BUSINESS ECONOMICS

UNIT-5
Product Pricing: Price and output determination under Perfect competition,
Monopoly-Monopoly Discriminating Monopoly - Monopolistic
competition - Oligopoly - Pricing Objectives and Methods.

Monopoly Definition

The term monopoly means a single seller (mono = single and poly = seller). In economics, a
monopoly refers to a firm which has a product without any substitute in the market.
Therefore, for all practical purposes, it is a single-firm industry.

Monopoly definition by Prof. A.J. Braff – ‘Under pure monopoly, there is a single seller in
the market. The monopolist’s demand is the market demand. The monopolist is a price maker.
Pure monopoly suggests a no substitute situation.‘
What is a monopoly and what are its three main features?
A monopoly refers to a firm which has a product without any substitute in the market. Hence,
it is a single-firm industry. The three main features of a monopoly are:

● Single seller and several buyers

● No close substitute of the product
● Strong barriers to the entry of new firms

Features of a Monopoly

Single seller and several buyers

The primary feature of a monopoly is a single seller and several buyers. Also, in a monopoly,
there is no difference between the firm and the industry.
This is because there is only one producer and/or seller. Therefore, the firm’s demand curve is
the industry’s demand curve. Since there are several buyers, an individual buyer cannot affect
the price in a monopoly market.

No close substitute

In a monopoly, the product that the monopolist produces has no close substitute. If a close
substitute exists, then the monopoly cannot exist. Therefore, the monopolist can determine
the price of his own choice and refuse to sell below the determined price.

Strong barriers to the entry of new firms

Even if the monopolist firm is earning super-normal profits, new firms face many hurdles in
trying to enter the industry. There are many reasons for this like legal barriers, technology, or
a naturally occurring substance which others cannot find. Sometimes, the monopolist works
in a small market making it economically challenging for new firms to enter.

Revenue curves under a Monopoly

A monopolistic firm is a price-maker, not a price-taker. Therefore, a monopolist can increase

or decrease the price. Also, when the price changes, the average revenue, and marginal
revenue changes too. Take a look at the table below:

Average Marginal
Total Revenue
Price per Revenue revenue
Quantity Sold
unit
(TR)
(AR) (MR)

1 6 6 6 6

2 5 10 5 4
 3 4 12 4 2

4 3 12 3 0

5 2 10 2 -2

6 1 6 1 -4

Let’s look at the revenue curves now:

As you can see in the figure above, both the revenue curves (Average Revenue and Marginal
Revenue) are sloping downwards. This is because of the decrease in price. If a monopolist
wants to increase his sales, then he must reduce the price of his product to induce:

● The existing buyers to purchase more

● New buyers to enter the market
Monopoly Diagram

A monopoly maximises profits where MR=MC (at point m). It sets a price of Pm and
quantity Qm.

Problems of Monopoly

1. Higher prices. Firms with monopoly power can set higher prices (Pm) than in
a competitive market (Pc). (Red area is supernormal profit)
2. Allocative inefficiency. A monopoly is allocatively inefficient because in
monopoly (at Qm) the price is greater than MC. (P > MC). In a competitive
market, the price would be lower and more consumers would benefit from
buying the goods. A monopoly results in dead-weight welfare loss indicated by
the blue triangle. (this is net loss of producer and consumer surplus)
3. Productive inefficiency A monopoly is productively inefficient because the
output does not occur at the lowest point on the AC curve.
4. X – Inefficiency. – It is argued that a monopoly has less incentive to cut costs
because it doesn’t face competition from other firms.Therefore the AC curve is
higher than it should be.
5. Supernormal Profit. A monopolist makes Supernormal Profit Qm * (AR –
AC ) leading to an unequal distribution of income in society.
6. Higher prices to suppliers – A monopoly may use its market power
(monopsony power) and pay lower prices to its suppliers. E.g. supermarkets
have been criticised for paying low prices to farmers. This is because farmers
have little alternative but to supply supermarkets who have dominant buying
power.
 7. Diseconomies of scale – It is possible that if a monopoly gets too big it may
experience dis-economies of scale. – higher average costs because it gets too
big and difficult to coordinate.
8. Lack of incentives. A monopoly faces a lack of competition, and therefore, it
may have less incentive to work at product innovation and develop better
products.
9. Lack of choice. Consumers in a monopoly market face a lack of choice. Types
of monopoly

There exist several different types of monopolies in an economy. These different types of
monopolies are listed below:

● Private Monopoly – A private monopoly is one that is owned by an individual

or a group of individuals. These monopolies mainly aim for profits.
● Public Monopoly – A public monopoly is one that is owned by the
government. These monopolies are set up for the welfare of the masses. An
example of a public monopoly would be the U. S. Postal Service.
● Pure/ Absolute Monopoly – The monopolist controls the entire market supply
for its product without facing any form of competition. This is possible because
there is absolutely no close or remote substitute available in the market.
● Imperfect Monopoly – The monopolist controls the entire market supply for
its product as there is no close substitute, but there is a remote substitute for the
product available in the market.
● Simple Monopoly – A simple monopoly is one in which a single seller sells its
product or service for a single price. There is no price discrimination in a
simple monopoly.
● Discriminating Monopoly – A discriminating monopoly is one where a single
seller does not sell his product or service for a single price. Price
discrimination is witnessed wherein prices may vary from region to region, or
people coming from different economic backgrounds may be charged a
different price, etc.
● Legal Monopoly – A legal monopolist enjoys government approved rights like
trademark, patent, copyright, etc.
● Natural Monopoly – A natural monopolist enjoys or benefits from natural
factors like locational advantages, locational reputation, natural talents and
skill sets of the producers, etc.
● Technological Monopoly – When a firm holds a technologically superior
position that other firms cannot compete with, the firm is said to be a
technological monopoly.
● Joint Monopoly – When two or more firms join hands in order to form a
monopoly, it is referred to as a joint or a shared monopoly.

Definition of Discriminating Monopoly

A discriminating monopoly refers to a market situation where a single seller sells the same
product or service at different prices to different customers. This price discrimination is based
not on the cost of production but rather on the willingness or ability of consumers to pay. The
monopoly exploits its market power to maximise profits by charging each customer or group
of customers a price that corresponds closely to their individual demand curves.

Example

Consider a railway company that operates without competition on its routes. It can be
classified as a discriminating monopoly if it charges different fares for the same journey
based on certain criteria, such as time of travel (peak vs. off-peak), age (adults vs. children),
or purchasing channel (online vs. in-person).

For instance, the company might charge higher prices for business travellers who usually
travel during peak hours and are less sensitive to price changes, compared to students who are
more price-sensitive and can travel during off-peak hours at reduced fares.

There are three types of price discrimination, which are shown in Figure-13:

i. Personal: Refers to price discrimination when different prices are charged from different
individuals. The different prices are charged according to the level of income of consumers as
well as their willingness to purchase a product. For example, a doctor charges different fees
from poor and rich patients.

ii. Geographical: Refers to price discrimination when the monopolist charges different prices
at different places for the same product. This type of discrimination is also called dumping.

iii. On the basis of use: Occurs when different prices are charged according to the use of a
product. For instance, an electricity supply board charges lower rates for domestic
consumption of electricity and higher rates for commercial consumption.

Benefits of price discrimination in monopoly

Increases profit
Price discrimination typically helps increase the monopoly firm's profit by maximising its
total revenue. A monopolist charges some customers higher prices rather than a uniform fee
for all buyers. Price discrimination among customers with inconsistent demands can
minimise the risk of setting up a uniformly high price.

Increases customer satisfaction

Customers usually associate a higher price with an excellent customer experience. Price
discrimination may increase buyers' loyalty because the firm can charge different prices for
each of them, giving a few premium experiences. It can also encourage customers to shift
towards a monopoly product or service over alternative products because they get more
satisfaction.

Concentrates on core market segments

Price discrimination encourages monopolists to focus on marketing their products and
services towards specific groups of people. Price discrimination is a strategy firms can use to
improve their total revenue, profit, and productivity. It often leads to market segmentation,
minimises competition, and increases profit.

Increases investments
Price discrimination encourages monopolists to make more investments, like new marketing
efforts, to reach their target market. Investment projects can generate more revenue and
increase a monopoly's profits.

Empowers consumers
Price discrimination can empower consumers because they may have the freedom to choose
what they pay for products. It allows consumers to determine their priorities of price, quality,
and other aspects of choice. A monopolist can control the price of its product or service and
manage the consumer's demand.

Controls demand
Monopolies also use price discrimination to manage the demand for a product or service. For
example, transport services such as taxis can be more expensive during the rush hours to
manage demand. They can also offer incentives to encourage customers to travel at different
times.

What is a Monopolistic Competition?

Monopolistic competition definition says that it stands for an industry in which many firms
service similar products which are not a perfect substitute. There are very low barriers to
entry or exit in monopolistic competition. In this competition, one firm decision doesn't affect
the whole industry or another firm. Monopolistic competition is just related to the business
strategy of brand variation.
Monopolistic Competition Meaning
Monopolistic competition means monopoly plus a perfect competition. This market is a
perfect mixture of monopoly and perfect competition. This industry is one of the best
classical monopolistic competition examples.
Understanding of Monopolistic Competition
Monopolistic competition is half monopoly half and perfect competition. It combines
elements of both in a theoretical state. In this competition, every brand tries to make its own
unique product, and they make it slightly different from other brands of the same item. While
we are judging them roughly, there is no difference as such. Although when we examine them
closely, we can find some little difference between different brand products.
If we take the soap brands of India as monopolistic competition examples, it can be easily
revealed the idea of monopolistic competition. Though all the soap brands such as Lux,
Dove, Vivel, Fiama, Pears produce the same item, They contain some different features from
others in their product to make it unique.
Features of Monopolistic Competition

● A Large Number of Sellers: There are many sellers involved in the market of
monopolistic competition. They also own some small shares of that market.
● Entry-Exit Freedom: Any firm can enter or exit in this industry for monopolistic
competition. They are free to get involved in this or they can also get out of this as per
their wish. It is not necessary to explain the reasons behind it.
● Product Variation: Every brand involved in this industry tries to produce item
variation to add monopoly. They make some small differences so that their product
can be unique. All the products are somewhere different from others. Therefore, the
brand can fix the price of the product as per their choice. It also creates a problem for
all the brands as they tend to lose some customers.
● Non-Price Factors: Besides the price competition, there are some other factors to
compete in the market. The brands attract customers through advertising, product
development, extra features, great service, etc. All the brands promote and take the
initiative to make their product better than other available products in the market.
Equilibrium for Monopolistic Competition
There are two types of equilibrium in this competition that define monopolistic competition
as imperfect competition i.e. short-run equilibrium and long-run equilibrium.
Short-run equilibrium increases profit and makes marginal revenue (MR) and marginal cost
(MC) equal. Long-run equilibrium makes changes in marginal and average revenue (MR &
AR) in the entrance of other brands. The firm never sells products above average cost and
doesn't claim economic profit in long-run equilibrium.
In the monopolistic market, you can see many monopolistic competition examples following
all the classic rules of this industry. Some common examples are soap brands, toothpaste
brands, electronics, furniture, smartphone, stationeries, etc. All these brands make their
products considering all these competitive factors and ensure the uniqueness of their product.
What is Monopolistic Competition and How Does It work?

"What is Monopolistic Competition?"

'Monopolistic competition is a market circumstance in which many vendors compete for the
same product, but each seller's product differs in some way from every other seller's product
in the minds of consumers.'
Features of Monopolistic Competition
● Under Monopolistic Competition, a buyer can only buy a specific type of product
from a single manufacturer. In other words, product differentiation exists.
● Because there is product differentiation, businesses must incur sales expenses.
● There are a lot of sellers, and their demand and supply are all intertwined. Sellers set
prices, and the demand curve for a single seller's goods is downward sloping. Demand
isn't completely elastic.
● The company can also increase or degrade the quality of its products. Improving the
product's quality helps to increase demand and pricing. On the other hand, lowering
the quality helps lower the average production cost.
● Inputs are also a source of competition for businesses. They must also work within a
certain technological range. As a result, no company can provide a higher-quality
product at a lower average price.
● Firms should be aware of their demand and cost conditions. They must also apply this
knowledge in order to optimise the predicted profit income.
● A company can quit a product group's group of companies at any time. New
enterprises can also join the group and produce close alternatives for the company's
existing items. This assures that no company loses money or makes excessive profits.
 ● Every enterprise in Monopolistic Competition must strive for profit maximisation.
● All enterprises in this market structure are believed to have the same cost and demand
circumstances.

Equilibrium under Monopolistic Competition

Before determining a firm’s equilibrium under Monopolistic Competition, it is important to

note that there are two possible demand curves – both sloping downwards. In this article, we
will look at a firm’s short-run and long-run equilibrium under Monopolistic Competition.

Equilibrium under Monopolistic Competition

The two types of demand curves of a firm under monopolistic competition are due to the
following reasons:

● When a firm revises the price of its product, the rival firms don’t always increase
the prices of their products too. Therefore, the demand curve has a smaller slope
and the demand for the product is more elastic.
● If the rival firms follow the price revision by the first firm, then the demand for
its product becomes less elastic. In such cases, the firm needs to slash its prices
further to achieve an increase in demand. In this case, the demand curve has a
steeper slope.

A Firm’s Short-Run Equilibrium under Monopolistic Competition

Under Monopolistic Competition, the revenue curves are downward sloping (like under
Monopoly). This is because, in order to sell more, the firm has to decrease the price.

A firm under Monopolistic Competition can either earn normal profits, super-normal profits,
or incur losses. Also, like under Monopoly, a firm earns super-normal profits if the demand
for its product is very high.

Also, in the short-run, new firms cannot enter the group and enhance the supply of the
product group. Therefore, they cannot compete with the super-normal profits of the firm.
Also, in the short-run, a firm faces certain fixed costs. These can include production as well
as selling costs.

In the figure above, you can see that the AR and MR curves of the firm have negative slopes.
Further, the AVC curve includes the production costs as well as the variable components of
selling expenses. Furthermore.

The MC curve cuts the AVC curve at its lowest point. Also, the ATC curve represents the
average of the total cost of the firm including the fixed selling expenses.

The MC curve intersects the MR curve from below at point I. Hence, the firm decides to
produce a quantity of OM and charge a price of EM per unit.

By doing so, the firm earns a profit of EK per unit and the entry of rival firms does not
compete with it. However, based on the relative location of the cost and revenue curves, it is
possible that the firm is in equilibrium with:

● Only normal profit

● Covering a part of fixed costs. Therefore, incurring a loss less than its fixed costs
● Loss equal to the fixed costs (where AR is tangent to the AVC curve)
Group Equilibrium

Group equilibrium is the simultaneous equilibrium of all the firms in the group. We know that
the cost and demand conditions of individual firms differ from each other.

Further, they produce differentiated products making it impossible to derive demand and
supply curves for the group as a whole.

Chamberlin assumed that all firms in the group have identical demand and cost conditions.
Therefore, when in equilibrium, all firms produce the same quantities of their respective
products and sell them at the same prices.

This, however, is a little unrealistic assumption. For all practical purposes, it is important to
determine a firm’s equilibrium under Monopolistic Competition individually.

A Firm’s Long-Run Equilibrium under Monopolistic Competition

To discuss a firm’s long-run equilibrium under Monopolistic Competition, it is important to

remember the following points:

● There are no fixed costs in the long-run. The firm can vary its inputs as well as
its selling costs. Further, the firm can choose between various product qualities.
● There is no compulsion on a firm to operate at a loss. It can leave the industry
whenever it wants. When a firm leaves the industry, the absolute market shares
of the remaining firms increase. Further, their demand curve shifts right and
upwards. This continues until other firms can produce without incurring a loss.
● On the other hand, if the demand is so strong that the existing firms make
supernormal profits, then new firms can enter the group.
● They produce close substitutes of the existing products and increase the total
product supply. Therefore, the demand shares of the existing firms reduce.
Hence, the demand curve of a firm cannot stay above its long-run average cost
curve.
● All firms operating under Monopolistic Competition can make a choice between
combinations of:
 ○ Product quality
○ Product Differentiation
○ Selling costs
● A firm must consider the fact that any variation of price on its part can attract a
reaction from its rivals. Therefore, it faces a much steeper demand curve.

Therefore, under Monopolistic Competition, a firm is exposed to constant interaction with the
rest of the firms in the group. Its decisions are not independent of the decisions of the other
firms.

Further, the firm’s demand curve depends on its actions AS WELL AS on the actions of its
rivals. Therefore, it must consider different combinations of its cost components pertaining to
the product quality and its selling expenses, etc. This helps the firm estimate the slope and
position of the demand curve.

Graphical Representation

Let’s say that the LAC curve in Fig. I represent the product quality and selling expenses that a
firm selects. This has a corresponding long-term MC curve (LMC) which intersects the MR
curve from below at point I.
Therefore, the firm decides to produce a quantity of OM and sell it at a per unit price of EM.
This gets a profit of EK per unit. However, soon new firms enter the market and start offering
close substitutes and bring the profit down.

Therefore, there is a reduction in the market shares of the existing firms. The firm’s AR curve
shifts left until it becomes tangent to the LAC curve at point E as shown in Fig. ii. This
ensures that the firm earns only normal profit. Once this stage is reached, there is no incentive
for new firms to enter the market.

This results in the firm’s long-term equilibrium under Monopolistic Competition. The
equilibrium is given by the point of tangency between the firm’s AR curve and LAC curve,
which is at point E in Fig. ii. Therefore, in the long-run, under monopolistic competition,
firms earn only normal profits.

What Is an Oligopoly?
An oligopoly is a type of market structure in which a small number of firms control the
market. Where oligopolies exist, producers can indirectly or directly restrict output or prices
to achieve higher returns.

Advantages and Disadvantages of an Oligopoly

Advantages

One of the main benefits of having an oligopoly is that competition is very limited. That's
because there are very few players in the market. Since there are few competitors, an
oligopoly allows those who participate to net a higher amount of profits.

Disadvantages

Oligopolies come with higher barriers to entry for new participants. This means that it can be
difficult to enter the market because of the high costs associated with doing business, the
regulatory environment, and the problems that arise when it comes to accessing supply and
distribution channels.
Because of the lack of competition, there may be very little incentive to innovate product and
service offerings. With no diversity in offerings, consumers remain loyal to what they know
best.

Pros

​ Limited competition
​ Higher profits for companies
​ Greater consumer demand

Cons

​ High barriers to entry for new participants

​ Lack of innovation
​ Very little choice for consumers

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