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Chapter 4 : Market Structure

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Market Structure• Market : Any arrangement that enables buyers and sellers

to contact for transactions.• The term market is derived from the Latin word “Marcatus”

which means merchandise or trade.• Market is an area or atmosphere of potential exchange -

Phillip Kotler• Market structure – identifies how a market is made up in

terms of:– The number of firms in the industry– The nature of the product produced– The degree of monopoly power each firm has– The degree to which the firm can influence price– Firms’ behavior – pricing strategies, non-price competition, output

levels, Profit levels– The extent of barriers to entry

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Market Structure• Market contains 2 kinds of competition :

1) Price competition - Seller competes among each other by setting a lower price.

2) Non-price competition - Sellers compete in area like product quality, advertising, packaging and service other than price.

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Market Classification

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Market Structure• There are 2 types of Market Structure:

1) Perfect Competition 2) Imperfect Competition

1)Perfect Competition and its features• Homogenous Products: The goods are sold by

different sellers as exactly alike from the consumers regard. Consumer has no reason to express a preference for any firm.

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1)Perfect Competition• Free entry and exit: Firms are free to enter or leave

the market. They do not face restriction on competing with other sellers.

• Perfect Information: All the buyers and sellers know the aspects of the market, including price, quality and quantity of the good. Consumers and producers have perfect knowledge about the market.

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1)Perfect Competition• Individual sellers have no influence on the market: In a

perfectly competitive market, there are many buyers and sellers, since all the buyers and sellers know the aspects of the market, goods are homogenous, so no individual seller can affect the market price, because his output just takes up a little part of the whole market output. Firms are price takers as they have no control over the price they charge for their product. Each producer supplies a very small proportion of total industry output.

• Every firm has only one goal of maximising its profits.

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Demand Curve

https://www.youtube.com/watch?v=ZhGDce_a5eE

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Demand Curve• The demand curve for an individual firm is different from a market

demand curve. The market demand curve slopes downward, while the firm's demand curve is a horizontal line.

• The market demand curve is a downward sloping line, reflecting the fact that as the price of an ordinary good increases, the quantity demanded of that good decreases.

• Price is determined by the intersection of market demand and market supply; individual firms do not have any influence on the market price in perfect competition.

• Once the market price has been determined by market supply and demand forces, individual firms become price takers.

• Individual firms are forced to charge the equilibrium price of the market or consumers will purchase the product from the numerous other firms in the market charging a lower price.

• The demand curve for an individual firm is thus equal to the equilibrium price of the market .

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Price Determination• The twin forces of market demand and market supply

determine price. • The level of price at which demand and supply curves

interact each other will finally prevail in the market. • The price at which quantity demanded equals quantity

supplied is called equilibrium price. • The quantity of the good bought and sold at this price is

called equilibrium price. • Thus the interaction of demand and supply curves

determines price-quantity equilibrium. • At the equilibrium price the buyers and sellers are satisfied. https://www.youtube.com/watch?v=XIyv7_WhkGohttps://www.khanacademy.org/economics-finance-domain/microeconomics/perfect-competition-topic/perfect-competition/v/perfect-competition

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AR and MR Curves• AR(Average revenue) curve and MR(Marginal Revenue)

curve under perfect competition becomes equal to D(Demand) curve and it would be a horizontal line or parallel to the X-axis

• The curve simply implies that a firm under perfect competition can sell as much quantity as it likes at the given price determined by the industry i.e. a perfectly elastic demand curve

Pric

e

Commodity

Perfectly Elastic Demand Curve(AR=MR=D)

4 3 2 1 0

D

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Firm Equilibrium• Firm’s Equilibrium means, “the level of output where the

firm is maximizing its profits and therefore, has no tendency to change its output”.

• In this situation either the Firm will be earning maximum profit or incurring minimum loss i.e. it refers to the profit maximization

• In the words of HansenHansen, “A Firm will be in equilibrium when it is of no advantage to increase or decrease its output”.

• Profit of a Firm is equal to the difference between its total revenue (TR) and the total cost (TC) i.e., (Profit=TR-TC) and so for the equilibrium of the Firm it should be maximum

• Marginal cost should be equal to Marginal revenue (MC=MR). And when these are equal profit is maximum

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Change in Equilibrium

• Equilibrium can change when demand or supply change.• Change in Demand will have 2 possibilities• 1. Demand increases – It happens when income of the

buyer increases, substitutes become less available or more expensive, number of consumers increase, information about the product increases the desire for it, buyers have an expectation of higher future price of the good, etc.

As the demand increases, the demand curve moves to the right (the purple curve), the equilibrium price increases to P2 and the quantity increases to Q2. Buyers buy more of the good, but must pay a higher price to get it.

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Change in Equilibrium• 2. Demand decreases – if incomes of buyers are

decreased, substitutes become less expensive or more available, number of consumers decreases (due to population, demographics), fashions, tastes and attitudes make the good less popular, information about the good (advertising) decreases desire for the good, buyers have an expectation of lower future price for the good, etc

As the demand decreases, demand curve moves to the left (the purple curve), the equilibrium price decreases to P2 and the quantity decreases to Q2. Buyers buy less of the good, and pay a lower price to get it.

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Change in Equilibrium• Change in Supply will also have 2 possibilities

• 1. Supply can increase (moving the supply curve to the right) if costs are lower due to lower resource prices, new technology for producing is used, larger number of sellers, favorable environment for producing or selling, lower taxes, etc.

• When supply increases for one of these reasons, it will move the equilibrium, and thus decrease the price and increase the quantity traded of the good

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Change in Equilibrium• The original equilibrium

occurs at the price of P1 and quantity of Q1.

• As the supply curve moves (to the purple curve), the equilibrium price decreases to P2 and the quantity increases to Q2.

• Sellers sell more of the good, but get paid a lower price to sell it.

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Change in Equilibrium2. Supply can decrease (moving the supply

curve to the left) if costs are higher due to higher resource prices, smaller number of sellers, unfavorable environment for producing or selling, higher taxes, etc.When supply decreases for one of these reasons, it will move the equilibrium, and thus increase the price and decrease the quantity traded of the good

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Change in Equilibrium

• The original equilibrium occurs at the price of P1 and quantity of Q1.

• As the supply curve moves (to the purple curve), the equilibrium price increases to P2 and the quantity decreases to Q2.

• Sellers sell less of the good, but get paid a higher price to sell it.

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Summary

Event Effect on Price Effect on Quantity bought and sold

Demand Increases Price Increases Quantity Increases

Demand Decreases Price Decreases Quantity Decreases

Supply Increases Price Decreases Quantity Increases

Supply Decreases Price Increases Quantity Decreases

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What if more than one thing is changing?

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The other possibilitiesEvent Effect on Price Effect on Quantity

bought and sold

Demand IncreaseswhileSupply Increases

Price Decreases orPrice Increases orPrice stays the same(depends on which changes the most)

Quantity Increases

Demand IncreaseswhileSupply Decreases

Price Increases

Quantity Decreases orQuantity Increases orQuantity stays the same(depends on which changes the most)

Demand DecreaseswhileSupply Increases

Price Decreases

Quantity Decreases orQuantity Increases orQuantity stays the same(depends on which changes the most)

Demand DecreaseswhileSupply Decreases

Price Decreases orPrice Increases orPrice stays the same(depends on which changes the most)

Quantity Decreases

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Equilibrium position of a firmIn order to attain equilibrium, a firm has to satisfy 2 conditions:– MR= MC since profits are maximum at this point.– MC curve should cut MR curve from below i.e. MC should have a

positive slope.

MC curve in the figure cuts MR at two place i.e. T and R. At T, it is cutting MR from above and its not the equilibrium point as it doesn’t satisfy 2nd condition. At R, MC is cutting MR curve from below. Hence R is the point of equilibrium.

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Can a competitive firm earn profit?• In a short run, a firm can attain equilibrium and earn

supernormal profits, normal profits or losses depending upon the cost conditions.

• Normal profit is defined as the minimum reward that is just sufficient to keep the entrepreneur supplying their enterprise. In other words, the reward is just covering opportunity cost - that is, just better than the next best alternative. This exists when total revenue TR, equals total cost TC.

• If a firm makes more than normal profit it is called super-normal profit. Supernormal profit is also called economic profit, and abnormal profit, and is earned when total revenue is greater than the total costs. 

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Short run equilibrium: Supernormal profitsSuppose the cost of producing 1000 units of a product by a firm is Rs 15000. The entrepreneur has invested Rs 50000 in the business and normal rate of return in the market is 10%. Thus the entrepreneur must earn at least Rs 5000. Total cost of production is Rs15000+Rs5000=Rs 20000. If the firm is selling the product at Rs 20, it is earning normal profits because AR (Rs 20)=ATC (Rs 20). If the firm is selling at Rs 22, its AR (Rs 22) > ATC (Rs 20) and it is earning supernormal profit at rate of Rs 2 per unit.

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Short run equilibrium : normal profits• When a business just meets its ATC, it earns

normal profits. Here AR = ATC. MR=MC at E. the equilibrium output is OQ. Since AR=ATC or OP=EQ, the firm is earning just normal profits.

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Long run equilibrium

Long run equilibrium of the firm :• In the long run, the firms are in equilibrium when they

have adjusted their plant so as to produce at the minimum point of their long run AC curve. In the long run, the firms will be earning only normal profits.

• If they are making super normal profits in the short run, new firms will be attracted in the industry which will lead to a fall in price and an upward shift of the cost curves due to increase in the prices of the factors as the industry expands.

• If the firm makes losses in the short term, they will leave the industry in the long run. This will raise the price and costs may fall as the industry contracts.

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Long run equilibriumLong run equilibrium of the industry:

• A perfectly competitive industry is in long run equilibrium when:1. all the firms are earning normal profits only i.e. all the

firms are in equilibrium2. There is no further entry or exit from the market.

• The following conditions are associated with the long run equilibrium of the industry:1. The output is produced at the minimum feasible cost.2. Consumers pay the minimum possible price which just

covers the Marginal cost i.e. MC=AC3. Firms earn only normal profits i.e. AC=AR4. Firms maximise profits(i.e. MC=MR) but the level of

profits will be just normal.

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Closing Thoughts• It should be remembered that

the perfectly competitive market is a myth.

• This is because the assumptions on which this system is based are never found in the real market conditions.

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Imperfect Competition

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Monopoly• The word monopoly is derived from two Greek words-Mono

and Poly. Mono means single and Poly means 'seller‘.• Monopoly is a situation in which there is a single seller of a

product which has no close substitute. • Under monopoly there is no rival or competitors. The degree

of competition in monopoly is nil. Thus if the buyers is to purchase the commodity, he can purchase it only from that seller.

• The seller dictates the price to consumers. Unlike perfect competition a monopolist can fix up the price.

• As monopoly is a form of imperfect market organization, there is no difference between firm and industry. A monopoly firm is said to be an industry.

• Eg: Railways, electricity

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Monopoly• Features:

– Single seller of the product – In a monopoly market, there is only one firm producing and selling a product. This single firm constitutes the industry as there is no distinction between firm and industry.

– Restrictions to entry – There are strong barriers to entry to this market. It could be economic, institutional or legal. Entry is almost blocked.

– No close substitutes – This market sells a product which has no close substitute.

– The products sold in a monopoly market may be homogenous or heterogeneous.

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Monopoly• Information of the market is imperfect: No perfect

information in the market. Neither the sellers nor buyers know all aspects of the market.

• The monopolist is a price searcher: A monopolist faces the entire market demand. He needs to find out the price that he can earn the most and sell most of its product.

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Price Discrimination in monopoly• The monopolist may use his monopolistic power in any manner in

order to realize maximum revenue. He may also adopt price discrimination.

• One of the important feature of monopoly is price discrimination i.e. charging different prices for same product from different consumers.

• Price discrimination is a method of pricing adopted by the monopolist in order to earn abnormal profits.

• Eg : The family doctor in your neighborhood charges a higher fees from a rich patient compared to the fees charged from a poor patient even though both are suffering from viral fever. Electricity companies sell electricity at cheaper rates for home consumption in rural areas than for industrial use.

• Price Discrimination cannot persist under perfect competition because the seller has no influence over market determined rate. Price Discrimination requires an element of monopoly so that the seller can influence the price of his product.

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Price Discrimination in monopolyConditions for price discrimination:• The seller should have some control over the supply of his product i.e.

monopoly power in some form is necessary to discriminate price.• The seller should be able to divide his market into 2 or more sub markets.• It should not be possible for the buyers of low priced market to resell the

product to the buyers of high-priced market.• The price elasticity of the product should be different in different sub

markets. The monopolist fixes a high price for his product for those buyers whose price elasticity of demand for the product is less than one. This means that if monopolist charges high price from them, they do not significantly reduce their purchases in response to high price.

A monopolist charges higher price in a market which has a relatively inelastic demand. The market which is highly responsive to price changes is charged less. On the whole, the monopolist benefits from such a discrimination.

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Objectives of Price discrimination• To earn maximum profit• To dispose off surplus stock• To enjoy economies of scale• To capture foreign markets• To secure equity through pricing

Price discrimination is carried out to capture consumer surplus that is enjoyed by consumers. Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service and the total amount that they actually do pay (i.e. the market price).Professor Pigou classified 3 degrees of price discrimination.

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Degrees of Monopoly• First degree Price Discrimination – Under the first degree

price discrimination, the monopolist will fix a price which will take away the entire consumer’s surplus i.e. their maximum willingness to pay. It is also known as perfect price discrimination. Eg: Auctions

• Second Degree Price Discrimination - Under the second degree price discrimination, he will take away only a part of the consumer’s surplus. Here price varies according to the quantity sold. Larger quantities are available at lower unit price.

• Third Degree Price Discrimination - Under third degree price discrimination, the price varies by attributes such as location or by consumer segment. Here the monopolist, will divide the consumers into separate sub markets and charge different prices in different sub- markets. Eg: Dumping, Bus passes

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Price and Output determination

• The aim of a monopolist is to maximize his profits. For that, he has 2 choice:

1. He can fix the price for his good and leave the market to decide what output will be required.

2. Or he can fix the output and leave the price to be determined by the interaction of supply and demand. In other words, he can either fix the price or the output. If the demand for the commodity is elastic, the monopolist cannot fix a very high price because a rise in price may result in a fall of demand. So he cannot sell much and he may not get large profits. In such a case, the monopolist will fix a low price. If the commodity has inelastic demand, the monopolist may fix a high price. Even if the price is high, there will not be a fall in demand. Then the monopolist will get maximum profits by fixing a high price.

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Demand Curve of monopoly• Since the monopolist firm is assumed to be the only producer of a

particular product, its demand curve is identical with the market demand curve for the product.

• The demand curve is downward sloping because of law of demand.

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Demand Curve of monopoly• The seller can’t sell anything if he charges Rs10. If he wishes to sell 10 units, he needs

to sell it at Rs 5.• In perfect competition, AR and MR are identical, but this isn’t true in monopoly as the

monopolist can increase the sales by decreasing the price of the product.• Hence MR is less than the price, because firm has to lower the price to sell an extra unit.The relationship between AR and MR of a monopoly firm can be stated as follows:1. AR and MR are both negatively sloped.2. MR curve lies half way between AR curve and Y.3. AR can not be zero but MR can be zero or negative.

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Difference Between a Monopolist and a Perfect Competitor

• A monopolistic firm’s marginal revenue is not its price. Marginal revenue is always below its price. Marginal revenue changes as output changes and is not equal to the price

• A monopolistic firm’s output decision can affect price.

• There is no competition in monopolistic markets so monopolists see to it that monopolists, not consumers, benefit.

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Equilibrium of the monopoly firm• Firms in a perfectly competitive market are price takers so

they are only concerned about determination of output. But this isn’t a case with a monopolist. A monopolist not only has to determine his output but also the price of his product.

• Since he faces downward sloping demand curve, if he raises the price of his product, his sales will go down. On the other hand, if he wants to improve his sales volume, he will have to be content with lower price.

• He will try to reach the level of output at which the profits are maximum i.e. he will try to attain the equilibrium level of output.

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Short run equilibriumConditions for equilibrium: The twin conditions for equilibrium in a monopoly market are:i) MC=MR and ii) MC Curve must cut MR curve from belowThe figure shows that MC curve cuts MR curve at E. That means at E, the equilibrium price is OP and equilibrium output is OQ.

https://www.youtube.com/watch?v=s49P6yN-_pk

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Short run equilibrium• In order to know whether the monopolist is making profits or losses in

the short run, we need to introduce the ATC curve.• MC cuts MR at E to give equilibrium output as OQ. At OQ, price charged

is OP ( we find it by extending line EQ till it touches AR/demand curve). Also, at OQ, the cost per unit is BQ. Therefore, profit per unit is AB and total profit is ABCP.

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Can a monopolist incur losses?• One of the misconceptions about a

monopolist is that it always makes profit. • It is to be noted that nothing guarantees that

a monopolist makes profit. • It all depends on his demand and cost

conditions.• If he faces very low demand for his product

and his cost conditions are such that ATC>AR, he will not be making profits, rather he will incur losses.

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Long run equilibrium• Long run is a period long enough to allow the

monopolist to adjust his plant size or use his existing plant at any level that maximises his profit.

• In the absence of competition, the monopolist need not produce at optimal level.

• The monopolist will not continue if he makes losses in the long run.

• He can make super normal profits in the long run as the entry of outside firms are blocked.

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Monopolistic Competition• Monopolistic competition is another type of

imperfect competition other than monopoly• Monopolistic Competition refers to a market

situation in which there are large numbers of firms which sell closely related but differentiated products. Markets of products like soap, toothpaste AC, etc. are examples of monopolistic competition.

• Monopoly + Competition = Monopolistic Competition

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Features of Monopolistic market• Features of both perfect competition and monopoly are

present.Similar features to perfect competition

1. A large no. of sellers and buyers – In a monopolistic market, there are large number of sellers who individually have a small share in the market. Eg: Hundreds of hair salons and boutiques in Surat.

2. Free entry and exit :New firms have to compete with existing firms for business. Entry and exit is not restricted.

Different features from perfect competition3. Imperfect information of the market: Neither the sellers nor

buyers know all aspect of the market.

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Features of Monopolistic market4. The goods sold are heterogeneous: The product

sold by different sellers are different. The differentiation may rise from differences in quality, package design, advertisements, etc. Product differentiation gives rise to an element of monopoly to the producer over the competing product. The producer of a brand can raise the price of his product knowing that he will not lose all the customers to other brands because of lack of perfect substitutability.

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Features of Monopolistic market• 5. Non price competition: In addition to price

competition, non-price competition also exists under monopolistic competition. Non-Price Competition refers to competing with other firms by offering free gifts, making favorable credit terms, etc without changing prices of their own products. Firms under monopolistic competition compete in a number of ways to attract customers.

• 6. Pricing Decision: A firm under monopolistic competition is neither a price- taker nor a price-maker. However, by producing a unique product or establishing a particular reputation, each firm has partial control over the price. The extent of power to control price depends upon how strongly the buyers are attached to his brand.

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• Example of Monopolistic Competition: Toothpaste Market:

• When you walk into a departmental store to buy toothpaste, you will find a number of brands, like Pepsodent, Colgate, Neem, Babool, etc.i. On one hand, the market for toothpaste seems to be full of competition, with thousands of competing brands and freedom of entry.ii. On the other hand, its market seems to be monopolistic, due to uniqueness of each toothpaste and power to charge different price.Such a market for toothpaste is a monopolistic competitive market.

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Demand Curve in Monopolistic market• Under monopolistic competition, large number of firms selling

closely related but differentiated products makes the demand curve downward sloping. It implies that a firm can sell more output only by reducing the price of its product.

At OP price, a seller can sell OQ quantity. Demand rises to OQ1, when price is reduced to OP1. So, demand curve under monopolistic competition is negatively sloped as more quantity can be sold only at a lower price. As a result, revenue generated from every additional unit is less than price of the product. Hence MR < AR just like it is in monopoly.

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Demand Curve: Monopolistic Competition Vs. Monopoly:

• The demand curve of monopolistic competition looks exactly like the demand curve under monopoly as both faces downward sloping demand curves.

• However, demand curve under monopolistic competition is more elastic as compared to demand curve under monopoly.

• This happens because differentiated products under monopolistic competition have close substitutes, whereas there are no close substitutes in case of monopoly.

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Price and output determination• In a monopolistically competitive market, each firm is a price maker

since the product is differentiated.• The 2 conditions of price and output determination and equilibrium of a

firm are MC = MR and MC curve should cut MR curve from below.• At E, the equilibrium price is OP and the equilibrium output is OM. Per

unit cost is SM, per unit super normal profit is QS and the total supernormal profit is PQSR.

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Price and output determination

• Monopolistic firms may also incur losses in short term.• Per unit cost HN is higher than OT/KN and the loss per unit

in KH. The total loss is GHKT.

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Price and output determination

Long run equilibrium : • If the firms in the industry earn super normal

profits in the short run, there will be an incentive for new firms to enter the industry.

• As more firms enter, profits per firm will go on decreasing as the total demand for the product will be shared among large number of firms.

• This will happen till all the profits are wiped away and all the firms earn only normal profits. Thus in the long run all the firms will earn only normal profits.

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Oligopoly• Oligopoly is described as competition among the few.• An oligopoly is a market structure in which a few firms

dominate. When a market is shared between a few firms, it is said to be highly concentrated. Although only a few firms dominate, it is possible that many small firms may also operate in the market.

• For example, major airlines like British Airways and Air France operate their routes with only a few close competitors, but there are also many small airlines catering for the holidaymaker or offering specialist services.

• An oligopoly is similar to a monopoly, except that rather than one firm, two or more firms dominate the market. There is no precise upper limit to the number of firms in an oligopoly, but the number must be low enough that the actions of one firm significantly impact and influence the others.

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Features of Oligopoly• 1. Interdependence: The most important feature of

oligopoly is the interdependence in decision making of the few firms which comprise the industry. This is because when the number of competitors is few, any change in price, output, product etc. by a firm will have a direct effect on the fortune of its rivals, which will then retaliate in changing their own prices, output or products as the case may be. It is, therefore, clear that the oligopolistic firm must consider not only the market demand for the industry’s product but also the reactions of the other firms in the industry to any action or decision it may take.

• Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product differentiation are all examples of non-price competition.

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Features of Oligopoly• 2. Group Behavior: Oligopoly market is about group

behavior not of mass or individual behavior. There are few firms in a group which are very much interdependent. Each oligopolist closely watches the business behavior of other oligopolists in the industry and designs his moves on the basis of how they behave or likely to behave.

• 3. Barriers to entry: The main reason for few firms under oligopoly is the barriers, which prevent entry of new firms into the industry. Patents, requirement of large capital, control over crucial raw materials, etc are some of the reasons which prevent new firms from entering into industry. Only those firms enter into the industry which are able to cross these barriers.

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Features of Oligopoly4. Importance of advertising and selling costs: In an oligopoly

market, firms have to employ various aggressive and defensive marketing weapons to gain a greater share in the market or to prevent a fall in their market share. For this various firms have to incur a good deal of costs on advertising and on other measures of sales promotion.

• Under perfect competition, advertising by an individual firm is unnecessary. A monopolist may perhaps advertise when he has to inform the public about his introduction of a new model of his product or he may advertise in order to attract potential consumers who have not yet tried his product. Under monopolistic competition advertising plays an important role because of the product differentiation that exists under it, but not as much important as under oligopoly.

• Under oligopoly, advertising can become a life-and-death matter where a firm which fails to keep up with the advertising budget of its competitors may find its customers drifting off to rival products.

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Types of Oligopoly1. Pure or Perfect Oligopoly: If the firms produce homogeneous products, then it is called pure or perfect oligopoly. Though, it is rare to find pure oligopoly situation, yet, cement, steel, aluminum and chemicals producing industries approach pure oligopoly.2. Imperfect or Differentiated Oligopoly: If the firms produce differentiated products, then it is called differentiated or imperfect oligopoly. For example, cigarettes or soft drinks. The goods produced by different firms have their own distinguishing characteristics, yet all of them are close substitutes of each other.3. Open Vs Closed Oligopoly: This classification is made on the basis of freedom to enter into the new industry. An open Oligopoly is the market situation wherein firm can enter into the industry any time it wants, whereas, in the case of a closed Oligopoly, there are certain restrictions that act as a barrier for a new firm to enter into the industry.

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Types of Oligopoly4. Partial Vs Full Oligopoly: This classification is done on the basis of price leadership. The partial Oligopoly refers to the market situation, wherein one large firm dominates the market and is looked upon as a price leader. Whereas in full Oligopoly, the price leadership is conspicuous by its absence.5. Collusive Vs Non-Collusive Oligopoly: This classification is made on the basis of agreement or understanding between the firms. In Collusive Oligopoly, instead of competing with each other, the firms come together and with the consensus of all fixes the price and the outputs. Eg: OPEC. Whereas in the case of a non-collusive Oligopoly, there is a lack of understanding among the firms and they compete against each other to achieve their respective targets.

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Collusive oligopoly• Collusion refers to the agreement between few firms of an

industry. It may either be formal or tacit agreement. If it is a tacit one the firms follow a secret agreement. Here there is no direct conduct among firms. But in a formal agreement all conditions and conducts are open. So, they take decisions jointly by a direct discussion or meeting.

Why Collusion?: Few firms in an Oligopoly industry collude on the basis of certain agreements. So, they may have the following purposes.a) Reduce the competition between themselves and increase profits.b) To create a collective or group monopoly and thereby create a barrier for new firms which want to enter to the industry.

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Pricing under perfect collusion There are two types of collusion in a oligopoly market.

1. Cartel : A oligopoly industry can be said to be cartel when all the individual firms are running on the basis of the agreements. So, each firm can earn monopoly profits by cooperating with other firms in the agreement. It may be either international or domestic cartel. Oil and Petroleum Exporting Countries (OPEC) is an example for international cartel.

2. Price Leadership: Price leadership is another form of collusion of Oligopoly firms. One firm assumes the role of a price leader and fixes the price of the product on the entire industry. All the firms in the Oligopoly industry will follow the rules fixed by the leader. Here there is no possibility of competition between leader and individual firms.

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Price LeadershipGenerally three types of price leadership can be seen-i) low cost price leadership - It can be seen in an industry where each firm produces homogenous products with various costs. So, it is easier to sell large quantity for the firm who produce with low cost. So, other firms may suffer losses. ii) Dominant price leadership - In some market, we can see that, a few firms are producing large amount of commodity and by getting huge market share. So, they will fix their own prices and related things. Here any small firm cannot influence to fix the price. So, all the firms will follow the price which fixed by the dominant firm in the industry.iii) Barometric price leadership - Here a firm acts as a leader of others. The leader considered as the large or most experienced or an old firm. Such firm has enough knowledge about market. So, all other firms follow his actions in price. It may be a low cost firm or a dominant firm.

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Demand Curve of oligopoly • The demand curve dD has a kink at a point P. Upper portion from point P is

more elastic because it is made on the assumption that when one firm changes its price, others will keep their price constant. Firm loses market share.

• Lower portion from point P is less elastic because it is made on the assumption that all the firm will change their price. Hence there will be little increase in the sale of the firms. Little gain in market share.

• When an oligopolistic firm changes its price, its rival firms will retaliate/react and change their prices which in turn effects the demand of the former firm. Therefore an oligopolistic firm can not have sure and definite demand curve, since it keeps shifting as the rivals change their prices in reaction to the price changes made by it.

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A quick comparison

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Summary

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