Unit 1 Unit 2 Unit 3 Unit 4 Theory of Firm and Market Organisation : Perfect Competition Perfect competition is a type of market structure where there are a large number of buyers and sellers each selling a product which is exactly identical at a single price. perfect competition is also characterized by perfect knowledge between the buyers and sellers about the market conditions and there is also free entry and exit the firms. Price under perfect competition is determined by aggregate demand and aggregate supply in the industry. every seller under perfect competition takes these prise as given and sales as many quantities as he can. no individual cellar can change this price. so price under perfect competition is always equal to p= AR = MR Output are the perfect competition is determined at the point marginal revenue is equal to marginal cost. every individual seller will keep on producing so long as the revenue generated from the additional unit is greater than the cost. it will stop producing at a point where marginal revenue is equal to marginal cost. In the short run a firm under perfect competition can either make losses, supernormal profit or normal profit Depending on the cost of production. But in the long run every firm under perfect competition will be earning only normal profit. This is because when existing firms earn super normal profits new firms attracted by these profits will enter the industry. when this happens to tell output or supply will increase and if demand remains the same price or apparatus revenue will come down to point of the average cost where all the farms will then be earning normal profit. similarly if farms were making losses they will exit the industry causing a contraction of the total supply or output. when supply falls it will cause an increase in the price or the average revenue of the firms which then will make all firms or only normal profit. Monopoly Monopoly refers to market structure where there is a single seller for a product which has no close substitutes. also under a monopoly type of market there are restrictions or strong barriers to entry. How is price and output determined under monopolistic market ? A monopolist determines his price on the basis of the market demand curve which shows the different quantities consumers are willing to buy at different prices. The average revenue curve or the demand curve facing a monopolist is downward sloping which indicates if the price is high the monopolist will be able to sell a smaller quantity. in other words he has to reduce the price in order to sell more. the MR curve of the monopolist is also therefore downward sloping. Indicating that additional units will have to be sold at the reduced prices. The MR curve is always less than the AR curve. The output of the monopolist is also determined at the point where MR =MC . depending on his AC curve monopolist can either make SNP or NP or even loses. What do you mean by Price Discrimination ? Price discrimination refers to the practice of selling the same product at different prices to different buyers. Example: if a seller sells a refrigerator at 10,000 to one buyer and 12,000 to another buyer He is practicing price discrimination (all conditions of sale and delivery being the same) Price discrimination may be a. Personal - price discrimination is personal when a seller changes different prices from different persons b. local - price discrimination is local when the seller charges different prices from different areas or localities. c. according to use or trade - price discrimination according to use or trade is when different prices are charged according to the use which is being put into When is Price Discrimination possible or profitable ? Conditions necessary for price discrimination to be possible. Two fundamental conditions have to be present for making price discrimination possible 1. price discrimination can occur only when it is not possible to transfer any unit of the product from one market to another or in other words price discrimination is are divided in just with that the product sold in a cheaper market cannot be sold if the dearer market. 2. price discrimination occurred when the buyers in the dryer market should not be able to transfer themselves to the cheaper market for buying the product. Conditions Necessary for PD to be possible Price discrimination is possible only in the following cases a. nature of the commodity or the service is such that there is no possible of transference from one market to another. Example in case of scale of direct services like that of a surgeon or a lawyer where the patient cannot pretend to be a poorer person to pay a small fee than a richer person Monopolistic Competition Monopolistic competition refers to a form of market structure Where there are large number of firms producing similar products but which are not identical. Under monopolistic competition, there are large number of farm producing differentiated products which are a close substitute for one another. Features of monopolistic competition. 1. Large number of firms, each occupying a small share of the total market demand. Because of the numbers being lost, there is stiff competition between them. 2. Product differentiation. Products are not identical, though similar. Products are differentiated on the basis of actual or real differences or artificial differences. 3. Some influence over the price that every farm under Monopolistic competition has got some influence in determining the price. If a firm lower its price, it may be able to increase its demand. On the other hand, if it increases the price of its product, it may lose some of its customers. 4. Non price competition. Competition between firms under monopolistic competition is not so much on price, but more on advertisement, and other selling Cost. 5. Freedom to entry and exit. Farms are free to enter an exit under monopolistic competition. Product differentiation / Product variation Productive differentiation is one of the most important feature of monopolistic competition. Product in monopolistic competition are similar but not identical. Seller differentiate their product on the basis of actual differences or imaginary differences. Differentiation based on certain characteristics of the product itself such as exclusive painting feature trademark and trade names special types of packages or wraps any difference in quality design color or style. Real qualitative differences like those of material design , like workmen ship or mean of differentiating product. But imaginary differences created through advertising, use of attractive packets, trademarks and brand names are also common. Excess capacity under Monopolistic Competition One of the distinctive feature under monopolistic competition is the existence of excess capacity. Excess capacity refers to a situation where the equilibrium level of output is less than the socially optimum or ideal output. The socially level of output is generally considered to be the minimum point of the LAC. The long run equilibrium output of firms under monopolistic competition is always at the following part of the average revenue curve. Causes for excess capacity under monopolistic competition. Excess capacity exist on a monopolistic competition because of two reasons. 1. The demand curve or the average revenue curve under monopolistic competition is downward sloping and as such it can be tangent only to the following portion of the long run average cost curve. A horizontal average revenue curve can be tangent to the minimum point of the LRC curve and hence it is only under perfect competition that there is no excess capacity. 2. Excess capacity exists under monopolistic competition because of the large number of firms each getting a very small share of the total market or demand. Therefore, it may not be required by the form to produce at the socially optimum level of output. Oligopoly It is a type of market structure where there are few sellers selling products which may either be homogeneous or slightly differentiated. Features or characteristics of oligopoly market. 1. Interdependence. It is one of the most important features of oligopoly type of market. Because of the few firms in the industry, only decisions by one firm regarding price, output or the product will have a direct effect on the fortune of its rival firms, who will then retaliate similarly. For example. If one farm reduces its fries, other farm will also reduce their prices. 2. Importance of advertisement and selling cost. The direct effect of interdependence between oligopolistic firm is that firm will have to employ various aggressive and defensive methods to gain a larger share of the market. In other words, competition between oligopolistic farm is not so much in price, but more on other factors like better advertisements and other selling and marketing techniques. 3. Group behavior. Because of interdependence, it is noticed that firms under oligopolistic competition tends to follow common group policies or what is called common group behavior. Each farm will closely watch the behavior of other farms in taking any kind of decision. Price and output decision under oligopolistic competition. It has been observed that firms under oligopolistic market find it difficult to fix their price and output because of interdependence. An oligopolistic firm cannot assume that its rival firms will keep their prices at quantities constant when it made changes in its price or quantities when an oligopolistic firm changes its price, its rival firm will retaliate or react and also change their price which in turn would affect the demand of the former firm. Thus, an oligopolistic firm cannot have a sure and definitive demand curve, as its rival will also keep changing their prices. When an Oregon police does not know his demand curve, he will therefore also not be able to fix his price and output. However, various theories have been put forwarded by economists for explaining a price output model for oligopolistic market. The more popular version is that one given by the American economics name Sweezy. According to Sweezy, " The demand curve facing an oligopolist has a " kink " at the level of the revealing price. This is more famously known as the kinket DC hypothesis. This hypothesis supports the view that there is "Price Rigidity" under oligopoly. This can be explained with the help of the following diagram. The small d is a DC facing an oligopoly. The kink is formed at the prevailing price of P. The upper segment of the DC. dP is more elastic than the lower segment PD. The price determinant is OP and the output is OM. The price tends to be sticky at OP. This is because when the oligopolist lowers its price below the prevailing price, other competitor will also follow and hence he will not gain much. His demand curve will therefore will be more inelastic before the prevailing price. On the other hand when he raises his price other competitors may not increase their prices which in turn will make him lose his customer. The DC therefore is more elastic on the upper segment of the prevailing price. This shows that prices are the OM tends to be sticky or rigid at the point of the kink.
