can earn economic profits in the short run or long run.

 It depends upon demand for its product

 It can earn higher profits by discriminating prices

 Dumping the products at lower rate in international market and

charging higher profits in domestic market can maximise profits.

 But the changes in economies of business ( customers, technology

and competition) can break down the a dominating company’s
monopolistic power.
 DEAD WEIGHT LOSS &
MONOPOLY
 Monopoly creates a deadweight loss, due to the fact that
the monopoly restricts supply below the socially efficient
quantity.
 Another way to see this inefficiency is that the monopoly
always chooses a price that is above marginal cost.
There are some lost gains from trade, from buyers
whose willingness to pay is above marginal cost, but
below the monopoly price.
 Another type of inefficiency occurs if the monopoly
incurs costs to maintain its monopoly position. These
resources could instead be used for productive
purposes. For example, the monopoly could be wasting
resources in order to lobby government officials for
favorable legislation or contracts.
Equilibrium of the Firm
and Industry under

Monopolistic Competition
 Introduction
 The difference between the price and MR at equilibrium output is
regarded as the Degree of Imperfection

 The relative magnitudes of price and MR at equilibrium output help

us to distinguish between different degrees of Imperfection or
Monopoly power in various market structure.

 The product differentiation is a distinguishing feature of

monopolistic competition which makes it as a blending of perfect
competition and Monopoly.
 Introduction

Thus as each Monopolist has a competitor which

produces a product not homogenous but differentiated
though closely related, it becomes a
Monopolistic Competition.
 Overview of
Competitive Environment
Perfect Monopoly Monopolistic Oligopoly
Competition Competition

Market Power No Yes, subject to Yes Yes

Govt regulation

Mutual Interdependence No No No Yes

among competing Firms

Non- Price Competition No Optional Yes Yes

Easy Market entry or Exit Yes No Yes, relatively No,

Easy relatively
Difficult
 Features of
Monopolistic Competition
1. A large number of Firms:
Each firm having a small share of the market demand
There exist a stiff competition
Size of each firm is relatively small

2.Product Differentiation
3. Selling Costs
4. Influence over Price/Independent decision making
A firm has to choose a price and output which maximises profits
5.Imperfect knowledge
6.Unrestricted entry and exit
7.Non Price Competition
Expenditure on Advertising and other selling cost
 Non- Price Competition
The ability to differentiate their product in Imperfect competition with
the
variable other than price.

 Advertising
 Promotion
 Location and distribution channels
 Market segmentation
 Loyalty program
 Product extension / new product development
 Special customer service
 Product tie-ups
 • Firms in a M.C. generally are too large to completely fail.
Instead they merge with other firms. There are 3 different
types of mergers:
 1. Vertical Merger: firms looking to save on costs will
merge with a resource provide (example: McDonalds buys
a paper cup manufacture or a cattle ranch; Ford buys a
steel manufacture)
 2. Horizontal Merger: firms in competing industries buy
each other in order to dominate one single industry
(example: McDonalds buys Wendys; Nissan buys Honda)
 3. Conglomerate: firms in unrelated industries buy each
other in order to offer a diversified set of products
(example: Procter & Gamble who produces everything
from shampoo, to dog food, to coffee, to Duracell batteries)
 Shape of MR and AR curve
 Since close substitutes are available in the market, the demand

curve for the product of an individual firm under monopolistic

competition is fairly Elastic.

 Both AR and MR curve are Downward sloping

 MR curve lies below the AR curve.

 Producer has to choose a price –quantity combination which yields

him maximum possible profits.
Nature of MR and AR Curve

M
P

AR

O Q MR
 Short Run Equilibrium
1) Super Normal Profits
2) Losses
 Long Run Equilibrium
 If the firm earn supernormal or economic profits in the short run, it
will lead to entry of new firms in the long run.

 The cross elasticity of demand between the products of various

firms will increase.

 Which will cause a resultant shift in the demand curve to the left.

 Equilibrium will be at a point where AR becomes tangent to the AC

curve.

 The firm would be making normal profits in the long run, but its price
would be higher and output smaller than under Perfect
Competition.
Long Run Equilibrium
Equilibrium of the Firm
and Industry under

OLIGOPOLY
Imperfect
Oligopoly
 Introduction

 It is refereed to as “Competition among few firms”.

 Two kinds
 Pure Oligopoly : Oligopoly without Product Differentiation
 Differentiated Oligopoly: Oligopoly with Product Differentiation
 Features / Characteristics
 Few Sellers

 Interdependence
Competitors are few, any change in price, output, product will have
a direct effect on competitors .

 Importance of Advertising and selling cost

Aggressive and defensive marketing strategies.

 Group Behaviour
Do the few firms cooperate with each other in promotion of common
interest or do they fight to promote individual interest.

 Constant shifting of the demand curve.

Competitors keep on changing the price with the change in price of the
firm.
 Factors leading to emergence
of oligopoly
 Absolute cost advantage to the existing firms.

 Barriers to Entry : Technological and Economic Barriers

 Product differentiation creates Market Power

 Takeovers / Mergers create oligopolies.

 Economies of Scale
Few firms can fulfil the demand of the product by producing at large
scale and thus lowering the average cost of production.

 Economies of Scope
 Production of multi-products leads to lower average cost
 Causes for the Oligopolies

Are oligopolies due to Economies of scale or Mergers / Take-over?

 Both
 In some industries few firms dominate due to Economies of scale
 But in some its get dominated due to policy of mergers and
takeovers
 Cooperative Vs
Non Cooperative Behaviour
 The behaviour of oligopolistic firm can be strategic in deciding about
their price and output policies.

 The strategic behaviour means that the oligopolistic firms must take
into account the effect of their price- output decision on their firms
and on the reaction they expect from other firms.

 Two types of strategies:

 Compete with their rivals to promote their individual interests
 Cooperate with them to promote mutual interest ( maximise profits)
 Collusive Oligopoly :
Cooperative Model
 To avoid uncertainty of interdependence, price wars, cut throat
competition, firms enter into agreement regarding uniform price-
output policy.

 The agreement can be formal (open) or tacit (secret)

 These agreements are called as Collusive agreements:

 A) Cartels
 B) Price leadership
 A) CARTELS
 Firms jointly fix a price and output policy through agreements
 Cartels usually occur where there are a small no. of sellers selling
homogenous products.
 Now-a-days all types of formal or informal and tacit agreements are
made among oligopolisitic firms.
 Formation of Cartels involves:

 Agreement on price fixation

 Total industry output
 Market share
 Allocation of customers
 Allocation of territories
 Establishment of common sales agencies
 Division of profits
 Perfect Cartels
When member firms agree to surrender completely their rights of price
and output determination to Central Administrative agency, so
as to secure maximum joint profits.

The total profits is distributed among the member firm already agreed
between them.

The output to be produced by each firm is decided by the central

agency in such a way that total cost of the total output is minimum.

The total cost will be minimum when firms in cartel produces such
output so that their marginal cost is equal.

Perfect Cartel is quite rare in the world

As both Price and output get decided by the central Agency
 Market Sharing Cartels

 1) Non- Price Competition:

 A uniform price is fixed and members are free to produce and sell
the amount of output which will maximise their individual profits.
 The firms agree not to sell at a price below the fixed price.
 But they are free to vary the style of their product and advertising
expenditure.
 If the members firms have identical cost then the price (monopoly
price) will ensure maximisation of joint profits
 But when the cost differs from the cartel price will be fixed by
bargaining between the firms.

But with cost differences such loose cartels are unstable.

 Market Sharing Cartels

 2) Output Quota:
 Agreement between firms regarding quota of output and sold by
each of them at the agreed price.
 As the cost of firms are different , the quotas will be fixed and
market share differ
 Which are decided through bargaining between the firms.
 Which is based on
 Past – period sales

 Productive capacity
 Division of market share region wise
 B) Price Leadership
 One firm sets the price and other follows it.

 The follower firm adopts the price of the leader, even though they
have to forgo from their profit maximising position.

 Price leadership are illegal, so it is a result of informal and tacit

understanding.

 Types of Price Leadership

 Price set by low- cost firm
 Price by dominant firm
 Barometric price
 Effective PL can exist in the market if the
following conditions are fulfilled:
 Existence of small no. of firms in the market
 Products, by & large identical
 Restraint upon entry of firms in market
 Prevalence of equal costs
 Product having relatively a low elasticity of
demand
 Difficulties of Price Leadership

 Success of Price leadership depends upon the correctness of his (the

leader’s) estimates about the reactions of the followers. If its not
correct then it jeopardise his position in the market

 If the leader fixes a higher price than the price preferred by followers,
the followers can make hidden price cuts in order to increase their
share.

 Tendency on part of the followers to indulge in non- price competition

to increase sales
 Pricing in a Oligopolistic Market/
Price Rigidity
 In oligopoly there is a degree of price rigidity or stability.

 Price rigidity has been explained by Kinked Demand Curve

 As in oligopoly the products are differentiated, it is unlikely that when

the firm raises its price, all customers would leave.

 As a result the demand curve is not perfectly elastic or inelastic.

 The kink is formed at the price because the segment of the demand
curve above the price is highly elastic and the segment of the demand
curve below the price is inelastic
 The possibility of price rigidity in oligopoly market
may exist due to the following reasons:
i) Maintenance of a specific price to prevent threat of
entry from the potential rivals.
ii) Buyers may become accustomed to a particular
product with a specified price. Hence, sellers may not
like to change the price.
iii) Charging of high price may engender resentment
among the buyers. Therefore firms may keep a
reasonable and acceptable price undisturbed.
iv) The oligopolist may avoid the upward revision of price
for the fear of state intervention.
v) The established price might have resulted from tough
bargaining and some formal agreement.
vi) Kinked DD Curve.
 Pricing in a Oligopolistic Market
 Kinked Demand Curve: Coined by P.M Sweezy
Each oligopolist believes that if he lowers the price below the prevailing
level, his competitor will follow him and will accordingly lower their
prices. Whereas if he raises the price, competition will not follow his
increase in the price.

 Oligopolist will not gain a large share by d

reducing its price, and will have reduction in sales
if it increase price. So there is Price Rigidity K
P

 dK of the demand curve is relatively elastic

 KD is relatively inelastic
D
M
 Equilibrium in a Oligopolistic
Market
 Oligopoloist will be maximising his profits at the current price level.
 MR curve is a discontinuous curve
 The length of the MR discontinuity depends upon the relative
elasticities of the demand curve (dK and KD)
 Greater the difference in two elasticities, greater the length of the
discontinuity.
 MR curve is drawn with a gap of BC
 If the MC passes between this gap say point C it will be maximising
profit at the price of OP
 Even if there is change in cost and MC1 shifts to MC2, equilibrium
output will remain unchanged
Equilibrium in a Oligopolistic
Market
NORMAL PROFIT
ABNORMAL PROFIT
LOSS
COMMON EXAMPLES
-Operating Systems : Apple, Microsoft

-Gaming Consoles : Nintendo, Sony, Microsoft

-Canada's wireless service : Rogers Wireless, Bell Mobility,  Telus

-UK's supermarkets : Tesco, Sainsbury's, Asda and Morrisons

-World wide food processing : Kraft Foods, PepsiCo and Nestle

-Airliners : Boeing and Airbus

-American TV : Disney/ABC, CBS Corporation, NBC Universal, Time Warner,

and News Corporation

-UK's detergent market : Unilever and Procter & Gamble

 Critical Appraisal of Kinked
Demand Curve Theory
 It does not explain how price has been determined.

 It does not apply to the oligopoly cases of prices of Price leadership

and price cartels which account for quite a large part of oligopolist
markets.
 Fails to explain the position of kink
 More focus on price rigidity
 Inapplicability for differentiated products
 Uncertain price solution during boom or inflation
 Suppose the demand function of an industry is-
 P=100-0.5X.
 Further assume that firm A has a constant cost
fn.CA = 5XA
 & B has an increasing cost function CB = 0.5 XB

 Find their profit maximizing level of output.