Faculty of Management

Managerial Economics
102-18

Lecture 26- 29: Market Structures

Subject In-charge: Dr. Neha Singh

Designation: Assistant Professor
Mail ID: neha.j348@cgc.ac.in
 Lecture Outline
 Market Structures- Concept

 Market Classification

 Perfect Competition

 Imperfect Competition

Topics Outcome: CO4: Analyze the parameters of market structures for

equilibrium.
 Market Structure
•Market : Any arrangement that enables buyers and sellers to contact for
transactions.
•The term market is derived from the Latin word “Marcatus” which means
merchandise or trade.
•Market is an area or atmosphere of potential exchange
•-Phillip Kotler
•Market structure – identifies how a market is made up in terms of:
oThe number of firms in the industry
oThe nature of the product produced
oThe degree of monopoly power each firm has
oThe degree to which the firm can influence price
oFirms’ behavior – pricing strategies, non-price competition, output levels, Profit
levels
oThe extent of barriers to entry
 Market Structure
Market contains 2 kinds of competition :
1) Price competition - Seller competes among each
other by setting a lower price.

2) Non-price competition - Sellers compete in area like

product quality, advertising, packaging and service other
than price.
 Market Structure
There are 2 types of Market Structure:
1)Perfect Competition
2)Imperfect Competition
1)Perfect Competition and its features
•Homogenous Products: The goods are sold by different
sellers as exactly alike from the consumers regard.
Consumer has no reason to express a preference for any
firm.
 1)Perfect Competition
•Free entry and exit: Firms are free to enter or leave the
market. They do not face restriction on competing with other
sellers.

•Perfect Information: All the buyers and sellers know the

aspects of the market, including price, quality and quantity of
the good. Consumers and producers have perfect knowledge
about the market.
 1)Perfect Competition
Individual sellers have no influence on the market: In a
perfectly competitive market, there are many buyers and
sellers, since all the buyers and sellers know the aspects of
the market, goods are homogenous, so no individual seller can
affect the market price, because his output just takes up a little
part of the whole market output. Firms are price takers as they
have no control over the price they charge for their product.
Each producer supplies a very small proportion of total industry
output.

Every firm has only one goal of maximising its profits.

 Demand Curve

https://www.youtube.com/watch?v=ZhGDce_a5eE
 Demand Curve
•The demand curve for an individual firm is different from a market demand
curve. The market demand curve slopes downward, while the firm's demand
curve is a horizontal line.
•The market demand curve is a downward sloping line, reflecting the fact that
as the price of an ordinary good increases, the quantity demanded of that
good decreases.
•Price is determined by the intersection of market demand and market
supply; individual firms do not have any influence on the market price in
perfect competition.
•Once the market price has been determined by market supply and demand
forces, individual firms become price takers.
•Individual firms are forced to charge the equilibrium price of the market or
consumers will purchase the product from the numerous other firms in the
market charging a lower price.
•The demand curve for an individual firm is thus equal to the equilibrium price
of the market .
 Price Determination
•The twin forces of market demand and market supply
determine price.
•The level of price at which demand and supply curves
interact each other will finally prevail in the market.
•The price at which quantity demanded equals quantity
supplied is called equilibrium price.
•The quantity of the good bought and sold at this price is
called equilibrium price.
•Thus the interaction of demand and supply curves
determines price-quantity equilibrium.
•At the equilibrium price the buyers and sellers are satisfied.
https://www.youtube.com/watch?v=XIyv7_WhkGo
https://www.khanacademy.org/economics-finance-domain/microeconomics/perfect-competition
 AR and MR Curves
• AR(Average revenue) curve and MR(Marginal Revenue)
curve under perfect competition becomes equal to
D(Demand) curve and it would be a horizontal line or parallel
to the X-axis
The curve simply implies that a
Perfectly Elastic Demand
firm under perfect competition Curve(AR=MR=D)
D
can sell as much quantity as it
likes at the given price
determined by the industry i.e. a
perfectly elastic demand curve
0 1 2 3 4
Commodity
 Firm Equilibrium
•Firm’s Equilibrium means, “the level of output where the firm is maximizing
its profits and therefore, has no tendency to change its output”.

•In this situation either the Firm will be earning maximum profit or incurring
minimum loss i.e. it refers to the profit maximization

•In the words of Hansen, “A Firm will be in equilibrium when it is of no

advantage to increase or decrease its output”.

•Profit of a Firm is equal to the difference between its total revenue (TR) and
the total cost (TC) i.e., (Profit=TR-TC) and so for the equilibrium of the Firm it
should be maximum
•Marginal cost should be equal to Marginal revenue (MC=MR). And when
these are equal profit is maximum
 Change in Equilibrium
Equilibrium can change when demand or supply change. Change in Demand will
have 2 possibilities
1. Demand increases – It happens when income of the buyer increases, substitutes
become less available or more expensive, number of consumers increase,
information about the product increases the desire for it, buyers have an
expectation of higher future price of the good, etc.
As the demand increases, the demand curve moves to the right (the purple curve),
the equilibrium price increases to P2 and the quantity increases to Q2. The
Buyers buy more of good, but must pay a higher price to get it.
 Change in Equilibrium
2. Demand decreases – if incomes of buyers are decreased, substitutes become
less expensive or more available, number of consumers decreases (due to
population, demographics), fashions, tastes and attitudes make the good less
popular, information about the good (advertising) decreases desire for the good,
buyers have an expectation of lower future price for the good, etc

As the demand decreases, demand curve moves to the left (the purple curve),
the equilibrium price decreases to P2 and the quantity decreases to Q2. Buyers
buy less of the good, and pay a lower price to get it.
 Change in Equilibrium
• Change in Supply will also have 2 possibilities

1. Supply can increase (moving the supply curve to the right)

if costs are lower due to lower resource prices, new
technology for producing is used, larger number of sellers,
favorable environment for producing or selling, lower
taxes, etc.
When supply increases for one of these reasons, it will move
the equilibrium, and thus decrease the price and increase
the quantity traded of the good.
 Change in Equilibrium
•The original equilibrium occurs at
the price of P1 and quantity of Q1.

•As the supply curve moves (to the

purple curve), the equilibrium price
decreases to P2 and the quantity
increases to Q2.

•Sellers sell more of the good, but

get paid a lower price to sell it.
 Change in Equilibrium
2. Supply can decrease (moving the supply curve to the left) if
costs are higher due to higher resource prices, smaller
number of sellers, unfavorable environment for producing
or selling, higher taxes, etc.

When supply decreases for one of these reasons, it will move

the equilibrium, and thus increase the price and decrease
the quantity traded of the good.
 Change in Equilibrium
•The original equilibrium occurs at
the price of P1 and quantity of Q1.

•As the supply curve moves (to the

purple curve), the equilibrium price
increases to P2 and the quantity
decreases to Q2.

•Sellers sell less of the good, but

get paid a higher price to sell it.
 Equilibrium position of a firm
In order to attain equilibrium, a firm has to satisfy 2 conditions:
–MR= MC since profits are maximum at this point.

–MC curve should cut MR curve from below i.e. MC should have a positive slope.

MC curve in the figure cuts MR at two place i.e. T and R. At T, it is cutting MR from
above and its not the equilibrium point as it doesn’t satisfy 2nd condition. At R, MC is
cutting MR curve from below. Hence R is the point of equilibrium.
 Can a competitive firm earn profit?
• In a short run, a firm can attain equilibrium and earn
supernormal profits, normal profits or losses depending upon
the cost conditions.
• Normal profit is defined as the minimum reward that is just
sufficient to keep the entrepreneur supplying their enterprise.
In other words, the reward is just covering opportunity cost -
that is, just better than the next best alternative. This exists
when total revenue TR, equals total cost TC.
• If a firm makes more than normal profit it is called super-
normal profit. Supernormal profit is also called economic
profit, and abnormal profit, and is earned when total revenue
is greater than the total costs.
 Short run equilibrium: Supernormal profits
• Suppose the cost of producing 1000 units of a product by a firm is Rs 15000.
The entrepreneur has invested Rs 50000 in the business and normal rate of
return in the market is 10%. Thus the entrepreneur must earn at least Rs 5000.
Total cost of production is Rs15000+Rs5000=Rs 20000. If the firm is selling the
product at Rs 20, it is earning normal profits because AR (Rs 20)=ATC (Rs 20). If
the firm is selling at Rs 22, its AR (Rs 22) > ATC (Rs 20) and it is earning
supernormal profit at rate of Rs 2 per unit.
 Short run equilibrium : Normal profits
• When a business just meets its ATC, it earns normal profits.
Here AR = ATC. MR=MC at E. the equilibrium output is OQ.
Since AR=ATC or OP=EQ, the firm is earning just normal
profits.
 Long run equilibrium
Long run equilibrium of the firm :
•In the long run, the firms are in equilibrium when they have
adjusted their plant so as to produce at the minimum point of
their long run AC curve. In the long run, the firms will be
earning only normal profits.
•If they are making super normal profits in the short run, new
firms will be attracted in the industry which will lead to a fall in
price and an upward shift of the cost curves due to increase in
the prices of the factors as the industry expands.
•If the firm makes losses in the short term, they will leave the
industry in the long run. This will raise the price and costs may
fall as the industry contracts.
 Long run equilibrium
Long run equilibrium of the industry:
A perfectly competitive industry is in long run equilibrium when:
1. all the firms are earning normal profits only i.e. all the firms are in
equilibrium
2. There is no further entry or exit from the market.
The following conditions are associated with the long run equilibrium of
the industry:
1. The output is produced at the minimum feasible cost.
2. Consumers pay the minimum possible price which just covers the
Marginal cost i.e. MC=AC
3. Firms earn only normal profits i.e. AC=AR
4. Firms maximise profits(i.e. MC=MR) but the level of profits will be just
normal.
 Imperfect
Competition
 Monopoly
•The word monopoly is derived from two Greek words-Mono
and Poly. Mono means single and Poly means 'seller‘.
•Monopoly is a situation in which there is a single seller of a
product which has no close substitute.
•Under monopoly there is no rival or competitors. The degree of
competition in monopoly is nil. Thus if the buyers is to purchase
the commodity, he can purchase it only from that seller.
•The seller dictates the price to consumers. Unlike perfect
competition a monopolist can fix up the price.
•As monopoly is a form of imperfect market organization, there
is no difference between firm and industry. A monopoly firm is
said to be an industry.
•Eg: Railways, electricity
 Monopoly
Features:

–Single seller of the product – In a monopoly market, there is only one firm
producing and selling a product. This single firm constitutes the industry as
there is no distinction between firm and industry.

–Restrictions to entry – There are strong barriers to entry to this market. It

could be economic, institutional or legal. Entry is almost blocked.

–No close substitutes – This market sells a product which has no close
substitute.

–The products sold in a monopoly market may be homogenous or

heterogeneous.
 Monopoly
• Information of the market is imperfect: No perfect information
in the market. Neither the sellers nor buyers know all aspects
of the market.

• The monopolist is a price searcher: A monopolist faces the

entire market demand. He needs to find out the price that he
can earn the most and sell most of it

s product.
 Price Discrimination in monopoly
•The monopolist may use his monopolistic power in any manner in order to realize maximum
revenue. He may also adopt price discrimination.

•One of the important feature of monopoly is price discrimination i.e. charging different prices for
same product from different consumers.

•Price discrimination is a method of pricing adopted by the monopolist in order to earn abnormal
profits.

•Eg : The family doctor in your neighborhood charges a higher fees from a rich patient compared
to the fees charged from a poor patient even though both are suffering from viral fever.
Electricity companies sell electricity at cheaper rates for home consumption in rural areas than
for industrial use.

•Price Discrimination cannot persist under perfect competition because the seller has no
influence over market determined rate. Price Discrimination requires an element of monopoly so
that the seller can influence the price of his product.
 Price Discrimination in monopoly
Conditions for price discrimination:
• The seller should have some control over the supply of his product i.e.
monopoly power in some form is necessary to discriminate price.
• The seller should be able to divide his market into 2 or more sub markets.
• It should not be possible for the buyers of low priced market to resell the
product to the buyers of high-priced market.
• The price elasticity of the product should be different in different sub
markets. The monopolist fixes a high price for his product for those buyers
whose price elasticity of demand for the product is less than one. This
means that if monopolist charges high price from them, they do not
significantly reduce their purchases in response to high price.

A monopolist charges higher price in a market which has a relatively

inelastic demand. The market which is highly responsive to price changes
is charged less. On the whole, the monopolist benefits from such a
discrimination.
 Objectives of Price discrimination
•To earn maximum profit
•To dispose off surplus stock
•To enjoy economies of scale
•To capture foreign markets
•To secure equity through pricing

Price discrimination is carried out to capture consumer surplus

that is enjoyed by consumers. Consumer surplus is the
difference between the total amount that consumers are willing
and able to pay for a good or service and the total amount that
they actually do pay (i.e. the market price).
Professor Pigou classified 3 degrees of price discrimination.
 Degrees of
Monopoly
•First degree Price Discrimination – Under the first degree price discrimination, the
monopolist will fix a price which will take away the entire consumer’s surplus i.e. their
maximum willingness to pay. It is also known as perfect price discrimination. Eg:
Auctions

•Second Degree Price Discrimination - Under the second degree price

discrimination, he will take away only a part of the consumer’s surplus. Here price
varies according to the quantity sold. Larger quantities are available at lower unit
price.

•Third Degree Price Discrimination - Under third degree price discrimination, the
price varies by attributes such as location or by consumer segment. Here the
monopolist, will divide the consumers into separate sub markets and charge different
prices in different sub- markets. Eg: Dumping, Bus passes
 Price and Output determination
• The aim of a monopolist is to maximize his profits. For that, he has 2 choice:

1. He can fix the price for his good and leave the market to decide what output will
be required.

2. Or he can fix the output and leave the price to be determined by the interaction of
supply and demand.

In other words, he can either fix the price or the output. If the demand for the
commodity is elastic, the monopolist cannot fix a very high price because a rise in
price may result in a fall of demand. So he cannot sell much and he may not get
large profits. In such a case, the monopolist will fix a low price.

If the commodity has inelastic demand, the monopolist may fix a high price. Even if
the price is high, there will not be a fall in demand. Then the monopolist will get
maximum profits by fixing a high price.
 Demand Curve of monopoly
•Since the monopolist firm is assumed to be the only producer of a
particular product, its demand curve is identical with the market demand
curve for the product.
•The demand curve is downward sloping because of law of demand.
 Demand Curve of monopoly
•The seller can’t sell anything if he charges Rs10. If he wishes to sell 10 units, he needs to
sell it at Rs 5.
•In perfect competition, AR and MR are identical, but this isn’t true in monopoly as the
monopolist can increase the sales by decreasing the price of the product.
•Hence MR is less than the price, because firm has to lower the price to sell an extra unit.
The relationship between AR and MR of a monopoly firm can be stated as follows:
1.AR and MR are both negatively sloped.
2.MR curve lies half way between AR curve and Y.
3.AR can not be zero but MR can be zero or negative.
 Difference Between a Monopolist and a Perfect
Competitor

• A monopolistic firm’s marginal revenue is not its price. Marginal

revenue is always below its price. Marginal revenue changes as
output changes and is not equal to the price

• A monopolistic firm’s output decision can affect price.

• There is no competition in monopolistic markets so monopolists

see to it that monopolists, not consumers, benefit.
 Equilibrium of the monopoly firm
•Firms in a perfectly competitive market are price takers so they are only
concerned about determination of output. But this isn’t a case with a
monopolist. A monopolist not only has to determine his output but also the
price of his product.

•Since he faces downward sloping demand curve, if he raises the price of his
product, his sales will go down. On the other hand, if he wants to improve his
sales volume, he will have to be content with lower price.

•He will try to reach the level of output at which the profits are maximum i.e.
he will try to attain the equilibrium level of output.
 Short run equilibrium
•Conditions for equilibrium: The twin conditions for equilibrium
in a monopoly market are:
i) MC=MR and ii) MC Curve must cut MR curve from below
•The figure shows that MC curve cuts MR curve at E. That
means at E, the equilibrium price is OP and equilibrium output
is OQ.
https://www.youtube.com/watch?v=s49P6yN-_pk
 Short run equilibrium
• In order to know whether the monopolist is making profits or losses in the short
run, we need to introduce the ATC curve.
• MC cuts MR at E to give equilibrium output as OQ. At OQ, price charged is OP
(we find it by extending line EQ till it touches AR/demand curve).
• Also, at OQ, the cost per unit is BQ. Therefore, profit per unit is AB and total
profit is ABCP.
 Can a monopolist incur losses?
• One of the misconceptions about a monopolist is that it
always makes profit.

• It is to be noted that nothing guarantees that a monopolist

makes profit.

• It all depends on his demand and cost conditions.

• If he faces very low demand for his product and his cost
conditions are such that ATC>AR, he will not be making
profits, rather he will incur losses.
 Long run equilibrium
• Long run is a period long enough to allow the monopolist to
adjust his plant size or use his existing plant at any level that
maximizes his profit.
• In the absence of competition, the monopolist need not
produce at optimal level.
• The monopolist will not continue if he makes losses in the
long run.
• He can make super normal profits in the long run as the entry
of outside firms are blocked.
 Monopolistic Competition
• Monopolistic competition is another type of imperfect
competition other than monopoly

• Monopolistic Competition refers to a market situation in which

there are large numbers of firms which sell closely related but
differentiated products. Markets of products like soap,
toothpaste AC, etc. are examples of monopolistic competition.

Monopoly + Competition = Monopolistic Competition

 Features of Monopolistic
market
Features of both perfect competition and monopoly are present.
Similar features to perfect competition
1. A large no. of sellers and buyers – In a monopolistic market,
there are large number of sellers who individually have a small
share in the market. Eg: Hundreds of hair salons and
boutiques in Surat.
2. Free entry and exit :New firms have to compete with existing
firms for business. Entry and exit is not restricted.

Different features from perfect competition

3. Imperfect information of the market: Neither the sellers nor
buyers know all aspect of the market.
 Features of Monopolistic
4.
market
The goods sold are heterogeneous: The product sold by
different sellers are different. The differentiation may rise
from differences in quality, package design, advertisements,
etc. Product differentiation gives rise to an element of
monopoly to the producer over the competing product. The
producer of a brand can raise the price of his product
knowing that he will not lose all the customers to other
brands because of lack of perfect substitutability.
 Features of Monopolistic market
5.Non price competition: In addition to price competition, non-price
competition also exists under monopolistic competition. Non-Price
Competition refers to competing with other firms by offering free gifts,
making favorable credit terms, etc without changing prices of their own
products. Firms under monopolistic competition compete in a number of
ways to attract customers.

6.Pricing Decision: A firm under monopolistic competition is neither a price-

taker nor a price-maker. However, by producing a unique product or
establishing a particular reputation, each firm has partial control over the
price. The extent of power to control price depends upon how strongly the
buyers are attached to his brand.
Example of Monopolistic Competition: Toothpaste Market:
When you walk into a departmental store to buy toothpaste,
you will find a number of brands, like Pepsodent, Colgate,
Neem, Babool, etc.
i.On one hand, the market for toothpaste seems to be full of
competition, with thousands of competing brands and freedom
of entry.
ii.On the other hand, its market seems to be monopolistic, due
to uniqueness of each toothpaste and power to charge
different price.
Such a market for toothpaste is a monopolistic competitive
market.
 Demand Curve in Monopolistic market
• Under monopolistic competition, large number of firms selling closely related but
differentiated products makes the demand curve downward sloping. It implies that
a firm can sell more output only by reducing the price of its product.

At OP price, a seller can sell OQ quantity.

Demand rises to OQ1, when price is
reduced to OP1. So, demand curve under
monopolistic competition is negatively
sloped as more quantity can be sold only
at a lower price. As a result, revenue
generated from every additional unit is less
than price of the product.

Hence MR < AR just like it is in monopoly.

 Demand Curve: Monopolistic Competition Vs.
Monopoly:
• The demand curve of monopolistic competition looks exactly like the
demand curve under monopoly as both faces downward sloping
demand curves.

• However, demand curve under monopolistic competition is more elastic

as compared to demand curve under monopoly.

• This happens because differentiated products under monopolistic

competition have close substitutes, whereas there are no close
substitutes in case of monopoly.
 Price and output determination
• In a monopolistically competitive market, each firm is a price maker since the
product is differentiated.

• The 2 conditions of price and output determination and equilibrium of a firm are MC
= MR and MC curve should cut MR curve from below.

• At E, the equilibrium price is OP and the equilibrium output is OM. Per unit cost is
SM, per unit super normal profit is QS and the total supernormal profit is PQSR.
 Price and output determination
•Monopolistic firms may also incur losses in short term.

•Per unit cost HN is higher than OT/KN and the loss per unit in KH. The total
loss is GHKT.
Price and output determination
Long run equilibrium :
•If the firms in the industry earn super normal profits in the
short run, there will be an incentive for new firms to enter the
industry.
•As more firms enter, profits per firm will go on decreasing as
the total demand for the product will be shared among large
number of firms.
•This will happen till all the profits are wiped away and all the
firms earn only normal profits. Thus in the long run all the
firms will earn only normal profits.
 Oligopoly
•Oligopoly is described as competition among the few.

•An oligopoly is a market structure in which a few firms dominate. When a market is
shared between a few firms, it is said to be highly concentrated. Although only a few
firms dominate, it is possible that many small firms may also operate in the market.

•For example, major airlines like British Airways and Air France operate their routes
with only a few close competitors, but there are also many small airlines catering for
the holidaymaker or offering specialist services.

•An oligopoly is similar to a monopoly, except that rather than one firm, two or more
firms dominate the market. There is no precise upper limit to the number of firms in an
oligopoly, but the number must be low enough that the actions of one firm
significantly impact and influence the others.
 Features of Oligopoly
1. Interdependence: The most important feature of oligopoly is the interdependence
in decision making of the few firms which comprise the industry. This is because
when the number of competitors is few, any change in price, output, product etc. by a
firm will have a direct effect on the fortune of its rivals, which will then retaliate in
changing their own prices, output or products as the case may be. It is, therefore,
clear that the oligopolistic firm must consider not only the market demand for the
industry’s product but also the reactions of the other firms in the industry to any action
or decision it may take.

Oligopolies tend to compete on terms other than price. Loyalty schemes,

advertisement, and product differentiation are all examples of non-price competition.
 Features of Oligopoly
2.Group Behavior: Oligopoly market is about group behavior not of mass or

individual behavior. There are few firms in a group which are very much

interdependent. Each oligopolist closely watches the business behavior of other

oligopolists in the industry and designs his moves on the basis of how they behave or

likely to behave.

3.Barriers to entry: The main reason for few firms under oligopoly is the barriers,

which prevent entry of new firms into the industry. Patents, requirement of large

capital, control over crucial raw materials, etc are some of the reasons which prevent

new firms from entering into industry. Only those firms enter into the industry which

are able to cross these barriers.

 Features of Oligopoly
4. Importance of advertising and selling costs: In an oligopoly market, firms have to
employ various aggressive and defensive marketing weapons to gain a greater share in the
market or to prevent a fall in their market share. For this various firms have to incur a
good deal of costs on advertising and on other measures of sales promotion.
• Under perfect competition, advertising by an individual firm is unnecessary. A monopolist
may perhaps advertise when he has to inform the public about his introduction of a new
model of his product or he may advertise in order to attract potential consumers who
have not yet tried his product. Under monopolistic competition advertising plays an
important role because of the product differentiation that exists under it, but not as much
important as under oligopoly.

• Under oligopoly, advertising can become a life-and-death matter where a firm which fails
to keep up with the advertising budget of its competitors may find its customers drifting
off to rival products.
 Types of Oligopoly
1. Pure or Perfect Oligopoly: If the firms produce homogeneous products, then it is called
pure or perfect oligopoly. Though, it is rare to find pure oligopoly situation, yet, cement,
steel, aluminum and chemicals producing industries approach pure oligopoly.

2. Imperfect or Differentiated Oligopoly: If the firms produce differentiated products, then

it is called differentiated or imperfect oligopoly. For example, cigarettes or soft drinks. The
goods produced by different firms have their own distinguishing characteristics, yet all of
them are close substitutes of each other.

3. Open Vs Closed Oligopoly: This classification is made on the basis of freedom to enter
into the new industry. An open Oligopoly is the market situation wherein firm can enter
into the industry any time it wants, whereas, in the case of a closed Oligopoly, there are
certain restrictions that act as a barrier for a new firm to enter into the industry.
 Types of Oligopoly
4.Partial Vs Full Oligopoly: This classification is done on the basis of price
leadership. The partial Oligopoly refers to the market situation, wherein one large firm
dominates the market and is looked upon as a price leader. Whereas in full Oligopoly,
the price leadership is conspicuous by its absence.

5.Collusive Vs Non-Collusive Oligopoly: This classification is made on the basis of

agreement or understanding between the firms. In Collusive Oligopoly, instead of
competing with each other, the firms come together and with the consensus of all fixes
the price and the outputs. Eg: OPEC. Whereas in the case of a non- collusive
Oligopoly, there is a lack of understanding among the firms and they compete against
each other to achieve their respective targets.
 Collusive
oligopoly
Collusion refers to the agreement between few firms of an industry. It may
either be formal or tacit agreement. If it is a tacit one the firms follow a secret
agreement. Here there is no direct conduct among firms. But in a formal
agreement all conditions and conducts are open. So, they take decisions
jointly by a direct discussion or meeting.
Why Collusion?: Few firms in an Oligopoly industry collude on the basis of
certain agreements. So, they may have the following purposes.

a)Reduce the competition between themselves and increase profits.

b)To create a collective or group monopoly and thereby create a barrier for
new firms which want to enter to the industry.
 Pricing under perfect collusion
There are two types of collusion in a oligopoly market.

1.Cartel : A oligopoly industry can be said to be cartel when all the individual
firms are running on the basis of the agreements. So, each firm can earn
monopoly profits by cooperating with other firms in the agreement. It may be
either international or domestic cartel. Oil and Petroleum Exporting Countries
(OPEC) is an example for international cartel.

2.Price Leadership: Price leadership is another form of collusion of

Oligopoly firms. One firm assumes the role of a price leader and fixes the
price of the product on the entire industry. All the firms in the Oligopoly
industry will follow the rules fixed by the leader. Here there is no possibility of
competition between leader and individual firms.
 Price Leadership
Generally three types of price leadership can be seen-
i)low cost price leadership - It can be seen in an industry where each firm
produces homogenous products with various costs. So, it is easier to sell
large quantity for the firm who produce with low cost. So, other firms may
suffer losses.
ii)Dominant price leadership - In some market, we can see that, a few
firms are producing large amount of commodity and by getting huge market
share. So, they will fix their own prices and related things. Here any small
firm cannot influence to fix the price. So, all the firms will follow the price
which fixed by the dominant firm in the industry.
iii)Barometric price leadership - Here a firm acts as a leader of others.
The leader considered as the large or most experienced or an old firm. Such
firm has enough knowledge about market. So, all other firms follow his
actions in price. It may be a low cost firm or a dominant firm.
 Demand Curve of oligopoly
• The demand curve dD has a kink at a point P. Upper portion from point P is more
elastic because it is made on the assumption that when one firm changes its price,
others will keep their price constant. Firm loses market share.
• Lower portion from point P is less elastic because it is made on the assumption that all
the firm will change their price. Hence there will be little increase in the sale of the
firms. Little gain in market share.
• When an oligopolistic firm changes its price, its rival firms will retaliate/react and
change their prices which in turn effects the demand of the former firm. Therefore an
oligopolistic firm can not have sure and definite demand curve, since it keeps shifting
as the rivals change their prices in reaction to the price changes made by it.
A quick
comparison
Summary
 References & Sources
• https://www.academia.edu/34707649/Managerial_Economics_Textbook - E-book by

Samuelson & Marks, Managerial Economics, 7th edition, Wiley Publications.

• https://books.google.co.in/ - Google E-book by Geetika, Managerial Economics, Tata

McGraw publication.

• T. R. Jain, Managerial Economics, Vikas Publications

 Topics to be covered in Next Lecture

• Supply
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