Download Long Run-Equilibrium of Firm and Industry

Chapter Six: Theory of Product Pricing
Perfect Competition
Introduction
Perfect competition is one of the forms of market economy or free economy. It is such a market mechanism in
which large number of buyers and sellers get involve to exchange homogenous products (products having close
substitutes). In the words of Case and Fair, “an industry structure in which there are many firms, each small
relative to the industry, producing virtually identical products and in which no firm is large enough to have any
control over prices is called perfect competition.”
Perfect competition functions under the interaction of aggregate demand and supply of goods and services in the
market. The market price of goods and services, in it is determined by the industry (producers) as a whole. It
remains almost fixed unless it is changed by the industry. It cannot be changed by individual buyers and sellers.
Therefore, buyers and sellers in this market are supposed as price takers and producers as the price makers.
Differences between Perfect Competition and Pure Competition
The distinction between perfect and pure competition lies on their degrees of characteristics.
Perfect competition possesses the features like largest number of buyers and sellers, homogenous product, perfect
mobility of factors of production, free entry and exit of firms, no government interference, absence of collusion
and independent and perfect knowledge about price and quantity and market of the product
From the above features, if two of the features perfect mobility of factors of production and perfect
knowledge of price and quality of product are excluded, the market will turn to the pure competition. The pure
competition is such a market where one can not feel the sense of monopoly at all.
Characteristics
There are several distinct characteristics or features of perfect competition, which are briefly described below:
1. Large Number of Buyers and Sellers: This market consists of large number of buyers and sellers to
exchange homogenous goods and services. It provides platform to producers of agricultural goods, industrial
goods, services of various kinds and consumers of those products. The price of goods and services in this
market remains fixed. Small number of buyers and sellers cannot change the price structure of a commodity.
Price of goods and services is determined by the intersection of demand for and supply of the commodity
offered by the seller and purchased by the consumers.
2. Homogenous Product: The perfect competition among close substitute or homogenous product is most
important feature of this market. Consumers of this market do not concern about the producers of a
commodity but they strictly observe to the price, quality and quantity of the products. The price and quality of
homogenous products remains almost similar in this market.
3. Free Entry and Exit: All producers, sellers and buyers of this market can experience total freedom regarding
demand and supply of goods and services. Producers can enter into the new industry if there is good profit in
the business or can leave the industry if they face losses in their business. Generally, firms or producers of
perfectly competitive market earn only normal profit (profit which is just sufficient to run the business) in
long- run. Similarly consumers of this market can demand any kind of goods and services according to their
ability to pay, willingness to pay and habit of consumption.
4. Perfect Knowledge: Most of the goods and services under perfect competition are advertised in the market
through electronic Medias, newspapers, hoarding boards and so on. As a result, every consumer gets
complete information about price, quality and quantity of the products supplied in the market. Therefore,
neither sellers can cheat buyers nor buyers would be ready to pay more amount of money for a particular
commodity. A single price of a commodity rules in the entire market.
5. Free Mobility of Factors of Production: The factors of production like labour and organization can play
active role in this market. They can join into a new industry if there is high amount of profit or can leave the
industry if there are losses. They can be mobile everywhere according to their conveniences or opportunity
cost.
6. No Government Interference.
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A Government does not interfere to any activities of the market. Neither has it control over price nor to the
output. It simply stands as a guardian of overall market system. The government does not impose
discriminating taxes or subsidies, no licensing system to join in the market, no allocations of inputs to the firms
and industries of this market. The government practices a free enterprise policy in this system.
7. Absence of collusion and independent decision making by firms
Firms and industries of this market do not form a group to change price and hold the market with some
objectives. On the other hand, buyers of this market also do not form any kind of collusion to influence price
and output. Buyers and sellers take their decisions independently and act freely.
Price and Output Determination under Perfect Competition
There are two approaches to determine price and output in the perfect competition. They are discussed below.
Total Revenue-Total Cost (TR-TC) approach:
In this approach, total revenue and total cost are under consideration. Since, the objective of the firm is profit
maximization, let us find the profit function. Profit is the difference between total revenue (TR) and total cost
(TC). i.e. Profit (Π)=Total Revenue (TR)- Total Cost (TC) …………………. (1)
When, TR>TC  Π>0, i.e. excess profit, When, TR< TC  Π<0, i.e. loss, and
When, TR=TC  Π=0, i.e Normal profit.
The profit is maximized at the output where there is the biggest gap or highest difference between TR and TC. It
is shown in figure below:
Diagrammatic Representation
Y
TC
Loss
TR
C, R
B
O
Loss
A
Q1
Q2
Q3
Quantity
X
-curve
Fig : TR-TC Approach.
In this figure, TR curve under perfect competition is a straight line, positively sloped and passes through origin. It
is because of the price being constant. TC curve is inverse S-shaped comprising total variable cost and total fixed
cost as discussed in the theory of cost. TR curve intersects TC curve at points A and B. At point A output is Q 1
and at point B output is Q3. In the figure, before the output level Q1 and after output level Q3, there is loss because
TR curve lies below the TC curve (i.e. TR<TC). The output between Q1 and Q3 , there is TR> TC which shows
there is profit. The biggest gap between TR and TC is at output level Q 2 where, profit is maximum. Thus, the
output at this position gives the equilibrium output of the firm.
In the below portion of the figure, profit curve (i.e. Π-curve) is drawn measuring the gap between TR and TC
curves. Before the output Q1 and after the output Q3 the Π-curve lies below X-axis. It shows there is loss to the
firm. Between outputs from Q1 to Q2 the Π-curve rises, showing that there is profit which increases as increase in
output. In the similar fashion, the Π-curve starts to fall from the outputs between Q2 and Q3. The maximum profit
is at the output Q2.
By this method only the equilibrium output of a firm can be determined. Price is already considered as constant
and determined in the industry.
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(B) Marginal Revenue-Marginal Cost Approach
The MR-MC approach is based on revenue and cost curves to determine industry price and output. It
shows an ideal point of equilibrium to fix the equilibrium price and output of an industry.
An industry consists of many firms under it. Equilibrium of each and every firm is determined by the price
and output fixed by the industry as whole. An individual firm can't influence price structure of an industry
which is given. There should not arise any tendency to increase or decrease output without permission of
industry. The existing firms under perfect competition should produce and supply their products at the
point where marginal cost and average cost become equal. Each and every firm and even the industry
under perfect competition earn just normal profit in long-run.
An industry and its firms may be in equilibrium if they fulfill the following three conditions.
Condition-I: Marginal Revenue (MR) is equal to Marginal Cost (MC) or (MR = MC) at the equilibrium point,
As we know that,
First order condition is:
 =TR-TC ……………… (1)
The objective of the firm is profit maximization, thus
d  /dQ= d(TR)/dQ –d(TC)/dQ=0 or, MR-MC=0 or, MR=MC
Second order condition is:
Condition-II: Marginal Cost (MC) curve must cut Marginal Revenue (MR) from below at the equilibrium point.
d2  /dQ2= d(MR)/dQ –d(MC)/dQ<0 or, slope of MR<slope of MC i.e. MC cuts MR from below
In summary,
First order condition or necessary condition: MC= MR
Second order condition or sufficient condition
Slope of MC curve >Slope of MR curve i.e. MC curve cuts MR curve from below.
Condition-III: Each and every firm should have earned only normal profit under the industry. It takes place at
that point where Price or Average Revenue (AR) is equal to Average Cost (AC) at the equilibrium
point.
The following diagram shows equilibrium under MR-MC approach in perfect competition.
Diagrammatic Representation
Y
Y
D
Price
D1
S1
O
Q
Output of an industry
Fig a: Equilibrium of Industry
Revenue and cost
E
P
MC
S
P
AC
E
AR / MR
Q
X O
X
Output of a firm
Fig b: Equilibrium of Firm
The given diagram is related to the price and output determination of firm and industry under ‘MR – MC’
approach in perfect competition. Price and output are measured along Y-axis and X– axis respectively.
The industry equilibrium point is represented by point ‘E’ in figure-a, where market demand is equal to market
supply. Moreover, the industry is earning only normal profit at ‘OP’ price and ‘OQ’ output.
In figure-b, a firm is supposed to be in equilibrium at point E where marginal cost is equal to marginal revenue;
marginal cost curve has cut marginal revenue curve as well as AC curve from below at this point. The demand
curve is horizontal straight line or perfectly elastic to output because of constant price level. Therefore, ‘OP’ and
‘OQ’ represent the firm equilibrium price and output respectively.
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SHORT RUN-E QUILIBRIUM OF FIRM AND INDUSTRY
Short-run is a period of time in which a firm can change output by changing variable factors of production such as
raw materials, labor, energy etc. The firm can not change fixed factors of production such as land, building,
vehicles, and machineries due to shortage of time. New firms can not enter into the industry because they can not
manage production in short period. Likewise, the existing firms do not leave the industry unless and until they
continue earning abnormal profit in the industry.
Firms under perfect competition produce their product at the price fixed by the industry. As a result, the demand
curve or average revenue curve of the firm becomes horizontal straight line or perfectly elastic to output axis. The
marginal curve also coincides with the average revenue curve.
Firms and industry in short run, under perfect competition, will be in equilibrium if they fulfill following
conditions.
Condition 1: Marginal Revenue (MR) is equal to Marginal Cost (MC) or (MR = MC) at the equilibrium point,
Condition 2: Marginal Cost (MC) curve must cut Marginal Revenue (MR) from below at the equilibrium point.
Condition 3: Each and every firm and industry should have earned abnormal profit under the industry. It takes
place at that point where industry Price or Average Revenue (AR) is greater than Average Cost (AC)
at the equilibrium point.
The following diagram shows the short run equilibrium of firm and industry in prefect competition.

Diagrammatic Representation
MC
Y
Y
D
S1
A
E
Price
P
O
AC
B
S
MC
Y
Y
AC
MC
E1
AR/MR
Loss
P
E2
AC
AR/MR
C
A
B
D1
Q
Output of an industry
Fig. 7.4
X
O
Q1
Output of Firm -1
Fig. 7.4 (a)
X
O
Q2
Output of Firm -2
Fig. 7.4 (b)
X
E3
O
Profit
C
Q3
Output of Firm -3
X
Fig. 7.4 (c)

The industry equilibrium point is represented by point ‘E’ in figure-7.4 where market demand curve DD1
is equal to market supply curve SS1. An industry could have losses or normal profit or supernormal profit at ‘OP’
price and ‘OQ’ output depending upon the situation of the market.
There are figures of three firms of different conditions in an industry. In figure-7.4 (a), firm-1 is supposed
to be in equilibrium at point E1 where marginal cost is equal to marginal revenue; marginal cost curve has cut
marginal revenue curve. The minimum point of AC curve is above the AR/Price/demand curve. It implies losses
to the firm equal to the region ABCE1 at OB price and OQ1 output.
Similarly in figure-7.4 (b), firm-2 is in equilibrium at point E2 where MR = MC, Mc curve has cut MR
curve from below and Price (AR) is just equal to AC. It implies that the firm is able to earn only normal profit at
OB price and OQ2 output.
Likewise, in figure 7.4 (c), firm–3 is in equilibrium at point E3 where MR = MC, Price (AR) is greater
than AC which implies that the firm is able to earn supernormal profit equal to the region ABCE 3 at OA price and
OQ3 output.
The total profit of the firm-3 is calculated as follows:
Total Profit = Total Revenue – Total Cost
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= (P × Q) – (AC × Q) = (AO × OQ) – (BO × OQ) = AOQE3 – BOQC = ABCE3
The shaded region ‘ABCE3’ indicates the supernormal profit of the firm in short–run under perfect competition.
Similarly, the firm may earn normal profit only or it may incur loss in the short run. The profit and loss of a firm
depends upon the price and average cost of the firm.
1.
If price is equal to AC, then the firm earns only normal profit.
2.
If price is less than AC, the firm incurs loss in the short run. And
3.
If price is greater than AC, the firm earns abnormal profit.
Thus, it is a short run equilibrium in which existing firms in the industry may be in the situation of profit or loss.
In the long run, the firms incurring loss and unable to readjust their plant size will close down, and the firms
earning abnormal profits will expand their capacity. In this way, entry, exit and readjustment of the existing firms
in the industry will lead to the long run equilibrium of the industry and firms.
LONG RUN-E QUILIBRIUM OF FIRM AND INDUSTRY
Long-run is a period of time in which a firm can change its level of output by making change in every factors of
production such as land, building, machines, raw materials, labor, energy etc. the producer may have plenty of
time to make adjustment of all factors of production in long run. New firms may enter into the industry if there is
possibility of profit and even old forms can leave the industry if they face losses.
The firms under perfect competition produce and supply their product at the price fixed by the industry. As a
result, the demand curve or average revenue curve of the firm becomes horizontal straight line or perfectly elastic
to output axis. The marginal curve also coincides with the average revenue curve.
Firms and industry in long run, under perfect competition, will be in equilibrium if they fulfill following
conditions.
Condition 1: Long run Marginal Revenue (LMR) is equal to Long run Marginal Cost (LMC) or (LMR = LMC)
at the equilibrium point,
Condition 2: Long run Marginal Cost (LMC) curve must cut Long run Marginal Revenue (LMR) from below at
the equilibrium point.
Condition 3: Each and every firm and industry should have earned abnormal profit under the industry. It takes
place at that point where industry Price or Average Revenue (AR) is greater than Long run Average
Cost (LAC) at the equilibrium point.
The following diagram shows the short run equilibrium of firm and industry in prefect competition.
Diagrammatic Representation
Y
Y
D
Revenue and
cost
E
Price
P
S1
O
LMC
S
Q
Output of an industry
Fig a: Long run Equilibrium of Industry
D1
X O
P
LAC
E
AR / MR
Q
X
Output of a firm
Fig: b Long run Equilibrium of Firm
The figure (a) and (b) show the equilibrium of industry and firm respectively under perfect competition. In Figure
(b) the firm is in equilibrium at point ‘D’ where long - run marginal cost curve has cut long - run marginal
revenue curve from below and the marginal cost is equal to the marginal revenue at this point. The minimum
point of long – run average cost (LAC) curve is below the long – run marginal cost curve (LMC) at equilibrium
output. The equilibrium price and output of a firm is represented by ‘OP’ and ‘OQ’ respectively.
The shaded region ‘ABCD’ indicates the abnormal profit of the firm in short–run under perfect competition.
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Figure (a) shows long - run equilibrium of an industry under perfect competition. The equilibrium point is
represented by point ‘E’ where demand curve ‘DD1’ and supply curve ‘SS1’ are intersected. The equilibrium price
and output so determined is ‘OP’ and ‘OQ’ respectively. The industry can earn simply the normal profit at ‘OP’
price and OQ output.
MONOPOLY
Meaning
Monopoly is such a market mechanism in which a single producer or seller controls the whole supply of a
commodity that has no close substitute. According to A. Koutsoyiannis, “Monopoly is a market structure in which
there is a single seller, there are no close substitutes for the commodity it produces and there are barriers to
entry”.
Characteristics
1. Single Seller: The most important characteristics of monopoly, is that there should be only one seller for a
single commodity in the entire market. The monopolist owns sole control both on quantity supply and price
of its product. Monopoly right can be observed in the form of individual firm as well as in joint - stock
company.
2. Absence of Close Substitutes: Existence of close substitute goods is strictly prohibited in this market. If the
substitute goods are supplied, there would be competition among them and the monopoly power on a particular
commodity would disappear.
3. Barriers to Entry: A monopoly producer does not permit any new firms to enter and produce any close
substitute goods in the market. The existing producer own sole control on price and quantity supply. It is
because; the monopolist earns abnormal profit both in short run and long run which it does not want to share
at any cost.
4. Profit Maximising objective of firm: A monopolist seeks to make the highest possible profit. Profit maximization
is the only objective of the monopoly firm. There is no any competitive firm and no close substitute product in the
monopoly market. Hence the monopoly firm can earn maximum profits.
Reasons for Monopoly
There are many reasons of monopoly. The following three are seem to be particularly important in the views of
Edwin Mansfield:
1. Input Control: A single firm may control the entire supply of a basic input that is required to manufacture a
given product.
2. Patient Right: A firm may acquire a monopoly over the production of a good by having patent right on the
product or on certain basic processes that are used in its production.
3. Market Franchise: A firm may become a monopolist on account of market franchise provided by a government.
Such firm gets exclusive privilege to produce a given good or service in a particular area from government.
SHORT-RUN EQUILIBRIUM OF MONOPOLY
The Short-run equilibrium of monopoly producer for a commodity can be analyzed by two approaches:
Case - I: Total Revenue –Total Cost Approach
Total revenue of a monopoly producer is the sum of income obtained from the product of price per unit and total
quantity supplied into the market. Similarly total cost of production is the sum of cost of fixed and variable
factors of production. Since a monopolist aims to minimize total cost and maximize total revenue greater than
total cost to earn profit. It is because profit is the difference between TR and TC. A monopolist produces its
product at that level of output where the difference between TR and TC becomes the maximum. The graphical
presentation of TR-TC approach has been presented below.
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Diagrammatic Representation
TC
Y
Loss
C, R
B
TR
Loss
A
O
Q2 Q3
Quantity -curve
Q1
X
Fig: TR-TC Approach.
The given diagram is about short-run equilibrium of monopoly under TR-TC approach. TR and TC is expressed
on y-axis and output on X-axis. The total Revenue and Total Cost curves are denoted by TR and TC respectively.
Before the OQ1 level of output, the TC curve is above TR curve which shows losses to the monopoly producer.
At the OQ1 level of output at point A. TR is equal to TC which implies neither profit nor loss (Break Even Point)
of the monopoly producer. Any unit output beyond OQ1 results greater value of TR than TC, which shows
increasing profit margin. The gap between TR and TC curve is maximum at OQ2 level of output which is fixed by
drawing tangent ab on TR at point P and cd on TC at point M. Any increase in production beyond OQ2 level
contracts the gap between TR and TC. Finally, they intersect at point B indicating OQ3 level of output. The point
B also indicates neither profit nor loss (Break Even Point) to the monopoly producer. Therefore, the best level of
output is OQ2 where the difference between TR and TC is maximum by amount PM. A monopoly can maximize
revenue and minimize cost at this level of output.
Case II: Marginal Revenue-Marginal Cost approach:
The process of price and output detraction under monopoly is guided by its objectives. A monopolist can have sole
control over the price and quantity supply of its product. A monopolist is normally guided by sales maximizing and
profit maximizing objectives. A monopolist under sales maximizing policy aims to supply larg e quantity of its output
at falling price. On the other side, under profit maximizing policy, it plans to supply less quantity of its product at
higher price. A monopoly price and output is determined at that point where the following conditions are fulfilled:
Condition 1: The Marginal Cost (MC) must be equal to Marginal Revenue (MR) at the equilibrium point.
Condition 2: The MC curve must cut MR curve from below at the equilibrium point.
Condition 3: The MC curve must cut Average Cost curve (AC) from below at its minimum point beyond the
equilibrium point.
The process of price and output determination under monopoly is shown in the following diagram.
Diagrammatic Representation
Y
MC
Cost and Revenue
AC
D
A
Profit
B
C
AR
E
O
X
Q
MR
Output
Fig : Price and Output Determination under Monopoly
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The above diagram shows price and output determination under monopoly. The monopoly equilibrium is
represented by point ‘E’, where marginal cost curve has cut marginal revenue curve from below and marginal
cost is equal to marginal revenue. The equilibrium price and output is OA and ‘OQ’ respectively. The difference
between ‘DQ’ and ‘CQ’, i.e. (DC = AB) is the profit per unit output. Then, the total profit of the monopolist is
calculated as follows:
Total profit = Profit per unit × Total Quantity Supplied
= AB × OQ = AB × BC= ABCD
The shaded region ‘ABCD is the abnormal profit earned by a monopolist at ‘OA’ price and ‘OQ’ output.
LONG-RUN EQUILIBRIUM OF MONOPOLY
Long run is a period of time during which a firm can change all factors of production. In the long run, a
monopolist may have time to expand its plant or to use its plant at any level. Under monopoly, there are barriers
to entry of new firms even in the long run.
In the short run, a monopoly firm may earn normal profit or abnormal profit or may incur loss also. But, in
the long run, a monopolist will not operate if it makes losses. It generally earns abnormal profit or supernormal
profit because of the barriers to entry of new firms in the market. In the long run, a monopoly firm is in
equilibrium if the following conditions are fulfilled:
1.
Marginal Revenue is equal to Long run Marginal Cost at equilibrium point,
2.
LMC cuts minimum point of MR curve from below at equilibrium point
3.
Price/AR must be greater than LAC (P > LAC) to ensure supernormal profit.
Diagrammatic Representation
Y
LMC
Cost and Revenue
SMC
O
A
D
LAC
SAC
Profit
B
C
AR
E
Q
X
MR
Output of a Monopoly Firm

In the above figure, a monopoly firm is in equilibrium at point 'E' where MR=LMC, LMC cuts LMR from
below and DQ (Price=AR) is greater than LAC (CQ). The monopoly firm produces OQ output at AO price and
gains abnormal profit which is denoted by the shaded region ABCD.
PRICE DISCRIMINATION UNDER MONOPOLY
Price discrimination is such a business policy of a monopolist in which different prices of same kind of product
are charged to the consumers of separate market. It is also known as selective pricing or pricing by market
segmentation.
Price discrimination in the words of John Robinson is “The art of selling the same commodity produced by a
single firm to different buyers at different prices at a same time.” The quality and quantity of the product should
be almost similar in each market. However there may be change in brand name, packing style binding style
changing color and publicity.
Assumption:
1. There should be monopoly or imperfect competition in the market for a particular product.
2. There should be at least two separated market in which consumer can not contact each other
3. The monopolist should have absolute control over the supply at the product.
4. The elasticity of demand should be different in two markets.
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Forms of Price Discrimination
1. Personal Discrimination:
If a monopolist charges different prices to the same goods or services to the buyers according to the economic
status of the buyer it is called personal price discrimination. For example, doctor’s fee to rich and poor
patients, tuition fees charged by teachers to the students etc.
2. Age Discrimination:
If a monopolist charges different prices to the same good or service to the buyers according to the age status
of the buyer, it is called age discrimination for e.g. a barber may charges less amount of service charge to the
children than to the adult one.
3. Gender Discrimination:
If a monopolist charges different prices to the buyers according to the gender (male of female) it is called
gender discrimination. For example, discount facility to women by travel agencies, hospitals etc.
4. Location Discrimination
5. Comforts Discrimination
6. Use Discrimination
The fundamental conditions are necessary to discriminate price of a product. First, price discrimination can occur
only if it is not possible to transfer any unit of the product from one market to another. Second essential condition for
price discrimination to occur is that it should not be possible for the buyers in the dearer market to transfer
themselves into the cheaper market to buy the product. Third condition is, there should be different price elasticity of
demand for the product in different markets. Therefore, the act of price discrimination will not be possible unless the
following three conditions are fulfilled.
i. Existence of monopoly power:
For price discrimination, the firm should have a monopoly in the market. It
means the firm must be able to set its price and to regulate its output. The firm can not discriminate the price in
the perfectly competitive market.
ii. Difficulty in Re-Selling: The product sold in one market should not be re-sold in another market for the price
discrimination. It is one of the necessary conditions for price discrimination. If re-sale is possible then price
discrimination does not work.
iii. Possibility of Market Segmentation: Market segmentation is necessary for price discrimination. The firm
should be able to segment the market into different sub-markets. The firm has to divide the market into two or
more than two submarkets on the basis of the elasticity of demand.
iv. Different Price Elasticity of Demand in Different Market: If the price elasticity’s are different in different
markets, then the firm will charges higher price in the market where demand is inelastic and lower price where
demand is elastic.
Degrees of Price Discrimination
A.C. Pigou classified degree of price discrimination in to three types. They are briefly discussed below:
1. First Degree Price Discrimination:
It is such a pricing strategy of a monopolist that takes away the consumer’s surplus totally. It is possible if a seller
knows the price that buyer is prepared to pay for his product. The monopolist sets highest possible price for a
commodity to grab the consumer’s surplus. He plans to exhaust total consumers surplus and reduces price
gradually to the subsequent unit of quantity supply keeping the fact that consumer demands more units only when
the price falls. This way of charging different price for same commodity is called first degree price
discrimination. This sort of pricing policy is practiced by doctors, lawyers, tuition teachers in their service
charges.
In short, if a monopolist sells various units of same commodity at various prices to the different buyers, it is said
to be first degree price description. It is also known as Perfect Price Discrimination.
Features:
a) A monopolist collects information about the consumer’s willingness to pay for his product.
b) He /she charges such a prices which will make consumer’s surplus Zero on the commodity.
c) The monopolist negotiates each consumer separately.
d) This scheme leads a consumer to the position of either “take it or leave it”
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Diagrammatic Representation
In the given diagram when a consumers demands 1st unit of a commodity he charges Rs. 9 per unit because the
monopolist knows that the consumer is ready to pay Rs. 9. Taking this advantage, he does not leave any amount
of consumer’s surplus. In the same way, as the consumer demands more unit of same commodity, the consumers
surplus declines consequently because he will be prepare to pay fewer amounts for additional units. As a result,
the monopolist charges less and less prices to every successive units of his sale.
Second Degree Price Discrimination
The strategy of a monopolist to supply a commodity at different price to different group of consumers is known as
second degree price discrimination. It is often known as ‘Bloc Pricing System’. A monopolist seeks to exhaust
major part of the consumer’s surplus rather than the entire amount of it. This strategy will be possible only if;
a) There is large number of consumer and they are independent to each other.
b) Demand curves of all consumers are identical.
c) A single rate is applicable for a large number of buyers.
Under the second degree price discrimination, a monopoly producer divides the consumers into many groups.
Then he supplies his products at different price according to the quantity demand /consumption by the consumers.
Table of Second Degree Price Discrimination
Options
Quantity supplied
Price ( Rs/unit)
MR
TR
I
15
30
450 (15×30)
450
II
15(+10) = 25
30(-5) = 25
250 (10×25)
700
III
25(+5) = 30
25(-5) = 20
100 (5×20)
800
IV
30(+2) = 32
20(-2) = 18
36 (2×18)
836
Here in the table,
Option-I Shows MR= Rs.450 from the sale of 15 units at RS 30 per unit of a commodity.
Option-II Shows MR= Rs.250 from the scale of 10 unit addition quantity at Rs 25 per unit.
Option-III Shows MR=100 from the scale of 5 unit additional quantity at Rs 20/ unit.
Option-IV Shows MR= 36 from the scale of 2 unit additional quantity at Rs. 18/ units.
It shows that a monopolist aims to maximize total revenue by selling different units at different price of a
commodity.
Diagrammatic Representation
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Here in the figure, prices and quantity supplied are expressed in Y and X axes respectively. It is related to Second
Degree Price Discrimination where demand curve DD1is downward slopping demand curve of a consumer. The
figure reveals that when a monopoly producer sells his 15 units at Rs. 30 the MR = Rs.450. As he sells 10
additional units at Rs. 25 the MR = Rs.250. Similarly as he sells 5 more units at Rs. 20, the MR = Rs.100. Finally
supply of 2 more units will give MR = Rs. 36. The monopolist will have maximum revenue from this way of
selling its products in different market.
Third Degree Price Discrimination
Third degree price discrimination by a monopolist is guided by the objective of profit maximization. It requires
two different (Independent in any respect) markets with different prices and different elasticity of two demand
curves. Sometime it may be practiced even more than two independent markets.
A monopolist allocates total output in two different markets in such a proportion that the total profit will be
maximum. The monopoly profit will be maximum in each market only if it supplies its output at the point where
MR=MC. The process of fixing price and output for two different markets is shown in the following diagram.
Let there are two monopoly market A and B and their respective MR and AR are MR A and ARA for market A and
MRB and ARB for market B. Similarly demand curves for market A and B are DA and DB respectively which
also represent price line as well as AR of the monopolist.
Diagrammatic Representation
Y
Y
Y
Sub Market A
P1
PA
PB
P1
P2
Price, Cost & Revenue
A
Price, Cost & Revenue
Price, Cost & Revenue
P1
P2
Determination of price
and output
Sub Market B
PB
A
P2
MC
AC
DF = ARF
EA
MC
EB
MC
MC
E
DB = ARB
DA = ARA
MRF
O
QA
X O
MRA
X
QB
O
QF
Quantity
MRB
Quantity
Quantity
Fig. 1: Market Awith less elastic demand
Fig. 2: Market Bwith more elastic demand
Fig. 3: Equilibriumof firm
X
Fig;- Third Degree Price Discrimination
In fig (1), there is less elastic demand curve which is, more steeped and represented by ARA for market A. In fig
(2), there is more elastic demand curve which is less steeped represented by AR B for market B in comparison to
ARA. ARA start from P1 but ARB starts from P2. Between the price P1 and P2 there is certain amount of demand in
market A but there is no demand in market B. The corresponding marginal revenue curves MRA and MRB are also
drawn as per the relationship between AR and MR curves. In fig (3), combination of both markets is shown. In
this figure, the aggregate demand curve is drawn by the horizontal summation of the demand curves in market A
and market B (i.e. DA+DB=DF).The portion P1A of the demand curve only represents the market demand curve in
market A because there is no demand in market B between price P1 and P2. The quantity demanded below the
price P2 includes the quantity demanded in market A and B. Thus, it is kinked at point A and the demand curve
becomes flatter than both markets i.e. it is outward twisted from point A represented by DF=ARF. The
corresponding MRF is also the horizontal summation of MRA and MRB and it is bended below price P2.
MONOPOLISTIC COMPETITION
Introduction:
Monopolistic competition is such a market structure which lies in between monopoly and perfect competition. It
deserves some features of monopoly and some of perfect competition.
Definition:
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Monopolistic competition refers to a market structure in which a large number of sellers sell differentiated
products which are close substitutes to each another. Some products of monopolistic market are: Washing soap:
Puja, OK, Gorkha, Diyo etc. Shampo: Dabur Vatika, Head and Shoulder, clinic plus etc. Motorcycle: Hero
Honda, Discoveri, Yamaha, pulsar etc. Noodles: Wai- Wai, Mayos, Rum Pum etc.
Causes of Monopolistic Competition
Case –I: Monopolistic market enjoys monopoly power in a sense that each form deserves absolute right to
produce and sell a branded or patented product. No other firms can use a brand name of a firm by law it is
restricted. For example: brand name of Hulas can not be used by other firm to produce a commodity.
Case-II: Monopolistic competition is also associated with many features of perfect competition. The competition
among firms takes place in regard of capturing the largest possible market share. It is practiced through
advertisement of their product through different means of communications.
Characteristics of Monopolistic Competition:
The characteristics of monopolistic market are the blend of characteristics of monopoly and perfect competition.
Some common characteristics are as follows:
1) Product Differentiation:
Product differentiation means production and marketing of close substitute goods by each firm making
differences in respect of their shape, size, colors, design, minor qualitative differences, packaging, after-saleservice, guarantee and warrantee, etc. The objective impresses the consumers that a product is different from
other available in the market.
2) Large Number of Sellers:
The number of sellers for differentiated product in this market would be less than perfect competition and more
than oligopolistic competition. The number of firms in on economy is found to be 10-20 and in some cases more
than 20, depending upon the size of market. Unlike role of firms under perfect competition, the firms of
monopolistic price of their product. They can make necessary adjustment to the price as per market competition.
1) Free Entry and Free Exit:As like the feature of perfect competition, there is freedom of entry and exit in monopolistic market too. New
firms may enter in expectation of earning profit and old one may quit the industry when there are losses. Entry of
new firms reduces the share of market to the firms and exit of firms provides larger market run as per their
competition capacity with rival firms, in regard of price, quality, technology, etc.
2)
Selling Costs :
Firms of monopolistic competition have to allocate large amount of budget for its expenditure on advertisement
and other sales promotion schemes for their products. The selling costs include all sorts of expenses on
advertisement sales promotion schemes, salaries of sales promotion personal. Generally firms of this market have
to spend more cost on sales rather than cost of production of their product.
Short-run Equilibrium of Monopolistic Competition Firm
The short-run equilibrium of firm under monopolistic competition is nearly similar to that of monopoly firm. The
demand curve of individual firm may be different from other due to product differentiation. However a normal
demand curve of the 'group' would be more elastic than that of monopoly firm. The equilibrium condition requires
the combination of short-run marginal cost, average cost, marginal revenue etc. The associated firms of this
market are supposed to be in equilibrium, if they fulfill the following conditions:
Condition:-I: Marginal Revenue (MR) must be equal to marginal cost (MC) at the equilibrium point.
Condition-II: Price or AR must be greater than average cost (P > AC) so that the group may earn abnormal or
super normal profit.
Condition-III: Marginal cost curve must cut minimum point of average cost curve beyond the equilibrium point.
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Y
Diagrammatic Representation
Cost and Revenue
MC
D
A
AC
Profit
B
C
AR
E
O
X
Q
MR
Output
Fig : Price and Output Determination under Monopoly
Fig: Short-run equilibrium of firms (under Monopolistic Competition)
The above diagram shows price and output determination under monopolistic competition in short run. A firm’s
equilibrium is represented by point ‘E’, where marginal cost curve has cut marginal revenue curve from below
and marginal cost is equal to marginal revenue. The equilibrium price and output is OA and ‘OQ’ respectively.
The difference between ‘DQ’ and ‘CQ’, i.e. (DC = AB) is the profit per unit output. Then, the total profit of the
monopolist is calculated as follows:
Total Profit = Total Revenue – Total Cost
= (P x Q) – (AC x Q) = (AO x OQ) – (BO x OQ) = AOQD – BOQC = ABCD
The shaded region ‘ABCD is the abnormal profit earned by a monopolist at ‘OA’ price and ‘OQ’ output.
Long-Run equilibrium of Monopolistic Competition Firm
Long run equilibrium of firm under monopolistic competition is different from short run under the following
conditions:
1. New firms may enter into the industry
2. Firms may involve in price competition.
3. Firms advertize their products more vigorously.
A firm under monopolistic competition is supposed to be in equilibrium if it fulfills the following conditions:
1. MR = LMC at equilibrium point
2. LMC must cut MR from below at the equilibrium point
3. Price or Average Revenue must be equal to LAC at the equilibrium point.
4. LMC cuts the minimum point of LAC beyond the equilibrium point.
Diagrammatic Representation
The above diagram shows price and output determination under monopolistic competition in long run. A
firm’s equilibrium is represented by point ‘E’, where long run marginal cost curve has cut marginal revenue
curve from below and long run marginal cost is equal to marginal revenue. The equilibrium price and output
is PE and ‘OQ’ respectively. The firm earns just normal profit in long run.
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