Page No.

F.Y.B.COM BUSINESS ECONOMICS –I SEMESTER- II

Unit- I : Market structure: Perfect competition and Monopoly, Monopolistic

competition and Oligopoly
1. Explain the classification of the market structure?
2. What is a perfect competition? Explain its feature.
3. Illustrate the supply curve of a competitive firm
4. How can an industry attain short run under perfect competitions?
5. How can an industry attain long run under perfect competitions?
6. What does monopoly mean? What are the features of monopoly market?
7. What are the types / source of monopoly?
8. Explain price and output determination in the short run under monopoly.
9. Explain price and output determination in the long run under monopoly.

Q.1. Explain the classification of the market structure.

Market is a place where goods and services are bought and sold. It is the place where
goods are traded in. market is classified into two major classifications. Perfect competition
and Imperfect competition. Under imperfect competition monopoly, monopolistic and
oligopoly market come.

1. Perfect competition:
It is a market structure where large number sellers and buyers are involved in buying and
selling of goods at equilibrium price which is fixed by the industry. Good sold in this market
are homogenous in nature and have no substitutes. Sellers are price takers as they sell their
products at equilibrium price only. This market is hypothetical and is myth as no such market
exists actually. It is based on number of hypothetical conditions like no transport cost, no
advertisement cost, full knowledge of markets among buyers and sellers etc.

2. Imperfect competition:
a. Monopoly:
it is a market structure where only singer seller exists with number of buyers. The goods sold
by monopolist have no close substitute so cross elasticity of demand is zero in this market.
The goods sold are generally of special kind. Monopolist, being the single seller, carries price
discrimination and sells the same product to many buyers at different rates. There are many
types of monopoly such as legal, natural, technical, pure monopoly.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.2

b. Monopolistic competition:
It is a market where are there are many sellers and buyers who are engaged in selling and
buying goods. This market is a combination of perfect competition and monopoly. Prof.
Chamberlin gave term’ Group ‘to this market as it has independent policies still competes in
the open market. No entry is restricted in this market. This market deals in differentiation
goods which are not exactly identical. Selling cost is the main feature of this market as
without advertisement this market cannot sustain.

C. Oligopoly:
This market structure has a few sellers and many buyers. The sellers in this market have
interdependence policies and compete with each other with competitive nature. Survival is
difficult in this market as competition is tough and there is reaction of each seller for other
seller’s action of policies. Price rigidity is the main feature of this market. Cartel is an
example of such as market.

Q.2.What is perfect competition and explains its features?

Perfect competition refers to the market structure where competition among the
sellers and the buyers exists in its most perfect from. In such a market, there is a single
price, which is determined by the interaction of demand and supply.
1.Many Sellers : There are many sellers or firms selling a commodity in the market. Their
number is so large that any single seller or firm cannot influence a given market price. So
an individual seller or a firm is a price-taker.
2.Many Buyers : There are many actual buyers. Their number is so large that any single
buyer cannot influence a given market price. This is because his individual demand is a
very small fraction in the total market demand so buyer is also a price-taker.
3.Homogeneous Products : All firms or producers produce and sell identical products i.e.
same in respect of size, shape, color, packaging, etc. So there is no difference in between
various products, which are perfect substitutes for each other.
4.Free Entry and Exit:-There is perfect freedom for new firms or sellers to enter a market or
an industry without any legal, economic, or any other type of restrictions or barriers,
Likewise, the existing producers or sellers are free to leave the market.
5.Perfect Knowledge: -There is perfect knowledge on the part of the buyers and sellers
regarding the market conditions especially regarding the prevailing market price and
quantity of supply. So a single price would prevail (exists) for a commodity in the entire
market.
6.Perfect Mobility of Factors of Production: - The factors of production are perfectly free
to move from one firm to another or from one industry to another or from one region to
another or from one occupation to another. This ensures freedom of entry and exit for
individuals and firms.
7.Transport Costs: -It is assumed that there are no transport costs. The transport costs
incurred by buyers and sellers to take the advantage of price changes, in a market, are
ignored.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.3

8.Non-Intervention by the Government:-It is assumed that the government does not

interfere with the working of a market economy, i.e. it does not interfere with the
economic activities in the form of controls on the supply of raw materials, tariffs, subsidies,
rationing, licensing etc.

Q.3. Illustrate supply curve of a competitive firm.

Supply curve can be divided into two parts as: Short run and Long run.
A. Short Run Supply Curve of a Firm :
Short run is a period in which supply can be changed by changing only the variable
factors, fixed factors remaining the same. That way, if the firm shuts down, it has to bear
fixed costs. That is why in the short run, the firm will supply commodity till price is either
greater or equal to average variable cost. Thus a firm will continue supplying the commodity
till marginal cost is equal to price or average revenue. Under perfect competition average
revenue is equal to marginal revenue, so the firm will produce up to that point where
marginal revenue and marginal cost are equal.
Short run supply curve of a perfectly competitive firm is that portion of marginal cost
curve which is above average variable cost curve.

From above figure it is clear that there is no supply if price is below OP. At priceless
that OP the firm will not be covering its average variable cost (AVC).At OP price OM is the
supply. In this case firm’s marginal revenue and marginal cost cut each other at A, OM is
equilibrium output. If price goes up to OP1 the firm will produce OM1 output. This is firms
short run supply curve starts from A upwards i.e. line AB.

B. Long Run Supply Curve of Firm :

Long run is a period in which supply can be changed by changing all the factors of
production. There is no distinction between fixed and variable factors. In the long run firm
produces only at minimum average cost. In this situation long run marginal cost, marginal
revenue, average revenue, and average cost are equal i.e. LMC=LMR=LAR=LAC.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.4

So that position of marginal cost curve will determine the supply curve which is
above the minimum average variable cost. The point where minimum average cost is equal to
marginal cost is called optimum production. Thus long run supply curve of a firm is that
portion of its marginal cost curve that lies above the minimum point of the average cost
curve.

In the above figure firm is in equilibrium at point E where LMR=LMC=LAR. LAC is

minimum corresponding to this point. This point E is also called point because at this point
LMR=LMC=LAR minimum LAC. That portion of LMC which is above E is called long run
supply curve.

Q.4. How can an firm / industry attain Short run under perfect
competitions?
Short Run equilibrium :Short-run is a period of time in which all factors of production
cannot be changed. Some factor will remain fixed. In short period equilibrium following two
conditions should be satisfied for the firm.

1. The Marginal Revenue (MR) is equal to Marginal Cost (MC) i.e. MR=MC
2. The Marginal Cost (MC) curve should cut Marginal Revenue (MR) curve from
below.

In the short run different following equilibrium position are settled down.

A. Super Normal Profit (AR > AC):Super normal profit is also known as Abnormal Profit.
The firm is in equilibrium at point E where MR=MC. With OQ as the equilibrium output.
OP is the price. Average Revenue is EQ and Average Cost is BQ. Therefore profit can be
calculated as follow :

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.5

Profit = Total Revenue (TR)–Total Cost (TC)

Total Revenue (TR) = Average Revenue x Quantity
= EQ x OQ
= OPEQ
Total Cost (TC) = Average Cost x Output
= BQ x OQ
= OABQ
Profit = TR –TC
= Area OPEQ – Area OABQ
Profit =Area APEB

B. Loss (AR < AC) :When Average cost is more than Average Revenue firm makes loss.
The loss of firm shown in following figure :

Loss = Total Cost (TC) – Total Revenue (TR)

Total Revenue (TR) = Average Revenue x Quantity

= EQ x OQ
= OPEQ
Total Cost (TC) = Average Cost x Output
= BQ x OQ
= OABQ
Loss = TC –TR
= Area OABQ – Area OPEQ
Loss = Area PABE

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.6

Average revenue is less than Average cost (AR < AC) the firm is making loss. Thus firn
in above figure suffer losses which are PABE.

C. Normal Profit (AR = AC) :The firm at equilibrium will make normal profit if at
equilibrium point AR=AC i.e. AC curve is tangent to AR.

Total Revenue (TR) = Average Revenue x Quantity

= EQ x OQ
= OPEQ
Total Cost (TC) = Average Cost x Output
= EQ x OQ
= OPEQ
Hence Total Revenue (TR) = Total Cost(TC) i.e. Area OPEQ = Area OPEQ the firm is
making normal profit.

Q.5. How can an firm/ industry attain long run under perfect
competitions?
Long Run Equilibrium :Long run is a period on which all factors of production are variable.
When some firms are earning super normal profit (AR > AC) in the short run it attracts large
number of firms into the industry. As a result output increases resulting in fall in market price
and supernormal profit will be wiped away and the normal profit will continue in the long
run.
When some firm suffers losses (AR <AC) in the short run they start leaving industry
in the long run. Reduction in the number of firms leads to contraction of industry’s output. As
a result price increases and due to this all losses will be wiped away and only normal profit
will continue in the long run.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.7

In long run the firm is in equilibrium at the point where the LMC = LMR at the same
time LAC = LAR. If it is assumed that all the firms are facing the similar cost conditions all
the firms are in equilibrium at the point where all will earn only normal profit with LAC =
LMC = LAR = LMR

Q.6. What does monopoly mean? What are the features of monopoly
market?
The word ‘Monopoly’ is derived from two words ‘Mono’ which means single and ‘Poly’
which means sellers. Hence monopoly is a market situation in which there is one seller of
product who controls the entire market supply’
1. Single producer or seller: Monopoly is the market structure where only one seller is
involved in business activities. He has full control over his business. He is the sole
authority to take decision regarding production and pricing policies.
2. No Distinction between Firm and the industry: In this market there is no distinction
between firm and industry as it is featured with one seller. There are no competitors. So
the distinction between firm and industry disappears.
3. No close substitute: Monopoly market does not face competition there is no close
substitute available for his product. The monopolist produces all the output in a market.
4. Absence of competition: There is no competition for monopoly. So the product sold by
monopolist has no substitute or complementary product. Cross elasticity of demand is
zero in monopoly market.
5. Price maker: Monopoly is a price maker being having control over his business. He does
carry price discrimination by charging various prices to different consumers.
6. Complete control : Monopoly has complete control over the production and market
supply. Decision about production is the sole decision of his. Entry to new firms are
restricted.
7. Downward Sloping demand curve : Monopolist faces a downward sloping demand curve
which indicates that it can sell more at a lower price.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.8

Q.7. Explain the types/ Sources of Monopoly in brief.

1. Pure/ Perfect Monopoly : A Pure or perfect monopoly is one, which has no close
substitutes. Such type of monopoly is very rare.
2. Imperfect Monopoly : Imperfect monopoly is one, which has remote substitute in the
market. Such type of monopoly is very common.
3. Legal Monopoly : Legal monopoly exists due to some statutory regulations like Patents,
Trademarks, copyrights etc.
4. Natural Monopoly :Natural monopoly arises as a result of natural advantages like good
location, minerals, Natural resources, goodwill etc. E.g Tea of Assam
5. Technological Monopoly : It arises because of some technological advantages like use of
capital goods, new methods of production etc.
6. Joint Monopoly : When many firms come together and form associations like pools,
cartels, syndicates etc. it is termed as Joint Monopoly. They come together for mutual
cooperation and carrying joint business.
7. Public Monopoly : When the production of goods and services are fully owned and
controlled by the Govt. it is termed as Public Monopoly. However the main aim of the
government is not to earn profits but to provide services. Hence they are also termed as
Welfare monopolies. For e.g Indian Railways, M.S.E.B etc.
8. Private Monopoly: When the production is owned, managed &controlled by the private
entrepreneurs, it is termed as the Private monopolies. The aim of such monopoly is to
earn maximum profits.
9. Simple Monopoly : A Simple Monopoly charges uniform price (single price) to all
customers. Monopolist cannot set a price to maximize his profit. It is termed as Simple
Monopoly.
10. Discriminating Monopoly : Discriminating Monopoly charges different prices to
different customers for the same products or service. For e.g M.S.E.B charges lower rate
for domestic consumption and higher rate for commercial consumption.

Q.8. Explain price and output determination in the short run under
monopoly.
Short Run Equilibrium :
1. Super Normal Profit : If the Average Revenue (AR) is greater than Average Cost (AC)
(AR > AC) the monopoly firm will earn supernormal profit. Profit of monopolist is
shown in following diagram.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.9

Profit = Total Revenue (TR) – Total Cost (TC)

Total Revenue (TR) = Average Revenue x Quantity
= AQ x OQ
= OPAQ
Total Cost (TC) = Average Cost x Output
= CQ x OQ
= OBCQ
Profit = TR –TC
= Area OPAQ – Area OBCQ
Profit = Area BPAC
Hence the monopolist enjoys supernormal profit of BPAC and this is also as monopoly
profit.
2.Losses :If the Average Revenue (AR) is less than Average Cost (AC) (AR < AC) the
monopoly firm will suffer from losses. Loss of monopolist is shown in following diagram.

Loss = Total Cost (TC) – Total Revenue (TR)

Total Revenue (TR) = Average Revenue x Quantity

= AQ x OQ
= OPAQ
Total Cost (TC) = Average Cost x Output
= CQ x OQ
= OBCQ
Loss = TC –TR
= Area OPAQ – Area OBCQ
Profit = Area PBCA

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.10

3. Normal Profit :The monopoly firm at equilibrium will make normal profit if at
equilibrium point AR=AC i.e. AC curve is tangent to AR.

Total Revenue (TR) = Average Revenue x Quantity

= AQ x OQ
= OPAQ
Total Cost (TC) = Average Cost x Output
= AQ x OQ
= OPAQ
Monopoly firm in short run may also earn normal profit if SAC is tangent to the AR at
equilibrium point (E). If in short run monopolist firm earn normal profit monopolist will not
produce the output. Monopolist always wants supernormal profit.

Q.9. Explain price and output determination in the long run under
monopoly.
Long Run Equilibrium : Monopoly is associated with profits and it is called monopoly
profit. This applies to the long run equilibrium under monopoly. The monopolist will always
make profit in the long run where monopolist is not under pressure to operate on the existing
plant scale.

Above diagram shows the profit of monopolist in long run. Monopolist produced and
sold OQ quantity at price OP. For this output long run average cost (LAC) is CQ and total
cost is OBCQ while total revenue OPAQ. In long run monopolist earn profit area BPAC.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.11

Unit II. : Market structure: Pricing and Output Decisions under imperfect
completion.
1. Explain features / characteristics of monopolistic competitions.
2. Explain the short run equilibrium of a firm under monopolistic competitions.
3. Explain the long run equilibrium of a firm under monopolistic competitions.
4. Discuss the role of advertising in monopolistic competition.
5. Explain the features of the oligopoly in brief
6. Explain the Price and Output Determination Under collusive oligopoly market. /
Illustrate Cartel in the model oligopoly.
7. Explain the Paul Sweezy model of price rigidity. / Explain the kinked Demand Curve
Model.
8. Explain the types of Price Leadership.
9. Distinguish between perfect competitions and monopolistic competitions.
10. Distinguish between Monopoly and monopolistic competitions.

Q.1. What are the features / characteristics of monopolistic competition?

Monopolistic competition was introduced by Prof. E.H. Chamberlin and Prof. Mrs. Joan
Robinson. Monopolistic competition is the type of market structure where there exist
monopoly on one side and perfect competition on other side. Simply we can also say that
it is a mixture of monopoly and perfect competition.
1.Large number of firm :In a Monopolistic competition there is relatively large number of
firms each satisfying a small share of the market demand for the product. As there are large
number of firms there exists stiff competition between them. But the size of the firm will be
relatively small.
2.Product Differentiation : In a Monopolistic competition the products produced by various
firms are not identical but slightly different from each other, which means the products
are not same but are similar and hence their prices are not much different. They are close
substitutes of each other.
3.Selling Cost : Firms in Monopolistic competition incur expenditure to promote sales,
which is called as ‘Selling Cost’. Selling cost is incurred in the form of advertisement
like on T.V., Radio, Press, Exhibitions, free samples etc. Selling cost tries to influence
consumers demand and promote sales.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.12

4.Free entry and exist : In a Monopolistic competition it is easy for the new firms to enter
and the existing firm to leave it. Free entry means that when in the industry existing firms
are making supernormal profit new firms enter in the industry and the losses will compel
them to leave the industry or group.
5.Absence of Interdependence : Under Monopolistic competition firms are large but not
their size. They are too small. It means every firm has its own policies like production,
output, price policy etc. Thus the policy of an individual firm cannot influence the
policy of other firms which means all firms are independent but not interdependent.
6.Concept of Group : In Monopolistic Competition the word ‘industry’ loses its significance
as Prof. Chamberlin has used the word ‘Group’ which means number of producers
whose goods are fairly close substitutes.
7.Nature of Demand Curve :-In a Monopolistic competition the demand curve slopes
downward from left to right, which an individual firms can sell more by lowering price. DD
curve of monopolistic always slopes negatively.

Q.2. Explain the Short Run Equilibrium under Monopoly Market.

A firm under monopolistic completion faces three situations i.e. supernormal profit, loss,
and normal profit.
1. Super Normal Profit : If the Average Revenue (AR) is greater than Average Cost (AC)
(AR > AC) the monopoly firm will earn supernormal profit. Profit of monopolistic firm is
shown in following diagram.

Profit = Total Revenue (TR) – Total Cost (TC)

Total Revenue (TR) = Average Revenue x Quantity
= AQ x OQ = Area OPAQ
Total Cost (TC) = Average Cost x Output
= CQ x OQ = Area OBCQ
Profit = TR –TC
= Area OPAQ – Area OBCQ
Profit = Area BPAC
Hence the monopolist enjoys supernormal profit of BPAC and this is also as monopoly
profit.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.13

2. Losses : If the Average Revenue (AR) is less than Average Cost (AC) (AR < AC) the
monopoly firm will suffer from losses. Loss of monopolistic firm is shown in following
diagram.

Loss = Total Cost (TC) – Total Revenue (TR)

Total Revenue (TR) = Average Revenue x Quantity

= AQ x OQ
= OPAQ
Total Cost (TC) = Average Cost x Output
= CQ x OQ
= OBCQ
Loss = TC –TR
= Area OPAQ – Area OBCQ
Profit = Area PBCA
4. Normal Profit : The monopolistic firm at equilibrium will make normal profit if at
equilibrium point AR=AC i.e. AC curve is tangent to AR.

Total Revenue (TR) = Average Revenue x Quantity

= AQ x OQ = Area OPAQ
Total Cost (TC) = Average Cost x Output
= AQ x OQ = Area OPAQ
Monopolistic firm in short run may also earn normal profit if SAC is tangent to the AR at
equilibrium point (E). If in short run monopolist firm earn normal profit monopolist will not
produce the output. Monopolist always wants supernormal profit.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.14

Q.3. Explain the Long Run Equilibrium under Monopolistic competition.

In long run firms working under monopolistic completion earn only normal profits.
The equilibrium of a firm under monopolistic completion is shown in the figure below.

Above diagram shows the normal profit of monopolistic firm in long run.
Monopolistic firm produced and sold OQ quantity at price OP. For this output long run
average cost (LAC) is AQ and total cost is OQAP while total revenue OQAP. In long run
monopolist earn profit area BPAC.

Q.4. Discuss the role of advertising in monopolistic competition.

A monopolistic firm produces close substitute products and therefore each firm in
order to attract consumers towards their product and increase their market share invests
heavily on advertisement. It may result in increase in profits. Firms that sell highly
differentiated consumer goods such as perfumes, soft drinks etc. spend between 10 to 20 % of
revenue on advertising.
Debate over role of advertising in monopolistic completion.
The Critique of Advertising : It is criticized that firms advertise in order to influence
consumer’s tastes. Much advertising is psychological rather that informational.
Example. Advertisement of a brand of wrist watch. The advertisement shown in
newspaper and television does not tell the viewer about the price or quality of product.
Instead it might show a group of youngsters wearing the watch in their friends groups and
they make impression on others. The goal of the advertisement is to convey a subconscious
massage “You too can impress others and be happy, if only you wear our product” Critics
says that such a advertisements creates a desire in the consumers unnecessary and increases
the completion in the market.
The Defence of Advertising : Defenders of advertisement says that firms use
advertising provides information to consumers. Advertising also convey the message about
price of product, location of store etc. which is convenient to consumer.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.15

Advertising makes consumers more fully informed about product and firm. In
addition advertisement allows new firms to enter more easily because advertisement gives
entrants a way to attract customers from competitors.

Q.5. Explain the features of the oligopoly in brief.

Oligopoly is a market situation where there are only few sellers in a given line at
production. Mr. Feller defines Oligopoly as “Competition among the few”. In this type of
market the firm may be producing either homogeneous products or may be having product
differentiation in the given line of production.
Features:-
1. Few Sellers:-Under Oligopoly there are few sellers producing or supplying either
homogeneous products or differentiated products.
2. Interdependence:-The firms have a high degree of interdependence in their business
policies about fixing of price and determination of output.
3. Advertisement & selling cost :-Advertisement and selling cost have strategic importance
to the firms under oligopoly. Each firm tries to attract maximum number of consumers
towards its products by spending huge amount of money on advertisement and publicity.
4. High Cross elasticity’s of demand:-Under Oligopoly the firms have a high degree of
cross elasticity’s of demand. So there is always a fear of retaliation by the rivals. For e.g. if
coke reduces its price by 2 Rs. Pepsi may retaliate by reducing its price by 3 Rs.
5. Constant Struggle:-Competition is of unique type in a Oligopolistic market. Here
competition consists of constant struggle of rivals against rivals (competitors).
6. Lack of Uniformity:-In Oligopoly the size of the firms are not uniform. Some firms are
very big in size and some firms are very small in size. Uneven sizes of firms are found in this
market.
7. Price Rigidity:-In Oligopoly market each firm sticks to its own price. This is because it is
in constant fear of retaliation by the rivals if it reduces the price.
8. Kinked Demand Curve:-According to Mr. Paul Sweezy firm is an Oligopolistic market
have Kinky demand curve. This is because when a firm changes its price the other firms also
change their price. Hence the demand curve of an Oligopolistic is not definite it goes on
changing.
Three Important Models of Oligopoly are as :
(1) Price and output determination under collusive oligopoly.
(2) Price and output determination under non-collusive oligopoly.
(3) Price leadership model.

Q.6. Explain the Price and Output Determination Under collusive oligopoly
market. / Illustrate Cartel in the model oligopoly.
Collusive Oligopoly : The term 'collusion' implies to 'play together'. When firms under
oligopoly agree formally not to compete with each other about price or output, it is
called collusive oligopoly. The firms may agree on setting output quota, or fix prices or limit

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.16

product promotion or agree not to 'poach' in each other's market. The completing firms thus
from a 'cartel'. The members of firms behave as if they are a single firm.
There are two forms of cartel:
1. Cartel aiming at joint profit maximization
2. Cartel aiming at sharing of the market
Each of the form of the model is discussed below :
1. Cartel aiming at joint profit maximization :
In this form of cartel the aim is to maximize joint industry profits. A central
administrative agency decides total quantity to be produce, price, allocation of output
among each firm and distribution of profit among each firm.
In order to maximize joint profits central agency will apply marginal list rule i.e.
equate industry marginal cost and industry marginal revenue curve.

In above figure the industry demand curve DD consisting of two firms. Marginal cost
curve (MC) is obtained by the horizontal summation of MCA and MCB. So the MR curve and
MC curve which are identical. The cartel's MR curve intersects the MC curve at point E.
Profits are maximized at output OQ, where MC = MR. The cartel will set a price OP, at
which OQ, output will be produced and demanded.
Once the allocation is done in such a way that the marginal cost o each firm is equal,
i.e. MCA = MCB = MR. The total output produced by firm A and B would be determined
points EA and EB respectively. Thus firm A produce OQA and firm B produce OQB level of
output. Therefore total output is the sum of individual output of A and B i.e. OQ = OQA +
OQB .
It is considered that firm A is low cost firm then firm A makes profits equal to PNML
while firm B makes profit PRST. The maximum joint profit is obtained by summing the
individual profit of the firm.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.17

2. Cartel aiming at sharing of the market :

In this form of cartel members firms agree not only to a common price but also
agree on the quantity which they can sell in the market.
If there is are only two firms in the cartel each firm will sell half of the total market
demand at that price. The quotas of market share are decided by bargaining between the
firms. This is graphically shown below.

Consider two firms A and B form a cartel in industry. DD is the market demand curve
and MR is the corresponding marginal revenue curve. MC curve obtained by the horizontal
summation of MCA and MCB. at the equilibrium point E, where MC=MR the cartel will
achieve maximum profits. The total equilibrium output will be OQ and price OP.
The total output of firm A will be OQA and of firm B will be OQB. Thus total output
in the industry will be,
OQ = OQA + OQB
The total output OQ is obtained by drawing a line parallel to X- axis from point E that
intersect MCA at point EA and MCB at point EB. Thus each firm sells output at monopoly
price OP. This is called as market sharing cartel.

Q.7. Explain the Paul Sweezy model of price rigidity. / Explain the kinked
Demand Curve Model.
The Kinked demand curve model was developed by Paul Sweezy (1939). According
to him, the firms under oligopoly try to avoid any activity which could lead to price wars
among them. The firms mostly make efforts to operate in non price competition for
increasing their respective shares of the market and their profit. An analytical device which is
used to explain the oligopolistic price rigidity is the Kinked Demand Curve.
Mr. Paul Sweezy used two demand curve concepts to explain the model. These are
reproduced below:

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.18

Diagram:

In the above diagram DD is a kinked demand curve. It is made up or two segments

DB and BD. The demand curve is kinked or has a bend at point B. The kink is formed at the
prevailing market price level BM (10) . The segment of the demand curve above the
prevailing price level is highly elastic (DB) and the segment of the demand curve below the
prevailing price level is fairly inelastic (BD1). This is explained now in brief.

Explanation:
Price increase. If an oligopolistic raises the price of his products from 10 per unit to 12 per
unit, he loses a large part of the market and his sale comes down to 40 units from 120 units.
There is a loss of 80 units in sale as most of his customers are now purchasing goods from his
competitor firms who are selling the goods at 10 per units. So an increase in price above the
prevailing level-shows that the demand curve to the left of and above point B is fairly elastic.

Price reduction. If an oligopolistic reduces the prices of its goods below the prevailing price
level BM (10 per unit) for increasing his sales, his competitors will also match price changes
so that their customers do not go away from them. Let us assume that Oligopolist has lowered
the price to 4 per unit. Its competitors in the industry match the price cut. The sale of the
oligopolist with a big price cut of 6 per unit has increased by only 40 units (160 - 120 = 40).
The firm does not gain as the total revenue decreases with the price cut. The BD/ portion of
the demand curve which lies on the right side and below point B is fairly inelastic.

Rigid Prices. The firms in the oligopolist market 'have no incentive to raise or lower the
prices of the goods. They prefer to sell the goods at the prevailing price level due to reaction
function. The price BM (10 per unit) will, therefore, tend to remain stable or rigid, as every
member of the oligopoly does not see any gain by lowering or raising the price of his goods.

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.19

8. Explain the types of Price Leadership.

Price leadership is a form of collusion in which one firm sets the price and other
firms in the market follow it. Hence it is called as price leadership.

Assumptions:
(a) There are two firms A and B in the market.
(b) The output produced by the two firms is homogeneous.
(c) The firm 'A being the low cost firm or a dominant firm acts as a leader firm.
(d) Both of the firms face the same demand curve.
(e) Each of the two firms has an equal share in the market.
The price and output determination under price leadership is now explained with the
help of the diagram below.

Diagram:

In above figure DD1 is the demand curve which is faced by each of the two firms. MR
is the marginal revenue curve of each firm. MCA is the marginal cost of firm A and MCB is
the marginal cost of firm B. It is assumed that the firm A is a low cost firm than firm B. As
such the MCA lies below MCB.
The leader firm using the marginalistic rule of MC = MR is in equilibrium at point E. The
firm A maximizes profits by selling output OM and setting price MP. The firm B is in
equilibrium at point F where MCB = MR. The firm B maximizes profits by producing ON
output and selling it at NK price. The firm B has to compete firm A in the market, if the firm
B fixes the price NK per unit, it will not be able to compete with firm A which is selling
goods at MP price per unit.
Hence, the firm B will be compelled to follow the leader firm A. The firm B will also
charge MP price per unit as set by the firm A. The firm B will also produce QM output like

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA
 Page No.20

the firm A. Thus both the firms will charge the same price MP and sell each of them OM
output. The total output will thus be twice of OM.
The firm A being the low cost firm will maximize profits by selling OM output at MP
price. The profits of the firm B is lower than of firm A because its costs of production is
higher than of firm A.

Q.9. Distinguish between perfect competitions and monopolistic

competitions.
Q.10. Distinguish between Monopoly and monopolistic competitions.

MARKETS STRUCTURE
Perfect Monopoly Monopolistic Oligopoly
Competition competition
Numbers Large sellers and Single seller and Many sellers and A few sellers
large buyers large buyers many buyers and large buyers

Product Homogeneous Particular or Heterogeneous Homogeneous

specialist or
heterogeneous
price Equilibrium Price Independent Interdependent
price(fixed by discrimination pricing policy pricing policy
industry where
Demand =Supply
Seller A price taker A price maker A price dictator Price imitator
Demand Horizontal to X Slopes Slopes Kink demand
curve axis downward downward(Flatter) curve(Price
(Steeper) Rigidity)
Known as Perfect Imperfect Imperfect Imperfect
competition competition competition competition
existence It is unreal market It is restricted It is in existence It is existence
Entry and Free entry and No entry Free entry and exit Entry prohibited
exit exit
Special Assumption Remote Group concept Price rigidity
feature based competitors (Chamberlin) (to stop
competitors)
Substitutes Number of No substitute Number of A few

PROF. RAJESH H.B

Prof. KARBHARI BHALCHANDRA