UNIT 4

MARKET ANALYSIS
By: Rupam Jyoti Deka
Assistant Professor, BVIMR
 Types of Market

 The nature of the commodity determines the market structure. the commodity may
be either homogeneous or identical and heterogeneous or differentiated.
 A variety of market structures will characterize an economy. Such market structures
essentially refer to the degree of competition in a market.
 There are other determinants of market structures such as the nature of the goods
and products, the number of sellers, number of consumers, the nature of the product or
service, economies of scale etc. We will discuss the four basic types of market structures in
any economy.
 One thing to remember is that not all these types of market structures actually exist. Some of
them are just theoretical concepts. But they help us understand the principles behind the
classification of market structures.
Types of Market Structures in Economics
From the viewpoint of competition the types of
market structures in economics are the following:

1. Perfect competition
2. Monopolistic competition
3. Oligopoly
4. Duopoly
5. Monopoly
The Market Structure can be shown by the following chart:

Thus, there are two extremes of market structure. On the one hand, we have
perfect competition or pure competition and monopoly on the other hand.

In between these two extremes have imperfect competition consisting of monopolistic

competition, oligopoly, and duopoly.
 PERFECT COMPETITION MARKET
 A Perfect Competition market is that type of market in which the number of buyers
and sellers is very large, all are engaged in buying and selling a homogeneous
product without any artificial restrictions and possessing perfect knowledge of the
market at a time.
 In this connection Mrs. Joan Robinson has said—”Perfect Competition
prevails when the demand for the output of each producer is perfectly
elastic.”
 According to Boulding—”A Perfect Competition market may be defined as a large
number of buyers and sellers all engaged in the purchase and sale of identically
similar commodities, who are in close contact with one another and who buy and
sell freely among themselves.”
Characteristics of Perfect Competition:

 The following characteristics are essential for the existence of Perfect Competition:

 1. Large Number of Buyers and Sellers:

 2. Homogeneity of the Product:
 3. Free Entry and Exit of Firms:
 4. Perfect Knowledge of the Market:
 5. Perfect Mobility of the Factors of Production and Goods:
 6. Absence of Price Control:
 7. Perfect Competition among Buyers and Sellers:
 8. Absence of Transport Cost:
 9. One Price of the Commodity:
 10. Independent Relationship between Buyers and Sellers:
1. Large Number of Buyers and Sellers:
The first condition is that the number of buyers and sellers must be so large that none of them individually is in a
position to influence the price and output of the industry as a whole. In the market the position of a purchaser or a
seller is just like a drop of water in an ocean.
2. Homogeneity of the Product:
Each firm should produce and sell a homogeneous product so that no buyer has any preference for the product of
any individual seller over others. If goods will be homogeneous then price will also be uniform everywhere.
3. Free Entry and Exit of Firms:
The firm should be free to enter or leave the firm. If there is hope of profit the firm will enter in business and if
there is profitability of loss, the firm will leave the business.
4. Perfect Knowledge of the Market:
Buyers and sellers must possess complete knowledge about the prices at which goods are being bought and sold
and of the prices at which others are prepared to buy and sell. This will help in having uniformity in prices.
5. Perfect Mobility of the Factors of Production and Goods:
There should be perfect mobility of goods and factors between industries. Goods should be free to move to those
places where they can fetch the highest price.
6. Absence of Price Control:
There should be complete openness in buying and selling of goods. Here prices are liable to change
freely in response to demand and supply conditions.
7. Perfect Competition among Buyers and Sellers:
In this purchasers and sellers have got complete freedom for bargaining, no restrictions in charging
more or demanding less, competition feeling must be present there.
8. Absence of Transport Cost:
There must be absence of transport cost. In having less or negligible transport cost will help
complete market in maintaining uniformity in price.
9. One Price of the Commodity:
There is always one price of the commodity available in the market.
10. Independent Relationship between Buyers and Sellers:
There should not be any attachment between sellers and purchasers in the market. Here, the seller
should not show prick and choose method in accepting the price of the commodity. If we will see
from the close we will find that in real life “Perfect Competition is a pure myth.”
Price- Output Determination under Perfect Competition:

Perfect competition refers to a market situation where there are a

large number of buyers and sellers dealing in homogenous products.

Moreover, under perfect competition, there are no legal, social, or

technological barriers on the entry or exit of organizations.

In perfect competition, sellers and buyers are fully aware about the
current market price of a product. Therefore, none of them sell or
buy at a higher rate. As a result, the same price prevails in the
market under perfect competition.
Under perfect competition, the buyers and sellers cannot influence the market price by increasing or
decreasing their purchases or output, respectively. The market price of products in perfect
competition is determined by the industry. This implies that in perfect competition, the market
price of products is determined by taking into account two market forces, namely market demand
and market supply.

 Demand under Perfect Competition:

Demand refers to the quantity of a product that consumers are willing to purchase at a particular
price, while other factors remain constant. A consumer demands more quantity at lower price and
less quantity at higher price. Therefore, the demand varies at different prices.
Figure-1 represents the demand curve under perfect competition:

As shown in Figure-1, when price is OP, the

quantity demanded is OQ. On the other hand,
when price increases to OP1, the quantity
demanded reduces to OQ1. Therefore, under
perfect competition, the demand curve (DD’)
slopes downward.
Supply under Perfect Competition:
Supply refers to quantity of a product that producers are willing to supply at a particular price.
Generally, the supply of a product increases at high price and decreases at low price.

Figure-2 shows the supply curve under perfect competition:

In Figure-2, the quantity supplied is OQ at price OP. When

price increases to OP1, the quantity supplied increases to
OQ1. This is because the producers are able to earn large
profits by supplying products at higher price. Therefore,
under perfect competition, the supply curves (SS’) slopes
upward.
Equilibrium under Perfect Competition:
As discussed earlier, in perfect competition, the price of a product is determined at a point at which the demand
and supply curve intersect each other. This point is known as equilibrium point. At this point, the quantity
demanded and supplied is called equilibrium quantity.
Figure-3 shows the equilibrium in Industry under perfect competition:

In Figure-3, it can be seen that at price OP1, supply is more than the demand. Therefore, prices will fall down to OP. Similarly, at
price OP2, demand is more than the supply. Similarly, in such a case, the prices will rise to OP. Thus, E is the equilibrium at
which equilibrium price is OP and equilibrium quantity is OQ.

Equilibrium price for the industry is determined through the interaction of demand and supply is ` 2 per unit. The individual ‑rms
will accept ` 2 per unit as the price and sell different quantities at this price. Let us consider the case of firm ‘X’. Firm X’s
quantity sold, total revenue, average revenue and marginal revenue are as given in Table 4.
 Equilibrium of the Industry:
 An industry in economic terminology consists of a large number of independent rms. Each such unit
in the industry produces a homogeneous product so that there is competition amongst goods
produced by different units. When the total output of the industry is equal to the total demand, we
say that the industry is in equilibrium; the price then prevailing is equilibrium price. A rm is said to
be in equilibrium when it is maximising its profits and has no incentive to expand or contract
production. As stated above, under competitive conditions, the equilibrium price for a given
product is determined by the interaction of the forces of demand and supply for it as is shown in
the graph and table.
 In diagram, OP is the equilibrium price and OQ is the equilibrium quantity which will be sold at that
price. The equilibrium price is the price at which both demand and supply are equal and therefore,
no buyer who wanted to buy at that price goes dissatisfied and none of the sellers is dissatisfied
that he could not sell his goods at that price. It may be noticed that if the price were to be fixed at
any other level, higher or lower, demand remaining the same, there would not be equilibrium in the
market. Likewise, if the quantities of goods were greater or smaller than the demand, there would
not be equilibrium in the market.
 Equilibrium of the Firm:
The firm is said to be in equilibrium when it maximizes its profit. The output which gives
maximum profit to the firm is called equilibrium output. In the equilibrium state, the rm has no
incentive either to increase or decrease its output. Firms in a competitive market are price-
takers. This is because there are a large number of rms in the market who are producing identical
or homogeneous products. As such these firms cannot influence the price in their individual
capacities. They have to accept the price determined through the interaction of total demand and
total supply of the commodity which they produce.

Firm X’s price, average revenue and marginal revenue are equal to 2. Thus, we see that in perfectly
competitive market a price-taking firm’s average revenue, marginal revenue and price are equal. As a result,
when the rm sells an additional unit, its total revenue increases by an amount equal to its price. AR = MR =
Price.
  This is illustrated in the following graph:

The fi­rm’s demand curve under perfect competition The market price OP is fixed through the interaction of total demand
and total supply of the industry. Firms have to accept this price as given and as such they are price-takers rather than price-
makers. They cannot increase the price above OP individually because of the fear of losing its customers to other firms.
They do not try to sell the product below OP because they do not have any incentive for lowering it. They will try to sell as
much as they can at price OP.

As such, P-line acts as demand curve for the firm. Because it is a price taker, the demand curve D facing an individual
competitive firm is given by a horizontal line at the level of market price set by the industry. In other words, the demand
curve of each firm is perfectly (or infinitely) elastic. The firm can sell as much or as little output as it likes along the
horizontal price line. Since price is given, a competitive firm has to adjust its output to the market price so that it earns
maximum profit.
 Conditions for equilibrium of a firm:

 As discussed earlier, a rm, in order to attain equilibrium position, has to satisfy two conditions as below:
(Note that because competitive rms take price as fixed, this is a rule for setting output, not price).
 (i) The marginal revenue should be equal to the marginal cost. i.e. MR = MC. If MR is greater than MC,
there is always an incentive for the rm to expand its production further and gain by selling additional units.
If MR is less than MC, the rm will have to reduce output since an additional unit adds more to cost than to
revenue. Prots are maximum only at the point where MR = MC. Because the demand curve facing a
competitive rm is horizontal, so that MR = P, the general rule for prot maximization can be simplified. A
perfectly competitive rm should choose its output so that marginal cost equals price.

 (ii) The MC curve should cut MR curve from below. In other words, MC should have a positive slope. . In
other words, MC should have a positive slope. Short-Run Profi­t Maximization by a Competitive Firm We
shall begin with the short-run output decision and then move on to the long run. In the short run, a firm
operates with a fixed amount of capital and must choose the levels of its variable inputs so as to maximize
profit.
 In figure 16, DD and SS are the industry demand and supply curves which intersect at E to set the market price as
OP. The firms of perfectly competitive industry adopt OP price as given and considers P-Line as demand (average
revenue) curve which is perfectly elastic at P. As all the units are priced at the same level, MR is a horizontal line
equal to AR line. Note that MC curve cuts MR curve at two places T and R respectively. But at T, the MC curve is
cutting MR curve from above. T is not the point of equilibrium as the second condition is not satisfied. The ‑rm
will bene‑t if it goes beyond T as the additional cost of producing an additional unit is falling. At R, the MC curve
is cutting MR curve from below. Hence, R is the point of equilibrium and OQ2 is the equilibrium level of output.
3.0.2 Short run supply curve of the ­rm in a competitive market One interesting thing about the MC curve of a firm
in a perfectly competitive industry is that it depicts the firm’s supply curve.
i. Super Normal Profit:
A firm will earn super normal profit in short run if its SAC is less than the AR at the point of equilibrium. Such a
firm has been depicted in Figure 10.5.
It shows firm’s equilibrium at point R where its output is
OQ1. At this point, both the equilibrium conditions are
satisfied, i.e. MR = MC and, the MC curve is positively
sloped at the point of intersection. The average cost of the
firm, as represented by the SAC curve, is OT (= SQ1) at
this output level. Based on it, profit can be estimated as —
Total revenue – Total cost
Given that total revenue is OPRQ1 and total cost is OTSQ1,
Profit = PTSR = OPRQ1 – OTSQ1
This is the profit which the firm earns over and above the
normal profit and, hence, termed as super normal profit. It
has been shown by the shaded area in the figure.
 ii. Normal Profit:
Figure 10.6 depicts case of a firm which has been earning only a normal profit.

The figure shows equilibrium at point R where the output is OQ1. At this level of output,
AC is RQ1, as shown by its SAC curve. It is equal to the per unit revenue which is also
RQ1. It means that firm is making only normal profit which is a part of average cost. In this
case —
Total revenue = Total cost = OPRQ1
iii. Firm Incurring Losses:
A firm can incur loss in short run. Such a firm is represented in Figure 10.7.

In the given situation, firm’s equilibrium is at

point R where the output level is OQ1. The
average cost of the firm is represented by SAC
curve and the average variable cost by SAVC
curve. Obviously, the gap between SAC and
SAVC will represent the average fixed cost
(SAFC).

The figure shows that at output level OQ1,

average cost (SQ1) is more that its average
revenue (RQ1). Thus, the firm has incurred a
per unit loss of SR (= SQ1 – RQ1).

 Total loss = Total cost – Total revenue

 Given that total cost = OTSQ1 and total revenue = OPRQ1 in the figure,
 Total loss = TSRP = OTSQ1 – OPRQ1
 Thus, it will minimize losses (= AFC) by stopping the production altogether.
 Based on above, we can discuss two situations in which a firm will minimize losses (i) by continuing
production and (ii) by stopping it altogether.

Minimizing Losses by Continuing Production:

 Figure 10.7 presents a case where a firm will minimize losses if it continues production. The firm is in a
state of equilibrium at point R at which output level is OQ 1. In this situation, his average cost (SQ1) is
more than the average revenue (RQ1) and, hence, the per unit loss of SR (= SQ1 – RQ1) is reported by the
firm.
 At this level, however, the SAVC is UQ1 which is less than its AR (= RQ1). It means that firm is not only
able to cover the entire variable cost but also generating a part of fixed cost. Thus, the firm’s per unit loss
(SR) will be less than AFC (= SU).
 In such situation, firm will be better off if it continues production at OQ 1 output level. Its total loss will
be –
 = OQ1 * SR
 Or, = PR * SR = PRST < AFC (= VUST)
 Thus, the firm should continue production to minimize losses.
Minimizing Losses by Stopping Production:
 Unlike the above case, we will now consider a firm which
will minimize losses by way of stopping production. In
this situation, its losses would be equal to the fixed cost.
But, if it continues production, its losses will be more than
the fixed cost. Hence, the firm will be better off if it stops
production. This is called as shut down situation.
 In Figure 10.8, the firm finds its equilibrium at point R
which suggests an output level OQ1. At this level, average
cost is SQ1 which is more than the AR (= RQ1) generating
per unit loss of SR (= SQ1 – RQ1) and total loss of TSRP.
 One can see that per unit loss (SR) is more than the AFC
(= SU) at this level of output. It means that the AR is
unable to cover even the variable cost. The firm should,
therefore, stops production to minimize losses equal to the
AFC.
 Long Run Equilibrium of the Industry & Firms:
A long-run competitive equilibrium of a perfectly competitive industry occurs when three conditions hold: All
firms in the industry are in equilibrium i.e. all firms are maximizing profit. No firm has an incentive either to
enter or exit the industry because all firms are earning zero economic profit or normal profit. The price of the
product is such that the quantity supplied by the industry is equal to the quantity demanded by consumers.

Figure 22 shows that in the long-run AR = MR = LAC =

LMC at E1 . In the long run, each ‑rm attains the plant size
and output level at which its cost per unit is as low as
possible. Since E1 is the minimum point of LAC curve, the
‑rm produces equilibrium output OM at the minimum
(optimum) cost. A firm producing output at optimum cost is
called an optimum firm. In the long run, all firms under
perfect competition are optimum firms having optimum size
and these firms charge minimum possible price which just
covers their marginal cost. Thus, in the long run, under
perfect competition, the market mechanism leads to optimal
allocation of resources.
The optimality is shown by the following outcomes associated with the long run
equilibrium of the industry:

 (a) The output is produced at the minimum feasible cost.

 (b) Consumers pay the minimum possible price which just covers the marginal cost
 i.e. MC = AR. (P = MC)
 (c) Plants are used to full capacity in the long run, so that there is no wastage of
resources i.e. MC = AC. (d) Firms earn only normal profits i.e. AC = AR.
 (e) Firms maximize profits (i.e. MC = MR), but the level of profits will be just
normal.
 (f) There is optimum number of firms in the industry. In other words, in the long run,
 LAR = LMR = P = LMC = LAC and there will be optimum allocation of resources.
 PRICE-OUTPUT DETERMINATION UNDER MONOPOLY MARKET

 Monopoly market is a market structure in which a single firm is a sole

producer of a product for which there are no close substitutes available in
the market. Since there’ is only one seller in the market, it eliminates the
rivals and direct competitors. Therefore, the monopolist has full control over
its price. Hence, the seller in this market is not known as a price maker. The
seller, by itself, determines the price and the quantity to be sold by him in
the market.
 Since this market consists of a single seller, It abolishes the difference
between firm and industry. Hence, it is clear that the firm or market means
the same in this market.
 Example: Railways in India are a monopoly industry of Government of India.
Characteristics of Monopoly Market :

Some of the characteristics of this market are:

 One seller and a large number of buyers:
 Monopoly is an Industry:
 Restrictions on the entry of new firms:
 Monopoly has no close Substitutes:
 Price Maker:
 Price Discrimination:
 Absence of the Supply Curve
 Demand Curve in the Monopoly Firm:
 One seller and a large number of buyers:
Under this market, there is only a single seller or producer of a commodity. He may be a sole
proprietor or group of persons or joint-stock company or a state. However, the number of buyers
against one seller is large.
 Monopoly is an Industry:
As there is only one producer or seller in the market, the difference between industry and firm
disappears. Thus, it means that the monopoly can be said as an industry in the market. In other
words, these two terms can be used in place of each other.
 Restrictions on the entry of new firms:
There are some restrictions on the entry of new firms in the monopoly industry. Generally, there
are patent rights, government laws, economies of scale etc. which acts as barriers for the entry of
new firms. Also, a monopolistic firm has exclusive right over the technique of production. Thus, due
to the restriction of entry, the monopolist earns extra-normal profits in long as well as short period.
 Monopoly has no close Substitutes:
The product, produced by the firm should have no close substitutes. Otherwise, the monopolist will
not be able to determine the price of the commodity as per his discretion. For example, there is no
substitute for Electricity.
 Price Maker:
Being a single seller, the monopolist has full control over the price or supply of product. Thus, he
can fix any price for his product. On the other hand, there is a large number of buyers, but the
demand for a single buyer constitutes only a small portion of it. Hence, the buyer has to pay the
price fixed by the monopolist. Therefore, the monopolist can be said as the price maker.
 Price Discrimination:
A monopolist can charge any price from different consumers for the same commodity. When a
seller charges different prices from different commodities. It is known as price discrimination. Thus,
this market includes price discrimination by the sellers.
 Absence of the Supply Curve:
The monopolist doesn’t have a supply curve independent of demand. The monopolist
simultaneously examines the demand i.e. marginal revenue and cost i.e. marginal cost when to
decide the quantity and price of a commodity.
 Demand Curve in the Monopoly Firm:
Full control over the price doesn’t mean the seller can charge any price or he can sell the
commodity at any price. Once the monopolist fixes the price, the demand depends upon the
buyers. Consequently, if the price is low, the buyers will demand more and demand less when the
price is high. Therefore, there is an inverse relationship between price and quantity sold by the
monopoly firm. Accordingly, the demand curve slopes downward.
PRICE-PUTPUT DETERMINATION UNDER MONOPOLY
Monopoly refers to a market structure in which there is a single producer or seller that has a control
on the entire market.

This single seller deals in the products that have no close substitutes and has a direct demand,
supply, and prices of a product.

Therefore, in monopoly, there is no distinction between an one organization constitutes the whole
industry.

Equilibrium in Monopoly
The conditions for Equilibrium in Monopoly are the same as those under perfect competition. The marginal
cost (MC) is equal to the marginal revenue (MR) and the MC curve cuts the MR curve from below.
Demand and Revenue under Monopoly:
 In monopoly, there is only one producer of a product, who influences the price of the product by
making Change m supply. The producer under monopoly is called monopolist. If the monopolist
wants to sell more, he/she can reduce the price of a product. On the other hand, if he/she is willing
to sell less, he/she can increase the price.
 As we know, there is no difference between organization and industry under monopoly.
Accordingly, the demand curve of the organization constitutes the demand curve of the entire
industry. The demand curve of the monopolist is Average Revenue (AR), which slopes downward.
Figure-9 shows the AR curve of the monopolist:
In Figure-9, it can be seen that more quantity (OQ2)
can only be sold at lower price (OP2). Under
monopoly, the slope of AR curve is downward, which
implies that if the high prices are set by the
monopolist, the demand will fall. In addition, in
monopoly, AR curve and Marginal Revenue (MR)
curve are different from each other. However, both
of them slope downward.
 The negative AR and MR curve depicts the following facts:
 i. When MR is greater than AR, the AR rises
 ii. When MR is equal to AR, then AR remains constant
 iii. When MR is lesser than AR, then AR falls
 Here, AR is the price of a product, As we know, AR falls under monopoly; thus, MR is less than
AR.
Figure-10 shows AR and MR curves In figure-10, MR curve is shown below the AR curve because AR falls.
Table-1 shows the numerical calculation of AR and MR under monopoly:
under monopoly:

As shown in Table-1, AR is equal to price. MR is less than AR and falls

twice the rate than AR. For instance, when two units of Output are sold,
MR falls by Rs. 2, whereas AR falls by Re. 1.
 Short Run Equilibrium Price and Output Under Monopoly:
 Short Run Equilibrium of the Monopoly Firm:
In the short period, the monopolist behaves like any other firm. A monopolist will
maximize profit or minimize losses by producing that output for which marginal cost
(MC) equals marginal revenue (MR). Whether a profit or loss is made or not depends
upon the relation between price and average total cost (ATC). It may be made clear
here that a monopolist does not necessarily makes profit. He may earn super profit or
normal profit or even produce at a loss in the short ran.

Conditions for the Equilibrium of a Monopoly Firm:

There are two basic conditions for the equilibrium of the monopoly firm:
 First Order Condition: MC = MR.
 Second Order Condition: MC curve cuts MR curve from below.
Determining Price and Output under Monopoly:
 Q1. What are the three possibilities for a firm’s Equilibrium in Monopoly?
 Answer: The three possibilities are:
1. The average cost = the average revenue: the firm earns normal profits.
2. The average cost < the average revenue: the firm earns super-normal profits
3. Or, the average cost > the average revenue: the firm incurs losses

(a) Short Run Monopoly Equilibrium With Supernormal Profit:

In the short period, if the demand for the product is high, a monopolist increase the price and the
quantity of output. He can increase the, output by hiring more labor, using more raw material,
increasing working hours etc. However, he cannot change his fixed plant and equipment. In
case, the demand for the product falls, he then decreases the use of variable inputs, (like labor,
material etc.).
As regards the price, the monopolist is a price maker. There is a greater tendency for the
monopolist to have a price which earns positive profits. This can only be possible if the price
(AR) is higher than average total cost (ATC). The short run profit earned by the monopolist is
now explained with the help of the diagram (16.3) below.
 Supernormal Profit in Monopoly Market

 In this diagram, the monopoly firm is in equilibrium at point K where SMC = MR. The short run marginal cost
(SMC) curve cuts MR from below. At point K both the equilibrium conditions are fulfilled. As a result, therefore,
OE is monopoly price and OB, the monopoly output. At the monopoly output OB, the average total cost OF = BN.
The profit per unit is FE. The short run monopoly profit is ETNF, It is represented by the area of shaded rectangle
in figure 16.3.
 At the output smaller than OB (say at point P) MR > SMC. Therefore, increased output up to B adds more to total
receipts than to total costs. In case, the output is increased beyond OB, the MR < SMC. Hence, the increased
outputs beyond OB adds more to total cost than to total receipts. This causes profits to decrease. So the best
 (b) Short Run Equilibrium With Normal Profit Under Monopoly:
There is a false impression regarding the powers of a monopolist. It is said that the monopolistic
entrepreneur always earns profits. The fact, however, is that there is no guarantee for the monopolist to
earn profit in the short run. If a monopolist firm produces a new commodity and attempts to change the
taste pattern of the consumers through advertising campaigns etc., then the firm may operate at normal
profit or even produce at a loss minimizing price in the short run (Covering variable cost only). The
normal profit short run equilibrium of the monopoly firm is explained, in brief, with the help of the
diagrams.

In figure (16.4), a firm is in the short run

equilibrium at point K, where SMC = MR.
The price line is tangent to SAC at point C.
The firm charges CB price per unit for units
of output OB. The total revenue of the firm
is equal to the area OPCB. The total cost
of the firm is also equal to the area OPCB.
The firm earns only normal profits and
continues operating.
(c) Short Run Equilibrium With Losses Under Monopoly:

A monopolist also accepts short run losses provided the variable costs of the firm are fully covered.
The loss minimizing short run equilibrium analysis is presented graphically.
 n this figure (16.5), the best short run
level of output is OB units which is given
by the point L where MC = MR. A
monopolist sells OB units of output at
price CB. The total revenue of the firm
is equal to OBCF. The total cost of
producing OB units is OBHE. The
monopoly firm suffers a net loss equal
to the area FCHE. If the firm ceases
production, it then has to bear to total
fixed cost equal to GKHE. The firm in
the short run prefers to operate and
reduces its losses to FCHE only. In the
long, if the loss continues, the firm shall
have to close down.
 Long Run Equilibrium Under Monopoly:
The monopolist creates barriers of entry for the new firms into the industry. The entry into the
industry is blocked by having control over the raw materials needed for the production of goods or
he may hold full rights to the production of a certain good (patent) or the market of the good may be
limited. If new firms try to enter in the field, it lowers the price of the good to such on extent that it
becomes unprofitable for new firms to continue production etc.
When there is no threat of the entry of new firms into the industry, the monopoly firm makes long run
adjustments in the scale of plant. In case, the demand for the product is limited, the monopolist can
afford to produce output at sub optimum scale. If the market size is large and permits to expand
output, then the monopolist would build an optimum scale of plant and would produce goods at the
minimum cost per unit. However, the monopolist would not stay in the business, if he makes losses
in the long period. The long run equilibrium of a monopoly firm is now explained with the help of
the following diagram.
 Diagram/Curve:

 In the long run, all the factors of production including the size of the plant are variable. A monopoly firm will
maximize profit at that level of output for which long run marginal cost (MC) is equal to marginal revenue
(MR) and the LMC curve intersects the MR curve from below. In the figure (16.6), the monopoly firm is in
equilibrium at point E where LMC = MR and LMC cuts MR curve from below. QP is the equilibrium price and
OQ is the equilibrium output.
 At OQ level of output, the cost per unit is QH (LAC), whereas the price per unit of the good is QP. HP
represents the per unit super normal profit. The total super normal profit is equal to KPHN. It may here be
noted that at the equilibrium output OQ, the plant is not being fully utilized. The long run average cost (LAC)
is not minimum at this level of output OQ. The firm will build an optimum scale of plant only if the demand for
the product increases.
 Threat of Entry of New Firms:

If there is a threat of entry of new firms into the market, the monopolist adopts price reduction strategy. He
instead of charging QP price per unit, lowers the price to BR. Since the per unit price BR is equal to the cost per
unit at R, the monopoly firm is earning only normal profit in the long run. The reduction in price and so in profits
is adopted to prevent the entry of new firms in the market.
Summing up, if a monopoly firm is in a position to maintain its monopoly status, it can earn super normal profit
in the long period. However, if there is an effective threat of the entry of potential firms in, the industry, then the
firm can earn just normal profit by reducing the price. The reduction in price depends on how strong is the threat
of potential entry into the industry.

 Monopolistic competition
Monopolistic competition is a market structure characterized by many firms selling products that
are similar but not identical, so firms compete on other factors besides price. Monopolistic
competition implies imperfect competition, because the market structure is between pure
monopoly and pure competition.
Monopolistic competition is the economic market model with many sellers selling similar, but not
identical, products. The demand curve of monopolistic competition is elastic because although the
firms are selling differentiated products, many are still close substitutes, so if one firm raises its
price too high, many of its customers will switch to products made by other firms. This elasticity of
demand is like pure competition where elasticity is perfect. Demand is not perfectly elastic because
a monopolistic competitor has fewer rivals than would be the case for perfect competition, and
because the products are differentiated to some degree, so they are not perfect substitutes.
Monopolistic competition has a downward sloping demand curve. Thus, just as for a pure
monopoly, its marginal revenue will always be less than the market price, because it can only
increase demand by lowering prices, but by doing so, it must lower the prices of all units of its
product. Hence, monopolistically competitive firms maximize profits or minimize losses by
producing that quantity where marginal revenue = marginal cost, both over the short run and the
long run.
 Characteristics Monopolistic Competition:
Chamberlin’s theory of monopolistic competition has the following
characteristics:

 i. Large Number of Sellers:

 ii. Differentiated Products:
 iii. Elastic Demand Curve:
 iv. Free Entry and Exit:
 v. Non-Price Competition:
 vi. Advertising and Brand Names:
 i. Large Number of Sellers:
Like perfect competition, there are a large number of sellers and buyers. But the ‘number’ is not too
large like perfect competition. As a result, each firm has an insignificant share in the market so that
action of one seller does not affect rival sellers to any great extent. Every seller in this market form
believes that his actions will go unnoticed by his rivals in the market. Thus, each seller behaves
independently in the market.

 ii. Differentiated Products:

Sellers sell differentiated products, but they are close— but not perfect—substitutes. Buyers may not
mind if they do not get Lux soap rather than Rexona. Different varieties of soap that are available in the
Indian market are slightly differentiated products and, hence, close substitutes. It is the degree of
differentiation that creates both monopoly and competitive elements.
Every product is unique to the buyers. So every seller enjoys some degree of monopoly of his own
product over other sellers. But since these goods are close substitutes, sellers face competition. Because
of brand loyalty of buyers, sellers exercise some monopoly power.
And sales of closely related goods create a competitive environ­ment. Thus monopolists compete among
themselves. It is product differentiation that enables monopolistically competitive firms to possess
market power with competition amongst the firms. In this market, monopoly power is, therefore, small.
 Monopolistic competition cannot exist unless there is at least a perceived difference among products
provided by the firms in the industry. The major tool of competition is product differentiation,
which results from differences in product quality, location, service, and advertising. Product quality
can differ in function, design, materials, and workmanship. Location is often a good differentiator of
products. Generally, firms more conveniently located can charge higher prices. Likewise, stores open
extended hours also provide convenience. For instance, if you need cold medicine in the middle of the
night, you may go to a 24-hour drugstore to purchase the medicine, even if it is at a higher price, since
you want immediate relief. Services include time of availability, the firm's reputation for servicing or
exchanging products, and speed of service.
 There are many examples of product differentiation in modern economies. Restaurants serve different
menu items at different prices in different locations, thus providing varying degrees of time and place
utility. Furniture stores sell different types of furniture made of different materials such as oak,
walnut, cherry, and maple. Clothes retailers sell different types of clothing at different prices, where
people pay not only for good workmanship, but also for items that suit their taste.
 A new front of monopolistic competition occurs among online retailers. In this case, their location
does not really matter. What matters is the convenience of shopping online, how well the products are
described, and reviews of the products by consumers who actually bought the product. Other
important qualities include trustworthiness of the firm and return policies.
 iii. Elastic Demand Curve:
Since product of each seller is slightly different from his rivals he enjoys some degree of monopoly power and,
hence, can raise the price of his product without losing most customers. But as other rival firms produce closely
related goods, every firm faces competition and its influence over the price of the product is rather limited.
Thus, each firm has a downward sloping demand curve implying that it behaves as a price-maker. Since a seller
faces a large number of competitors to whom buyers may turn, the demand curve is more elastic.

 iv. Free Entry and Exit:

Like perfect competition, there is complete freedom of entry and exit.
Because most firms engaged in monopolistic competition have low capital requirements, firms can easily enter or
exit the market. However, the amount of investment is generally larger than for pure competition, since there is
an expense to developing differentiated products and for advertising. A primary feature of monopolistic
competition is the constantly changing array of products that are competing in the marketplace. Firms must
continually experiment with product, prices, and advertising to see what yields the greatest profit. Although this
leads to productive and allocative inefficiency, the variety of goods offered more than compensates for this
inefficiency.
With easy entry and exit, firms will enter a market where present firms are earning an economic profit and will
exit the market where firms are losing money — thus, allowing the remaining firms to earn a normal profit.
 v. Non-Price Competition:
Besides price competition, Chamberlin suggested cases of non-price competition that arise due to product variation and selling
activities. Seller always tries to establish the fact that his product is superior to others by improving the quality of his product.
And in doing so, he incurs selling costs or makes advertise­ment to attract more customers in his fold. It is the product
differentiation that causes selling costs to emerge, in addition to production costs.
In Chamberlin’s model, demand for any commodity is not only affected by the price of a commodity but also by non-price
competition (i.e., product variation and selling activities). Selling costs or advertising outlays are peculiar to this market.

 vi. Advertising and Brand Names:

When there are only small differences between products, product differentiation would not be useful unless it can be
communicated to the consumer. This communication is accomplished through advertising, brand names, and packaging, which
are forms of nonprice competition, in that they compel consumers to pay a higher price if they perceive — rightly or wrongly
— that the quality is greater. Advertising serves to inform customers of the differentiated products and why they are superior
over close substitutes. Even if there are no differences, as is often the case between store brands and national brands, or between
a brand name drug and its generics, a consumer can still prefer one brand over another because of the advertising.
Brand names serve to distinguish identical or nearly identical products and to increase the value of advertising in that the brand
name serves as an object to which desirable characteristics can be attached. Advertising is used to build brand awareness or
loyalty to a particular company.
 Price and Output Determination under Short Run:
Under monopolistic competition price and output are determined as under other type of market structure during short
period. The point of equilibrium of an individual firm will be at the point where its marginal cost is equal to its marginal
revenue (MC=MR).
During short period there may be three situations of the firms under monopolistic competition as given below:
 (1) Super-normal Profit:
Profit making situation will be when individual firm’s revenue is greater than its cost (AR>AC). Profit making situation
is also called abnormal or super profit situation as given in Diagram 1.

Price, costs and revenues are

shown on OY-axis while output
on OX-axis. The point of
equilibrium is E where marginal
cost is equal to marginal revenue
(MC=MR) of the firm. The price
is OP, output is OQ. The average
profit (AR—AC) is TS and total
profit is PLST.
 (2) Normal Profit:
When the firm’s average revenue is equal to its average cost the situation is called normal profit.
It can be seen from the following

In the diagram output is shown on

OX-axis, price, costs and revenue
are shown on OY-axis. The point
of equilibrium is E where firm’s
marginal cost is equal to its
marginal revenue (MC=MR).
Price is PQ and output is OQ. At P
the average revenue is equal to
average cost hence the firm is
earning normal profit only.
 (3) Loss:
Under monopolistic situation during short period a firm will earn loss when its cost is greater than its
revenue (AC>AR). It can be explained with the help of the Diagram 3.

Price, cost and revenue are shown

on OY-axis while output is shown
on OY-axis respectively. The
point of equilibrium (MC=MR) is
E. Price is OP and output is OQ.
Average loss (AC- AR) is ST and
total loss is LPTS.
 Price and Output Determination during Long Run:
Under monopolistic competition, firms have freedom to enter and exit the industry. In the long run if firms
are earning profit new firms are attracted and it will increase the output and consequently prices will fall
leading to conversion of profit making situation into normal profit situation.
Contrary to it when firms are incurring losses during long period they will leave the industry. It will reduce
the volume of output, prices will increase and the loss making situation will be converted into normal profit.
Thus, the firms will earn normal profit only during long period. It can be seen from Diagram 4.

Price, costs and revenue are shown on OY-axis and

output on OX-axis. Point of equilibrium (MC=MR)
is E. Price is PQ and output is OQ. At P point
average cost is equal to average revenue (AC=AR).
Hence, the firm is earning normal profit only during
long period.
 Oligopoly Market:
 Oligopoly is an important form of imperfect competition. Oligopoly is often described as
‘competition among the few’. Prof. Stigler denes oligopoly as that “situation in which a rm bases
its market policy, in part, on the expected behaviour of a few close rivals”.
 In other words, when there are few (two to ten) sellers in a market selling homogeneous or
differentiated products, oligopoly is said to exist. Oligopolies mostly arise due to those factors
which are responsible for the emergence of monopolies. Unlike monopoly where a single rm enjoys
absolute market power, under oligopoly a few rms exercise their power to keep possible
competitors out.
 Consider the example of cold drinks industry or automobile industry. There are a handful firms
manufacturing cold drinks in India. Similarly, there are a few firms in the automobile industry in
India. Airlines industry, petroleum refining, power generation and supply in most of the parts of the
country, mobile telephony and Internet service providers are other examples of oligopolistic
market. These industries exhibit some special features which are discussed in the following
paragraphs.
 Example of Oligopoly:
 In India, markets for automobiles, cement, steel, aluminium, etc, are the examples of oligopolistic market. In
all these markets, there are few firms for each particular product.
 DUOPOLY is a special case of oligopoly, in which there are exactly two sellers. Under duopoly, it is assumed
that the product sold by the two firms is homogeneous and there is no substitute for it.

Examples where two companies control a large proportion of a market are:

 (i) Pepsi and Coca-Cola in the soft drink market;
 (ii) Airbus and Boeing in the commercial large jet aircraft market;
 (iii) Intel and AMD in the consumer desktop computer microprocessor market.
 Types of Oligopoly:
 1. Pure or Perfect Oligopoly:
Pure oligopoly or perfect oligopoly occurs when the product is homogeneous in nature,
e.g. Aluminium industry. This type of oligopoly tends to process raw materials or produce intermediate goods
that are used as inputs by other industries. Notable examples are petroleum, steel, and aluminium.
 2. Imperfect or Differentiated Oligopoly:
Differentiated or imperfect oligopoly occurs when goods sold is based on product differentiation,
e.g., passenger cars, cigarettes or soft drinks. The goods produced by different firms have their own
distinguishing characteristics, yet all of them are close substitutes of each other.
3. Open and closed oligopoly:
In an open oligopoly market new firms can enter the market and compete with the existing firms. But, in closed
oligopoly entry is restricted.
4. Collusive and Competitive oligopoly:
 If the firms cooperate with each other in determining price or output or both, it is called collusive oligopoly or cooperative
oligopoly. When few firms of the oligopoly market come to a common understanding or act in collusion with each other either
in fixing price or output or both, it is collusive oligopoly.
 When there is absence of such an understanding among the rms and they compete with each other, it is called competitive
oligopoly. If firms in an oligopoly market compete with each other, it is called a non-collusive or non-cooperative oligopoly.
 Collusive and non–collusive oligopoly can be separated on the basis of agreement. If the firms in oligopoly market are
functioning on the basis of an agreement between them, it becomes a collusive oligopoly. Oil and Petroleum Exporting
Countries (OPEC) is the best example, where few countries are producing the commodity and they collude under the label of
OPEC and it influence the price fixing, market sharing and other related policies.
 Non - collusive Oligopoly market is one, where there is no any kind of agreements and conducts between the firms. Each
firms running on the basis of the policies of themselves. No one will ever depend on the decision of others. Automobile
industry is the best example. Where, each firm fixes their price and other matters left independently.

5. Partial or 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. In full oligopoly, the market will be conspicuous by the absence of price
leadership.
6. Syndicated and organized oligopoly:
 Syndicated oligopoly refers to that situation where the firms sell their products through a centralized syndicate. Organized
oligopoly refers to the situation where the firms organize themselves into a central association for fixing prices, output,
quotas, etc.
Types of Oligopoly (Collusion)
As said above there are two types of collusion can be seen in oligopoly market. Each of them is briefly
described below.
 I – Cartel
An oligopoly industry can be said to be cartel when all the individual firms are running on the basis of the
agreements. So, each firm can earn monopoly profits by cooperating with other firms in the agreement. It may
be either international or domestic cartel. Oil and Petroleum Exporting Countries (OPEC) is an example for
international cartel. One of the biggest cartels in India is the cement cartel followed by telecom cartel, aviation
cartel and lots more.
 II – Price Leadership
Price leadership is another form of collusion of oligopoly firms. Actually it is a secret matter among firms. And
one firm considered as the leader and fix price and related things. All the firms in the oligopoly industry will
follow the rules fixed by the leader. Here there is no possibility of competition between leader and individual
firms.
e.g. Indian Telecom Company (Reliance JIO) gave a free Internet and calling facility for more than six months
after its launch. The existing telecom providers were charging for both Internet and calling during that time.
Generally three types of price leadership can see in practice, like
 i- Low cost price leadership
 ii- Dominant price leadership
 iii- Barometric price leadership
 Each of them is briefly described below.

 i) Low cost price leadership

It can be seen in an industry where each firm produces homogenous products with various costs. So, it is easier to sell large quantity
for the firm who produce with low cost. So, other firms may suffer losses. Here the low cost firm acts as a leader to set price, which
is beneficial for all firms in the industry.
 ii) Dominant price leadership
In some market, we can see that, a few firms are producing large amount of commodity and by getting huge market share. So, they
will fix their own prices and related things. Here any small firm cannot influence to fix the price. So, all the firms will follow the
price which fixed by the dominant firm in the industry.
 iii) Barometric price leadership
Here a firm acts as a leader of others. The leader considered as the large or most experienced or an old firm. Such firm has enough
knowledge about market. So, all other firms follow his actions in price. It may be a low cost firm or a dominant firm. This is a quick
adaptability. Once a firm discovers a sudden efficient, cost-effective way of production due to research or discovery, then he starts to
follow it and hence reduces its prices. Other firms, in order to compete with the firm, start following the same production schedule
and minimizes price as the firm is not big enough, so the leadership is short-lived. Big firms soon take-over the price.
 Features of Oligopoly:
The main features of oligopoly are elaborated as follows:

1. Few firms:
2. Interdependence:
3. Non-Price Competition:
4. Barriers to Entry of Firms:
5. Role of Selling Costs:
6. Group Behaviour:
7. Nature of the Product:
8. Indeterminate Demand Curve:
 1. Few firms:
Under oligopoly, there are few large firms. The exact number of firms is not defined. Each firm produces
a significant portion of the total output. There exists severe competition among different firms and each
firm try to manipulate both prices and volume of production to outsmart each other.
For example, the market for automobiles in India is an oligopolist structure as there are only few
producers of automobiles.
The number of the firms is so small that an action by any one firm is likely to affect the rival firms. So,
every firm keeps a close watch on the activities of rival firms.
 2. Interdependence:
Firms under oligopoly are interdependent. Interdependence means that actions of one firm affect the
actions of other firms. A firm considers the action and reaction of the rival firms while determining its
price and output levels. A change in output or price by one firm evokes reaction from other firms
operating in the market.
For example, market for cars in India is dominated by few firms (Maruti, Tata, Hyundai, Ford, Honda,
etc.). A change by any one firm (say, Tata) in any of its vehicle (say, Indica) will induce other firms (say,
Maruti, Hyundai, etc.) to make changes in their respective vehicles.
 3. Non-Price Competition:
Under oligopoly, firms are in a position to influence the prices. However, they try to avoid price competition for the
fear of price war. They follow the policy of price rigidity. Price rigidity refers to a situation in which price tends to
stay fixed irrespective of changes in demand and supply conditions. Firms use other methods like advertising, better
services to customers, etc. to compete with each other.
If a firm tries to reduce the price, the rivals will also react by reducing their prices. However, if it tries to raise the
price, other firms might not do so. It will lead to loss of customers for the firm, which intended to raise the price. So,
firms prefer non- price competition instead of price competition.

 4. Barriers to Entry of Firms:

The main reason for few firms under oligopoly is the barriers, which prevent entry of new firms into the industry.
Patents, requirement of large capital, control over crucial raw materials, etc, are some of the reasons, which prevent
new firms from entering into industry. Only those firms enter into the industry which is able to cross these barriers.
As a result, firms can earn abnormal profits in the long run.

 5. Role of Selling Costs:

Due to severe competition ‘and interdependence of the firms, various sales promotion techniques are used to
promote sales of the product. Advertisement is in full swing under oligopoly, and many a times advertisement can
become a matter of life-and-death. A firm under oligopoly relies more on non-price competition.
Selling costs are more important under oligopoly than under monopolistic competition.
 6. Group Behaviour:
Under oligopoly, there is complete interdependence among different firms. So, price and output decisions of a
particular firm directly influence the competing firms. Instead of independent price and output strategy,
oligopoly firms prefer group decisions that will protect the interest of all the firms. Group Behaviour means
that firms tend to behave as if they were a single firm even though individually they retain their
independence.

 7. Nature of the Product:

The firms under oligopoly may produce homogeneous or differentiated product.
i. If the firms produce a homogeneous product, like cement or steel, the industry is called a pure or perfect
oligopoly.
ii. If the firms produce a differentiated product, like automobiles, the industry is called differentiated or
imperfect oligopoly.

 8. Indeterminate Demand Curve:

Under oligopoly, the exact behaviour pattern of a producer cannot be determined with certainty. So, demand
curve faced by an oligopolist is indeterminate (uncertain). As firms are inter-dependent, a firm cannot ignore
the reaction of the rival firms. Any change in price by one firm may lead to change in prices by the competing
firms. So, demand curve keeps on shifting and it is not definite, rather it is indeterminate.