Chapter 7

Competition
(Discriminating Monopoly,
Monopolistic and Oligopoly)

Pricing Under Discriminating

Monopoly
(Price Discrimination)
À Discriminating Monopolist: Charges
different prices from different buyers for
the same good.
À Act of selling the same commodity at
different prices to different buyers (Price
Discrimination).
Degrees of Price Discrimination:
À Perfect Price Discrimination (First Degree)
À Second Degree Price Discrimination
À Third Degree Price Discrimination

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 First Degree Price Discrimination:
À Monopolist charges different price for each
unit of good.
À Highest price for the first unit and reduction
in price for every successive unit.
À Guided by Law of Diminishing Marginal
Utility – unless a consumer is offered
successive units at falling prices, he would
not purchase the additional unit of a good.
À Monopolist exploits the consumers to the
maximum possible extent.

Second Degree Price Discrimination:

À Monopolist sets block prices.
À Price is the highest for the first block of
quantity bought and it is reduced for every
successive block of quantity bought.
Third Degree Price Discrimination:
À Different prices are charged for the same
homogeneous good from different
customers.
À Customers are differentiated on the basis of
geographical location, product use,
purchase time, age, sex etc.

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 Conditions for Price Discrimination:
À The market must be clearly separable into
two or more parts.
À No resale of the product can take place
from low-price market to a high-price
market.
À Price Elasticity of Demand for the product
must be different in different markets (Price
Discrimination to be profitable).
Issues before Discriminating
Monopolist
À How much to produce?
À How to distribute the total production in
various markets?

À What priced must be charged in various

markets?
Equilibrium of a Discriminating
Monopolist
À The firm maximizes its profit at an output at
which:
1.CMR = MC.
2.MC curve intersects the CMR curve from
below.
3.MR1 = MR2 = MC (For the distribution of
output in two markets to be optimum).

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À Total output of the Monopolist Q = Q1 + Q2.
À Total Revenue R = R1 + R2 .
À Total cost function = C (Q) = C (Q1 + Q2).
À Profit = π = R1 + R2 – C.
À To maximize profit the first order condition
requires that dπ / dQ1 = 0 and dπ / dQ2 = 0.
À That is dπ / dQ1 = dR1/ dQ1- dC/ dQ1= 0
À dR1/ dQ1 = dC/ dQ1 or MR1 = MC1
À Again dπ / dQ2 = dR2/ dQ2 - dC/ dQ2 = 0
À dR2 / dQ2 = dC/ dQ2 or MR2 = MC2

À Hence the condition of profitable price

discrimination is MR1 = MR2 = MC.
À To maximize profit the Monopolist will
distribute output in two markets in such a
way that MR is the same in both the
markets and is equal to MC.
À So long as MR1 > MR2, it will be profitable
for the Monopolist to shift one unit of
output from the second market to the first.
À Shifting will continue so long as MR1 is
higher than MR2 and the opposite happens
when MR2 > MR1.

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 AR1,MR1 AR2,MR2
MR
MC

MC

P1 P2
E

AR1 AR2
MR
MR1 MR2
0
Q1 0 Q2 0 Q

À MC curve intersects MR curve at point E

where the equilibrium level of output is OQ.
À OQ1 and OQ2 output is sold in the first and
second market respectively to equalize MR.
À OP1 and OP2 Prices are determined for
market 1 and 2 respectively.
À As the elasticity of demand in the first
market is less than that of the second
market, the price in the first market is
higher than that of the second market.
À By differentiating the price from one to the
other market, the monopolist maximizes
profits.

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 Class Assignment: 1
A garment manufacturing firm has the total
demand function for its product P = 100 –
4Q. However, the demand function for
selling garments in the domestic market and
foreign countries are P1 = 80 – 5Q1 and P2 =
180 – 20Q2 respectively. The total cost
function of the firm TC = 50 + 20Q.
Determine the following:
À The price that will be charged by the firm to
maximize profit in absence of price
discrimination.

À The price that will be charged by the firm to

maximize profit when the domestic price is
discriminated from the international price.
À The difference in the profit of the firm
between discrimination and non-
discrimination.

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 Monopolistic Competition
À It is a blending of competition and
monopoly. Refers to competition among the
monopolists.
À Many sellers, each having an insignificant
share in the total supply of the product in
the market.
À Product differentiation, products of various
firms are similar but not perfect substitutes.
À Easy entry and easy exit.
À Existence of non-price competition.

À The demand curve for a monopolistically

competitive firm is downward sloping
because of product differentiation.
À It is highly elastic though not perfectly
elastic as there are close but not perfect
substitutes for its product.
À The MR for any quantity will be less than the
corresponding price as the demand curve is
downward sloping.
À The firm can sell a larger quantity only by
lowering the price, i.e., each additional unit
adds a smaller amount to TR.

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 Demand and marginal revenue curves
for a firm in monopolistic competition
Price, Revenue

D=AR

MR
Quantity

SR Equilibrium of a Monopolistic Firm

À A firm’s equilibrium is determined at the level
of output which satisfies the two conditions:
MC = MR
MC curve cuts MR curve from below.
À A monopolistic competitive firm may face
either of the three possibilities in the SR:
À At the equilibrium output it may earn
abnormal profits.
À At the equilibrium output it may incur losses.
À At the equilibrium output it may break-even.

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 Y Abnormal profits or Economic profits
MC

T
P AC
Equilibrium Point :E
K Equilibrium Output : OQ
S Equilibrium Price : OP = QT
At Equilibrium AR : QT
AR At Equilibrium AC : QK
Profit per unit : QT – QK = KT
Total profits : KT × OQ = PTKS
E

MR

0 X
Q

Y
Loss Making Firm

MC
AC Equilibrium Point :E
K Equilibrium Output : OQ
P Equilibrium Price : OP = QT
At Equilibrium AR : QT
At Equilibrium AC : QK
S
Loss per unit : QK - QT = KT
T Total Loss : KT × OQ = PTKS
AR

E
MR

0 X
Q

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 Y
Normal Profits

MC
Equilibrium Point :E
Equilibrium output : OQ
AC Equilibrium Price : OP
= QT
T At equilibrium AR : QT
P At equilibrium AC : QT
As AR equals AC the firm
breaks even, i.e., it earns
AR normal profit.

E
MR

0 X
Q

À In the SR, a firm will continue to be in

production as long as at any level of output
its AR ≥ AVC.
LR Equilibrium of a Monopolistic Firm
À In SR, if existing firms in the industry earn
excess profits, new firms would enter the
industry in the LR.
À Each firm’s share of the total industry
demand falls and demand curve for each
firm will shift to the left.
À If the firm was running into losses, it would
leave industry in the LR to avoid losses.

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À In LR, all firms break-even and produce on
the negatively sloped portion of their LAC
curve.
À Due to normal profit (P = AC), the entry
and exit of firms will not take place.
À Two conditions of LR equilibrium of a firm
are:
MC = MR
P or AR = AC
À When all firms reach their respective break-
even points, the Group Equilibrium is
attained.

AC

MC

P2

AR

MR
0
Q2 Q3

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À The equilibrium level of output would fall
short of the optimal level of output, i.e.,
Q2Q3.
À OQ2 is the LR equilibrium output and OQ3 is
the output at which AC is the least.
À Full capacity output is the one at which AC is
the minimum (OQ3).
À Since OQ2 denotes equilibrium output, Q2Q3
measures the excess capacity.
À A firm under monopolistic competition never
operates at its minimum AC or always has
an excess capacity.

MC
ATC

B
PmC L
PPC D = ARPC = MRPC

D= ARMC

MRMC
0 Quantity
Q MC Q PC
Excess capacity

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À Perfectly Competitive firm operates at the
minimum point of the LAC curve.
À Since P > MR and MR = MC for a firm under
monopolistic competition, it operates when
P > MC.
À Both types of firm earn only normal profit in
LR, means D = AR must be tangent to AC
curve.
À D = AR for a perfectly competitive firm is a
horizontal straight line and it is tangent to AC
only at the minimum point of AC.

À D = AR for a monopolistically competitive

firm is negatively sloped and is tangent to
AC to the left of its minimum point.
À The firm in monopolistic competition is a
wasteful as it does not produce at the
minimum cost per unit as the purely
competitive firm does.
À Implies that the firm has excess or
underutilized capacity.
À The firm in monopolistic competition
produces socially sub-optimal output as P >
MC.

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À Purely competitive firm produces a larger
volume of output Qpc than the
monopolistically competitive firm does
(Qmc).
À Price charged by the monopolistically
competitive firm Pmc is higher than the
purely competitive price Ppc.
À Under pure competition, the consumer pays
a lower price but no choice of product.
À In monopolistically competitive industry, the
consumer can have wider choice.

Class Assignment: 2
A firm is operating in monopolistic
competition with the following demand and
cost functions:
P = 11,100 – 30Q
TC = 400,000 + 300Q – 30Q2 + Q3
What is the short run equilibrium output,
price and profit for the firm?

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 Oligopoly
À Consists of only a few firms.
À Each produces a relatively large share of the
total output of the industry.
À Firms in oligopolistic market structure are
aware of their mutual interdependence.
À Firms are quite interdependent in pricing
decisions, i.e., actions taken by one firm
have a large effect on other firms.
À Barriers but possible entry and exit.
À Firms produce identical or differentiated
products.

Sources of Oligopoly
À Economies of scale may operate over a
large range of output.
À Huge capital investments and specialized
inputs.
À Patent right for exclusive production or to
use a process.
À Loyal customers base on product quality.
À Government may give franchise to only few
firms to operate.
À Presence of Mergers and Acquisitions.

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 Oligopoly Equilibrium
À A number of theories known as models have
been proposed to explain Oligopoly
Equilibrium.
À Models which recognize the existence of
interdependence are:
Cartelization and Formal Collusion
Kinked Demand Curve Models
Price Leadership Models

Collusion Model
À All the firms recognize their
interdependence.
À Decide to collaborate in the form of a cartel
in the matter of Pricing.
À One market demand function (AR and MR)
and as many cost functions (AC and MC) as
the firms.
À Profit-maximizing output for the industry
given by intersection of CMC and MR curve.
À Given the equilibrium output, the AR curve
give the equilibrium price.

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 À Distribution of output among firms is
obtained by equating MR to each of the MC.
À Industry output OQ is divided among the
three firms oq1 to firm 1, oq2 to firm 2 and
oq3 to firm 3.
À All firms sell at an uniform price OP.
À All firms have different levels of output and
profits due to differences in costs.
À Efficient firms earn more profits and others
may loose.
À Perfect collusion avoids price wars among
rivals.

(a) Firm I (b) Firm II (c) Firm III (d) Industry

AC1
2
AC
MC2

3
AC
MC3

MC1
P
AR
Price

C
CM
MR

0
q1 0 q2 0 q3 0 Q
Quantity

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À Consumers are adversely affected by high
prices and restricted quantities.
À Chances of arriving at a common
understanding would be difficult in case
number of firms are large.
À Cartels are more difficult in case of
differentiated oligopoly.
À Tendencies to break the cartel exist.
À Cartels imply direct agreement among the
oligopolists for reducing uncertainty.
À Aim of the cartel is the maximization of the
industry profit.

Price Leadership
À One firm sets the price and other firms
follow, to avoid uncertainty.
À Can be worked easily in case of identical
products.
À Price Leader sets his price by equating MR
= MC for maximizing profit.
À Followers considering the same price may
not maximize profits, if, may be by accident
rather than by their independent decisions.

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 MC2 MC1

P2*

P1 = P2

E
E2
D

AR1 = AR2
E1

MR1 = MR2
0 Q
Q2* Q1 = Q2

À Assumed that the two sellers have equal

markets and have the same AR and MR
curves.
À Assumed that the first firm has lower costs
than the firm 2, MC1 lying below MC2.
À Low cost firm will charge the price P1 and
this will be followed by the high-cost firm.
À Firm’s 1 MR = MC at point E1 , the output is
OQ1 and the price is OP1.
À Firm 2 charges the same price P1 and by that
not maximizing the profit.

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 Kinked Demand Curve
À Developed by Paul Sweezy, explained
observed rigidity of price in oligopoly
market.
Assumptions:
À Many firms in Oligopolistic industry.
À Each produces a product which is a close
substitute for that of the others.
À Each oligopolist believes that (a) if he
lowers the price, rivals will also lower the
prices and (b) if he raises, others will
maintain the prices at the existing levels.

À Demand curve faced by the firm has a kink

at the initial price-output combination.
À Based on - rivals react differently to a rise in
price or to a fall in price.
À Demand curve is relatively elastic for a rise
in price.
À Demand curve is relatively inelastic for a fall
in price.
À A rise in price by one seller will not be
followed by a rise in price of other sellers,
while a fall in price of one seller will be
followed by corresponding fall in price by
others.

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À dd is drawn on the basis that when one
seller changes his price, others do not
change their prices.
À DD is drawn on the basis that when one
seller changes his price, others also change
in the same direction.
À Demand curves DD and dd intersect at point
P.
À Demand curve is dPD which has a kink at
point P.
À As the demand curve is kinked, the MR
curve will be discontinuous.

Q
0 D d

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À dA portion of the MR curve corresponds to
the dP portion of the demand curve.
À BC portion of the MR curve corresponds to
the PD portion of the demand curve.
À Length of discontinuity is equal to AB.
À Point P on the demand curve has two
elasticities of demand.
À If P is a point on dd, there is one elasticity of
demand and if P is a point on DD another
elasticity of demand.
À MC curve passes through discontinuous
range of the MR curve.

P
C’
M
C
M

B
0 Q
M MR D
C

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À Equality of MR and MC is not possible.
À MR can not be less than MC.
À Price and quantity remain the same at the
kink point.
À Even if MC curve shifts but passes through
the discontinuous range AB, the Price-Q
combination will remain constant.
À Price rise or fall is not profitable for a single
seller.
À Equilibrium of the firm is defined at the
point of the kink.

À Any output level < OM, MC is below MR and

any output level > OM, MC is greater than
MR.
À Total profit is maximized at kink though
profit maximizing condition MR = MC is not
fulfilled at the kink point.
À Not an analytical sound analysis for price-
output determination.
À Accepted as a reasonable explanation for
the rigidity of price and output in the
oligopolistic markets.

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Thank You for going through the
material

Prof. (Dr.) T.R. Dash

Director, Post Graduate Studies, BBU
&
Director, Institute of Mobilizing Knowledge
for Economic Development and Peace, BBU

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