IMPERFECT COMPETITION - MONOPOLY Marshalls perfect competition showed the economic heaven, but like all heavens, it was

illusive. The conclusions of perfect competition were unreal. As per Marshallian theory, every firm under perfect competition would be an optimum firm in the long run where AR=MR would be tangent to AC at its minimum level where MC intersected it. This is shown in the following diagram.

Consumer paid the lowest possible price, entrepreneure made normal profit and society used all its resources at their maximum efficiency. Ideal as the perfect market was, it was unreal. During 1915-20, in a series of articles in Economic Journal, two economists Sraffa and Knight critiqued equilibrium under perfect competition. Their main criticism was that the conclusion of perfect competition that in due course every firm would reach optimum production with least cost combination was far from reality. Firms did not reach the optimum efficiency. Their empirical research had shown that firms stopped production long before reaching the optimum. Their equilibrium was generally reached while they operated under increasing returns and diminishing costs. Their main question was, how do we explain equilibrium with increasing returns and diminishing costs? Mrs. Robinson developed her theory essentially as a response to the question on equilibrium with diminishing costs. She said that under perfect competition, a seller was a price taker while in reality the seller is a price maker. With a price taking seller, his AR was horizontal straight line and MR was = AR. The horizontal AR=MR in competitive environment eventually became tangent to AC at its minimum point, resulting in least cost combination being achieved as a matter of course.

The seller under perfect competition was insignificant where as in reality, the seller was significant. Mrs. Robinson asserted that the assumption of very large number of sellers accounted for the insignificance of the seller and resulted in unreal outcome. She argued that competition was never perfect and called her theory as value under imperfect competition. She asserted that to study reality, one had to drop the assumption of large number and start at the opposite end. She considered situation where there was a single seller in the market. She called him a monopolist. Mrs. Robinson defined a monopolist seller in a round about way. She said that a monopolist seller was the seller of a product which in a chain of substitutes had links on either side misssing. He was a seller of a product that had no close substitute. The demand he faced was the demand curve of the market. What the monopolist could sell at different prices depended on what buyers would buy at different prices. AR of a seller would slope downward from left to right. With falling AR, MR would lie below the AR and with help of simple geometry, Mrs. Robinson showed that MR would lie exactly half way between the AR and the Y axis. She showed that MR would bisect all the perpandiculars drawn from AR on the Y axis. Mrs. Robinson agreed on the behaviour of cost curve and said that subjected to the laws of return, the AC would slope down and reach a minimum while the production was under increasing returns. Once diminishing returns set in, the AC would rise. MC would come from below, interesect AC at its minimum point and then rise. For equilibrium, equality of MR and MC gave maximum profits. So long as MR > MC, every additional unit added to the net revenue and the monopolist would expand outpur. If MR < MC, every additional unit would drain the revenue and the firm would contract production. Equilibrium would be reached when the last unit produced produced paid for itself, i.e., where MR = MC. The diagram below shows the equilibrium of a monopolist.

X is the point where MC intersects MR. OM is the monopoly equilibrium output. PM would be the monopoly price. QM was the unit cost of production and PQ was the profit per unit. Area of rectangle PQRN represented the monopoly profits. OM output is not the most efficient output. The firm is operating under increasing returns and diminishing cost. Minimum average cost is further to the right. By expanding output, the firm could reduce the cost but would not want to do so because every unit after OM will cost more than what it gets (MR < MC) This is a problem of monopoly that the seller under perfect competition did not encounter. The seller under perfect competition was a price taker and sold all that he could produce at the market determined price. Competition forced the market price down till it was equal to minimum AC and the firm produced with highest efficiency. Monopolist, as price maker with market demand curve as his AR, can sell more only if he reduced his price. Once he reaches the equilibrium output OM, he finds that the sacrifice of revenue on additional sales because of reduced price would be more than gain he would have on reduced cost. He would not go beyond the OM output selling at PM price.

One can deduce from this that monopoly output would not be the most efficient. Monopoly price would be higher than the price under perfect competition and monopoly output lower than output under pefect competition. Monopolist would generally make profit over and above normal profit. His excess profits would be beyond competition and he would enjoy these super normal profit without fear of competitiors knocking the price down. PRICE DISCRIMINATION Mrs. Robinsons monopoly concepts were later rejected and significantly modified. Her major contribution to the theory, however was the concept of price discrimination. Mrs. Robinson asserted that a monopolist would often find a situation where he could increase the profit by charging different prices in different markets. The process of charging different prices she called price discrimination and the monoplist doing so was the discriminating monopolist. Price discrimination is practiced extensively in reality by all sellers under different market structures. The priniples enunciated by Mrs. Robinson for possibility of discriminating between the markets remain valid in reality. Conditions for Price Discrimination: The markets should be distinct. The seller should be able to distinguish between the markets. If markets are not distinct, the price discrimination may not be possible. The distinction may take many forms. Children, adults and senior citizens are often distinguished and given different prices by the seller. In almost all forms of public transportation, children pay less than the adults. Infants below a certain age often are not charged at all. Geographical borders and legal limitation give distinction to the markets where goods from one market can be moved to the other causing price discrimination to hold. Arbitrage should not be possible. Arbitrage is a practice by which an individual or a company would buy in the cheaper market to sell in the more expensive market. The process of arbitrage generally leads to equalization of prices. The buying pressure in the low priced market would raise its price where as selling presser in the expensive market would lower its price. The process of arbitrage will go on till prices in markets are equal. Arbitrage defeats the very purpose of price discrimination. (In case of age related discrimination, say as in airlines, it is not possible to adults to represent themselves as children. Arbitrage would not be possible and price discrimination would hold.) Elasticity of Demand in Different Markets should be Different: Mrs. Robinson showed that case for price discrimination would arise only if elasticity of demand in different market is different. With difference in responsiveness, the seller would

charge a higher price in market which is inelastic and lower price in market that is elastic. There are three degrees of price discrimination. First degree price discrimination is when individuals are market by themselves. Individuals have different price sensitivity of demand and the seller exploits difference in price sensitivity to practice discrimination. In almost all professions, prices vary from individual to individual. Street hawker identifies the extent to which a buyer would bargain and accordingly quotes initial price and later charge different prices. To those with inelastic demand, he would charge more and those with elastic demand, he would charge less. Second degree price discrimination is where the seller divides markets in groups and charges different prices to different groups. Groups may be separated on the basis of age children or senior citizens; sex female accompany the male free and the like. A very effective way the seller uses to buy loyalty is through the loyalty card or loyalty programme. Most airlines give the loyalty programme and give mileage credit for regular travel on the airlines giving them express check in, lounge facility, free upgrades or free or discounted tickets as incentive. Most stores give membership where members are given special offers or discounted prices. Airlines also practice effective second degree price discrimination by identifying different groups of flyers based on the time of booking, time of flying, mode of payment, routing and rights of cancellation. A person travelling from New York to Los Angeles may pay only $ 99 because he has no right for refund on cancellation and he has booked six weeks in advance. He is a bargain hunter with price elastic demand who plans early and tries to get best price. Person in the next seat, flying between same destinations on the same flights getting same service may pay $ 399 because he has booked just a day before and enjoys 100 % cancellation refund. Airlines now provide no frills economy flights at prices significantly lower than full service flights. Price sensitive travelers opt for budget flights and others prefer full service price. Red eye flights is another variance where travelers who take late night flights are offer bargain because for flights at the late night time no service needs be provided anyway. In the US, to economize on the cost, and to better utilize the capacity, airlines have developed the concept of hub. Most flights originate and terminate in the hub and routing through hubs is cheaper than direct flights. For instance, price of a Chicago New York direct flight would be higher than another from Chicago to New York via Atlanta. Letter flight involves lot more time from origin to destination but the airline

benefits by making Atlanta as its hub bring passengers from various directions to Atlanta and then redirect them from Atlanta to different destination. Third degree price discrimination involves total markets with different elasticity of demand. There the seller sells more to the elastic demand market at a lower price and less to the inelastic market at a higher price. For the third degree price discrimination, Mrs. Robinson discussed the equilibrium conditions. Two markets are separated with different elasticity of demand. Demand in Market 1 is relatively inelastic and that in Market two is relatively elastic. In diagram below, these markets are shown separately in figure 1 and 2 with respective AR1 and AR2. MR1 and MR2 for these markets would lie half way between the respective ARs and the Y axis. In figure 3, two ARs are combined to get the total AR. This is derived by horizontal additions of the two markets. For a range of high price, there is only demand from Market 1 and then there the ARs are totaled. The total AR is kinked and total MR lying halfway between AR and Y axis is also kinked. For equilibrium and maximum profits, total MR has to be equal to total MC which is drawn in figure 3.

OM is the equilibrium output. Now, the monopolist has to decide on how he would distribute OM output between the two markets that would give you maximum revenue and maximum profits. One of the major among Mankiws 10 Principles of Economics is that rational people think at margin. The discriminating monopolist would devide his output in such a way that he gets the same revenue by selling last unit in either market. If revenue by selling the last unit in one market is greater than in the other, he could increase the revenue by switching sales from less marginal revenue yielding market to more marginal yielding market. For euilibrium MR1 has to be = MR2.

Since maximum profit is when MR = MC, for the discriminating monopolist, equilibrium is when MR1 = MR2 = MC. In the diagram the horizontal line is drawn from the point of intersection between total MR and MC. Price in either market would then yield the same ravenue. He would charge a higher price P1M1 selling less OM1 in the inelastic market and charge lower price P2M2 selling more OM2 in the elastic market. It should be noted that OM1 + OM2 = OM DUMPING : Mrs. Robinson considered dumping as a special case of price discrimination. According to her, it often happens that the seller is a monopolist in the home market, a price maker, with downward sloping AR and MR lying below and has to operate in perfectly competitive foreign market where he is a price taker and where his AR is a horizontal straight line and AR = MR. The diagram below shows both the home and foreign markets put together.

So far as domestic MR (revenue from selling last unit at home) is greater than the foreign price, there is no incentive to sell in the foreign market. (In first four decades of Indias independence, the government had adopted the policy of import-substitution. High tariff barriers prevented competition from abroad and

domestic manufacturers built high cost domestic industry. Price they got at home was so attractive that there was neither capability nor desire to export.) In the diagram OMH is the quantity he would sell at home. Once the MR at home is = foreign competitive price, the seller could sell reminder of all that he could produce, in the foreign market. Home MR after OMH output is lower than the foreign price and he would sell abroad only. When we introduce MC in the diagram, PF is the pont when MC = MR and his total equilibrium production would be OMF. He has sold OMH at home at a high monopoly price of PHMH and remaing MHMF abroad at the foreign competitive price of PFMF. Mrs. Robinson characterised every case where domestic price was higher than foreign price as an act of Dumping. The very fact that the home buyer paid more than the foreign buyer, was enough to consider the act of dumping as evil and on which she wanted regulators to come down heavily. Today WTO has redefined Dumping. Not every case where domestic price is higher than the foreign price is considered as Dumping. If at the low foreign price, the seller covers his AC, WTO does not regard it as dumping. In the diagram, if AC1 is the situation of costs, the seller covers the cost and even makes profit. It is not Dumping. If average cost is higher than the foreign price as is AC2, than the seller is selling at a loss in the foreign market and subsidieses his loss by higher domestic price. Making the home buyer pay for foreign losses is an unfair trade practice and if this is proved, WTO lets it be declared as Dumping. The onus of proof that a foreign supplier is Dumping goods is on the country that suffers. Once the case of Dumping is established, WTO permits the aggrieved country to impose anti-dumping duties on its imports so that competitive price is effectively raised,