Price and Output Determination in Monopoly and Imperfect Markets

Monopoly

• Derived   from   Greek   word   "Mono" means "Single" and "Polein" means "Seller".

• Monopoly means "Alone to Sell".

• Monopoly signifies absolute power to Produce & Sell a Product which has no Close Substitute.

• Industry is a Single Firm Industry.

• Monopoly  is  a  Market  situation  in  which there is  a  Single Seller,  there are no Close Substitutes for Commodity it produces, there are Barriers to Entry. - Koutsoyiannis

• Pure  or  Absolute  Monopoly  exists  when  a Single Firm is the Sole Producer for a Product for which there are no Close Substitutes.  - Mc Connel

Features of Monopoly

1. • One Seller & Large Number of Buyers
2. • Monopoly is also an Industry
3. • Restrictions on the Entry of New Firms
   1. – Economic,   Institutional,    Legal   or   Artificial Barriers
4. • No Close Substitutes
   1. – Cross Elasticity of Demand is Zero or Very Small
   2. – Price Elasticity of Demand < 1
5. • Price Maker
6. General Economics:Price & Output

Sources of Monopoly (Barriers)

• Legal Restrictions

– Created by Law in Public Interest

– Like     Postal,     Telephone,     Generation     & Distribution  of  Electricity, Railways, Roadways, Airlines, etc.

– State   may   create   Monopolies   in   Private Sector  by  restricting  Entry  of  other  Firms. Such Monopolies are known as "Franchise Monopoly".

• Control over Key Raw Materials

– Firms  that  acquire  Monopoly  because  of their Traditional Control over certain Scarce & Key raw Materials, which are essential for the Production of certain other Goods, are known as "Raw Material Monopolies".

– For    Example,    Aluminium    Company    of America had monopolized the Aluminium Industry by acquiring control over almost all

• Efficiency

– Primary    and    Technical    reason    for growth  of  Monopolies  is  the Economies of Scale.

– Emerges    either    due    to    Technical Efficiency or is Created  by the Law on Efficiency grounds.

– Termed as "Natural Monopolies"

• Patent Rights

– Patent Rights are granted by Government to a Firm to produce a Commodity of Specified Quality & Character or to use a Specified Technique of Production.

– Patent Rights gives a Firm Exclusive Rights to produce the specified commodity or to use the Specified Technique of Production.

– Termed as "Patent Monopolies". 

Demand & Revenue Under Monopoly

• Firm’s   Demand   Curve   also   constitutes Industry’s Demand Curve.

• Demand   Curve   of   Monopolist   is   also Average Revenue (AR) Curve.

• AR Curve & MR Curve are separate from one another.

• MR Curve lies below the AR Curve.

• Slope of MR Curve is TWICE the Slope of AR Curve.

Relationship between AR & MR of Monopoly

• AR  &  MR  are  both  Negatively  Sloped Curves.

• MR Curve lies half way between the AR Curve and the Y-Axis i.e. it cuts the area between AR Curve and Y-Axis into two equal parts.

• AR cannot be Zero, but MR can be Zero or even Negative

Equilibrium under Monopoly

• Conditions of Equilibrium

A  Monopolist is  in  Equilibrium when he produces the amount of Output which yields him Maximum Total Profit.

• Profit is Maximum when:

1.  Marginal Cost = Marginal Revenue

2.  Marginal Cost Curve cuts Marginal Revenue from     below     under     Increasing     Cost condition.

 

Price Discrimination Under Monopoly

• The Act of Selling the same Article produced under Single Control at  a  different Price is known as Price Discrimination. – Mrs. Joan Robinson

• Price  Discrimination  refers  strictly  to  the practice  by  a  Seller  to  charging  different Prices from different Buyers for the same Good. – J.S.Bains

Conditions of Price Discrimination

• Existence of Monopoly

• Separation  of  Markets  possible  i.e.  No transfer of Commodity from Low Priced Market to High Priced Market.

• Difference in Elasticity of Demand

– Inelastic  Demand  →  Higher  Price  Per Unit

– Elastic Demand → Lower Price Per Unit 

Comparing Monopoly to Perfect Competition

Basis of Comparision	Perfect Competition	Monopoly
Goods Produces	Homogenous Products	Unique Product with Close Substitute
Sellers & Buyers	Large Number of Buyers & Sellers	One Seller & Large Number of Buyers
Price Control	Price Taker	Price Maker
Profit Maximization	AR = P = MC	MR = MC
Entry & Exit of Firms	Free Entry & Exit	Barriers to Entry
Decisions Taken	Quantity to be Produced	Either Price or Quantity to be Produced
Maximized Profit in Long Run	Normal Profits	Abnormal Profits
Technology’s Effect	Still Zero Profit; Usually Price goes downand output goes up	Generate Higher Profits Price and Output is not determined

Monopolistic Competition

• Developed by Edward H. Chamberlin

• Monopolistic Competition is a Blend of Monopoly & Perfect Competition.

• Monopolistic  Competition  is  a  Market Structure in which a Large Number of Sellers sell Differentiated Products which are close, but not perfect substitutes for one another.

• Monopolistic Competition is a Market situation in which there are many Sellers of a particular Product, but the Product of each Seller is in some way  Differentiated  in  the  minds  of  Consumers from the Product of every other Seller. -By: Leftwitch

• Monopolistic competition is found in the industry where there is a large number of small sellers, selling  differentiated  but  close  substitute products. -By: J.S.Bains

Features of Monopolistic Competition

• Large  Number  of  Sellers  &  Buyers  in  the Market.

• Product Differentiation

• Free Entry & Exit of Firms.

• Non-Price Competition.

• Price Policy (Firm is a Price Maker)

• Selling Cost

• Less Mobility

• Imperfect Knowledge

• Product Differentiation

– Product  Differentiation  refers  to  that  situation wherein the  Buyers can distinguish one Product from the other.

– Arises due to the Characteristics of the Products, E.g, Shape, Colour, Durability, Quality, Size etc.

– Differentiated  Products  are   Close,   not   Perfect Substitutes for one another.

– For  Example,  Lux,  Godrej,  Hamam,  Rexona,etc. among Bathing Soaps.

• Price Policy

– Each firm has its own price policy. Average and Marginal revenue curves of a firm under monopolistic competition slope downwards as in case of monopoly. It means if a firm wants to sell more units of its product it will have to lower the price per unit. If it wants to sell fewer units it

• Non-Price Competition

– When    Different    Firms    compete    with    one another without changing the Price of the Product, it is termed as Non-Price Competition.

– For Example, Firms producing Washing Powder, ‘Surf’ and ‘Farishta’. With one pack of ‘Surf’ the Company  may  give  a  Free  Gift  as  one  Glass- Tumbler. Likewise, with one pack  ‘Farishta’, the other Company may give a Stainless Steel Spoon as a Free Gift.

Short-Run Equilibrium under Monopolistic Competition

• In  Short  Run,  a  Firm  will  be  in  Equilibrium when

i.   MC = MR

ii.  MC Curve cuts MR Curve from below

•   The Quantum of Profit available to a Firm in Equilibrium in Short Period depends upon

–  The Demand for the Good

– The Efficiency of the firm

 

•  If MC = MR, then the Output produced by the Firm, at the Point of Equilibrium, will yield Maximum Profit. It will not be advisable for the Firm to Produce more than it.

•  If AR(P)

•  If AR(P) > AC, the Firm will get Super Normal Profit.

•  If AR(P) < AC, the Firm will incur Minimum Loss, however the Firm will continue its Production as long as the

Long Run Equilibrium under Monopolistic Competition

•  In the Long Period, each Firm will produce up to that Limit where MR = LRMC.

•  Firms earn Normal Profit only as:

– If  Firms  can  earn  Super  Normal Profit,  then  new Firms will enter. As a result of it, Total Supply will Increase which lowers the Profit Margin.

– To create more Demand new Firms will lower the Prices, old Firms too will lower the Price of their products, if they are to exist in the Market. Thus, because of Fall in Price both old and new Firms will get only Normal
• In Long Run, no Firm will incur Loss. It a Firm incurs Loss, it is better for the Firm to Shut Down. As Firms Quits, Total Supply of Goods will fall Short of Total Demand, causing their Price to Rise and enabling the Firms to earn Normal Profit once again.

• A Firm is in Equilibrium Position at a Point where it has Excess Capacity.

 

Oligopoly

• Derived    from    Greek    words    "Oligi" meaning "Few" and "Polein" meaning "Sellers".

• Often described as "Competition Among the Few".

• When there are few (Two or Ten) sellers in a Market selling Homogenous or Differentiated   Products,   Oligopoly   is General Economics:Price & Output said to Exist. determinatin in Monopoly & Imperfect                                                                        

Features of Oligopoly Market

• Few Sellers

• Interdependence of Business Decision

• High Cross Elasticity of Demand

• Advertising & Selling Cost

• Price Rigidity

• Intensive Competition

• Barrier to entry

 Kinked Demand Curve

• Propounded by Paul M. Sweezy

• Does   not   deal   with   Price   &   Output Determination.

• Seeks  to  Establish   that   once   a  Price- Quantity combination  is  determined, an Oligopoly Firm will not find it Profitable to change its Price even in response to the Small Changes in the Cost of Production.

• If an Oligopoly Firm, reduces the Price of its Product, the Rival Firms will follow & neutralize the Expected Gain from Price Reduction.

• If an Oligopoly Firm, raises the Price of its Product, the Rival Firm would either maintain their Prices or indulge in Price- Cutting.

• Three Possible ways in which Rival Firms may react to Change in Price by one of Firms:

– The Rival Firms follow the Price changes, both Cut & Hike.

– The  Rival  Firm  do  not  follow  the  Price Changes.

– Rival Firms do not react to Price-hikes but they do follow price cutting

Summary

Form of Market Structure	No. Of Firms	Nature of Product	Price Elasticity of Demand of a Firm	Degree of Control Over
Perfect Competition	A large no of firms	Homogeneous	Infinite	None
Monopoly	One	Unique Product with close  Substitute	Small	Very  Considerable
Imperfect Competition
Monopolistic Competition	A large no. of Firms	Diffreretiated Products	Large	Some
Oligopoly	Few Firms	Homogeneous or  Differentiated  Product	Small	Some

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