Monopoly and Price discriminationDefinition and Meaning of Monopoly:

“Monopoly” means absence of competition. It is an extreme

situation in imperfect competition. It denotes a single seller or

producer having the control over the market. A monopoly may be

defined as a condition of production in which a single person or a

number of persons acting in combination, having the power to fix

the price of the commodity. The commodity produced by the

monopolist has no substitutes. It is a situation where there

exists single control over the market producing a commodity having

no substitutes and no possibility for anyone to enter the industry

and compete. Single control may mean a single producer or a joint

stock organization or any organization, governmental or Quasi

governmental.

Monopolistic firm should have certain features to be identified as

such. They are;

1) It has single seller.

2) The commodity produced should not have any close substitutes.

3) No freedom to other entrepreneurs to enter and compete with

the existing seller.

4) The monopolist may use his monopolistic power in any manner

in order to realise maximum revenue. He may adopt price

discrimination.

Since there is only one seller the distinction between the firm

and industry disappears in monopoly. The firm becomes the

industry itself.

Kinds of monopoly:

1

1

Monopoly may be of different types. It may be private monopoly,

public or state monopoly, simple monopoly, discriminating

monopoly, absolute and limited monopolies.

Private and public monopolies:

When monopolistic control exists in private sector, we call

it as private monopoly. If the state controls the production and

pricing of the commodity it is public or state monopoly. Many of

the public sector undertakings come under this category.

Pure monopoly:

It is a phenomenon which exists only in public sector.

Production of a particular commodity will be the exclusive

privilege of the state or state sponsored undertaking.

Simple monopoly

There are larger possibilities of simple monopoly in the real

world. It is a situation where the single producer produces a

commodity having only a remote substitute. In pure monopoly there

are no substitute commodities for the product produced by the

monopoly firm. But in simple monopoly the producer of the firm

may have some substitute. But in economic theory and analysis we

assume that the monopoly firm produces a commodity having no close

substitutes.

Discrimination monopoly

The monopolist may charge different prices for different

customers or markets. He has not only the power to fix the price

of the commodity but also charge different prices for different

customers. The monopolist will be discrimination between the

markets.

Determination of price in monopoly

2

2

O utput

X O M 2

D K

Price

Y

K2

M

D

R

R 2

It would be a mistake to suppose that the monopolist will

always push up his prices higher and higher. If he does so, he

must consider the effect of such a procedure on demand which will

shrink as price rise. The monopolist cannot compel the consumer

to buy at higher prices. A very important point to be borne in

mind is that unlike competitive firm, a monopolist firm will have

a downward sloping demand curve and his average revenue will fall

as the output is increased, because the buyers will take up larger

quantities only at lower. The monopolist can charge a higher, but

he will sell less. If he wants to sell more, he has to lower his

price.

In the diagram, DD is the demand curve. According to this

diagram, the monopolist cannot for example fix his output at one

and expect to be able to sell at OK2 price per unit. If he

decides to fix the price at OK2 the output has to be automatically

fixed by him at OM2, because at OK2 price he can sell only OM2

units. Out of any number of possible prices, the monopolist3

3

endeavors to choose that price which yields here the highest net

monopoly revenue. Net monopoly revenue is the profit realized by

the monopolist by selling the commodity at a particular price.

Price determination under monopoly depends on two factors.

The nature of demand for the commodity produced by the monopolist

and the cost of production of the commodity. If the demand for the

commodity is inelastic the prices may be raised without the demand

being appreciably curtailed in consequence. If the demand for the

commodity is very elastic and increased price will lead to

decrease in sales and the revenue will be less. On the cost side,

if the monopolist is producing under increasing returns or

decreasing costs he can produce larger amount of commodity at

lower cost and sell it at lower price. If the commodity has

elastic demand and it is produced under diminishing cost, the

interest of the monopolist will be better served if he fixes the

price at a low level. If on the other hand, the commodity has

inelastic demand and it is produced under increasing cost or

diminishing returns, the price can be fixed at a higher level, by

doing so, the sales will not diminish much even if it reduces a

little, the output at that reduced level will cost here less. In

the case of commodities subject to the law of constant returns or

cost, the monopolist can exclusively concentrate his attention on

the demand side, since there are no changes on cost which

indicates only the lower limit to the price to be fixed according

to the elasticity or inelasticity of demand. If the demand is

elastic, price will be low, if inelastic, prices will be high.

Thus in all cases of monopoly prices, the monopolist carefully

weigh two main considerations nature of demand or average revenue4

4

realized and the expenses of production or cost of production per

unit. But in all cases, the price will be fixed in such a way that

the net monopoly revenue is maximum. We can illustrate the

fixation of monopoly price with the help of a sample schedule.

Output in

units

Cost per

units in

Rs

Total Cost

in Rs.

Price /

Unit

Total

Revenue in

Rs

Net

Monopoly

revenue

1000 5 5000 30 30000 250002000 7 14000 25 50000 360004000 10 40000 20 80000 400008000 15 120000 16 128000 8000

The maximum profit or the net monopoly revenue will be

realized when the output is 4000 units at this level the net

monopoly revenue is maximum, that is, Rs 40000.

Price – Output determination or monopoly equilibrium

In monopoly the average revenue curve will slope downwards.

Further the marginal revenue per will also be falling and it will

be steeper occupying a low level than the AR curve. The reason is

since the AR is falling the extra units sold will be fetch less

and lesser revenue in the market. In the case of perfect

competition, both AR and MR is the same horizontal line parallel

to X access and equal to the price. But in monopoly, this is not

so. The AR curve will be at a higher level sloping down, the MR

curve will be at a lower level sloping down.

The principle of profit maximization is the same as that of

perfect competition. The monopolist will maximize his net monopoly

5

5

revenue by keeping the marginal cost and the marginal revenue at

the same level. The following diagram illustrate monopoly

equilibrium and price fixation.

Where,

AR = Average Revenue

MR = Marginal Revenue

AC = Average Cost

MC = Marginal Cost

OM = Equilibrium Output

OP = Price

E = Equilibrium point where

MR = MC

PQRS = Net Monopoly Revenue

6

6

Output

AR

AC

MC

MR

E

MO

Y

X

Q

R

P

S

Profit

With the AR curve falling and MR curve falling below it and cost curve,

the Monopolist comes to the equilibrium at the point E where MR = MC and

produces OM units of the commodity fixing the price at OP. at this price an

output the monopolist realizes the maximum profit shown by the shaded area

PQRS. In the diagram at OM output the Marginal revenue is greater than the

marginal cost, but beyond OM, Marginal revenue is less than marginal cost. So

equilibrium output is OM. This output OM can be sold in the market at a price

OP according to the demand curve (AR curve). At this level of out put the

difference between average cost and average revenue is QR. The total profit

is PQRS.

The monopolist firm has come to equilibrium and it is earning maximum

profit. The equilibrium fall a short period is also for a long period under

monopoly as there will not be any competitor entering the field.

Price discrimination

Price discrimination means the practice of selling the same commodity at

different prices to different buyers. Under monopoly the producer usually

restricts output and sells it at a higher price, thereby making maximum

profit. If the monopolist charges different prices from different customers

for the same commodity, it is called price discrimination or discriminating

monopoly. The idea is to get from each customer whatever profits could be

squeezed out of him depending on his ability to pay and intensity of demand.

When a seller charges Rs.20 for a commodity from a customer A and Rs.22 for

the same commodity from customer B, he is practicing price discrimination.

Joan Robinson defines price discrimination as, “the act of selling the same

article produce under a single control at different prices”. Price

discrimination may also be defined as, “the sale of technically similar

products at prices which are not proportional to marginal cost”.

Types of price discrimination

There are different types of price discrimination. They are

1. Personal discrimination: in personal discrimination, the monopolist will

charge different prices from different customers on the basis of their ability

to pay. Rich customers will be asked to pay more and poor customers to pay

less. This is possible in specialized personal services of doctors and

lawyers. If it is a commodity the discrimination will not be done openly but

in a disguised manner. For e.g. the book of a famous Author can be sold in the

market at different prices to different class of customers – deluxe edition is

higher than the popular edition at a considerably lower price. Though the cost

of producing deluxe edition is higher than the popular edition, the price

fixed for the former will be very high than the price fixed for the latter.

The content of the book is the same for which different customers pay the

different prices. The deluxe edition will command a market among the richer

class and it will have prestige value. Thus personal discrimination can be mad

by making some superficial changes.

Similar principle of personal discrimination adopted in railways or transport

organization. The upper class passengers pay more than the lower class for

the same services rendered.

2. Place discrimination: monopolist having different markets in different

regions may charge different prices for the same commodity in the different

regions or localities. The locality in which his market is situated will be

the criteria in fixing up the price. Suppose a monopolist has a shop in an

aristocratic locality and also in a slum. He will charge higher prices in the

former shop and lesser price in the slum shop on the understanding that

aristocrats will not go for shopping in the slum. Generally the extra price

charge in an aristocratic locality will not be felt by the customers as this

shop would cater to their extra needs such as ‘drive - in‘ facility, ‘door -

delivery’ etc. sometimes the monopolist may charge lower prices in a foreign

country than in the home market. This is also place discrimination. This

method is adopted for “dumping” the goods in the foreign markets

3. Trade discrimination: this can also be called ‘use discrimination’. By

this method, the monopolist will charge different price for the same

commodity for different types of users to which the commodity is put to.

For instance, electricity will be sold at cheaper rates for industrial

establishments and charged at a higher rate for domestic consumption.

Similarly accessories like small springs, bolts, nuts, etc will be

charged at a higher price for automobiles and a lower price when the

same material is used for bicycles and for domestic purposes.

Degrees of price discrimination:

Prof. A.C. Pigou has distinguished between three types of price

discrimination on the basis of the degree or extent of price

discrimination. Under price discrimination of the first degree, the

producer exploits the consumer to the maximum possible extent by asking him

to pay the maximum he is prepared to pay rather than go without the

commodity. This type of price discrimination is called perfect

discrimination

In the price discrimination of the second degree, the markets are

divided on the basis in each market the lowest price, which the poorest

member of the group are prepared to pay will be charged in that market for

all consumers.

It is price discrimination of the third degree which has been commonly

practiced by monopolist. In this case the markets are divided into many

submarkets and in each submarket, the price charged will not be the minimum

price but the price depending on the output and demand of that market. With

the quantum output on hand which is fixed the monopolist will fix the

X O M Quantity

Price

Y

P3

P2

P1 D1 M kt - I

D2 M kt - II

D3 M kt - III

prices in each submarket on the basis of the demand curve in each. This is

illustrated in the following diagram.

The market demand curve is

broken up into demand curves for

three separate markets or sub

markets under monopolist

control. Assuming that the

monopolist is selling in each

market the same quantity OM,

he will charge a price OP, in market

I represented by demand curve

D1.The price market II will be OP2

and in the market III OP3 as shown in the diagram. When a producer

undertakes “dumping” and charges for the same commodity one price in one

country and different price in another country, it is also a case of price

discrimination of the third degree.

Pricing under discriminating monopoly:

Under simple monopoly the producer will charge the equilibrium price on

the basis of total output and the marginal revenue and marginal cost will

decide the equilibrium of the monopoly firm. In order to discrimination

prices, the entire market will be divided into sub-markets on the basis of

the elasticity of demand for the product. Only if the elasticity of demand is

different, price discrimination will be profitable. After dividing the

market, the producer has to decide the supply for each submarket. Here the

decision of out put for each sub – market depends on the equilibrium

condition of each sub-market with the total cost condition and the revenue

curves of the sub-market. The monopolist should decide two things on the

basis of his cost and revenue curves.

Y

O X M 1

Price

Q uantity

AR 1 M R 1

P1

E1

Y

O X M 2 Q uantity

AR 2 M R 2

P2 E2

Y

O X M Q uantity

AAR AM R

E

M C

Sub M arket - A Sub M arket - B Total M arket

1. how much the total output should produce

2. How the total output should be shared between the sub-markets and what

prices should be charged in each of his sub-market.

For sake of simplicity, we shall take that a monopolist device his market,

into sub-markets A and B and finds the AR curve different in these two. The

following diagram illustrates the revenue curves of the two sub-markets A and

B and the aggregate situation in the entire market under his control.

The sub-

market A

given on the

extreme left

AR, is the

demand curve

or the

average revenue curve of the market. In sub-market B it is the demand curve

or the average revenue curve of the market. Note that the elasticity of

demand in these two sub-market are different. In sub-market A the demand

curve show inelastic in nature and in sub-market B the curve shows the

elastic in nature. The two sub-markets respective marginal revenue curves are

shown as MR1 and MR2 .which lie below the average revenue curve of the

respective sub-market. The figure on the extreme rite shows the total market

where the aggregate conditions of the revenue curves are shown. The total

average revenue curves of the two sub-markets have been shown in the total

market as AAR. Similarly, the aggregate of the two marginal revenue curves of

the sub-markets has been shown as AMR. According to the figure AR1 + AR2 =

AAR. MR1+MR2=AMR combined at various levels of output. Since the output is

under single control the marginal cost curve in the aggregate figure. MC in

the total market shows the marginal cost for the entire production. The level

of production is determine at the point where MR=MC. In the total market the

aggregate MR curve cuts the MC curve at E and the total output is determine

at OM for the two sub-markets. How much of OM goes to each of these markets

is found out by drawing from E a line parallel to X-axis. This line

indicating marginal cost of output cuts the marginal revenue curves of the

sub-markets at E2 and E1. at the point E1 the marginal revenue of the sub-

market A and the marginal cost of production are equal. So the equilibrium

condition in sub-market A lies at E1 where the quantity of commodity should

be OM1. Similarly the equilibrium point in sub-market B lies at the point E2

where the marginal cost level meets the marginal revenue level of that sub-

market. The corresponding quantity of the commodity in sub-market B is OM2.

Therefore quantity OM will be sold in sub-market A and quantity OM2 in

the sub-market B. At the equilibrium point E1 in sub-market A the price of

the commodity will be P1M1 as at the level of equilibrium output the average

revenue is P1M1. In submarket B, at the equilibrium output the average

revenue P2 M2. So, the price of the commodity in that sub-market will be P2M2.

Thus the monopolist producing OM quantities in sub-market A at a priceP1M1. He will sell OM2 quantity in sub-market B at a price P2M2. in the figure

price is higher in sub-market A and lower in B. It has discriminated the two

and charges different prices for the same commodity.

Price discrimination under dumping.

The monopolist producer having monopoly power in the domestic market may

not have it in the world market, where he has face lot of competition

approximately to perfect competition. So, a monopolist has to discriminate

between the domestic market and the world market. In the world market the

producer has to keep the prices decided on the basis of perfect competition.

While he can keep the price at a higher level in the home market. If the

Y

O X

E1 E

M M 1

PW PH B

Price

and Cost M C

D ARW = M RW

O utput

ARH M RH

producer charges a lower price in the world market than in the home market,

he said to be dumping in the world market.

How will the monopolist discriminate between the home market and the

world market and decide price output equilibrium. In the home market he will

face falling revenue curve or demand curve. In the world market since it is

perfect competition the revenue or demand curve will be straight line

parallel to X-axis. In the home market, demand is inelastic while in the

world market it is elastic. The condition of equilibrium and price

discrimination is illustrated in the diagram

NC=Marginal Cost Curve

ARW=Average Revenue Curve of the World market

MRW=Marginal Revenue Curve of the World market

ARH/MRH=Average Revenue and Marginal Revenue of Home market.

The average revenue curve for the world market and the marginal revenue

market curve are the same. We have to find out equilibrium output where the

Marginal Cost Curve cuts the aggregate marginal revenue curve of the world

market and home market. The marginal revenue for world market is MRW: for the

home market it is MRH in the figure. The aggregate position of the aggregate

MR curve is represented by the curve BKED which is the summation of MRW and

MRH. This aggregate MR curves cut the MC at E. which is equilibrium position

where the output is OM unit. Now how much of this quantity goes to home

market? The equilibrium E where extended to MRH meets at E1 showing the

equilibrium point for the home market. At this point the output is OM1. So

the monopolist will produce OM units of the commodity and sells OM1 units in

the home market and sells M1M units in the world market. At the equilibrium

point position of output the price of the home market is OPH and the

equilibrium point position of output the price in the world market is OPW.

Thus the monopolist sells OM quantity at the price OPH in the home and

sells M1M in the world market at a price OPW, which is less than the price

charge at home. This practice is called dumping.

Monopolistic Competition

Perfect competition is the extreme of perfection on the nature of

competition while monopoly is the other extreme where there will not be any

competition at all in production and selling by rival firms. There are two

different extreme can be concerned only in theory. But in practical world we

cannot meet a situation of either perfect competition or complete monopoly,

the market forms will be really between the two extremes exhibition both

monopoly and perfect competition.

Monopolistic competition is a term which is used interchangeably with perfect

competition, as it describes a condition of imperfection.

Assumption and features of monopolistic competition

Monopolistic competition, as the name itself implies, is a blend of

monopoly and perfect competition. It refers to the market situation in which

many producers produce goods which are close substitutes of one another. But

there will be some differentiation to identify it with the firms, and that

particular brand of consumers. In this respect each firm will have some

monopoly at the same time the firm has to compete in the market will other

firms as they produce close substitutes. The essential feature of

monopolistic competition is produce differentiation and existence of many

firms supplying the market.

The main features of monopolistic competition are;

1. Existence of large number of firms :

Under monopolistic competition the number of firms producing a commodity

will be very large. The term very large denotes that the total demand of the

product is small. Each will be acting independently on the basis of product

differentiation and each firm determines its price output policies. Under

these conditions the firms are bound to be small sized. Any acting of the

individual firm in increasing or decreasing the output will have little or no

effect on other firms.

2. Product differentiation:

Product differentiation is the essence of monopolistic competition.

Many firms popularize their products stressing on the special features of

their products and the customers are made to feel that there are differences.

In the production of soaps, cigarettes, cosmetics etc. different firms

producing the same commodity differentiate their product for instance, many

firms produce toilet soaps. Any toilet soap is a substitute for the toilet

soap produced by different firms. But by popularising a particular brand

with specific aroma, size, shape, colour, the firm captures a portion of the

market and the consumer will become used to that brand. In this way the

producer exhibits monopolistic power over his loyal customers. Greater the

product differentiation, greater will be the element of monopoly for the

firm.

Product differentiation can be brought about in various ways. It may be

by using different quality of the raw material, different chemicals and

mixtures used in the product. Difference in workshop, durability and

strength will also make product differentiation. Product differentiation may

also be effected by offering customers some benefits with the sale of the

product facilities like free servicing home delivery, acceptance of returned

goods, etc would make the customers demand that particular brand of product.

Product differentiation through effective advertisement is another method.

This is known as sale promotion. By frequently advertising the brand of the

product through press, film, radio and television, the consumers are made to

feel that the brand produced by the firm in question is superior to that of

other brands sold by other firms. Thus, product differentiation is attempted

through

a) physical difference

b) quality difference

c) imaginary difference

d) purchase benefit difference

The ultimate aim in product differentiation in product differentiation

is to capture a large number of customers to the firm’s product and advance

monopolistic interest in the midst of large number of firms competing

3. Selling costs:

Because of product differentiation we can infer that the producer under

monopolistic competition has to incur expenses to popularize his brand. This

expenditure involved in selling the product is called “Selling Cost”. Most

important form of selling cost is advertisement. Sales promotion by

advertisement is called non-price competition.

4. Freedom of entry and exit of firms :

Another important feature is the freedom for any firm to enter into the

field and produce the commodity under his own brand name and any firm can go

out of the field if it so chooses. Monopolistic competition presupposes that

customers have definite preferences for particular varieties or brand of

products. Hence pricing is not the problem but product differentiation is

the problem and competition is not prices on products.

Thus in monopolistic competition the features of monopoly and perfect

competition are partially present.

Price determination under monopolistic competition

Price-output determination under monopolistic competition is governed by

the cost and revenue curves of the firm. The cost curves are governed by

laws of production. The revenue curves of the firm will not be very elastic,

to be parallel to x-axis as in monopoly. The average revenue curve of the

firm under monopolistic competition will be a sloping down curve, the sloping

being neither too steep nor too flat. It will not be flat or parallel

straight line because the firm may not have very elastic demand for its

product. The product is not homogenous but slightly different from that of

other firms. The firm cannot sell unlimited quantities at the established

prices as the products of other firms are close substitutes if not perfect

substitutes. The curve will not be too steep because the demand under

monopolistic condition will be much more sensitive to small changes in price

as any fall in price could ensure more customers using the substitute product

of other firms, similarly any rise in price will drive out many customers

from the firm to go demanding other firms product. Thus under monopolistic

competition the AR curve will be fairly a sloping down curve and MR curve

will be below it.

Equilibrium of the individual firm:

The monopolistic competitive firm will come to equilibrium on the same

principle of equalizing MR and MC. Each firm will choose that price that

Y

O X M

S P

Price

Output

AR M R

R Q

Profit SM C SAC

Y

O X

Price

and Cost

O utput

AR M R

Q 1

Loss SM C SAC

R1 P1 S1

E1

price and output where it will be maximizing its profit. The following

diagram shows the equilibrium of the individual firm in short period.

The short period marginal cost and

average cost curves are shown as SMC

and SAC. The sloping down average

revenue and marginal revenue curves are

shown as AR and MR. The equilibrium

point is E where MR equals MC. The

equilibrium output is OM and the price

is fixed OP. The difference between average cost and average revenue is RQ.

The output is OM. So, the supernormal profit for the firm is shown by the

rectangle PQRS. The firm by producing OM units of its commodity and selling

it at a price of OP per unit realizes the maximum profit in the short run.

Firms may also incur loss also which can be indicated in the following

diagram.

With the revenue curves and cost curves

the firm comes to equilibrium at E1

where MR equals MC. At this point the

firm is making the minimum loss P1Q1R1S1

shown by the shaded rectangle. The

price is P1. The firm incurs loss in

the short run because average cost is

high than average revenue.

The different firms in monopolistic competition may be making either

abnormal profits or losses in the short period depending on their costs and

revenue curves. The price of the commodity of the different firms will be

different because the firm adopt individual price policy. Based on consumer

preferences of the product of the firm and the cost of production each firm

will be fixing its price which may be different from the price of other

firms. Old and long standing firms with established customers and goodwill

will find high price advantageous. The technique of production due to long

experience may result in the cost position very comfortable. So, established

firms will be making abnormal profits in the short period. Newly started

firms may have to fix the price at a lower possible level to establish

themselves. The profit may not be very high. It may even result in loss at

the initial stages. Thus in monopolistic competition firms may be making

abnormal profit, normal profit or loss in the short period. Firms making

losses will keep the loss out at minimum and try to cover the average

variable cost.

Group equilibrium in the long period

Group equilibrium means price-output adjustment of a number of firms,

instead of an individual firm, whose products are close substitutes. The

different firms in a group adopt independent price-output policies because of

their monopolistic position with reference to the peculiarity of the product.

Where it should be remembered that product is a close substitute of other

firms. In the short run when firms make huge profit, the tendency will be for

the new producers to enter the field. But the difficulty of finding out the

group equilibrium arises out of diversity of conditions of various firms

constituting the group. Each firm in its own way carters the specific tastes

and preferences of the group consumers. So, each firm will have different

demand curves and cost curves depending on their efficiency

Chamberlin solved the difficulty by making some heroic assumption of

uniformity to arrive at the long run equilibrium of the group.

1. The firms competing in the group are producing more or less similar

products

2. The firms competing have equal share of the market demand which

means that the shape of the AR curve will be the same for all

3. All firms have equal efficiency in production and therefore the

cost curve are similar and

4. The numbers of firms are fairly large and each firm regards itself

as independent in the group. This assumption of chamberlain

actually boils down to the conditions of the perfect competition

with minor differences.

The abnormal profit earn in short period will attract new comers to the

group. The new comers will fix lower prices than the prices charged by the

existing firms. This will compel the existing firms to reduce the prices. As

a result of such a keen competition, price will fall. Consequently the AR

curve will shift to a lower position. The AC curve will shift to a higher

position due to increased demand on factors of production. This distance

between AR and AC will be narrowed down and the abnormal profits will be

removed. Ultimately the firms will earn only normal profits. The group

equilibrium in the long run under monopolistic competition is shown below.

Y

O X

Price

and Cost

O utput

LPAR LPM R

LPM C LPAC

P

M

K

E

LPAR and LPMR indicate the long period average and marginal revenues.

LPMC and LP AC show the long period marginal and average cost curves. The

point E is the equilibrium where marginal revenue equals marginal cost and

the output is OM. At the equilibrium output the average revenue or the price

of the price is OP. the figure shows that the firm produces OM units and

sells it at a price of OP per unit making only normal profit. The figure

shows that the average curve just touches the AC curve at the point of

equilibrium output. So average cost equals average revenue. The firm is not

making any abnormal profit but only normal profit. Over a long period of

time, under monopolistic competition, every firm will earn only normal

profit. This situation is exactly similar to the perfect competition, long

run equilibrium. The main difference is that in perfect competition the AR is

horizontal touching to the average cost curve at the lowest point showing

that the average cost is the minimum cost and the prices also minimum. But in

monopolistic competition the average revenue curve is sloping down. It

touches the average cost curve not at the minim point but at the falling side

(point K in the figure). So long as the shape of the average cost curve is

‘U’ shaped, the long period equilibrium of a firm producing under

monopolistic competition will necessarily result in smaller output than in

the perfect competition.

Since all the firms are producing on no-profit no-loss condition (Normal

Profit) there will be no tendency for the new firms to enter nor existing

firms to go out. The group has come to equilibrium.

Thus by Chamberlin’s method we can arrive at the group equilibrium in

the long run in the monopolistic competition. But Stigler and Kaldor have

criticized this method and they have questioned the assumption made by

Chamberlin. The uniformity assumption is criticized grossly unrealistic. How

can differentiated products of different firms have uniform demand and costs?

If the cost, demands and prices of the products of various firms are assumed

to be uniformed then the demand curve of the each firm would become perfectly

elastic as the situation becomes perfect competition. The condition seized to

be monopolistic competition with downward sloping demand curve. Further the

assumption of “perfect freedom of entry” when interpreted properly means

freedom to enter and produce completely identical product of those of any

other producer in the market. If this be so, the free entry strikes at the

very root of monopolistic competition and makes it perfect competition. When

this was pointed out to chamberlain, he agreed and put a restriction on the

interpretation of freedom of entry by saying that with respect to the

particular product by any individual firm under monopolistic competition

there can be no freedom of entry whatever chamberlain thus revised the view

of freedom of entry to interpret in a narrow sense of entering to produce

only close substitute and not identical substitute.

Selling costs and monopolistic competition

Definition and meaning of selling cost:-

Selling cost literally means the cost of selling a product in the

market. It denotes the expenses incurred in connection with salesmanship,

propaganda advertisement in order to push up the sales of a product. It

refers to the expenditure incurred by the firm to canvass or persuade the

buyers to buy its product rather than the product of any other firm. It is an

attempt to net large number of buyers to become the customers of the firm.

Selling cost has been defined as, “cost incurred in order to alter the

position or shape of the demand curve for a product”. Selling cost may be

incurred on various items like advertisement, salaries, allowances given to

salesman, display and demonstration. Free supply of samples to prospective

buyers, entertaining there are costs connected with selling. A large portion

of the selling cost will be incurred on advertisement. But Watson is of the

opinion that the term selling cost is wider than the cost of advertisement.

Selling cost, in short, is the cost involved in sales promotion.

Differences between selling cost and production cost:-

A distribution is made between selling cost and production cost. The

cost incurred in raw materials, wages to the workers, fuel, packing,

transport to the market as classified as production cost. This is defined as

those costs which are incurred by a firm in the production of a given variety

of a product. Production is not complete unless it is placed in the market

for consumers. So production costs include the transport costs. On the other

hand, the cost of changing consumers wants are selling costs. This is done

through “sales promotion programme”. The distinction may not be clear cut

always. For instance, an attractive packing may result in increased sales.

The cost of packing can be taken as production cost and because of the result

it can taken as sales cost. But it cannot be taken in both. Similarly, when

the product of the firm is sold by a mobile demonstration team for publicity,

the expenses may be take under selling cost or as production cost. Professor

Watson therefore, points out that it is difficult to differentiate between

selling cost and production cost though Chamberlin has given a distinct place

for selling cost.

Significance of selling costs:-

Selling cost has special place and significance tin the theory of

pricing as it is exclusively associated with imperfect competition. Under

perfect competition the consumer have full knowledge of the market and price

of the commodity. Hence there is no need for publicity and advertisement and

the firms incur only production costs. But in monopolistic competition market

has to be created by making the people know about the product and price.

Further, there is difference in quality and variety of the product unlike

perfect competition. So, the firms have to necessarily incur expenditure in

selling the commodity through various methods. The people should be made

known of the commodity produced by the firm. Then the consumers of the

product should be advised or educated to that particular variety produced by

the firm. For this advertisement plays a vital part in monopolistic

competition. In perfect competition and monopoly there is no need for

advertisement as in the former people know the product and in the latter the

firm does not have nay rival. Product difference and rivalry by the other

firms make advertisement as integral programme of modern production in

monopolistic competition.

Selling costs are incurred to promote sales. But, it is not possible to

establish a direct relationship between selling costs incurred and the volume

of business done by the firm. The anticipated result of advertisement and

publicity may not be forthcoming. The selling cost may even prove utterly

barren. Further the advertisement of one form will evoke counter

advertisement. So, selling cost will get inflated by counter advertisement as

it may eventually lead to advertisement war. Ultimately, the firms

advertising may not get any extra profit, but the available profits will be

eaten away due to inflated selling costs. Hence this cost is significant and

producers have to be very cautious and choosy. Further, the benefits from

selling cost may also accrue to rival firms as the advertisement made may

create a potential demand and not necessarily the benefits should go the firm

advertising the consumer would go in for the variety of other firms.

Selling costs are incurred on the assumption that a large number of

customers will be prepared to change their preference on advertisement and

publicity. This may not be so as the consumer gets resistance from his

habits. The firm cannot asses the extent of new customers won by

advertisement ad the increased demand due to advertisement may be from

existing customers as well as new customers. If new customers are won by

advertisement holds on the existing customers, then the selling costs is

fixed cost.

OLIGOPOLYMeaning and definition of Oligopoly.

“Oligopoly” is a term derived from two Greek words “Oligos” meaning a

few “pollein” meaning to sell. Thus Oligopoly refers to that form of

imperfect competition where there will be only a few sellers producing either

a homogenous product which are close substitutes but not perfect

substitutes .Oligopoly is also referred to as “competition among the few” as

a few big firms will be producing and competing in the market. The simplest

case of Oligopoly is duopoly which prevails when there are only two producers

in the market.

Professor Sligter defines Oligopoly as that “selication in which a firm

bases its market policy in part on the expected behavior of a few close

rivals”. According to professor Leftwich, “An Oligopolistic industry is one

in which the number of sellers is small enough for the activities of a single

seller to affect other firms and for the activities of other firms to affect

him”.

Classification of Oligopoly

There are different types of Oligopoly .They are:

1.Pure or perfect Oligopoly and differentiated or imperfect Oligopoly:-

Oligopoly is said to be pure or perfect based on the product. If firms

competing produce homogenous product it is perfect Oligopoly. If there is

product differentiation where the products of a few competing firms are

only close substitutes but not perfect substitutes, it is called imperfect

or differentiated Oligopoly. Production of cement, Aluminum industry can be

taken as the exampled of the former type, while production of talcum powder

or aspirin tablets may be taken as the example of the latter.

2. Open and closed Oligopoly:-

In the former the new firms can enter the market and compete with the

existing firms. But in closed Oligopoly entry into the industry is not

possible.

3. Collusive and competitive Oligopoly:-

When the few firms of the Oligopolistic market come to a common

understanding or act in collusion with each other I fixing price and out

put, it is collusive Oligopoly. A non-collusive Oligopoly denotes lack of

understanding between the firms and they maybe competing making the market

competitive Oligopoly.

4. Partial and full Oligopoly:-

Oligopoly is partial when the industry is dominated by one large firm

which is considered or looked upon as the leader of the group. The

dominating firm will be the price leader. The rest of the smaller firms

would follow the leader in fixing prices of their products. In full

Oligopoly, the market will be conspicuous by the absence of price

leadership.

5. Syndicated and Organized Oligopoly:-

The extent and degree of coordination between the firms will decide

this type of classification. Syndicated Oligopoly refers to that situation

where the firms sell their product through a centralized indicate.

Organized Oligopoly refers to the situation where the firms organize

themselves into a central association for fixing prices, out put, quotas.

Etc

On the basis of these different situations of Oligopoly market a few

characteristics features can be enumerated. These special features are not

found in other market forms.

Characteristics of Oligopoly.

1. Interdependence.

The most striking feature of Oligopoly market is the interdependence of

the firms operating. The price and out put decisions of one will affect the

other firms and any decision can be arrived at only after deep consideration

of the possible reaction of the rival firms or firms in the group. As the

number of firms is few, a change in price and out put by a firm will directly

affect the fortunes of its rivals which will retaliate by changing their own

price and output policies. Decision making is closely connected with price

output policies of other firms. Hence in Oligopolistic market a firm cannot

act independently in fixing the price. This interdependence between the firms

is a special feature of Oligopoly. Imperfect competition each firm is a price

taker and each firm has elastic demand curve and as such they follow

independent output policies and firms are on no way inter dependent. In

monopoly the question of dependence does not arrives as there are no rival

and the firm is a price maker. In monopolistic competition because of the

large number of firms in the groups, the price and out put decision will not

affect other firms in a larger measure due to product differentiation. But in

Oligopoly, firms are interdependent.

2. Indeterminate Demand curve.

This feature is a natural outcome of the first feature. No firm in

Oligopoly can forecast with fair degree of certainty about the nature and

position of its demand curve whenever a change in price output policy is

contemplated. The firm cannot make an estimate of sales of its product if it

were to cut the price by a certain percentage. Hence the demand curve or the

revenue curve of the firm is indeterminate. When a firm decides a course of

action and implements it, there will be quick and equal reaction, if not

more, from the rivals. In this process the firms would try to outguess each

other and a state of uncertainty would prevail and the firm cannot anticipate

with definiteness the quality that can be sold in the market. This

indeterminate demand condition is a singularly important feature when

contrasted with other types of market. In perfect competition, the demand

curve is given as a horizontal line. The firm has elastic demand. In monopoly

the fixation of price depends on the shape of the demand curve. In

monopolistic competition each firm anticipates their demand and fixed the

price on the basis of demand curve. But in the case of Oligopoly, since

demand is indeterminate the curve cannot be arrived at easily.

3.Importance of selling cost.

Indeterminate demand leads to the condition of aggressive advertisement

to bring more customers in to the fold of the firm. A direct effect of

interdependence and indeterminateness of demand of various firms in Oligopoly

is the enormous selling cost incurred by the competing firms. To make the

average revenue curve, decisive and also favorable each firm will be

employing various advertisement techniques and consequently the selling cost

will be very high. In perfect competition, advertising by a firm is

unnecessary as the firm can sell any amount at the market price. In monopoly

advertisement plays a very insignificant role. It will be used only for the,

introduction of a product and not for competition. In monopolistic

competition the advertisement plays a significant role due to producer

differentiation. But advertisement plays a bigger role in Oligopoly “leader

Oligopoly, advertisement can become a life and death matter, where a firm

which fails to keep up with the advertising budget of its competitors may

tend its customers drifting off to rival products”. Thus selling cost

occupies a very significant part in Oligopoly market.

4.Group behavior.

Another peculiarity in Oligopoly is the conflicting attitudes of the

firms in the group. The firms are interdependent in the market and they also

realize the importance of mutual co-operation to their best advantage. When

such desire to further their common interest arises, the group will have a

tendency of collision. At other items, the desire of each firm to earn

maximum profit may initiate antagonism and competitive spirit, which causes

uncertainty.

5. Element of monopoly:-

In Oligopolistic market, where there are only a few firms, monopoly

element may be present if there is product differentiation. Each firm

controls a large share of the market and markets a differentiated product.

So, each firm becomes a petty monopolist. The monopoly power will be all the

more conspicuous if the customers are deeply attached to the product of a

particular firm in Oligopolistic market. In that case the firm will have more

independence.

6. Price rigidity:-

Another important feature of oligopoly with product differentiation is

price rigidity. The price will be kept unchanged due to be sticky and

inflexible. Even for years together the price may remain rigid. No fir would

indulge in price cutting as it would eventually lead to a price war with no

benefit to anyone. The price may be kept constant even without any collusion

or agreement. The season for price rigidity are:-

a) The firms know the ultimate out come of price cutting.

b) Large firms will have to incur unnecessary expenditure in bringing out

revised prices. Revised schedule of rates, catalogue and negotiation

with customers on new terms would mean extra expenditure. Further it

would even irritate the longstanding customers.

c) The firms would like to keep the price fairly at lower level to

discourage any new firm entering into the field of production of that

product.

d) Price rise by a firm would result in losing the customers; a fall in

price will result in counter measures. In both ways the firm would face

difficulties. When firms get a fair and reasonable profit the change of

price will not be attempted. Instead of price cutting, the firms will

intensify sales through effective advertisement.

Pricing under oligopoly

Kinked demand curve

Price rigidity under oligopoly is better explained by kinked demand

curve. The kinked demand model represents a condition in which the firm has

no incentive either to increase the price or to decrease the price but keep

the price rigid at a particular level. The firm believes that the rival firms

will not follow suit if it raises the price. But if it cuts down the price

the rival firms will follow suit. Adding on this belief the firm maintains

the present price. If it increases the price sales will be decreased

automatically and that will prove advantages to the rivals who have not

increased the price. If price reduction is restored, the rivals also would

not improve appreciably. Hence to stick on to the present price is very

expedient. Only in the event of any drastic changes in demand and cost

conditions the firm could think of changing the price.

Under such a condition the demand curve of the firm, as anticipated by the

firm would be kinked. This means that the curve will have a kink at the

present price. The following diagram shows kinked demand curve.

Price and cost

MR

D

y

K

P

B

x

L

In the figure the demand curves with a kink point P has been shown. P is

the price at which the firm is selling the product by producing ON units.

Above the price P the demand curve as anticipated by the firm is DP. The

curve is elastic. Below the price P the anticipated demand will be PB which

is inelastic. This shows that when the firm increases the price above P and

if all other firms maintain the old price, then the demand for the firms

product would fall off. So the demand curve is highly elastic above P [DP

portion]. The total revenue and profits of the firm would be reduced. The

corresponding portion of marginal revenue curve is also shown in the figure

[MR]. If the firm decreases the price the demand curve becomes much less

[PB]. PB curve is inelastic because, the reduction in price will be followed

by other firms and the sales may not increases appreciably, than what it is

at the price P. as this level the marginal revenue curve is shown as MR,

when the demand curve is positive. When the demand curve is PB the marginal

revenue becomes negative. When there is no scope of better profit in either

way, why should the firm think of changing the price from what it is. (P) so

the price PN as shown in the diagram becomes rigid.

The peculiarity of this figure is that there is gap or discontinuity in

MR curve below the point of kink. KL shows the gap or extent of discontinuity

between MR and MR1. This gap will depend on the elasticity of demand above

and below the kink.

The gap will be larger if the elasticity is greater above the kink and

elasticity is also greater below the kink, price will not change oligopoly

unless there is drastic change in demand and cost conditions.

The kinked demand curve theory of oligopoly explains the price rigidity

but it does not explain how the price under oligopoly is determined. Moreover

this theory has little application to oligopoly with product differentiation.

This method is not useful in case of price leadership or collusive oligopoly.

Because of this complexities and variations and uncertainties a general

theory of pricing under oligopoly is not possible.

Equilibrium under oligopoly without product differentiation

As a result of competition and price war, let us imagine that the firms

have settled down to a price OP. at this price the firm sells an output OM

earning just normal profit. This OM output is the optimum output as it is

produced at the lower average cost. If the firm increases the price beyond OP

it will lose all its customers because the product is not differentiated. It

is assumed that other firms will not increase the price. The firm cannot

reduce the price as it will go out of business without normal profits.

Price

M

P AR

AC

Outputx

y

AC: Average Cost

AR: Average Revenue

Equilibrium with product differentiation

Let us imagine that after price war the price has settled at OP and the

firm is producing ON output. The firm is earning just the normal profit. The

equilibrium in the case of product differentiation under oligopoly is similar

to monopolistic competition. The firm is earning normal profit but it is

producing less than the optimum output.

Price

P

y

x

AR

Output

N

AC

Final price under oligopoly with product differentiation will lie between

monopoly price and competitive price and it will vary from case t case

depending on market conditions.

Marginal productivity theory of distribution.

The marginal productivity theory states that remuneration of each factor

of production tends to be equal to its marginal productivity. Marginal

productivity is the addition to the total production by using one extra unit

of the factor. In order to find out the marginal productivity of a factor we

have to change the quantity of a factor concerned by one unit while keeping

quantity of others factors constant and see the difference in the total

production for example, if 10 machines and 100 labourers produce 1000 units

of cloth, the same 10 machines are worked with 101 labourers, the total

production increases 1006 units of cloth. It is evident that the marginal

labourer has contributed towards 6 units of cloth. So, marginal productivity

of labour is 6 units of cloth. This is called marginal physical product. This

means the exact physical quantity of the product produced by the marginal

unit of factor. When this marginal physical product is expressed in terms of

market value, it is called marginal value product. The value of marginal

product is found out by multiplying of the commodity by its price in the

market. In our example if 6 units of marginal product is valued at the rate

of Rs. 3 per unit in the market, the total value of the marginal product is

18 (6 x 3 = 18).

So long as the marginal cost is less than the marginal productivity, the

entrepreneur will go on employing more and more units of the factors. He will

stop giving further employment as soon as the marginal productivity of the

factor is equal to marginal cost. Now obvious no entrepreneur will pay a

factor anything more than what it is worth. The worth of a factor is what it

could fetch in the market for the entrepreneur in the selling of the marginal

product produced by it. So each factor is paid accordingly to its production

at he market.

The marginal productivity theory is based on the principle of law of

diminishing return. As the producer employs more and more of a factor in the

production of a commodity the marginal productivity of that factor

diminishes. He shall employ a factor so long as its productivity exceeds its

remuneration otherwise when returns diminish and costs go up, the producer

will meet loses. As such the producer has to substitute and combine the

different factors of production in such a way that the factor –price and

marginal productivity are equal. The producer stops at the point when

marginal revenue product is equal to the price of the factor. At this point

he makes maximum profit and beyond this point he will loose if he employs

more units of a factor of production.

Assumption of the theory

1) the marginal productivity theory assumes perfect competition. Through

perfect competition the price of factors throughout the market is

assumed to be uniform and each factor receives the same remuneration at

different places in the same market. Only on this conclusion the

marginal productivity shall be equal and factor prices be uniform.

2) All the factor of production are assumed to be perfectly mobile as

between different uses and regions. This assumption is essential as will

not be possible to have equi marginal returns from different factors of

production through the principle of substitution without perfect

mobility of factors.

3) The different units of a factor of production are alike and homogeneous

in all respects. It means that one unit is as efficient as that of the

other units. Without this assumption substitution of factors cannot be

worked out to increaser production.

4) The employer is interested in getting maximum amount of profit. This

basic assumption is essential in economic analysis. Only in the context

of maximum profits, the producer uses the factor units in such away that

the cost of the last unit employed is equal to the product of the last

worker.

5) All factor units are employed and no factor unit is prepared to come for

work for any remuneration which is less than the market remuneration. In

other words the full market condition is assumed.

6) Although the scale and proportions of factors for production changeable,

the technique of production is assumed to remain constant.

7) The theory is assumed to be applicable in the long period to prove that

the remuneration of factor will be equal to both average and marginal

productivity.

Based on these assumptions, the marginal productivity theory of

distribution states that :

i) The price or remuneration of a factor will depend upon productivity

or contribution that it makes to production.

ii) The price of a factor is determined by the marginal

productivity of that factor unit and it is equal to marginal

productivity.

iii) In the long period, the price of remuneration of factor unit

will be equal to average product also.

From the above analysis and assumptions, there is a market for factors

of production. This market has its buyers and sellers and these forces –

demand and supply determine the price of the commodity. On the side of demand

the producer is willing to pay a maximum price equal to the marginal

productivity. On the supply side of the demand, the producer is willing to

pay the maximum price equal to the marginal productivity. On the supply side

the factors of production will be willing to charge a minimum price equal to

its marginal productivity and this maximum price almost unlimited. Taking

these two forces, the equilibrium point where the supply will be equal to

demand and at this point it is equivalent to marginal productivity. Thus the

price of factor of production is equal to marginal, a price at which both

buyers and sellers are willing to buy and sell the factor. This is

illustrated in this diagram.

X- Axis we measure number of factor units and so on the y – axis price for

factor. SS is the supply and DD demand curve. They intersect at P. the price

is equal to PM which is equal to marginal productivity.

Criticism of Marginal Productivity Theory

No. of factor units

S

S

D

D

P

Marginal productivity theory has been criticized by a large number of

economists notably Taussig, Davenport, Maurice, Dobb, Keynes and others. The

main point of criticism is as follows.

1) the theory is based on two realistic assumptions: prevalence of perfect

competition and state of full employment condition. In the real world

there is neither full employment nor perfect competition. Under

imperfect and monopolistic conditions there will be exploitation of

factor of production and they are paid much below their marginal

productivity.

2) The assumption of perfect mobility of factors between different

employment and regions is also another unrealistic assumption in

practical side there are many obstacles to free movement of factors. In

these days of increasing speculation the mobility of a factor gets

restricted and it may not be paid equal to its marginal productivity.

3) Assumption of homogeneity of factors is far from reality. The factors

are neither identical nor homogeneous or equal in all respects so that

the principle of substitution would not work perfectly well. In reality

factors of production are heterogeneous and they differ widely in

efficiencies. This difference is productivity accounts for differential

rents in factors which marginal productivity theory has ignored.

Similarly the assumption of divisibility of factors into small

quantities is also unreal for instance it’s not possible to divide an

entrepreneur.

4) Taussig and Davenport are of the view that production of a commodity

cannot be attributed to any one factor of production. Production is the

result of factors working in cooperation with one another. The

additional product which attribute to the additional unit of factor,

cannot be solely caused by the additional unit. The marginal production

or the extra production due to extra unit of the factor is the result of

extra unit working in cooperation with existing factors and as such the

extra output cannot be solely attributed to the extra factor. So it is

not possible in production to make any one unit of output as specific to

particular unit of factor used.

5) Variations in proportions of factors of production are not easy. It is

not done purely from the point of view of increasing production nor

could it be done with ………………………… Hobson points out that the proportion

in which factors are used is determined by technical condition of

business and not by any arbitrary decisions of the producer. It may,

therefore, not be possible to vary the use of factor without making a

corresponding variation in the use of other factors.

6) The theory does not carry with it any ethical justification. The reward

of a factor of production which tends to equal to the marginal net

product bears no necessary relation to with the social service. The

theory should not be constructed as a apology for perpetuating the

existing inequalities of income.

In spite of its draw backs and defects the marginal productivity

theory of distribution offers a reasonable understanding of factor

pricing.

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