1. INTRODUCTION

In classical economics, market pricing is primarily determined by the

interaction of supply and demand. Price is interrelated with both of these measures

of value. The relationship between price and supply is generally negative,

meaning that the higher the price climbs, the lower amount of the supply is

demanded. Conversely, the lower the price, the greater the supply is demanded.

Price, the amount of goods for which a product is sold, may be seen as a financial

expression of the value of the product. Setting the right price is an important part

of effective marketing, being the only part of the marketing mix that generates

revenue, as product, promotion, and place are all about marketing costs. Price is

also the marketing variable that can be changed most quickly.

For a consumer, price is the monetary expression of the value to be

enjoyed/benefits of purchasing a product, as compared with other available items.

A customer’s motivation to purchase a product comes firstly from a need and a

want. The second motivation comes from a perception of the value of a product in

satisfying that need/want. The perception of the value of a product varies from

customer to customer, because perceptions of benefits and costs vary. Perceived

benefits are often largely dependent on personal taste. In order to obtain the

maximum possible value from the available market, businesses try to segment the

market – that is to divide up the market into groups of consumers whose

preferences are broadly similar – and to adapt their products to attract these

customers.

In general, a products perceived value may be increased in one of two ways –

either by increasing the benefits that the product will deliver or by reducing the

cost. For consumers, the price of a product is the most obvious indicator of cost

hence the need to get product pricing right.

This report focuses on Natural Price, Market Price and the relationship between

them. It also discusses standard market forms – Monopoly, Oligopoly and Perfect

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Competition. In economics Natural price is the price for a good or service that is

equal to the cost of production whereas market price is the economic price for

which a good or service is offered in the marketplace. It is of interest mainly in the

study of microeconomics. There are four basic types of market structures by

traditional economic analysis: perfect competition, monopolistic competition,

oligopoly and monopoly. A monopoly is a market structure in which a single

supplier produces and sells a given product. An oligopoly is a market dominated

by a few large suppliers. In economic theory, perfect competition describes

markets such that no participants are large enough to have the market to set the

price of a homogeneous product.

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2. NATURAL PRICE AND MARKET PRICE

2.1. NATURAL PRICE

There is in every society an ordinary or average rate both of wages and

profit in every different employment of labour and stock. This rate is naturally

regulated, partly by the general circumstances of the society, their riches or

poverty, their advancing, stationary, or declining condition; and partly by the

particular nature of each employment. Similarly there is an average rate of rent,

which is regulated, partly by the general circumstances of the society or

neighbourhood in which the land is situated, and partly by the natural or improved

fertility of the land. These average rates may be called the natural rates of wages,

profit, and rent, at the time and place in which they commonly prevail.

When the price of any commodity is neither more nor less than what is sufficient

to pay the rent of the land, the wages of the labour, and the profits of the stock

employed in raising, preparing, and bringing it to market, according to their

natural rates, the commodity is then sold for what may be called its natural price.

The commodity is then sold precisely for what it is worth, or for what it really

costs the person who brings it to market. It does not comprehend the profit of the

person who is to sell it again, if he sells it at a price which does not allow him the

ordinary rate of profit in his neighbourhood, he is evidently a loser by the trade, as

by employing his stock in some other way he might have made that profit. His

profit, besides, is his revenue, the proper fund of his subsistence. As he is

preparing and bringing the goods to market, he advances to his workmen their

wages, or their subsistence; so he advances to himself, in the same manner, his

own subsistence, which is generally suitable to the profit which he may

reasonably expect from the sale of his goods. Unless they yield him this profit,

they do not repay him what they may have really cost him.

Though the price, therefore, which leaves him this profit, is not always the lowest

at which a dealer may sometimes sell his goods, it is the lowest at which he is

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likely to sell them for any considerable time, at least where there is perfect liberty,

or where he may change his trade as often as he pleases.

The natural price itself varies with the natural rate of each of its component parts,

of wages, profit, and rent; and in every society this rate varies according to their

circumstances, according to their riches or poverty, their advancing, stationary, or

declining condition.

The natural price of labour is that price which is necessary to enable the labourers,

to subsist and to perpetuate their race.The power of the labourer to support

himself, and the family which may be necessary to keep up the number of

labourers, does not depend on the quantity of money which he may receive for

wages, but on the quantity of food, necessaries, and conveniences become

essential to him from habit, which that money will purchase. The natural price of

labour, therefore, depends on the price of the food, necessaries, and conveniences

required for the support of the labourer and his family. With a rise in the price of

food and necessaries, the natural price of labour will rise, with the fall in their

price, the natural price of labour will fall.

With the progress of society the natural price of labour has always a tendency to

rise, because one of the principal commodities by which its natural price is

regulated, has a tendency to become dearer, from the greater difficulty of

producing it. However, the improvements in agriculture, the discovery of new

markets, may for a time counteract the tendency to a rise in the price of

necessaries, and may even occasion their natural price to fall, so will the same

causes produce the correspondent effects on the natural price of labour.

The natural price of all commodities, except raw produce and labour, has a

tendency to fall, in the progress of wealth and population. Though, on one hand,

they are enhanced in real value, from the rise in the natural price of the raw

material of which they are made, this is more than counterbalanced by the

improvements in machinery, by the better division and distribution of labour, and

by the increasing skill, both in science and art of the producers.

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2.2. MARKET PRICE

The actual price at which any commodity is commonly sold is called its

Market price. It may either be above, or below, or exactly the same with its

natural price. The market price of every particular commodity is regulated by the

proportion between the quantity which is actually brought to market, and the

demand of those who are willing to pay the natural price of the commodity, or the

whole value of the rent, labour, and profit, which must be paid in order to bring it

to market. Such people may be called the effectual demanders, and their demand

the effectual demand, since it may be sufficient to effectuate the bringing of the

commodity to market. It is different from the absolute demand. A very poor man

may be said in some sense to have a demand for a coach and six, he might like to

have it, but his demand is not an effectual demand, as the commodity can never be

brought to market in order to satisfy it.

When the quantity of any commodity which is brought to market falls short of the

effectual demand, all those who are willing to pay the whole value of the rent,

wages, and profit, which must be paid in order to bring it , cannot be supplied with

the quantity which they want. Rather than want it altogether, some of them will be

willing to give more. A competition will immediately begin among them, and the

market price will rise more or less above the natural price, according as either the

greatness of the deficiency. The wealth and want on luxury of the competitors

happen to animate more or less the eagerness of the competition. Among

competitors of equal wealth and luxury the same deficiency will generally

occasion a more or less eager competition, according as the acquisition of the

commodity happens to be of more or less importance to them.

When the quantity brought to market exceeds the effectual demand, it cannot be

all sold to those who are willing to pay the whole value of the rent, wages, and

profit, which must be paid in order to bring it. Some part must be sold to those

who are willing to pay less, and the low price which they give for it must reduce

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the price of the whole. The market price will sink more or less below the natural

price, according as the greatness of the excess increases more or less the

competition of the sellers, or according as it happens to be more or less important

to them to get immediately rid of the commodity.

The market price of labour is the price which is really paid for it, from the natural

operation of the proportion of the supply to the demand; labour is dear when it is

scarce, and cheap when it is plentiful. However much the market price of labour

may deviate from its natural price, it has, like commodities, a tendency to conform

to it.

2.3. RELATIONSHIP BETWEEN NATURAL PRICE

AND MARKET PRICE

When the quantity brought to market is just sufficient to supply the

effectual demand, and no more, the market price naturally comes to be either

exactly, or as nearly the same with the natural price. The whole quantity upon

hand can be disposed of for this price, and cannot be disposed of for more. The

competition of the different dealers obliges them all to accept of this price, but

does not oblige them to accept of less.

The quantity of every commodity brought to market naturally suits itself to the

effectual demand. It is the interest of all those who employ their land, labour, or

stock, in bringing any commodity to market, that the quantity never should exceed

the effectual demand and it is the interest of all other people that it never should

fall short of that demand. If at any time it exceeds the effectual demand, some of

the component parts of its price must be paid below their natural rate. If it is rent,

the interest of the landlords will immediately prompt them to withdraw a part of

their land and if it is wages or profit, the interest of the labourers in the one case,

and of their employers in the other, will prompt them to withdraw a part of their

labour or stock from this employment. The quantity brought to market will soon

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be no more than sufficient to supply the effectual demand. All the different parts

of its price will rise to their natural rate, and the whole price to its natural price.

If, on the contrary, the quantity brought to market should at any time fall short of

the effectual demand, some of the component parts of its price must rise above

their natural rate. If it is rent, the interest of all other landlords will naturally

prompt them to prepare more land for the raising of this commodity, if it is wages

or profit, the interest of all other labourers and dealers will soon prompt them to

employ more labour and stock in preparing and bringing it to market. The quantity

brought will soon be sufficient to supply the effectual demand. All the different

parts of its price will soon sink to their natural rate, and the whole price to its

natural price.

When the market price of labour exceeds its natural price, that the condition of the

labourer is flourishing and happy, that he has it in his power to command a greater

proportion of the necessaries and enjoyments of life, and therefore to rear a

healthy and numerous family. When, however, by the encouragement with high

wages give to the increase of population, the number of labourers is increased,

wages again fall to their natural price, and indeed from a reaction sometimes fall

below it. When the market price of labour is below its natural price, the condition

of the labourers is most wretched. Poverty deprives them of those comforts which

custom renders absolute necessaries. It is only after their privations have reduced

their number, or the demand for labour has increased, that the market price of

labour will rise to its natural price, and that the labourer will have the moderate

comforts which the natural rate of wages will afford.

The natural price therefore, is the central price, to which the prices of all

commodities are continually gravitating. Different accidents may sometimes keep

them suspended a good deal above it, and sometimes force them down even

somewhat below it. But whatever may be the obstacles which hinder them from

settling in this centre of repose and continuance, they are constantly tending

towards it.

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3. STANDARD MARKET FORMS

There are four basic types of market structures by traditional economic

analysis: Monopoly, Oligopoly, Perfect competition and Monopolistic

competition.

A monopoly is a market structure in which a single supplier produces and sells a

given product. If there is a single seller in a certain industry and there are not any

close substitutes for the product, then the market structure is that of a "Pure

Monopoly".

Sometimes, there are many sellers in an industry and/or there exist many close

substitutes for the goods being produced, but nevertheless companies retain some

market power. This is termed monopolistic competition, whereas by oligopoly the

companies interact strategically.

Economists assume that there are a number of different buyers and sellers in the

marketplace. This means that we have competition in the market, which allows

price to change in response to changes in supply and demand. For almost every

product there are substitutes, so if one product becomes too expensive, a buyer

can choose a cheaper substitute instead. In a market with many buyers and sellers,

both the consumer and the supplier have equal ability to influence price. 

In some industries, there are no substitutes and there is no competition. In a

market that has only one or few suppliers of a good or service, the producer(s) can

control price, meaning that a consumer does not have choice, cannot maximize his

or her total utility and has have very little influence over the price of goods. 

A monopoly is a market structure in which there is only one producer/seller for a

product. In other words, the single business is the industry. Entry into such a

market is restricted due to high costs or other impediments, which may be

economic, social or political. For instance, a government can create a monopoly

over an industry that it wants to control, such as electricity. Another reason for the

barriers against entry into a monopolistic industry is that oftentimes, one entity

has the exclusive rights to a natural resource. For example, in Saudi Arabia the

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government has sole control over the oil industry. A monopoly may also form

when a company has a copyright or patent that prevents others from entering the

market. Pfizer, for instance, had a patent on Viagra. 

In an oligopoly, there are only a few firms that make up an industry. This select

group of firms has control over the price and like a monopoly, an oligopoly has

high barriers to entry. The products that the oligopolistic firms produce are

often nearly identical and therefore the companies which are competing for

market share are interdependent as a result of market forces.

There are two extreme forms of market structure: monopoly and, its

opposite, perfect competition. Perfect competition is characterized by many

buyers and sellers, many products that are similar in nature and, as a result, many

substitutes. Perfect competition means there are few, if any, barriers to entry for

new companies, and prices are determined by supply and demand. Thus,

producers in a perfectly competitive market are subject to the prices determined

by the market and do not have any leverage. For example, in a perfectly

competitive market, should a single firm decide to increase its selling price of a

good, the consumers can just turn to the nearest competitor for a better price,

causing any firm that increases its prices to lose market share and profits. 

3.1. Monopoly

A monopoly exists when a specific person or enterprise is the only supplier

of a particular commodity. Monopolies are thus characterized by a lack of

economic competition to produce the good or service and a lack of

viable substitute goods. The verb "monopolize" refers to the process by which a

company gains the ability to raise prices or exclude competitors. In economics, a

monopoly is a single seller. In law, a monopoly is a business entity that has

significant market power, that is, the power, to charge high prices. Although

monopolies may be big businesses, size is not a characteristic of a monopoly. A

small business may still have the power to raise prices in a small industry (or

market).

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A monopoly is distinguished from a monopsony, in which there is only

one buyer of a product or service; a monopoly may also have monopsony control

of a sector of a market. Likewise, a monopoly should be distinguished from

a cartel (a form of oligopoly), in which several providers act together to

coordinate services, prices or sale of goods. Monopolies, monopsonies and

oligopolies are all situations such that one or a few of the entities have market

power and therefore interact with their customers (monopoly), suppliers

(monopsony) and the other companies (oligopoly) in ways that leave market

interactions distorted.

When not coerced legally to do otherwise, monopolies typically maximize their

profit by producing fewer goods and selling them at higher prices than would be

the case for perfect competition. Monopolies can be established by a government,

form naturally, or form by integration.

In many jurisdictions, competition laws restrict monopolies. Holding a dominant

position or a monopoly of a market is not illegal in itself, however certain

categories of behaviour can, when a business is dominant, be considered abusive

and therefore incur legal sanctions. A government-granted monopoly or legal

monopoly, by contrast, is sanctioned by the state, often to provide an incentive to

invest in a risky venture or enrich a domestic interest group. Patents, copyright,

and trademarks are sometimes used as examples of government granted

monopolies, but they rarely provide market power. The government may also

reserve the venture for itself, thus forming a government monopoly

Characteristics of monopoly

Profit Maximizer: Maximizes profits.

Price Maker: Decides the price of the good or product to be sold.

High Barriers to Entry: Other sellers are unable to enter the market of the

monopoly.

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Single seller: In a monopoly, there is one seller of the good that produces all

the output. Therefore, the whole market is being served by a single company.

Price Discrimination: A monopolist can change the price and quality of the

product. He sells more quantities charging fewer prices for the product in a

very elastic market and sells less quantities charging high price in a less

elastic market.

Formation of monopolies

Monopolies can form for a variety of reasons, including the following:

I. If a firm has exclusive ownership of a scarce resource, such as Microsoft

owning the Windows operating system brand, it has monopoly power over

this resource and is the only firm that can exploit it.

II. Governments may grant a firm monopoly status, such as with the Post

Office, which was given monopoly status by Oliver Cromwell in 1654.

The Royal Mail Group finally lost its monopoly status in 2006, when the

market was opened up to competition.

III. Producers may have patents over designs, or copyright over ideas,

characters, images, sounds or names, giving them exclusive rights to sell a

good or service, such as a song writer having a monopoly over their own

material.

IV. A monopoly could be created following the merger of two or more firms.

Given that this will reduce competition, such mergers are subject to close

regulation and may be prevented if the two firms gain a combined market

share of 25% or more.

Sources of monopoly power

Monopolies derive their market power from barriers to entry – circumstances that

prevent or greatly impede a potential competitor's ability to compete in a market.

There are three major types of barriers to entry; economic, legal and deliberate.

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Economic barriers: Economic barriers include economies of scale, capital

requirements, cost advantages and technological superiority.

Economies of scale: Monopolies are characterised by decreasing costs for a

relatively large range of production. Decreasing costs coupled with large

initial costs give monopolies an advantage over would-be competitors.

Monopolies are often in a position to reduce prices below a new entrant's

operating costs and thereby prevent them from continuing to compete.

Capital requirements: Production processes that require large investments of

capital, or large research and development costs or substantial sunk costs limit

the number of companies in an industry. Large fixed costs also make it

difficult for a small company to enter an industry and expand.

Technological superiority: A monopoly may be better able to acquire,

integrate and use the best possible technology in producing its goods while

entrants do not have the size or finances to use the best available technology.

One large company can sometimes produce goods cheaper than several small

companies.

No substitute goods: A monopoly sells a good for which there is no close

substitute. The absence of substitutes makes the demand for the good

relatively inelastic enabling monopolies to extract positive profits.

Control of natural resources: A prime source of monopoly power is the

control of resources that are critical to the production of a final good.

Network externalities: The use of a product by a person can affect the value

of that product to other people. This is the network effect. There is a direct

relationship between the proportion of people using a product and the demand

for that product. In other words the more people who are using a product the

greater the probability of any individual starting to use the product. This effect

accounts for fads and fashion trends. It also can play a crucial role in the

development or acquisition of market power. The most famous current

example is the market dominance of the Microsoft operating system in

personal computers.

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Legal barriers: Legal rights can provide opportunity to monopolise the

market of a good. Intellectual property rights, including patents and

copyrights, give a monopolist exclusive control of the production and selling

of certain goods.

Deliberate actions: A company wanting to monopolise a market may engage

in various types of deliberate action to exclude competitors or eliminate

competition. Such actions include collusion, lobbying governmental

authorities, and force.

Types of monopolies

I. Natural monopoly

A natural monopoly is a company that experiences increasing returns to

scale over the relevant range of output and relatively high fixed costs. A

natural monopoly occurs where the average cost of production "declines

throughout the relevant range of product demand". The relevant range of

product demand is where the average cost curve is below the demand

curve. When this situation occurs, it is always cheaper for one large company

to supply the market than multiple smaller companies; in fact, absent

government intervention in such markets, will naturally evolve into a

monopoly. An early market entrant that takes advantage of the cost structure

and can expand rapidly can exclude smaller companies from entering and can

drive or buy out other companies. A natural monopoly suffers from the same

inefficiencies as any other monopoly. Regulation of natural monopolies is

problematic. Fragmenting such monopolies is by definition inefficient. The

most frequently used methods dealing with natural monopolies are

government regulations and public ownership.

II. Government-granted monopoly

A government-granted monopoly is a form of coercive monopoly by which a

government grants exclusive privilege to a private individual or company to

be the sole provider of a commodity; potential competitors are excluded from

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the market by law, regulation, or other mechanisms of government

enforcement.

III. Bilateral monopoly

In a bilateral monopoly there is both a monopoly (a single seller)

and monopsony (a single buyer) in the same market.

In such, market price and output will be determined by forces like bargaining

power of both buyer and seller.

An example of a bilateral monopoly would be when a labor union (a

monopolist in the supply of labor) faces a single large employer in a factory

town (a monopsonist). A peculiar one exists in the market for nuclear-powered

aircraft carriers in the United States, where the buyer (the United States Navy)

is the only one demanding the product, and there is only one seller (Huntington

Ingalls Industries) by stipulation of the regulations promulgated by the buyer's

parent organization (the United States Department of Defense, which has thus

far not licensed any other firm to manufacture, overhaul, or decommission.

IV. Complementary monopoly

In a complementary monopoly, consent must be obtained from more than one

agent in order to obtain the good. This leads to a reduction in surplus generated

relative to an outright monopoly, if the two agents do not cooperate. This can

be seen in private toll roads where more than one operator controls a different

section of the road. The solution is for one agent to purchase all sections of the

road. Complementary goods are a less extreme form of this effect. In this case,

one good is still of value even if the other good is not obtained.

Monopoly and efficiency

According to the standard model, in which a monopolist sets a single price for all

consumers, the monopolist will sell a lesser quantity of goods at a higher price

than would companies by perfect competition. Because the monopolist ultimately

forgoes transactions with consumers who value the product or service more than

its cost, monopoly pricing creates a deadweight loss referring to potential gains

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that went neither to the monopolist nor to consumers. Given the presence of this

deadweight loss, the combined surplus (or wealth) for the monopolist and

consumers is necessarily less than the total surplus obtained by consumers by

perfect competition. Where efficiency is defined by the total gains from trade, the

monopoly setting is less efficient than perfect competition.

It is often argued that monopolies tend to become less efficient and less innovative

over time, becoming "complacent", because they do not have to be efficient or

innovative to compete in the marketplace. Sometimes this very loss of

psychological efficiency can increase a potential competitor's value enough to

overcome market entry barriers, or provide incentive for research and investment

into new alternatives.

Examples of monopolies

Global

The salt commission, a legal monopoly in China formed in 758.

The British Honourable East India Company; created as a legal trading

monopoly in 1600.

Netherlands East India Company; created as a legal trading monopoly in 1602.

Western Union was criticized as a "price gouging" monopoly in the late 19th

century.

Standard Oil; broken up in 1911, two of its surviving "child" companies

are ExxonMobil and the Chevron Corporation.

U.S. Steel; anti-trust prosecution failed in 1911.

United Aircraft and Transport Corporation; aircraft manufacturer holding

company forced to divest itself of airlines in 1934.

American Telephone & Telegraph; telecommunications giant broken up in

1984.

Microsoft; settled anti-trust litigation in the U.S. in 2001; fined 493 million

euros by the European Commission in 2004 which was upheld for the most

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part by the Court of First Instance of the European Communities in 2007. The

fine was 1.35 Billion USD in 2008 for noncompliance with the 2004 rule.

Indian

Indian Railways has monopoly in Railroad transportation

State Electricity board have monopoly over generation and distribution of

electricity in many of the states.

Hindustan Aeronautics Limited has monopoly over production of aircraft.

There is Government monopoly over production of nuclear power.

Operation of bus transportation within many cities.

Land line telephone service in most of the country is provided only by the

government run BSNL

Laws in India against monopoly

India has been very conscious about the competition in the market place and

has been vigilant to frame laws curtailing monopolies and restrictive trade

practices The Monopolies & Restrictive Trade Practices Act, 1969 is the first

enactment to deal with competition issues and came into effect on 1st June

1970.

The Government had appointed a committee in October 1999 to examine the

existing MRTP Act for shifting the focus of the law from curbing monopolies

to promoting competition and to suggest a modern competition law. Pursuant

to the recommendations of this committee, the Competition Act, 2002, was

enacted on 13th January 2003. The objectives of the Competition Act are to

prevent anti-competitive practices, promote and sustain competition, protect

the interests of the consumers and ensure freedom of trade. This Act provides

for different notifications for making different provisions of the Act effective.

ADVANTAGES OF MONOPOLIES

Monopolies can be defended on the following grounds:

I. They can benefit from economies of scale, and may be ‘natural’ monopolies,

so it may be argued that it is best for them to remain monopolies to avoid the

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wasteful duplication of infrastructure that would happen if new firms were

encouraged to build their own infrastructure.

II. Domestic monopolies can become dominant in their own territory and then

penetrate overseas markets, earning a country valuable export revenues. This

is certainly the case with Microsoft.

III. It has been consistently argued by some economists that monopoly power is

required to generate dynamic efficiency, that is, technological progressiveness.

This is because:

IV. High profit levels boost investment in R&D.

V. Innovation is more likely with large enterprises and this innovation can

lead to lower costs than in competitive markets.

VI. A firm needs a dominant position to bear the risks associated with innovation.

VII. Firms need to be able to protect their intellectual property by

establishing barriers to entry; otherwise, there will be a free rider problem.

VIII. If some of the profits are invested in new technology, costs are reduced via

process innovation. The result is lower price and higher output in the long run.

DISADVANTAGES OF MONOPOLY TO THE CONSUMER

Monopolies can be criticised because of their potential negative effects on the

consumer, including:

I. Restricting output onto the market.

II. Charging a higher price than in a more competitive market.

III. Reducing consumer surplus and economic welfare.

IV. Restricting choice for consumers.

V. Reducing consumer sovereignty.

MONOPOLY VERSUS COMPETITIVE MARKETS

While monopoly and perfect competition mark the extremes of market

structures there is some similarity. The cost functions are the same. Both

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monopolies and perfectly competitive companies minimize cost and maximize

profit. The shutdown decisions are the same. Both are assumed to have perfectly

competitive factors markets. There are distinctions, some of the more important of

which are as follows:

Marginal revenue and price: In a perfectly competitive market, price equals

marginal cost. In a monopolistic market, however, price is set above marginal

cost.

Product differentiation: There is zero product differentiation in a perfectly

competitive market. Every product is perfectly homogeneous and a perfect

substitute for any other. With a monopoly, there is great to absolute product

differentiation in the sense that there is no available substitute for a

monopolized good. The monopolist is the sole supplier of the good in

question. A customer either buys from the monopolizing entity on its terms or

does without.

Number of competitors: PC markets are populated by an infinite number of

buyers and sellers. Monopoly involves a single seller.

Barriers to Entry: Barriers to entry are factors and circumstances that prevent

entry into market by would-be competitors and limit new companies from

operating and expanding within the market. PC markets have free entry and

exit. There are no barriers to entry, exit or competition. Monopolies have

relatively high barriers to entry. The barriers must be strong enough to prevent

or discourage any potential competitor from entering the market.

Excess Profits: Excess or positive profits are profit more than the normal

expected return on investment. A PC company can make excess profits in the

short term but excess profits attract competitors, which can enter the market

freely and decrease prices, eventually reducing excess profits to zero. A

monopoly can preserve excess profits because barriers to entry prevent

competitors from entering the market.

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Supply Curve: in a perfectly competitive market there is a well-defined

supply function with a one to one relationship between price and quantity

supplied. In a monopolistic market no such supply relationship exists. A

monopolist cannot trace a short term supply curve because for a given price

there is not a unique quantity supplied. 

3.2. OLIGOPOLY

An oligopoly is a market dominated by a few large suppliers. The degree

of market concentration is very high (i.e. a large % of the market is taken up by

the leading firms). Firms within an oligopoly produce branded products

(advertising and marketing is an important feature of competition within such

markets) and there are also barriers to entry.

Another important characteristic of an oligopoly is interdependence between

firms. This means that each firm must take into account the likely reactions of

other firms in the market when making pricing and investment decisions. This

creates uncertainty in such markets - which economists seek to model through the

use of game theory.

Economics is much like a game in which the players anticipate one another's

moves. Game theory may be applied in situations in which decision makers must

take into account the reasoning of other decision makers. It has been used, for

example, to determine the formation of political coalitions or business

conglomerates, the optimum price at which to sell products or services, the best

site for a manufacturing plant, and even the behaviour of certain species in the

struggle for survival.

The on-going interdependence between businesses can lead to implicit and

explicit collusion between the major firms in the market. Collusion occurs when

businesses agree to act as if they were in a monopoly position.

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CHARACTERISTICS

Profit maximization conditions: An oligopoly maximizes profits by

producing where marginal revenue equals marginal costs.

Ability to set price: Oligopolies are price setters rather than price takers.

Entry and exit: Barriers to entry are high. The most important barriers are

economies of scale, patents, access to expensive and complex technology, and

strategic actions by incumbent firms designed to discourage or destroy nascent

firms. Additional sources of barriers to entry often result from government

regulation favouring existing firms making it difficult for new firms to enter

the market.

Number of firms: "Few" – a "handful" of sellers. There are so few firms that

the actions of one firm can influence the actions of the other firms.

Long run profits: Oligopolies can retain long run abnormal profits. High

barriers of entry prevent side-line firms from entering market to capture excess

profits.

Product differentiation: Product may be homogeneous (steel) or

differentiated (automobiles).

Perfect knowledge: Assumptions about perfect knowledge vary but the

knowledge of various economic factors can be generally described as

selective. Oligopolies have perfect knowledge of their own cost and demand

functions but their inter-firm information may be incomplete. Buyers have

only imperfect knowledge as to price, cost and product quality.

Interdependence: The distinctive feature of an oligopoly is

interdependence. Oligopolies are typically composed of a few large firms.

Each firm is so large that its actions affect market conditions. Therefore the

competing firms will be aware of a firm's market actions and will respond

appropriately. This means that in contemplating a market action, a firm must

take into consideration the possible reactions of all competing firms and the

firm's countermoves. It is very much like a game of chess or pool in which a

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player must anticipate a whole sequence of moves and countermoves in

determining how to achieve his or her objectives. For example, an oligopoly

considering a price reduction may wish to estimate the likelihood that

competing firms would also lower their prices and possibly trigger a ruinous

price war. Or if the firm is considering a price increase, it may want to know

whether other firms will also increase prices or hold existing prices constant.

This high degree of interdependence and need to be aware of what other firms

are doing or might do is to be contrasted with lack of interdependence in other

market structures. In a perfectly competitive (PC) market there is zero

interdependence because no firm is large enough to affect market price. All

firms in a PC market are price takers, as current market selling price can be

followed predictably to maximize short-term profits. In a monopoly, there are

no competitors to be concerned about. In a monopolistically-competitive

market, each firm's effects on market conditions are so negligible as to be

safely ignored by competitors.

Non-Price Competition: Oligopolies tend to compete on terms other than

price. Loyalty schemes, advertisement, and product differentiation are all

examples of non-price competition.

MODELING

There is no single model describing the operation of an oligopolistic market. The

variety and complexity of the models is because you can have two to 10 firms

competing on the basis of price, quantity, technological innovations, marketing,

advertising and reputation. Fortunately, there are a series of simplified models that

attempt to describe market behaviour under certain circumstances. Some of the

better-known models are the dominant firm model, the Cournot-Nash model,

the Bertrand model and the kinked demand model.

Key Features of Oligopoly

A few firms selling similar product

Each firm produces branded products

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Likely to be significant entry barriers into the market in the long run which

allows firms to make supernormal profits.

Interdependence between competing firms. Businesses have to take into

account likely reactions of rivals to any change in price and output

THEORIES ABOUT OLIGOPOLY PRICING

There are four major theories about oligopoly pricing:

I. Oligopoly firms collaborate to charge the monopoly price and get monopoly

profits

II. Oligopoly firms compete on price so that price and profits will be the same as

a competitive industry 

III. Oligopoly price and profits will be between the monopoly and competitive

ends of the scale 

IV. Oligopoly prices and profits are "indeterminate" because of the difficulties in

modelling interdependent price and output decisions

IMPORTANCE OF PRICE AND NON-PRICE COMPETITION

Firms compete for market share and the demand from consumers in lots of ways.

We make an important distinction between price competition and non-price

competition. Price competition can involve discounting the price of a product (or a

range of products) to increase demand. 

Non-price competition focuses on other strategies for increasing market share.

Consider the example of the highly competitive UK supermarket industry where

non-price competition has become very important in the battle for sales

Mass media advertising and marketing 

Store Loyalty cards 

Banking and other Financial Services (including travel insurance) 

In-store chemists / post offices / crèches 

Home delivery systems 

Discounted petrol at hyper-markets 

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Extension of opening hours (24 hour shopping in many stores) 

Innovative use of technology for shoppers including self-scanning

machines

Financial incentives to shop at off-peak times 

Internet shopping for customers

PRICE LEADERSHIP IN OLIGOPOLISTIC MARKETS

When one firm has a dominant position in the market the oligopoly may

experience price leadership. The firms with lower market shares may simply

follow the pricing changes prompted by the dominant firms. We see examples of

this with the major mortgage lenders and petrol retailers.

COMPARISON BETWEEN MONOPOLY AND OLIGOPOLY

Monopoly and oligopoly are economic market conditions. Monopoly is defined by

the dominance of just one seller in the market; oligopoly is an economic situation

where a number of sellers populate the market.

COMPARISON CHART

Domains Monopoly Oligopoly

MeaningAn economic market condition where

one seller dominates the entire market.An economic market condition where

numerous sellers have their presence in

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one single market.

Characteristics

A single firm controls a large market

share in the industry, thereby gaining

the ability to set price.

A small number of firms dominate the

industry. These firms compete with each

other based on product differentiation,

price, customer service etc.

PricesHigh prices may be charged since there

is no competition

Moderate/fair pricing due to competition

in market. But much higher than perfect

competition(where there is a large number

of buyers and sellers)

Sources of

Power

Market making ability by virtue of

being virtually the only viable seller in

the industry.

Market making ability because of very

few firms in the industry. Each firm can

therefore significantly influence the

market by setting price or production

quantity.

Barriers to

entry

A monopoly usually exists when

barriers to entry are very high - either

due to technology, patents, distribution

overheads, government regulation or

capital-intensive nature of the industry.

Barriers to entry are very high as it is

difficult to enter the industry because of

economies of scale.

Examples

Microsoft (Operating systems,

productivity suites), Google (web

search,

search advertising),DeBeers (diamonds)

, Monsanto (seeds), Long Island Rail

Road etc.

Health insurers, wireless carriers, beer

(Anheuser-Busch and MillerCoors),

media (TV broadcasting, book publishing,

movies) etc.

CHARACTERISTICS

Monopolistic markets are controlled by one seller only. The seller here has the

power to influence market prices and decisions. Consumers have limited

choices and have to choose from what is supplied. The monopolist asserts all the

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power while the consumer is left with no choice. This market condition usually

arises from mergers, take-overs and acquisitions.

Oligopoly, on the other hand, is a market condition where numerous sellers co-

exist in the market place. This market situation is very consumer-friendly because

it induces competition amongst sellers. Competition in turn ensures moderate

prices and numerous choices for consumers. A decision taken by one seller in an

oligopolistic market has a direct effect on the functioning of other sellers.

SOURCES OF POWER

A monopolistic market derives its power through three

sources: economic, legal and deliberate. A monopolistic entity will use the

position it is in to its advantage and drive out competitors either by reducing

prices to such an extent that survival for another seller may become impossible or

by virtue of economic conditions like large capital requirement for start-up

companies. Legal barriers like intellectual property rights also help a monopolistic

entity retain its power. Deliberate attempts for monopolistic markets would

include collusion, lobbying governmental authorities etc.

Though an oligopolistic market does not have any sources of power, it comes into

existence solely due to the accommodating nature of other sellers.

Prices

A monopolistic market may quote high prices. Since there is no other competitor

to fear from, the sellers will use their status of dominance and maximize their

profits.

Oligopoly markets on the other hand, ensure competitive hence fair prices for the

consumer.

Examples

Four music companies control 80% of the market - Universal Music Group, Sony Music Entertainment, Warner Music Group and EMI Group

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Six major book publishers - Random House, Pearson, Hachette, HarperCollins, Simon & Schuster and Holtzbrinck

Four breakfast cereal manufacturers - Kellogg, General Mills, Post and Quaker

Two major producers in the beer industry - Anheuser-Busch and MillerCoors

Two major providers in the healthcare insurance market - Anthem and Kaiser Permanente

3.3. Perfect competition

In economic theory,  perfect competition  (sometimes called pure

competition) describes markets such that no participants are large enough to have

the market to set the price of a homogeneous product. Because the conditions for

perfect competition are strict, there are few if any perfectly competitive markets.

Still, buyers and sellers in some auction-type markets say for commodities or

some financial assets may approximate the concept. Perfect competition serves as

a benchmark against which we can measure real-life and imperfectly

competitive markets.

The degree to which a market or industry can be described as competitive depends

in part on how many suppliers are seeking the demand of consumers and the ease

with which new businesses can enter and exit a particular market in the long run.

The spectrum of competition ranges from highly competitive markets where there

are many sellers, each of whom has little or no control over the market price - to a

situation of pure monopoly where a market or an industry is dominated by one

single supplier who enjoys considerable discretion in setting prices, unless subject

to some form of direct regulation by the government.

In many sectors of the economy markets are best described by the term oligopoly -

where a few producers dominate the majority of the market and the industry is

highly concentrated. In a duopoly two firms dominate the market although there

may be many smaller players in the industry.

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BASIC STRUCTURAL CHARACTERISTICS

Generally, a perfectly competitive market exists when every participant is a "price

taker", and no participant influences the price of the product it buys or sells.

Specific characteristics may include:

Infinite buyers and sellers – An infinite number of consumers with the

willingness and ability to buy the product at a certain price, and infinite

producers with the willingness and ability to supply the product at a certain

price.

Zero entry and exit barriers – A lack of entry and exit barriers makes it

extremely easy to enter or exit a perfectly competitive market.

Perfect factor mobility – In the long run factors of production are perfectly

mobile, allowing free long term adjustments to changing market conditions.

Perfect information - All consumers and producers are assumed to have

perfect knowledge of price, utility, quality and production methods of

products.

Zero transaction costs - Buyers and sellers do not incur costs in making an

exchange of goods in a perfectly competitive market.

Profit maximization - Firms are assumed to sell where marginal costs meet

marginal revenue, where the most profit is generated.

Homogenous products - The qualities and characteristics of a market good or

service do not vary between different suppliers.

Non-increasing returns to scale - The lack of increasing returns to scale (or

economies of scale) ensures that there will always be a sufficient number of

firms in the industry.

Property rights - Well defined property rights determine what may be sold,

as well as what rights are conferred on the buyer.

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In the short run, perfectly-competitive markets are not productively efficient as

output will not occur where marginal cost is equal to average cost (MC=AC).

They are allocatively efficient, as output will always occur where marginal cost is

equal to marginal revenue (MC=MR). In the long run, perfectly competitive

markets are both allocatively and productively efficient.

In perfect competition, any profit-maximizing producer faces a market price equal

to its marginal cost (P=MC). This implies that a factor's price equals the factor's

marginal revenue product. It allows for derivation of the supply curve on which

the neoclassical approach is based. This is also the reason why "a monopoly does

not have a supply curve". The abandonment of price taking creates considerable

difficulties for the demonstration of a general equilibrium except under other, very

specific conditions such as that of monopolistic competition.

ASSUMPTIONS BEHIND A PERFECTLY COMPETITIVE MARKET

I. Many suppliers each with an insignificant share of the market – this

means that each firm is too small relative to the overall market to affect

price via a change in its own supply – each individual firm is assumed to

be a price taker.

II. An identical output produced by each firm – in other words, the market

supplies homogeneous or standardised products that are perfect substitutes

for each other. Consumers perceive the products to be identical

III. Consumers have perfect information about the prices all sellers in the

market charge – so if some firms decide to charge a price higher than the

ruling market price, there will be a large substitution effect away from this

firm

IV. All firms (industry participants and new entrants) are assumed to have

equal access to resources (technology, other factor inputs) and

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improvements in production technologies achieved by one firm can spill-

over to all the other suppliers in the market

V. There are assumed to be no barriers to entry & exit of firms in long run –

which means that the market is open to competition from new suppliers –

this affects the long run profits made by each firm in the industry. The

long run equilibrium for a perfectly competitive market occurs when the

marginal firm makes normal profit only in the long term

VI. No externalities in production and consumption so that there is no

divergence between private and social costs and benefits

SHORT RUN PRICE AND OUTPUT FOR THE COMPETITIVE

INDUSTRY AND FIRM

In the short run the equilibrium market price is determined by the interaction

between market demand and market supply. In the diagram shown above, price P1

is the market-clearing price and this price is then taken by each of the firms.

Because the market price is constant for each unit sold, the AR curve also

becomes the Marginal Revenue curve (MR). A firm maximises profits when

marginal revenue = marginal cost. In the diagram above, the profit-maximising

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output is Q1. The firm sells Q1 at price P1. The area shaded is the economic

(supernormal profit) made in the short run because the ruling market price P1 is

greater than average total cost.

Not all firms make supernormal profits in the short run. Their profits depend on

the position of their short run cost curves. Some firms may be experiencing sub-

normal profits because their average total costs exceed the current market price.

Other firms may be making normal profits where total revenue equals total cost

(i.e. they are at the break-even output). In the diagram below, the firm shown has

high short run costs such that the ruling market price is below the average total

cost curve. At the profit maximising level of output, the firm is making an

economic loss (or sub-normal profits)

EFFECTS OF CHANGE IN MARKET DEMAND

In the diagram below there has been an increase in market demand (ceteris

paribus). This causes an increase in market price and quantity traded. The firm's

average revenue curve shifts up to AR2 (=MR2) and the profit maximising output

expands to Q2. Notice that the MC curve is the firm's supply curve. Higher prices

cause an expansion along the supply curve. Following the increase in demand,

total profits have increased. An inward shift in market demand would have the

opposite effect. Think also about the effect of a change in market supply - perhaps

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arising from a cost-reducing technological innovation available to all firms in a

competitive market.

LONG RUN ADJUSTMENT PROCESS

If most firms are making abnormal profits in the short run there will be an

expansion of the output of existing firms and we expect to see the entry of new

firms into the industry. Firms are responding to the profit motive and supernormal

profits act as a signal for a reallocation of resources within the market. The

addition of new suppliers causes an outward shift in the market supply curve. This

is shown in the diagram below.

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Making the assumption that the market demand curve remains unchanged, higher

market supply will reduce the equilibrium market price until the price = long run

average cost. At this point each firm is making normal profits only. There is no

further incentive for movement of firms in and out of the industry and a long-run

equilibrium has been established.

The entry of new firms shifts the market supply curve to MS2 and drives down the

market price to P2. At the profit-maximising output level Q3 only normal profits

are being made. There is no incentive for firms to enter or leave the industry. Thus

a long-run equilibrium is established.

Does perfect competition lead to economic efficiency?

Perfect competition is used as a yardstick to compare with other market structures

(such a monopoly and oligopoly) because it displays high levels of economic

efficiency. In both the short and long run, price is equal to marginal cost (P=MC)

and therefore allocate efficiency is achieved – the price that consumers are paying

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in the market reflects the factor cost of resources used up in producing / providing

the good or service.

Productive efficiency occurs when price is equal to average cost at its minimum

point. This is not achieved in the short run – firms can be operating at any point on

their short run average total cost curve, but productive efficiency is attained in the

long run because the profit maximising output is achieved at a level where

average (and marginal) revenue is tangential to the average total cost curve. The

long run of perfect competition, therefore, exhibits optimal levels of static

economic efficiency.

There is of course another form of economic efficiency – dynamic efficiency –

which relates to aspects of market competition such as the rate of innovation in a

market, the quality of output provided over time.

CONDITIONS FOR PERFECT COMPETITION

When economists analyse the production decisions of a firm, they take into

account the structure of the market in which the firm is operating. The structure of

the market is determined by four different market characteristics: the number and

size of the firms in the market, the ease with which firms may enter and exit the

market, the degree to which firms' products are differentiated, and the amount of

information available to both buyers and sellers regarding prices, product

characteristics, and production techniques.

Four characteristics or conditions must be present for a perfectly competitive

market structure to exist. First, there must be many firms in the market, none of

which is large in terms of its sales. Second, firms should be able to enter and exit

the market easily. Third, each firm in the market produces and sells a non-

differentiated or homogeneous product. Fourth, all firms and consumers in the

market have complete information about prices, product quality, and production

techniques.

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Price-taking behaviour:-A firm that is operating in a perfectly competitive market

will be a price-taker. A price-taker cannot control the price of the good it sells; it

simply takes the market price as given. The conditions that cause a market to be

perfectly competitive also cause the firms in that market to be price-takers. When

there are many firms, all producing and selling the same product using the same

inputs and technology, competition forces each firm to charge the same market

price for its good. Because each firm in the market sells the same, homogeneous

product, no single firm can increase the price that it charges above the price

charged by the other firms in the market without losing business. It is also

impossible for a single firm to affect the market price by changing the quantity of

output it supplies because, by assumption, there are many firms and each firm is

small in size.

EXAMPLES

Though there is no actual perfectly competitive market in the real world, a number

of approximations exist:

Perhaps the closest thing to a perfectly competitive market would be a large

auction of identical goods with all potential buyers and sellers present. By design,

a stock exchange resembles this, not as a complete description (for no markets

may satisfy all requirements of the model) but as an approximation. The flaw in

considering the stock exchange as an example of Perfect Competition is the fact

that large institutional investors (e.g. investment banks) may solely influence the

market price. This, of course, violates the condition that "no one seller can

influence market price".

Horse betting is also quite a close approximation. When placing bets, consumers

can just look down the line to see who is offering the best odds, and so no one

bookie can offer worse odds than those being offered by the market as a whole,

since consumers will just go to another bookie. This makes the bookies price-

takers. Furthermore, the product on offer is very homogeneous, with the only

differences between individual bets being the pay-off and the horse. Of course,

34

there are not an infinite amount of bookies, and some barriers to entry exist, such

as a license and the capital required setting up.

Free software works along lines that approximate perfect competition as well.

Anyone is free to enter and leave the market at no cost. All code is freely

accessible and modifiable, and individuals are free to behave independently. Free

software may be bought or sold at whatever price that the market may allow.

Some believe that one of the prime examples of a perfectly competitive market

anywhere in the world is street food in developing countries. This is so since

relatively few barriers to entry/exit exist for street vendors. Furthermore, there are

often numerous buyers and sellers of a given street food, in addition to

consumers/sellers possessing perfect information of the product in question. It is

often the case that street vendors may serve a homogenous product; in which little

to no variations in the product's nature exist.

EQUILIBRIUM IN PERFECT COMPETITION

Equilibrium in perfect competition is the point where market demands will be

equal to market supply. A firm's price will be determined at this point. In the short

run, equilibrium will be affected by demand. In the long run, both demand and

supply of a product will affect the equilibrium in perfect competition. A firm will

receive only normal profit in the long run at the equilibrium

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4. CONCLUSION

The market price of every particular commodity is continually gravitating,

towards the natural price, yet sometimes particular accidents, sometimes natural

causes, and sometimes particular regulations of police, may, in many

commodities, keep up the market price, for a long time together, a good deal

above the natural price.

When by an increase in the effectual demand, the market price of some particular

commodity happens to rise a good deal above the natural price, those who employ

their stocks in supplying that market are generally careful to conceal this change.

If it was commonly known, their great profit would tempt so many new rivals to

employ their stocks in the same way that, the effectual demand being fully

supplied, the market price would soon be reduced to the natural price, and perhaps

for some time even below it. If the market is at a great distance from the residence

of those who supply it, they may sometimes be able to keep the secret for several

years together, and may so long enjoy their extraordinary profits without any new

rivals. Secrets of this kind, however, it must be acknowledged, can seldom be long

kept; and the extraordinary profit can last very little longer than they are kept.

Market economies are assumed to have many buyers and sellers, high competition

and many substitutes. Monopolies characterize industries in which the supplier

determines prices and high barriers prevent any competitors from entering the

market. Oligopolies are industries with a few interdependent companies. Perfect

competition represents an economy with many businesses competing with one

another for consumer interest and profits. 

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5. REFERENCES

An Inquiry into the Nature and Causes of Wealth of Nations, by Adam Smith

(http://geolib.com/smith.adam/won1-07.html)

On The Principles of Political Economy and Taxation, by David Recardo

(http://www.marxists.org/reference/subject/economics/ricardo/tax/ch05.htm)

The monopolies and restrictive trade practises act , 1969 published by

universal law publishing co. Pvt. Ltd. (www.unilawbooks.com)

THECOMPETITION ACT,2002No. 12 OF 2003as amended by The

Competition (Amendment) Act, 2007

Goodwin, Nelson, Ackerman, & Weissskopf, Microeconomics in Context 2d

ed. (Sharpe 2009) at 307.

Samuelson & Marks, Managerial Economics 4th ed. (Wiley 2003) at 365.

Monopoly, George J. Stigler

(http://www.econlib.org/library/Enc/Monopoly.html)

Economics Basics: Monopolies, Oligopolies and Perfect Competition

(

http://www.investopedia.com/university/economics/economics6.asp#axzz2JW

o77soL)

Perfect competition – the economics of competitive market

(http://tutor2u.net/economics/content/topics/competition/competition.htm)

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Monopoly vs Oligopoly

(http://www.diffen.com/difference/Monopoly_vs_Oligopoly)

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