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N on-competitiv e M arkN on-competitiv e M arkN on-competitiv e M arkN on-competitiv e M arkN on-competitiv e M arketsetsetsetsets
We reca ll t ha t pe r fec t compe t i t ion was theor i sed as a m arke t
s t ru c tu re where bo th consu mers an d firms were pr ice t ak e rs .
The beh aviour of th e firm in s u ch c i rcum sta nces was descr ibed
in the Chap te r 4 . We d i scu ss ed th a t the pe r fec t compe t i t ion
ma rke t s t ru c tu re i s a pproxima ted b y a ma rke t s a t i s fy ing th e
followin g con dit ions :(i) there exist a very large nu mb er of firms a nd consu mers of the
commodity, su ch th at th e outpu t sold by each firm is negligibly
sm all compa red to th e total outp u t of al l th e firms com bined,
and simi lar ly , the amount purchased by each consumer i s
ext remely sma ll in comp arison to the qu an t ity purch ased by
all consu mers together;
(ii) firms ar e free to s ta rt p rodu cing th e comm odity or to stop
product ion;
(iii) th e ou tp u t p ro d u ced b y ea ch firm in th e in d u s tr y is
ind ist inguish able from th e others an d th e ou tpu t of an y other
indu s t ry cann ot subs t i tu t e th is ou tpu t ; and
(iv) consu mers an d firm s ha ve perfect kn owledge of th e ou tpu t,inpu ts a nd their pr ices.
In th is ch apter, we sh all discus s s itu ations where one or m ore
of th ese con ditions ar e n ot sa tisfied. If as su m ptions (i) an d (ii) ar e
dropp ed, we get ma rket s tru ctu res ca lled m onopoly an d oligopoly.
If as su mp tion (iii) is dropped , we obtain a m ark et stru ctu re called
mon opolistic comp etition. Dr opping of ass u mp tion (iv) is dea lt with
as economics of risk . Th is ch ap ter will exam ine th e m ark et
stru ctu res of monopoly, m onopolist ic comp etit ion an d oligopoly.
6 . 1 S IMPLE MONOPOLYINTHE COMMODITY MARKET
A ma rket s tru ctu re in wh ich th ere is a single seller
is called m onop oly. Th e condit ions h idden in
th is sin gle lin e defin ition, h owever, need to be
expl ic i t ly s ta ted . A m on opoly m ar ket
st ru c tu re r equ i res t h at th ere i s a
single produ cer of a par t icular
comm odity; no oth er commod ity
works as a su bs t i tu te for
th is comm odity; an d for th is
s i tu a t ion to pe r s i s t ove r
time, su fficien t res triction s I M Per fect Comp et it ion
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For the m onopoly firm , the a bove argu men t express es i tself from th e reverse
direction . Th e m onop oly firms d ecision t o sell a lar ger qu an tity is p oss ible only
at a lower price. Convers ely, if th e mon opoly firm br ings a s m aller qua n tity of
th e comm odity int o the m ark et for sa le it wil l be ab le to sell at a h igher pr ice.
Thu s, for the m onopoly firm , the p rice depend s on the qu an tity of the comm odity
sold. The sam e is also expressed by s tat ing tha t pr ice is a d ecreasing fu nction ofthe quant i ty sold. Thus, for the monopoly f i rm, the market demand curve
express es th e price tha t is a vailable for different qu an tities s u pplied. This idea is
reflected in th e statem ent th at th e monopoly firm faces th e ma rket dema nd curve.
Th e above idea can b e viewed from a n other a n gle. Sin ce the firm is ass u m ed
to ha ve perfect kn owledge of th e ma rket dem an d cu rve, the m onopoly firm can
decide th e price at which it wish es to s ell its comm odity, an d th erefore, determines
the quanti ty to be sold. For instance, examining Figure 6.1 again, since the
monopoly firm is aware of the shape of the curve DD, if it wishes to sell the
comm odity at th e price p0, it can do so by produ cing an d sellin g quan ti ty q
0,
since at th e price p0, cons u mers are willing to pu rchas e the qu an t ity q
0. This
idea is con cretised in th e slogan: Mon opoly firm is a pr ice mak er.
The contr as t with th e firm in a perfectly competitive ma rket s tru ctur e sh ouldbe c lear . In tha t case , the firm could br ing into th e mark et as mu ch qu an t ity of
th e comm odity as i t wish ed an d could sell i t at the s am e price. Since th is d oes
not happen for a monopoly firm, the amount of money received by the firm
throu gh th e sa le of the comm odity has to be examined again.
We do this exercise th rough a sch edu le, a grap h, an d u sing a simple equ ation
of a straight l ine demand curve. As an example, let the demand function be
given by th e equ ation
q = 2 0 2 p,
where q is th e qua nt i ty sold an d p is the price in ru pees.
The equ a t ion can be wr it t en in t e rms of p a s
p = 1 0 0 .5q
Su bs t i tut ing di fferent valu es of q from 0 to 13 gives u s t he p r ices f rom 10
to 3.5 . Th es e a re s h own in th e q a n d p
colu m n s of Table 6.1 .
Thes e nu mbers a re dep icted in a g raph in
Figure 6 .2 with pr ices on th e ver t ica l axis a nd
qu an t i t ie s on th e h or izon t a l ax i s . The pr i ces
th at are availab le for different qu an ti t ies of the
c o m m o d i t y a r e s h o w n b y t h e s o lid s t r a i gh t
l in e D.
The tot al reven u e (TR) received by th e firm
from the sale of the commodity equals the
produ ct of th e price an d th e qua n ti ty sold. Inth e case of th e mon opoly firm, th e total revenu e
is n ot a straight l ine. Its sh ape depen ds on th e
shape of the demand curve. Mathematically,
TR is repr esented a s a fu nction of the qu an tity
sold. Hen ce, in our examp le
TR = p q
= (10 0 .5q) q
= 1 0q 0 .5 q2
q p TR AR MR
0 1 0 0
1 9 .5 9 .5 9 .5 9 .5
2 9 1 8 9 8 .5
3 8 .5 25 .5 8 .5 7 .5
4 8 3 2 8 6 .5
5 7 .5 37 .5 7 .5 5 .5
6 7 4 2 7 4 .5
7 6 .5 45 .5 6 .5 3 .5
8 6 4 8 6 2 .5
9 5 .5 49 .5 5 .5 1 .5
1 0 5 5 0 5 0 .5
1 1 4 .5 4 9 .5 4 .5 -0 .5
1 2 4 4 8 4 -1 .5
1 3 3 .5 4 5 .5 3 .5 -2 .5
Table 6 .1:Prices and Revenue
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This is not the equation of a
st r a ight l in e . I t i s a qu ad ra t ic
equa t ion in which the squared
term has a negat ive coff ic ient .
Such a n equa t ion represen t s an
inverted vertical para bola.In Table 6.1, the TR column
represents the product of the p
a n d q colu mn s. It can b e noticed
tha t as the qua nti ty increases, TR
increases to Rs 50 when output
becomes 1 0 u ni ts , and after this
level of ou tp u t , tot a l re ven u e
st a r t s dec l in in g . Th e s am e i s
visible in Figu re 6.2 .
The revenue received by the
firm per unit of commodity sold
is ca lled th e Average Revenu e (AR). Math em at ically, AR = TR/ q. In Tab le 6.1, th eAR colu mn provides valu es obt ained by dividin g TR values b y q valu es. It can
be seen tha t the AR values tu rn ou t to be the sam e as th e values in the p column.
Th is is only to be expected
AR =TRq
Since TR = p q, su bs ti tuting this into th e AR equ ation
AR =( )p q
q
= p
As seen earl ier, the p va lues represen t th e marke t dema nd curve as sh own
in Figu re 6 .2. The AR cu rve will th erefore l ie exact ly on th e m ar ket dem an d
cu rve. Thi s i s expressed b y the s t a t emen t th a t th e ma rke t dem an d cu rve is
the a verage revenu e cur ve for the
m on opoly firm.
Graphically, the value of AR
can be found from the TR curve
for a n y level of qu a n t i t y s old
th rou gh a s imp le con st r u c t ion
given in Figure 6.3. When qu an tity
is of 6 units, draw a vertical line
passing through the value 6 on
th e h orizont al axis. This lin e will
cu t th e TR cu rve a t t h e p o in tma rked a at a height equ al to 42.
Draw a straight l ine joining the
origin O an d point a. The s lope
of this ray from the origin to a
point on th e TR provides the value
of AR. Th e slope of this r ay is equ al
to 7. Therefore, AR ha s th e valu e
7. The sa m e can be verified from
Table 6.1.
R e l a t i o n b e t w e e n A v e r a g e R e v e n u e a n d
T o ta l Reve nue Curves . The average revenue
at an y level of output is given by the s lope of the
line joining th e origin and the point on the total
revenue curve corres ponding to the output level
und er consideration.
T ota l , Average a nd Marg ina l Revenue Curves :
The total revenue, a verage revenue and the m arginal
revenue curves a re depicted h ere.
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6 .1 .2 Total , Average and Marginal Reven ues
A more car efu l glan ce a t Table 6 .1 reveals th at TR does n ot increase b y the
sa me a mou nt for every un it increase in qu an t ity . Sale of the f irs t u ni t leads to
a ch an ge in TR from Rs 0 wh en qu an t i ty i s of 0 u ni t to Rs 9.50 wh en qu an t i ty
is 1 u n it , i.e . , a rise of Rs 9.50. As th e qua nt ity in creases fu rth er, th e rise in TR
is smaller. For example, for the 5 th unit of the commodity, the rise in TR isRs 5.50 (Rs 3 7.50 for 5 u ni ts m inu s Rs 3 2 for 4 u ni ts). As m ent ioned ear l ier ,
af ter 10 u ni ts of outp u t , TR star ts d eclining. This impl ies th at b r inging m ore
th an 10 u nits for sa le leads to a level of TR less t ha n Rs 50. Thu s, th e rise in TR
du e to th e 12th u n it i s : 48 49.50 = 1.5, ie a fa l l of Rs 1.50.
This ch an ge in TR du e to the s a le of an add it iona l un it i s termed Margina l
Reven u e (MR). In Tab le 6.1, th is is d epicted in th e las t colu m n . Th e valu es in
every row of th e MR colum n a fter th e first equ al th e TR valu e in t h at r ow m inu s
th e TR value in th e previou s row. In th e las t par agraph , it was sh own th at TR
increases more slowly as qu an tity sold increa ses a n d falls a fter qua n tity reach es
10 uni ts . The same can be viewed through the MR values which fa l l as q
in creases . After th e qua nt ity reaches 10 u nits, MR ha s n egative values . In Figure
6.2, MR is depicted by th e dotted l in e.Grap h ically, th e valu es of
the MR curve are given by the
slope of th e TR cu rve. Th e slope
of an y smooth cu rve is d efined
as the s lope of the ta ngent to the
cu rve a t th a t poin t . Th is i s
depicted in Figure 6 .4. At point
a on th e TR cur ve, th e value of
MR is given by th e s lope of the
line L1, an d a t point b by th e
line L2. It can be seen th a t bo th
lin es h ave positive slope, bu t th eline L
2is f la t ter tha n l ine L
1, ie
i ts s lope is lesser. The value of
MR for th e sa m e level of qu an tity
is a lso less er . When 10 u ni ts of
th e com m od ity a re s old, th e
tan gent to th e TR is hor izonta l,
ie its slope is zero. The value of
th e MR for th e sa me qu an ti ty is zero. At point d on t h e TR cur ve, where t h e
tan gent is n egatively sloped , the MR tak es a n egative valu e.
We can now conclu de th at wh en tota l revenu e is r i s ing, mar gina l revenu e
is posit ive, an d when total revenu e sh ows a fal l, ma rgin al revenu e is n egative.
Anoth er re la t ion can be seen between the AR an d th e MR curves. F igure6.2 s hows th at th e MR curve lies below th e AR curve. Th e sam e can be seen in
Table 6 .1 wh ere th e valu es of MR at an y level of ou tpu t a re lower th an th e
corres pon ding values of AR. We can conclu de th at if th e AR cur ve (ie th e dem an d
cu rve) is fal l in g steep ly, th e MR cu rve is far below the AR cu rve. On th e oth er
ha nd , if th e AR curve is less s teep, th e ver t ica l dis ta nce between th e AR an d
MR cu rves is s m aller. Figu re 6 .5(a) sh ows a flatter AR cu rve while Figure 6 .5(b)
sh ows a steeper AR curve. For the s am e u nits of th e comm odity, the difference
between AR an d MR in p an el (a) is s ma ller th an th e differen ce in pa n el (b).
Rela t ion be tween Marg ina l Revenue and T o ta l
Revenue Curves . The marginal revenue at an y level
of output is given by the s lope of the total revenu e
curve at tha t level of outpu t.
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Rela t ion be tween Average Revenue and Marg ina l Revenue curves . If the AR curve is
ste eper, then th e MR curve is far below th e AR curve.
6 .1 .3 Marginal Revenue and Price Elasticity of Demand
Th e MR valu es a lso ha ve a relat ion with t h e price elas ticity of dem an d. The deta iled
relation is not derived here. It is sufficient to notice only one aspect price
elas ticity of dema nd is m ore than 1 when th e MR has a pos itive valu e, and becomes
less th an the u nity when MR has a n egative value. This can be seen in Table 6.2,
which u ses th e sam e data p resen ted in Table 6.1. As th e quan tity of th e comm odity
increas es, MR valu e becomes s ma ller an d th e valu e of th e price elas ticity of dem an d
also becomes s ma ller. Recall th at th e dema n d cu rve is called elas tic at a p oin t
where price elast ici ty is greater than unity, inelast ic at a point where the
price elasticity is less tha n u nity and u nitary elas tic when price elas ticity is equ al
to 1. Table 6.2 sh ows th at when qu an tity is less th an 10 u nits, MR is positive an d
the demand curve is elast ic and when quanti ty is of more than 10 units, the
dem an d cu rve is inelas tic. At th e qua nt ity level of 10 u nits, th e dema n d cu rve is
u nitary elastic.
6 .1 .4 Short Run Equil ibrium of the
Monopoly Firm
As in the case of perfect competition, we
continue to regard the monopoly firm as
one which m aximises pr ofit. In t h is section ,
we a n a ly s e t h is p r o fit m a xi m is in g
be h a viou r to de ter m in e th e qu a n t i ty
produ ced by a monopoly firm an d price at
which it is s old. We sh all as su me th at a firm
does not ma inta in s tocks of the qu an t ity
produ ced a nd tha t the en t i re qu an t ityproduced is pu t u p for sa le.
The S im ple Case o f Zero Cos t
Suppose there exists a vi l lage si tuated
su fficien tly far awa y from oth er villages. In
th is village, th ere is exactly one well from
which wa ter is available. All res ident s a re
com ple te ly dep en den t for th e i r wat er
q p MR Elas t ic ity
0 1 0 - -
1 9 .5 9 .5 1 9
2 9 8 .5 9
3 8 .5 7 .5 5 .6 7
4 8 6 .5 4
5 7 .5 5 .5 3
6 7 4 .5 2 .3 37 6 .5 3 .5 1 .8 6
8 6 2 .5 1 .5
9 5 .5 1 .5 1 .2 2
1 0 5 0 .5 1
1 1 4 .5 -0 .5 0 .8 2
1 2 4 -1 .5 0 .6 7
1 3 3 .5 -2 .5 0 .5 4
Table 6 .2 : MR an d Price Elasticity
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requiremen ts on th is well. The well is owned by one p erson who is ab le to prevent
others from d rawing water from it except th rou gh pu rch as e of water. The pers on
who pu rcha ses th e water ha s to dr aw th e water out of the well. Th e well owner is
th u s a m onop oli s t fi rm which bea rs ze ro cos t in p r odu c ing th e good .
We sh all an alyse th is simple case of a m onopolist bearing zero costs t o determ ine
th e am oun t of water sold an d th e price at which i t is s old.Figure 6.6 depic ts the same
TR, AR a n d MR cu rves , a s in
Figu re 6 .2. The p rofit received by
t h e fir m eq u a ls t h e r eve n u e
received b y the firm m inu s th e cost
incu rred, t h at is, Profit = TR TC.
Since in t h is cas e TC is zero, profit
is m a x im u m w h e n TR is
ma ximu m. This , as we have seen
earl ier, occurs wh en ou tpu t is of
10 units. This is also the level
wh en MR eq u a ls ze r o. Th eamount of profi t is given by the
length of th e vertical lin e s egment
from a to th e h orizont al axis.
The pr ice at which this outp u t
will be sold is the price that the
consu mers as a whole are willing
to pay. Th is is given by th e ma rket d ema n d cu rve D. At ou tpu t level of 10
u n its, th e price is Rs 5. Since th e ma rket dem an d cu rve is the AR curve for the
m onop olist firm, Rs 5 is th e average reven u e received by th e firm. The total
revenu e is given b y the prod u ct of AR an d th e qua n ti ty sold, ie Rs 5 10 un it s
= Rs 5 0. This i s depic ted by the area of th e sh aded rectan gle .
Co m p a r i s o n w i t h Per f ec t C om p e t i t i o n
We compa re th e above ou tcome with wha t it wou ld be un der p erfectly competitive
ma rket s t ru cture . Let us ass um e that there is a n inf ini te num ber of su ch wells .
If one well owner ch ar ges Rs 5 p er u n it of water t o get a p rofit of Rs 50 , an oth er
well owner realising there are still consumers willing to buy water at a lower
rate, will fix the pr ice lower th an Rs 5, sa y at Rs 4. Cons u mers will decide to
pu rchas e from th e second water seller and dema nd a larger qua nti ty of 12 u nits
creating a total revenu e of Rs 48 . In similar fas hion, a noth er water s eller, in
order t o obtain t h e reven u e, wou ld offer a s till lower price, say Rs 3, an d s elling
14 u n its ea rn ing a revenu e of Rs 42. Since there is an infin ite nu mb er of firm s,
price wou ld continu e to move down infinitely till it reach es zero. At th is out pu t,
20 u n its of water wou ld be sold an d p rofit would become zero.
Thr ough this compar ison, we can see th at a perfectly competitive equilibriumresu lts in a larger qu an ti ty being sold a t a lower pr ice. We can now proceed to
th e gen era l cas e in volving positive costs of produ ction .
In t rod ucing Pos i t i ve Cos t s
Analysing using Total curves
In Chapter 3 , we ha ve discu ssed the concept of cost a nd the s ha pe of the tota l
cost cu rve havin g been dep icted a s s h own by TC in Figure 6 .7. Th e TR curve is
also drawn in th e sam e diagram . The p rofit received by th e firm equa ls th e total
revenue minus the total cost . In the figure, we can see that if quanti ty q1
is
Short Run Equil ibr ium of the Monopolis t w i th
Zero Cost s . The monopolists profit is m aximised
at tha t leve l of output for w hich the total reve nu e is
the maximum .
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produ ced, the total revenu e is TR1
an d total cost is TC1. The differen ce, TR
1 TC
1,
is th e profit received. The s am e is depicted b y the length of th e line segmen t AB,
i.e. , the vert ical distan ce between th e TR an d TC curves a t q1
level of ou tp u t. It
sh ould be clear th at th is vert ical distan ce chan ges for diferent levels of ou tpu t.
Wh en ou tpu t level is less th an q2, th e TC cur ve lies ab ove th e TR curve, i.e., TC is
greater tha n TR, and th erefore profi t is n egative an d th e firm ma kes losses.The s am e si tua tion exists for
ou tp u t levels great er th an q3.
Hence, the firm can ma ke positive
p ro f it s on ly a t ou tp u t levels
between q2
an d q3, where TR cu rve
lies a b ove th e TC cu rve. Th e
monopoly firm will choose that
level of ou tpu t wh ich ma ximises
its pr ofit. Th is would b e th e level
of output for which the vert ical
distan ce between th e TR and TC
is m aximu m a nd TR is a bove the
TC, i.e., TR TC is m aximu m. This
occurs at the level of output q0.
I f t h e d i f fer en ce TR TC is
calcula ted an d drawn as a graph,
it will look as in th e cu rve mar ked
Profit in Figu re 6 .7. It sh ou ld be
noticed tha t th e Profi t cu rve h as
its m aximu m value a t th e level of
o u t p u t q0.
The p rice at which th is ou tpu t is sold is th e price consu mers are willing to pay
for th is q0
qua ntity of th e commodity. So the m onopoly firm will char ge the price
correspon ding to the qu an ti ty level q0
on the deman d curve.
Using Average and Marginal curves
The a na lysis s hown a bove can a lso be condu cted u sing Average and Margina l
Revenu e an d Average an d Margina l Cost . Though a b i t more complex, this
meth od is ab le to exhibit th e process in greater light .
In Figu re 6 .8 , th e Average
Cost (AC), Average Variable Cost
(AVC) and Marginal Cost (MC)
curves are dra wn a long with the
Dema n d (Average Revenu e) Cu rve
an d Mar gin al Revenu e crve.
It ma y be seen that a t quan tity
level below q0, the level of MR is
h igh er th an th e level of MC. This
means that th e increase in tota l
revenu e from s elling an extra u nit
of th e commod ity is greater th an
th e in crea s e in tot a l cos t for
produ cing th e ad ditional u nit. This
imp lies th at a n addit ional u nit of
output would create addi t ional
profits since Change in profit =
Change in TR Change in TC.
Equi libr ium of the Monopo l i s t in t erm s o f th e
Total Curves . The monopolis ts p rofit is ma ximise d
at the level of output for w hich the vertical distan ce
betw een the TR and TC is a maximum and TR is
above the TC.
Equil ibr ium of the Monopolis t in terms of the
Average a nd t he Margina l Curve. The m onopolis ts
profit is maximised at that level of output for w hich
the MR = MC an d th e MC is ris ing.
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Th erefore, if th e firm is pr odu cing a level of ou tpu t less th an q0, it would des ire to
increas e its ou tpu t since th at wou ld add t o its p rofits. As long as th e MR curve lies
above the MC cu rve, the rea son ing provided a bove wou ld a pply and thu s th e firm
wou ld increase its outpu t. This process comes to a h alt when th e firm r eaches a n
ou tpu t level ofq0
since at this level MR equa ls MC and increas ing ou tpu t pr ovides
no increas e in pr ofits.On th e other h an d, if the firm was pr odu cing a level of outp u t which is greater
t h a n q0, MC is greater th an MR. This m ean s th at t he lowering of total cost b y
reducing one u ni t of outpu t i s greater tha n the loss in tota l revenu e du e to this
redu ction. It is therefore advisa ble for th e firm to redu ce outpu t. This a rgum ent
wou ld hold good as long as th e MC cu rve lies a bove the MR cu rve, and th e firm
wou ld keep redu cing i ts outpu t. Once outpu t level reach es q0, th e valu es of MC
an d MR become equa l and th e firm stops redu cing it s ou tpu t .
Since the firm inevitably reach es th e outp u t level q0, th is level is called t h e
equilibrium level of ou tpu t. Since th is equ ilibriu m level of outp u t corresp onds
to th e point where t h e MR equa ls MC, this equ ality is called th e equilibriu m
condit ion for the ou tpu t produ ced by a mon opoly firm .
At th is equ ilibrium level of ou tpu t q0, th e average cost is given by th e point
d where the vertical line from q0
cut s th e AC curve. The a verage cost is th u s
given by th e height d q0. Since total cost equ als th e produ ct of AC an d th e qua ntity
produced being q0, the s am e is given b y the area of th e rectan gle Oq
0d c.
As sh own ea rl ier, once the qu an ti ty of out pu t produ ced is deter mined, th e
price at wh ich i t is sold is given b y the am oun t th at th e consu mers are willing to
pay, as expressed th rough th e ma rket dema nd curve . Thu s, th e pr ice is given
by the point a wher e th e vertical line th rou gh q0
meets the marke t deman d
cu rve D. Th is provides price given by th e height a q0. Since th e price received by
th e firm is th e revenu e per u nit of ou tpu t, it is th e Average Revenu e for th e firm.
Th e total revenu e being the produ ct of AR an d th e level of outp u t q0, can be
sh own as the a rea of the rec tangle Oq0ab .
It can be seen from the d iagram tha t th e area of the rectan gle Oq0ab is larger
tha n th e area of the rectangle Oq0d c, i.e., TR is great er th an TC. The differen ce isth e area of the rectan gle cdab . Th u s, Pr ofit = TR TC which can be represen ted
by this area cdab .
Co m p a r i s o n w i t h P er f ec t Co m p e t i t i o n a g a i n
We compa re th e mon opoly fi rms equ il ibr ium qu an t i ty an d pr ice with th at of
th e perfectly comp etitive firm . Recall th at t h e perfectly com pet itive firm was a
price taker. Given th e ma rket p rice, th e firm in a per fectly com peti t ive m ark et
st r u c tu re b elieved t h at i t cou ld n ot a l ter t h e pr ice by p rodu c in g more of th e
ou tp u t or less of it .
Su ppos e th at t h e firm, whos e equilibriu m we were cons iderin g above, believed
th at it was a p erfectly compet itive firm. Then , given its level of ou tp u t at q0, price
of th e comm odity at a q0 = Ob , i t wou ld expect th e price to rema in fixed a t Ob ,an d th erefore, every addit ion al un it of outp u t could be sold at th at p rice. Sin ce
the cost of produ cing an add it ional u nit , given b y the MC, stan ds at eq0
which is
less tha n aq0, the firm wou ld expect a gain in pr ofit by increasing th e outp u t.
Th is would continu e as long as th e price remained h igher th an th e MC. At the
point f in Figur e 6.8, where th e MC cur ve cu ts th e dema n d cu rve, price received
by th e firm becomes equa l to the MC. Hen ce, it would n o longer be con sidered
ben eficial by this per fectly competitive firm to incr eas e ou tpu t. It is for th is reas on
th at Price = Margin al Cost th at is cons idered th e equilibrium condit ion for th e
per fectly comp etitive firm .
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The diagram sh ows th at a t th is level of outpu t, the qu an tity produced qcis
greater th an q0. Also, the price paid by the con su mers is lower at p
c. From th is we
conclu de th at th e perfectly competitive ma rket pr ovides a produ ction a nd sa le of
a larger quan tity of the comm odity comp ared to a mon opoly firm. Fu rth er th e
price of th e comm odity u n der p erfect competition is lower comp ared to mon opoly.
The pr ofit earn ed b y the p erfectly competitive firm is also s m aller.
In the Long Run
We sa w in Ch ap ter 5 th at with free entry an d exit , perfectly comp eti t ive firms
obta in zero profit s . That was d u e to th e fac t th a t i f profit s earn ed by fi rms were
posi t ive, more fi rms would enter th e mar ket an d th e in crease in outp u t wou ld
bring the p r ice down, th ereby decreasing the ear nings of the exist ing firm s.
Similar ly, if firms were facing losses , som e firms would close down a n d th e
redu ction in outp u t wou ld raise prices an d increase th e earnings of the rem aining
firm s. The sa me is n ot the cas e with mon opoly fi rms. S ince other f irm s a re
prevented from en ter ing th e ma rket , th e profit s ear ned b y monopoly fi rms d o
not go away in th e long ru n.
Som e Cr i t i ca l ViewsTh e resu lts presen ted ab ove portray an extremely n egative picture of th e imp act
of monopoly in a commodi ty market : the monopoly f i rms sole ly benef i t
them selves, a t the cost of consu mers . The m onopoly firm receives a higher
profit an d a p osit ive profi t even in th e long ru n. On th e other ha n d, consu mers
get a lesser qua nti ty of the outp u t an d h ave to pay more for each u nit cons um ed.
However, varying views h ave been expressed by economists concern ing the
ques tion of monopoly. First, it can be ar gued th at m onopoly of the kind d escribed
above cann ot exist in th e real world. This is b ecau se a l l comm odities a re, in a
sen se, su bst itu tes for each other. Th is in tu rn is becaus e of the fact th at al l th e
firms produ cing comm odities, in th e fina l ana lysis, comp ete to obtain th e income
in th e hand s of cons u mers.
Anoth er argu men t is th at even a firm in a pu re mon opoly situ ation is neverwithout competi t ion. This is because the economy is never stat ionary. New
comm odities u sing n ew techn ologies a re always coming up , which are close
substi tutes for the commodity produced by the monopoly firm. Hence, the
mon opoly firm a lways h as comp etit ion in th e long run . Even in the sh ort ru n,
th e threa t of competi t ion is always pr esen t an d th e mon opoly firm is un able to
beha ve in th e man n er we have described ab ove.
Still an oth er view argu es th at th e existen ce of mon opolies m ay be ben eficial
to society. Since m onopoly firm s earn large profits, th ey posses s su fficient fu nd s
to take u p res earch a nd development work, som ething which th e sm all perfectly
competi t ive firm is u n able to do. By doin g su ch r esearch , mon opoly firms are
able to produce bet ter qual i ty goods. Also, because of the more modern
techn ologies which su ch firm s ar e able to u se, their ma rgin al cost m ay be somu ch lower th at th e equilibrium level of outp u t, where MC = MR, may be even
larger th an th at in t he cas e of perfect comp etit ion.
6 .2 OTHER NON-PERFECTLY COMPETITIVE MARKETS
6 .2 .1 Monopol ist ic Com peti t ion
We now cons ider a ma rket stru cture where th e nu mber of firms is large, there is
free en t ry a nd ex it o f fi rms , bu t t h e goods produ ced b y th em a r e n o t
hom ogeneou s. Su ch a m ark et stru ctu re is called mon opolist ic competi t ion.
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This kind of a structure is more commonly visible. There is a very large
nu mb er of biscuit produ cing firm s, for example. Bu t m an y of the b iscu its b eing
produ ced are associa ted with s ome bran d n am e and are dist ingu ish able from
one an other by these b ran d n am es an d p ackaging an d a re s l ight ly different in
tas te. The cons u mer develops a tast e for a part icular br an d of biscu it over t ime,
or becomes loyal to a part icular b ran d for some rea son , an d is, therefore, notimmediately willing to substitute it for another biscuit. However, if the price
difference becomes large, th e consu mer would be willing to choose a biscu it of
another brand. The price difference required for the consumer to change the
bra nd consu med ma y vary. Therefore, if price of a p art icular b ran d is lowered,
som e con su mers will sh ift to cons u ming tha t bran d. Furt h er, lowering of th e
price will lead to more cons u mers sh ift ing to the br an d with th e lower pr ice.
Hence, th e dem an d cu rve faced b y the firm is not h orizont al (perfectly elas tic)
as is the ca se with perfect competi t ion. The dem an d cu rve faced b y the firm is
not th e mar ket deman d cu rve , as in th e case with monopoly. In the case of
m onop olistic comp etition, th e firm expects s m all increa ses in dem an d if it lowers
th e price. Hence, the m arginal revenu e is sligh tly less th an th e average revenu e.
The firm increases its ou tpu t whenever th e mar gina l revenu e is greater tha n thema rgina l cost. But since the m argina l revenu e is lower than the price, th e mar gina l
revenu e becomes equ al to the m argina l cost a t a lower level of outpu t compa red
to per fect comp etition.
For this reas on, th e mon opolistic com petitive firm produ ces lower ou tpu t as
compa red to th e perfectly competitive firm . Given lower outp u t, since con su mers
as a wh ole are willin g to pay more per u n it, the price of th e comm odity becomes
higher tha n th e price un der perfect competi t ion.
The s itu a t ion desc r ibed a bove is one th a t ex is t s in the s hor t ru n . Bu t th e
ma rket s tru ctu re of mon opolist ic competi t ion a llows for new firm s to en ter th e
m ar ket. If th e firms in th e in du str y are receiving posit ive am ou n ts of profit in
the short run, this wi l l a t t rac t new f i rms to s tar t producing the commodi ty
(ent ry into th e ma rket ). As ou tpu t of the comm odity expan ds, p r ices in th e
m ar ket will tend t o fal l t i ll profi ts becom e zero and th ere is n ow no att ra ction
for n ew firm s t o enter. Conversely, if firms in th e indu st ry are facing loss es in
th e sh ort ru n, s ome firm s would stop produ cing (exit from th e ma rket ) th e
comm odity and th e fal l in total qua nt ity produ ced wou ld lead to a h igher price.
En try or exi t would h al t once profi t s become zero an d th is would serve as th e
long ru n equ il ibr ium .
S ince th e deman d of the ou tpu t o f each f irm cont inu es to inc reas e w ith a
fa l l in th e pr ice of it s bra n d, th e lon g r u n equ i libr iu m cont in u es to be
as socia ted wi th a lower level of tota l ou tpu t an d a h igh er pr ice as comp ared
to perfect comp eti t ion.
6 .2 .2 How do Firms behave in Oligopoly?
If th e ma rket of a pa r t icu lar comm odity cons ists of more th an one se l ler bu tth e nu mb er of se l lers i s few, the m ark et s t r u ctu re i s termed oligopoly. The
sp ecial cas e of oligopoly wher e th ere ar e exactly two sellers is ter m ed du opoly.
In a na lys ing th is m arke t s t ru c ture , we assu me tha t the p rodu c t so ld by the
two firm s is homogeneous a nd th ere is n o sub sti tu te for the produ ct, produ ced
by an y other firm .
Given t ha t th ere are a few firms, th e outp u t decisions of an y on e firm wou ld
necess ari ly affect the ma rket price an d th erefore the am oun t sold by th e oth er
firm s as also th eir total revenu es. It is, th erefore, only to be expected th at other
firm s would react to protect th eir profits. This reaction wou ld be th rou gh tak ing
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fresh decisions abou t th e qua nt i ty and pr ice of thei r own outpu t . There are
various ways in which th is can be th eorised. We briefly explain two of th em.
First ly du opoly firms ma y collude together a nd decide n ot to compete with
each oth er an d m aximise total profi ts of th e two firm s together. In s u ch a ca se
th e two firms would beh ave like a s ingle m onopoly firm th at ha s two different
factories p rodu cing th e comm odity.Secondly, take t he ca se of a d u opoly wh ere each of th e two firms decides
how mu ch qu an t ity to produ ce by maximising i t s own profit as su ming that the
other firm wou ld n ot chan ge th e qua n ti ty th at i t is s u pplyin g.
We can exam ine th e imp act u sing a simp le exam ple where both t he du opolist
firms h ave zero cost . A similar si tu ation in t h e cas e of m onop oly was earl ier
considered in The Simp le Case of Zero Cost in s ection 6 .1.4. Recall th at in th at
case we were able to show that given a s t ra ight l ine demand curve , the
maximum qua nt i ty deman ded by the consu mers was 20 u n i t s a t zero pr ice,
an d th is wou ld ha ve been th e equi libr ium in case of a perfect ly comp et it ive
mark e t s t ru c ture . G iven a monopoly s t ruc tu re , t he qua nt i ty su ppl ied was 10
un it s a t a p r i ce o f Rs 5 . It can be sh own tha t whenever the dema nd curve is a
st ra ight l ine an d tota l cost is zero, the mon opolis t find s it m ost p rofitab le tosu pply ha lf of the m aximu m deman d of the good. Let us u se th e sam e exam ple
to examine th e outcom e in ca se th ere were two duop oly firms , A an d B beh avin g
in the m an ner desc r ibed a bove .
Ass u me th at Firm B s u pplies zero un its of th e good, then Firm A realizing
that maximum demand is 20 units, would decide to supply half of i t , i .e . 10
u n its. Given th at Firm A is s u pplying 10 u nits, Firm B wou ld rea lize th at ou t of
the m aximu m deman d of 20 u ni ts , a deman d of 10 u ni ts (i. e. 20 m inu s 10 ) s t i ll
exists an d h ence would su pply half of it , i.e . 5 un its. Since firm B h as cha nged
its s u pply from zero to 5 un its, Firm A wou ld rea lize th at th e total deman d is 15
u nits (i .e . , 20 m in u s 5) an d su pply h alf to it , i.e ., 7.5 u n its. In th e fas hion, th e
two firms would keep making moves. It can be shown that these lead to an
equilibrium . Let us examine thes e steps:
S tep Fir m Q u a n tit y S u p p lied
1 B 0
2 A12
20 =202
3 B12
(20 12
20 ) =202
2 04
4 A12
(20 12
(20 12
20 )) =202
204
+208
5 B12
(20 12
(20 12
(20 12
20))) =202
204
+2 08
2016
An d so on.
Therefore both th e firms wou ld finally su pply an ou tpu t equa l to
202
204
+208
201 6
+2032
206 4
+2 0
12 8... =
203
The tota l qu an t ity supp lied in the m arket equa ls th e su m of the qu an t ity
su pplied by th e two firms is
203
+203
= 2 203
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which is greater tha n th e quan tity su pplied un der a monopoly ma rket stru cture
and less than the quanti ty supplied under a perfectly competi t ive structure.
Sin ce p r ice d ep en d s on t h e qu a n t i ty s u p p l ied b y th e form u la
p = 10 0.5q, for q =403
, price is 1 0 2 03
= Rs 3 .33. This is lower th an the p rice
u nder monopoly and higher than u nder perfect compet it ion.Even in the case where there are posi t ive costs , the mathemat ics only
becomes m ore comp lex, bu t th e resu lts a re s imi lar . Tha t th rou gh a very large
number o f moves and counte rmoves , the two f i rm reach an equi l ib r ium
qu an ti ty of total ou tpu t. Th e qua nt ity produ ced by both firm s togeth er is m ore
tha n wha t a pu re m onopoly wou ld ha ve p rodu ced a nd le sse r tha n tha t
produ ced i f the ma rket s t ru ctu re was perfect ly comp et it ive. The equi libr iu m
ma rket pr ice is n atu ra l ly lower tha n in th e case of pu re mon opoly and higher
tha n u nd er perfect compet i t ion.
Thirdly, some econom ists a rgue th at oligopoly ma rket str u ctu re mak es th e
ma rket price of th e comm odity rigid, i.e . the ma rket price does n ot m ove freely
in respon se to chan ges in d ema nd . Th e reason for th is lies in the way in wh ich
oligopoly firms rea ct to a ch an ge in price initiated b y an y firm. If one firm feelsth at a price increa se would genera te higher p rofits, an d th erefore increas es th e
price at wh ich i t sel ls i ts ou tpu t, other firms do n ot follow. The price in crease
wou ld therefore lead to a hu ge fal l in th e qu an ti ty sold by th e firm leading to a
fall in its revenu e an d pr ofit. It is th erefore n ot rat ion al for an y firm to increa se
the pr ice. On th e other ha nd , a firm ma y est ima te that it could earn a larger
revenu e an d p rofi t by sell in g a larger qua nt ity of outp u t a nd th erefore lowers
th e price at which it sells th e comm odity. Other firm s wou ld p erceive th is action
as a th reat an d t herefore follow the first firm an d lower th eir p rice as well . The
increase in t he t otal qua nt ity sold du e to the lowerin g of price is th erefore sh ared
by all the firms, a nd th e firm th at ha d initially lowered th e price is able to ach ieve
only a s m all in crea se in th e qu an tity it s ells. A relatively large lowerin g of price
by th e first firm leads to a r elat ively sm all in crease in th e qu an ti ty sold. Thu s,th is firm experiences a n inelast ic dema nd cur ve an d i ts decision to lower price
lead s to a lowering of its revenu e an d p rofit. Any firm th erefore fin ds it irra tion al
to cha n ge th e prevailing price, leadin g to prices th at a re more rigid comp ar ed to
perfect competition.
The ma rket stru ctur e called monopoly exists where there is exactly one seller
in a ny market .
A commodity ma rket ha s a mon opoly stru ctu re, if there is one seller of the
comm odity, the commodity has no su bst i tute , and en t ry into the indu st ry
by an other firm is p revented.
The market pr ice of the comm odity depends on the amoun t supp lied by the
mon opoly firm . The ma rket d eman d cu rve is th e average revenu e cur ve for
th e mon opoly firm.
The sha pe of the tota l revenu e cu rve depends on th e shape of the average
revenu e cu rve. In th e cas e of a n egatively sloping stra ight line d ema nd cur ve,
th e total revenu e curve is an inverted vertical para bola.
Average revenu e for any quan ti ty level can be mea su red by the slope of the
lin e from th e origin t o the relevan t point on th e total revenu e cur ve.
Margina l revenu e for any qu an tity level can be meas u red by th e slope of the
tan gent a t the relevan t point on the total revenu e curve.
Summary
Summary
Summary
Summary
Summary
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KKKKKeyCo
ncepts
eyConcepts
eyCo
ncepts
eyConcepts
eyConcepts Monopoly
Mon opolist ic Compet ition
Oligopoly.
Exercises
Exercises
Exercises
Exercises
Exercises 1 . Wha t wou ld be the s ha pe of the dem an d cu rve so that th e total revenu e curve is
(a) a posit ively sloped straight l ine passing through the origin?
(b) a horizontal l ine?
2 . From the schedule provided below calculate the total revenue, demand curve
and the price elasticity of demand:
3 . What is the value of the MR when the demand curve is elastic?
4 . A monopoly firm has a total f ixed cost of Rs 100 and has the following
dem and schedu l e :
Find the shor t run equi l ibr ium quant i ty, pr ice and total prof i t . What would be
the equ ilibr ium in th e long run ? In ca se th e total cost was Rs 1 000, descr ibe the
equi l ibr ium in the shor t run and in the long run.
The average revenu e is a declin ing cu rve if an d only if th e valu e of th e marginal
revenu e is lesser tha n the a verage revenu e.
The steeper is the negatively sloped dema nd cu rve, the fu rth er below is the
ma rgina l revenu e cu rve.
The deman d curve is elast ic when ma rgina l revenu e has a posit ive value, an d
inelast ic when the m argina l revenu e ha s a n egative value.
If the mon opoly firm h as zero costs or only ha s fixed cost, the qua ntity su pplied
in equilibrium is given by the point where marginal revenue is zero. In
contra st, perfect competition would su pply an equ ilibriu m qu an tity given b y
th e poin t where average reven u e is zero.
Equ i libr iu m of a m onop oly fi rm is def in ed as th e poin t where MR = MC
an d MC is r i s ing. Th is p oin t provides th e equi libr iu m qu an t i ty produ ced.
Th e equ i l ib riu m p rice is p rovid ed by th e d em a n d cu rve given th e
equ il ibr iu m qu an ti ty.
Posit ive sh ort ru n profit to a mon opoly firm continu e in th e long ru n.
Monopolistic competition in a commodity ma rket arises du e to the comm odity
being n on-homogenous .
In monopolis t ic compet it ion, the short run equi libr ium resu lts in qua nt i ty
produ ced be ing l e sse r an d pr i ces be ing h igher comp ared to pe r fec t
compet it ion. This s itu at ion persis ts in th e long ru n, bu t long ru n p rofit s
are zero.
Oligopoly in a commodi ty ma rket occurs when there are a smal l nu mber of
firm s produ cing a h omogenou s comm odity.
Q u a n t it y 1 2 3 4 5 6 7 8 9
Ma rgin a l Reven u e 10 6 2 2 2 0 0 0 -5
Q u a n t it y 1 2 3 4 5 6 7 8 9 1 0
Pr ice 1 00 9 0 8 0 7 0 6 0 5 0 4 0 3 0 20 1 0
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5 . If the monopolist f irm of Exercise 3, was a public sector f irm. The government
set a ru le for i ts ma na ger to accept t he govermen t fixed pr ice as given (i .e. to be
a price taker and therefore behave as a f irm in a perfectly competit ive market) ,
and the government decide to set the pr ice so that demand and supply in the
market are equal. What would be the equilibrium price, quantity and profit in
th i s case?
6 . Comment on the shape of the MR curve in case the TR curve is a ( i) posit ively
sloped straight line, (ii) horizontal straight line.
7 . The market demand curve for a commodi ty and the total cost for a monopoly
fi rm pr odu c ing the com m odi ty is g iven by th e sch edu l es be low. Use th e
information to calculate the following:
(a) The MR and MC schedules(b) The quant i tes for which the MR and MC are equal
(c) Th e eq u i l ibriu m qu a n t i t y of ou tp u t a n d th e eq u i l ibriu m p rice of th e
commodi ty
(d) The total revenue, total cost and total profit in equilibrium.
8 . Will th e mon opolist firm continu e to produ ce in th e sh ort ru n if a loss is incu rred
at the best shor t run level of output?
9 . Explain why the demand curve facing a f irm under monopolist ic competit ion is
negatively sloped.
1 0 . Wha t is th e r eas on for t h e long ru n equ i libr iu m of a f irm in m onop ol ist ic
competit ion to be associated with zero profit?
1 1 . List the three different ways in which oligopoly firms may behave.
1 2 . I f duopoly behaviour i s one that i s descr ibed by Cournot , the market demandcurve is given by the equation q = 200 4p, and both th e firms ha ve zero costs ,
f ind the quant i ty suppl i ed by each f i rm in equi l ibr ium and the equi l ibr ium
market pr ice.
1 3 . What is meant by prices being rigid? How can oligopoly behaviour lead to such
an outcome?
Q u a n t it y 0 1 2 3 4 5 6 7 8
Pr ice 5 2 4 4 3 7 3 1 2 6 2 2 1 9 1 6 1 3
Q u a n t it y 0 1 2 3 4 5 6 7 8
Tota l Cos t 1 0 6 0 9 0 1 00 1 0 2 1 0 5 1 0 9 11 5 1 2 5
