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UNIT - 1V

MARKET
Market is a place where buyers & sellers meet in order to buy & sell goods at a price.
CLASSIFICATION OF MARKETS BASED ON TIME PERIODS
A. Very Short Pe riod or Market period: This type of market is for perishable goods where
the time period is very short & the supply of goods is perfectly inelastic. It means that the
price alone will change according to demand but the supply will not change.
B. Short Period: This type of market is for Reproducible goods or durable goods where the
businessman has got enough time to wait for the right price & the supply of goods is normal
in the beginning & it becomes perfectly inelastic only in the later stage.
C. Long Period: During this period all the firms will try to earn normal profits by charging a
low price, so that they can be stable in the market.
EQUILIBRIUM PRICE
The price at which quantity demanded is equal to the quantity supplied is the equilibrium
price. This is explained with the help of a diagram.

X axis Quantity
Y axis Price
DD Demand curve
SS Supply curve
Explanation:
i. Price is determined in the market at the level where demand and supply curve interest each
other.
ii. R is the equilibrium point, where OP is the price & OM is the output.
iii. The equilibrium between and supply, or market equilibrium, determines the price in the
market.

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THE CHANGE IN EQUILIBRIUM PRICE
Changes in equilibrium price: The equilibrium price will be change if either the demand or
supply curve change due to a change in demand or supply conditions., demand curve
remaining the same will lower the price and a decrease in supply (i.e., shift in the supply
curve to the left) will raise the price.
(A) Change in equilibrium price as a result of shifts in de mand curve & supply curve
re maining constant: Given the supply curve as constant, an increase in demand (i.e., shift of
the demand curve to the right upwards) will increase the price and a decrease in demand (i.e.,
shift of the demand curve to the right downwards) will decrease the price. This is explained
with the help of a diagram.

X axis Quantity or Output


Y axis Price
SS Supply curve
D, D'D',D''D''- Demand curve
Explanation:
i. When the demand curve DD cuts the supply curve at point R, the price is OP & the output is
OM.
ii. When the demand increases to D'D', it cuts the supply curve at R', which is the new
equilibrium point. The price will rise to OP'& the output will also increase to OM'.
iii. If the demand decreases from to D''D'', it cuts the supply curve at R'', which is the new
equilibrium point. The price will decrease to OP''& the output will also decrease to OM''.
iv. It means that if supply is constant, both the price & output will increase with increase in
demand & vice versa.
(B) Change in equilibrium price due to shifts in supply curve & de mand curve
re maining the same: Given the Demand curve as constant, an increase in supply (i.e., shift
of the supply curve to the right downwards) will reduce the price and a decrease in supp ly
(i.e., shift of the supply curve to the left upwards) will increase the price. This is explained
with the help of a diagram.

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X axis Quantity or Output


Y axis Price
S, S' S' ,S''S'' Supply curve
DD Demand curve
Explanation:
i. When the supply curve SS cuts the demand curve at point R, the price is OP & the output is
OM.
ii. When the supply increases to S'S', it cuts the demand curve at R', which is the new
equilibrium point. The price will decrease to OP'& the output will increase to OM'.
iii. If the supply decreases from to S''S'', it cuts the demand curve at R'', which is the new
equilibrium point. The price will increase to OP''& the output will decrease to OM''.
iv. It means that if demand is constant, then there will be inverse relationship between rice &
quantity or output.
THE DETERMINATION OF MARKET PRICE AT DIFFERENT TIME PERIODS
(A) Very short period or market period: During this period the supply is fixed or is
limited. This happens in case of perishable goods. In the case of a p erishable commodity like
fish, the supply is limited by the quantity available or stock in a day and which cannot be kept
back for the next period. Hence, the whole of it must be sold away on the same day whatever
may be the price. This is explained with the help of a diagram.

X axis Quantity or Output


Y axis Price
SM Vertical or Perfectly Inelastic supply curve
DD, D'D',D''D'' Demand curve
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Explanation:
i. The figure shows that the supply is fixed. When the demand curve DD cuts the supply curve
at point E, the price is OP & the supply is SM.
ii. It is seen that when the demand increases to D'D', it cuts the supply curve at point E', & only
the price increases to is OP' & where as the supply remains constant.
iii. Similarly, when the demand decreases to D''D'', it cuts the supply curve at point E'', & only
the price decreases to is OP'' & where as the supply remains constant.
iv. It means that during the very short period or the market period, the price alone will change
due to the changes in demand, whereas the supply will remain fixed.
(B) Short period: This is the case of durable goods or reproducible goods where, If a sudden
and once-for-all increase in demand takes place, there will be a sharp rise in market price but,
there can be no change in the amount supplied, because in the market period, firms can sell
only what they have already produced, i.e., what is in stock. In case of non-perishable but
reproducible goods, the supply curve cannot be a vertical straight line throughout its length,
because some of the goods can be preserved or kept back from the market, and carried over to
the next market period. There will be then two critical price levels. The first, it price is very
high, the seller will be prepared to sell the whole stock. The second level is set by a very low
price at which seller would not sell any amount in the present market period, but will hold
back the whole stock for some better time. This is explained with the help of a diagram.

X axis Quantity or Output


Y axis Price
SS Supply curve
DD Demand curve
Explanation:
i. When the demand curve DD cuts the supply curve at point R, the price is OP & the output is
OM.
ii. When the demand increases to D'D', it cuts the supply curve at F, which is the new
equilibrium point. The price will rise to OP'& the output will also increase to Q.
iii. If the demand decreases from to D''D'', it cuts the supply curve at R'', which is the new
equilibrium point. The price will decrease to OP''& the output will also decrease to OM''.
iv. It means that if supply is constant, both the price & output will increase with increase in
demand & vice versa.
v. Up to the price OP1 (=QF), the quantity supplied varies with price. At the price OS, nothing
is sold, the whole stock being held back. Therefore, SF portion of the supply curve slopes
upwards from left to right.
vi. At the price OP1 (=QF), the whole of the stock is offered for sale, and beyond OP1, the
quantity supplied remains the same the same whatever the price. Therefore, beyond price
OP1, the market supply curve has been shown as a vertical straight line.
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BREAKEVEN POINT ANALYSIS OF THE FIRM OR THE EQUILIBRIUM OF THE
FIRM BY USING TOTAL REVENUES AND TOTAL COST
Equilibrium of the firm: A firm is said to be in equilibrium when it has no incentive either
to expand or to contract its output only when its total profits are the maximum. A rational
entrepreneur will expand output if he thinks he can increase his total profits by doing so, and
likewise, he will contract his output if he thinks he can avoid losses and thus increase his total
profits. Therefore, a firm is an equilibrium position when it is earning maximum money
profits.
Assumptions:
i. The owner of the firm is rational. It implies that he tries to maximize his money profits.
ii. Whatever output the firm produces, it produces as cheaply as possible given the existing
production techniques.
iii. The firm produces only one product.
This is explained with the help of a diagram.

X axis Output
Y axis Revenue/cost
TR Total Revenue
TC Total Cost
Breakeven point explanation:
i. At any output smaller than OL, total cost exceeds total revenue and the firm is having losses.
ii. At the output OL total cost equals total revenue and the firm is having neither losses nor
profits. This point L is called Break-even points.
iii. At the outputs larger than ON, the total revenue is less than total cost so that the firm is
having losses.
iv. Point N is again a break-even point. Between OL and ON will lie the optimum point of
maximum profits.
LIMITATIONS OF BREAKEVEN POINT ANALYSIS
i. Difficult to see at a glance: Maximum vertical distance between the total revenue and total
cost curve is difficult to see at a glance. Many tangents have to be drawn before one reaches
the appropriate one corresponding to the maximum pro fit point.
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ii. Not possible to discover price pe r unit: It is not possible to discover price per unit at
various outputs at first sight. Total revenue has to be divided by total number of units
produced in order to get the price per unit.
iii. Complicated problems cannot be discussed: Complicated problems of equilibrium analysis
cannot be discussed easily and clearly in this way of representing equilibrium of the firm.
THE EQUILIBRIUM OF THE FIRM UNDER PERFECT COMPETITION OR THE
EQUILIBRIUM OF THE FIRM USING MARGINAL REVENUES CURVES
A firm will be in equilibrium when it is earning maximum profits, to make maximum profits,
two conditions are essential:
i. Marginal revenue = Marginal cost, and
ii. MC curve should cut MR curve from below at the equilibrium point.
Conditions of equilibrium:
The demand curve or average revenue curve facing a firm under perfect competition is
perfectly elastic at the ruling price. Since a perfectly competitive firm can sell as much as it
wants without affecting the price, addition made to total revenue by an extra unit of output,
i.e., marginal revenue, is equal to the price (average revenue) of the commodity. Hence, the
average revenue (or demand) curve, (AR) and marginal revenue curve (MR) must coincide
with each other for a firm under perfect competition. This is explained with the help of a
diagram.

X axis Output
Y axis Revenue/cost
MR=AR Marginal revenue= Average revenue
Explanation:
i. Under perfect competition, a firms MC curve is also its supply curve. Profits are the greatest
at the level of output for which marginal cost is equal to marginal revenue and marginal cost
curve cuts the marginal revenue curve form below.
ii. At point T though MC is equal to MR but MC is cutting MR from above rather than from
below. Therefore, T cannot be a position of equilibrium.
iii. At point P or output OM, the marginal cost equals MR and marginal cost equals MR and
marginal cost curve is also cutting MR curve from below.
iv. Hence, at the output OM or point P, the profit would be maximum and the firm would be in
equilibrium position.
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THE EQUILIBRIUM OF THE FIRM DURING SHORT RUN UNDER PERFECT
COMPETITION
Equilibrium in short run:
The short run has been has been defined as a period of time sufficient to allow the firm to
adjust its output by increasing or decreasing the amount of variable factors of production
cannot be altered. Thus in the short run; the size and kind of plant cannot be changed, nor can
new firms enter the industry.
Assumptions:
i. All firms are working under identical conditions.
ii. The factors of production used by the different firms are homogeneous and are available at
given and constant prices.
This is explained with the help of a diagram.

X axis =Output
Y axis= Revenue/cost
SAC= Short run average cost curve
SMC = Short run marginal cost curve
L,L1,L2 = AR=MR (Average Revenue = Marginal Revenue)
Explanation:
i. When the firm makes supernormal profits in the short-run: The firm makes supernormal
profits in the short-run when the price is OP1, because only at this price the average cost is
less than the price.
ii. The firm just makes normal profit: The firm makes normal profits in the short-run when
the price is OP, because only at this price the average cost is equal to the price.
iii. The firm incurring losses, but does not shut down: The firm incurs loss in the short-run
when the price is OP2, because only at this price the average cost is more than the p rice. Even
if the firm is incurring losses but still the firm will not shut down.
THE SHUT DOWN POINT OF THE FIRM
The point at which when the firm is not able to cover even its average variable cost is called
the shut down point of a firm.
This is explained with the help of a diagram.

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X axis = Output
Y axis = revenue/cost
AC = Average cost curve
MC = Marginal cost curve
AVC = Average variable cost curve
L,L1,L2 = AR=MR
Explanation:
i. If price is OP2, the firm is incurring losses, because the price is less than the average cost.
ii. But if the price happens to be OP3, the firm will be in equilibrium at point D. At point D, the
firm would be covering total variable costs but no part of the fixed costs, since price OP3 is
equal to average variable cost MD at the equilibrium output OM.
iii. But if the price is OP4, the firm would shut down, as in this situation the firm is not able to
cover even variable costs, since the price will be less than the average variable cost. Point D
is therefore called shut down point.

THE EQUILIBRIUM OF THE FIRM DURING LONG RUN UNDER PERFECT


COMPETITION
Equilibrium in the long run: The long run is a period of time long enough to permit
changes in the variable as well as in the fixed factors. In the long run, accordingly, all factors
are the variable and none fixed. Thus, in the long run, firms can change their output by
increasing their fixed equipment.
Conditions of equilibrium:
Price = Marginal cost
Price = Average cost
Thus, the conditions for long-run equilibrium of perfectly competitive firm can be written as:
Price = Marginal cost = Minimum Average Cost.
This is explained with the help of a diagram.

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X axis = Output
Y axis = revenue/cost
LAC = Long run average cost curve
LMC = Long run marginal cost curve
L,L1,L2= LAR=LMR
Explanation:
i. The firm under perfect competition cannot be in long run equilibrium at price OP1 because it
is greater than the average cost & point the firm will be earning supernormal profits. Hence,
there will be incentives for the new firms to enter the industry. As a result, the price will be
forced down to the level OP at which price, the firm is in equilibrium at R and will produce
OM output.
ii. The firm under perfect competition cannot be in long run equilibrium at price OP2 because it
is less than the average cost & point the firm will be incurring loss. To avoid these losses,
some of the firms will leave the industry. As a result, the price will be rise to OP, where again
all firms are making normal profits. When the price OP is reached, the firms would have no
further tendency to quit.
iii. Therefore the firm under perfect competition will be in lo ng run equilibrium at price OP. At
point R the equilibrium output is OM, the price is equal to average cost, and hence the firm
will be earning only normal profits. Therefore at price OP, there will be no tendency for the
outside firms to enter. Hence, the firm will be in equilibrium at OP price and OM output.

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THE SHORT RUN SUPPLY OF PERFECT COMPETITIVE INDUSTRY OR
DERIVATION SHORT RUN SUPPLY CURVE OF PERFECTLY COMPETITIVE
INDUSTRY
Short run supply curve:
The short run is a period in which the capital equipment is fixed and the increased demand is
possible only by the intensive use of the given plant, i.e., by increasing the amount of the
variable factors.
This is explained with the help of diagram.

[Both Panels (a) & Panel (b)]


Panel (a) = Shows the production level
Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price
SMC Short run average cost curve
SAC Short run average cost curve
SAVC Short run average variable cost curve
SRS Short run supply curve
The short run supply curve for the perfectly competitive industry is derived by adding up
both panel (a) & panel (b).
Explanation for Panel (a):
i. Panel (a) explains about the various equilibrium points & the different levels of output being
produced at various prices.
ii. At price OP0, the SMC cuts the price at pt.E0, hence the firm will produce OM0 amount of
output, since only at this output the price OP0 equals marginal cost.
iii. Similarly, at prices OP1, OP2, OP3 & OP4, the SMC cuts the price at points E1, E2, E3 &
E4, hence the firm will produceOM1, OM2, OM3, & OM4 amount of output respectively,
since only at these outputs the prices are equal to their marginal costs.
Explanation for Panel (b):
i. Panel (b) explains about the supply of output at various prices.
ii. It shows that at price OP0, the firm will supply OM0 amount of output.

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iii. As the price increases from OP1 to OP4, the supply of output also increases from OM1 to
OM4 respectively.
iv. It means that as the price increases the supply also increases. Thus, the short run supply curve
of the perfectly competitive industry slopes upwards.

THE LONG RUN SUPPLY AT DIFFERENT COST CONDITIONS


Long run supply curve:
Long run supply is defined as supplies offered at various prices by the existing as well as the
potential procedures in the long run.
(A) Supply curve of the constant cost industry:
An industry is a constant cost industry if its expansion generates neither external economies
nor external diseconomies. This is explained with the help of a diagram.

Panel (a) = Shows the production level


Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price
LAC long run average cost curve
LMC long run marginal cost curve
LSC - long run supply curve
Explanation:
i. In the case of constant cost industry, the long run supply curve will be a horizontal straight
line.
ii. Every firm will be in long run equilibrium at the minimum point of the long run average cost.
iii. In the long run, new firms will enter the industry without raising or lowering the cost curves
of the firms in the industry so that the industry so that the industry would supply any amount
of commodity at the price of OP which is equal to the minimum long run average cost.
iv. The long run supply curve is horizontal straight line (i.e., perfectly elastic) at price OP, which
is equal to the minimum average cost.

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(B) Supply curve of the increasing cost industry: If the industry is of a big size, then
sometimes due to the disadvantages of large scale production the cost of production will rise
resulting in increase in prices of the product. Therefore it will shift both the average and
marginal cost curves to upwards towards the left. It means that less output will be produced at
high cost. This is explained with the help of a diagram.

Panel (a)
Panel (b)
Panel (a) = Shows the production level
Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price
LAC long run average cost curve
LMC long run marginal cost curve
LSC - long run supply curve
Explanation for Panel (a):
i. Panel (a) explains about the various equilibrium points & the different levels of output being
produced at various prices.
ii. It shows that at OP price, OM level amount of output is produced.
iii. It is seen that when the price is increased to OP1, the output is decreased to OM1 & the LAC
& LMC curves are shifted upwards towards the left side.
iv. It means that both the cost & price have increased & the production of output has decreased.
Explanation for Panel (b):
i. Panel (b) explains about the supply of output at various prices.
ii. It shows that as the price increases from OP0 to OP1, the supply also increases from ON to
ON1 respectively.
iii. It means that in an increasing cost industry more output will be supplied at higher price.
iv. Thus the long run supply curve (LSC) of the increasing cost industry will slope upwards as
shown in panel (b) of the figure.
(C) Supply curve of the decreasing cost industry: An industry might have decreasing costs
due to advantages of large scale production so that, with the expansion of the industry, the
cost of production will be reduced. Therefore it will shift both the average and marginal cost
curves to downwards towards the right. It means that more output will be produced at less
cost. This is explained with the help of a diagram.

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Panel (a) = Shows the production level


Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price
LAC long run average cost curve
LMC long run marginal cost curve
LSC - long run supply curve
Explanation for Panel (a):
i. Panel (a) explains about the various equilibrium points & the different levels of output being
produced at various prices.
ii. It shows that at OP price, OM level amount of output is produced.
iii. It is seen that when the price is decreased to OP1, the output is increased to OM1 & the LAC
& LMC curves are shifted downwards towards the right side.
iv. It means that both the cost & price have decreased & the production of output has increased.
Explanation for Panel (b):
i. Panel (b) explains about the supply of output at various prices.
ii. It shows that as the price decreases from OP0 to OP1, the supply also increases from ON to
ON1 respectively.
iii. It means that in a decreasing cost industry more output will be supplied at less price.
iv. Thus the long run supply curve (LSC) of the increasing cost industry will slope downwards
as shown in panel (b) of the figure.

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THE PRICE-OUTPUT DETERMINATION UNDER PERFECT COMPETITION
DURING THE SHORT-RUN
Short-run period: This period is sufficient only to make limited output adjustment with the
existing equipment by expanding output along the short-run marginal cost curves. This is
explained with the help of a diagram.

Panel (a)
Panel (b)
Panel (a) = Shows the production level
Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price
MC Marginal cost curve
AC Average cost curve
AVC Average variable cost curve
SRS Short-run supply curve
MPS Market period supply curve
DD Demand curve
Explanation for Panel (a):
i. Panel (a) explains about the various equilibrium points & the different levels of output being
produced at various prices.
ii. At price OP, the firm will produces ON amount of output, since only at this output the price
OP equals marginal cost.
iii. Similarly, when the price increases to OR the firm will increase its output to ON' amount of
output & when the price decreases to OT the firm will decrease its output to ON'' amount of
output & respectively, since only at these outputs the prices are equal to their marginal costs.
Explanation for Panel (b):
i. Panel (b) explains about the changes in price & output at different demands during the market
period & short period supply.
ii. It is seen that when the DD curve cuts the MPS curve & SRS curve, the price is OP & the
output is OM.
iii. When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OK,
but the output does not change Again when the decreased demand curve D''D'' cuts the MPS
curve, the price alone decreases to OL, but the output does not change. It means that during
the market period only the price changes & the output remain fixed.
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iv. When the increased demand curve D'D' cuts the SRS curve, the price increases to OR & the
output increases to OM'. Again when the decreased demand curve D''D'' cuts the SRS curve,
the price decreases to OT & the output also decreases to OM''. It means during the short run
more output will be supplied at a higher price & vice versa.

THE PRICE-OUTPUT DETERMINATION UNDER PERFECT COMPETITION


DURING THE LONG-RUN
Long-run period: In the long run, the time is long enough for the firms to change the size of
their plants or build new plants. Also, new firms can enter the industry. In the long-run the
firms can a band on old plants or build new ones and when the new firms can enter the
industry or old ones can leave it. This is explained with help of a diagram.

X axis Output
Y axis Cost & Revenue
LMC Long-run marginal cost curve
LAC Long-run average cost curve
Explanation:
i. If the price is above the minimum long-run average cost, the firm will be making
supernormal profits. Therefore, in the long-run new firms will enter the industry to compete
away their extra profits and the price will fall to the level where it is equal to the minimum
long-run average cost.
ii. Neither can the price will fall below the minimum average cost since in that case the firms
will be incurring losses. In long-run, if these losses persist, some of the firms will leave the
industry. As a result, the price will rise to the level of minimum average cost, so that in the
long-run firms are earning only normal profits.
iii. Therefore during the long run the firms will be earning only normal profits & will be in
equilibrium at point S, where the long run average cost is equal to the long run average
revenue.
THE PRICE-OUTPUT DETERMINATION UNDER PERFECT COMPETITION
DURING THE LONG-RUN UNDER DIFFERENT COST CONDITIONS
THE PRICE OUTPUT DETERMINATION OF THE LONG-RUN NORMAL PRICE
IN INCREASING COST INDUSTRY
Long-run normal price in increasing-cost industry: Supply curve of an increasing-cost
industry slopes upwards from left to right. This is so because when a full-sized industry
expands as a result of the increased demand for its product, it experiences certain external
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economies and diseconomies. But external diseconomies in the case of an increasing-cost
industry outweigh the external economies and this brings about an upward shift in the cost
curves of all firms. This is explained with the help of a diagram.

Panel (a) = Shows the production level


Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price/Cost
LMC Long-run marginal cost curve
LAC Long-run average cost curve
DD Demand curve
MPS Market-period supply curve
SRS Short-run supply curve
LRS Long-run supply curve
Explanation for Panel (a):
i. Panel (a) explains about the cost & output at different levels of prices.
ii. It shows that OP is the basic price. In the increasing cost industry, the cost of production is
increased, which increases the price to OP''', thereby shifting the LAC & LMC curves
upwards towards the left side.
Explanation for Panel (b):

i. Panel (b) explains about the changes in price & output at different demands during the market
period supply, short run supply & long run supply.
ii. It is seen that when the DD curve cuts the MPS curve, SRS curve & LRS curve, the basic
price is OP & the output remains the same i.e OM.
iii. When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OP',
but the output remains the same i.e OM. It means that during the market period only the price
changes & the output remain fixed.
iv. When the increased demand curve D'D' cuts the SRS curve, the price increases to OP'' & the
output increases to OM'. It means during the short run more output will be supplied at a
higher price.
v. When the increased demand curve D'D' cuts the LRS curve, the price increases to OP''' & the
output increases to OM''. It means that in increasing cost industry during the long run more
output will be supplied at a higher price.
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THE PRICE OUTPUT DETERMINATION OF LONG RUN NORMAL PRICE IN
CONSTANT-COST INDUSTRY
Long run normal price in constant-cost industry: Industry will be a constant-sot industry
if, on its expansion, external economies and diseconomies cancel each other so that the
constituent firms of an enlarged industry do not experience shift in their cost curves. An
industry can also be a constant-cost industry if its expansion breeds neither external
economies nor external diseconomies. This is explained with the help of a diagram.

Panel (a) = Shows the production level


Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price/Cost
DD Demand curve
LMC Long-run marginal cost curve
LAC Long-run average cost curve
MPS Market-period supply curve
SRS Short-run supply curve
LRS Long-run supply curve
Explanation for Panel (a):
i. Panel (a) explains about the cost & output at different levels of prices.
ii. It shows that OP is the basic price. In the constant cost industry, the cost of production will
remain the same & the price will also be to OP, thereby LAC & LMC curves will not be
shifted anywhere.
Explanation for Panel (b):
i. Panel (b) explains about the changes in price & output at different demands during the market
period supply, short run supply & long run supply.
ii. It is seen that when the DD curve cuts the MPS curve, SRS curve & LRS curve, the basic
price is OP & the output remains the same i.e OM.
iii. When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OP',
but the output remains the same i.e OM. It means that during the market period only the
price changes & the output remain fixed.
iv. When the increased demand curve D'D' cuts the SRS curve, the price increases to OP'' & the
output increases to OM'. It means during the short run more output will be supplied at a
higher price.
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v. When the increased demand curve D'D' cuts the LRS curve, the price does not change, it
remains the basic price as OP but the output alone increases to OM''. It means in the constant
cost industry during the long run more output will be supplied at the same price.
THE PRICE-OUTPUT DETERMINATION OF LONG-RUN NORMAL PRICE IN
DECREASING-COST INDUSTRY
Long-run normal price in decreasing-cost industry: In the case of a young industry in its
early stages of growth, the external economies may overweigh the external diseconomies.
This phenomenon of net external economies lowers the cost curves of all firms. In the case of
a decreasing-cost industry, the additional supplies of the product will forth coming at reduced
costs and, therefore, the long-run supply curve of the industry will slope downwards from left
to right. This is explained with the help of a diagram.

Panel (a) = Shows the production level


Panel (b) = Shows the supply of output at different prices
X axis Output
Y axis Price
DD Demand curve
LMC Long-run marginal cost curve
LAC Long-run average cost curve
MPS Market-period supply curve
SRS Short-run supply curve
LRS Long-run supply curve
Explanation for Panel (a):
i. Panel (a) explains about the cost & output at different levels of prices.
ii. It shows that OP is the basic price. In the increasing cost industry, the cost of production is
decreased, which decreases the price to OP''', thereby shifting the LAC & LMC curves
downwards towards the right side.
Explanation for Panel (b):
i. Panel (b) explains about the changes in price & output at different demands during the market
period supply, short run supply & long run supply.
ii. It is seen that when the DD curve cuts the MPS curve, SRS curve & LRS curve, the basic
price is OP & the output remains the same i.e OM.
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iii. When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OP',
but the output remains the same i.e OM. It means that during the market period only the price
changes & the output remain fixed.
iv. When the increased demand curve D'D' cuts the SRS curve, the price increases to OP'' & the
output increases to OM'. It means during the short run more output will be supplied at a
higher price.
v. When the increased demand curve D'D' cuts the LRS curve, the price decreases to OP''' & the
output increases to OM''. It means that in decreasing cost industry during the long run more
output will be supplied at a lesser price.
MONOPOLY
The monopoly is that market form in which a single producer controls the whole supply of a
single commodity which has no close substitutes
PRICE-OUT DETERMINATION UNDER MONOPOLY OR THE EQUILIBRIUM
OF THE FIRM AND INDUSTRY UNDER MONOPOLY
Assumptions:
i. There is one seller or producer of a homogeneous product
ii. There are no close substitutes for the product
iii. There is pure competition in the factor market so that the price of each input he buys is given
to him
iv. The monopolist is a rational being who aims at maximum profit with the minimum of costs.
v. There are many buyers on the demand side but none is in a position to influence the price of
the product by his individual actions. Thus the price of the product is given for the consumer.
vi. The monopolist does not charge discriminating price. He treats all consumers alike and
charges a uniform price for his product.
vii. The monopoly price is uncontrolled. There are no restrictions on the power of the monopolist.
viii. There is no threat of entry of other firms.
This is explained with the help of a diagram.
Price output equilibrium under monopoly [monopoly earning super normal profits]

X axis = output
Y axis = Revenue / cost
AR = Average revenue
MR = Marginal Revenue
AC = Average cost
MC = Marginal cost
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Explanation:
i. E is the equilibrium point where the MC curve cuts the MR curve from below
ii. It is seen that the average cost is less than the average revenue. It means that the monopolist is
earning super normal profits in the short run.
Price output equilibrium under monopoly [monopoly incurring losses]

X Axis = output
Y Axis = Revenue / cost
AR = Average revenue
MR = Marginal Revenue
AC = Average cost
MC = Marginal cost
Explanation:
i.
ii.

E is the equilibrium point where the MC curve cuts the MR curve from below
It is seen that the average cost is more than the average revenue. It means that the
monopolist is incurring losses in the short-run.
PRICE DISCRIMINATION
Price discrimination means charging different prices from different customers or for different
units of the same product.
CONDITIONS OF PRICE DISCRIMINATION:

i. The aim of the monopolist is to maximize his profits. He, therefore, produces that output at
which his marginal revenue equals marginal cost.
ii. The number of buyers in each market is very large and there is perfect competition among
them
iii. There is no possibility of resale from one market to the other
iv. The monopolists demand curve in each market is downward sloping which implies that his
monopoly in selling the commodity is well established in the two markets.
v. The most important condition for price discrimination is that the elasticities of demand in the
two markets must be different. If the elasticities of demand are the same, marginal revenues
will also be the same.
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WHEN IS PRICE DISCRIMINATION PROFITABLE
(A) Price discrimination not profitable when the demand curves are iso-elastic:
We shall take the two markets where the demand curves are iso-elastic, i.e., where at every
price, elasticity of demand curve is the same.
When in two markets elasticity of demand is the same, then the marginal revenue will also be
the same. Marginal revenue in the two markets being the same, it will not be profitable from
one market to another in order to change a different price. This is explained with the help of a
diagram.

X axis = output
Y axis = Revenue / cost
Markets A & B=Markets having same elasticties
ARa & ARb = Average revenue curve of market A & B
MRa & MRb = Marginal Revenue curve of market A & B
Explanation:
i. The demand curves ARa and ARb have the same elasticity at the price OP. At this price,
marginal revenue in the two markets is the same.
ii. Now if the monopolist increases the price in market A from OP to OP' to earn profit, the
output will be reduced from OM toON1. Thus the monopolist incurs loss in market A.
iii. In order to compensate loss the monopolist decreases the price from OP to OP'' in market B
& the output also increases from OM2 to ON2. Thus the monopolist earns profit in market B.
iv. But the profit in Market B is less than the loss in market A.
v. This shows that when the demand curve have the same elasticity then price discrimination
will not be profitable.
(B) Price discrimination profitable when elasticities differ:
The monopolist will find it profitable to charge discriminating prices, when the elasticities of
demand in the two markets are different. Rather, this is the only way for him to maximize
profits. If elasticity of demand is different in the two markets, he would charge higher price in
the market where elasticity is low and low price where it is high. This is explained with the
help of a diagram.

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X axis = output
Y axis = Revenue / cost
Markets A & B=Markets having different elasticities
ARa & ARb = Average revenue curve of market A & B
MRa & MRb = Marginal Revenue curve of market A & B
Explanation:
i. The demand curves ARa and ARb have the different elasticity at the price OP. At this price,
marginal revenue in the two markets is different.
ii. Now if the monopolist increases the price in market A from OP to OP' to earn profit, the
output will be reduced from OM1 toON1. Thus the monopolist incurs loss in market A.
iii. In order to compensate loss the monopolist decreases the price from OP to OP'' in market B
& the output also increases from OM to ON2. Thus the monopolist earns profit in market B.
iv. Now the profit in Market B is greater than the loss in market A.
v. This shows that when the demand curve have different elasticity then price discrimination
will t be profitable.
PRICE-OUTPUT EQUILIBRIUM UNDER DISCRIMINATING MONOPOLY
A Discriminating monopoly is the one who charges different prices from different customers
or for different units of the same product. This is explained with help of a diagram.

X axis = output
Y axis = Revenue / cost
AR & AR' = Average revenue curves of markets A & B
MR& MR ' = Marginal Revenue curves of markets A & B
MC= Marginal Cost curve
CMR= Combined Marginal Revenue curves of markets A & B
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Explanation:
i. The equilibrium of the discriminating monopolist is established at the output OM at which
MC cuts MR.
ii. Now the output OM of the Total Market has therefore to be distributed between the two
markets A & B in such a way that marginal revenue in each is equal to ME which is the
marginal cost being on the MC curve.
iii. The output OM1 will be sold in market A, because only at this output marginal revenue MR1
in market A is equal to ME. The price charged in the market for output OM1 is equal to M1
P1.
iv. The output OM2 will be sold in market B as only at this output, marginal revenue in market
B ,that is MR2 is equal to ME.Price charged in market B for output OM2 is M2 P2 which is
lower than the M1 P1 which is charged in market A.
v. Thus in market B in which elasticity of demand is greater, the price charged is lower than that
in market A, where the elasticity of demand is less.
THE VARIOUS SOURCES AND TYPES OF MONOPOLY
i. Grant of a patent right to a firm by the government to make, use or sell its own invention.
ii. Control of a strategic raw material for an exclusive production process.
iii. A natural monopoly enjoyed by a firm when it supplies the entire market at a lower unit cost
due to increasing economies of scale just as in the supply of electricity, gas etc.
iv. Government may grant exclusive right to a private firm to operate under its re gulation. Such
privately owned and government regulated monopolies are mostly in public utilities and are
called legal monopolies such as in transport communications, etc.
v. There may be government owned and regulated monopoly such as postal services, water, and
sever systems of municipal corporation etc.
vi. Government may grant license to a sole firm and protect it to exclude foreign rivals.
vii. The sole manufacturer of a product may adopt a limit pricing policy in order top prevent the
entry of new firms.
THE VARIOUS TYPES OF PRICE DISCRIMINATION
i. Personal price discrimination based on the income of the customer: For example, doctors
and lawyers charge different fees from different customers on the basis of their incomes.
Higher fees are charged to rich persons and lower to the poor.
ii. Price discrimination based on the nature of the product: Paperback is cheaper than the
deluxe edition of the same book, for the former is bought by the majority of readers, and the
latter by libraries. Unbranded products, like open tea are sold at lower prices than branded
products like brooke bond or lipton tea. Economy size tooth pastes are relatively cheaper than
ordinary sized tooth pastes. In the case of services too, such price discrimination is practiced
when off-season rates of holds at hill stations are very low as compared to the peak season.
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Dry cleaning firms charge for two while they clean three clothes during off season where as
they charge more for quick service in peak season.
iii. Price discrimination related to the age, gender and status: price discrimination is also
related to the age, gender and status of the customers. Barbers charge less for childrens
haircuts. Certain cinema halls admit ladies only at lower rates. Military personnel in uniform
are admitted at concessional rates in all cinema houses.
iv. Discrimination is also based on the time of service: Cinema houses at certain places, like
new delhi, charge half the rates in the morning show than in the afternoon shows.
v. Geographical or local discrimination: There is geographical or local discrimination when a
monopolist sells in one market at a higher price than in the other market.
vi. Discrimination based on the use of the product: Railways charge different rates for
different compartments or for different services. Less is charged for the transportation of coal
than for bales of cloth on the same route. State power boards charge low rates for industrial
use than for domestic consumption of electricity.
THE VARIOUS CONDITIONS OF PRICE DISCRIMINATION
i. Market imperfection: The individual seller is able to divide and keep his market into
separate parts only if it is imperfect. Customers do not move readily from one market to the
other because of ignorance.
ii. Agreement between rival sellers: price discrimination also takes place when the seller of a
commodity is a monopolist or when rivals enter into an agreement for the sale of the product
at different prices to different customers. This is usually possible in the sale of direct services.
iii. Geographical and tariff barriers: The monopolist may discriminate between home and
foreign buyers by selling at a lower price in the foreign market than in the domestic market.
This type of discrimination is known as dumping
iv. Differential products: Discrimination is possible when buyers need the same service in
connection with differential products.
v. Ignorance of buyers: Discrimination also occurs when small manufacturers sell goods made
to order. They charge different rates to different buyers depending upon the intensity of their
demand for the product
vi. Artificial difference between goods: A monopolist may create artificial difference by
presenting the same commodity in different quantities. He may present it under different
names and lables, one for rich and snobbish buye rs and the other for the ordinary. Thus he
may charge different prices for substantially the same product.
vii. Difference in demand: For price discrimination, the demand in the separate markets must be
considerably different. Different prices can be charged in separate markets based on
differences of elasticity of demand, low price is charged where demand is more elastic and
high price in the market with the less elastic demand.

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METHODS TO CONTROL AND REGULATE MONOPOLY
(A) Fear that prevent the monopolist from charging a very high price in order to earn
large super-normal profits.
i. Fear of potential rivals: The fear of potential competitors may prevent a monopolist to
charge a very high price to his customers. If he sets a very high price he will earn large super
normal profits. Attracted by these monopoly profits new entrants may force themselves into
the monopolized industry. The monopolist being averse to the entry of new firms would
prefer to charge a reasonable price and thus earn only a modest pro fit.
ii. Fear of government regulation: Same consideration applies to potential government
regulation. The monopolist is well aware that charging unusually high price or profits would
attracts the attention of the government. Rather than risk government regulation he may
voluntarily fix a low price and earn less monopoly profits.
iii. Fear of nationalization: The fear of nationalization also prevents the monopolist to wield an
absolute monopoly power. If the products or service which monopolist produces is a public
utility service, that is every likelihood of the states taking over the monopoly organization in
public interest. This consideration may prevent the monopolist from charging too high a
price.
iv. Fear of public reaction: The monopolist is also aware of public reaction he charges a very
high price and earns huge profits. Voices may be raised against the monopoly firm in
parliament to press for anti- monopoly legislation.
v. Fear of boycott: People may even boycott the use of monopolized product or service and
start their own service instead. For instance, if in a big city taxi operators combine to charge
high rates, people may boycott taxi services and even start operating their own services by
forming a cooperative society. Naturally such a fear compels monopoly firms to charge
reasonable prices and earn only nominal profits.
vi. Fear of substitutes: Then there is the fear of substitutes. In fact the fear of substitutes is the
most potent- factor which prevents monopoly firms from charging very high prices and
thereby earning huge super- normal profits. It is only under pure monopoly that there are
absolutely no substitutes for the product. But pure monopoly like pure competition being
unreal, the monopoly product has some substitute though it is not a close substitutes is always
uppermost in the mind of the monopolist which acts as a restraint on his absolute power.
vii. Difference in elasticity of demand: The difference in the short and long run elasticities of
demand for monopoly product also limit monopoly power. In the short run the monopolist
can charge a very high price because customers take time to adjust their habits tastes, and
income to some other substitutes. The demand for the monopoly products is, therefore less
elastic in the short run but in the long run the fear of public opinion emergence of substitutes,
government regulations etc will force the monopolist to set a low price. He will view his
demand curve as elastic and sell more at a low price.
(B) Control of monopoly through legislation: Government tries to control monopoly by
anti- monopoly lows and restrictive trade practices legislation. These measures tend to:
i. Remove restrictive trade practices and fix high prices.
ii. Reduce the incidence of market-sharing agreements.
iii. Remove unfair competition.
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iv. Restrict the control of very large share of the market.
v. Prevent unfair price discrimination.
vi. Restrict mergers in order to avoid market domination.
vii. Prohibit exclusive agreements between the producer and retailer to the detriment of other
traders.
(C) Control of monopoly through price regulation and taxation:
i.Regulated monopoly pricing: To regulate monopoly the government imposes price ceiling
so that monopoly price should be near or equal to competitive price. This done when the
government appoints a regulating authority or commission which fixes a prices for the
monopoly product below the monopoly price, thereby increasing output and lowering the
price for the consumer.
ii.Taxation: Taxation is another way of controlling monopoly power. The tax may be levied
lump sum without any regard to the output of the monopolist or it may be proportional to the
output the amount of tax rising with the increase in output.
iii.Lump sum tax: By levying a lump sum tax, the government can reduce or even eliminate
monopoly profits without affecting either the price or output of the product.
iv.Specific tax: The government can also reduce monopoly profits by levying a specific or a per
unit tax on the monopolists product.
MONOPOLISTIC COMPETITION
Monopolistic competition refers to a market situation where are many firms selling a
differentiated product.
THE VARIOUS FEATURES OF MONOPOLISTIC COMPETITION
i. Large number of sellers: In monopolistic competition the number of sellers is large. No
seller by changing its price-output policy can have any perceptible effect on the sales of
others and in turn be influenced by them.
ii. Product Differentiation: One of the most important features of the monopolistic
competition is product differentiation. A general class of product is differentiated if any
significant basis exists for distinguishing the goods(or services) of one seller from those of
another .
iii. Freedom of Entry and Exit of firms: Another features of monopolistic competition is the
freedom of entry and exit of firms. The fact that firms are small size and are capable of
producing close subsitiutes make it possible for them to leave or enter the industry or group
in the long run. In fact, product differentiation tends to increase rather than reduce the entry
of new firms in the group, for each firm produces a distinct product from the other.
iv. Nature of Demand Curve: Under monopolistic competition no single firm controls more
than a small portion of the total output of a product. No doubt there is an element of
differentiation, nevertheless the products are close substitutes. As a result, a reduction in its
price will increase the sales of the firm but it will have little effect on the price-output
conditions of other firms, each will lose only a few of its customers. Likewise, an increase in
its price will reduce its demand substantially but each of its rivals will attracts only a few of
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its customers. Therefore, the demand curve(average revenue curve) of a firm under
monopolistic competition slopes downward to the right.
PRICE OUTPUT DETERMINATION UNDER MONOPOLISTIC COMPETITION
DURING THE SHORT RUN
Assumptions:
i. The number of sellers is large and they act independently of each other. Each is a monopolist
in his own sphere.
ii. The product of each seller is differentiated from the other product.
iii. The firm has a determinate demand curve (AR) which is elastic.
iv. The factor services are in perfectly elastic supply for the production of the product in
questions.
v. The short-run cost curves of each firm differ from each other.
No new firms enter the industry.
This is explained with the help of a diagram.

(A) Equilibrium under monopolistic competition during the short run [Monopolistic
firm earning profits]: The monolopolistic firm will earn profits when the Average cost will
be less than average revenue.

X axis = output
Y-axis = cost/revenue
AR = Average revenue curve
MR = Marginal revenue curve
SAC = Short-run average cost curve
SMC = Short-run marginal cost curve
Explanation:
It is seen that during the short run average cost is less than the average revenue. It means that
the monopolistic firm is earning super normal profits during the short run.

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(B) Equilibrium unde r monopolistic competition during the short-run [Monopolistic
firm incurring losses]: The monolopolistic firm will incur losses when the Average cost will
be greater than average revenue. This is explained with the help of a diagram.

X axis = output
Y-axis = cost/revenue
AR = Average revenue curve
MR = Marginal revenue curve
SAC = Short-run average cost curve
SMC = Short-run marginal cost curve
Explanation:
It is seen that during the short run average cost is more than the average revenue. It means
that the monopolistic firm is incurring losses during the short run.
THE LONG-RUN EQUILIBRIUM OF THE FIRM
The firms under monopolistic competition can earn supernormal profits in the short run. But,
in the long-run, such profits disappear. This is because we assume that entry is free and new
firms will enter the industry, if the existing firms are making supernormal profits. As new
firms enter and start production, supply will increase and the price will fall.
The supernormal profits will be competed away and the firms will be earning only normal
profits. If in the short run, firms are realizing losses, then, in the long run, some firms will
leave the industry so that the remaining firms will be earning normal profits.
Therefore, there is equilibrium in the long run under monopolistic competition when,
Average Revenue= Average cost. This is explained with the help of a diagram.

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X axis = output
Y axis = cost/revenue
AR = Average revenue
MR = Marginal revenue
LAC = Long-run average cost curve
LMC = Long-run marginal cost curve
Explanation:
i.
ii.
iii.
iv.

Average revenue curve(AR) is a tangent to the average cost curve (LAC) at P.


Therefore, the equilibrium output in the long run is OM and the corresponding price is MP.
At this point average cost is also MP and so is average revenue.
Therefore, there are no supernormal profits; there are only the normal profits which form part
of the cost of production.
CHAMBERLINTS
GROUP
EQUILIBRIUM
MONOPOLISTIC COMPETITION

OF

THE

FIRM

UNDER

Group equilibrium means price-output adjustment of a number of firms, instead of an


individual firm, whose products are close substitutes. Within the group, if a firm has
successfully designed a popular brand, it will be making supernormal pro fit but, in the long
run, other firms will imitate the design so that extra profits will tend to disappear. This is
what happens within the monopolistically competitive groups. But if the group as a whole is
making supernormal profits in the short run, outside firms will enter into the group, unless the
entry is legally or economically barred. In this way extra profits will be competed away.
Assumptions:
i. The number of firms is large.
ii. Each firm produces a differentiated product which is a close substitute for the others
product.
iii. There is a large number of buyers.
iv. Each firm has an independent price policy and faces a fairly elastic demand curve at the same
time excepting its rivals not to take any notice of its actions.
v. Each firm knows its demand and cost curves.
vi. Factors prices and technology remain constant.
vii. Each firm aims at profit maximization both in the short run and the long run.
viii. Any adjustment of price by a single firm produces its effect on the entire group so that the
impact felt by any one firm is negligible. This is the symmetry assumption.
ix. As put forth by chamberlin, there is the heroic assumption that both demand and cost
curves for all the products are uniform throughout the group.
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This is explained with the help of a diagram.
Short run equilibrium

Long run equilibrium

X axis-> output
Y axis-> price
SMR and SAR->Short run marginal revenue curve, Short run average revenue curve
SMC and SAC->Short run marginal cost curve & Short run average cost curve
LAR and LMR->Long run average revenue curve & Long run marginal revenue curve
LAC and LMC->Long run average cost curve & Long run marginal cost curve

Explanation: Short run equilibrium


i. In the short run, the price is OP; whereas average cost is MN at the output OM where
marginal revenue is equal to the marginal cost.
ii. Hence there is supernormal profit represented by the shaded area PRNP1.
Long run equilibrium:
i. But in the long run, the surplus profit will be competed away.
ii. The marginal revenue equals marginal cost at the output level OM1.
iii. The average revenue curve(LAR) is a tangent to the average cost curve(LAC) which means
that the average revenue(ie., price) is equal to average cost and there is no extra profit, i.e.,
only normal profit is being made.
SELLING COST
The costs incurred on advertising, publicity and salesmanship are known as selling costs.
Selling costs have been defined as the costs necessary to persuade a buyer to buy one
product rather than another or to buy from one seller rather than another. The intervention of
selling costs adds to the difficulty of determining the most profitable output. It is obvious
that higher total selling costs will be necessary to sell a larger output at the same price or the
same output at a higher price. This is explained with the help of a diagram.

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X axis = output
Y axis = price
AR = Average revenue curve
MR = Marginal revenue curve
MC = Marginal Cost curve
AUTC = Average Total Unit Cost
Explanation:
i. DP is the net return per unit of the output OM.
ii. Thus, area DEFP indicates the maximum net return in the case i.e., Total revenue OMPF-total
cost OMDE.
THE WASTES OF MONOPOLISTIC COMPETITION (OR) THE CONCEPT OF
EXCESS CAPACITY
A firm under monopolistic competition or imperfect competition produces an output in the
long run equilibrium which is less than socially optimum or ideal output. In other words, they
do not produce that level of output at which long-run average cost is minimum. They do not
increase their output, because their profits have already been maximized at the level of output
smaller than at which their long-run average cost would be minimum. This happens at a point
where equality between marginal revenue and marginal cost has been attained. The
productive resources of the community are fully utilized only when they are used to produce
that level of output which brings down the long-run average cost to the lowest point. But the
monopolistic firms produce less than that level of output which is socially optimum or ideal
output. This is explained with the help of a diagram.

Monopolistic Competition
Figure (a)

Perfect Competition
Figure (b)
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X axis = output
Y axis = cost/revenue
AR = Average revenue
MR = Marginal revenue
LMC = Long-run marginal cost curve
LAC = Long-run average cost curve

Explanation: Figure (a): The long-run position of a firm under Monopolistic competition
i. In this case, the long-run equilibrium is achieved at OM output at which the marginal revenue
is equal to marginal cost and price is equal to average cost.
ii. Here average revenue curve AR is tangential to average cost curve AC at point F
corresponding to output OM.
iii. It can be seen that at output OM, average cost is still falling and it continues to fall up to ON
which means that the firm can produce maximum output till ON but it produces only less
output till OM.
iv. This shows that the capacity to produce MN quantity of output has been wasted or unutilized.
Hence, the ideal output is ON where the long-run average cost is minimum.
v. This means that this firm is producing MN quantity less than the ideal output. Hence MN
output represents excess capacity which emerges under monopolistic competition.
Figure (b): The long-run position of a perfectly competitive firm.
i. The firm is in long-run equilibrium at the level of ON output where the long-run average cost
is minimum.
ii. At this point, price=MC=AC which means that the double condition of long-run equilibrium
is satisfied. This represents the socially ideal output.
iii. It means that there is no waste or excess capacity under perfect competition.
CRITICISM OF EXCESS
COMPETITION

CAPACITY OR WASTES OF MONOPOLISTIC

i. Restriction of output: One of the workers of imperfect competition is the restriction of


output so that price is kept higher than the marginal cost.
ii. Competitive advertisement: Expenditure on competitive advertisement is usually regarded
as a waste of competition.
iii. Cross-Transport: Another similar waste is expenditure on cross-transport.
iv. Specialization: The failure of each firm is an industry to specialization in the production of
those things for which it is best suited.
v. Valuable resources are wasted: Valuable resources are wasted because of excess capacity
resulting in idle plant and manpower in each firm.
vi. Prevent Standardization: Imperfect competition may prevent that standardization of
commodities which is essential if the most efficient methods of production are to be adopted.
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vii. Excess capacity: Monopolistic competition has also been criticized on the ground that the
firms under this type of market operate with excess capacity.
OLIGOPOLY
It is a market situation in which there are a few firms selling homogenous or differentiated
products. It is difficult to pinpoint the number of firms in the oligopolistic market. There
may be three, four or five firms. It is also known as competition among the few.
CHARACTERISTIC FEATURES OF OLIGOPOLY
i. Inte rdepende nce: There is a recognized interdependence among the sellers in the
oligopolistic market.
ii. Adve rtisement: One producers fortunes are dependent on the policies and fortunes of the
other producers in the industry. It is for this reason that oligopolistic firms spend much on
advertisement and customer services.
iii. Competition: In oligopolistic market, each seller is always on the alert over the moves of its
rivals in order to have a counter-move.
iv. Barrie rs to Entry of Firms: As there is keen competition in an oligopolistic industry, there
are no barriers to entry into or exit from it.
v. Lack of Uniformity: In oligopoly market, there is a lack of uniformity in the size of firms.
vi. Demand Curve: Under oligopoly, the exact behaviour pattern of a producer cannot be
ascertained with certainty his demand curve cannot be drawn accurately.
vii. No Unique Pattern of Pricing Behaviour: The rivalry arising from interdependence among
the oligopolists leads to two conflicting motives. So it is not possible to predict any unique
pattern of pricing behavior in oligopoly markets.
THE PRICE-OUTPUT DETERMINATION UNDER OLIGOLOPOLY OR THE
SWEEZY MODEL OF KINKED DEMAND CURVE (RIGID PRICES)
Assumptions
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.

There are few firms in the oligopolistic industry.


The product produced by one firm is a close substitute for the other firms.
The product is of the same quality. There is no product differentiation.
There are no advertising expenditures
There is an establishment or prevailing market price for the product at which all the sellers
are satisfied.
Each sellers attitude depends on the attitude of his rivals.
Any attempt on the part of a seller to push up his sales by reducing the price of his product
will be counteracted by the other sellers who will follow his move.
If he raises the price others will not follow him, rather the y will stick to the prevailing price
and cater to the customers, leaving the price-raising seller.
The marginal cost curve passes through the dotted portion of the marginal revenue curve so
that changes in marginal cost do not affect output and price.
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This is explained with the help of a diagram.

X axis = output
Y axis = Price
DD= Demand Curve/ Average revenue
MR = Marginal revenue curve
MC = Marginal cost curve
Explanation:
i. There are two oligopolistic firms, one facing the elastic demand & the other one facing
inelastic demand.
ii. The fixing of prices under oligopoly is a very difficult situation as the oligopolists will not
agree for a common price.
iii. Therefore, it is said that under oligopoly price is fixed at the kink, where the MC curve cuts
the MR curve from below.
EFFECTS OF OLIGOPOLY
i. Small output and higher prices: Oligopoly results in the restriction of output and changing
of higher prices.
ii. Prices exceed average costs: Owing to restrictions, partial or complete, on the entry of new
firms, the prices fixed, under oligopoly, are higher than the average cost. The consumers
have to pay more than is necessary to retain the resources in the industry.
iii. Lower efficiency: There is no tendency under oligopoly, for the firms in the industry to build
optimum scales of plant and operate them at the optimum rates of output. They do not,
therefore attain maximum potential economic efficiency.
iv. Selling costs: In order to snatch markets form their rivals the oligopolistic firms engage in
aggressive and extensive sales promotion effort by means of advertisement and by changing
the design and improving the quality of their products.
v. Wide r range of products: Oligopoly places at the consumers disposal a wider range of
commodities. To this extent, it promotes consumers welfare.
vi. Welfare effect: Under oligopoly, since output does not generally correspond to the minimum
long-run unit cost, more units of resources per unit of output are utilized than it its necessary.

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EVILS OF OILGOPOLY
i. Price war: There is generally a continuous price war which finally results in disastrously low
level of prices.
ii. Cut-throat competition: Such cut-throat competition in industries characterized by heavy
overheads and increasing costs proves ruinous to all producers.
iii. Price agreements: There may tacitly or explicitly enter into price agreements, which may
results in the exploitation of the consumers.
iv. Earn a fair return on past investments: A tendency to earn a fair return on past
investments, resulting in the excessive plant capacity, is detrimental to consumers welfare,
because they face scarce output and high prices.
v. Liquidate excess capacity: Hence, cut-throat competition may be, essential to liquidate
excess capacity through losses or sub-normal profits.
vi. Idle plants: oligopoly, prices stay firm and only output varies resulting in idle plants. This is
bad for the society and bad for the government.

REMEDIAL MEASURES TO CONTROL EVILS OF OLIGOPOLY


i. Government regulation is necessary to pull down barriers: To pull down barriers to the
entry to new firms.
ii. Government regulation is necessary to grown on collusions: To grown on collusions to
maintain prices and restrict supply.
iii. Government regulation is necessary to break big firms: To break big firms or to prevent
them from becoming bigger.
PRICE LEADERSHIP
Under price leadership, one firm assumes the role of a price leader and fixes the price of the
product for the entire industry. The other firms in the industry simply follow the price leader
and accept the price fixed by him and adjust their output to this price. The price leader is
generally a very large or a dominant firm or a firm with the lowest cost of production. It
often happens that price leadership is established as a result of price war in which one firm
emerges as the winner.
THE PRICE-OUTPUT DETERMINATION UNDER PRICE LEADERSHIP
Assumptions:
i. There are only two firms A and B and firm A has a lower cost of production than B
ii. The product of the firms is homogenous or identical so that the consumers are indifferent as
between the firms.
iii. Both A and B have equal share in the market, i.e., they are facing the same demand curve
which will be half of the total market demand curve.
This is explained with the help of a diagram.
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X axis = Quantity
Y axis = Price and cost
MR = Marginal revenue curve
MCa, & MCb = Marginal cost curve of firms A & B
DD = Demand curve
Explanation:
i. Let us take the firm A first. A will be maximizing its profits by selling output OM and setting
price MP, because at the output OM its marginal cost is equal to its marginal revenue.
ii. As regards the firm B, the profits will be maximum when it sells ON output and fixes NK
price, because at this output its marginal cost is equal to its marginal revenue.
iii. It can be seen that the profit- maximizing price MP of the firm A is lower than the profitmaximizing price NK of the firm B.
iv. The two firms will have to charge the same price since the products of the two firms have
been assumed to be homogenous
v. This means that the firm A, whose price MP is lower, will dictate the price to the firm B
whose profit- maximizing price NK is higher.
vi. In case the firm B refuses to fall in line, it can be ousted by the firm A which will be charging
the lower price.
vii. This shows that in this situation, the firm A is the price leader and the firm B has to follow it.
DUOPOLY
Duopoly is a special case of the theory of oligopoly in which there are only two sellers. Both
the sellers are completely independent and no agreement exists between them. Even though
they are independent, a change in the price and output of one will affect the other, and may
set a chain of reactions. A seller may however, assume that his rival is unaffected by what he
does, in that case he takes only his own direct influence on the price.
COURNOT MODEL OF DUOPOLY
Assumptions:
i. There are two independent sellers. In other words, interdependence of the duopolists is
ignored.
ii. They produce and sell a homogenous product- mineral water.
iii. The total output must be sold out, being perishable and non-storable.
iv. The number of buyers is large.
v. Each seller knows the market demand curve for the product.
vi. The cost of production is assumed to be zero.
vii. Both have identical costs and identical demands.
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viii. Each seller decides about the quantity he wants to produce and sell in each period.
ix. But each is ignorant about his rivals plan about output.
x. At the same time, each seller takes the supply output of its rival as constant.
xi. Neither of them fixes the price for its product, but each accepts the market demand price at
which the product can be sold.
xii. The entry of firms is blocked.
xiii. Each seller aims at obtaining the maximum net revenue or profit.
This is explained with the help of a diagram:

X axis = output
Y axis = Price
Explanation:
i. It shows how A and B producers share the total market and adjust output and how they
maximize their profits.
ii. SB is the total demand. Let the unit cost be zero i.e., MC=0. Therefore MR is also zero at A.
iii. Before B enters the market, A produces OA=Half of OB. The price is OC giving maximum
profits OAPC.
iv. Then B enters the market and produces AH = Half of AB, i.e the remaining market.
v. This process will continue till equilibrium output and price are achieved. As more and more
firms enter, they will produce output approaching the competitive output. If the number of
firms goes up to N they will produce N+1 (N) OB.
THE EDGE WORTH MODEL OF DUOPOLY: This can be explained with the help of
diagram.

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X axis = output
Y axis = Price
Explanation:
i. It is assumed that each producers capacity is limited to 3/4 th of his entire market and each is
confronted with his own demand curve made up of one half of the consumers. The maximum
output that A can produce is OB and B can produce OB.
ii. The demand curves of A and B respectively are DT and DH.
iii. The A first enters the market and sets his price P1 he sells the total output aP1.Then B enters
the market and sells at price slightly lower than A and thus captures his market.
iv. B then sells the whole output at P2 and snatches fro m Abb of sales. Now A reacts and
captures Bs market to the extent of CC.
v. This process of price-cutting continues until one of them say B fixes his prices at P4.At this
point none can snatch the market from the other by lowering the price.
vi. Then A raises the price back to P1 to maximize his profits from his share of the market
knowing that B has already thrown his entire supply, B then follows suit.
vii. There is thus continual oscillation of price between P1 and P4 i.e., the upper and lower limits.
CHAMBERLIN MODEL OF DUOPOLY: This can be explained with the help of diagram.

X axis = output
Y axis = Price
Explanation:
i. Suppose the producer A enters the market first DB is the demand curve and OL is the total
output he chooses to produce.
ii. It is sold at OA price and the total profit made is OLPA.
iii. Now the producer B enters the market and produces LH quantity.
iv. Now the total quantity produced is OL+LH=OH.

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