module no.5 market morphology

MODULE NO.5

MARKET MORPHOLOGY

Prepared and Presented By

Dr. Abhishek Mukherjee

Ph.D., M.Phil., UGC NET, MBA, BBA

1

Points of Discussion

Market Morphology

• Concept of Market

• Perfect Competition: Features and Price Determination under Short-Run and

Long-Run.

• Monopoly: Features and Price Determination under Short-Run and Long-Run.

Sources of Monopoly and Price Discrimination.

• Monopolistic Competition: Features, Price Determination under Short Run

and Long-Run, Product Differentiation.

• Oligopoly: Kinked Demand Curve, Price Wars, Game Theory and Nash

Equilibrium.

2

What is a Market?

• A market is a system by which buyers and sellers bargain for the price of a

product, settle the price and transact their business – buy and sell a

product.

• Personal contact between buyer and seller is not necessary

• In some cases, e.g. forward sale and purchase, even immediate transfer of

ownership of goods is not necessary.

• Market does not necessarily mean a place.

• What makes a market is a set of buyers and a set of sellers and a

commodity.

• While buyers are willing to buy and sellers are willing to sell, and there is a

price for the commodity.

3

How is the Price of a Commodity Determined in a Market?

• The determination of price of a commodity depends on the number of

sellers and the number of buyers.

• The number of sellers of a product in a market determines the

nature and degree of competition in the market.

• The nature and degree of competition make the Structure of the

Market.

Note: Higher the degree of competition in the market, the lower the

firm’s degree of freedom in pricing decision and control over the

price of its own product.

4

Market Structure

5

Market Structure

Perfect Competition Imperfect Competition

Monopoly

Monopolistic

Oligopoly

TYPES OF MARKET STRUCTURE

6

Market

Structure

No. of Firms & Degree

of

Production

Differentiation

Nature of the

Industry

Where Prevalent

Control

over

Price

Method of

Marketing

1Perfect

Competition

Large no. of firms with

identical products

Financial Markets and

Some Farm Products None

Market Exchange or

Auction

2Imperfect

Competition

(a)Monopolistic

Competition

Many firms with real or

perceived product

differentiation

Manufacturing, tea,

toothpastes, TV sets,

Shoes, Refrigerators,

etc.

Some

Competitive

Advertising,

Quality Rivalry

(b) Oligopoly Little or no product

differentiation

Aluminium, Steel,

Cigarettes, Cars,

Passenger Cars, etc.

Some

Competitive

Advertising,

Quality Rivalry

(c) MonopolyA Single Product without

close substitute

Public Utilities:

Electricity, etc.

Considerable

but usually

regulated

Promotional

Advertising if

supply is large

PERFECT COMPETITION

7

What is Perfect Competition?

“Perfect competition describes a market structure where competition is at its

greatest possible level.”

Characteristics of Perfect Competition:

1. Large number of buyers and sellers.

2. Homogenous product is produced by every firm.

3. Free entry and exit of firms.

4. Zero advertising cost.

5. Consumers have perfect knowledge about the market and are well aware of

any changes in the market. Consumers indulge in rational decision

making.

Characteristics of Perfect Competition

6. All the factors of production, viz. labor, capital, etc., have perfect mobility

in the market and are not hindered by any market factors or market forces.

7. No government intervention.

8. No transportation costs.

9. Each firm earns normal profits and no firms can earn super-normal profits.

10. Every firm is a price taker. It takes the price as decided by the forces of

demand and supply. No firm can influence the price of the product.

Price Determination Under Perfect Competition

• Market price in a perfectly competitive market is determined by the

market forces – market demand and market supply.

• Market demand refers to the demand for the industry as a whole, it is the

sum of the quantity demanded by each individual consumer or user at

different prices.

• Market Supply is the sum of quantity supplied by the individual firms in

the industry.

• The market price is, therefore, determined for the industry and is given for

each individual firm and for each buyer.

• Thus the seller in a perfectly competitive firm is a ‘price taker’ and

not a ‘price maker’.

10

Price Determination Under Perfect Competition

• In a perfectly competitive market, therefore, the main problem for a

profit maximizing firm is not to determine the price of its product but

to adjust its output to the market price so that the profit is maximum.

• Price determination under Perfect Competition is analysed under three

different time period:

(i) Market Period or Very Short Run

(ii) Short Run

(iii) Long Run

Note : Market Period refers to a time period in which quantity supplied is

absolutely fixed or, in other words, supply response to price is nil.

11

Determination of Price under “Perfect Competition” in “Market Period or Very Short Run”

12

Perfect Competition – Price Determination in Market Period

• In Market Period the Supply Curve is perfectly inelastic.

• The Price is determined solely by the demand condition.

• Supply remains an inactive agent.

For E.g.

• Suppose the number of marriage houses in a city in a marriage season is given

at OQ and the supply curve takes the shape of a straight line SQ.

• Suppose also that the demand curve for the marriage houses during a season is

given by D1.

• Demand Curve and Supply Curve intersect at a point M, determining the rent

at MQ = OP1.

• If during the marriage season the demand for marriage increases suddenly

because more parents are celebrating the wedding of their sons and daughters

the demand curve D1 will shift upward to D2.

• The equilibrium point – the point of intersection of demand and supply curves

- shifts from M to P, and rentals rise to PQ = OP2.

• This price becomes the barometric price for all buyers.

13

Perfect Competition - Pricing in Market Period

14

Perfect Competition - Pricing in Market Period

• If its supply decreases suddenly due to draught, floods and sudden

increase in export of a product, the prices of such products shoot up.

• For Example: The price of onion had shot up from Rs. 12 per Kg to Rs. 36

per Kg in 1998 due to export of onion.

• In case of supply determined price, supply curve shifts leftward causing a

rise in price of the short supply goods.

• E.g. Given the demand curve (D) and Supply Curve (S2) the price is

determined at OP1.

• Demand curve remaining the same, the fall in supply makes the supply

curve shift leftward to S1. As a result the price increases from OP1 to OP2.

• Other examples of very short run are daily fish market, stock market, daily

milk market, coffin market during a period of natural calamities, certain

essential medicines during epidemic, etc.

15

Determination of Price under “Perfect Competition” in “Short Run”

16

“Perfect Competition” – “Price Determination in the Short-Run”

• A ‘Short Run’ is a period in which firms can neither change their size nor

quit, nor can new firms enter the industry.

• In the short run, it is possible to increase or decrease the supply by

increasing or decreasing the variable inputs.

• Supply Curve is elastic.

For E.g.

• The figure below shows the price determination for the industry by the

demand curve DD and the supply curve SS, at price OP1 or PQ. This price

is fixed for all the firms in the industry.

• Given the price PQ (=OP1) an individual firm can produce or sell any

quantity at this price. But any quantity will not yield maximum profit.

Given their cost curves, the firms are required to adjust their output to the

price PQ so that they maximize their profit.

17

Pricing under Perfect Competition: Short–Run

18

Perfect Competition – Price Determination in the Short-Run

• The process of firm’s output determination and its equilibrium is shown in the

figure.

• Profit is maximum at the level of output where MR = MC.

• Since price is fixed at PQ, a firm’s AR = PQ.

• If AR is given AR= MR. The firm’s MR is shown by AR = MR line.

• Firm’s upward sloping MC curve intersects MR at point E.

• At point E, MR = MC.

• Point E is therefore, firm’s equilibrium point.

• An ordinate drawn from point E to the horizontal axis determines the profit

maximizing output at OM.

• At this output firm’s MC=MR which satisfies the necessary condition for

maximum profit.

• The total maximum profit is shown by the area P1TNE.

• The total profit may be calculated as Profit = (AR – AC) Q

19

Determination of Price under “Perfect Competition” in “Long Run”

20

Perfect Competition – Price Determination in the Long Run

• In the long run the firms can adjust their size or quit the industry and new

firms can enter the industry.

• If the market price is such that AR > AC, then the firms make economic

profit or super-normal profit. As a result new firms are attracted to

industry causing a rightward shift in the supply curve.

• Similarly if AR < AC, then the firm make losses.

• Therefore marginal firms quit the industry causing a leftward shift in the

supply curve.

• The rightward shift in the supply curve pulls down the price and its

leftward shift pushes it up.

• This continues until price is so determined that AR=AC and firms earn

only normal profit.

21


22


• Let us suppose that the long run demand curve is DD’; the short run supply

is SS1 and price is determined at OP1.

• At this price the firms adjust their output to point M, the equilibrium point

where OP1 = AR’ = MR’ = LMC.

• Firms make an economic profit of MS per unit.

• The Supernormal profit allures other firms into the industry.

• Consequently the industry’s supply curve shifts rightward to SS2 causing a

fall in price to OP2.

• At this price, the firms are in a position to cover only LMC (=NQ2) at

output OQ2 and are making losses because AR<LAC.

• Firms incurring losses cannot survive in the long run. Such firms,

therefore quit the industry.

23


• Price is determined at OP0.

• The existing firms adjust their output to the new market price, at OQ.

• At the output OQ, firms are in a position, to make only normal profit since

at this output, OP0=AR=MR=LMC=LAC (=EQ).

• No firm is in a position to make economic profit, nor does any firm make

losses.

• Therefore there is no tendency of new firms entering the industry or the

existing ones going out.

• At this price and output, individual firms and the industry both are in long

run equilibrium.

24

EXERCISE

Q1. Perfect competition is characterized by:

A. Large number of firms; heterogeneous product; easy entry and exit.

B. Large number of firms; homogeneous product; incomplete

information.

C. Large number of firms; homogeneous product; easy entry and exit.

D. Few firms; homogeneous product; difficult entry and exit.

E. Few firms; differentiated product; easy entry and exit.

25

EXERCISE

Q1. Perfect competition is characterized by:

A. Large number of firms; heterogeneous product; easy entry and exit.

B. Large number of firms; homogeneous product; incomplete

information.

C. Large number of firms; homogeneous product; easy entry and exit.

D. Few firms; homogeneous product; difficult entry and exit.

E. Few firms; differentiated product; easy entry and exit.

Answer: C.

26

EXERCISE

Q2. Firms in perfectly-competitive industries may be characterized

as:

A. Price takers.

B. Price creators.

C. Price makers.

D. Price setters.

E. Price negotiators.

27

EXERCISE

Q2. Firms in perfectly-competitive industries may be characterized

as:

A. Price takers.

B. Price creators.

C. Price makers.

D. Price setters.

E. Price negotiators.

Answer: A.

28

EXERCISE

Q3. A firm operating in a perfectly-competitive industry faces a

demand that is:

A. Vertical.

B. Horizontal.

C. Downward sloping.

D. Upward sloping.

29

EXERCISE

Q3. A firm operating in a perfectly-competitive industry faces a

demand that is:

A. Vertical.

B. Horizontal.

C. Downward sloping.

D. Upward sloping.

Answer: B.

30

EXERCISE

Q4. In the short run, perfectly-competitive firms may earn:

A. Positive economic profit.

B. Positive accounting profit.

C. Normal profit.

D. Negative economic profit.

E. All of the above.

31

EXERCISE

Q4. In the short run, perfectly-competitive firms may earn:

A. Positive economic profit.

B. Positive accounting profit.

C. Normal profit.

D. Negative economic profit.

E. All of the above.

Answer: E.

Note: Economic profit = total revenue - (explicit costs + implicit costs).

Accounting profit = total monetary revenue- total costs.

32

EXERCISE

Q5. To maximize profit, a perfectly-competitive firm should produce

up to the output level where:

A. MR = MC.

B. P = MR.

C. P = MC.

D. P = ATC.

E. A and C are correct.

33

EXERCISE

Q5. To maximize profit, a perfectly-competitive firm should produce

up to the output level where:

A. MR = MC.

B. P = MR.

C. P = MC.

D. P = ATC.

E. A and C are correct.

Answer: E.

34

EXERCISE

Q6. To maximize profit, a perfectly-competitive firm should produce up to

the output level where:

I. The addition to total cost is equal to the selling price of the product.

II. The cost of producing the last unit of output is equal to the selling

price of the product.

III. Marginal profit is zero.

Which of the following is correct?

A. I only.

B. II only.

C. III only.

D. I and II only.

E. I and III are correct.

35

EXERCISE

Q6. To maximize profit, a perfectly-competitive firm should produce up to

the output level where:

I. The addition to total cost is equal to the selling price of the product.

II. The cost of producing the last unit of output is equal to the selling

price of the product.

III. Marginal profit is zero.

Which of the following is correct?

A. I only.

B. II only.

C. III only.

D. I and II only.

E. I and III are correct.

Answer: E.36

EXERCISE

Q7. In the short run, a profit-maximizing perfectly-competitive firm

will definitely earn positive economic profits when:

A. P = MC.

B. MR = MC.

C. P > ATC.

D. P > AVC.

E. A and B are correct.

37

EXERCISE

Q7. In the short run, a profit-maximizing perfectly-competitive firm

will definitely earn positive economic profits when:

A. P = MC.

B. MR = MC.

C. P > ATC.

D. P > AVC.

E. A and B are correct.

Answer: C.

38

EXERCISE

Q8. A profit-maximizing perfectly-competitive firm will break even

when:

A. P = MC.

B. MR = MC.

C. AVC = ATC.

D. P = ATC.

39

EXERCISE

Q8. A profit-maximizing perfectly-competitive firm will break even

when:

A. P = MC.

B. MR = MC.

C. AVC = ATC.

D. P = ATC.

Answer: D.

40

EXERCISE

Q9. A profit-maximizing perfectly-competitive firm will shut down

when:

A. P < 0.

B. P < MC.

C. P < ATC.

D. P < AVC.

41

EXERCISE

Q9. A profit-maximizing perfectly-competitive firm will shut down

when:

A. P < 0.

B. P < MC.

C. P < ATC.

D. P < AVC.

Answer: D.

42

EXERCISE

Q10.If P < MC, then a profit-maximizing perfectly-competitive firm

can increase its economic profit by:

A. Increasing output.

B. Decreasing output.

C. Reducing total fixed cost.

D. Lowering wage rates.

E. B, C, and D are correct.

43

EXERCISE

Q10.If P < MC, then a profit-maximizing perfectly-competitive firm

can increase its economic profit by:

A. Increasing output.

B. Decreasing output.

C. Reducing total fixed cost.

D. Lowering wage rates.

E. B, C, and D are correct.

Answer: B.

44

EXERCISE

Q11. _________ is the market structure that maximises efficiency

and markets have no participants large enough to own the

market power to set the price of a homogeneous product.

(a) Perfect competition

(b) Imperfect competition

(c) Equilibrium

45

EXERCISE

Q11. _________ is the market structure that maximises efficiency

and markets have no participants large enough to own the

market power to set the price of a homogeneous product.

(a) Perfect competition

(b) Imperfect competition

(c) Equilibrium

Answer: (a)Perfect Competition

46

EXERCISE

Q12. Perfect Competition is characterised by a large number of

buyers and sellers with the________ and ability to buy the

product at a certain price.

(a) Willingness

(b) Supply

(c) Demand

(d) Income

47

EXERCISE

Q12. Perfect Competition is characterised by a large number of

buyers and sellers with the________ and ability to buy the

product at a certain price.

(a) Willingness

(b) Supply

(c) Demand

(d) Income

Answer: (a) Willingness

48

EXERCISE

Q13. Homogeneous products are the products that are perfect

______ for each other.

(a) Complements

(b) Competitors

(c) Substitutes

(d) Revenues

49

EXERCISE

Q13. Homogeneous products are the products that are perfect

______ for each other.

(a) Complements

(b) Competitors

(c) Substitutes

(d) Revenues

Answer: (c) Substitutes

50

EXERCISE

Q14. Consumers and producers are assumed to have perfect

______ of price, utility, quality and production methods of

products.

(a) Knowledge

(b) Income

(c) Demand

(d) Competition

51

EXERCISE

Q14. Consumers and producers are assumed to have perfect

______ of price, utility, quality and production methods of

products.

(a) Knowledge

(b) Income

(c) Demand

(d) Competition

Answer: (a) Knowledge

52

EXERCISE

Q15. Demand curve is _______ in perfect market structure.

(a) Perfectly elastic

(b) Perfectly inelastic

(c) Unit elastic

(d) None of the above.

53

EXERCISE

Q5. Demand curve is _______ in perfect market structure.

(a) Perfectly Elastic

(b) Perfectly Inelastic

(c) Unit Elastic

(d) None of the above.

Answer: (a) Perfectly Elastic

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IMPERFCT COMPETITION

55

Imperfect Competition

1. Monopolistic Competition.

2. Oligopoly.

3. Monopoly.

56

What is Monopolistic Competition?

• Monopolistic Competition is defined as a market setting in which a large

number of sellers sell differentiated products.

• Monopolistic Competition is most common now in retail trade, and

service sectors.

• Example: Clothing, fabrics, footwear, paper, sugar, vegetable oils, coffee,

spices, and spun yarn have the characteristics of monopolistic

competition.

57

Characteristic features of Monopolistic Competition

• Large number of sellers.

• Free entry and free exit.

• Perfect factor mobility.

• Complete Dissemination of market information.

• Differentiated Products.

58

Difference Between Perfect Competition and Monopolistic Competition

Perfect Competition

• Products are homogenous.

• Decision making under perfect

competition is independent of

other firms.

• Number of sellers is large. E.g.

Agricultural products, retail

business and share markets

Monopolistic Competition

• Products are differentiated by

brand name, trade mark, design,

colour and shape, packaging, credit

terms, prompt after sales service

etc.

• Firm’s decision and business

behaviour are not absolutely

independent of each other.

• Number of sellers is large but

limited – 50 to 100 or even more.

59

Determination of Price and Output under “Monopolistic Competition” in “Short Run”

60

Price and Output Decisions in the Short-Run -Monopolistic Competition

• Although Monopolistic Competition is characteristically close to Perfect

Competition, but pricing and output decision under this kind of market is

similar to those under monopoly.

• The reason is that firm under monopolistic competition, like a monopolist,

faces a downward sloping curve.

• The kind of demand curve is the result of (a) strong preference of a

section of consumers for the product (b)quasi-monopoly of the seller over

the supply.

• The strong brand preference or brand loyalty of the consumers give the

seller an opportunity to raise the price and yet to retain consumers.

• Since each product is a substitute of the other, the firms can attract the

consumers of other product by lowering their prices.

61

Price-Output Determination under Monopolistic Competition –In Short Run

62

Price and Output Decisions in the Short-Run - Monopolistic Competition

• In the figure, firm’s MR intersect its MC at a point N.

• This point fulfils the necessary condition of profit maximization at output OQ.

• Given the demand curve this output can be sold at price PQ.

• So the price is determined at PQ.

• At this output and price, the firm earns a maximum monopoly or economic

profit PM per unit of output and a total monopoly profit shown by the

rectangle P1PMP2.

• The economic profit , PM per unit exists in the short run because of no

possibility of new firms entering the industry.

• But the rate of profit will not be the same for all the firms under monopolistic

competition because of difference in the elasticity of demand for their product.

• Some firms may earn only a normal profit if their costs are higher than those of

others.

• For the same reason some firms may even make losses in the short run to the

extent of their average fixed cost.

63

Determination of Price and Output under “Monopolistic Competition” in “Long Run”

64

Price and Output Determination in the Long – Run –Monopolistic Competition

65

Price and Output Determination in the Long – Run – Monopolistic Competition

• Let us suppose that at some point in the long run, firm’s revenue curves are

given as AR1 and MR1 and the long run cost curves as LAC and LMC.

• MR1 and LMC intersect at point M determining the equilibrium output at

OQ2 and price P2Q2.

• At price P2Q2 the firm makes a supernormal or economic profit of P2T per

unit of output. This situation is suitable to short run equilibrium.

• In the long run, the supernormal profit brings about two important

changes in a monopolistically competitive market.

• First, the supernormal profit attracts new firms to the industry. As a result,

the existing firms lose a part of their market share to new firms.

Consequently their demand curve shifts downwards to the left until AR is

tangent to LAC.

• This kind of change in the demand curve is shown in the figure by the shift

of AR curve from AR1 to AR2 and MR curve from MR1 to MR2.

66


• Second, the increasing number of firms intensifies the price competition

between the firms.

• Price competition increases because losing firms try to regain or retain

their market share by cutting down the price of their product.

• And new firms in order to penetrate the market set comparatively low

prices of their product.

• The price competition increases the slope of the firm’s demand curve or we

can say it makes the demand curve more elastic.

• Note that AR2 has a greater slope than AR1.

• The MR2 is the MR curve corresponding to AR2.

• The ultimate picture of price and output determination under

monopolistic competition is shown at point P1.

67


• LMC intersects MR2 at point N where the firm’s long-run equilibrium

output is determined at OQ1 and price at P1Q1.

• Note that price at P1Q1 equals the LAC.

• It means that under monopolistic competition, firms make only normal

profit in the long run.

• Once all the firms reach this stage, there is no attraction for the new firms

to enter the industry nor their is any reason for the existing firms to quit

the industry.

• This signifies long – run equilibrium of the industry.

68

OLIGOPOLY

69

What is Oligopoly?

• The term ‘Oligopoly’ has been derived from two Greek words:

• ‘Oligi’ meaning ‘a few’ and Polein meaning ‘sellers’.

• Thus Oligopoly is a market setting in which there are only a few sellers.

• Oligopoly is defined as a market structure in which there are a few sellers

selling a homogenous products or differentiated products.

• When Oligopoly firms sell a homogenous product, it is called pure or

Homogenous Oligopoly. For e.g. Industries producing bread, cement, steel,

petrol, cooking gas, chemicals, aluminium and sugar are industries

characterised by Homogenous Oligopoly.

• Where firms of an oligopoly industry sell differentiated products, it is called

differentiated or Heterogeneous Oligopoly.

70

Characteristic features of Oligopoly

1. Small number of sellers.

2. Interdependence of decision – making.

3. Barriers to entry.

4. Indeterminate price and output.

Note: Important feature of Oligopolistic market is the indeterminateness of

price and output. The characteristic fewness and interdependence of

oligopoly firms makes derivation of the demand curve a difficult

proposition. Therefore, price and output are said to be indeterminate.

71

Kinked Demand Curve Analysis of Price Stability: Sweezy’s Model

• The Kinked Demand Curve model of Oligopoly was developed by Paul M.

Sweezy and Hall and Hitch.

• The kinked demand curve model developed by Paul M Sweezy has features

common to most oligopoly pricing models.

• The Kinked Demand Curve Analysis does not deal with price and output

determination. Rather, it seeks to establish that once price quantity

combination is determined, an oligopoly firm does not find it profitable to

change its price even if there is a considerable change in cost of

production.

• An Oligopoly firm believes that if it reduces the price of its product, rival

firms would follow and neutralize the expected gains from price reduction.

But if it raises its price, rival firms would either maintain their prices or

may even cut their prices down.

• In either cases, the price raising firms stands to lose, at least a part of its

market share.

72


Possible reactions of the rival firms to the price changes made by one of

the Firms

There are three possible ways in which the rival firms may react:

(i) The rival firms follow the price changes, both cut and hike.

(ii) The rival firms do not follow the price changes.

(iii) Rival firms follow the price cuts but not the price hikes.

73

Kinked Demand Curve Analysis

74


• Let us suppose that the market demand curve for a product is given by dd’

curve.

• The initial price is fixed at PQ.

• Now let one of the firms change price.

• If the rival firm reacts in manner i.e. they react with hike for hike and cut

for cut, the price changing firm moves along the demand curve dd’.

• And if the rival firms do not follow the price changes, the price changing

firm will move along the demand curve DD’.

• Note that the firm initiating price change-faces two different demand

curves conforming to two different kinds of reactions (i) and (ii)

• The demand curve dd’ is based on reaction (i) and is less elastic because

changes in demand in response to changes in price are restrained by the

countermoves by the rival firms.

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• Given the two demand curves, dd’ and DD’, let us now introduce reaction

(iii) a more realistic one i.e. the rival firms follow a price-cut but do not

follow the price-hike.

• This asymmetrical behavior of the rival firms, makes only a part of the two

demand curves relevant and produces a ‘Kinked Demand Curve’.

• Thus the two parts of the Demand Curve put together give the relevant

demand curve for the firm as DPd’ which has a kink at point P.

76

MONOPOLY

77

What is Monopoly?

• The term Monopoly signifies an absolute power to produce and sell a

product which has no close substitute.

• A monopoly market is one in which there is only one seller of a product

having no close substitute.

• The cross elasticity of demand for a monopoly product is either zero or

negative.

• A monopolized industry is a single-firm industry.

78

Characteristic features of Monopoly

The following are the features of Monopoly:

• Single Seller

• Restriction to entry.

• No close substitute.

• No competition.

79

Causes of Monopolies

• The survival of monopoly is attributed to the factors which prevent the

entry of other firms into the industry and eliminate the existing ones.

• The barriers to entry are therefore major sources of monopoly power.

• The major sources of barriers to entry are:

(a) Legal Restrictions

(b) Sole control over supply of scarce and key raw materials

(c) Efficiency and economies of scale.

80

Kinds of Monopolies

• Franchise Monopolies: The state may create monopolies in the private

sector also through license or patent, provided they show the potential of

and opportunity for reducing cost of production to the minimum by

enlarging the size and investing in technological innovations. Such

monopolies are known as Franchise Monopolies.

• Raw Material Monopolies: Some firms acquire monopoly power because

of their traditional control over certain scarce and key raw material which

are essential for production of certain other goods. E.g. bauxite, graphite,

diamond etc. Such monopolies are called as Raw Material Monopolies.

• Natural Monopolies: A natural monopoly may emerge out of the

technical conditions of efficiency or may be created by law on efficiency

grounds.

81

Monopoly Pricing and Output Decision: Short-Run

• Pricing and output decision under monopoly are based on revenue and

cost conditions.

• Although cost conditions AC and MC curves in a competitive and

monopoly market are identical, revenue conditions differ.

• Revenue conditions, i.e. AR and MR curves are different under monopoly

because a monopoly firm faces a downward sloping demand curve.

• When a demand curve is sloping downward, Marginal Revenue (MR),

curve lies below the AR curve and the slope of the MR is twice that of AR.

• Firm’s average and marginal revenue curves are shown by the AR and MR

curves respectively and its short-run average and marginal cost curves are

shown by SAC and SMC curves respectively.

• A profit maximizing monopoly firm chooses a price –output combination

at which MR=SMC.

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• Firm’s MR and SMC intersect each other at a point N.

• An ordinate drawn form this point N to X-axis , determines the profit

maximizing output for the firm at OQ.

• At this output, firm’s MR =SMC.

• Given the demand curve AR=D, the output OQ can be sold per time unit at

only one price, i.e. PQ (=OP1).

• Thus determination of output simultaneously determines the price for the

monopoly firm.

• Once price is fixed, the unit and total profit are also simultaneously

determined. Hence the monopoly firm is in a state of equilibrium.

• At output OQ and price PQ, the monopoly firm maximizes its unit and

total profits.

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Monopoly Pricing and Output Decision: Long Run

• The equilibrium of monopoly price and output determination in the long

run is shown in the figure.

• The AR and MR curves show the market demand and marginal revenue

conditions faced by a monopoly firm.

• The LAC and LMC show the long run cost conditions.

• Monopoly’s LMC and MR intersect at a point P where output is OQ2.

• This is the Profit Maximizing output.

• Given the AR curve, the price at which the total output OQ2 can be sold is

P2Q2.

• Thus in the long run the output will be OQ2 and price P2Q2.

• This output price combination maximizes the monopolist’s long-run

profit.

• The total monopoly profit is shown by area LMSP2.

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Monopoly Pricing and Output Decision: Long-Run

Monopoly Pricing and Output Decision: Long Run

• Compared to short run equilibrium, the monopolist produces a larger

output and charges a lower price and makes a larger monopoly profit in

the long run.

• In short run, the firm’s equilibrium is at output OQ1 which is less than

long –run output OQ2.

• But short-run equilibrium price P1Q1 is greater than the long run

equilibrium price P2Q2.

• The total short run monopoly profit is shown by the area JKTP1 which is

much smaller than the long-run profit area, LMSP2.

• This however is not necessary, it all depends on the cost and revenue

conditions in the short and long runs.

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THANK YOU

HAVE A GREAT DAY AHEAD!!!

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module no.5 market morphology

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