7 & 8 Chapter

Competition

Dr. Gopalakrishna B.V.,

Faculty in MBA,
SDM, Mangalore
 Meaning of Market
• Market in general – mean particular place
or locality where goods are sold and
purchase.
• In economics, the term market we do not
mean any particular place/locality in which
goods are bought and sold.
• Buyers and sellers contact through
personal contact, exchange of letters,
telegrams, telephones and e-mail etc.
• For example trade between America and
India.
 Meaning of Market……
 In the words of Cournot – market not any
particular market place in which things are
bought and sold but the whole of any region
in which buyers and sellers are in such free
interact with one another.
 Thus, essential of market are –
a) Commodity which is dealt with
b) The existence of buyers and sellers
c) A place, be it a certain
region/country/world
d) Price prevailing for the commodity.
 Classification of Market Structure
 Perfect competition and Imperfect
competition
1. Perfect Competition
 market, where there is a large number of
producers (firms) producing a homogeneous
product, homogeneous price existence.
2. Imperfect competition
 It is an important market category where in
individual firms exercise control over the price
of commodity.
 Imperfect competition has several sub-markets
-
1) Monopolistic competition
2) Pure Oligopoly
3) Differentiated Oligopoly
4) Monopoly
 Monopolistic competition
 Prof Chamberlin and Mrs. Joan Robinson were
developed monopolistic competition in 1933.
 Chamberlin’s in his work “The Theory of
Monopolistic Competition” and Mrs. Robinson
“The Economic Imperfect Competition” in 1933.
 The firm produces differentiated product but
some how close substitute each other.
 Sellers are numerous but not as much of perfectly
competitive market.
 A wide range of consumer goods like toothpastes,
soaps, cigarette, radio’s, TVs, Scoters,
Commercial vehicle – large degree of product
differentiation.
 This market condition characterized by mixture of
perfect competitive and a certain degree of
monopoly power.
 Forms of Market Competition

Models of Number of Number of Nature of Barriers to

Competition buyers sellers products entry and
exit
Perfect Very large Very large Identical None
competition products
Monopoly Very large One Single Very large
product
Monopolistic Very large Large Minimum None
competition differences

Oligopoly Very large Very few Large Large

differences
 Perfect Competitive Market

Features of perfect competitive market

1. Large number of buyers and sellers
2. Homogeneous product
3. Free entry and exist conditions
4. Perfect knowledge about market
5. Perfect mobility of factors of
production
6. Absence of transport cost
1. Large Number of buyers and sellers
 There will be a large number of buyers and
sellers existed in the market.
 Any single producer or consumers influences -
demand and prices - drop of water put into sea
like..
 Individual firm is only a price taker and not
price-maker.
2. Homogeneous Product
 Commodities produced by all the firms is
homogenous and identical in all respects.
 There is no changes in terms of quality, size,
taste etc between the firms.
 No. one firms influences prices either
increase/decrease in the market.
3. Free entry and exists
 There are no artificial restrictions either preventing the
entry of new firms into market or compelling the existing
firms to continue.
 The firms have full liberty to choose either to continue or go
out of the industry.
4. Perfect knowledge on the part of buyers and sellers
 Both buyers and sellers got good knowledge about market
conditions – price of commodities.
 Due to perfect knowledge by both buyers and sellers, there
need not be any advertisement.
5. Perfect mobility of factors of production
 The factors like labour & capital should be freely mobile
place to place and region to regions
6. Absence of transport cost
 If transport costs are incurred, prices should be
differentiated in different sectors of the market.
 Price and Output Determination
 Price under perfect competition is determined by
the interaction of the two forces – demand and
supply.
 Though individuals cannot change the price, but
aggregate forces of demand and supply can
change.
 Demand side – marginal utility of commodity to
the buyers
 Supply side – cost of production – producers
 The interaction of demand and supply is called
the equilibrium price.
 Equilibrium price is that price at which quantity
demanded is equal to the quantity supplied at
give price – both buyers and sellers satisfied
Equilibrium between demand and
supply
Price of Demand Supply Pressure on
commodities price

5 12 1
Excess
10 10 2
Demand
15 08 4
20 06 6 Equilibrium
25 04 8
Excess
30 02 10
Supply
35 01 12
Price and Output Determination

12
 Elements of time – price theory

 Alfred Marshall was the first

economists to introduced “Time
Factor” – price determination.
 He divided time period into three
ways –
1. Market Period
2. Short Period and
3. Long Period
 1. Market Period
 Market period are also called as very
short period.
 The supply of a commodity is almost
fixed and the demand will play a decisive
role in determining the price of products.
 This market period may be an hour, a
day, or few days or even a few weeks –
depends on nature of commodities.
 Types of commodities are –
1. Perishable commodities
2. Non-perishable commodities
 Perishable commodities

 Fish, milk, vegetables, flowers, meat and

butters etc are perishable commodities.
Supply is limited in the existing stocks.
 The fundamental features of this period –
supply of the commodity is absolutely
fixed and therefore, the supply curve of
each firm will be a vertical straight line.
 Demand factors more important than
supply in determining price.
 Perishable commodities

Y S

D1
D
D2
P1
P
Price
P2 D2
D
D2

O M X
Quantities
 Non-perishable/Durable
commodities
 Durable goods are those which can
be reproduced or those can be
stored. Like perishable goods, the
supply of durable goods is not
vertical throughout the length.
 Firms selling such goods have a
minimum reserve price – they will
not sell goods at less than reserve
price – wheat, soap & oil etc.
 Factors affecting Reserve Price
1. Price in future – if seller expects that a high price will prevail in future.
2. Liquidity preference – if the seller is in urgent need of money his
reserve price will be low & vice-versa.
3. Future cost of production – if the seller expects that in future the cost
of production will fall, his reserve price will be lower & vice-versa.
4. Storage Expenses – if the seller finds that the storage expenses are
higher & the time for which the stocks have to be held are longer, his
reserve price will be lower & vice-versa.
5. Durability of commodity – more durable commodity is higher will be
the reserved price.
6. 6. Future demand
 Future demand of a commodity also influences the reserve price of the
producer.
 If the producer expects a higher demand in future, his reserve price will also
be higher.
Short period – Price determination
• Short period refers to that period in which supply
can be adjusted to a limited extent.
• Stigler in his word short period is a period in which
the rate of production, change by change in
variable with existence of fixed inputs.
• In short period fixed factors – machinery, plant,
building etc cannot be altered and variable factors
may be increased or decreased according to the
change in demand.
• In short period, price is determined by the
interaction of two forces – demand and supply.
• Demand factors were more dominated factors in
short period.
 Short period price
determination
D1
S

E1
P1

D
E2
Price

P2
P E

S D1

M M1
Out put
 Long period price determination
• Long period is a period of many years 5, 10,
15 20 & above.
• In this period supply conditions are fully
able to meet the new demand conditions.
• In the long run no fixed & variable factors
all the factors treated as variable factors.
• New plants/new firms can enter into the
market & old firms can leave the market.
 Long run Price determination
Y
MPSC

SPSC
E1
P1

P2 E2
Price

LPSC
P
E

M1 M2 M3 X
O
Output
 Monopoly Market
• Monopoly is a market situation in which there
is only one seller/producer who controls the
entire market supply.
• There are no close substitutes for his product
& there are barriers to the entry of rival
producers.
• The term monopoly has originated from the
two Greek words “Mono” – single & “poly” –
seller, thus, monopoly means single seller
existence.
• Thus, monopoly market model is – opposite
extreme of perfect competition.
• The degree of competition in monopoly
market structure is nil or extremely small.
 Features of Monopoly
1. One seller & large number of buyers
 the monopolist’s firm is the only firm – it is an industry.
 But the number of buyers is assumed to be large.
2. No close substitutes
 There shall not be any close substitutes for the product sold by the
monopolist.
 The cross elasticity of demand between the product of the
monopolist and others must be negligible or zero.
3. Difficulty of entry of new firms
 There are either natural or artificial restrictions on the entry of firms
into the industry, even when the firm is making abnormal profits.
4. Monopoly is also an industry
 Under monopoly there is only one firm which constitutes the
industry.
 Difference between firm and industry comes to an end.
5. Price Maker
 Monopolistic has full control over the supply of the commodity
 But due to large number of buyers, demand of any one buyer
constitutes an infinitely small part of the total demand.
 Nature of Demand curve
• Demand curve of the monopoly
market is sloping downwards.
• If he wants to increase the sale of his
good, he must reduce the price or
• he can raise the price by reducing his
level of output.
Nature of Demand curve
Price and output determination
– The goal of the monopolist is to maximise
profits – rational behavior.
– Profit maximisation of monopoly firms depends
on demand & cost conditions.
– If he raises the price of his product, the
quantity demanded of it will fall & if he lowers
the price the quantity demanded of his product
will increase.
– He will therefore choose price-output
combination which maximises his profits.
– Profit are maximised at the level of output at
which MR=MC & MC cuts MR from the below.
Price & output determination -
Monopoly
MC
Price

P Economic S

Profit
H T
AC
D

M MR Quantity of output
 Monopolistic Competition
• In the real world, either perfect competition or monopoly
does not existed, but it only an imperfect competition like
monopolistic competition.
• The credit for the development of monopolistic competition
goes to Joan Robinson of UK & Chamberlin of USA in
1933.
• Mrs Joan Robinson her book “The Economic of Imperfect
Competition & Prof Edward. H. Chamberlin “The theory
of Monopolistic competition” in 1933.
• Thus, monopolistic competition refers to competition
among a large number of sellers producing close substitute
but not perfect substitutes.
• Further, in this market condition there is freedom of entry
into & exist from the industry.
• It defined as the form of market structure in which there is
a large number of firms producing differentiated products
which are close substitutes of each other.
 Product differentiation

• The products of various sellers under this market conditions

are fairly similar but not perfect/close substitutes of each
other.
• Every seller has a monopoly of his own product variety but
he has to face a stiff competition from his rival sellers,
selling close substitutes of his product.
• Bathing soap – which produce different brands such as
Lux, Human, Godrej, jai, dove etc.
• Shampoo – Sunsilk, Clinic plus, Head & Shoulders etc.
• Blade – Swiss, Wilkinson, Sword & 7.0 clock etc.
• Tooth paste – Colgate, close-up, promise, Pepsudent etc.
• Two wheeler bike – Hero Honda, Pulsor, TVS Victor,
Yamaha etc.
• Cool drinks – Pepsi, coco-cola, sprite, 7up, Mirinda, Maza
slice etc.
 Features of Monopolistic
Competition
1. A large number of firms
2. Product differentiation
3. Free entry & exists of firms
4. Selling cost
5. Non-price competition
6. Product variation
1. A large number of firms
 There are a relatively large number of firms existed in the market.
 Because of large number of firms, there is stiff competition between them.
 Unlike perfect competition these large number of firms do not produce
identical but they have perfect substitutes between them.
 The size of each firm will be relatively small.
2. Product differentiation
• Products produced by various firms are not identical but are slightly different
from each others – close substitutes of each other.
• Therefore, their prices cannot be very much different from each other.
• Their products are similar & close substitutes of each others.
• Product differentiated – differences in the quality, tastes, preferences,
workmanship, durability, size, shape, design, colour, fragrance, packing etc.
3. Freedom of entry & exist
• New firms to enter & existing firms to leave industry.
• If industry making super-normal profits new firms can
enter it – which leads to the expansion of output.
• Exist firms can leave industry – if they incurs losses.
4. Product variation
• Product variation under monopolistic competition exists
because there is differentiation of products of various
firms.
• The variation of product refers to a change in the quality
of the product itself, technical change, design, better
materials package etc.
5. Non-price competition
• Selling cost & advertisement expenditure is an unique feature of
monopolitic competition.
• The firms incur a considerable expenditure on advertisements &
selling cost to promote the sales of heir products.
• The advertisement & other selling outlays – change he demand
for its product
• Firms maximising profits through advertisement & selling cost.
 Nature of Demand curve
• Under monopolistic competition enjoys some
control over the price of its product – since
its product is somewhat differentiated from
others.
• If a firm raises the price of its product it will find
some of its customers going away to buy other
products.
• As a result, the quantity demanded of its product
will fall.
• On the contrary if it lowers the price, it will find
that buyers from other varieties of the product
will start purchasing its product & as a result
the quantity demanded of its product will
increase.
• Therefore, demand curve facing an individual firm
under monopolistic competition slopes
downward.
• If a firms wants to increase the sales of its
product, it must lower the price.
Nature of Demand curve
 Nature of Demand curve…….
• Demand curve facing a firm will be his average
revenue curve (AR).
• Thus, average revenue curve of the
monopolistic competitive firm slopes downward
throughout its length.
• Since average revenue curve slopes downward,
marginal revenue (MR) curve lies below it.
• The implication of MR curve lying below AR
curve is that the MR will be less than the price
or average revenue.
• If the firm wants to sell more, the price of its
product fall MR therefore must be less than the
price.
 Short period - Price and output
determination
• Price & output determination under monopolistic
competition was developed by Edward H.
Chamberlin – in the early 1930s.
• Monopolistic competition refers to large number of
sellers sell differentiated products, which are
close to each other.
• The price and output determination – are similar to
monopoly market condition.
• Demand curve sloping downward like monopoly AR
& MR.
• Various firms producing differentiated product,
which are close to each other.
• In the short run, firms incurring super normal
profits, normal profits & economic losses, it
depends upon the nature of average cost &
average revenue
 Super normal profit and
economic losses
(a) (b)
Y Dollars SAC
SMC SAC MC SMC
H
Profit

G
Revenue/

S
P Profit 40
K
H T Total Loss

E E

AR/D
D D
O M Output X O M X
MR OutputMR
 Price and Output
Determination – short period –
Normal Profits
$60 MC

40 E

10,000 30,000
MR

Lieberman & Hall; Introduction to

40
Economics, 2005
Monopolistic Competition in the Short
Run
• In the short-run, a monopolistically competitive firm will
produce up to the point where MR = MC.

• This firm is earning

positive profits in the
short-run.
Monopolistic Competition in the Short-
Run
• Profits are not guaranteed. Here, a firm with a
similar cost structure is shown facing a weaker
demand and suffering short-run losses.
Monopolistic Competition in the Long-
Run

• The firm’s demand curve

must end up tangent to
its average total cost
curve for profits to equal
zero. This is the
condition for long-run
equilibrium in a
monopolistically
competitive industry.
 Oligopoly
 The term Oligopoly derived from two Greek words ‘Oligos’ – a
few & Pollein – to sell.
 Thus, oligopoly refers to that form of imperfect competition
where there will be only a few sellers producing either a
homogeneous product or products which are close
substitutes but not perfect substitutes.
 Oligopoly is also referred as “Competition among the few” as
a few big firms will be producing & competing in the market.
 Oligopoly market is different from monopoly, duopoly,
monopolistic competition and perfect competition, it is
sometimes called limited competition, incomplete monopoly
or multiple monopoly.
 Oligopoly market are generally found in modern capitalist
countries.
 Earlier it is called as pure or perfect oligopoly & the latter it is
called as imperfect or differentiated oligopoly.
 Classification of Oligopoly
1. Pure or perfect oligopoly & differentiated
or imperfect oligopoly
• If the firm producing/competing
identical/homogeneous product it is called as
pure/perfect oligopoly. for example – Cement &
Aluminum Industries.
• While, the firm producing & competing different
commodities/close substitute & not perfect
substitution called different/imperfect oligopoly.
2. Open and Closed oligopoly
• Open oligopoly refers to new firms can enter the
market & compete with the existing firms.
• Closed Oligopoly – no freedom to entry & exist
of firms to industry.
3. Collusive and non – collusive Oligopoly
• Collusive means co-operation between the
competing firms in pricing their products
• All the existing firm acts independently in the
determination of prices.
• There is no insecurity, uncertainty in the oligopoly
industry.
• Where as non-collusive oligopoly each firms
undertaken independent decision making with
regard to price & output of the commodity (lack
of understanding between the firms & competing
within themselves).
4. Partial and Full Oligopoly
• Partial oligopoly market one of the dominant
firms undertake decision-making of price &
output & other firms follows it – price leadership.
• Where as, full oligopoly – the market will be
conspicous by the absence of price leadership.
 Features of Oligopoly
Market
1. Interdependence
2. Indeterminate demand curve
3. Importance of advertising & selling
costs
4. Group Behaviour
5. Element of Monopoly
6. Price Rigidity
1. Interdependece
• The price & output decisions of one firm will affect
the other firms & any decision can be arrived at
only after deep consideration of the possible
reaction of the rival firms in the group.
• As the number of firms are few, a change in price &
output by a firm will directly affect the fortunes of
its rivals.
• Decision-making is closely connected with the price
output policies of other firms.
2. Indeterminate Demand Curve
• No firm in oligopoly market can forecast with some
degree of certainty about the nature & position of
its demand curve.
• 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.
3. Importance of advertisement & selling cost
• Due to indeterminate demand curve leads to the
condition of aggressive advertisement to bring more
customers into the fold of the firm.
• A direct effect of interdependence & indeterminate -
demand of various firms – firms incurs the enormous
selling & advertisement cost.
• Therefore, there is a great importance of advertising &
selling costs under conditions of oligopoly market.
• Prof Baumol rightly says that “it is only under oligopoly
market advertising comes fully into its own”.
4. Group Behaviour
• The firms under oligopoly recognize their
interdependence & realise the importance of mutual co-
operation.
• Therefore, there is a tendency among them for collusion.
• Collusion as well as competition prevail in the
oligopolistc market leading to uncertainty and
indeterminateness.
5. Price Rigidity
• Prices tend to be sticky or rigidity under
oligopoly market – product differentiation.
• The price will be kept unchanged due to
fear of retaliation & counter-action from
other firms – sticky & inflexible.
• No firm would indulge in price cutting, as it
would eventually lead to a price war.
• Price War - if any one firm introduces a
price cut it will attract to customers, the
rival firms will retaliate by cutting down
their prices No benefit to rivals
• The price may be kept constant even
without any collusion or agreement
 Kinked Demand Curve
• In 1939, Prof Paul Sweezy has introduced the
Kinked Demand Curve – determination of
equilibrium in oligopoly market.
• He used the kinked demand curve model – explain
about price rigidity under oligopoly market.
• Demand curve facing an oligopolist has a kink at
the prevailing price.
• If he lowers the price below the prevailing level his
competitors will follow him & will lower their prices.
• But if he increases his price above the prevailing
level his competitors will not follow his increase in
price.
• Upper segment of the demand curve is relatively
elastic and the lower portion is relatively inelastic.
 Assumptions
1. There is an established market price
at which all the sellers are satisfied.
2. Each sellers attitude depends on the
attitude of his rivals.
3. An attempt of every seller to push
up his ales by reducing the price will
be counteracted by other sellers.
4. If the seller raises the price, other
will not follow him rather they will
stick to the prevailing price.
 Kinked Demand Curve

Y More Elastic

d MC
P K
Revenue
/Cost

A Less Elastic

B D/AR

O M X
MR
quantity
• dKd is the kinked demand curve of an oligopolistic firm.
• OP is the prevailing market price & OM is the equilibrium
level of output.
• If an oligopolistic seller (firm) increases the price of the
product above OP, this will reduce his sales – because the
rivals are not expected to follow his price.
• This is because the dk portion of the kinked demand curve
is elastic & the corresponding dA portion of the MR curve is
positive.
• If the seller reduces the price of the product below OP, his
rivals will also reduce their price.
• Though he increase's his sales, his profits would be less
than before.
• The reason is that kd portion of the kinked demand curve
below OP is less elastic & MR curve below B is negative.
• Thus in both the price-rising & price reducing situations –
the oligopolistc seller will be the loser.
• Therefore, he will stick to the prevailing market price OP
which remains rigid.
• A kinked demand curve is said to occur when there is a
sudden change in the slope of the demand curve.
Price and output determination -
Oligopoly
• There is no one system of pricing under
oligopoly market.
• Price policy followed by a firm depends on
the nature of oligopoly & rival reactions.
• Therefore, there are three types of pricing
under oligopoly.
1. Independent Pricing
2. Pricing under Collusion
3. Pricing under Price Leadership
1. Independent Pricing or (Non-collusive oligopoly)
Homogeneous Product
 When goods produced by different oligopolists are more or
less similar or homogeneous in nature.
 There will be a tendency for the firms to fix a common
pricing – “Going Price” – accepting price.
 So that firm earns adequate profits at this price.
Non-homogeneous Product or Different Product
 When goods produced by different firms are different in
nature, each firm will be following an independent price
policy – like monopoly.
 Due to product differentiation, each firm has some
monopoly power.
 Price war between different firms & each firm may fix price
at the competitive level.
 A firm tend to change prices even below the variable costs,
the other firms are also cutting the price as same as them –
cut throat competition.
 Independent pricing in reality leads to antagonism, friction,
rivalary, infighting, price-wars etc.
2. Pricing under Collusion
• The term collusion means - to play together in
economics. It means that the firms co-operation
between the competing firms in pricing their
products.
• Three main reasons for collusion
1. Oligopoly firms wants to reduce competition & increasing
profits.
2. Collusion helps them to reduce uncertainty.
3. To prevent the entry of new firms into the industry.
• Collusion based on oral agreements or written
agreements.
• Oral agreements – “Gentlemen’s agreement – it does
not consist of any records.
• Written agreements are called as CARTELS.
• Two kinds of collusion
• 1. Perfect Collusion &
• 2. Imperfect Collusion
1. Perfect collusion (centralized cartel)
 The firms surrender all their rights to a central
authority when sets prices, output & quotas
for each firm, distributes profits etc.
 The cartel are similar to a monopoly, where
entire oligopoly industry is controlled &
directed by the central agency.
2. Imperfect collusion
 Refers to a secret or informal agreement
under which the colluding firms in the
oligopoly industry seek to fix prices & outputs
of their products.
 Price leadership is an ou5tstanding example of
imperfect collusion.
 Pricing under collusion

Y MC1
MC2

IMC
P
Price & Cost

Q1 Q2
Q3 ID

MR

O M1 M2 M3 X
Output
• ID industry’s demand curve & MD – marginal revenue curve.
• The marginal cost of the cartel (IMC) is the sum-total of the marginal
cost curves of the two firms in the industry.
• At point Q, the aggregate marginal cost of the industry (IMC) is
equal to the marginal revenue.
• Therefore, the cartel will naturally produce OM3 output for the
industry & fix PM3 price for the product.
• Because, it is at this output & price that the cartel is able to
maximise the profits of the industry.
• There are two oligopoly firms in the industry named as A & B.
• The marginal cost curve of the firm ‘A’ is MC1 & of the firm B is MC2.
• The output of each firm will be fixed on the basis of its efficiency.
• The efficiency of A firms lower than B firms.
• OM1 quantity of output with MC1 marginal cost of firm A, while firm B
produces OM2 of output with MC2 marginal cost.
• Thus, the output of A firm is OM. B firm is OM2 & total output is OM3
& the price at which this output is old is PM3.
 3. Price Leadership under
oligopoly
• When price is determined by one big firms
in the industry & this price is accepted by
all the other firms (small firms).
• Price fixation is generally the result of tacit
understanding rather than of a formal
agreement.
• The big firms – scale of production, most
senior/experienced firms etc.
• In America, price leadership industries are
– biscuits, cement, cigarettes, flower,
fertilizers, petroleum, milk, steel etc.
 Price leadership under oligopoly

Y Figure 1 Y Figure 2

ID
MCA MCB
MCC

D
P1
Q1 Q2 Q3 P

&
ue
n
ve ost ID
R e C

O M1 M2 M3 X O M X

Output
£ Price Leadership
MC

l t
PL
AR = D market

AR = D leader

MR leader
O QL QT Q
• ID represents the total industry’s demand at OP price, the
industry sells OM of output.
• The average revenue curve of the smaller firms is a horizontal
straight line – because they accepted price fixed by dominant
firm.
• We have taken three smaller firms as A, B & C.
• The price is OP1 & therefore, the AR curve is a horizontal straight
line.
• Therefore, their MR curve is also the same as AR curve.
• Each firms have their own separate marginal cost curves. MCA of
A MCB of B & MCc of C firms.
• Q1 is the point at which the marginal cost of the firm A is equal to
its marginal revenue & therefore, it produces OM1 output.
• Q2 is the point at which the marginal cost of the firm B is equal to
its marginal revenue & therefore, it produces OM2 output.
• Similarly, the firm C produces OM3 output. The total output of the
industry is OM & therefore, the output of the dominant firm would
be OM = (OM1 + OM2 + OM3).
• The dominant firm can determine its price & output by the quality
of its marginal cost & marginal revenue.