MICRO.

ECO-XI-6
Non-competitive Markets
1. Perfect Competition (Recap)

A market is considered perfectly competitive when:

 There are a very large number of buyers and sellers, each too small to affect the overall
market.

 Firms can freely enter or exit the market.

 The products offered by different firms are identical (homogeneous) and cannot be
substituted by goods from other industries.

 Buyers and sellers have perfect knowledge of products, inputs, and prices.

2. Non-competitive Markets: When Perfect Competition Conditions Fail

When one or more of the perfect competition conditions are not met, we get non-competitive
markets. The chapter focuses on three main types: Monopoly, Monopolistic Competition, and
Oligopoly.

3. Monopoly

 Definition: A market with only one seller and many buyers.

 Key Features:

o Single Producer: Only one firm produces the commodity.

o No Close Substitutes: There are no other goods that can effectively replace this
commodity.

o Barriers to Entry: Significant restrictions prevent other firms from entering the
market and selling the same product. Dropping the free entry assumption (ii) of
perfect competition often leads to a monopoly.

 Monopolist as a Price Maker: Unlike firms in perfect competition (price takers), a monopolist
can influence the price by changing the quantity supplied.

 Market Demand Curve is the Average Revenue Curve:

o The market demand curve shows the quantity consumers are willing to buy at
different prices.

o For a monopolist, to sell a larger quantity, it must lower the price. Conversely, selling
less allows it to charge a higher price.
 o Therefore, the price depends on the quantity sold, and the monopolist faces the
entire downward-sloping market demand curve.

o Average Revenue (AR), which is total revenue (TR) divided by quantity (q) (AR =
TR/q), is equal to the price (p). Thus, the market demand curve is the monopolist's
AR curve.

 Total, Average, and Marginal Revenues:

o Total Revenue (TR): The total money received from selling the output (TR = p × q).
For a monopolist with a downward-sloping demand curve, TR is not a straight line; it
typically increases, reaches a maximum, and then decreases as quantity increases.
This is because to sell more, the price must fall.

o Average Revenue (AR): Revenue per unit sold (AR = TR/q = p). As noted, this is the
demand curve.

o Marginal Revenue (MR): The change in total revenue from selling one additional
unit of output (MR = ΔTR/Δq).

o Relationship between AR and MR: For a monopolist, the MR curve lies below the AR
curve. This is because to sell one more unit, the monopolist must lower the price not
only for that additional unit but also for all the previous units sold.

o Graphical Representation: The slope of the ray from the origin to a point on the TR
curve gives AR. The slope of the tangent to the TR curve at a point gives MR.

 Marginal Revenue and Price Elasticity of Demand:

o When demand is elastic (price elasticity > 1), MR is positive. Selling more increases
total revenue.

o When demand is inelastic (price elasticity < 1), MR is negative. Selling more
decreases total revenue.

o When demand is unitary elastic (price elasticity = 1), MR is zero. Total revenue is at
its maximum.

 Short Run Equilibrium of the Monopoly Firm: A monopolist aims to maximize profit (Profit =
TR - Total Cost (TC)).

o Zero Cost Case: If the monopolist has zero costs, profit is maximized when TR is
maximized, which occurs when MR is zero.

o Positive Cost Case (Using Total Curves): Profit is maximum where the vertical
distance between the TR curve and the TC curve is the largest, and TR is above TC.

o Positive Cost Case (Using Average and Marginal Curves): Profit is maximized at the
level of output where Marginal Revenue (MR) equals Marginal Cost (MC), and the
MC curve is rising. The price at this equilibrium quantity is determined by the
demand curve (AR curve).
 o Comparison with Perfect Competition: A monopoly typically produces a smaller
quantity and charges a higher price compared to a perfectly competitive market
with the same cost and demand conditions.

 Long Run Equilibrium of the Monopoly Firm: Unlike perfectly competitive firms that earn
zero economic profit in the long run due to free entry, a monopolist can continue to earn
positive economic profits in the long run because barriers to entry prevent new firms from
competing away these profits.

 Competitive Behaviour vs. Competitive Structure: A perfectly competitive market structure

leads to less competitive behaviour (firms don't need to compete on price). Conversely, a less
competitive market structure like oligopoly can lead to more strategic and competitive
behaviour among the few firms. In a monopoly, there is no other firm to compete with
directly.

 Critical Views on Monopoly:

o Monopolies may charge higher prices and are often seen as exploitative.

o However, some argue that pure monopolies are rare in reality due to the availability
of substitutes.

o Competition may arise from new technologies and products in the long run.

o Monopolies may have more funds for research and development, potentially
leading to better or cheaper goods.

4. Monopolistic Competition

 Definition: A market structure with a large number of firms, free entry and exit, but
differentiated products.

 Key Features:

o Large Number of Firms: Similar to perfect competition, but not as many.

o Free Entry and Exit: Relatively easy for new firms to enter and existing firms to leave.

o Product Differentiation: Firms sell products that are close substitutes but are not
identical. Differentiation can be based on brand names, packaging, taste, etc.. This is
the key difference from perfect competition (homogeneous products).

 Downward Sloping Demand Curve: Due to product differentiation, each firm faces a
downward-sloping demand curve (but more elastic than a monopolist's). If a firm raises its
price, it will lose some customers to rivals, but not all, as some consumers have brand
loyalty.

 AR and MR Curves: The demand curve is the firm's AR curve, and the MR curve lies below it
and is also downward sloping.
  Short Run Equilibrium: Similar to a monopolist, a monopolistically competitive firm
maximizes profit by producing the quantity where MR = MC. The price is determined by the
demand curve at this quantity. Firms can earn supernormal profits in the short run.

 Long Run Equilibrium: The possibility of free entry eliminates supernormal profits in the long
run. If firms are making profits, new firms enter, increasing supply and shifting the demand
curve for existing firms to the left (reducing demand and price). This continues until profits
are driven to zero (AR = AC). However, unlike perfect competition where P = MC at the
minimum of AC, in monopolistic competition, P > MC and the firm operates on the
downward-sloping portion of the AC curve, leading to excess capacity. Price is higher and
quantity is lower than under perfect competition.

5. Oligopoly

 Definition: A market structure with a small number of large firms producing a

homogeneous product (pure oligopoly, like some raw materials) or differentiated products
(differentiated oligopoly, like automobiles). A special case with only two firms is called
duopoly.

 Key Features:

o Few Large Firms: Each firm's output is a significant portion of the total market
supply.

o Interdependence: Firms are mutually dependent. Each firm's actions (e.g., changing
price or output) significantly affect the other firms' profits, leading to strategic
interactions and reactions. This interdependence makes analyzing oligopoly
behaviour complex.

o Barriers to Entry: Some barriers to entry exist, preventing a large number of firms
from entering.

 Firm Behaviour: Due to interdependence, there is no single, universally accepted theory of

how oligopoly firms behave. Some possible behaviours include:

o Collusion: Firms cooperate to maximize joint profits, acting like a monopoly. This can
take the form of a cartel. However, collusion is often difficult to maintain due to
incentives for individual firms to cheat.

o Competition: Firms may compete on price, output, advertising, etc., to gain market
share. Fierce price competition can drive prices down towards marginal cost, similar
to perfect competition.

o Strategic Interaction: Firms make decisions based on what they expect their rivals to
do. Various models (like Cournot) analyze this strategic behaviour.

o Price Rigidity: In some oligopolistic markets, prices tend to be stable (rigid) even
when costs or demand change. This can be explained by the fear of retaliation from
rivals if a firm raises prices (others won't follow, leading to loss of market share) or
 lowers prices (others will also lower prices, leading to a price war and reduced
profits for all).

Relationships Between Concepts:

 Demand Curve and Revenue Curves: The market demand curve is the AR curve for a
monopolist. For a monopolistically competitive firm, its individual demand curve is its AR
curve. The shape of the demand curve (its elasticity) determines the relationship between
AR and MR. A downward-sloping demand curve implies MR is less than AR.

 Total Revenue and Marginal Revenue: MR is the slope of the TR curve. When TR is
increasing, MR is positive. When TR is maximum, MR is zero. When TR is decreasing, MR is
negative.

 Profit Maximization: All types of firms (monopoly, monopolistic competition) aim to

maximize profit by equating MR and MC in the short run.

 Market Structure and Competition: More competitive market structures (like perfect
competition) lead to less competitive behaviour among individual firms. Less competitive
structures (like oligopoly) can lead to more strategic and competitive behaviour among the
few firms.

 Barriers to Entry and Long Run Profits: High barriers to entry allow monopolies to sustain
long-run profits. Free entry in monopolistic competition eliminates long-run supernormal
profits.

Expected Prelims Questions (Based on Previous Years' Trends):

 Consider a market where there is only one seller of a commodity with no close substitutes.
Which of the following market structures best describes this situation?

o (a) Perfect Competition

o (b) Monopolistic Competition

o (c) Monopoly

o (d) Oligopoly

 In a monopoly market, the marginal revenue curve is:

o (a) Equal to the average revenue curve.

o (b) Above the average revenue curve.

o (c) Below the average revenue curve.

o (d) Perfectly elastic.

 Which of the following is a key characteristic of monopolistic competition?

 o (a) Homogeneous products

o (b) A small number of firms

o (c) Free entry and exit of firms

o (d) A perfectly elastic demand curve for each firm.

 In the long run, a firm under monopolistic competition typically operates with:

o (a) Zero economic profit and producing at the minimum of the average cost curve.

o (b) Positive economic profit and producing at the minimum of the average cost
curve.

o (c) Zero economic profit and producing with excess capacity.

o (d) Negative economic profit and producing with excess capacity.

 Oligopoly is characterized by:

o (a) A very large number of buyers and sellers.

o (b) Free entry and exit of firms.

o (c) Interdependence among firms.

o (d) Homogeneous products only.

 When the demand curve facing a firm is elastic, its marginal revenue will be:

o (a) Negative.

o (b) Zero.

o (c) Positive.

o (d) Equal to average revenue.

Expected Mains Questions (Based on Previous Years' Trends):

 "While monopoly may lead to higher prices and lower output, it can also foster innovation
due to the availability of supernormal profits." Critically analyze this statement.

 Compare and contrast the short-run and long-run equilibrium of a firm under monopolistic
competition with that of a firm under perfect competition. What are the implications for
consumer welfare?

 Explain the challenges in analyzing the behaviour of firms in an oligopolistic market. Discuss
the different approaches used to understand oligopoly.

 Discuss the relationship between price elasticity of demand and the marginal revenue of a
monopolist. How does this relationship influence a monopolist's pricing decisions?

 "The absence of perfect competition often leads to market inefficiencies." Elaborate on this
statement with reference to monopoly and monopolistic competition.
  What are the key factors that lead to the emergence of monopoly in a market? Discuss the
measures that governments can take to address the potential negative consequences of
monopoly.

Keywords and Definitions:

 Perfect Competition: A market structure with many small firms, free entry/exit,
homogeneous products, and perfect information.

 Price Taker: A firm in perfect competition that has no power to influence the market price.

 Non-competitive Markets: Market structures where firms have some degree of market
power to influence prices.

 Monopoly: A market with a single seller.

 Price Maker: A monopolist that can influence the market price by adjusting output.

 Barriers to Entry: Factors that prevent new firms from entering a market.

 Market Demand Curve: Shows the total quantity demanded at different prices.

 Average Revenue (AR): Total revenue per unit sold (AR = TR/q = p).

 Total Revenue (TR): Total earnings from sales (TR = p × q).

 Marginal Revenue (MR): The change in total revenue from selling one more unit (MR =
ΔTR/Δq).

 Price Elasticity of Demand: Measures the responsiveness of quantity demanded to a change

in price.

 Monopolistic Competition: A market with many firms, free entry/exit, and differentiated
products.

 Product Differentiation: Making a product distinct from competitors' products.

 Excess Capacity: The difference between the minimum efficient scale of production and the
actual output level in the long run in monopolistic competition.

 Oligopoly: A market with a few large firms.

 Duopoly: An oligopoly with only two firms.

 Interdependence (of firms): The situation in oligopoly where each firm's actions affect the
others.

 Collusion: Cooperation among oligopoly firms to limit competition and increase joint profits.

 Cartel: A formal agreement among oligopoly firms to collude.

 Price Rigidity: The tendency of prices in some oligopolistic markets to remain stable.
Formulas:

 Total Revenue (TR) = Price (p) × Quantity (q)

 Average Revenue (AR) = Total Revenue (TR) / Quantity (q) = Price (p)

 Marginal Revenue (MR) = Change in Total Revenue (ΔTR) / Change in Quantity (Δq)

 Profit = Total Revenue (TR) - Total Cost (TC)

 Equilibrium Condition (General): Marginal Revenue (MR) = Marginal Cost (MC) (for
maximizing profit).