Unit - 4

1. Perfect Competition
• De nition: A market where no individual buyer or seller can in uence the
price.
• Features:
• Large number of buyers and sellers.
• Homogeneous products.
• Free entry and exit.
• Perfect knowledge of market.
• Perfect mobility of factors.
• Price & Output Determination:
• Firms are price takers.
• Price set by market demand and supply.
• Equilibrium: MR = MC.
• Long-run: Only normal pro ts.

2. Monopoly
• De nition: Market with a single seller and no close substitutes.
• Features:
• Single producer.
• High entry barriers.
• Price maker.
• Price discrimination possible.
• Price & Output Determination:
• Firm sets output where MR = MC.
• Price is determined from demand curve.
• Leads to supernormal pro ts and restricted output.

3. Monopolistic Competition
• De nition: Market with many sellers o ering di erentiated products.
• Features:
• Product di erentiation.
• Many sellers and buyers.
• Some control over price.
• Advertising plays a key role.
• Price & Output Determination:
• Short-run: Supernormal pro ts possible.
• Long-run: Only normal pro ts.
• Equilibrium: MR = MC.
• Leads to excess capacity.

4. Price Determination
• Perfect Competition: Price by demand-supply forces.
• Monopoly: Price from demand curve after setting output at MR = MC.
• Monopolistic Competition: Price slightly above MC due to product variation.

5. Game Theory
• De nition: Study of strategic interactions between rms.
• Used in: Oligopoly markets.
• Key Concepts:
• Mutual interdependence.
• Nash Equilibrium.
• Prisoner’s Dilemma.
• Collusion and non-cooperative strategies.
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 1. Perfect Competition

Features:
• Large number of buyers and sellers.
• Homogeneous product.
• Free entry and exit.
• Perfect knowledge of market conditions.
• No transport cost.
• Perfect mobility of factors.

Price and Output Determination:

• Price is determined by market demand and supply.
• A rm is a price taker.
• In the short run, rms may earn supernormal pro ts, normal pro ts, or
losses.
• In the long run, only normal pro ts are possible due to free entry and exit.
• Equilibrium condition: MC = MR = Price.

2. Monopoly

Features:
• Single seller and many buyers.
• No close substitutes.
• High barriers to entry.
• Price maker.
• Possibility of price discrimination.
• Downward sloping demand curve.

Price and Output Determination:

• Firm is a price maker, faces the market demand curve.
• Produces output where MR = MC.
• Can earn supernormal pro ts in the short and long run.
• Price is set above marginal cost.
• Restricts output to maximize pro ts, leading to deadweight loss.

3. Monopolistic Competition

Features:
• Large number of rms.
• Product di erentiation.
• Free entry and exit.
• Selling costs like advertising.
• Some control over price.

Price and Output Determination:

• Firm faces downward sloping demand curve due to product
di erentiation.
• In the short run: Can earn supernormal pro ts.
• In the long run: Only normal pro ts due to new rms entering the market.
• Equilibrium: MR = MC, but price > MC.
• Excess capacity due to downward sloping demand.

4. Price Determination

Under Perfect Competition:

• Price determined by intersection of demand and supply.
• Individual rm accepts this price.
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Under Monopoly:
• Determined by marginal cost and marginal revenue.
• Firm decides price based on pro t-maximizing output.

Under Monopolistic Competition:

• Price set above marginal cost.
• In uenced by product di erentiation and selling costs.

5. Game Theory (Oligopoly Context)

Key Concepts:
• Used to analyze strategic interaction between rms.
• Firms consider the possible actions of rivals when making decisions.

Features:
• Few dominant rms.
• Mutual interdependence.
• Strategies include pricing, advertising, output.

Types:
• Cooperative games: Firms may collude to x prices.
• Non-cooperative games: Firms act independently (e.g., Nash
Equilibrium).

Example:
• Prisoner’s Dilemma: Illustrates why rms may not cooperate even if it is in
their best interest.
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 • Perfect Competition

De nition:

Perfect competition is a market structure where a large number of buyers and sellers engage
in the sale and purchase of a homogeneous product under conditions of perfect knowledge
and free entry and exit. In this market, no single buyer or seller can in uence the price,
making each rm a price taker.

Features of Perfect Competition:

1. Large Number of Buyers and Sellers:
No single buyer or seller can in uence the market price.
2. Homogeneous Product:
All rms sell identical products, so consumers have no preference between sellers.
3. Free Entry and Exit:
Firms can freely enter or exit the market in the long run, ensuring normal pro ts.
4. Perfect Knowledge:
Buyers and sellers are fully aware of prices, products, and technology.
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 5. Perfect Mobility of Factors:
Factors of production (like labor and capital) can move freely from one use to another.
6. No Transportation Costs:
Products are assumed to be available everywhere without transport charges.

Price and Output Determination:

• Price Determination:
Price is determined by the intersection of market demand and supply. Since all rms
sell the same product, the market sets a uniform price.
• Firm’s Role:
Each rm is a price taker and can sell any quantity at the market price.
• Equilibrium Condition:
A rm maximizes pro t where Marginal Cost (MC) = Marginal Revenue (MR).
In perfect competition, MR = Price, so the equilibrium is where MC = Price.
• Short Run:
Firms can earn normal or supernormal pro ts, or even losses.
• Long Run:
Due to free entry and exit, rms earn only normal pro ts, and price equals Average Cost
(AC) and Marginal Cost (MC).

• Monopolistic Competition – De nition:

Monopolistic competition is a market structure where many sellers o er similar but not identical
products. Each rm has some degree of market power due to product di erentiation, allowing
them to in uence prices to a certain extent.

Features of Monopolistic Competition:

1. Large Number of Sellers: Many rms compete, but each has a small share
of the market.
2. Product Di erentiation: Each rm o ers a product that is slightly di erent
in quality, brand, features, or services.
3. Free Entry and Exit: Firms can enter or leave the market easily in the long
run.
4. Some Price Control: Firms have limited control over pricing due to brand
loyalty.
5. Selling Costs: Firms incur advertising and promotional costs to di erentiate
their products.
6. Non-price Competition: Firms compete on quality, packaging, brand
image, etc.

Price and Output Determination:

Short Run:
• Firms can earn supernormal pro ts, normal pro ts, or losses.
• Equilibrium is where Marginal Revenue (MR) = Marginal Cost (MC).
• Price is set based on the demand curve, which is downward sloping due
to product di erentiation.

Long Run:
• Due to free entry and exit, abnormal pro ts attract new rms.
• As more rms enter, demand for existing rms’ products becomes more
elastic.
• Firms end up earning only normal pro ts.
• Equilibrium: Still occurs where MR = MC, but now price = Average Cost
(AC).

• Oligopoly Competition
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 De nition:

Oligopoly is a market structure where a few large rms dominate the industry. These rms
produce either homogeneous or di erentiated products, and each rm’s decisions a ect the
others, leading to mutual interdependence.

Features of Oligopoly:
1. Few Sellers: A small number of large rms control most of the market.
2. Interdependence: Firms consider the actions and reactions of competitors
when making decisions.
3. Barriers to Entry: High start-up costs and other factors prevent new rms
from entering easily.
4. Non-Price Competition: Firms often compete through advertising and
product variation instead of price changes.
5. Price Rigidity: Prices tend to remain stable due to fear of price wars.
6. Kinked Demand Curve: Suggests that rms face a dual demand curve —
elastic above the current price and inelastic below it.

Price and Output Determination:

• No single method: Varies depending on whether rms collude or act
independently.

a) Collusive Oligopoly (Cartel):

• Firms agree to x prices and output.
• Price and output are decided collectively, similar to a monopoly.

b) Non-Collusive Oligopoly:
• Firms compete independently.
• Due to uncertainty, rms may keep prices rigid to avoid retaliation.
• Use Game Theory to make strategic decisions (e.g., pricing, output,
advertising).

c) Kinked Demand Curve Model (Sweezy Model):

• Explains price rigidity.
• Above the current price: demand is elastic (loss of customers).
• Below the current price: demand is inelastic (others match the price cut).
• So, rms prefer not to change prices, leading to price stability.

• Monopoly

A monopoly is a type of market structure where a single seller controls the entire supply
of a product or service that has no close substitutes. This gives the rm signi cant
control over the price and output in the market.

Features of Monopoly
1. Single Seller: One rm controls the entire market supply.
2. No Close Substitutes: The product o ered is unique, with no similar
alternatives.
3. Price Maker: The monopolist can set the price because they face no
competition.
4. High Barriers to Entry: Legal, technological, or nancial obstacles prevent
other rms from entering the market.
5. Downward Sloping Demand Curve: To sell more, the monopolist must
lower the price.
6. Possibility of Price Discrimination: The monopolist can charge di erent
prices to di erent consumers for the same product.
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 7. Control Over Supply: Full control over the quantity supplied allows
in uence over market price.

Price and Output Determination under Monopoly

• Demand Curve: The monopolist faces the market demand curve, which is
downward sloping (more quantity is sold at a lower price).
• Marginal Revenue (MR): Because the rm must lower the price to sell
more, MR < Price.
• Cost Structure: The rm has its own marginal cost (MC) and average
cost (AC) curves.

Pro t Maximization Condition:

• The monopolist maximizes pro t where MR = MC.
• At this output level, the corresponding price is determined from the
demand curve.

Short-Run and Long-Run:

• Short Run: Can earn supernormal pro ts (TR > TC), normal pro ts, or
even losses.
• Long Run: Usually continues to earn supernormal pro ts because of
barriers to entry.

Price > Marginal Cost:

• Unlike perfect competition, in monopoly, the price is higher than MC,
resulting in allocative ine ciency.
• Price Determination

Price Determination refers to the process through which the price of a good or service is
established in the market, depending on the interaction of demand and supply. The process
varies by market structure:

1. In Perfect Competition:
• Price is determined by market demand and supply.
• Individual rms are price takers, meaning they have no control over the
price.
• The equilibrium price is set where market demand = market supply.
• Firms accept this price and produce output where Marginal Cost (MC) =
Price.

2. In Monopoly:
• The monopolist is a price maker and controls both price and output.
• The rm faces the entire market demand curve.
• Price is determined by nding output where Marginal Revenue (MR) =
Marginal Cost (MC), and then charging the price from the demand curve at that quantity.
• This results in higher price and lower output compared to perfect
competition.

3. In Monopolistic Competition:
• Firms have some control over price due to product di erentiation.
• Like monopoly, they set output where MR = MC, but in the long run, only
normal pro ts are possible.
• Price is determined above marginal cost but limited by the availability of
close substitutes

• Game Theory
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 Game Theory is the study of strategic decision-making where the outcome for each participant
depends on the actions of others. It’s most commonly used in Oligopoly, where few rms
dominate the market.

Key Concepts:
• Players: The rms or decision-makers.
• Strategies: The choices available to each player (e.g., set a high price or
low price).
• Payo s: The outcomes or pro ts resulting from the combination of
strategies.
• Interdependence: Each rm’s success depends on its own actions and the
actions of rivals.

Important Models:
1. Prisoner’s Dilemma (example of non-cooperative game):
• Two rms might bene t from cooperation (e.g., xing high prices).
• But due to lack of trust or fear of cheating, both may choose to
compete (e.g., lower prices), leading to lower pro ts for both.
2. Nash Equilibrium:
• A situation where no player can improve their outcome by changing
their strategy while the other players keep theirs unchanged.
• Firms settle into a strategy that is best given what others are doing.
3. Collusion/Cartel (Cooperative Game):
• Firms cooperate (legally or illegally) to set prices or output to maximize joint pro ts.
• Example: OPEC setting oil prices.

Market Structure Price Determination Key Characteristics Price Behavior

Perfect Competition Price is determined by - Large number of - Price is set at
the intersection of the rms- Homogeneous equilibrium where
market’s supply and products- Free entry supply equals
demand curves. and exit- Perfect demand.- Firms
Producers are price information and cannot in uence price;
takers. mobility. they accept the
market price.
Monopolistic Price is determined by - Many rms- - Price is higher than
Competition the rm’s demand Di erentiated in perfect competition
curve and is products- Free entry but not as high as in
in uenced by the and exit- Some monopoly.- Firms
degree of product control over price due have some power over
di erentiation. to di erentiation.- price due to product
Advertising plays a di erentiation.
signi cant role.
Monopoly The monopolist - Single rm - Price is higher than
determines price dominates the market- in competitive markets
based on the market High barriers to entry- due to lack of
demand curve. They Unique product with competition.-
maximize pro t by no close substitutes- Monopolist can
setting MR = MC Price maker. restrict output to
(Marginal Revenue = increase prices.
Marginal Cost).
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 Oligopoly Price is determined by - Few rms dominate - Prices tend to be
interactions between a the market- Products sticky (do not change
few large rms. Firms may be di erentiated easily)- Firms may
may either collaborate or homogeneous- engage in price
(collusion) or compete. High barriers to entry- leadership or
Mutual collusion.- Prices may
interdependence be stable but higher
among rms. than in competitive
markets.
Game Theory (in Price determination is - Firms make - Firms in oligopolies
Oligopoly) in uenced by strategic decisions based on often avoid price wars
decision-making what others do- through collusion.-
between rms. It Prisoner’s Dilemma, Non-price competition
examines the Nash Equilibrium are (advertising, product
outcomes of di erent key concepts.- Firms di erentiation) may be
pricing strategies. may cooperate or used instead of
compete based on changing prices.
expected outcomes.

Market De nition Features Price Output

Structure Determination Determination
Perfect A market - Many rms- Price is Output is
Competition structure where Homogeneous determined by determined
many rms sell products- Free the intersection where MC = MR
identical entry and exit- of market supply (Marginal Cost =
products, and no Perfect and market Marginal
single rm can information- demand curves. Revenue) for the
in uence the Firms are price Firms accept this individual rm,
market price. takers. price. producing at
optimal
e ciency.
Monopolistic A market - Many rms- Price is Output is
Competition structure where Product in uenced by determined
many rms sell di erentiation- demand and where MC = MR,
similar but not Free entry and product but rms can
identical exit- Some di erentiation. adjust based on
products, control over Firms have some perceived
allowing for some price- Heavy price-setting demand for their
degree of price reliance on power, but not di erentiated
control. advertising. total control. products.
Monopoly A market - Single rm- Price is set by the Output is
structure where a Unique product monopolist, restricted to
single rm with no close typically where maximize pro t at
dominates the substitutes- High MC = MR to the point where
entire market, barriers to entry- maximize pro t. MC = MR, which
with no close Price maker- The monopolist typically results in
substitutes for its Signi cant can choose the lower output and
product. control over price. higher prices.
supply.
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 Game Theory A theoretical - Strategic Price may be Output is
framework used decision-making- in uenced by determined
to model Focus on strategic based on the
strategic interdependence interactions strategies rms
interactions of rms- Use of between rms. choose in relation
between rms, Nash Equilibrium, Firms anticipate to each other.
particularly in Prisoner’s competitors’ Firms may
oligopolistic Dilemma, and actions to set collude or
markets. other strategies. prices. compete on price
and output.

Here is a table summarizing the

Summary of Key Points:
• Perfect Competition: Many rms, homogeneous products, no control over
prices; output is determined by the market equilibrium.
• Monopolistic Competition: Many rms with di erentiated products, some
price control; output is based on MC = MR but in uenced by product di erentiation.
• Monopoly: Single rm with unique product, price maker; output is restricted
to maximize pro ts, leading to higher prices and lower output.
• Game Theory: Strategic interaction between rms in oligopolies,
considering competitors’ actions; price and output depend on the strategic choices made
by rms.

This table outlines the foundational concepts of each market structure, how prices and
outputs are determined, and the features that distinguish them.
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