Market structure and

Pricing Practices
Module - 4
Contents
• Perfect Competition: Features, Determination of price under perfect
competition,
• Monopolistic Competition: Features, Pricing Under monopolistic
competition, Product differentiation.
• Oligopoly: Features, Kinked demand Curve, Cartels, Price leadership.
• Monopoly: Features, Pricing under monopoly, Price Discrimination.
• Descriptive Pricing Approaches: Loss leader pricing, Peak Load
pricing, Transfer pricing.
Monopoly Definition

• The term monopoly means a single seller (mono = single and poly
= seller).

• In economics, a monopoly refers to a firm which has a product

without any substitute in the market.

• Therefore, for all practical purposes, it is a single-firm industry.

Monopoly Definition

• Monopoly definition by Prof. A.J. Braff – ‘Under pure monopoly,

there is a single seller in the market. The monopolist’s demand is
the market demand. The monopolist is a price maker. Pure
monopoly suggests a no substitute situation.’
Features of a Monopoly
• Single seller and several buyers

• The primary feature of a monopoly is a single seller and several buyers. Also,
in a monopoly, there is no difference between the firm and the industry.

• This is because there is only one producer and/or seller. Therefore, the firm’s
demand curve is the industry’s demand curve. Since there are several buyers,
an individual buyer cannot affect the price in a monopoly market.
Features of a Monopoly
• No close substitute

• In a monopoly, the product that the monopolist produces has no close

substitute. If a close substitute exists, then the monopoly cannot exist.

• Remember, a monopoly can only exist when the cross-elasticity of the

product that the monopolist produces is zero. Therefore, the
monopolist can determine the price of his own choice and refuse to sell
below the determined price.
Features of a Monopoly

• Strong barriers to the entry of new firms

• Even if the monopolist firm is earning super-normal profits, new

firms face many hurdles in trying to enter the industry. There are
many reasons for this like legal barriers, technology, or a naturally
occurring substance which others cannot find. Sometimes, the
monopolist works in a small market making it economically
challenging for new firms to enter.
Revenue curves under a Monopoly

• A monopolistic firm is a price-maker, not a price-taker. Therefore,

a monopolist can increase or decrease the price. Also, when the
price changes, the average revenue, and marginal revenue changes
too. Take a look at the table below:
Revenue curves under a Monopoly
Let’s look at the revenue curves now:
Revenue curves under a Monopoly
• As you can see in the figure above, both the revenue curves (Average
Revenue and Marginal Revenue) are sloping downwards. This is
because of the decrease in price. If a monopolist wants to increase his
sales, then he must reduce the price of his product to induce:

• The existing buyers to purchase more

• New buyers to enter the market

Revenue curves under a Monopoly
• Hence, the demand conditions for his product are different than those
in a competitive market. In fact, the monopolist faces demand
conditions similar to the industry as a whole.

• Therefore, he faces a negatively sloped demand curve for his product. In

the long-run, the demand curve can shift in its slope as well as location.
Unfortunately, there is no theoretical basis for determining the
direction and extent of this shift.
Revenue curves under a Monopoly

• Talking about the cost of production, a monopolist faces similar

conditions that a single firm faces in a competitive market. He is
not the sole buyer of the inputs but only one of the many in the
market. Therefore, he has no control over the prices of the inputs
that he uses.
A Firm’s Short-Run Equilibrium in
Monopoly
• Like in perfect competition, there are three possibilities for a firm’s
Equilibrium in Monopoly. These are:

• The firm earns normal profits – If the average cost = the average
revenue
• It earns super-normal profits – If the average cost < the average
revenue
• It incurs losses – If the average cost > the average revenue
Normal Profits

• A firm earns normal profits when the average cost of production is

equal to the average revenue for the corresponding output.
Normal Profits

• In the figure above, you can see that the MC curve cuts the MR
curve at the equilibrium point E.

• Also, the AC curve touches the AR curve at a point corresponding

to the same point.

• Therefore, the firm earns normal profits.

Super-normal Profits

• A firm earns super-normal profits when the average cost of

production is less than the average revenue for the corresponding
output.
Super-normal Profits
• In the figure above, you can see that the price per unit = OP = QA.
Also, the cost per unit = OP’. Therefore, the firm is earning more
and incurring a lesser cost. In this case, the per unit profit is

• OP – OP’ = PP’

• Also, the total profit earned by the monopolist is PP’BA.

Losses
• A firm earns losses when the average cost of production is higher
than the average revenue for the corresponding output.
Losses

• In the figure above, you can see that the average cost curve lies
above the average revenue curve for the same quantity. The
average revenue = OP and the average cost = OP’.

• Therefore, the firm is incurring an average loss of PP’ and the total
loss is PP’BA. In the short-run, a monopolist sometimes sets a
lower price and incurs losses to keep new firms away.
Summary of Short-run Equilibrium in
Monopoly
• In the short-run, a monopolist firm cannot vary all its factors of
production as its cost curves are similar to a firm operating in
perfect competition. Also, in the short-run, a monopolist might
incur losses but will shut down only if the losses exceed its fixed
costs. Further, if the demand for his product is high, then the
monopolist can also make super-normal profits.
Summary of Short-run Equilibrium in
Monopoly
Summary of Short-run Equilibrium in
Monopoly
• The figure shown above depicts a firm’s short-run Equilibrium in
Monopoly. The quantity is along the X-axis and price and cost of
production along the Y-axis.

• There are three curves – the average variable cost (AVC) curve, the
average total cost (ATC) curve, and the marginal cost (MC) curve.
Further, there are three demand curves to explain the possible positions
of the equilibrium:
Demand Curve D1 is tangent to the AVC
curve at point E1
• Its corresponding MC curve intersects the MR1 curve from below
at point A1. Therefore, while the monopolist satisfies the first
condition of equilibrium, he is unable to recover his complete cost
of production.

• However, even if he closes the plant down, he cannot reduce the

losses since they are fixed costs.
Demand Curve D1 is tangent to the AVC
curve at point E1
• Therefore, he decides to produce – OM1 quantity of output and sells it at
a price E1M1. This ensures that he suffers a loss which is equal to his
fixed costs.

• It is important to note that if the demand curve lies left to the position
of D1, then there is no production since the monopolist would simply
add to his losses by operating the plant. In such cases, a monopolist
would close down the plan and restrict his losses to the fixed costs.
Demand curve D2

• If the demand curve lies to the right of D1, then the monopolist can
recover a part of his fixed costs. Further, if this demand curve is
tangent to the ATC curve (demand curve D2), then the monopolist
can also recover his complete cost of production.
Demand curve D2

• If D2 is the demand curve, then the equilibrium position of the

monopolist is at the intersection of the MC curve and the MR2
curve at point A2. This corresponds with the point of tangency
between D2 and the ATC curve (point E2).
Demand curve D2

• Therefore, the MC curve cuts the MR2 curve from below and AR =
ATC. Hence, the monopolist earns normal profits by producing a
quantity OM2 and selling it at a price E2M2.
Demand Curve D3

• If the demand curve lies further to the right of D2 (like D3), the
monopolist can earn super-normal profits. The equilibrium
position is the point of intersection between the MC curve and the
MR3 curve at point A3. Therefore, the monopolist produces a
quantity OM3 and sells it at a price E3M3.
A Firm’s Long-run Equilibrium in
Monopoly
• In the long-run, a monopolist can vary all the inputs. Therefore, to
determine the equilibrium of the firm, we need only two cost
curves – the AC and the MC. Further, since the monopolist exits the
market if he is operating at a loss, the demand curve must be
tangent to the AC curve or lie to the right and intersect it twice.
A Firm’s Long-run Equilibrium in
Monopoly
A Firm’s Long-run Equilibrium in
Monopoly
• As you can see above, there are two alternative cases for the
determination of Equilibrium in Monopoly:

• With normal profits

• With super-normal profits

• We have not taken the loss scenario here because if the monopolist
incurs losses in the long-run, he will stop operating.
A Firm’s Long-run Equilibrium in
Monopoly
• Case 1

• The demand curve AR1 is tangent to AC or LAC at point E. Remember, if

the demand curve lies to the left of the AC curve, then the monopolist is
unable to recover his costs and closes down.

• However, if the AR curve is tangent to the AC curve, then the monopolist

can recover his costs and stay in the market.
A Firm’s Long-run Equilibrium in
Monopoly
• Further, note that the perpendicular drawn from point E to the X-
axis, the MC curve, and the MR curve are concurrent at point A.

• Therefore, all the conditions of equilibrium are satisfied. The

monopolist produces OM quantity and sells it at a price of EM per
unit which covers its average costs + normal profits.
A Firm’s Long-run Equilibrium in
Monopoly
• Case 2

• The marginal revenue curve MR2 cuts the MC curve from below at point
B. The corresponding height of the AR2 curve is E’M1.

• Hence, the monopolist produces OM1 quantity and sells it at E’M1 per
unit to earn an extra profit of E’B per unit. Being a monopoly, this extra
profit is not lost to competition or newer firms entering the industry.
Monopoly Price Discrimination:

• Definition of Price Discrimination:

• While discussing price determination under monopoly, it was

assumed that a monopolist charges only one price for his product
from all the customers in the market.

• But it often so happens that a monopolist, by virtue of his

monopolistic position, may manage to sell the same commodity at
different prices to different customers or in different markets.
Monopoly Price Discrimination:
• Definition of Price Discrimination:

• The practice on the part of the monopolist to sell the identical goods at
the same time to different buyers at different prices when the price
difference is not Justified by difference in costs in called price
discrimination.

• In the words of Mrs. Joan Robinson: "Price discrimination is the act of

selling the same article produced under single control at a different
prices to the different buyers".
Types and Examples of Price
Discrimination:
• Price discrimination may be of various types.

• It may either be (i) personal (ii) trade discrimination (iii) local discrimination.

• (1) Personal discrimination. It is personal, when separate price is charged

from each buyer according to the intensity of his desire or according to the
size of his pocket.

• For instance, a doctor may charge Rs.1,00,000 from a rich person for an eye
operation and Rs.25000 only from a poor man for the similar operation.
Types and Examples of Price
Discrimination:
• (2) Trade discrimination. It may take place when a monopolist
charges different prices according to the uses to which the
commodity is put.

• For example, an electricity company may charge low rate for

electric current used in an industrial concern than for the
electricity used for the domestic purpose.
Types and Examples of Price
Discrimination:
• (3) Place discrimination. It occurs when a monopolist charges
different prices for the same commodity at different places. This
type of discrimination is called dumping.

• In Economics, a monopolist sells the same commodity at a higher

price in one market and at a lower price in the other. Dumping
may be undertaken due to several reasons:
Types and Examples of Price
Discrimination:
• (a) a monopolist may resort to dumping in order to dispose off the
accumulated stock or

• (b) he may, dump the commodity with a desire to capture the foreign
market,

• (c) dumping may also be done to drive the competitors out of the
market,

• (d) the motive may also be to reap. the economies of large scale
production, etc.
Degrees of Price Discrimination:
• There are three main degrees of price discrimination: (1) First degree price
discrimination, (2) Second degree price discrimination and (3) Third degree price
discrimination.

• (1) First degree price discrimination. The monopolist charges a different price
equal to the maximum amount for each unit of the commodity from each consumer
separately.

• The price of each unit is equal to its demand price so that the consumer is unable to
enjoy any consumer surplus.

• Such prices are charged by doctors, lawyers etc. In fact, the first degree price
discrimination manifests itself in the form of as many prices as many consumers.
Degrees of Price Discrimination:

• (2) Second degree price discrimination.

• Here the monopolist divides his market into different groups of

customers and charges each group the highest price which the
marginal consumer belonging to that group is willing to pay.

• The railway, airlines etc., charge the fares from customers in this
way.
Degrees of Price Discrimination:
• (3) Third degree price discrimination. In the third degree price
discrimination, the monopolist divides the entire market into a few sub-
markets and charges different prices for the same commodity in
different sub-markets.

• The division here is among classes of consumers and not among

individual consumers.

• Third degree price discrimination is possible only if the classes of

consumers can be kept separate.
Degrees of Price Discrimination:
• Secondly, the various groups of customers must have different elasticities of
demand for his commodity.
• The segment with a less elastic demand pays a higher price than the segment
with a more elastic demand.
• The consumer faces a single price in each category of consumers. He can
purchase as much as desired at that price.
• It is the most common type of price discrimination.
• For example, movie theaters, railways, typically charge lower prices to senior
citizens, students etc.
Conditions of Price Discrimination:
• (1) Segregation by price. There should be no possibility, of
transferring a unit of commodity supplied from the low priced to the
high priced market.

• For instance, a rich patient cannot send a poor man to the doctor for his
medical cheek up at a cheaper rate for him.

• Similarly, if you want to send a kilogram of gold by train to a relative of

yours, you cannot get it converted into coal or iron simply because
these metals are transported at a cheaper rate.
Conditions of Price Discrimination:
• (2) Segregation by market. Another essential characteristic of price
discrimination is that there should be no possibility of transferring one
unit of demand from the high priced to the low priced market.

• For instance, a banana market is divided on the basis of wealth.

• The poor are supplied bananas at a concessional rate in one market.

• The rich people will not like to become poor in order to get the
commodity at a cheaper rate.
Conditions of Price Discrimination:

• A monopolist will maximize his total revenue by equalizing

marginal revenue from all the markets.

• For instance, if in a particular market, the marginal revenue of a

commodity is Rs.20 per quintal and in the other Rs.15 per quintal,
a monopolist will at once shift the supply of the commodity from
the later to the former till the marginal revenue from both the
markets becomes equal.
Conditions of Price Discrimination:

• (3) Segregation by demand. Price discrimination can be possible

if there is difference in the elasticity of demand in different
markets.

• If the demand for a certain commodity is elastic in a particular

market, the monopolist will charge lower prices.

• But if the demand is inelastic, the monopolist will fix higher prices
for his product.
Conditions of Price Discrimination:
• Here, a question can be asked as to how far is a price discrimination beneficial to
society.

• The answer is that if a monopolist charges low price for his product from the poor
people and higher price from the rich, then certainly we can say that it increases
economic welfare.

• But if a monopolist dumps his output in a foreign market at a low price and raises
the price of his commodity in the home market, then such a price discrimination is
certainly detrimental to society, if the production of certain commodity is subject to
law of increasing returns, then price discrimination may be to the advantage of the
society.
Conditions of Price Discrimination:

• The monopolist increases the sale of output in order to sell the

commodities in the foreign market.

• The monopolist fixes a low price for his output both for the home
market and the foreign market.

• It is from this point of view only that we say price discrimination is

desirable and beneficial.
Price and Output Determination Under
Discrimination Monopoly:
• Price discrimination takes place when a given product is sold by a monopolist at
more than one price and these price differences are not justified by cost differences.
The price discrimination is possible under the following conditions.

Conditions:

(1) Monopoly power. The seller of a good must be a monopolist.

(2) Segregation of market. The monopolist must be able to segregate buyers into
separate classes with different price elasticities.

(3) No reselling. There should be no possibility of reselling the good from a tow price
market to a high price market.
Purpose of Price Discrimination:
• Price discrimination takes place when a given product is sold by a monopolist at
more than one price and these price differences are not justified by cost differences.
The price discrimination is possible under the following conditions.

Conditions:

(1) Monopoly power. The seller of a good must be a monopolist.

(2) Segregation of market. The monopolist must be able to segregate buyers into
separate classes with different price elasticities.

(3) No reselling. There should be no possibility of reselling the good from a tow price
market to a high price market.
Purpose of Price Discrimination:

• The purpose of price discrimination by a monopolist is two fold.

• Firstly, to increase his total revenue and profits and secondly, to

produce a larger output than a non-practicing monopolist.

• Determination of price and output under monopolistic

competition.
Purpose of Price Discrimination:
• Price discrimination is possible and profitable when the
monopolist is able to control the amount and distribution of
supply and the buyers can be separated into different classes
having a demand curve with different elasticities.

• Let us assume that the monopolist sells his total product in two
sub-markets A and B.

• Sub-market A has low price elastic demand for the product and the
sub-market B has high price elasticity of demand.
Purpose of Price Discrimination:

• The discriminating monopolist will sell a greater quantity of his

product by making a price reduction in market B.

• He sells lesser commodity in market A at a price higher than in

market B.

• The monopolist will then earn maximum profit by price

discriminating as is illustrated with the help of diagram given
below.
Purpose of Price Discrimination:
Purpose of Price Discrimination:
• In this figure market A and Market B have different elasticity of demand
for the product of the monopolist.

• The slopes of the AR and MR curves in each market are different

depending upon the elasticity of demand for the commodity.

• In market A, the elasticity of demand is relatively inelastic.

• The rise in price does not cause a much fall in demand.

• In market B, the demand for the monopolist product is relatively elastic.

Purpose of Price Discrimination:
• A reduction in price leads greater increase in the demand for the
product and adds more to the revenue.

• In figure, the combined marginal cost curve (MC) of the total output of
the monopolist intersects the combined marginal revenue curve of the
two markets A and B from below at point P.

• The best levels of output of the monopolist is OT given by the point P

where MC curve cuts the AR curve from below.

• The monopolist Is to distribute this equilibrium output OT between the

two markets A and B in such a way that the MR in each market is OP.
Purpose of Price Discrimination:
• In market A, MR equates MC at point F. The monopolist sells output OB
at price KB.

• In market B, where the demand is more elastic, the monopolist

maximizes profit by selling output OB2 at price K2B2 in market B, where
the demand is more elastic, the price K2B2 is lower than in market A, the
profit of the monopolist is maximum when he sells output of OB at price
KB in market A and output of OB2 at price of K2B2 in market B.

• The monopolist total profit is shown in the shaded area APE in figure.
Purpose of Price Discrimination:
• Summing up, a discriminating monopolist can maximize profits
only when:

• (1) It is profitable for him to sell the output in different markets.

• (2) The price is charged in different markets in such a way that the
last unit of the commodity sold in market gives the same marginal
revenue.

• (3) The marginal revenue is equal to the marginal cost of total

output.
Assessment of Discriminating Monopoly or
Price Discrimination:
• Price discrimination is said to occur when a monopolist charges
more than one price for an identical product and these price
differences are not justified by cost differences.

• Is this price discrimination, unchecked monopoly power, collusion,

price fixing is beneficial for a society or harmful to a economy is
debatable.

• The main points which go in favor or against of discriminating

monopoly are discussed in brief as under:
Case for Discriminating Monopoly:
• (1) Need for strong companies to face global competition: The industries
which require a great deal of capital need protection and support of the
government to face global competition. If these companies are made larger
and given more monopolistic power, they will be able to avail of the
economies of scale and face competition in the global market

• (2) Research and development: Schumpeter is of the view that it is only the
monopolists or the oligopolist that can provide large sums of money for
carrying out expensive research and development programmes. So the
support for discriminating monopoly.
Case for Discriminating Monopoly:

• (3) Capital flow: It is also argued that investors are always looking for
profitable ventures and mobilize huge sums of money to enter unto the
industry which is most profitable. The businesses which have monopoly
earn more profit and so attract large capital.

• (4) Redistribution of income: The case for monopoly is pleaded on

the ground also that it brings a redistribution of income. The
monopolist earning huge profits give bonuses, higher reward to the
workers. The wealth thus gets redistributed from the rich to the poor.
Case Against Discriminating Monopoly:

• 1) Dumping: A monopolist often tries to dump its surplus output on

foreign markets, at below cost price. When a dumping company
succeeds in driving out competitors, it then raises the price of its
product. So the price discrimination that lessens competition is
considered harmful and illegal.

• (2) Allocative inefficiency: it is a fact that a monopolist produces

goods at a price greater than marginal cost. It represents a
misallocation of resources.
Conclusion:

• The government plays two basic roles which are contradictory,

• (i) it promotes competition and

• (ii) it restricts competition by regulating and protecting certain

industries. The government protects the natural monopolies by
taking complete control over them.

• Sometimes they are operated through public private ownership.

Conclusion:

• The most popular trend, of the 1980's is the transfer of

government business to the private sector.

• The basic logic behind privatization of business is that incentive to

be efficient is greater when one's own money is at risk.

• Those who oppose privatization argue that monopoly must be

regulated as it is in the public interest.
Dumping: Definition
• Dumping is a special case of price discrimination.

• Dumping is a situation in which the price, a firm charges for its goods in
a foreign market is lower than either the price it charges in its home
market or the production cost.

• Dumping thus is the sale of surplus output of a firm on foreign markets

at below cost price.

• Dumping also occurs when a firm sells its products at a higher price in
the home market and at a lower price in the foreign market.
Dumping: Reasons
• (1) Price discrimination: The first reason of dumping is price
discrimination. If a firm has monopoly of a good in home market, but
faces strong competition in foreign market, the firm will naturally
charge a higher price in home market and lower competitive price in
foreign market.

• (2) Predatory pricing: The second major reason is predatory pricing.

It is the practice of cutting prices of goods in an attempt to derive rival
firms out of business.
Dumping: Reasons
• (3) Surplus stock: A firm may resort to dumping to dispose off surplus stock.

• (4) Economies of large scale production: The big firms where huge fixed
capital is required for producing the goods may resort to dumping to avail of
the economies of large scale production.

• Dumping is illegal under international trade agreements of World Trade

Organization (WTO). A nation can impose anti dumping duties only on
production that are being dumped.