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Perfect competition

Differentiate between pure competition and perfect competition.


Ans: pure competition exists when the following conditions are satisfied
i) Large number of buyers and sellers
ii) Identical product; and
iii) Free entry and exit
On the other hand in perfect competition some more additional conditions have to be fulfilled, like (a) the
buyers and sellers must have perfect knowledge of market conditions (b) the factors of production must be
perfectly mobile between industries
(c) Government should adopt leissez-faire policy (d) no transportation costs.
Explain the features of perfect competition.
Ans : Perfect competition exists when the following requirements are met.
1. Many Firms and Numerous Buyers. There must be a large number of
firms and many buyers in the market to make it perfectly competitive. Each of the firm controls a very small
proportion of the total output so that its addition or removal from the market does not carry any effect or little
effect on the market price. Similarly, the actions of individual buyers do not affect the market structure as a
whole. The number of buyers and sellers is so large and the share of each one of them is so small that they have
negligible impact and influence on the market price.
2. Identical Product. All firms must produce identical products. Each firm produces the product, which
cannot be differenced from the products of the other firms. There exists neither imaginary nor real difference
between the products sold by two different firms.
3. Freedom of Entry and Exit. There are no artificial hindrances created either for the entry or the exit of the
firm. Buyers and sellers are free to enter, produce, sell and buy or leave the industry any time they desire.
4. Independent Decision-making. There are no restrictions or limitations on the independence of seller or
buyer either though deliberate and purposive contract, collusion or the imposition of public control.
5. Perfect Knowledge. Buyers and sellers have perfect knowledge about the market conditions. None of
them is ignorant about the market for the commodity.
6. Single Price. Since the product sold in this market is homogeneous and competition is perfect, the
product is sold at the same price. There prevails only one price under perfect competition and it is determined
by the demand for and the supply of the product in question.
7. Mobility of Capital. Capital moves freely from one product to another and from one firm to another.
There is complete mobility of capital and other relevant factors of production.
8. Continuous Trading. The commodity or product is bought and sold in the market which is properly
organized and in which trading is continuous. Buyers and sellers are completely aware regarding the fact that
every unit is bought and sold at the same price at any particular point of time.
Write a distinction between market price and normal price.
Ans: In a very short period the supply is more or less fixed. It is a period of a day or a few days. It generally
exist for perishable commodities like fish, milk, vegetables etc
The price prevails in this period is called the market price.
In a long period supply has enough time to adjust itself to any change in demand. It is the time period
during which all factors inputs are variable. The price in the long-run is determined depending upon the nature
of supply curve. The price that prevails in the long period is known as the 'Long-Run Normal Price’.
The distinction between these two, i.e. market price and normal price are as follows
The market price prevails in the very short period. The market price is determined by temporary forces.
It is unstable and exists in practice. It is subject to fluctuation.
The normal price prevails in the short period as well as and long run. It is determined by relatively stable
forces and is theoretical concept. It does not fluctuate very much.
The market is short lived. It oscillates round the normal price
The normal price is long lived. It is permanently determined.
What is perfect competition? How is price & output determined under perfect competition?
Ans: In a perfect competitive market, only a single market price is ruling for the product. The competitive firm
is, thus, a price-taker. It has a perfectly elastic demand for its product, so it can sell whatever is produced at a
given price.
Since the firm has to accept the market determined price for the product, it can decide only about the
quantity of the product.
The firm decides only about the equilibrium level of output. Under the sole objective of profit
maximization, thus, the firm will produce that level of output which maximizes its profit.
The behavioral rule of profit maximization is to equate marginal revenue with marginal cost. The
marginal cost curve should cut the marginal revenue curve from below.
Profit is maximized when MC = MR. Obviously, then, how much a competitive firm will produce in the
short period depends on its short run marginal cost and the prevailing market price (since, under perfect
competition, Price = MR in the short run).
Equilibrium of the firm and Industry under Perfect Competition
Short run is a functional or operational time period during which the firm cannot change its size, as
certain fixed factors and the plant cannot be altered. So, the firm produces more only with the help of variable
inputs along with the given fixed factor inputs.
To determine the equilibrium level of output at a given price in the short run, the firm compares its short
run marginal cost (SMC) with the short run marginal revenue (SMR) of the product.
The short run marginal revenue (SMR) of the firm depends on the price of the product. The competitive
price is a market-determined phenomenon. The short run equilibrium price is determined in the market by the
inter-section of the short period demand curve(SRD) and short period supply curve(SRS), as shown in Figure .
Diagram C5
In the short run, the competitive firm maximizes its profits by choosing an output (OQ) at which it’s SMC = SMR.. PEAB measures the profits
.At this short run price OP, the firm obtains its revenue functions from the demand curve for its products. From
the Firm’s point of view, the demand for the product is perfectly elastic. Thus, at the short period market price, OP is the
demand curve, which is a horizontal straight line, corresponding to which the short run average revenue (SAR) and the
short run marginal revenue (SMR) are depicted.
Along with this, the short run average cost (SAC) and short run marginal cost (SMC) are drawn for comparison.
The equilibrium point is determined by the intersection of the SMC curve from below, so that SMC = SMR. In Figure, E is
the equilibrium point, at which the SMC curve intersects the SMR curve from below.
Consequently, OQ is the equilibrium level of output determined by the firm in the short run. Since areas under
the respective average revenue and average cost curve measure total revenue and total costs, the differences between the
two show profit.
Profit = total revenue – total cost
= OPEQ - OBEQ
= PEAB
The shaded area PEAB represents the maximized profits.
EQUILIBRIUM OF THE INDUSTRY IN THE LONG RUN
The equilibrium in a perfectly competitive industry is established under the following conditions:
1. Industry being a collection of firms, for an industry to be a long run equilibrium, apparently all the existing firms
in the industry must be producing an equilibrium level of output by equating the long run marginal cost with the long run
marginal revenue : (LMC = LMR). Aggregate of their output constitutes the total supply of the industry.
2. The number of firms in the industry must be stable. There should be no entry of a new firm. Neither there is exit
of any from the existing ones. This requires that all the existing firms must be earning normal profits. This happens when
all the firms have Price of LAR = LAC.
Unless all the firms are earning just the normal profits, industry will not attain a stable equilibrium in the long run.
Because, if some firms are earning excess profits, it would encourage new entrants in the industry which will lead to
changes in the industry supply and market prices in the long run. Thus, it is essential that all the firms must earn normal
profits in the long run so that the industry attains an equilibrium position.
3. The long equilibrium price is established so that total quantities demanded and supplied in the long run are equal
and the market is cleared off. The long run equilibrium of the industry is portrayed in Figure.

Diagram C6
Long run equilibrium: Price = LAR = LAC = LMR = LMC
In Figure the long run price OP is determined by the intersection of the long run supply curves S and demand
curve D. At this price, the firm’s equilibrium is determined by equating LMR = LMC. Thus, OM is the equilibrium
output of the firm in the long run. There is a full equilibrium position: Price = LAR = LMR = LAC = LMC. As such, the
firm enjoys just normal profits.
It follows that, when all the firms are in equilibrium, and all of them earn normal profits, or their number being
stable, the market supply position becomes stable in the long run and under the given demand condition (D in Figure
Panel A), the long run equilibrium price (OP) is established making industry in the long run equilibrium. The firms under
homogeneity conditions are identical – having identical cost functions so they must be operating at the minimum point of
LAC (see Figure Panel B). Those firms which are inefficient so that their cost-functions are at a higher level, i.e. LAC
price, have to quit the industry in the long run as they fail to earn normal profits and losses are not sustainable by them.
To sum up, industry and firm’s equilibrium conditions in the long run are Long Run Equilibrium Price = LAR =
LAC = LMR = LMC.

Monopoly
Describe the features of monopoly.
Ans : Monopoly is a form of market structure in which a single seller or firm has control over the entire
market supply, as there are no close substitutes for his products and there are barriers to the entry of rival
producers. This sole seller in the market is called ‘monopolist.’ The characteristic features of a monopoly
firm are:
Single Firm. The monopolist is the single producer in the market. Thus, under monopoly firm and
industry are identical.
No substitute. There are no closely competitive substitutes for the product. So the buyers have no
alternative or choice. They have either to buy the product or go without it.
Anti-thesis of Competition. Being a single source of supply, Monopoly is a complete negation of
competition.
Price-maker. A monopolist is a price-maker and not a price-taker. In fact, his price fixing power is
absolute. He is in a position to fix the price for the product as he likes. He can vary the price from buyer to
buyer. Thus, in a competitive industry, there is single ruling price, while in a monopoly, there may be price
differentials.
Entry Barriers. A pure monopolist has no immediate rivals due to certain barriers to entry in the field.
There are legal, technological, economic or natural obstacles, which may block the entry of new firms.
Price-cum-output Determination. Since a monopolist has a complete control over the market supply in
the absence of a close or remote substitute for his product, he can fix the price as well as quantity of output to be
sold in the market.
Though a monopolist is a price-maker, he has no unlimited power to charge a high price for his product
in the market. This is because, he cannot disregard demand situation in the market. If buyers refuse to buy at a
very high price, he has to keep a lower price. He will produce that level of output, which maximizes the profits,
and charge only that price at which he is in a position to dispose of his entire output. Thus, a monopolist sets
price for his production in relation to the demand position, and not just fix up any price he likes.
Discuss the various types of price discrimination.
Ans: price discrimination refers to the practice of a seller selling the same product at different prices to different
buyers. It is possible only in monopoly market. The monopolist who adopts this policy is called ‘discriminating
monopolist’.
There are various types of price discrimination. They are
Personal Discrimination
Personal discrimination occurs when different prices are charged to different persons buying the same
commodity. This is more common in case of personal services. For example, a doctor may charge a higher fee
to a rich patient and a lower fee for a poor patient for exactly the same treatment. A barber may charge for
haircut a higher price to a fashionable college student and a lower price to others. Similarly, it teacher, an
advocate, a musician and a publisher may discriminate between persons while rendering their services. In all
these cases, discrimination is of a personal nature and hence is called personal discrimination

Place Discrimination
A monopolist may charge different prices to different buyers of different markets divided from each other
geographically. He may charge a lower price in the export market and higher price at home. This is commonly
described as 'Dumping'
Use or Trade Discrimination
A monopolist may charge different prices depending on the use to which a commodity is put. An electricity
company may charge a higher price when electricity is used for domestic purpose and a lower price when it is
used for industrial purposes. Such price discrimination is known as use or trade discrimination
COMMON FORMS OF PRICE DISCRIMINATION
Type Example(s)
Personal A teacher charging different amount as tuition fee to
different students, a doctor, a barber, a musician,
An Advocate, a publisher, an architect charging
different fees.
Group Railways [1st Class, 2nd Class, Student Concessions]
Cinema [Balcony, Reserve Class, 1st Class]
Restaurants [Special Rooms/General Rooms]
Hospitals [Special Wards/General Wards]
Status of buyers New buyers [lower price]
Big and loyal buyers [discounts]

Explain the conditions under which price discrimination is possible and profitable.
Ans: Price discrimination implies the act of selling the output of the same product at different prices in different
market or to different buyers. The following are the essential conditions enabling the firm to resort to price
discrimination:
Monopoly: Monopoly is a prerequisite of price discrimination. Undoubtedly, price discrimination is
incompatible with perfect competition, because, as there are many sellers selling a homogeneous product, if one
seller quotes a higher price to a group of buyers, who know the ruling market price, it is quite likely that they
will go to other sellers. Under a monopoly price discrimination is possible because even though different
buyers would know that they are differently charged, they have no alternative source of buying the product.
Monopoly is a necessary but a sufficient condition to engage in price discrimination.
Segmentation of the Market: The monopolist should be in a position to segment the market by classifying the
buyers into separate groups. When total market is divided into sub-markets, each sub-market acquires a
separate identity so that one sub-market has no connection with the others. Again, consumers have no
inclination to move from a high priced market to a low priced one due either to ignorance or absence of inertia.
Apparent Product Differentiation: Through artificial differences in the same product, such as differences in
packing, brand name, etc., an apparent product differentiation may be created, so that it can be sold to the poor
and the rich consumers at different prices. Price discrimination, with product differentiation, is tolerated by
buyers.
Buyers’ Illusion: When consumers have an irrational attitude that high priced goods are always highly
qualitative, a monopolist can resort to price discrimination. Obviously, there is hardly any difference in
viewing a film from the last row of the stalls and from the front row in the upper stall seats, yet a purchaser of
an upper stall seat derives greater pleasure or place utility of occupying a high priced seat.
Prevention of Resale or Re-exchange of Goods: Goods of discriminating monopoly, sold in different markets,
should not be re-exchangeable between buyers of a low priced market and a high-priced market. Wide
geographical distance, high cost of transport, national frontiers (in case of internationally traded goods) and
tariffs effectively prevents re-exchange.
Non-transferability Characteristics of Goods: There are some goods which, by their very nature, are non-
transferable between one buyer and another. In direct personal services, therefore, price discrimination is easily
resorted to because of this non-transferability characteristic. Obviously, a poor person cannot go on behalf of
the rich to get medical treatment from a doctor. Similarly, haircuts, private tuitions, etc., are non-transferable
services by their very nature.
Let-to-go Attitude of Buyers. When price differences between two markets are very small, the consumers do
not think it worthwhile to consider such discrimination. For instance, in the distribution of Dalda Vanaspati
(cooking medium), there is a zonal price differential which is a marginal one, so that we hardly pay any
attention to such differences of 25 to 50 paise per kilogram in different zones.
Legal Sanction: When, in some cases, price discrimination is legally sanctioned, the transfer of use of the
produce is legally prohibited in order to make it effective. For instance, if electricity, for domestic purposes is
used for commercial purposes, the consumer is liable to penalties.
How is price and output determined under monopoly in both short run and long run?
Ans: monopoly is a form of market structure in which a single seller or firm has control over the entire market
supply, as there is no close substitutes for his products and there are barrier to entry of rival producers. This sole
seller in the market is called ‘monopolist’ some of the characteristic features of monopoly firm are as follows,
The monopoly is sole producer with large number of buyer
There is no close substitute for a product produced by monopoly.
Monopolist is a price maker. He also charges different prices to different customers.
Short-run Monopoly Equilibrium
In the short-run, the monopolist has to work with the given plant and machinery. If he is desirous of altering the output; he
can do so by changing the variable factors. The monopoly firm comes to equilibrium where marginal revenue equals
marginal cost. It is the point where the monopolist gets short-run maximum profits. The monopoly equilibrium in the
short-run is represented by Fig.

Diagram C7
In Fig. on OX axis measuring output & on OY axis revenue, cost & price. SAC is the short-run average cost curve of the
monopolist. SMC indicates the short-run marginal cost curve. AR is the average revenue curve and MR the marginal
revenue curve. The short-run marginal cost curve of the monopolist intersects the marginal revenue curve at point K. Here
the marginal revenue is equal to the marginal cost which explains the equilibrium position of the monopolist. . OM is the
equilibrium output. At OM output the average revenue is AM, the price charged is AM or OB, Since areas under the
respective average revenue and average cost curve measure total revenue and total costs, the differences between the two
show profit.
Profit = total revenue – total cost
= OBAM – ORIM
= BAIR
and the short-run monopoly profits are shown by the rectangle BAIR.
Long-run Monopoly Equilibrium
In the long-run monopolist is in a position to alter not only the variable costs but also the fixed cost. Therefore, he will
take the decision to build the best size of the plant. The best size of the plant for him is one in which his current output can
be produced as cheaply as possible. In this case the monopoly firm attains its equilibrium position when the marginal
revenue curve intersects the long-run marginal cost curve. This is shown by Fig.

Diagram C8
In Fig, In Fig. on OX axis measuring output & on OY axis revenue, cost & price. the long-run marginal cost curve
(LMC) intersects the long-run marginal revenue curve (LMR) at point K. The long-run monopoly equilibrium therefore, is
established at point (K). The equilibrium output is OM At OM output the average revenue is IM, the price charged is IM
or ON. Since areas under the respective average revenue and average cost curve measure total revenue and total costs, the
differences between the two show profit.
Profit = total revenue – total cost
= ONIM – OASM
= NISA
and the long run monopoly profits are shown by NISA

Even though a distinction is made between the short and the long-run monopoly equilibrium, theoretically not much
importance is given to such discussion. In the words of Donald S. Watson, "Since the analytical problems of the theory of
monopoly pricing are on the demand side, not on the cost side, there is no need to dwell on the difference between pricing
in the short run and the long-run”.
How the price and output determined in discriminating monopoly?
Ans: Price discrimination refers to a situation where monopolist charges different prices to different customers for the
sale of the same commodity. The monopolists who do this policy of price discrimination is called the' Discriminating
Monopolist’. According to Mrs. Joan Robinson, "The act of selling the same article, produced under single control, at
different prices to different buyers is known as price discrimination.” Price discrimination cannot be practiced under
conditions of perfect competition. The assumptions of perfect competition like large number of buyers and sellers
homogeneous commodity etc. are such that under conditions of perfect competition only one price prevails in the market.
Naturally, there is no scope for price discrimination. In other words, discrimination between buyers is incompatible with
perfect competition. It exists under conditions of monopoly
According to Mrs. Joan Robinson, price discrimination is possible and profitable only when the following
conditions are satisfied:
First, price discrimination is possible when the market is divided in such a way that goods which are sold cannot
be bought in one market and resold in another. If the buyers of the commodity purchase the commodity in one market and
resale the same in another market, price discrimination becomes difficult. Price discrimination is not possible when the
industrial purchasers of electricity resale it to the domestic consumers
Secondly, price discrimination becomes possible when the buyers in the dearer market do no get themselves
transferred to cheaper market to get the benefits of lower price. When such a transfer of buyers takes place, it means they
do not purchase the commodity at a higher price.
Thirdly, price discrimination is profitable when the monopolist can separate the consumers into different markets
Lastly, to make price discrimination profitable, the elasticity of demand in different markets should be different.
When the elasticity of demand are the same in different markets, at a monopoly price, the marginal revenue in both the
markets will be the same and therefore the monopolist cannot introduce price discrimination. Price discrimination is
possible and profitable only when the elasticity of demand is different in different markets. When the elasticity of demand
is different in different markets, the monopolist can increase his profits by selling less in those markets where demand is
inelastic and selling more in these markets where demand is elastic. He goes on adjusting his output in such a way that on
the margin the revenue he gets is the same from all markets. The monopolist gets maximum amount of profit when his
marginal costs for the whole of output are equal to the marginal revenue in each separate market. In other words, the
output under discriminating monopoly is determined by the intersection of the monopolist's marginal cost curve for the
whole output and the total marginal revenue. The total output is made up of the amount sold in both the markets.
Equilibrium under discriminating monopoly may be shown with the help of Fig.

Diagram C10
Let us suppose that the monopolist is selling his product in two markets. Market one where the elasticity of
demand is less and market two where the elasticity of demand is more. In Fig.(A), we have shown the average
revenue curve and the marginal revenue curve of market one and in Fig.(B) average and marginal revenue
curves of market two. AMR is the aggregate marginal revenue curve which is shown in Fig(C). In the same
figure,(C) the cost curve for entire output is drawn. The output of the discriminating monopolist is determined
at point 'E' .in Fig.(C), where the aggregate marginal revenue is equal to the aggregate marginal cost (AMR =
AMC). The output so determined (OM) is distributed in both the markets, OMI in market one and the price is
OP1 as the price will be equal to average revenue and OM2 in market two and the price is OP2 which is equal to
average revenue. The output is distributed in both markets is such a way that marginal revenue in one market is
equal to the marginal revenue in market two (RIMI = R2M2) and they in turn are equal to the aggregate marginal
cost i.e. EM. At the point of equilibrium MRI = MR2 = MC i.e. RIM1 = R2M2 = EM. "This is nothing more than
an application of the general principle - 'in equilibrium marginal revenue equals marginal cost to special case
where discrimination, between different parts of the market is possible”,

What is dumping? How equilibrium is attained by discriminating monopolist through dumping?


Ans: The practice of discriminatory monopoly pricing in the area of foreign trade is described as "dumping." It
implies different prices in the domestic and foreign markets. Haberler defines dumping as "the sale of a good
abroad at a price which is lower than the selling price of the same good at the same time circumstances at
home, taking account of differences in transport costs." Under dumping, a producer possessing monopoly in
the domestic market for his product, charges a high price to the domestic buyers and sells it at a low
competitive price in foreign markets. The rationale behind dumping is that it enables the exporter to compete in
the foreign market and capture the market by selling at a low price, even sometimes below cost and to make up
the deficiency in sales revenue by charging high prices to the home buyers (taking advantage of monopoly
power in the home market). In fact, the higher domestic price serves to subsidize a segment of foreign price,
which considerably helps to promote exports. Export earnings may, however, be made available to promote,
the growth of home industries, which otherwise would not have been possible. Moreover, by resorting to
dumping when the producer is able to widen the size of foreign markets for ,his product, his investment risks
are minimised and when he has to launch large scale production, he can reap the economies of large scale,
resulting in cost minimisation. Eventually, in the long run, it may become possible for him to sell goods at a
cheaper price in the domestic market as well. Thus, dumping, in essence, implies price discrimination.
In this special case how the monopolist fixes the price is shown by Fig

Diagram C11
ARH is the average revenue curve of home market
MRH is the marginal revenue curve of the home market
ARF is the average revenue curve of the foreign market
MRF is the marginal revenue curve of the foreign market
PRA is the aggregate marginal revenue curve
MC is the marginal cost curve
The output under price discrimination is determined at the point where the aggregate marginal revenue curve (PRA)
cuts the marginal cost curve (MC). The output determined is ON which is to be distributed among the markets in such
a way that MR1 = MR2 = MC. Output sold in home market is ONI and the price charged is A1N1. The output sold in
foreign market is N1N and the price charged is AN. This again explains the same point namely under price
discrimination marginal revenue in one market is equal the marginal revenue in another market which is equal to the
total marginal cost of production.

explain the merits and demerits of monopoly.


Ans: Monopoly is a form of market structure in which a single seller or firm has control over the entire market supply, as
there are no close substitutes for his products and there are barriers to the entry of rival producers. This sole seller in the
market is called ‘monopolist.’
Monopoly has been criticized and considered as against public interest from the days of Adam Smith. It is assumed that
the powerful monopolist exploits the consumers. On the contrary, it was thought that competition works to the consumers'
advantage. Traditional economic theory has advocated competition as the best market situation compared to monopoly. In
this section, we will analyse the relative merits & demerits of monopoly over competition or the case for and the case
against monopoly
Demerits of monopoly:
(1) lesser output. If the competitive industry is taken over by the monopolist and in the process the cost and demand
curves do not change, monopoly results in lesser output and higher price compared to perfect competition.
(2) Monopoly prevents the best use of resources. Under perfect competition, in the long run, each firm produces at the
minimum possible average cost or the firm is an optimum firm. Perfect competition results in the best use of resources .
The resources (i. e. factors of production) are combined in such a way that they can result in minimum cost of production.
But this does not happen under monopoly. A monopoly firm produces at the point where marginal revenue is equal to
marginal cost and not where the average cost is at a minimum as under conditions of perfect competition. Monopoly,
restricting output, prohibits both low prices and the best use of resources. In this way, monopoly prevents the best use of
resources, i.e., production at the minimum cost of production compared to perfect competition. On this ground, the
traditional value theory prefers competition to monopoly
(3) Consumers are at a loss. Under conditions of perfect competition marginal cost of production is equal to price.
Marginal cost of production is the cost of producing of the last unit and the price is what the consumer is willing to pay
for the last unit he purchases. It means under conditions of perfect competition the consumer buys the last unit for a price
equal to the marginal cost of it. The consumer stands to gain under perfect competition.
Under conditions of monopoly the price is greater than the marginal cost of production. It means that the consumer
pays to the last unit he buys, an amount greater than the marginal cost of production. Under perfect competition, the
consumer pays to the commodities he buys according to their marginal cost of production. Under monopoly he pays more
than the marginal cost. Naturally, the consumer is the sufferer under conditions of monopoly compared to competition
Merits of monopoly:
The late Sir Henry Clay has pointed out certain benefits or instances wherein monopoly may be in the public interest.
1. Monopolies may produce more efficiently. Monopolies, because of their large-scale organization, can produce
more efficiently and at a lower cost compared to small competitive firms of perfect competition. The monopoly
organizations can reap technical and commercial advantages over the smaller firms of competition. Sir Henry Clay gives
the example of the British Cement Industry which has a monopoly organization and pointed out that its prices are lowest
in the world and it has achieved a very high labour productivity, nearer the American productivity than any other British
industry. The industry is working at lower costs of production, though there is a general rise in the cost of production
2. Monopoly can withstand depression. Monopoly, because of its larger financial resources and strength, can
withstand the depression. This is not possible for the small competitive firms. If the depression is severe such firms have
to close down their business. For instance, the British Cotton Industry survived the depression 1929-32 as it exercised
some collective control over prices. The other British industries which could withstand the depression because of their
monopoly actions are steel, coal and shipbuilding. The above examples clearly indicate that monopoly is in a better
position to withstand depression compared to small competitive firms because of its large scale organization.
3. Cut-throat competition may ruin the business. Sir Henry Clay has pointed out the under competition the prices
may be driven down to such a lower extent that they may not allow the firms to cover the fixed costs of production. Under
perfect competition each firm tries to get a larger share in the market by reducing the price. This may result in cut-throat
competition, and such competition may ruin the business itself as some of the firms may find that the price that they are
charging may not be enough to cover the fixed costs of production. Sometimes, the business receipts may be so low that
they may-not allow the firms to replace their plant and machinery. Such a situation does not arise under monopoly as there
is absence of competition. The monopoly firm will have its own monopoly profits and hence the firm will not face any
problem as regards the coverage of fixed costs or replacing plant and machinery
4. Monopoly may reduce the inequality of income. Generally, it is said that monopoly increases the inequality of
income. The monopolist gets profits by exploiting the consumer. But there are certain circumstances in which monopoly
reduces inequality of income. For instance, the monopoly of laborers, i.e. trade union fighting for higher wages tries to
reduce the inequality of the income and wealth.
The above discussion clearly indicates that the traditional economic theory was against monopoly. The theory
preferred competition to monopoly. But the recent discussion in economic theory pinpoints certain circumstances under
which monopoly may be in the public interest. Monopoly is not as bad as it was conceived in the traditional economic
theory

Explain the various measures which can be taken to control the evils practices of monopolies or
How can monopolies be controlled? Explain
Ans: Monopoly is a form of market structure in which a single seller or firm has control over the entire market supply, as
there are no close substitutes for his products and there are barriers to the entry of rival producers. This sole seller in the
market is called ‘monopolist.’
Monopoly has been criticized and considered as against public interest from the days of Adam Smith. It is assumed that
the powerful monopolist exploits the consumers. On the contrary, it was thought that competition works to the consumers'
advantage. Traditional economic theory has advocated competition as the best market situation compared to monopoly.
Therefore it is essential to control the monopoly.
Methods of Control Monopoly
1. Increasing Competition : To eliminate monopoly power in the market, competition can be promoted among the
monopolistic firms in the industry. A fair degree of competition has to be maintained throughout. The
competition among the firms will prevent the monopoly in fixing the higher price.
2. Government Regulation : Government can regulate the behavior of monopolists. To protect the interest of the
consumers and to reduce the exploitation by the monopolist firms, the Government may fix the maximum
statutory prices for the goods supplied by the monopolist beyond that he cannot fix the prices.
3. Public Ownership : To protect the interest of the consumers, the government can run the monopoly by itself. This
solution is common in many countries. In India, the Government runs the Railways. This may eliminate the
competition among the firms and it protects the interest of the consumers.

4. Legal Action: The government can enforce and enact laws to prevent the emergence and growth of monopolies.
It can restrict the entry of new monopoly firms and encourage competitions in different fields. Thereby it can
reduce or eliminate monopoly power.
5. Fiscal Measures: To control the excess profits earned by monopolist, Government can impose heavy taxes on
monopoly profits. This may discourage the monopoly from fixing the high price for his product.
6. Promotion of Co-operation: Encouragement for promoting co-operative movement or organizations should be
given by the government. Co-operative societies are useful in reducing the exploitation, excessive profits,
restricted output etc. thereby monopoly power can be controlled.
7. Publicity Drive : All the facts regarding monopoly practice should be made known to the public. When monopoly
depends on the good will and the consumers, publicity can adversely affect him.
8. Consumer Awareness: Consumer awareness programmes should be launched by government or by consumers
themselves. Through buyer’s association competition among the firms can be eliminated and the buyers can get
the goods at reasonable prices.
what is price discrimination? Explain the various kinds of price discrimination. Give the
justification for price discrimination.
Ans: price discrimination refers to the practice of a seller selling the same product at different prices to different
buyers. It is possible only in monopoly market. The monopolist who adopts this policy is called ‘discriminating
monopolist’.
There are various types of price discrimination. They are
Personal Discrimination
Personal discrimination occurs when different prices are charged to different persons buying the same
commodity. This is more common in case of personal services. For example, a doctor may charge a higher fee
to a rich patient and a lower fee for a poor patient for exactly the same treatment. Similarly, it teacher, an
advocate, a musician and a publisher may discriminate between persons while rendering their services. In all
these cases, discrimination is of a personal nature and hence is called personal discrimination

Place Discrimination
A monopolist may charge different prices to different buyers of different markets divided from each other
geographically. He may charge a lower price in the export market and higher price at home. This is commonly
described as 'Dumping'
Use or Trade Discrimination
A monopolist may charge different prices depending on the use to which a commodity is put. An electricity
company may charge a higher price when electricity is used for domestic purpose and a lower price when it is
used for industrial purposes. Such price discrimination is known as use or trade discrimination
Price discrimination can be beneficial to the society
in the following way.
Some of the commodities and services may not be produced in the absence of the price discrimination. The best
example is that of a doctor in a village. If the doctor charges the same price to all patients his income will be meager and
therefore he cannot continue his business any more. On the contrary, if he practices price discrimination he can charge
more to rich patients and get adequate amount of income. A doctor will be practicing in a village only if price
discrimination is allowed. According to Mrs. Joan Robinson, "It may happen, for instance, that a railway would not be
built or a country doctor would not set up his practice, if discrimination were forbidden. It is clearly desirable that price
discrimination should be permitted in such cases".
Sometimes, price discrimination leads to greater output compared to monopoly. Under such circumstances price
discrimination is beneficial to the society.
Price discrimination, from the view point of society, may become beneficial when the monopolist charges a higher price
to the rich and a lower price to poor. If there had not been price discrimination poor would have been required to pay the
same price as rich which is not socially desirable. Price discrimination is, thus beneficial from the point of view of society.

Oligopoly
8) Explain the characteristics of oligopoly.
Ans: oligopoly is a market situation comprising only a few in a given line of production. Their products may
be standardized or differentiated. The price and output policy of oligopolistic firms are interdependent. The
oligopoly model fits well into such industries as automobile, manufacturing of electrical appliances, etc., in our
country.
Feller defines oligopoly is “competition among the few.” In an oligopolistic market, the firms may be
producing either homogeneous products or may be having product differentiation in a given line of production.
The following are the distinguishing features of an oligopolistic market:
Few Sellers. There are a few sellers supplying either homogeneous products or differentiated products.
Interdependence. The firms have a high degree of interdependence in their business policies about
fixing of price and determination output.
High Cross Elasticity. The firms under oligopoly have a high degree of cross elasticity of demand for
their products, so there is always a fear of retaliation by rivals. Each firm consciously considers the possible
action and reaction of its competitors while making any change in their price or output.
Constant Struggle. Competition is of unique type in an oligopolistic market. Here, competition consists
of constant struggle of rivals against rivals.
Lack of Uniformity. Lack of uniformity in the size of different oligopolies is also a remarkable
characteristic.
Lack of Certainty. Lack of certainty is also an important feature. In oligopolistic competition, the firms
have two conflicting motives: (i) to remain independent in decision making and (ii) to maximize profits, despite
the fact that there is a high degree of interdependence among rivals in determining their course of business. To
pursue these ends, they act and react to the price output variation of one another in an unending atmosphere of
uncertainty.
Price Rigidity. In an oligopolistic market, each firm sticks to its own price. This is because it is in
constant fear of retaliation from rivals if it reduces the price. It, therefore, resorts to advertisement competition
rather than price cut. Hence there is price rigidity in an oligopolistic market.
Kinked Demand Curve: According to Paul Sweezy, firms in an oligopolistic market have a kinky
demand curve for their products.
Explain the price and output determination under oligopoly?
Ans: oligopoly is a market situation comprising only a few in a given line of production. Their products may be
standardized or differentiated. The price and output policy of oligopolistic firms are interdependent. The oligopoly model
fits well into such industries as automobile, manufacturing of electrical appliances, etc., in our country.
Feller defines oligopoly is “competition among the few.” In an oligopolistic market, the firms may be producing
either homogeneous products or may be having product differentiation in a given line of production.
The following are the distinguishing features of an oligopolistic market :
Few Sellers. There are a few sellers supplying either homogeneous products or differentiated products.
Interdependence. The firms have a high degree of interdependence in their business policies about fixing of price
and determination output.
High Cross Elasticity. The firms under oligopoly have a high degree of cross elasticity of demand for their
products, so there is always a fear of retaliation by rivals.
Constant Struggle. Competition is of unique type in an oligopolistic market. Here, competition consists of
constant struggle or rivals against rivals.
Lack of Uniformity. Lack of uniformity in the size of different oligopolies is also a remarkable characteristic.
Lack of Certainty. Lack of certainty is also an important feature. In oligopolistic competition, the firms have two
conflicting motives : (i) to remain independent in decision making, and (ii) to maximize profits, despite the fact that there
is a high degree of interdependence among rivals in determining their course of business. To pursue these ends, they act
and react to the price output variation of one another in an unending atmosphere of uncertainty.
Price Rigidity. In an oligopolistic market, each firm sticks to its own price. This is because, it is in constant fear
of relation from rivals if it reduces the price. It, therefore, resorts to advertisement competition rather than price cut.
Hence there is price rigidity in an oligopolistic market.
Kinked Demand Curve : According to Paul Sweezy, firms in an oligopolistic market have a kinky demand curve
for their products. It is made of two segments : (i) the relatively elastic demand curve and (ii) relatively inelastic demand
curve as shown in Figure

Diagram O-1
In Figure, corresponding to the given price OP, there is a kink at point K on the demand curve DD. Thus, DK is the
elastic segment and KD is the inelastic segment of the curve. Here, the kink implies an abrupt change in the slope of the
demand curve. Before the kink point, the demand curve is flatter, after the kink it becomes steeper.
The kink leads to indeterminateness of the course of demand for the product of the seller concerned. He thus,
think it worthwhile to follow the prevailing price and not to make any change in it, because raising of price would contract
sales as demand tends to be more elastic at this stage. There is also the fear of losing buyers to the rivals who would not
raise their prices. On the other hand, a lowering of price would imply an immediate retaliation from the rivals on account
of close interdependence of price output movement in the oligopolistic market. Hence, the seller will not expect much
rise in his sale with price reduction.
Above the kink at a given price, demand curve is more elastic and below the kink less elastic.
An important point involved in kinked demand curve is that it accounts for the kinked average revenue curve to
the oligopoly firm. The kinked average revenue curve, in turn, implies a discontinuous marginal revenue curve. MA-BR
(as shown in Fig.). Thus, the kinky marginal revenue curve explains the phenomenon of price rigidity in the theory of
oligopoly prices.
Because of discontinuous marginal revenue curve (MR), there is no change in equilibrium output, even though
marginal cost changes hence, there is price rigidity. The price OP does not change.
It is observed that quite often in oligopolistic markets, once a general price level is reached whether by collusion
or by price leadership or through some formal agreement, it tends to remain unchanged over a period of time. This price
rigidity is on account of conditions of price interdependence explained by the kinky demand curve. Discontinuity of the
oligopoly firm’s marginal revenue curve at the point of equilibrium price, the price output combination at the kink tends
to remain unchanged even though marginal cost may change, as shown in Figure

Diagram O -2
In the Figure it can be seen that the firm’s marginal cost curve can fluctuate between MC1 and MC2 within the
range of the gap in the MR curve, without disturbing the equilibrium price and output position of the firm. Hence, the
price remains at the same level OP, and output OQ, despite change in the marginal costs.
What is price leadership? How the price and output determined under price leadership?
Ans: An important form of price-fixation under oligopoly is known as price leadership. It is still another example of
tacit collusion under oligopoly. It refers to that market situation in which price is determined by one firm in the industry,
and then accepted by all the other firms in that industry. Several examples of this type of pricing policy are found in
industries like coal, cement, cigarettes, petroleum, steel, etc. in the U.S.A. Some firms like U.S.Steel, General Motors and
Alcoa have been price leaders in their respective industries for a fairly long time. The products of the various firms are
close, though not perfect substitutes. Price-fixation is generally the result of tacit understanding rather than of a formal
agreement. Under price leadership, one firm, usually the largest, initiates price changes and all other firms more or less
automatically follow the price change.
Two main types of price leadership are: (i) dominant firm type, and (ii) barometric type. In the dominant firm
type of price leadership, one firm’s products from major portion of the output of the industry. The balance of the output is
produced by the remaining firms which are small in size. None of these small firms produces enough output to have any
determinate effect on price. The result is that the dominant firm sets the price and other firms accept it. The other firms,
in view of their small and insignificant size, have to accept and follow the price policy laid down by the dominant firm. If
they charge a price above this price, they stand to lose most of their sales. And if they fix a price below the price of the
dominant firm, they do not secure any advantage because they could easily sell all their output at the price of the dominant
firm. For the smaller firms, therefore, the average revenue (AR) curve is a horizontal line determined by the price fixed by
the dominant firm. They will have to adjust their output to the point at which their marginal cost is equal to the price
established by the dominant firm. If the products of the firms are physically homogeneous, prices are usually uniform. If
the products are differentiated, prices can be uniform or can confirm to a definite pattern of differentials. From time to
time, the price leader announces a price change. The smaller firms follow the lead of the price leader “with motives
ranging from fear to convenience; to laziness.” The belief is professed by the smaller firms that profits will be greater in
the long run under price leadership than could be obtained under alternative pricing arrangements. In other words,
price leadership largely avoids the uncertainties of independent pricing and, at the same time, generally results in
substantial profits for both the leader and the followers.
The other type of price leadership is barometric price leadership. The barometric price leader does not dominate
the industry. It is not in a position to force other firms to follow its lead, but it fixes a price that is acceptable to the other
firms in the industry. When it comes to changes in price, the barometric price leader cannot introduce them in an arbitrary
fashion. If any changes are to be made in the existing price, these changes must really be warranted by market conditions.
When the other firms follow its lead, it is no doubt, the price leader. But, in reality, it follows the changes in market
conditions so that it is not only the "leader" but also the "follower" of the market conditions. It is not necessary that the
barometric price leader should be the largest firm in the industry. Any respectable firm, which makes an intelligent
appraisal of the demand and supply conditions in the market and sets the price accordingly, can act as the barometric price
leader.
The question now is: How does the dominant firm fix the price? The dominant firm will obviously choose that
price-output which maximizes its profits. The price-output which maximizes its profits will be the one at which the
marginal cost of the firm equals its marginal revenue. In other words, the same formula of equality of MR and MC will
determine the profit-maximizing price for the dominant firm. The firm will have to estimate its marginal cost and
marginal revenue curves to determine its profit-maximizing price. The marginal cost curve presents no difficulty, because
the firm can estimate its marginal cost easily. But the marginal revenue curve does present some problems to the firm in
question. The marginal revenue curve is, of course, derived from the average revenue curve. If the average revenue of
the dominant firm could be estimated, then the marginal revenue curve would present no difficulty. The main problem,
therefore, is to estimate the average revenue curve of the dominant firm. The problem is, however, not insolvable. The
dominant firm can construct its average revenue curve in the following manner. It should, first of all, estimate the total
industry demand by taking into account the different quantities demanded by the customers at various prices. Then it
should deduct from the total sales, the amounts which would be sold by the smaller firms at different prices. The balance,
of course, represents the sales of the dominant firm. On the basis of this balance, the dominant firm can easily estimate its
average revenue curve. The process has been illustrated with the help of the Diagram below.

Diagram O-3
In part (B) of this diagram, the curve DD represents the total industry demand. At the price of Re. 0.50, the
industry sells 100 units of the output. As pointed out above, the average revenue (AR) curve of the smaller firms is a
horizontal line, because they have to accept the price laid down by the dominant firm. In part (A) of the diagram, we have
shown three smaller firms (Nos.1, 2 and 3) with their AR curve drawn at Re. 0.50, because that is one of the prices in the
demand schedule. But the three firms have their own separate marginal cost curves indicated by MC1, MC2 and MC3
respectively. At the price of Re.0.50, Firm No.1 sells 10 units, Firm No.2, sells 16 units, and Firm No. 3, sells 23 units.
In all, the three firms sell 10 + 16 + 23 = 49 units at the price of Re. 0.50. The total industry sale at the price of Re. 0.50 is
100 units. Deducting the total sale of the three firms, i.e., 49 units from 100 units, we are left with 51 units which
represent the sale of the dominant firm. So one point on the demand curve or average revenue curve, of the dominant firm
has been discovered. The other points on the demand or average revenue curve of the dominant firm can be determined in
a similar manner. Having thus completed its average revenue curve, the firm can then derive the marginal revenue curve
from it. The marginal cost curve is already there. With the help of the two curves, the firm can determine the profit
maximizing price on the basis of the equality of MR and MC. The price so determined will be accepted by the smaller
firms, each of which will now adjust its output to the level at which its marginal cost equals that price. We, thus, find that
pricing under price leadership closely approximates that of monopoly pricing.
Let us take a simple case where there are only two firms A and B. The firm A has a lower cost of production than
B. The product of both the firms is homogeneous and each of the two firms has equal share in the market. Given the
above assumptions, price and output determination under price leadership is illustrated in Diagram below. Each firm is
facing demand curve DD which is half of the total demand curve for the product. MR is the marginal revenue curve of
each firm. MCa is the marginal cost curve of firm A and MCB is the marginal cost curve of firm B . MCa lies below MCb
as firm. A has a lower cost of production than B.

Diagram O-4
The Firm A can maximize its profits by selling OM output and MP price where MC = MR. Firm B will have
maximum profit by selling ON output at NK price. The profit maximizing price of A is lower than that of B. Since the
product is homogeneous, there cannot be two different prices. Firm A with the lower price will dictate the price to firm B
and will emerge as a price leader. Firm B will follow the price of firm A. Now both the firms will charge the same price
(MP) and sell the same amount (OM). In such a situation, profits earned by firm B will be smaller than those of firm A
because its costs are higher.
Dominant price leadership is sometimes called partial monopoly especially when the dominant firm is very large
and other firms small. The partial monopolist is more than just a price leader because he wields more or less monopoly
power.

Pricing in practice
Distinguish skimming and penetration price.
There are different ways of pricing a new product. Either the product can be charged a high price or low
price. The distinction between these two can be explained as follows
(i) Skimming Price
A skimming price is that where the initial price is high. Whenever a company introduces a new product,
it spends a huge sum of money on advertisements. The company may put the product in attractive packages.
Therefore, to cover all these costs, the company fixes a high price. If the new product, which has no substitute,
also has a good usage, the product can be sold at a high price. The company is quite sure that in course of time,
the substitutes are going to enter into the market. When it has no rivals, a high price is fixed for the product.
When the substitutes enter into the market, then the price is reduced and thereby the challenge is posed.
However, by the time the substitutes enter the market, it is not certain that this product will command a market
value. It may lose to the product of the competitors. Therefore, an initial high price is suggested for a new
product when it is introduced for the first time.
When a new product with a high skimming price is introduced, the demand may not increase all of a
sudden. Therefore, promotional expenditure of a high magnitude will have to be incurred. Further, if the price
is very high, many consumers may not buy it. Therefore, a potential market will have to be decided on the basis
of elasticity of demand. If the demand is inelastic, a high price may be fixed. When this segment of the market
is exhausted, then the second segment of the market will have to be tapped at a lesser price. For example, in the
case of the publication of a textbook, it is priced high. But the next paperback edition is priced low.
A high initial price may be useful if the production of the product requires high technical skill and it is
difficult and time consuming for competitors to enter on an economical scale.
Skimming price refers to setting initially high prices and slowly lowering them overtime to maintain
profits at every price sensitive layer in the market.
(ii) Penetration Price
A low penetration price pertains to charging a low price in the beginning itself. If the price is low, it can
penetrate into the market quickly. It is due to the fact that the consumers may buy the product at a low price.
Before fixing the low price for the new product, a market research is necessary. In the high skimming price
situation, the firm gets profit, which may arise, in the short run quickly but in the case of low penetration price,
profits may arise in the long run. One way this is advantageous, for it is possible for the product to establish
itself firmly in the market. If the price is raised afterwards, the demand is not going to fall.
The objective of low penetration pricing is to keep the rivals away from entering in to the market with
substitute products. The low price of the products prevents competition. If the price is set low the margin of
profit is also low and thereby new – comers are not going to venture into the production of this product. A low
penetration price is advantageous when the productive capacity of the plant is high. A low price is sure to
capture the entire market and production price is profitable because large quantity can be sold. In the case of a
multi-product firm, it is not the margin of profit that matters. If the potential market is large, the big companies
by selling the product at a low price drive away many small companies.
Penetration price involves setting a low initial price to enter the market quickly and deeply to attract a
large number of buyers and win a large market share.

Monopolistic competition
Differentiate between production cost and selling costs
Ans: selling costs are distinguished from production cost.
Production costs are those, which include the cost of raw material, labour used in production, cost of
manufacture. i.e. cost of production includes all expenses connected with the manufacture of a commodity & its
transportation to the market etc. Production cost adopt commodity to the demand.
Selling costs include all expenses incurred in order to secure a demand for the product. They are
incurred to alter the shape &/or position of the demand curve for a product are called selling costs. These are
incurred to increase the demand for a product. Consumers in the market do not have perfect knowledge. They
also do not know the products that are in the market, their prices & their availability. Therefore, if the
consumers are provided with such information as regards price, quality & the availability of the product, the
demand for the product may increase. To provide such information, the firm incurs certain expenditure. It
undertakes advertising, demonstration, door to door canvassing & follows other such methods to increase the
demand for the product. There are 2 types of advertisements:
(1) Informative Advertisement: It gives information regarding price, quality & the availability of the
product. It will create influence on demand for the product without changing the consumer’s scheme of
preferences.
(2) Manipulative Advertisement: It brings about a change in the demand for product by changing the
scheme of preferences of the consumers. For e.g. even though cigarette smoking is injurious to health, an
advertisement may suggest that healthy sportsmen smoke cigarettes for relaxation & convince the consumer that
smoking is not bad.
Selling cost not only include advertisement cost, but also salaries of salesmen, expenditure on sales
promotion & sales department, commission to retailers & wholesalers, expenditure on demonstration, window
display, poster etc. Prof. Chamberlin makes distinction between selling cost & the cost of production.
. In the modern world, they are becoming more & more important. In certain countries, selling costs are
nearly 40% of the total costs.
Thus Prof Chamberlin distinguishes the 2 costs as follows
Production cost adopt commodity to the demand, while selling cost adopt demand to the commodity. This is to
say that the production cost creates utilities, which will satisfy demand; while selling costs create, and shift the
demand itself.
What are the main features of monopolistic competition?
Ans : Monopolistic competition refers to a Market Situation where there are many firms selling a differentiated
products. There is a keen competition, though not perfect, among many firms producing very similar products.
The main features of monopolistic competition are as follows:
(a) Large Number of Sellers:
There are a large number of firms producing goods under monopolistic competition. Even though each
of the producers enjoys a monopoly privilege, he has to compete with the other producers in the market.
(b) Product Differentiation:
In monopolistic competition, neither products are homogeneous as in perfect competition nor they
remote substitutes as in monopoly. They produce the goods, which are different in same ways, and not
altogether different, i.e. products are slightly differentiated so that they act as relatively close substitutes to one
another. Brands, trade marks, trade names, distinctive designs, peculiarities of packaging & wrappers, offering
free gift or service along with the product, sales promotion activities etc. are some popular methods by which
products are differentiated.
(c) Free entry or Exit of the Firms:
There are no restrictions placed on the entry as well as exit of the firms.
(d) Independent Price Policy:
In monopolistic competition, each firm is producing differentiated products, which are close substitutes.
So they determine the price taking into consideration only there cost of production & demand.
(e) Selling Costs:
Another unique feature of monopolistic competition is selling costs. Since products are differentiated
& varied from time to time, advertising & other forms of sales promotion became necessary. Whatever amount
the firm spends on sales promotion is known as the selling outlays.
E.g. Advertising costs, salaries of salesman, expenditure on sales department, commission granted to
retailers & wholesalers, window display posters, demonstration, door to door canvassing etc.
(f) Two Dimensional Competition:
Monopolistic competition has 2 faces –
(i) Price Competition: In this kind of market, the firms compete with each other on the price issue.
(ii) Non-Price Competition: They compete on non price issues to expand their sale. Non-price
competition is in terms of product variation & selling costs incurred by each seller to capture his share in the
market.
(g) The Group:
Prof. Chamberlin introduced the concept of Group to replace the traditional concept of industry.
Industry refers to a collection of firms producing a homogeneous commodity. So it suits to perfect competition
as well as monopoly. But not for monopolistic competition which is characterized by product differentiation.
The products are similar but not identical goods. A Group consists of many firms whose products are very
much similar to one another & have closely interwoven market. An industry may consist of many groups of
produces, for e.g. in automobile industry, there are many groups each specializing in the production of a
particular article – one group produce car, another group produce heavy vehicles or Tractors etc.
There exists a very close competition between firms in the same group, but not so keen between firms
belonging to different groups.
These are the features of monopolistic competition.
What is group? Write a note on the Group Equilibrium.
Ans : A group consists of many firms whose products are very much similar to one another and have closely
interwoven market. An industry consists of many such groups specializing in the production of a particular
article. eg. In automobile industry one group produce car, another produce tractor, some other group specializes
in Lorries.
Group Equilibrium means price & output adjustment of a number of firms, whose products are close
substitutes. Group is a part of an industry. Industry consists of 2 or more groups of closely competing firms.
For e.g. in a book industry, there are several groups – one group specializing in textbooks; another group deals
with detective novels and so on. Hence, Prof. Chamberlin uses the concept of ‘product group’ for the industry.
Each firm in the group is a monopoly yet there is competition among those firms, which are producing
closely, related products. The price output determination of one firm will affect the decision of other firms.
There is no much qualitative difference between the products of the firm. Yet there is price & cost difference
between the firms. As a result, there are differences in prices including output & profits of the various firms in
the group.
In order to present the group equilibrium, Prof. Chamberlin makes certain important assumptions.
(i) Firm has identical demand & cost curves throughout the group. Prof. Chamberlin calls this assumption
the ‘Symmetry or Heroic’ assumption. So when all firms have equal demand & cost curve, then with the help
of one firm’s equilibrium, we can show the equilibrium of all other firms in the group.
(ii) Any adjustment of price or product by a single producer spends it’s influence over so many of his
competitors that the impact felt by any one is so negligible that it does not lead him to any readjustment of his
own situation.
(iii) He also assumes that the solution to the problem of group lies in Tangency. Tangency simply means
price is equal to cost of production. So with Tangency, all firms are earning only normal profits. So no firm
thinks of entering or leaving the group.
(iv) Unlike perfect competition, where in the long run the firm producing at a minimum cost of production &
become an optimum firm.
But in case of monopolistic competition even in the long run, the firm will not be an optimum firm. It
means the downward sloping Average Reverse Curve of the firm under monopolistic competition can not touch
the minimum point on Average Cost Curve even in the long run.
The Equilibrium of Group under monopolistic competition is explained with the help of diagram.
The short period “Group Equilibrium” is quite consistent with the existence of abnormal profits or losses
in the case of same firms, i.e. some may be earning normal profits, while some may be incurring actual losses.
But in the long period abnormal profit & losses disappear & all the firms earn only normal profits.
In the short period the equality between total supply & total demand is brought about & equilibrium
established through changes in the prices & output of individual firms.
In the long run, this equilibrium is established through the entry of new firms or the exit of existing
firms.
The long run group equilibrium is established at that point where Average Cost is equal to price [AC =
Price]. This is possible only when the Average Cost curve is tangent to the Average Revenue Curve [AC =
AR]. In the figure, the tangency between the [AC] Average cost curve & [AR] Average revenue curve is shown
at point N. The Equilibrium output is OM & the price is NM, which is equal to the cost of production.

Diagram M1
At the ‘NM’ price the firms in the group are earning only normal profits & supernormal profits have
disappeared.
Let us now discuss the long run group equilibrium under monopolistic competition. Prof. Chamberlin
has assumed that each firm has identical demand (AR) & cost curves. So it can be presumed that all the firms
will have equal share of the market. For instance, if there are 50 firms in the market, then each firm will get 2%
of the total sales. The Equilibrium condition can be illustrated with the help of the diagram below:

Diagram M2
The demand & cost curves are common to all the firms. Therefore, each firm has the demand curve
d1d1.
AC – is the average cost curve of each firm.
So, each firm earning abnormal or excess profits. As it is long period analysis – new firms will enter the
industry to take advantage of the excess profits. Their entry will result in putting into the market new varieties
of the product.
The new products will reduce the sales of the existing firms. The demand curve d 1d1 of existing firm
will have a tendency to shift downward to left.
Now existing & new firms will have to lower their prices to push up their sales. The process will go on
till d1d1 curve shift to d2d2. Now the d2d2 curve becomes tangent to the AC curve. Tangency means that the
price has now become equal to the average cost of production. Excess or abnormal profit has disappeared. The
firms earn only normal profits now. So PM is price & OM is the Equilibrium output. Since the firms earning
normal profit none of them would like to quit the group. As there is no excess profit, no outside firm would like
to enter the group. Thus under monopolistic competition, there is a tendency for prices to be pulled down to
Average Cost.
How price & output (of an individual firm) determined under monopolistic competition?
Ans : Monopolistic competition refers to a market situation where there are many firms selling a differentiated
products. There is a keen competition, though not perfect, among many firms producing very similar products.
The firm under monopolistic competition will have a downward sloping average revenue curve as there
will be many substitutes for the product of the firm. In other wards, demand for the product of a firm under
monopolistic competition is highly & not perfectly elastic.
Since average revenue is decreasing, marginal revenue will be less than the average revenue & as such
marginal revenue curve would like below the average revenue curve.
The firm under monopolistic competition in the short run will be in equilibrium where MC = MR. There
his price & level of output will be determined & can get maximum amount of profit.
In the diagram below :

Diagram M3
AC is the average cost curve
MC is the marginal cost curve
AR is the average revenue curve
MR is the marginal revenue curve
At point E, equilibrium is reached where MC = MR.
OT is an equilibrium level of output
AT (or OF) is a profit-maximizing price.
ST is an average cost of producing OT units of a commodity & AT is the average revenue.
In the short run, the firm is earning supernormal profit which is shown in shaded area, FASH.

We can calculate this profit in the following way.


Profit = [Price x Output] – [Average Cost x Output]
= [AT x OT] – [ST x OT]
= OTAF - OTSH
= FASH
or = average profit x output
= [ AR – AC ] x output
= [ AT – ST ] x OT
= AS x OT ( HS )
= FASH
Long term Equilibrium – In the long term, the price & output policy of an individual firm is determined
by the same general principle of equity of MR & MC as in the short period.
When firms in the short run earn abnormal profit in a monopolistically competitive market, some new
firms will be attracted to enter the business & the demand curve of individual firms tend to be more elastic as
the share in the total market is reduced due to competition from an increasing number of close substitutes.
Gradually, in the long run when the firm’s demand curve (AR) becomes tangent to its average curve, the firm
earns only normal profit.
In the diagram given below –

Diagram M4
LMR is the long run marginal revenue curve
LAR is the long run average revenue curve
LAC is the long run average cost curve &
LMC is the long run marginal cost curve
In the long run, the firm produces OQ level of output at which LMC = LMR.
At this equilibrium output, the LAR curve is tangent to the LAC curve at point P. So PQ is the price,
which is equal to the average cost. Therefore, OQPA is the total Revenue [Price & output] as well as total cost
[AC x output]. The firm earns only normal profit in the long run.
If he produce less than OQ, it implies that AR < AC indicating a loss. So also any output more than
OQ means P < AC & a loss.
So at E, LMC = LMR
& Price, PQ = LAR ( only normal profit. )

Thus in monopolistic competition, there is a severe competition between large number of firms producing close
substitute products. So this market situation is more similar to perfect competition than monopoly.
Profit
Distinguish between gross profit and net profit.
Profit is the income received by an organizer. It is the reward for the services of an entrepreneur. A firm makes
profit when it receives a surplus after it has paid interest on capital, wages to laborers and rent for land. Profit, in other
words, is the residual income, which is equal to the difference between the total revenue and the total cost of production.
Profit earned by the entrepreneur may be broadly divided into two categories viz., the Gross Profit and Net Profit.
Gross profit of the entrepreneur refers to the whole of the income earned by him. It consists of the reward for the
factors of production supplied by the organiser himself, reward for management and reward for the organization of
production. It is possible that the organiser may employ his own land or capital. The reward for such factors
supplied by him is, therefore, included in the Gross Profits.
Similarly, the organiser may himself manage the whole production instead of employing a salaried
manager. The wages of management are to be included in the gross profits because the organiser would have
earned the same wages had be been employed elsewhere. Gross profit also includes within it the net profits, i.e.
reward for undertaking the functions as an organiser
Net profit is the pure profit, which is the amount that accrues for bearing the risk. It is inseparable from
all business under a system in which production is done in the anticipation of demand. Pure profit is that profit
made exclusively for bearing risks.
Net profit refers to the income received by the entrepreneur after all factors of production including those
contributed by the entrepreneur himself are paid off. It includes reward for following factors:
Payment for Risk and Uncertainty -
When an entrepreneur starts a business, he takes certain risks. The most important risk is that of
production in anticipation of demand. Sometimes, the product does not meet the requirements of consumers,
the sales are bound to fall and he may incur losses. If the sales rise more than his expectation, he may get
profits. For risk bearing, he is rewarded. This reward is included in net profit.
Reward for Bargaining Ability
The entrepreneur having good bargaining power, purchases raw materials at reasonable prices. He hires labour at
normal wages and borrows working capital at reasonable rates of interests. Thus, he controls explicit costs. It means that
the bargaining ability of entrepreneur brings good net profit.
Reward for Innovations
Entrepreneurs are always looking for some good changes. Whenever there is an invention or an improvement, he
will be the first person to put it into reality. He may discover a new source for his raw materials or he may explore a new
market for his profit. All these are innovations. As a reward for this, he gets net profit.
Monopoly Gains
When an entrepreneur captures the entire market by eliminating competition, he becomes a monopolist & gets
monopoly profit. By increasing the price, he sells the product for which there is no substitute. Thus, he gets more profit.
This is called monopoly gain.
Chance Gains
Sometimes an entrepreneur gets windfall profits. This is due to the sudden rise in prices. This is also included
under net profit.
What is profit? How do profits arise?
Ans: Profit is the income received by an organizer. It is the reward for the services of an entrepreneur. A firm makes profit
when it receives a surplus after it has paid interest on capital, wages to labourers and rent for land.
Profits in a business arise mainly on account of the following factors
(i) Risk-Taking and Uncertainty bearing
(ii) Monopolistic control or Imperfections in the market
iii) Element of Luck or Chance
(iv) Innovations and
(v) Differences in Abilities of Entrepreneurs
1)Risk-Taking and Uncertainty bearing: It is commonly held that the emergence of profit is attributable to
risk taking on the part of the entrepreneurs. The expectation of profit is a necessary pre-requisite for starting any
new venture by the entrepreneur because every business involves certain risks. Greater the risk, higher should
be the gain or profit to induce the entrepreneur to start the business. There are certain risks in business such as
loss due to fire, earthquakes, floods and other natural calamities and loss due to theft, burglary and robbery
which can be calculated and insured against with the insurance companies. The entrepreneur is not to worry
about these risks. But there are certain other risks in the modem business, which cannot be measured and
insured against. These are called the non-insurable risks. These are to be necessarily borne by the entrepreneur
himself. These non-insurable risks include the risk of competition, technical risks, business cycle risks, risk of
development of new products and risks arising from government action through changes in economic policy.
These being unforeseeable risks and hence are called uncertainties.
Therefore risk and uncertainly are regarded to be one of the main factors on account of which profits
emerge or arise
2)Monopolistic Control or Imperfections in the market. Profits also arise on account of the monopolistic
control which the organizer is able to acquire in the market due to peculiar conditions prevalent. The presence
of monopoly element or imperfection in the market gives rise to profits. Monopolistic control gives the
entrepreneur complete control over the supply of a commodity and the price fixation in the absence of any
competition.
3)Element of Luck or Chance. Profits may also arise merely on account of good luck. Certain
entrepreneurs flourish only due to their good luck. Apart from luck, sometimes profits may arise just by chance
that appears in the business of selling their commodities at a better and higher price in the market. Such profits
would not have been there in the absence of war which gave chance to the entrepreneurs. Such profits are called
as the fortuitous gains
4) Innovations. Professor Schumpeter, a noted German economist, is of the opinion that profits arise on
account of economic innovation. By economic innovation is meant the introduction of a new product, the
introduction of a new process, opening of a new market, invention of new methods of production, development
of a new source of raw material and new methods of business organization. Therefore, economic innovation is
the source of profit.
5) Differences in Abilities of the Entrepreneurs: Professor Francis A. Walker contends that profits arise
mainly on account of differences in abilities of the entrepreneurs He compares profits with that of rent which
arises in case of land. Just as the superior grades of land earn a surplus over and above the marginal grade land,
the entrepreneurs superior in ability earn a surplus over and above the earnings of the marginal entrepreneurs.
Hence, he calls profits as the rent of ability In other words; profits arise also because of the difference in the
abilities of the entrepreneurs
Why to limit profit?
Ans: Profit is the income received by an organizer. It is the reward for the services of an entrepreneur. A firm
makes profit when it receives a surplus after it has paid interest on capital, wages to labourers and rent for land.
Profits of the firm can be limited by a number of factors. In fact, modem firms themselves try to limit the
profits on account of a number of reasons. The reasons to limit the profits are as follows
Threat of Competition
Birth of Substitutes
Heavy Taxation
Increased wages
Increasing cost of input
Ceiling on profits
1. Competition. Modern firms are afraid of the potential rivals or the competitors. When a firm is making
enormous profits, such profits can be limited or reduced by creating a fair competition by permitting new firms
to come into existence. Profits made in the absence of such competition will now get distributed among a large
number of firms and thus profits of an individual entrepreneur can be limited and evils of excess profits such as
inequalities of income and wealth and concentration of economic and political power can be easily avoided
2. Substitutes. Another factor that can limit the profits is the availability of substitutes. When there are a
few or no substitutes for the product of an entrepreneur, he is able to make huge profits. Huge profits, if
permitted, may perpetuate inequalities and cause a threat to the peace and progress of the country. In such a
case, profits of the entrepreneur can be reduced or brought down on limited by creating a number of substitutes
3. Heavy Taxation. Profits can also be limited by recoursing to heavy taxation. When firms are making
huge profits, a part of their profits may be taken away by means of heavy taxation. Either the existing tax rates
may be enhanced or the new taxes may be introduced Thus by imposing heavy does of taxation profits can be
limited.
4. Increased Wages. Another method of limiting profits is to increase the rate of wages. Labour is the factor
of production, which contributes the most in the production of a commodity. When excess profits are made by
firm, a part of it’s should be made to flow to the working class through increased wages. With increased wages
the total wages bill of the firm would increase and the profits limited or reduced
5. Increasing the cost of Inputs. When firms are making lot of profits, we can limit them by increasing the
cost of various inputs, which they use in the production of commodity. When the cost of inputs increases, their
total cost of production will increase and profits will be reduced. Generally, this method is not used for limiting
the profits because any increase in the cost is likely to be shifted on to the consumer by raising price of the
product. However, this is also one of the factors that can limit the profits provided price of the product is
controlled.
6. Ceiling on Profits. Lastly, profits can be limited by imposing direct controls such as ceiling on profits by
passing certain laws. This measure of limiting profits may work well in socialistic countries. In democratic
countries, entrepreneurs may object to this method of limiting the profits
Thus, in the modem business world profits are limited by the above mentioned factors

Explain the risk theory of profit.


Ans: an American economist, Prof. Hawley, propounded this theory in 1907. According to him Profit is the
reward for risk-taking in business.
Every business involves some risk or other. A producer produces goods without defiantly knowing as to
whether he can sell all the goods in the market. If all goods are not sold there will be losses. Since the
entrepreneur undertakes the risk, he becomes entitled to receive profit. If the entrepreneur does not receive the
reward, he will not be prepared to undertake the risk. Thus the higher the risk the greater is the possibility of
Profit. It should be remembered that this profit of entrepreneur exceeds the ordinary return on capital. If it is
less than the ordinary return on capital the entrepreneur would not be prepared to undertake the risk.
Hawley’s risk theory has been criticized on the following grounds:
i) The risk theory considers profit as a reward for taking risk in business. But there may not be a direct
relationship between risk and profit. Profit is not only influenced by risk but by many other factors.
ii) The entrepreneur gets large profits when he reduces the risk of business. According to Carver
profits are earned because risks are reduced not because they are undertaken.
iii) Prof Knight make distinct between the risk and uncertainty and maintains that profits is due to
uncertainty bearing. There are many risks, which can be calculated and insured against like fire and
accident. There are other risks which cannot be foreseen and calculated. So according to Prof.
Knight Profit is reward for uncertainty bearing.
Explain the uncertainty theory of profit.
Ans: the American economist, Prof Knight, first propounded this theory. According to him, Profit is the reward
of uncertainty bearing. Profit accrues to the entrepreneur because he bears uncertainty in business. As pointed
above Prof. Knight divided risk in to 2 types:
i) Foreseeable risk- a risk that can be foreseen by entrepreneur,
And ii) unforeseeable risk – a risk which cannot be foreseen by the entrepreneur. Prof Knight calls
unforeseeable risk as uncertainty bearing, and it is on account of this uncertainty bearing that profit accrues to
the entrepreneur. Profit according to him does not arise on account of foreseeable risk. Such a risk can be
covered through insurance. It is borne by insurance company, not the entrepreneur himself. The entrepreneur
gets this type of risk insured by payment of premium to the insurance company. The premium so paid is
included in the cost of production. insurance risk thus does not give rise to profit. Profit, according to
Prof.Knight, is due to non-insurable risk (or unforeseeable risk). Some of the non insurable risks which arise in
modern business are as follows:
i) Competitive risk. If new firms enter in the industry the existing firms may have to face serious
competition from them.
ii) Technical risk. Some new technique of production, new type of machinery may be evolved. Which
may not be adopted in the existing organizational set up and suffers losses in the competition with
other firms.
iii) Risk of government intervention. The government may intervene in to the affairs of industry by
fixing the maximum price of the product. it might ultimately reduce the profits of the firm.
iv) Business cycle risk. Advent of recession or depression might result in decrees in purchasing power
of consumer and as a result decrease in demand for the product
Since these risks cannot be foreseen and measured, no insurance provision can be made. Hence these are non-
insurable risk or uncertainty bearing. According to him ‘Greater the uncertainty bearing, the higher the level of
profit’. Thus there is a direct relation between uncertainty bearing and profit earning. So according to this
theory profit is due not to risk taking, but to uncertainty bearing.
This theory has been criticized on the following grounds.
i) Uncertainty bearing is not the only function of the entrepreneur for which he gets profits, but profit
is earned by the organizer is also due to other function like initiating, co coordinating etc.
ii) Profit is also realized due to business ability of the organizer rather than uncertainty bearing.
iii) There is no exact measure to calculate uncertainties there fore the exact amount of profit cannot be
determined.
iv) Profit may also arise on account of monopoly conditions existing in the market. A monopoly
producer without bearing uncertainties may be in a position to earn the profits.
v) Innovation is a source of profit – explain.
Or Explain the innovation theory of profit.
Ans: Prof.Joseph Schumpeter propounded this theory. According to him profit is a reward for innovation.
Innovation according to him refers to all those changes in the production prices the objective of which is to
reduce the cost of the commodity, and thus lead to a gap between the existing price of a commodity and its new
cost. An innovation can assume any shape; say the introduction of a new machine or a new plant, a change in
the internal organizational setup of the firm, use of a new source of raw material or a new form of energy,
change in the quality of the product or in the method of salesmanship, etc
The main motive for introducing innovation is the desire to earn profit. Profit is therefore, the cause of
innovation. It is not only the cause but also the effect of innovations, because if an innovation is successful
innovation result in the emergence of profit only for a temporary period. When an innovation comes to be
known to other firm and is widely adopted by them, it ceases to yield profit. The reason is obvious. For e.g.
American firm who invented coco-cola. This new commodity satisfied the consumer’s desire for soft drinks. Its
cost was very little to the firm but was sold at an exorbitant price, bringing huge profits initially. Soon others
come to know about its manufacturing prices and brought successful imitations of coco cola. The innovation
profit disappeared. After some time another innovation may takes place, yielding fresh profit to the firm who
innovated. Profit is a temporary surplus, which results from innovation.
Schumpeter’s theory has been criticized on the following grounds:
i) Schumpeter restricts the function of the entrepreneur to that of innovation only. But it is not the only
function of entrepreneur.
ii) He does not mention in his theory the important fact like risk taking and uncertainty bearing for the
emergence for profit.
iii) Another deficiency in this theory is that profits are only of short period in nature. But in fact if the
profits are temporary, no entrepreneur will stick to the production process.
Therefore it can be concluded that innovation theory is partially true. However Schumpeter has upheld the role
of an entrepreneur in introducing innovation in getting profit.

Differentiate between Accounting Profit and Economic Profit


Ans: Profit is the income received by an organizer. It is the reward for the services of an entrepreneur. A firm
makes profit when it receives a surplus after it has paid interest on capital, wages to labourers and rent for land.
This profit is classified as accounting profit and economic profit.
Accounting profit is defined as the revenue realized in a given period after providing for expenses
incurred during the production of a commodity. Accounting profit is also called Residual Profit. For the
business firm accounting profit is very important. In the balance sheet of a firm, accounting profit occupies an
important place. The accountant deducts explicit costs from the revenue in order to determine profit.
But this attitude does not satisfy the economist. The economists say that both explicit and imputed costs
(i.e. the cost that would have been incurred in the absence of self owned factors) are to be deducted from the
total revenue to determine economic profits. The entrepreneur’s wages, interests on his own capital rent for the
use of his own premises are to be taken into consideration in calculating economic profits. Thus, the profit
arrived all after deducting both explicit and imputed costs may be called economic profit. From the managerial
point of view, economic profit is very important because this alone shows the viability of a firm.
A firm may show accounting profit but it may incur economic losses. Such a firm cannot be considered
viable.
Accounting Profit = Total Revenue – Total Cost (explicit cost)
Economic Profit = Total Revenue – (Explicit cost + Implicit cost)
Or Economic Profit = Accounting profit – Implicit Cost
The following example makes the above concept clear.
The total revenue of the company manufacturing cloth = Rs. 10 lakhs.
The explicit costs incurred for production are:
a) Rent of factory premises =Rs. 50, 000
b) Interest on bank loans =Rs. 50, 000
c) Wages and salaries =Rs. 2, 50,000
d) Raw materials =Rs. 2, 50,000
Total explicit cost or paid cost =Rs. 6, 00,000
The implicit cost of the firm:
a) Wages for personal labour
Of the entrepreneur =Rs. 60, 000
b) Interest on his own capital =Rs.10, 000
c) Depreciation of machinery
& equipment =Rs.50, 000
d) Taxes paid to the govt =Rs.1, 25,000
Total implicit cost =Rs.2, 45,000
Now,
1) Accounting Profit = Total Revenue – Total Cost (explicit cost)
= Rs. 10, 00, 000 – Rs. 6, 00,000
= Rs.4,00, 000
2) Economic Profit = Accounting profit – Implicit Cost

=Rs.4,00, 000– Rs.2, 45,000


=1, 55, 000