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Competition
(Discriminating Monopoly,
Monopolistic and Oligopoly)
1
First Degree Price Discrimination:
À Monopolist charges different price for each
unit of good.
À Highest price for the first unit and reduction
in price for every successive unit.
À Guided by Law of Diminishing Marginal
Utility – unless a consumer is offered
successive units at falling prices, he would
not purchase the additional unit of a good.
À Monopolist exploits the consumers to the
maximum possible extent.
2
Conditions for Price Discrimination:
À The market must be clearly separable into
two or more parts.
À No resale of the product can take place
from low-price market to a high-price
market.
À Price Elasticity of Demand for the product
must be different in different markets (Price
Discrimination to be profitable).
Issues before Discriminating
Monopolist
À How much to produce?
À How to distribute the total production in
various markets?
3
À Total output of the Monopolist Q = Q1 + Q2.
À Total Revenue R = R1 + R2 .
À Total cost function = C (Q) = C (Q1 + Q2).
À Profit = π = R1 + R2 – C.
À To maximize profit the first order condition
requires that dπ / dQ1 = 0 and dπ / dQ2 = 0.
À That is dπ / dQ1 = dR1/ dQ1- dC/ dQ1= 0
À dR1/ dQ1 = dC/ dQ1 or MR1 = MC1
À Again dπ / dQ2 = dR2/ dQ2 - dC/ dQ2 = 0
À dR2 / dQ2 = dC/ dQ2 or MR2 = MC2
4
AR1,MR1 AR2,MR2
MR
MC
MC
P1 P2
E
AR1 AR2
MR
MR1 MR2
0
Q1 0 Q2 0 Q
5
Class Assignment: 1
A garment manufacturing firm has the total
demand function for its product P = 100 –
4Q. However, the demand function for
selling garments in the domestic market and
foreign countries are P1 = 80 – 5Q1 and P2 =
180 – 20Q2 respectively. The total cost
function of the firm TC = 50 + 20Q.
Determine the following:
À The price that will be charged by the firm to
maximize profit in absence of price
discrimination.
6
Monopolistic Competition
À It is a blending of competition and
monopoly. Refers to competition among the
monopolists.
À Many sellers, each having an insignificant
share in the total supply of the product in
the market.
À Product differentiation, products of various
firms are similar but not perfect substitutes.
À Easy entry and easy exit.
À Existence of non-price competition.
7
Demand and marginal revenue curves
for a firm in monopolistic competition
Price, Revenue
D=AR
MR
Quantity
8
Y Abnormal profits or Economic profits
MC
T
P AC
Equilibrium Point :E
K Equilibrium Output : OQ
S Equilibrium Price : OP = QT
At Equilibrium AR : QT
AR At Equilibrium AC : QK
Profit per unit : QT – QK = KT
Total profits : KT × OQ = PTKS
E
MR
0 X
Q
Y
Loss Making Firm
MC
AC Equilibrium Point :E
K Equilibrium Output : OQ
P Equilibrium Price : OP = QT
At Equilibrium AR : QT
At Equilibrium AC : QK
S
Loss per unit : QK - QT = KT
T Total Loss : KT × OQ = PTKS
AR
E
MR
0 X
Q
9
Y
Normal Profits
MC
Equilibrium Point :E
Equilibrium output : OQ
AC Equilibrium Price : OP
= QT
T At equilibrium AR : QT
P At equilibrium AC : QT
As AR equals AC the firm
breaks even, i.e., it earns
AR normal profit.
E
MR
0 X
Q
10
À In LR, all firms break-even and produce on
the negatively sloped portion of their LAC
curve.
À Due to normal profit (P = AC), the entry
and exit of firms will not take place.
À Two conditions of LR equilibrium of a firm
are:
MC = MR
P or AR = AC
À When all firms reach their respective break-
even points, the Group Equilibrium is
attained.
AC
MC
P2
AR
MR
0
Q2 Q3
11
À The equilibrium level of output would fall
short of the optimal level of output, i.e.,
Q2Q3.
À OQ2 is the LR equilibrium output and OQ3 is
the output at which AC is the least.
À Full capacity output is the one at which AC is
the minimum (OQ3).
À Since OQ2 denotes equilibrium output, Q2Q3
measures the excess capacity.
À A firm under monopolistic competition never
operates at its minimum AC or always has
an excess capacity.
MC
ATC
B
PmC L
PPC D = ARPC = MRPC
D= ARMC
MRMC
0 Quantity
Q MC Q PC
Excess capacity
12
À Perfectly Competitive firm operates at the
minimum point of the LAC curve.
À Since P > MR and MR = MC for a firm under
monopolistic competition, it operates when
P > MC.
À Both types of firm earn only normal profit in
LR, means D = AR must be tangent to AC
curve.
À D = AR for a perfectly competitive firm is a
horizontal straight line and it is tangent to AC
only at the minimum point of AC.
13
À Purely competitive firm produces a larger
volume of output Qpc than the
monopolistically competitive firm does
(Qmc).
À Price charged by the monopolistically
competitive firm Pmc is higher than the
purely competitive price Ppc.
À Under pure competition, the consumer pays
a lower price but no choice of product.
À In monopolistically competitive industry, the
consumer can have wider choice.
Class Assignment: 2
A firm is operating in monopolistic
competition with the following demand and
cost functions:
P = 11,100 – 30Q
TC = 400,000 + 300Q – 30Q2 + Q3
What is the short run equilibrium output,
price and profit for the firm?
14
Oligopoly
À Consists of only a few firms.
À Each produces a relatively large share of the
total output of the industry.
À Firms in oligopolistic market structure are
aware of their mutual interdependence.
À Firms are quite interdependent in pricing
decisions, i.e., actions taken by one firm
have a large effect on other firms.
À Barriers but possible entry and exit.
À Firms produce identical or differentiated
products.
Sources of Oligopoly
À Economies of scale may operate over a
large range of output.
À Huge capital investments and specialized
inputs.
À Patent right for exclusive production or to
use a process.
À Loyal customers base on product quality.
À Government may give franchise to only few
firms to operate.
À Presence of Mergers and Acquisitions.
15
Oligopoly Equilibrium
À A number of theories known as models have
been proposed to explain Oligopoly
Equilibrium.
À Models which recognize the existence of
interdependence are:
Cartelization and Formal Collusion
Kinked Demand Curve Models
Price Leadership Models
Collusion Model
À All the firms recognize their
interdependence.
À Decide to collaborate in the form of a cartel
in the matter of Pricing.
À One market demand function (AR and MR)
and as many cost functions (AC and MC) as
the firms.
À Profit-maximizing output for the industry
given by intersection of CMC and MR curve.
À Given the equilibrium output, the AR curve
give the equilibrium price.
16
À Distribution of output among firms is
obtained by equating MR to each of the MC.
À Industry output OQ is divided among the
three firms oq1 to firm 1, oq2 to firm 2 and
oq3 to firm 3.
À All firms sell at an uniform price OP.
À All firms have different levels of output and
profits due to differences in costs.
À Efficient firms earn more profits and others
may loose.
À Perfect collusion avoids price wars among
rivals.
AC1
2
AC
MC2
3
AC
MC3
MC1
P
AR
Price
C
CM
MR
0
q1 0 q2 0 q3 0 Q
Quantity
17
À Consumers are adversely affected by high
prices and restricted quantities.
À Chances of arriving at a common
understanding would be difficult in case
number of firms are large.
À Cartels are more difficult in case of
differentiated oligopoly.
À Tendencies to break the cartel exist.
À Cartels imply direct agreement among the
oligopolists for reducing uncertainty.
À Aim of the cartel is the maximization of the
industry profit.
Price Leadership
À One firm sets the price and other firms
follow, to avoid uncertainty.
À Can be worked easily in case of identical
products.
À Price Leader sets his price by equating MR
= MC for maximizing profit.
À Followers considering the same price may
not maximize profits, if, may be by accident
rather than by their independent decisions.
18
MC2 MC1
P2*
P1 = P2
E
E2
D
AR1 = AR2
E1
MR1 = MR2
0 Q
Q2* Q1 = Q2
19
Kinked Demand Curve
À Developed by Paul Sweezy, explained
observed rigidity of price in oligopoly
market.
Assumptions:
À Many firms in Oligopolistic industry.
À Each produces a product which is a close
substitute for that of the others.
À Each oligopolist believes that (a) if he
lowers the price, rivals will also lower the
prices and (b) if he raises, others will
maintain the prices at the existing levels.
20
À dd is drawn on the basis that when one
seller changes his price, others do not
change their prices.
À DD is drawn on the basis that when one
seller changes his price, others also change
in the same direction.
À Demand curves DD and dd intersect at point
P.
À Demand curve is dPD which has a kink at
point P.
À As the demand curve is kinked, the MR
curve will be discontinuous.
Q
0 D d
21
À dA portion of the MR curve corresponds to
the dP portion of the demand curve.
À BC portion of the MR curve corresponds to
the PD portion of the demand curve.
À Length of discontinuity is equal to AB.
À Point P on the demand curve has two
elasticities of demand.
À If P is a point on dd, there is one elasticity of
demand and if P is a point on DD another
elasticity of demand.
À MC curve passes through discontinuous
range of the MR curve.
P
C’
M
C
M
B
0 Q
M MR D
C
22
À Equality of MR and MC is not possible.
À MR can not be less than MC.
À Price and quantity remain the same at the
kink point.
À Even if MC curve shifts but passes through
the discontinuous range AB, the Price-Q
combination will remain constant.
À Price rise or fall is not profitable for a single
seller.
À Equilibrium of the firm is defined at the
point of the kink.
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