MARKET ANALYSIS

The word ‘market’ is generally used to refer to a particular place or locality where goods are
bought and sold. But in economics it does not refer to any particular place or locality where goods are
bought and sold. The buyers and sellers may be spread over a whole town, region or country but if they
are in close communication with each other through personal contact, exchange of letters, telegrams,
telephones etc., so that they can sell and buy a commodity at an agreed price, the market is said to exist.
In short market is an area where buyers and sellers are buying and selling the goods and services. In
short market refers to the contact between buyers and sellers.

Thus the essentials of the market are: (1) Existence of commodity (2) Existence of buyers and
sellers (3) Place or area, be it a certain region, a country or the entire world (4) Contact between buyers
and sellers (5) Price for which goods are exchanged.

PERFECT COMPETITION

Perfect competition is a market situation in which there are a large number of firms selling
a homogeneous product. The classical economists believed that the real world market is a perfectly
competitive market. In other words, it is a market situation where a large number of buyers and sellers
are engaged at home buying and selling identical product for a single price”.

According to Leftwitch, “Perfect Competition is a market in which there are many firms selling
identical products with no firm large enough relative to the entire market to influence market price”.

In the words of Mrs. Joan Robinson, “Perfect Competition prevails when the demand for the
output of each producer is perfectly elastic. This entails, first that the number of sellers is large so that
the output of any one seller is a negligible small proportion of the total output of the commodity and
second, that buyers are alike in respect of their choice of rival sellers, so that he market is perfect”.

According to Bilas, “The perfect competition is characterized by the presence of the many firms;
they all sell identically same product. The seller is a price taker”.

FEATURES OF PERFECT COMPETITION

1. Large number of Small Buyers and Sellers: The first requirement of perfect competition is that
there should be a large number of sellers and buyers in the market. Hence no individual seller or buyer
is in the position to influence the price and output of the industry. Each individual firm produces a
negligible portion of the total product and, hence cannot influence the price. Similarly, the quantity
bought by each individual buyer constitutes only a negligible part of total market demand, so that no
individual buyer can influence the market price of the product. In perfectly competitive market, the
importance of individual buyer and seller is like that of a drop of water in an ocean.

2. Homogeneous Product: The second condition of the perfect competition is that all firms are
producing a perfectly homogeneous product. There are no differences in the quality, colour, size, shape,
fragrance, taste or any other respect. Since the products are identical in all respects, buyers have no 1
special preferences for the product of any specific firm as such. The products produced by different
firms are perfect substitutes for one another.

3. Freedom of Entry and Exit for all firms: There is absolute freedom for firms to get into or get out
of the industry in prefect competition. In other words, under perfect competition, there are no barriers –
legal or other – for the movement of the firms into or out of the market. New firms enter the industry if
large profits are earned by the existing firms and some of the existing firms might leave the industry if
they incur loss.

4. Absence of Artificial Restrictions: There is complete openness in the buying and selling of goods.
The buyers are free to buy from any buyer and sellers are free to sell their goods to any buyer. Prices
change freely in response changes in the market forces of demand and supply. Perfect competition
assumes laissez faire policy on the part of the government. (Laissez faire means non-interference by the
government.) In other words, a perfectly competitive market is free from government control or
restriction on supply, pricing or demand.

5. Perfect Knowledge of Market Conditions: The buyers and sellers have perfect knowledge of
market conditions in a perfectly competitive market. The buyers know the nature of the product and the
price at which it is being sold. Sellers have perfect knowledge of the cost conditions and the potential
sales at various prices. Hence, advertisement and sales promotion activities have no scope under perfect
competition.

6. Perfect Mobility of Factors Production: The various factors of production are free to move into
any use and industry or region which they consider profitable for themselves. This leads to equalization
of price of factor among all alternative uses, industries and geographic regions.

7. Absence of Transport Cost: It is assumed that there are no transport costs in perfectly competitive
market. This implies that all firms are situated fairly close to the buyers so that buyers have no
particular preference for the product of any specific sellers for reasons of proximity.

8. Price is determined by Market Forces of Demand and Supply: The price of a commodity is
determined by market forces of demand and supply and not by a seller or a buyer or a firm or even by
the Government.

9. Single Price: At any given time, there is a single price for a commodity prevailing in the market and
at this price, all sellers are selling their products to any buyer and all buyers are buying them from one
or other seller without any preferences.

10. Unrestricted Competition: Competition in this type of market is full or unrestricted and is in
complete swing. There is no opportunity to form cartels or other unions. Hence each firm acts
independently.

PRICE DETERMINATON

Price under perfect competition is determined by the interaction of demand and supply. For a
long time, before Marshall, there was a controversy among economists on whether the supply or the 2
demand determined the price of a commodity. Alfred Marshall brought about a compromise between
the schools of thought by pointing out that both the demand and supply are equally needed for the
determination of price just as two blades of a pair of scissors are required to a piece of paper.

We know the nature of demand and supply curves a commodity. The demand curve generally
slopes downwards to the right indicating that higher the price, the lower is the demand curve and vice
versa. The slope of the supply curve is just opposite of the demand curve. It slopes upwards to the right
indicating that the lower the price, the smaller is the supply and vice versa. The price in the market is
determined by the interaction of the two curves. The price thus fixed in the market is known as the
equilibrium price or market price. The equilibrium price is the price at which the quantity supplied is
equal to the quantity demanded. The determination of price may be explained with a help of a table and
the diagram:

Price per unit Quantity Supplied Quantity Demanded

(Rs.) (Units) (Units)
1 20 60
2 30 50
3 40 40
4 50 30
5 60 20

When the price of the commodity is Rs.1, the supply is 20 units but demand is 60 units. As a
result of the excess demand, the price will move up. When the price is increased to Rs.3, the demand is
40 units. The supply is also 40 units. Therefore Rs.3 is the equilibrium price at which demand equals
supply.

D S
Price

P E

S D

O X
D
Quantity

In the above figure DD is the demand curve and SS is the supply curve. ‘E’ is the point of
equilibrium where demand and supply curves intersect each other. At this point OM is the quantity
supplied and demanded. OP is the equilibrium price.

Changes in Equilibrium:
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 If there are changes in demand or supply or both equilibrium price and output will change.
Demand changes when there are changes in the determinants of demand such as income, taste,
preferences, fashion, weather etc. A change in cost of production generally changes the supply. Change
in demand and supply shifts the demand and supply curves. Let us see the change in equilibrium price
as result of change in demand:

In the following diagram Ox axis represents price and OY axis represents quantity of the
commodity. DD is the demand curve and SS is the supply curve. E is the equilibrium point. OP is the
equilibrium price. When there is increase in demand, demand curve shifts to the right and D 1D1 is the
new demand curve. Supply remaining unchanged the new demand curve intersects the supply curve at
E1 which is the new equilibrium point. Now new equilibrium price is established at OP 1which is higher
than OP. On the other hand, a fall in demand results in a fall in price. Demand curve D 2D2 represents a
decrease in demand. It intersects supply curve at E2 which is the new

P1
Price

P2

Quantity

equilibrium point. The price fixed at this point is OP2 which is lower than OP.

Let us see the changes in equilibrium price as result of change in supply:

In the above diagram OX axis represents quantity and OY axis represents price. DD is the
demand curve and SS is the supply curve. Both intersect at E which is the equilibrium point. If supply
increases, the supply curve shifts to right and. Hence new supply curve S 1S1. Demand remaining
unchanged the new supply curve cuts demand curve DD at the point E1 at which new equilibrium is
established. As a result price falls to OP1. On the other hand when supply decreases, price will go up.
S2S2 supply curve represents a decrease in supply. Demand remaining constant, new equilibrium is
established at E2 corresponding price is OP2 which is less than OP.

Thus if the demand increases supply remaining constant, the price will rise. If demand decreases
supply remaining constant, the price will decline. On the other hand, if the supply increases demand
4
remaining the constant, the price will fall. On the other hand, the price will rise when supply decreases
demand remaining the same.

EQUILIBRIUM OF THE FIRM AND INDUSTRY

A firm is an individual unit of production. The industry is a group of firms producing the same
product. A firm is said to be in equilibrium when it earns the maximum profit. A firm should satisfy the
following two in order to attain its equilibrium.

(i) MR = MC
(ii) MC curve must cut the MR curve from below.

Now we shall discuss how the equilibrium of the firm and industry is determined under perfect
competition in the (a) short period and (b) long period.

(a) Equilibrium of the Firm and industry in the Short Period: Under perfect competition, an
individual firm produces a negligible portion of the total output and, hence cannot influence the price.
A firm is price taker not price maker. An individual firm adjusts its output to the ruling market price in
such a way that it gets maximum profit. Under perfect competition, the AR, i.e., the price will be the
same for all levels of output so far an individual firm is concerned. Since the AR is same for levels of
production, the MR will also be the same. Since the AR and MR of the firm under perfect competition
are equal, the AR and the MR curves will be one and the same and parallel to OX axis.

In the short run there is no time to change the fixed equipments or to adopt new technology or
for new firms to enter the industry. The output of the firm can be adjusted to the demand only partially
by changing the variable inputs. There are two types of costs in the short run: (i) Fixed costs and (ii)
variable costs. It is not always possible for a firm to recover the fixed costs in the short run and,
therefore, its output decisions are not influenced by the fixed cost. However, the firm must recover the
variable cost. If a firm does not recover the average variable cost (AVC) in the short run, it will close
down the production. In the short run the firm may get supernormal profit or normal profit or in some
cases suffer losses (but recover AVC) when it is in equilibrium.

(i) Firm’s Equilibrium with Supernormal Profit:

The diagram has two parts. The left hand portion of the diagram shows the determination of
price by the interaction of total demand and total supply at the industry level in the short period. The
price so determined is passed on to the firms. All the firms have to accept this price and adjust their 5
output to it. The right hand portion of the diagram shows the firm’s equilibrium at OM output. As
shown in the diagram, the MR and MC are equal at the point Q. Therefore the firm is in equilibrium at
Q producing OM output. At this point, AR of the firm is QM (=OP), while the AC is RM. Since the AR
is greater than AC, the firm gets supernormal profit equal to QR per unit of output or a total
supernormal profit of PQRS.

(ii) Firm’s Equilibrium with Normal Profit: When the cost conditions of the firm differ, some suffer
losses; some may get supernormal profit while others may earn only normal profits because all of them
have to sell all their output at the price determined at the industry level. Though price per unit is the
same, the cost per unit may not be the same in all firms. In the following figure, the firm is in
equilibrium in the short run earning only normal profit:

In the above figure when then firm is in equilibrium at OM output (MC =MR at Q), the AR of
the firm equals its AC. Therefore the firm will get only normal profit at equilibrium output.

(iii) Firm’s Equilibrium with Losses: In the following figure, at equilibrium output, the firm incurs
losses.

The firm’s equilibrium is attained at Q where MC = MR. At OP price, the firm produces OM
output. At this equilibrium level of output, the firm’s AR is OM (==psSOP), while the AC is RM.
Since the AR is lower than AC, the firm incurs loss equal to RQ per unit of output or a total loss equal
to PQRS.

Shut-down Point: In the above figure, Q is the shut-down point of the firm. At this point the
firm is just able to recover the variable cost. In other words, at this shut-down point AR (or the price) =
AVC. If the price falls below this level, the firm will close down the production. Therefore Q is called
shut-down point.
6
 It may be noted that in this case, inspite of the losses the firm will continue to produce so long as
it is able to recover the average variable cost.

(b) Equilibrium of the Firm and industry in the Long Period: There are no restrictions on the entry
and the exit of firms under perfect competition. If the firms in industry are earning supernormal profits
in the short-run, there will be the entry of new firms into the industry in long run. As a result, the
supply will increase and the price will fall; supernormal profits will disappear. If the firms are incurring
losses in the short run, some of them will go out of the industry in the long run. This will reduce the
supply and push up the price to the average cost level. When price (i.e., price) equals average cost,
profits will be normal; there will be no tendency for changing the total output of the industry.

The long run equilibrium of the firm and industry under perfect competition is illustrated in the
following figure:

When the firm attains long run equilibrium position, it no longer makes supernormal profits, as
shown in the above figure. The MR curve passes through the point of intersection between MC and AC
curves. The MR is a tangent to the AC curve at its lowest at Q. At this point the two conditions for the
equilibrium of the firm and industry are met.
MR = MC ------------------------- (1)
AR =AC --------------------------- (2)
Since AR = MR, MC =AC
Therefore, Price = AR = MR = MC = AC.

MONOPOLY COMPETITION

The word ‘monopoly’ is made up of two syllables, ‘mono’ and ‘poly’. ‘Mono’ means
single and ‘poly’ means selling. Thus monopoly is a situation in which there is a single seller of
product which has no close substitutes. Since he is the single producer or seller of his product, he has
complete control over the supply of his product. Pure or absolute monopoly is not found in practice.
The monopoly that we find in the market is mostly relative monopoly. In India generally we find
monopoly in public utilities like railways, electricity, water supply, etc.
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 According to Leftwitch, “Pure monopoly is a market situation in which a single firm
sells a product for which there is no good substitute”.

According to Triffin, “Pure monopoly is that where the cross elasticity of demand of
the monopolist’s product is zero”.

According to Mc Connel, “Pure or absolute monopoly exists when a single firm is the
sole producer of a product for which there is no close substitutes”.

FEATURES OF MONOPOLY

The following are the main features of the monopoly competition:

1. Single Seller: In a monopoly market, there is only one firm producing or selling a product or a
service. The single firm constitutes industry and, therefore, the monopolist firm represents the entire
industry. The buyers of the products of monopoly firm are however in a large number.

2. No Close Substitute: There is no close substitute for the product of the monopolist. Therefore the
buyers have no choice but to buy the product or go without it. In such a case, the cross elasticity of
demand between the product of the monopolist and that of any other product is zero.

3. Restriction on Entry: Under monopoly, there are various kinds of barriers to entry by others. The
barriers to the entry may be natural, artificial, institutional or legal.

4. Absence of competition: As there are no rivals in the market, there is complete absence competition
under monopoly.

5. Control over Price and Output: The monopolist is not price taker, but a price maker. Since the
monopolist controls the entire supply, he can control the price by regulating his output. However, the
monopolist’s control over the price and output is not absolute. He cannot control the both at the same
time. If he fixes the price, the output that he can sell at that price will be determined by the buyers. If he
decides the output to be produced, then the price at which he can sell will be decided by the buyers.

6. Single or differentiated Price: The monopolist may charge a single uniform price from all
customers for his product. Such monopoly is called ‘Simple Monopoly’. But sometimes the
monopolist may charge different prices from different customers in which case it is called
‘Discriminating Monopoly’.

7. Price Maker: Monopolist is a price-maker not a price taker. In taking decisions on price fixation,
the monopolist is independent. He can set the price to the best of his advantage.

8. No Difference between Firm and Industry: As there is only one firm dealing in the product, the
firm itself constitutes the industry. In other words, in a monopoly market there is no distinction
between the firm and the industry.

9. Profit Maximisation: A monopolist aims at maximizing his profits. So he fixes high price for the
8
products he sells.
10. No Selling Costs: As there is no competition, the monopolist need not spend anything on
advertisement and salesmanship.

CLASSIFICATION OF MONOPOLY

The monopoly is classified into:

1. Natural Monopoly: A firm may enjoy monopoly power because of its control over important raw
materials. Restriction and concentration of natural resources are responsible for natural monopoly.
Example: Oil fields in Gulf Countries.

2. Legal Monopoly: A firm can get monopoly power legally through patent right, copy right, trade
mark, etc. Monopoly power is sanctioned by the Government or State through law. Such a monopoly is
known as legal monopoly.

3. Social Monopoly: Monopoly created by the state in the social interest is called social monopoly. In
the interests of the public welfare, the government itself may assume monopoly power over public
utility services. Example - railway, water supply, electricity, etc.

4. Pure and Imperfect Monopoly: This distinction is made on the basis of the degree of monopoly
power. A single firm which controls the supply of the commodity which does not have even a remote
substitute enjoys absolute or pure monopoly. Pure monopoly is very rare economic phenomenon. But
in public sector a pure monopoly may exist. For example: Indian Railways. If remote substitute exists it
is called imperfect monopoly.

5. Private and Public Monopoly: In private monopoly, the monopoly power exists in private sector.
Monopoly power vested with public or government is known as public monopoly.

6. Simple and Discriminating Monopoly: This distinction is on the basis of price policy adopted by a
monopoly firm. If uniform price exists in the monopoly market it is simple monopoly. If different
prices are charged it is known as discriminating monopoly.

PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY

Under monopoly, since the monopolist controls the entire supply, he can influence the price by
regulating his output. If the monopolist wants sell more, he must be prepared to lower the price. The
average revenue curve of the monopolist slopes downwards to the right and the MR curve also slopes
downwards and is below the AR curve. The AR curve is also the demand curve of the monopolist.

As in the case of perfect competition, under monopoly also, then monopolist gets the maximum
profit and is in equilibrium when MR is equal to MC. In fact the conditions for equilibrium are the
same under all market conditions. They are: (i) MC = MR and (ii) MC curve must cut the MR curve
from below.

(a) Short run Equilibrium: In the short run monopolist cannot change the capacity or scale of
production of his plant. If the demand increases or falls, he can adjust his output only to limited extent 9
in the short period. The total fixed costs cannot be changed during this period. Because of these
reasons, monopoly firm may enjoy supernormal profit or suffer losses when it is in equilibrium in the
short run. The short run equilibrium of the monopoly firm is illustrated in the following figure:

The monopoly firm attains equilibrium at point E where MC curve intersects MR curve. The
firm produces OM output and the price is OP. At this point the firm’s average revenue (MQ in the
diagram) is higher than average cost (RM) and, therefore, it gets supernormal profit of QR per unit. The
supernormal profit is equal to PQRS.

There is no guarantee that the monopolist will always get profits in the short run. In fact it
depends upon the monopolist’s demand and cost conditions. If the demand for his product is very low
and his cost conditions are such that average cost is higher than average revenue, he will incur losses.

In the following figure, MC cuts MR at E. At E the equilibrium output is OM and price is OP.
since AC is greater than AR at OM output; the monopoly firm suffers a loss of RQ per unit. The total
loss is represented by the area PSRQ. This is due low demand and high cost.

(b) Long run Equilibrium: In the long run, there is no possibility of entry of new firms into the
industry. Therefore, the monopoly firm will adjust its output and price in such a way that it gets
supernormal profit in the long run. The long run equilibrium of the monopoly firm is shown in the
following figure:

10
 In the above figure, the monopoly firm is equilibrium at E where MC = MR. The firm
produces OM output at the price OP. The monopoly firm enjoys supernormal profit equal to PQRS
when it is in equilibrium.

PRICE DISCRIMINATION

Price discrimination refers to the practice of selling the same product at different prices to different
buyers. According to Mrs. Joan Robinson, “The act of selling the same article produced under the
single control at different prices to different buyers is known as price discrimination”. Price
discrimination is a special feature monopoly and it is practiced to maximize the profit.

Forms or Types of Price Discrimination:

There are three important types of price discrimination-

1. Personal Discrimination: When a monopolist charges different prices from different buyers at the
same time, it is called personal discrimination. Personal discrimination may be made on the basis of
consumer’s income, age, sex, quantity they buy, their association with the sellers, frequency of visits to
the shop, etc.

(a) A common example of personal discrimination is found in specialized personal services of

doctors and lawyers. For example a doctor may charge high fees from rich people, and low fees from
poor people for the same service rendered.

(b) Discrimination may be made on the basis of the age of the buyers. Usually barbers charge
lower rates for children’s haircuts than the rate for adults. Similarly in transport services children are
charged at half rates. The students’ concession also falls into this category.

(c) A monopolist may discriminate between male female customers. For example, some touring
agents may provide seats at concessional rate to the ladies.

(d) Price discrimination on the basis of quantity purchased is very common. Generally, the
sellers charge lower price when large quantity of a commodity is bought. In the case of electricity, upto
a certain level of consumption, the rates are low. For the owners of telephones, above a certain number
of calls the rates are higher.

(e) Similarly on the basis of time of service different prices may be levied. For example, STD
calls at night are cheaper than during the day. The auto rickshaw fares are higher during the night.
11
2. Place Discrimination: when the monopolist sells the same product or service at different prices in
different markets, it is called place discrimination. In those markets where the demand is highly elastic,
the monopolist may charge a lower price and in the markets where the demand is inelastic, he may sell
at a higher price. Place discrimination may be between different localities of the same city or between
rural and urban areas or different regions or even between countries. When discrimination is made
between two countries, it is known as ‘dumping’.

3. Trade Discrimination: When a monopolist charges different prices for different uses or from
different occupations, it is called trade discrimination. For example, electricity is usually sold at a lower
price for industrial uses than domestic purposes. A publisher sells student edition at a cheaper rate than
the library edition.

Degrees of Price Discrimination:

According to Prof A.C. Pigou, there are three degrees of price discrimination practiced by the
monopolists. They are the following:

(i) Price Discrimination of the First Degree: When monopolist charges different prices for different
units of the commodity, it is known as price discrimination of first degree. In this case, the producer
exploits the consumer to the maximum possible extent by charging the highest amount which the
consumer is prepared to pay. So it takes away consumer’s surplus completely. This type of
discrimination is also called ‘perfect price discrimination’.

(ii) Price Discrimination of the Second Degree: In price discrimination of second degree, the buyers
are divided into different groups and from each group different price is charged which is the lowest
demand price of that group. Under this method, the price which the monopolist charges from each
group is that which a marginal individual of that group is just willing to pay.

(iii) Price discrimination of the Third degree: Price discrimination of the third degree occurs when
the seller divides his buyers into two or more than two sub-markets and charges a different price in sub-
market. In this case the buyers are divided on the basis of elasticity of demand. This is a very common
method of price discrimination. Even dumping also comes under this method.

Essential Conditions for Price Discrimination [Possibility of Price Discrimination]:

The price discrimination is possible under following conditions:

1. Existence of monopoly: Price discrimination is possible only if the seller is monopolist. Under
competitive conditions, price discrimination is not possible.

2. Existence of Two or More than Two Markets: Price discrimination is possible only when the total
market is divided into several submarkets and when one submarket has no connection with the other.

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3. Existence of Different Elasticity of Demand in Different Market: Price discrimination will
succeed only if the elasticity of demand for the monopolist’s product is different in different markets.
The monopolist can charge a high price in the inelastic market and a low price in the elastic market.

4. Impossibility of Resale: If the buyers in a low priced market can resell the commodity in the high
priced market, price discrimination will not succeed. Similarly personal discrimination is not possible if
there is possibility of resale by the purchaser to whom the commodity is sold at a lower price. In certain
cases, especially in the case of direct services, such resale is not possible. While it is possible or books
or pens to be resold by a customer who is charged low price to one who pays high price, it is
impossible to do this with haircuts.

5. Preferences and Prejudices of the Consumers: A monopolist may sell the same at different prices
by using different packing, different brand names or labels in order to make the customers to believe
that certain brands superior to others.

6. Legal Sanction: In some cases price discrimination is legally sanctioned. For example, Railways
charge different freight rates for different kinds of goods for same distance. Similarly, the electricity
board sells electricity at a lower price for industrial purposes and at a higher price for domestic use.

5. Ignorance or Lethargy of Consumers: Many a time the consumers are ignorant about price
variations. In the same way, they do not even take the trouble of comparing the prices. Hence the
monopolist can charge higher prices from some consumers than the others. Besides, if the price
difference is very small, the consumers do not bother about such difference.

6. Special Orders: when the goods are being supplied to special orders, a monopolist can practice
easily discriminating prices.

Profitability of Price Discrimination:

In all cases where price discrimination is possible, it may not be profitable to the monopolist. It will
be profitable only under the following conditions:

(i) There should be two or more markets for the monopoly product or service
(ii) The elasticity of demand in each market should be different.
(iii) The cost keeping various markets and sub-markets with discriminating prices should be the
minimum.

Desirability of Price Discrimination:

Generally price discrimination is condemned as unethical, illegal and socially and economically
harmful. But, it may pointed out that in some cases price discrimination is not only justified, but also
beneficial to the consumers and, hence, desirable. 13
1. Social justice: Price discrimination is desirable if it helps the poor people to goods or services at
lower prices than the prices charged from the rich people. As a measure of social justice, it promotes
social welfare and is socially beneficial.

2. Inequality Reduction: Price discrimination is desirable if reduces inequalities of personal real

incomes. Lower price increases the consumer surplus of the poor whose personal real incomes are
raised due to low price.

3. Production Extension: By resorting to price discrimination, a monopolist may be able to produce a

larger output than when there is no price discrimination. The whole society benefits from increased
production.

4. Public Utility Services: Price discrimination is desirable in the case of public utility services also. If
the price is kept uniformly low, the cost production may not be met.

But the price discrimination is not considered a desirable policy on following grounds:

1. Selfish Motive: Price discrimination may be resorted with selfish motive of destroying rival firms
and strengthening the monopoly power. In such a case price discrimination is desirable.

2. Dumping: the monopolist penalizes the home customer by resorting to dumping. Selling a product
at a lower price in foreign market and at a higher price in domestic market is called dumping. Dumping
makes the foreign customer to enjoy at the cost of home customers. Dumping also lacks social
justification, and hence is undesirable.

PRICE OUTPUT DETERMINATION UNDER DISCRIMINATING MONOPOLY

A discriminating monopolist has decide the equilibrium level of total output and determine its
distribution in different markets and fix the prices to be charged in these markets in such a way that
profits are maximized. The following are the conditions for equilibrium of the discriminating
monopolists.

(i) The discriminating monopolist is guided by the same rule as any other producer for maximizing
his profits. The monopolist should equate MC with the aggregate marginal revenue (AMR or combined
marginal revenue).

(ii) The discriminating monopolist has not only to decide how much to produce but has also
distribute the output in different markets in such a way and in such a price that he gets maximum
profits. The profit in each market is maximized by equating MC and MR of each market, i.e., MC =
MR1 = MR2. In other words, the total output will be distributed in different markets in such a way that
MR in each market is the same.

The above conditions of equilibrium are shown in the following figure:

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 In the above figure there are two sub-markets, A and B. The demand curve in the market B (i.e.,
AR2 curve) is more elastic than the demand curve in market A (i.e., AR 1 curve). The monopolist
produces OM output when he is in equilibrium. He sells OM 1 quantity at OP1 price in the market A and
OM2 quantity in the market B at OP2 price. Thus he sells a smaller quantity at a higher price in market
A where the demand is inelastic and a larger quantity at a lower price in the market B which has a more
elastic demand.

MONOPOLISTIC COMPETITION

Neither perfect competition nor absolute monopoly is found in the real world. Most of the actual
situations are intermediate between these two. These situations are dealt in economic theory by the
analysis of monopolistic competition. Prof. E. H. Chamberlin of Harvard University and Mrs. Joan
Robinson of Cambridge University are the main architects of the theory of monopolistic competition.

Monopolistic competition is a market structure in which a large number of small sellers sell
differentiated products which are close but not perfect substitutes for one another. In other words,
monopolistic competition refers to a market situation where there are many firms selling
differentiated products. Competition exists between these producers but the competition is imperfect.
However the producers compete among themselves each one of them enjoys some monopoly power
over his product. For example, soap. Soap is one product. There is no single type of soap produced and
sold in the market, but there are varieties of soaps such as Lux, Santoor, Dove, Pears, Rexona, Dettol,
Lifebouy and many others. Every producer has a monopoly control over his product but at the same
time competition prevails between these varieties. There is thus a combination of monopoly and
competition in such a market.

According to Joe s Bain, “Monopolistic competition is found in the industry where there is a large
number of small sellers, selling differentiated but close substitute products”.

In the words of Leftwitch, “Monopolistic competition is a market situation in which there are many
sellers of a particular product, but the product of each seller in some way differentiated in the minds of
the consumers form the product of the every other seller”.

FEATURES OF MONOPOLISTIC COMPETITION

The following are the main features of monopolistic competition:

1. Large Number of Small Sellers: Under monopolistic competition there are a large number of
sellers producing similar, but not identical, products. The existence of a large number of firms in the
same line of production leads to competition. Because of the large number of firms, an individual firm
gets only a small share of the total market.

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2. Free Entry and Exit of the Firms: There is freedom of entry and exit for all firms. New firms come
in when existing firms are making supernormal profit and they get out of the industry when they suffer
losses.

3. Product Differentiation: The most important and distinguishing feature of monopolistic

competition is product differentiation. Under monopolistic competition, the products produced by
different firms are similar, but not identical. As the products of different firms are close substitutes, the
cross elasticity of demand is very high.

Product differentiation is brought about in two ways: (a) through sight changes in quality, and (b)
through sales promotion. The differences in quality may refer either to physical aspects of the
commodity such as shape, size etc. or to the differences in the service associated with sale.

Under the first method, the product differentiation has been achieved in the form size, shape,
colour, taste, fragrance and quality etc. the second method of bringing product differentiation is through
sales promotion. This is done through advertisement, distinctive designs, attractive packets and
wrappers, publicity and propaganda, trademarks, brand names, gift offers, discounts, guarantee repairs,
service after sales, sale on credit etc.

4. Selling Cost: The amount of money spent by a firm on sales promotion is called ‘selling cost’ by
Chamberlin. They are incurred to induce the buyers to by a given commodity. They include not only
advertisement costs, but also other expenses like salaries of salesmen, commission paid to the
wholesalers and retailers, door delivery, expenses on sales depots, decoration of the shop,
demonstrations, distribution of free samples, printing and distribution of pamphlets and many other
types of promotional activities.

5. The Concept of Groups: Chamberlin used the word ‘group’ instead of industry. The word
‘industry’ refers to a collection of firms which produce identical products. By ‘group’ he means a
number of producers whose goods are fairly substitutes. Thus group refers to a collection of firms that
produce closely related but not identical products.

6. Imperfect knowledge: Te buyers and sellers in the monopolistic market do not have perfect
knowledge of the market conditions and the prices prevailing in the market. Ignorance of the
consumers is the main reason for the growth if this market.

7. Profit Maximisation: Earning maximum profit is the main aim of every seller under this market
condition.

8. No uniform Price: Product differentiation and profit motive of the sellers have led to price
differentiation. As the products produced by one firm is different from that if the other, the prices of
these products also vary.

9. Price Maker: Sellers under this market condition are the price makers and not the price takers. As
the products are differentiated from one another, each seller has certain degree of monopoly control
over the trade. Hence, sellers fix the price for their products.
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10. Non-Price Competition: The firms under monopolistic competition try to win over the customers
through non-price competition. It may be offering guarantee upto a particular period of time, after sales
service, discounts, gifts, free home delivery etc. Hence, there is product competition rather than price
competition.

11. Transport Cost: Under monopolistic competition the producers and consumers do not have direct
link because of numerosity of products and product differentiation. Hence transport of goods becomes
inevitable. This necessitates the inclusion of transport cost in the price.

PRICE AND OUTPUT DETERMINATION UNDER MONOPOLISTIC COMPETITION

As in all other market forms, under monopolistic competition also, the conditions for the
equilibrium of a firm are: (i) MR = MC and (ii) MC curve must cut MR curve from below. The AR and
MR curves of a firm slope downwards.

(a) Short Run Equilibrium: In the short run, different firms earn supernormal profits or normal profits
or may incur losses when they are in equilibrium. This is because the firms follow independent price –
output policies. A firm which incurs losses will continue to produce so long as it is able to recover the
cost.

The short run equilibrium of a firm earning supernormal profit is shown in the following figure:

The firm is in equilibrium at E where MR and MC are equal. OM is the equilibrium output and QM
(=OP) is the price. The cost per unit is MR. Since AR is greater than AC, the firm enjoys a supernormal
profit of RQ per unit. The total supernormal profit is equal to PQRS.

It is possible that a firm may get only normal profit in the short run as shown in the following
figure:

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 In the above figure the firm’s equilibrium is attained at E where MC = MR. At the equilibrium price
OP, the firm produces OM output. Since at OM output the firm’s average revenue equals average cost,
it will get only normal profit.

In the short run, the firm may suffer losses if its average revenue is less than average cost. It is
illustrated with the help of a graph as under:

It is seen in the above figure that the price (MQ or OP) is less than average cost (MR). The firm
incurs a loss of RQ per unit. The total loss is represented by the area PSRQ.

(b) Long Run Equilibrium (or ‘Group’ equilibrium): As pointed out earlier, different firms in the
group adopt independent price-output policies because of product differentiation. Therefore, each firm
will have its own demand and cost curves. This creates a problem in finding out the equilibrium of the
group. To solve this difficulty, Chamberlin ignores these differences by making two “heroic”
assumptions:
(i) Uniformity assumption
(ii) Symmetry assumption
He assumes that the cost and demand curves all the products in the group are uniform. This is referred
to as uniformity assumption. Symmetry assumption means that the number of firms under monopolistic
competition is large and, hence, the action of an individual firm regarding price and output will have
negligible effect upon rivals. Based on these assumptions, the short run equilibrium of different firms
will not differ.
In the long run, the supernormal profits will disappear because of the entry of firms. All the firms
will be getting only normal profits in the long run when they are in equilibrium. In the absence of
supernormal profits, there is no incentive for the entry of new firms. Therefore, the ‘group’ will be in
equilibrium. The following graph illustrates the long run equilibrium of the firm under monopolistic
competition.

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 As shown in the diagram OM is the long run equilibrium output and MQ (=OP) is the long run
price. MQ is not only the price, but also the average cost of the firm. It is clear, therefore, that the firm
earns only normal profit.

Difference between Selling Cost and Production Cost:

Chamberlin introduced the concept of selling in economic analysis and distinguished it from
production costs. The term selling cost is broader than advertisement cost. While advertisement
expenditure includes only costs incurred on getting the products advertised in newspapers, magazines,
radio, television etc., selling costs include salaries and wages of salesmen, allowances to retailers for
the purpose of getting their product displayed by them and so many other types of promotional
activities besides advertisement.

According to Chamberlin, cost of production includes all those expenses which are incurred to
manufacture and provide a product to the customer to meet his given demand, while selling costs are
those which are incurred to change or create the demand for a product.

OLIGOPOLY

The term ‘Oligopoly’ is derived from two Greek words ‘Oligos’ meaning ‘a few’ and ‘Polien’
meaning ‘to sell’. Therefore, oligopoly is that form of market situation where there are a few firms
producing either homogeneous or differentiated products which are close but not perfect
substitutes of each other. The number of sellers in this market form is more than two, but not many.
Oligopoly may be two kinds: (i) Pure Oligopoly – exists when there are a few sellers producing
identical products. (ii) Differentiated Oligopoly – exists when the products are differentiated one
another.

FEATURES OF OLIGOPOLY
1. Element of Monopoly: There is an element of monopoly present under oligopoly with product
differentiation. Since each firm controls a large share of the market and produces a differentiated
product, it acts in its own limited sphere as a monopolist when it comes to price and output
determination.
2. Interdependence: Since the number of firm is small, each firm enjoys a large share in the market,
and is in a position to influence the price and output of the industry in a significant manner. No firm
can, therefore, fail to take into account the reactions of the other firms to its price-output policies. There
is, therefore, a good deal of interdependence of firms under oligopoly.
3. Indeterminateness of demand curve: Mutual interdependence of firms creates an atmosphere of
uncertainty for all the firms. A firm under oligopoly cannot make an estimate of what its sales would be
if it were to cut down the price of its product by a certain percentage. Hence, its demand curve is
indeterminate. The demand curve relates to the various quantities of the product that could be sold at
different prices. When the quantity to be sold at a particular price is itself uncertain, the demand curve
cannot obviously be definite, determinate and certain.
4. Conflicting Attitudes of the Firms: Another characteristic of oligopoly is the existence of two
opposing attitudes among sellers simultaneously all the time. In the first place, all the firms of the
oligopoly industry realize the disadvantages of competition and the need for a policy of cooperation 19
and united action or to act collusively. In this way, all of them can maximize the joint profits so that
each firm can get a greater share. In the second place, every firm in an oligopoly industry wants to
maximize its own share of profits and this naturally will lead to conflict and antagonism among
oligopoly firms. This will lead to an atmosphere of uncertainty under oligopoly.

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