Transcript PRICE DETERMINATION UNDER MONOPOLISTIC COMPETITION

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
According to J.S. Bains “Monopolistic
competition is found in the industry where
there is a large number of small seller, selling
differentiated but close substitute product.”
According to Lim Chong Yah “ Monopolistic
Competition is a market situation where there
are many producers but each offers a slightly
differentiated product.”
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LARGE NUMBER OF FIRMS AND BUYER: Under
monopolistic competition there are large
number of buyers and seller. But size of each
firm is small.
PRODUCT DIFFERENTIATION : It is a main
feature of monopolistic competition. Product
differentiation refers to that situation wherein
buyer can distinguish one product from
another.
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FREEDOM OF ENTRY AND EXIT : Firms under
monopolistic competition are free to enter
and leave the market . New firms face
difficulties to enter the market.
SELLING COST : Each firm spends a lot on
publicity of its products. with a view to selling
more and more units of the product it give
wide publicity of its product.
PRICE POLICY : Each firm has its own price
policy. Average and marginal revenue curve
of a firm under monopolistic competition
slopes downward. It means if firm want to
sell more it has to lower its price.
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NON PRICE COMPETITION : Another feature of
monopolistic competition is that, different
firms compete with one another without
changing the price of the product by offering
free gift with the product.
DEMAND CURVE : Demand curve (AR) and
marginal revenue curves are downward
sloping because of product differentiation.
Y
REVENUE

MR
o
AR
X
OUTPUT
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COST CURVE : Average cost curve, average
variable cost curve and marginal cost curves
are U-shaped under monopolistic
competition.
PRODUCT DIFFERENTIATION
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DEFINITION : According to Chamberlin “ A
general class of product is differentiated if
only sufficient basis exists for distinguishing
the goods(or services) of one dealer from
those of another. Such a basis may be real or
fancied, so long as it is of any importance
whatever to buyers and leads to a preference
for any variety of the product over another.”
Under monopolistic competition product
differentiation has great influence over firm’s
equilibrium. It can be clarified with following
diagram :
Y
REVENUE/COST

B
A
E
H
P
F
Q
G
R
O
N
OUTPUT
X
M
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Supposing price of a product has already
determined. It is assumed that producer will
de able to sell more if he produce quality
product.
It is clear form diagram that A and B
represents cost curve of good A and B
respectively. OP is the price in the market and
at this price level ON quantity of good A and
OM quantity of good B. Total profit of good B
is SGHP which is more than good A whose
profit is RFEP. So firm will prefer to produce
good B.
SHORT TERM EQUILIBRIUM OF THE FIRM :
 SUPER NORMAL PROFIT :
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OUTPUT
Y
MC
P
A
B
C
E is the point of
equilibrium . Firm earn
super normal profit
equal to ABCP , here
AM>BM.
AC
E
A
MR MC=MR
R
O
M
OUTPUT
X
 NORMAL
PROFIT :
REVENUE/COST
MC
P
AC
E
O
MR
M
OUTPUT
AR
E is the point of
equilibrium. Firm earn
normal profit as AR
curve is equal to AC
curve.
 MINIMUM
LOSS :
MC
Y
B
REVENUE/COST
P
Q
O
AV
C
A
E
MR=MC
MR
M
OUTPUT
 LONG
E is the point of
equilibrium. Firm suffer a
loss of AB per unit. Total
loss of a firm is BAPQ.
SAC
AR
X
TERM EQUILIBRIUM : In long term
equilibrium firm earn only normal profit. At
the point of equilibrium AR is tangent to LAC.
REVENUE/COST
Y
LMC
A
P
E
O
LAC
AR
MR
M
OUTPUT
X
GROUP EQUILIBRIUM
Two assumptions :
1) Demand and cost curves of all the firms of the group
are the same.
2) Number of firms are so large that no individual firm
can affect the price and output.
C
COST/REVENUE/PRI
CE
Y
D
D1
A
B
O
R
E
M1
C
G
M
D1
D
OUTPUT
X
Group equilibrium is explained in the figure. DD is a demand curve
and CC is a cost curve. At OA price, difference between cost and
revenue curve is maximum which will yield super normal profit equal
to BARG. This will tempt new firms to join the group and total
demand will be distributed among several sellers. The number of
firm will increase till DD1 becomes tangent to CC. OB will be
equilibrium price of the group and OM1 will be equilibrium output.
“Excess capacity is the difference between
optimum output and the actual output in the long
run equilibrium .Optimum output of a firm have
been regarded to be the output where long run
average cost is a minimum.”
REVENUE/COST
Y
LM
C
R
M
E
O
LAC
MR
Q Q1
OUTPUT
AR
X
According to Chamberlin , “ Selling costs are
costs incurred in order to alter the position or
shape of the demand curve for the product.”
According to Meyers , “Selling cost may be
defined as costs necessary to persuade a
buyer to buy one product rather than another
or to buy from one seller rather than
another.”
(2) Assumptions:
Selling costs are based on two assumption:
(I) Buyers’ demand and taste can be changed;
(ii) Buyers’ do not have full knowledge about the
different types of the product.
(iii)Selling costs appraise the buyers of the
conditions of the market , superiority of the
product and similar other things.
Selling Costs
(1) Those costs which Aim to
attract the customers to the
products.
(2)Selling costs include all kinds of
expenses on advertisements in
newspaper , magazines etc.
(3)The purpose of selling costs is
to push the demand for the
product.
Production costs
(1)Those costs which are incurred
in order to make the commodity
worthy of meeting the
requirements of customers.
(2)Production costs include such
expenditure as production of the
product, transportation, storage,
delivery to customer etc.
(3)The purpose of production costs
is to increase the supply of the
product.
(4)Shape of the Selling
Costs:
Y
S
SELLING
COST
S
X
O
Selling costs curves are also Ushaped. In fig. SS is average
selling cost curve . Initially it falls
and later it rises. It means in the
beginning proportionate increase
in sales is more than the increase
in selling costs. After a point
proportionate increase in sales is
less than the increase in selling
costs. It implies up to a point per
unit selling cost go on
diminishing but after a point the
same tend to increase.
OUTPU
T
(5) Selling Costs and Firm’s Equilibrium:
Firm has to decide about the price of
commodity and the selling costs to be
incurred. It is assumed that demand for the
product increases due to increase in selling
costs, resulting into extra profits for the
producers and demand curve shifts to the
right as a result of increase in selling costs.
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Output is shown on OX-axis , and costs on
OY-axis . Before incurring selling costs
,suppose that price is as shown by AR1 curve
and average cost of production is as shown by
ACP.In this , equilibrium output is OQ.It is
assumed that the output MC = MR. To avoid
the complexity of curves in the dig., MC & MR
curves have not been shown . In this, firm is
earning ABCD super normal profits.
(1)Assumption regarding Product:
Under perfect competition it is assumed that
all firms produce homogenous products.
Under monopolistic competition there is
product differentiation. Goods produced by the
firms differ in one way or the other because of
this difference each firm is a monopolist of its
own product.
(2)Assumption regarding number of
Buyers and Sellers :
Under perfect competition there are large
number of sellers of homogenous product
.Group of such sellers constitutes industry. No
seller by his individual actions can influence
other sellers. Under imperfect competition,
number of sellers is more than one .Many such
sellers are collectively called ‘Group’. In both
these market situations there are large
number of sellers.
(3)Assumption regarding Degree of
Knowledge:
Under perfect competition it is assumed that buyers
and sellers have perfect knowledge of the market
conditions . On the contrary, buyers and sellers under
monopolistic competition are not fully aware of the
market conditions.
(4) Assumption regarding shape of
demand curve:
Under perfect competition, due to large number of
firms and homogenous product , demand curve is
perfectly elastic. It means, under perfect competition
average revenue curve is parallel to OX-axis. In this
situation, average revenue is equal to marginal
revenue.
Y
(a) In fig..,AR and MR are
AR=MR
REVENU
E
P
P
O
Y
X
OUTPUT
REVENUE
(Rs.)
represented by a single curve
PP which is parallel to OXaxis. Price of the product is
determined by the industry
and each firm has got to
accept that price . Firm,
therefore, is a price-taker.
(b)In monopolistic competition,
AR curve slopes
downward.AR and MR curves
are not only separate
downward sloping curves but
MR curves is below AR curve.
So, firm is a price-maker.
AR
MR
O
OUTPUT
X
(5) Implications regarding decisions:
Under perfect competition, a firm can take
decision only with regard to the quantity of
output to be produced . A firm under perfect
competition need not incur any selling costs.
On the other hand, a firm under monopolistic
competition can determine either the output to
be produced or the price to be charged. Selling
costs are an important feature of monopolistic
competition.
(6) Implication regarding condition
of Maximum Profit:
According to marginal analysis decision
regarding achievement of equilibrium
position , both under perfect and
monopolistic competitions, can be taken on
the basis of the following principle:
Equilibrium = MR = MC
It proves that under both market conditions ,
position of equilibrium is achieved when
output is produced up to a level where MC =
MR.
(1)Assumption Regarding Product:
Product of a monopolist may or may not be
homogenous. However, product differentiation is
an important feature of monopolistic competition.
(2)Assumptions regarding number of
Sellers and Buyers:
In case of monopoly, there is only one seller and
large number of buyers. Under monopolistic
competition there are large number of buyers and
sellers producing close – substitutes.
(3) Assumption regarding Entry :
Under monopolistic competition there are no
restrictions on the new firms to enter into and
the old ones to leave the group. It is possible in
the long run only . But under monopoly there are
restrictions on the entry of new firms.
(4) Different Average and Marginal
Revenue Curves:
Under monopoly, AR and MR curves are two
separate curves.AR curve represents price of
different units and MR curves represents the MR
of different units.
Under monopolistic competition also,AR and MR
curves are two separate curves. They slope
downward from left to right. But both these
curves are more elastic than curves under
monopoly.
Y
REVENUE(Rs.)
Y
REVENUE(Rs.)

AR
AR
MR
o
OUTPUT
X
o
MR
OUTPUT
X
(5) Implications regarding Decisions:
A firm, whether operating under monopoly or
monopolistic competition , can either fix the price or
the output but it cannot fix both. A firm under
monopolistic competition has to spend a lot on
selling costs but a monopolistic spends very little on
selling costs.
(6) Comparison regarding profit:
In the short-run, the monopolistic and a firm under
monopolistic competition, may earn super normal
profit, normal profit and even suffer losses; but in
the long run whereas a monopolistic earns super
normal profit, a firm under monopolistic competition
generally earns normal profit only.