PERFECT COMPETITION

AND MONOPOLY
UNIT 3
Perfect Competition:
• What is perfect competition?
• A Perfect Competition market is that type of market in which the
number of buyers and sellers is very large, all are engaged in buying
and selling a homogeneous product without any artificial restrictions
and possessing perfect knowledge of the market at a time.
• According to Boulding—”A Perfect Competition market may be
defined as a large number of buyers and sellers all engaged in the
purchase and sale of identically similar commodities, who are in close
contact with one another and who buy and sell freely among
themselves.”
Characteristics/Assumptions of Perfect
Competition:
The following characteristics are essential for the existence of Perfect Competition :
• 1. Large Number of Buyers and Sellers:
• The first condition is that the number of buyers and sellers must be so large
that none of them individually is in a position to influence the price and
output of the industry as a whole. In the market the position of a purchaser
or a seller is just like a drop of water in an ocean.

• 2. Homogeneity of the Product:

• Each firm should produce and sell a homogeneous product so that no buyer
has any preference for the product of any individual seller over others. If
goods will be homogeneous then price will also be uniform everywhere.
• 3. Free Entry and Exit of Firms:
• The firm should be free to enter or leave the firm. If there is hope of
profit the firm will enter in business and if there is profitability of loss,
the firm will leave the business.

• 4. Perfect Knowledge of the Market:

• Buyers and sellers must possess complete knowledge about the prices at
which goods are being bought and sold and of the prices at which others
are prepared to buy and sell. This will help in having uniformity in prices.
• 5. Perfect Mobility of the Factors of Production and
Goods:
• There should be perfect mobility of goods and factors between
industries. Goods should be free to move to those places where they can
fetch the highest price.
• 6. Absence of Price Control:
• There should be complete openness in buying and selling of goods. Here
prices are liable to change freely in response to demand and supply
conditions.

• 7. Perfect Competition among Buyers and Sellers:

• In this purchasers and sellers have got complete freedom for bargaining, no
restrictions in charging more or demanding less, competition feeling must
be present there.

• 8. Absence of Transport Cost:

• There must be absence of transport cost. In having less or negligible
transport cost will help complete market in maintaining uniformity in price.
• 9. The firms are the Price Takers :
• There is always one price of the commodity available in the market.
The firms are price takers in the market.

• 10. Independent Relationship between Buyers and

Sellers:
• There should not be any attachment between sellers and purchasers in
the market. Here, the seller should not show prick and choose method
in accepting the price of the commodity. If we will see from the close
we will find that in real life “Perfect Competition is a pure myth.”
• Pure or perfect competition is a theoretical market structure in which
the following criteria are met:
• All companies sell an identical product.
• All companies accept prices (they cannot influence the market price
of their product).
• Market share does not influence prices.
• Buyers have complete or “perfect” information, past, present, and
future, about the product being sold and the prices charged by each
company.
• The resources for such work are perfectly mobile.
• Firms can enter or exit the market at no cost.
• Examples of perfect competition
• It is often claimed that perfect competition does not exist in the real world. Up
to a point, this proposition is correct. For example, perfect competition may
have existed in earlier centuries when commodities were the main source of
economic activity. In particular, coal, oil, metals, and corn were important parts
of the microeconomy . At the same time, they were homogeneous and fulfilled
the characteristics.

• If we go back centuries to old-fashioned markets, we would find many buyers

and many sellers of the same product. For example, there may be many bakers
who come to the market to sell loaves of bread. A homogeneous product, with a
large number of buyers and sellers who can enter or leave the market.
Equilibrium of Firm Under
Perfect Competition

• Equilibrium of firm means the level of output where the firm is

maximising its profits and therefore has no tendency to change its
output
• In this situation the firm will be earning maximum profit for
encouraging minimum loss.
 Short run Equilibrium under Perfect Competition

• The short run means a period of time within which the firms can alter their level of output only by
increasing or decreasing the amounts of variable factors such as labour and raw materials, while
fixed factors like capital equipment, machinery etc. remain un­changed. In short run the firm’s output
supply can be changed only by the variable factors
• Moreover, in the short run, new firms can neither enter the industry, nor the existing firms can leave
it. If the demand is increased the supply can be increased only up to its existing production capacity.
• Under perfect competition, an individual firm is a price taker, that is, it has to accept the prevailing
price as a given datum. It cannot influence the price by its indi­vidual action. As a result, demand curve
or average revenue curve of the firm is a horizontal straight line (i.e., perfectly elastic) at the level of
the prevailing price.
• Since perfectly competitive firm sells additional units of output at the same price, marginal revenue
curve coincides with average revenue curve. Marginal cost curve, as usual, is U-shaped. We shall
explain the equilibrium of a perfectly competitive firm by assuming that all firms are working under
identical cost conditions.
• Now, in order to decide about its equilibrium output, the firm will compare marginal cost with
marginal revenue. It will be in equilibrium at the level of output at which marginal cost equals
marginal revenue and marginal cost curve is cutting marginal revenue curve from below.
• Since marginal revenue is the same as price (or average revenue) under perfect
competition, the firm will equalise marginal cost with price to attain equilibrium
output.
• Consider Fig. 23.2 in which price OP is prevailing in the market. PL would then
be the demand curve or the average and marginal revenue curve of the firm. It
will be seen from Fig. 23.2 that marginal cost curve cuts average and marginal
revenue curve at two different points, F and E.
• F cannot be the position of equilibrium, since at F second order condition of
firm’s equilibrium, namely, that marginal cost curve must cut marginal revenue
curve from below at the point of equilibrium, is not satisfied. The firm will be
increasing its profits by increasing production beyond F because marginal
revenue is greater than marginal cost.
• The firm will be in equilibrium at point E or output OM since at E marginal cost
equals marginal revenue (or price) as well as marginal cost curve is cutting
marginal revenue curve from below. As under perfect competition marginal
revenue curve is a horizontal straight line, the marginal cost curve must be
rising so as to cut the marginal revenue curve from below.
• Therefore, in case of perfect competition the second order condition of firm’s
equilibrium requires that marginal cost curve must be rising at the point of
equilibrium.
• Hence the twin conditions of firm’s equilibrium under perfect competition are:
• (1) MC=MR = Price
• (2) MC curve must be rising at the point of equilibrium.
• But the fulfillment of the above two conditions does not guarantee
that the profits will be earned by the firm. In order to know whether
the firm is making profits or losses and how much of them, average
cost curve must be introduced in the figure. This has been done in
next fig where SAC and SMC curves are short-run av­erage cost and
short-run mar­ginal cost curves respectively.
• A firm may face following situations
• Abnormal Profit, Normal Profit, Abnormal Loss and Shutdown Point.
 (i) Abnormal/Supernormal Profit
• A firm will earn super normal profit in short run if its SAC is less
than the AR at the point of equilibrium. Such a firm has been
depicted in Figure.
• It shows firm’s equilibrium at point R where its output is OQ1. At
this point, both the equilibrium conditions are satisfied, i.e. MR =
MC and, the MC curve is positively sloped at the point of
intersection. The average cost of the firm, as represented by the
SAC curve, is OT (= SQ1) at this output level. Based on it,
• profit can be estimated as profit=Total revenue – Total cost
• Given that total revenue is OPRQ1 and total cost is OTSQ1,
• Profit = PTSR = OPRQ1 – OTSQ1
• This is the profit which the firm earns over and above the normal
profit and, hence, termed as super normal profit. It has been
shown by the shaded area in the figure.

• AR= avg revenue MR = marginal revenue

• AC= avg cost MC = Marginal cost
•
 (ii) Normal Profit
• The figure shows equilibrium at point R
where the output is OQ1. At this level of
output, AC is RQ1, as shown by its SAC
curve. It is equal to the per unit revenue
which is also RQ1. It means that firm is
making only normal profit which is a part
of average cost. In this case —
• Total revenue = Total cost = OPRQ1
• Therefore, no profit no loss
 (iii) Abnormal Loss/ Loss
• PL is the price line which lies below AC curve at all
levels of output.
• The firm will be in equilibrium at point E at where
MC=MR and MC curve is rising.
• Firm would be producing OM output but would be
making losses, since AR(or price) which is equal to
ME is less than AC which is equal to MF.
• OPEM’= total revenue
• OHFM= total cost
• Therefore, PHFE= loss
• In this situation, one may ask what a firm should do to minimize its losses. Should it
continue production and bear the losses or should it stop production and wait for
higher price level to come for a re-entry in the market? Answer to such questions will
depend upon the fact that, is the firm able to recover at least the variable cost from
its revenue or not?
• i). If the firm is able to recover the variable cost, or a little more, it should continue
production and bear the loss which will be equal to or less than its fixed cost. In such
a scenario, the firm will minimize losses by way of continuing production.
• The firm will continue to do so in short run even if AR = SAVC. It is because of the fact
that its loss will be equal to the fixed cost whether it stops production or continue to
produce. In such situation, the firm may be advised to continue the production and
remain in the market.
• ii) However, if the AR < SAVC, firm should stop production and minimize the loss
which will be equal to its fixed cost.
 (iv) Shutdown Situation
• we will now consider a firm which will minimize losses
by way of stopping production. In this situation, its
losses would be equal to the fixed cost. But, if it
continues production, its losses will be more than the
fixed cost. Hence, the firm will be better off if it stops
production. This is called as shut down situation.
• the firm finds its equilibrium at point R and output
level OQ1. At this level, average cost is SQ1 which is
more than the AR (= RQ1) generating per unit loss of
SR (= SQ1 – RQ1) and total loss of TSRP.
• per unit loss (SR) is more than the AFC (= SU) at this
level of output. It means that the AR is unable to cover
even the variable cost. The firm should, therefore,
stops production to minimize losses equal to the AFC.
Long Run Equilibrium Under Perfect Competition

• The long run is a period of time which is sufficiently long to allow the
firms to make changes in all factors of production.
• In the long run, all factors are variable and none fixed. The firms, in the
long run, can increase or decrease their output by changing their capital
equipment. Besides, in the long run, new firms can enter or exit the
industry.
• The long-run equilibrium then refers to the situation when free and full
adjustment in the capital equip­ment as well as in the number of firms
has been allowed to take place. It is therefore long-run average and
marginal cost curve which are relevant for deciding about equilibrium
output in the long run. Moreover, in the long run, it is the average total
cost which is of determining importance, since all costs are variable and
none fixed.
• fig. represents long-run equilibrium of firm under perfect
compe­tition. The firm cannot be in the long-run equilibrium at
a price greater than OP in Fig. 23.6. This is be­cause if price is
greater than OP, then the price line (demand curve) would lie
somewhere above the minimum point of the av­erage cost
curve so that marginal cost and price will be equal where the
firm is earning abnormal profits.
• Since there will be tendency for new firms to enter and
compete away these abnormal profits, the firm cannot be in
long-run equilibrium at any price higher than OP. Likewise, the
firm cannot be in long-run equilibrium at a price lower than OP
in Fig. 23.6 under perfect competition.
• If price is lower than OP, the average and marginal revenue
curve will lie below the average cost curve so that the marginal
cost and price will be equal at the point where the firm is
making losses. Therefore, there will be tendency for some of
the firms in the industry to go out with the result that price
will rise and the firms left in the industry make normal profits.
• We therefore conclude that the firm can be in long-run equilibrium under
perfect competition only when price is at such a level that the horizontal
demand curve (that is, AR curve) is tangent to the average cost curve so that
price equals average cost and firm makes only normal profits.
• It should be noted that a horizontal demand curve can be tangent to a U-
shaped average cost curve only at the latter’s minimum point. Since at the
minimum point of the average cost curve the marginal cost and average cost
are equal, price in long-run equilibrium is equal to both marginal cost and
average cost. In other words, double condition of long-run equilibrium is
fulfilled at the minimum point of the average cost curve.
• It is clear from above that long-run equilibrium of the firm under perfect
competition is estab­lished at the minimum point of the long-run average cost
curve. Working at the minimum point of the long-run average cost curve
signifies that the firm is of optimum size, that is, it is producing output at the
lowest possible cost.
 Measuring Producer’s Surplus under Perfect Competition

• The producer surplus is the area above the

supply curve (see the graph below) that
represents the difference between what a
producer is willing and able to accept for
selling a product, on the one hand, and what
the producer can actually sell it for, on the
other hand.
• That difference is the amount that the
producer receives as a result of selling the
good within the market. In other words, the
producer surplus actually measures producer
welfare.
• in this formula, total revenue refers to the revenue received from selling a particular
number of units of a good. Meanwhile, the total cost refers to the cost of producing the
number of units of the good. When you subtract the total cost from the total revenue, you
discover the producer’s total benefit, which is otherwise known as the producer surplus.
• When the price for the good on the market increases, the producer surplus also increases.
When the price of the good on the market decreases, the producer surplus likewise
decreases.
Effect of Taxes on Demand and
Supply
• One form of government intervention is the introduction of taxes. Taxes are typically
introduced to increase government revenue, but they also have the effect of raising the
cost of goods and services to the consumer. Because of the increased cost, we generally
see a reduction in the quantity of goods and services produced and consumed after the
introduction of taxes. A common form of tax is a sales tax, which is added on to the price
of a product and paid by the consumer. Another common type of tax is a VAT (value added
tax) which is paid by the producer along their production chain.
• The sales tax on the consumer shifts the demand curve to the left, symbolizing a reduction
in demand for the product because of the higher price. While demand for the product has
not changed (all of the determinants of demand are the same), consumers are required to
pay a higher price, which is why we see the new equilibrium point occurring at a higher
price and lower quantity. The magnitude of the shift in the demand curve will be equal to
the amount of the tax. This makes sense, because the change in demand is going to be
equal to the change in price that is caused by the tax.
• The VAT on the suppliers will shift the supply curve to the left, symbolizing a reduction in
supply (similar to firms facing higher input costs). While supply for the product has not
changed (all of the determinants of supply are the same), producers incur higher cost,
which is why we will see a new equilibrium point further up the demand curve at a higher
price and lower quantity. Once again, the magnitude of the shift in the supply curve will
be equal to the amount of the tax introduced by the government. Essentially, the firms
are passing on the tax to the consumers in the same way they would pass on higher input
costs.
 Effect of Subsidies on Demand
and Supply
• Subsidies are grants given to businesses or customers in order to
boost sales. These grants are used whenever there is a shortage in
supply, to encourage the purchase of safety or healthy products, or
whenever it is in the best interest of the public.
• Subsidies for producers increase supply and the quantity demanded
by consumers. The government provides production subsidies
whenever it is in the interest of the public in order to meet demand.
E1
• As the producer increases supply, the cost of production is reduced,
allowing the supplier to profit from both the subsidy and lower costs.
E2
The supply curve shifts downward and to the right due to the lower
costs and higher quantity provided. Lower costs to the manufacturer
are then transferred to the consumer in the form of lower prices.
Cost-conscious consumers will then be more inclined to purchase the
product.
• As a result of the subsidy, the increased supply will be able to
accommodate the higher quantity demanded. Although quantity
demanded increases, the demand curve does not shift. Instead, the
new equilibrium point is where the shifted supply curve meets the
higher quantity demanded point.
 MONOPOLY
• 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 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.
• 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.
• 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:
Short Run Equilibrium under
Monopoly
• 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:

i. The firm earns normal profits – If the average cost = the average
revenue
ii. It earns super-normal profits – If the average cost < the average
revenue
iii. 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.
• Equilibrium in Monopoly
• 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.
 Supernormal Profits
• A firm earns super-normal profits when the
average cost of production is less than the
average revenue for the corresponding output.
• Equilibrium in Monopoly
• 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.
• Equilibrium in Monopoly
• 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.

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. 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.
• 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).
• 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.
 Long Run Equilibrium under
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.
• 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.
• 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.
• 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.
• 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.
Shifts of demand curve under
Monopoly
• In the long run the cost and revenue curves of the monopolist may
shift due to various reasons — product or process innovation, impo­
sition of a tax or provision of subsidy.
• We may first consider the effect of a change in demand. Change in
demand may be of two types: short run and long run.
Changes in demand:
• Short-run shifts of demand for the product of the monopolist do not
always have an impact. But long-run (permanent) shifts in demand
are likely to have some notable consequences.
• Two possibilities are considered in Fig
• In panel (i), there is a parallel rightward (from D1 to D0) or leftward
(from D0 to D1) shift of the demand curve, with its slope remaining
unchanged.
• In panel (ii), the demand curve becomes flatter (by rotating
anticlockwise from D0 to D1.
• In both the panels of Fig, we observe one thing clearly: both price
and quantity rise when demand rises and both fall when demand
falls.
• The first case applies when a specific tax is imposed on or subsidy is
paid to the buyers of the output of the monopolist. If a tax is imposed
the demand curve shifts from D0 to D1. On the other hand, if a
subsidy is paid to consumers of the monopolist’s product, the curve
shifts from D1 to D0.
• If a per-unit tax is imposed the demand curve shifts to the left
(downward) exactly by the amount of the tax. So, the amount of the
tax is increased by the vertical distance between the two demand
curves (as shown by AB) in panel (i). Here, we see a parallel
downward shift of the demand curve
• This is due to the imposition of a specific tax on consumers. Here,
every points on the demand curve D0 shifts to the left by the same
amount. Exactly the opposite thing will happen if a fixed subsidy of BA
is provided to consumers.
• The second case applies when, for some reason (such as change in
the taste of consumers for the product of the monopolist), the total
demand for the product of the monopolist increases.
• If new customers start buying the product the market will expand. In
panel (ii) we show the same percentage change in quantity
demanded at each price. In other words, if the number of customers
increases by 10%, the quantity demanded also increases by 10% at
each price.
Absence of Supply Curve under
Monopoly!
An important feature of the monopoly is that, unlike a competitive firm, the
monopolist does not have the supply curve. It is worth noting that the supply curve
shows how much output a firm will produce at various given prices of a product.
The supply curve of a product by a firm traces out the unique price-output
relationship, that is, against a given price there is a particular amount of output which
the firm will produce and sell in the market.
The concept of supply curve is relevant only when the firm exercises no control over
the price of the product and therefore takes it as given.
Therefore, it is perfectly competitive firm which is a price taker and demand curve
facing it is a horizontal straight line that a unique price-output relationship is estab­
lished. For a perfectly competitive firm, marginal revenue (MR) equals price and
therefore to maxi­mize profits, the firm equates price (= MR) with marginal cost.
As price changes due to the shift in demand, the competitive firm equates the new
higher price (i.e. new MR) with its marginal cost at higher level of output. In this way
under perfect competition, marginal cost curve becomes the supply curve of the firm.
• But a monopolist does not take the price as given and exercises control over
the price of the product as he is the sole producer of the product. Further, for
a monopoly firm demand curve slopes downward and marginal revenue (MR)
curve lies below it.
• Therefore, a monopolist in order to maximise profits does not equate price
with marginal cost; instead he equates marginal revenue with marginal cost.
As a result, shifts in demand causing changes in price do not trace out a
unique price-output series as happens in case of a perfectly competitive firm.
In fact, under monopoly shifts in demand can lead to a change in price with no
change in output or a change in output with no change in price or they can lead
to changes in both price and output. This renders the concept of supply curve
inapplicable and irrelevant under conditions of monopoly.
Thus, there is no unique price-quantity relationship, since quantity supplied by
a firm under monopoly is not determined by price but in­stead by marginal
revenue, given the marginal cost curve.
Measurement of Monopoly Power and
Rule of Thumb for Pricing
• Monopoly power (also called market power) refers to a firm’s ability to charge a
price higher than its marginal cost. Monopoly power typically exists where the
there is low elasticity of demand and significant barriers to entry.
• Why is it that a firm in perfect competition is a price-taker while a monopoly
can set any price it deems fit?
• The answer lies in the nature of the demand curve facing each firm. In a perfect
competition, no firm has any market power because they face a horizontal
demand curve. They must supply at the prevailing market price or sell nothing.
A monopoly, on the other hand, need not worry about any competition. Since a
monopolist is the only firm in the market, if the elasticity of demand for its
product is low, he determines the market price. In other words, a monopolist
has infinite monopoly power.
• Rule of Thumb for pricing:
P= MC
1+(1/Ed)
This can be also written as
P-MC = - 1
P Ed

• Where P-MC/P = mark up

• Ed = elasticity of demand of firm
• There exists inverse relationship between the mark up and the Ed
• If the firm’s elasticity of demand is small, the mark up will be large, and firm will
have high monopoly power.
• However if the firm’s elasticity of demand is high, the mark up will be small, and
the firm will have lesser monopoly power.
 Measurement of Monopoly Power
Different measures that have been suggested to measure
monopoly power are as follows:

• 1. Learner’s Measure
• It is the oldest measure and is based on the difference between the price charged by the
monopolist and his marginal cost. Bober gives the formula 1/E. Thus, degree of
monopoly power varies inversely with the elasticity of demand for the commodity.
However, the more commonly used formula is:
Degree of monopoly power = (P-MC) / P
Where P is price charged by the monopolist and MC his marginal cost.
In perfect competition,
P = MC and the formula (P-MC)/P gives zero answer indicating no monopoly power.
If the monopolized product is a free good, MC = 0 and the formula registers unity. The
index of monopoly power thus varies from zero to unity. Since monopolized goods are
seldom free, monopoly power is seldom as high as unity.
• 2. Profit-Rate as a Measure:
• J.S. Bain used profit-rate as a measure of monopoly power. By high profits, economists mean returns
sufficiently in excess of all opportunity costs which potential new entrants desire for entering the industry size
of super-normal profits which a firm is able to earn is an indication of its monopoly power. In perfect
competition, a firm earns only normal profits. In monopoly, new entrants will not normally compete away
monopoly profits. But there will be some level of profits at which new firms will find it worth taking the risk of
trying to break the monopoly.
• The stronger the monopolists position, the greater the profits he will be able to earn without attracting new
rivals

• 3. Concentration Ratio:
• Concentration ratio refers to the fraction of total market sales controlled by the largest group of sellers. The
inclusion of the market shares of several firms in the concentration ratio rests upon the possibility that large
firms will adopt a common price- output policy which may not be very different from the one they would
adopt if they were under unified management. But here difficulty arises that they may not do so. Therefore, a
high concentration ratio may be necessary for the exercise of monopoly power but it is not sufficient.
• In short, it is said that neither concentration ratio nor profit-rate are ideal measures of the degree of
monopoly power, both are of some value nor both are widely used.
Price Discrimination In Price
Under Monopoly
• A monopoly firm can charge different prices from different buyers for its
product. This act selling the same product at different prices to other buyers
is known as price discrimination, and it differentiates the pricing under
monopoly.
A monopoly that pursues the policy of price discrimination is called a
discriminating monopoly. Pricing under monopoly is different prices from
different individuals in the same market or can charge different prices in other
markets. Also, it can charge different fees based on the use of goods.
Accordingly, there may be different types of price discrimination such as
personal price discrimination, geographical price discrimination. Price
discrimination based on time and price discrimination which differentiate
pricing under monopoly frim.
 Degrees Of Price Discrimination
In Pricing Under Monopoly
Price Discrimination Of First Degree
• First-degree price discrimination is where a business charges each customer the maximum they are
willing to pay, the monopoly firm may differentiate every consumer in the market in terms of price.
Pricing under monopoly may charge one price from one consumer and another price from others. It
can also set the maximum price for a consumer if the consumer is willing to pay. Thus, in the case of
the first degree of price discrimination, the consumer surplus is zero.
Price Discrimination Of Second Degree
• When a monopoly is able to sell different units of a commodity at different prices to other buyers, it
is a case of second-degree price discrimination. Electricity tariff in India is a classic example of
second-degree price discrimination.
Price Discrimination Of Third Degree
• In the case of third-degree pricing under monopoly, the firm divides the market into different sub-
markets and charges different price into other submarkets. However, the submarket where the
monopolist will charge more, the submarket where it will charge less depends on the price elasticity
of demand for the commodity produced by it in different sub-market.
Horizontal and Vertical
Integration of Firms
• There are two major forms of integration,
• i. Horizontal Integration
• Ii. Vertical Integration.
Horizontal Integration is a kind of business expansion strategy, wherein the
company acquires same business line or at the same level of value chain so as to
eliminate competition to a greater extent.
Vertical Integration is used to rule over the entire industry by covering the supply
chain. It implies the integration of various entities engaged in different stages of
the distribution chain.