UNIT IV-MG2452-Engineering Economics and Financial Accounting Notes.pdf

8/10/2019 UNIT IV-MG2452-Engineering Economics and Financial Accounting Notes.pdf

1/38

Page 1of 38 UNIT- IV

UNIT - 1V

MARKET

Market is a place where buyers & sellers meet in order to buy & sell goods at a price.

CLASSIFICATION OF MARKETS BASED ON TIME PERIODS

A.

Very Short Period or Market period: This type of market is for perishable goods where

the time period is very short & the supply of goods is perfectly inelastic. It means that the

price alone will change according to demand but the supply will not change.

B.Short Period:This type of market is for Reproducible goods or durable goods where the

businessman has got enough time to wait for the right price & the supply of goods is normal

in the beginning & it becomes perfectly inelastic only in the later stage.

C.

Long Period: During this period all the firms will try to earn normal profits by charging alow price, so that they can be stable in the market.

EQUILIBRIUM PRICE

The price at which quantity demanded is equal to the quantity supplied is the equilibrium

price. This is explained with the help of a diagram.

X axisQuantity

Y axisPriceDDDemand curveSSSupply curve

Explanation:

i.Price is determined in the market at the level where demand and supply curve interest eachother.

ii.

R is the equilibrium point, where OP is the price & OM is the output.iii.The equilibrium between and supply, or market equilibrium, determines the price in the

market.

vidyarthiplus.com

vidyarthiplus.com


2/38


THE CHANGE IN EQUILIBRIUM PRICE

Changes in equilibrium price: The equilibrium price will be change if either the demand orsupply curve change due to a change in demand or supply conditions., demand curve

remaining the same will lower the price and a decrease in supply (i.e., shift in the supplycurve to the left) will raise the price.

(A)Change in equilibrium price as a result of shifts in demand curve & supply curveremaining constant: Given the supply curve as constant, an increase in demand (i.e., shift of

the demand curve to the right upwards) will increase the price and a decrease in demand (i.e.,shift of the demand curve to the right downwards) will decrease the price. This is explainedwith the help of a diagram.

X axisQuantity or Output

Y axisPriceSSSupply curveD, D'D',D''D''- Demand curve

Explanation:

i.When the demand curve DD cuts the supply curve at point R, the price is OP & the output isOM.

ii.

When the demand increases to D'D', it cuts the supply curve at R', which is the newequilibrium point. The price will rise to OP'& the output will also increase to OM'.

iii.If the demand decreases from to D''D'', it cuts the supply curve at R'', which is the newequilibrium point. The price will decrease to OP''& the output will also decrease to OM''.

iv.

It means that if supply is constant, both the price & output will increase with increase in

demand & vice versa.

(B) Change in equilibrium price due to shifts in supply curve & demand curve

remaining the same: Given the Demand curve as constant, an increase in supply (i.e., shiftof the supply curve to the right downwards) will reduce the price and a decrease in supply

(i.e., shift of the supply curve to the left upwards) will increase the price. This is explainedwith the help of a diagram.

vidyarthiplus.com

vidyarthiplus.com


3/38



Y axisPriceS, S' S' ,S''S''Supply curve

DDDemand curve

Explanation:

i.When the supply curve SS cuts the demand curve at point R, the price is OP & the output is

OM.ii.When the supply increases to S'S', it cuts the demand curve at R', which is the new

equilibrium point. The price will decrease to OP'& the output will increase to OM'.

iii.If the supply decreases from to S''S'', it cuts the demand curve at R'', which is the newequilibrium point. The price will increase to OP''& the output will decrease to OM''.

iv.It means that if demand is constant, then there will be inverse relationship between rice &quantity or output.

THE DETERMINATION OF MARKET PRICE AT DIFFERENT TIME PERIODS

(A) Very short period or market period: During this period the supply is fixed or islimited. This happens in case of perishable goods. In the case of a perishable commodity likefish, the supply is limited by the quantity available or stock in a day and which cannot be kept

back for the next period. Hence, the whole of it must be sold away on the same day whatevermay be the price. This is explained with the help of a d iagram.

X axisQuantity or OutputY axisPrice

SMVertical or Perfectly Inelastic supply curveDD, D'D',D''D''Demand curve

vidyarthiplus.com

vidyarthiplus.com


4/38


Explanation:

i.

The figure shows that the supply is fixed. When the demand curve DD cuts the supply curve

at point E, the price is OP & the supply is SM.

ii.It is seen that when the demand increases to D'D', it cuts the supply curve at point E', & only

the price increases to is OP' & where as the supply remains constant.

iii.Similarly, when the demand decreases to D''D'', it cuts the supply curve at point E'', & only

the price decreases to is OP'' & where as the supply remains constant.iv.It means that during the very short period or the market period, the price alone will change

due to the changes in demand, whereas the supply will remain fixed.

(B) Short period: This is the case of durable goods or reproducible goods where, If a sudden

and once-for-all increase in demand takes place, there will be a sharp rise in market price but,there can be no change in the amount supplied, because in the market period, firms can sell

only what they have already produced, i.e., what is in stock. In case of non-perishable butreproducible goods, the supply curve cannot be a vertical straight line throughout its length,

because some of the goods can be preserved or kept back from the market, and carried over to

the next market period. There will be then two critical price levels. The first, it price is veryhigh, the seller will be prepared to sell the whole stock. The second level is set by a very low

price at which seller would not sell any amount in the present market period, but will holdback the whole stock for some better time. This is explained with the help of a diagram.


Y axisPriceSSSupply curve

DDDemand curve

Explanation:

i.

When the demand curve DD cuts the supply curve at point R, the price is OP & the output isOM.

ii.

When the demand increases to D'D', it cuts the supply curve at F, which is the newequilibrium point. The price will rise to OP'& the output will also increase to Q.

iii.If the demand decreases from to D''D'', it cuts the supply curve at R'', which is the newequilibrium point. The price will decrease to OP''& the output will also decrease to OM''.

iv.It means that if supply is constant, both the price & output will increase with increase indemand & vice versa.

v.Up to the price OP1 (=QF), the quantity supplied varies with price. At the price OS, nothing

is sold, the whole stock being held back. Therefore, SF portion of the supply curve slopesupwards from left to right.

vi.

At the price OP1 (=QF), the whole of the stock is offered for sale, and beyond OP1, thequantity supplied remains the same the same whatever the price. Therefore, beyond priceOP1, the market supply curve has been shown as a vertical straight line.

vidyarthiplus.com

vidyarthiplus.com


5/38


BREAKEVEN POINT ANALYSIS OF THE FIRM OR THE EQUILIBRIUM OF THE

FIRM BY USING TOTAL REVENUES AND TOTAL COST

Equilibrium of the firm: A firm is said to be in equilibrium when it has no incentive eitherto expand or to contract its output only when its total profits are the maximum. A rationalentrepreneur will expand output if he thinks he can increase his total profits by doing so, and

likewise, he will contract his output if he thinks he can avoid losses and thus increase his total

profits. Therefore, a firm is an equilibrium position when it is earning maximum money

profits.

Assumptions:

i.The owner of the firm is rational. It implies that he tries to maximize his money profits.

ii.Whatever output the firm produces, it produces as cheaply as possible given the existingproduction techniques.

iii.

The firm produces only one product.

This is explained with the help of a diagram.

X axisOutput

Y axisRevenue/costTRTotal Revenue

TCTotal Cost

Breakeven point explanation:

i.

At any output smaller than OL, total cost exceeds total revenue and the firm is having losses.ii.At the output OL total cost equals total revenue and the firm is having neither losses nor

profits. This point L is called Break-even points.iii.At the outputs larger than ON, the total revenue is less than total cost so that the firm is

having losses.iv.Point N is again a break-even point. Between OL and ON will lie the optimum point of

maximum profits.

LIMITATIONS OF BREAKEVEN POINT ANALYSIS

i.Difficult to see at a glance: Maximum vertical distance between the total revenue and total

cost curve is difficult to see at a glance. Many tangents have to be drawn before one reachesthe appropriate one corresponding to the maximum profit point.

vidyarthiplus.com

vidyarthiplus.com


6/38


ii.Not possible to discover price per unit: It is not possible to discover price per unit at

various outputs at first sight. Total revenue has to be divided by total number of unitsproduced in order to get the price per unit.

iii.Complicated problems cannot be discussed: Complicated problems of equilibrium analysiscannot be discussed easily and clearly in this way of representing equilibrium of the firm.

THE EQUILIBRIUM OF THE FIRM UNDER PERFECT COMPETITION OR THE

EQUILIBRIUM OF THE FIRM USING MARGINAL REVENUES CURVES

A firm will be in equilibrium when it is earning maximum profits, to make maximum profits,

two conditions are essential:

i.Marginal revenue = Marginal cost, andii.MC curve should cut MR curve from below at the equilibrium point.

Conditions of equilibrium:

The demand curve or average revenue curve facing a firm under perfect competition isperfectly elastic at the ruling price. S ince a perfect ly competitive firm can sell as much as itwants without affecting the price, addition made to total revenue by an extra unit of output,

i.e., marginal revenue, is equal to the price (average revenue) of the commodity. Hence, theaverage revenue (or demand) curve, (AR) and marginal revenue curve (MR) must coincide

with each other for a firm under perfect competition. This is explained with the help of adiagram.

X axisOutputY axisRevenue/costMR=ARMarginal revenue= Average revenue

Explanation:

i.Under perfect competition, a firms MC curve is also its supply curve. Profits are the greatestat the level of output for which marginal cost is equal to marginal revenue and marginal cost

curve cuts the marginal revenue curve form below.ii.At point T though MC is equal to MR but MC is cutting MR from above rather than from

below. Therefore, T cannot be a position of equilibrium.iii.At point P or output OM, the marginal cost equals MR and marginal cost equals MR and

marginal cost curve is also cutting MR curve from below.

iv.

Hence, at the output OM or point P, the profit would be maximum and the firm would be inequilibrium position.

vidyarthiplus.com

vidyarthiplus.com


7/38


THE EQUILIBRIUM OF THE FIRM DURING SHORT RUN UNDER PERFECT

COMPETITION

Equilibrium in short run:

The short run has been has been defined as a period of time sufficient to allow the firm toadjust its output by increasing or decreasing the amount of variable factors of production

cannot be altered. Thus in the short run; the size and kind of plant cannot be changed, nor can

new firms enter the industry.

Assumptions:

i.

All firms are working under identical conditions.ii.The factors of production used by the different firms are homogeneous and are available at

given and constant prices.


X axis =Output

Y axis= Revenue/costSAC= Short run average cost curve

SMC = Short run marginal cost curveL,L1,L2 = AR=MR (Average Revenue = Marginal Revenue)

Explanation:

i.When the firm makes supernormal profits in the short-run: The firm makes supernormalprofits in the short-run when the price is OP1, because only at this pr ice the average cost isless than the price.

ii.The firm just makes normal profit: The firm makes normal profits in the short-run when

the price is OP, because only at this price the average cost is equal to the price.iii.The firm incurring losses, but does not shut down: The firm incurs loss in the short-run

when the price is OP2, because only at this price the average cost is more than the price. Evenif the firm is incurring losses but still the firm will not shut down.

THE SHUT DOWN POINT OF THE FIRM

The point at which when the firm is not able to cover even its average variable cost is calledthe shut down point of a firm.


vidyarthiplus.com

vidyarthiplus.com


8/38


X axis = OutputY axis = revenue/cost

AC = Average cost curveMC = Marginal cost curve

AVC = Average variable cost curveL,L1,L2 = AR=MR

Explanation:

i.If price is OP2, the firm is incurring losses, because the price is less than the average cost.ii.But if the price happens to be OP3, the firm will be in equilibrium at point D. At point D, the

firm would be covering total variable costs but no part of the fixed costs, since price OP3 is

equal to average variable cost MD at the equilibrium output OM.iii.But if the price is OP4, the firm would shut down, as in this situation the firm is not able to

cover even variable costs, since the price will be less than the average variable cost. Point Dis therefore called shut down point.

THE EQUILIBRIUM OF THE FIRM DURING LONG RUN UNDER PERFECT

COMPETITION

Equilibrium in the long run: The long run is a period of time long enough to permit

changes in the variable as well as in the fixed factors. In the long run, accordingly, all factorsare the variable and none fixed. Thus, in the long run, firms can change their output by

increasing their fixed equipment.

Conditions of equilibrium:

Price = Marginal cost

Price = Average costThus, the conditions for long-run equilibrium of perfectly competitive firm can be written as:Price = Marginal cost = Minimum Average Cost.


vidyarthiplus.com

vidyarthiplus.com


9/38


X axis = Output

Y axis = revenue/costLAC = Long run average cost curveLMC = Long run marginal cost curve

L,L1,L2=LAR=LMR

Explanation:

i.

The firm under perfect competition cannot be in long run equilibrium at price OP1 because itis greater than the average cost & point the firm will be earning supernormal profits. Hence,there will be incentives for the new firms to enter the industry. As a result, the price will be

forced down to the level OP at which price, the firm is in equilibrium at R and will produceOM output.

ii.

The firm under perfect competition cannot be in long run equilibrium at price OP2 because itis less than the average cost & point the firm will be incurring loss. To avoid these losses,

some of the firms will leave the industry. As a result, the price will be rise to OP, where againall firms are making normal profits. When the price OP is reached, the firms would have nofurther tendency to quit.

iii.Therefore the firm under perfect competition will be in long run equilibrium at price OP. At

point R the equilibrium output is OM, the price is equal to average cost, and hence the firmwill be earning only normal profits. Therefore at price OP, there will be no tendency for theoutside firms to enter. Hence, the firm will be in equilibrium at OP price and OM output.

vidyarthiplus.com

vidyarthiplus.com


10/38


THE SHORT RUN SUPPLY OF PERFECT COMPETITIVE INDUSTRY OR

DERIVATION SHORT RUN SUPPLY CURVE OF PERFECTLY COMPETITIVE

INDUSTRY

Short run supply curve:

The short run is a period in which the capital equipment is fixed and the increased demand is

possible only by the intensive use of the given plant, i.e., by increasing the amount of the

variable factors.

This is explained with the help of diagram.

[Both Panels (a) & Panel (b)]Panel (a) = Shows the production level

Panel (b) = Shows the supply of output at different pricesX axisOutputY axisPrice

SMCShort run average cost curveSACShort run average cost curve

SAVCShort run average variable cost curveSRSShort run supply curveThe short run supply curve for the perfectly competitive industry is derived by adding up

both panel (a) & panel (b).

Explanation for Panel (a):

i.Panel (a) explains about the various equilibrium points & the different levels of output being

produced at various prices.ii.

At price OP0, the SMC cuts the price at pt.E0, hence the firm will produce OM0 amount of

output, since only at this output the price OP0 equals marginal cost.

iii.Similarly, at prices OP1, OP2, OP3 & OP4, the SMC cuts the price at points E1, E2, E3 &

E4, hence the firm will produceOM1, OM2, OM3, & OM4 amount of output respectively,since only at these outputs the prices are equal to their marginal costs.

Explanation for Panel (b):

i.Panel (b) explains about the supply of output at various prices.

ii.

It shows that at price OP0, the firm will supply OM0 amount of output.

vidyarthiplus.com

vidyarthiplus.com


11/38


iii.As the price increases from OP1 to OP4, the supply of output also increases from OM1 toOM4 respectively.

iv.

It means that as the price increases the supply also increases. Thus, the short run supply curveof the perfectly competitive industry slopes upwards.

THE LONG RUN SUPPLY AT DIFFERENT COST CONDITIONS

Long run supply curve:

Long run supply is defined as supplies offered at various prices by the existing as well as thepotential procedures in the long run.

(A)Supply curve of the constant cost industry:

An industry is a constant cost industry if its expansion generates neither external economiesnor external diseconomies. This is expla ined with the help of a diagram.

Panel (a) = Shows the production levelPanel (b) = Shows the supply of output at different pricesX axisOutput

Y axisPriceLAClong run average cost curve

LMClong run marginal cost curveLSC - long run supply curve

Explanation:

i.In the case of constant cost industry, the long run supply curve will be a horizontal straightline.

ii.Every firm will be in long run equilibrium at the minimum point of the long run average cost.

iii.In the long run, new firms will enter the industry without raising or lowering the cost curves

of the firms in the industry so that the industry so that the industry would supply any amountof commodity at the price of OP which is equal to the minimum long run average cost.

iv.The long run supply curve is horizontal straight line (i.e., perfectly elastic) at price OP, whichis equal to the minimum average cost.

vidyarthiplus.com

vidyarthiplus.com


12/38


(B)Supply curve of the increasing cost industry: If the industry is of a big size, thensometimes due to the disadvantages of large scale production the cost of production will rise

resulting in increase in prices of the product. Therefore it will shift both the average andmarginal cost curves to upwards towards the left. It means that less output will be produced at

high cost. This is explained with the help of a diagram.

Panel (a) Panel (b)Panel (a) = Shows the production level

Panel (b) = Shows the supply of output at different pricesX axisOutput

Y axisPriceLAClong run average cost curveLMClong run marginal cost curve

LSC - long run supply curve


i.

Panel (a) explains about the various equilibrium points & the different levels of output being

produced at various prices.ii.

It shows that at OP price, OM level amount of output is produced.

iii.It is seen that when the price is increased to OP1, the output is decreased to OM1 & the LAC& LMC curves are shifted upwards towards the left side.

iv.It means that both the cost & price have increased & the production of output has decreased.


i.

Panel (b) explains about the supply of output at various prices.ii.It shows that as the price increases from OP0 to OP1, the supply also increases from ON to

ON1 respectively.

iii.

It means that in an increasing cost industry more output will be supplied at higher price.iv. Thus the long run supply curve (LSC) of the increasing cost industry will slope upwards as

shown in panel (b) of the figure.

(C)Supply curve of the decreasing cost industry:An industry might have decreasing costsdue to advantages of large scale production so that, with the expansion of the industry, the

cost of production will be reduced. Therefore it will shift both the average and marginal costcurves to downwards towards the right. It means that more output will be produced at lesscost. This is explained with the help of a diagram.

vidyarthiplus.com

vidyarthiplus.com


13/38


Panel (a) = Shows the production level


Y axisPrice

LAClong run average cost curveLMClong run marginal cost curve

LSC - long run supply curve


i.

Panel (a) explains about the various equilibrium points & the different levels of output being

produced at various prices.ii.It shows that at OP price, OM level amount of output is produced.

iii.It is seen that when the price is decreased to OP1, the output is increased to OM1 & the LAC& LMC curves are shifted downwards towards the right s ide.

iv.

It means that both the cost & price have decreased & the production of output has increased.


i.Panel (b) explains about the supply of output at various prices.ii.It shows that as the price decreases from OP0 to OP1, the supply also increases from ON to

ON1 respectively.iii.It means that in a decreasing cost industry more output will be supplied at less price.

iv. Thus the long run supply curve (LSC) of the increasing cost industry will slope downwardsas shown in panel (b) of the figure.

vidyarthiplus.com

vidyarthiplus.com


14/38


THE PRICE-OUTPUT DETERMINATION UNDER PERFECT COMPETITION

DURING THE SHORT-RUN

Short-run period: This period is sufficient only to make limited output adjustment with the

existing equipment by expanding output along the short-run marginal cost curves. This isexplained with the help of a diagram.

Panel (a) Panel (b)Panel (a) = Shows the production levelPanel (b) = Shows the supply of output at different prices

X axisOutputY axisPrice

MCMarginal cost curveACAverage cost curveAVCAverage variable cost curve

SRSShort-run supply curveMPSMarket period supply curve

DDDemand curve


i.Panel (a) explains about the various equilibrium points & the different levels of output being

produced at various prices.ii.At price OP, the firm will produces ON amount of output, since only at this output the price

OP equals marginal cost.

iii.Similarly, when the price increases to OR the firm will increase its output to ON' amount ofoutput & when the price decreases to OT the firm will decrease its output to ON'' amount of

output & respectively, since only at these outputs the prices are equal to their marginal costs.


i.

Panel (b) explains about the changes in price & output at different demands during the market

period & short period supply.ii.It is seen that when the DD curve cuts the MPS curve & SRS curve, the price is OP & the

output is OM.

iii.When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OK,

but the output does not change Again when the decreased demand curve D''D'' cuts the MPScurve, the price alone decreases to OL, but the output does not change. It means that duringthe market period only the price changes & the output remain fixed.

vidyarthiplus.com

vidyarthiplus.com


15/38


iv.When the increased demand curve D'D' cuts the SRS curve, the price increases to OR & theoutput increases to OM'. Again when the decreased demand curve D''D'' cuts the SRS curve,

the price decreases to OT & the output also decreases to OM''. It means during the short runmore output will be supplied at a higher price & vice versa.


DURING THE LONG-RUN

Long-run period: In the long run, the time is long enough for the firms to change the size oftheir plants or build new plants. Also, new firms can enter the industry. In the long-run thefirms can a band on old plants or build new ones and when the new firms can enter the

industry or o ld ones can leave it. This is explained with help of a diagram.

X axisOutput

Y axisCost & RevenueLMCLong-run marginal cost curveLACLong-run average cost curve

Explanation:

i.

If the price is above the minimum long-run average cost, the firm will be makingsupernormal profits. Therefore, in the long-run new firms will enter the industry to compete

away their extra profits and the price will fall to the level where it is equal to the minimumlong-run average cost.

ii.Neither can the price will fall below the minimum average cost since in that case the firmswill be incurring losses. In long-run, if these losses persist, some of the firms will leave theindustry. As a result, the price will rise to the level of minimum average cost, so that in the

long-run firms are earning only normal profits.iii.

Therefore during the long run the firms will be earning only normal profits & will be in

equilibrium at point S, where the long run average cost is equal to the long run averagerevenue.


DURING THE LONG-RUN UNDER DIFFERENT COST CONDITIONS

THE PRICE OUTPUT DETERMINATION OF THE LONG-RUN NORMAL PRICEIN INCREASING COST INDUSTRY

Long-run normal price in increasing-cost industry: Supply curve of an increasing-costindustry slopes upwards from left to right. This is so because when a full-sized industryexpands as a result of the increased demand for its product, it experiences certain external

vidyarthiplus.com

vidyarthiplus.com


16/38


economies and diseconomies. But external diseconomies in the case of an increasing-costindustry outweigh the external economies and this brings about an upward shift in the cost

curves of all firms. This is explained with the help of a diagram.


Panel (b) = Shows the supply of output at different prices

X axisOutputY axisPrice/Cost

LMCLong-run marginal cost curveLACLong-run average cost curve

DDDemand curveMPSMarket-period supply curveSRSShort-run supply curve

LRSLong-run supply curve


i.

Panel (a) explains about the cost & output at different levels of prices.

ii.

It shows that OP is the basic price. In the increasing cost industry, the cost of production is

increased, which increases the price to OP''', thereby shifting the LAC & LMC curves

upwards towards the left side.


i.Panel (b) explains about the changes in price & output at different demands during the market

period supply, short run supply & long run supply.

ii.

It is seen that when the DD curve cuts the MPS curve, SRS curve & LRS curve, the basic

price is OP & the output remains the same i.e OM.

iii.

When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OP',

but the output remains the same i.e OM. It means that during the market period only the price

changes & the output remain fixed.

iv.When the increased demand curve D'D' cuts the SRS curve, the price increases to OP'' & the

output increases to OM'. It means during the short run more output will be supplied at a

higher price.

v.

When the increased demand curve D'D' cuts the LRS curve, the price increases to OP''' & the

output increases to OM''. It means that in increasing cost industry during the long run moreoutput will be supplied at a higher price.

vidyarthiplus.com

vidyarthiplus.com


17/38


THE PRICE OUTPUT DETERMINATION OF LONG RUN NORMAL PRICE IN

CONSTANT-COST INDUSTRY

Long run normal price in constant-cost industry: Industry will be a constant-sot industry

if, on its expansion, external economies and diseconomies cancel each other so that theconstituent firms of an enlarged industry do not experience shift in their cost curves. Anindustry can also be a constant-cost industry if its expansion breeds neither external

economies nor external diseconomies. This is explained with the help of a d iagram.


Panel (b) = Shows the supply of output at different pricesX axisOutputY axisPrice/Cost

DDDemand curveLMCLong-run marginal cost curve

LACLong-run average cost curveMPSMarket-period supply curve

SRSShort-run supply curveLRSLong-run supply curve


i.Panel (a) explains about the cost & output at different levels of prices.

ii.It shows that OP is the basic price. In the constant cost industry, the cost of production will

remain the same & the price will also be to OP, thereby LAC & LMC curves will not be

shifted anywhere.


i.

Panel (b) explains about the changes in price & output at different demands during the market


ii.It is seen that when the DD curve cuts the MPS curve, SRS curve & LRS curve, the basic


iii.When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OP',

but the output remains the same i.e OM. It means that during the market period only the

price changes & the output remain fixed.

iv.

When the increased demand curve D'D' cuts the SRS curve, the price increases to OP'' & theoutput increases to OM'. It means during the short run more output will be supplied at a

higher price.

vidyarthiplus.com

vidyarthiplus.com


18/38


v.When the increased demand curve D'D' cuts the LRS curve, the price does not change, it

remains the basic price as OP but the output alone increases to OM''. It means in the constant

cost industry during the long run more output will be supplied at the same price.

THE PRICE-OUTPUT DETERMINATION OF LONG-RUN NORMAL PRICE INDECREASING-COST INDUSTRY

Long-run normal price in decreasing-cost industry: In the case of a young industry in itsearly stages of growth, the external economies may overweigh the external diseconomies.

This phenomenon of net external economies lowers the cost curves of all firms. In the case ofa decreasing-cost industry, the additional supplies of the product will forth coming at reduced

costs and, therefore, the long-run supply curve of the industry will slope downwards from leftto right. This is explained with the help of a diagram.



Y axisPriceDDDemand curveLMCLong-run marginal cost curve

LACLong-run average cost curveMPSMarket-period supply curve

SRSShort-run supply curve

LRSLong-run supply curve


i.

Panel (a) explains about the cost & output at different levels of prices.

ii.It shows that OP is the basic price. In the increasing cost industry, the cost of production is

decreased, which decreases the price to OP''', thereby shifting the LAC & LMC curves

downwards towards the right side.


i.Panel (b) explains about the changes in price & output at different demands during the market


ii.

It is seen that when the DD curve cuts the MPS curve, SRS curve & LRS curve, the basic


vidyarthiplus.com

vidyarthiplus.com


19/38


iii.When the increased demand curve D'D' cuts the MPS curve, the price alone increase to OP',

but the output remains the same i.e OM. It means that during the market period only the price

changes & the output remain fixed.

iv.When the increased demand curve D'D' cuts the SRS curve, the price increases to OP'' & the

output increases to OM'. It means during the short run more output will be supplied at a

higher price.

v.When the increased demand curve D'D' cuts the LRS curve, the price decreases to OP''' & the

output increases to OM''. It means that in decreasing cost industry during the long run more

output will be supplied at a lesser price.

MONOPOLY

The monopoly is that market form in which a single producer controls the whole supply of asingle commodity which has no close substitutes

PRICE-OUT DETERMINATION UNDER MONOPOLY OR THE EQUILIBRIUM

OF THE FIRM AND INDUSTRY UNDER MONOPOLY

Assumptions:

i.There is one seller or producer of a homogeneous product

ii.There are no close substitutes for the productiii.

There is pure competition in the factor market so that the price of each input he buys is givento him

iv.The monopolist is a rational being who aims at maximum profit with the minimum of costs.v.There are many buyers on the demand side but none is in a position to influence the price of

the product by his individual actions. Thus the price of the product is given for the consumer.

vi.

The monopolist does not charge discriminating price. He treats all consumers alike andcharges a uniform price for his product.

vii.The monopoly price is uncontrolled. There are no restrictions on the power of the monopolist.viii.There is no threat of entry of other firms.

This is explained with the help of a diagram.Price output equilibrium under monopoly [monopoly earning super normal profits]

X axis = outputY axis = Revenue / cost

AR = Average revenueMR = Marginal Revenue

AC = Average costMC = Marginal cost

vidyarthiplus.com

vidyarthiplus.com


20/38


Explanation:

i.

E is the equilibrium point where the MC curve cuts the MR curve from below

ii.It is seen that the average cost is less than the average revenue. It means that the monopolist is

earning super normal profits in the short run.

Price output equilibrium under monopoly [monopoly incurring losses]

X Axis = output

Y Axis = Revenue / costAR = Average revenue

MR = Marginal RevenueAC = Average costMC = Marginal cost

Explanation:

i. E is the equilibrium point where the MC curve cuts the MR curve from below

ii. It is seen that the average cost is more than the average revenue. It means that the

monopolist is incurring losses in the short-run.

PRICE DISCRIMINATION

Price discrimination means charging different prices from different customers or for differentunits of the same product.

CONDITIONS OF PRICE DISCRIMINATION:

i.

The aim of the monopolist is to maximize his profits. He, therefore, produces that output atwhich his marginal revenue equals marginal cost.

ii.The number of buyers in each market is very large and there is perfect competition among

themiii.There is no possibility of resale from one market to the other

iv.

The monopolists demand curve in each market is downward sloping which implies that hismonopoly in selling the commodity is well established in the two markets.

v.The most important condition for price discrimination is that the elasticities of demand in the

two markets must be different. If the elasticities of demand are the same, marginal revenueswill also be the same.

vidyarthiplus.com

vidyarthiplus.com


21/38


WHEN IS PRICE DISCRIMINATION PROFITABLE

(A) Price discrimination not profitable when the demand curves are iso-elastic:

We shall take the two markets where the demand curves are iso-elastic, i.e., where at everyprice, elasticity of demand curve is the same.

When in two markets elasticity of demand is the same, then the marginal revenue will also be

the same. Marginal revenue in the two markets being the same, it will not be profitable from

one market to another in order to change a different price. This is explained with the help o f adiagram.


Markets A & B=Markets having same elastictiesARa & ARb = Average revenue curve of market A & BMRa & MRb = Marginal Revenue curve of market A & B

Explanation:

i.The demand curves ARa and ARb have the same elasticity at the price OP. At this price,marginal revenue in the two markets is the same.

ii.Now if the monopolist increases the price in market A from OP to OP' to earn profit, theoutput will be reduced from OM toON1. Thus the monopolist incurs loss in market A.

iii.In order to compensate loss the monopolist decreases the price from OP to OP'' in market B& the output also increases from OM2 to ON2. Thus the monopolist earns profit in market B.

iv.But the profit in Market B is less than the loss in market A.v.

This shows that when the demand curve have the same elasticity then price discrimination

will not be profitable.

(B) Price discrimination profitable when elasticities differ:

The monopolist will find it profitable to charge discriminating prices, when the elasticities of

demand in the two markets are different. Rather, this is the only way for him to maximizeprofits. If elasticity of demand is different in the two markets, he would charge higher price inthe market where elasticity is low and low price where it is high. This is explained with the

help of a diagram.

vidyarthiplus.com

vidyarthiplus.com


22/38



Markets A & B=Markets having different elasticitiesARa & ARb = Average revenue curve of market A & BMRa & MRb = Marginal Revenue curve of market A & B

Explanation:

i.The demand curves ARa and ARb have the different elasticity at the price OP. At this price,marginal revenue in the two markets is different.

ii.Now if the monopolist increases the price in market A from OP to OP' to earn profit, theoutput will be reduced from OM1 toON1. Thus the monopolist incurs loss in market A.

iii.

In order to compensate loss the monopolist decreases the price from OP to OP'' in market B& the output also increases from OM to ON2. Thus the monopolist earns profit in market B.

iv.Now the profit in Market B is greater than the loss in market A.

v.This shows that when the demand curve have different elasticity then price discriminationwill t be profitable.

PRICE-OUTPUT EQUILIBRIUM UNDER DISCRIMINATING MONOPOLY

A Discriminating monopoly is the one who charges different prices from different customersor for different units of the same product. This is explained with help of a diagram.

X axis = outputY axis = Revenue / costAR & AR' = Average revenue curves of markets A & B

MR& MR ' = Marginal Revenue curves of markets A & BMC= Marginal Cost curve

CMR= Combined Marginal Revenue curves of markets A & B

vidyarthiplus.com

vidyarthiplus.com


23/38


Explanation:

i.

The equilibrium of the discriminating monopolist is established at the output OM at whichMC cuts MR.

ii.Now the output OM of the Total Market has therefore to be distributed between the twomarkets A & B in such a way that marginal revenue in each is equal to ME which is the

marginal cost being on the MC curve.

iii.The output OM1 will be sold in market A, because only at this output marginal revenue MR1in market A is equal to ME. The price charged in the market for output OM1 is equal to M1P1.

iv.The output OM2 will be sold in market B as only at this output, marginal revenue in market

B ,that is MR2 is equal to ME.Price charged in market B for output OM2 is M2 P2 which islower than the M1 P1 which is charged in market A.

v.

Thus in market B in which elasticity of demand is greater, the price charged is lower than that

in market A, where the elasticity of demand is less.

THE VARIOUS SOURCES AND TYPES OF MONOPOLY

i.Grant of a patent right to a firm by the government to make, use or sell its own invention.

ii.Control of a strategic raw material for an exclusive production process.

iii.

A natural monopoly enjoyed by a firm when it supplies the entire market at a lower unit cost

due to increasing economies of sca le just as in the supply of electricity, gas etc.

iv.

Government may grant exclusive right to a private firm to operate under its re gulation. Suchprivately owned and government regulated monopolies are mostly in public utilities and arecalled legal monopolies such as in transport communications, etc.

v.There may be government owned and regulated monopoly such as postal services, water, and

sever systems of municipal corporation etc.

vi.

Government may grant license to a sole firm and protect it to exclude foreign rivals.

vii.The sole manufacturer of a product may adopt a limit pricing policy in order top prevent the

entry of new firms.

THE VARIOUS TYPES OF PRICE DISCRIMINATION

i.Personal price discrimination based on the income of the customer: For example, doctors

and lawyers charge different fees from different customers on the basis of their incomes.Higher fees are charged to rich persons and lower to the poor.

ii.Price discrimination based on the nature of the product: Paperback is cheaper than thedeluxe edition of the same book, for the former is bought by the majority of readers, and the

latter by libraries. Unbranded products, like open tea are sold at lower prices than brandedproducts like brooke bond or lipton tea. Economy size tooth pastes are relatively cheaper than

ordinary sized tooth pastes. In the case of services too, such price discrimination is practicedwhen off-season rates of holds at hill stations are very low as compared to the peak season.

vidyarthiplus.com

vidyarthiplus.com


24/38


Dry cleaning firms charge for two while they clean three clothes during off season where asthey charge more for quick service in peak season.

iii.Price discrimination related to the age, gender and status: price discrimination is also

related to the age, gender and status of the customers. Barbers charge less for childrenshaircuts. Certain cinema halls admit ladies only at lower rates. Military personnel in uniformare admitted at concessional rates in all cinema houses.

iv.

Discrimination is also based on the time of service: Cinema houses at certain places, like

new delhi, charge half the rates in the morning show than in the afternoon shows.

v.Geographical or local discrimination: There is geographical or local discrimination when a

monopolist sells in one market at a higher price than in the other market.

vi.Discrimination based on the use of the product: Railways charge different rates fordifferent compartments or for different services. Less is charged for the transportation of coalthan for bales of cloth on the same route. State power boards charge low rates for industrial

use than for domestic consumption of electricity.

THE VARIOUS CONDITIONS OF PRICE DISCRIMINATION

i.Market imperfection: The individual seller is able to divide and keep his market into

separate parts only if it is imperfect. Customers do not move readily from one market to theother because of ignorance.

ii.Agreement between rival sellers: price discrimination also takes place when the seller of acommodity is a monopolist or when rivals enter into an agreement for the sale of the product

at different prices to different customers. This is usually possible in the sa le of direct services.

iii.

Geographical and tariff barriers: The monopolist may discriminate between home andforeign buyers by selling at a lower price in the foreign market than in the domestic market.This type of discrimination is known as dumping

iv.Differential products: Discrimination is possible when buyers need the same service in

connection with differential products.

v.Ignorance of buyers: Discrimination also occurs when small manufacturers sell goods made

to order. They charge different rates to different buyers depending upon the intensity of theirdemand for the product

vi.

Artificial difference between goods: A monopolist may create artificial difference bypresenting the same commodity in different quantities. He may present it under different

names and lables, one for rich and snobbish buyers and the other for the ordinary. Thus hemay charge different prices for substantially the same product.

vii.Difference in demand: For price discrimination, the demand in the separate markets must beconsiderably different. Different prices can be charged in separate markets based on

differences of elasticity of demand, low price is charged where demand is more elastic andhigh price in the market with the less elastic demand.

vidyarthiplus.com

vidyarthiplus.com


25/38


METHODS TO CONTROL AND REGULATE MONOPOLY

(A) Fear that prevent the monopolist from charging a very high price in order to earnlarge super-normal profits.

i.Fear of potential rivals: The fear of potential competitors may prevent a monopolist tocharge a very high price to his customers. If he sets a very high price he will earn large super

normal profits. Attracted by these monopoly profits new entrants may force themselves into

the monopolized industry. The monopolist being averse to the entry of new firms would

prefer to charge a reasonable price and thus earn only a modest profit.

ii.Fear of government regulation: Same consideration applies to potential government

regulation. The monopolist is well aware that charging unusually high price or profits wouldattracts the attention of the government. Rather than risk government regulation he may

voluntarily fix a low price and earn less monopoly profits.

iii.Fear of nationalization: The fear of nationalization also prevents the monopolist to wield an

absolute monopoly power. If the products or service which monopolist produces is a public

utility service, that is every likelihood of the states taking over the monopoly organization inpublic interest. This consideration may prevent the monopolist from charging too high aprice.

iv.Fear of public reaction: The monopolist is also aware of public reaction he charges a veryhigh price and earns huge profits. Voices may be raised against the monopoly firm in

parliament to press for anti-monopoly legislation.

v.Fear of boycott:People may even boycott the use of monopolized product or service and

start their own service instead. For instance, if in a big city taxi operators combine to chargehigh rates, people may boycott taxi services and even start operating their own services by

forming a cooperative society. Naturally such a fear compels monopoly firms to chargereasonable prices and earn only nominal profits.

vi.Fear of substitutes:Then there is the fear of substitutes. In fact the fear of substitutes is themost potent-factor which prevents monopoly firms from charging very high prices and

thereby earning huge super-normal profits. It is only under pure monopoly that there areabsolutely no substitutes for the product. But pure monopoly like pure competition beingunreal, the monopoly product has some substitute though it is not a close substitutes is always

uppermost in the mind of the monopolist which acts as a restraint on his absolute power.

vii.Difference in elasticity of demand: The difference in the short and long run elasticities of

demand for monopoly product also limit monopoly power. In the short run the monopolistcan charge a very high price because customers take time to adjust their habits tastes, and

income to some other substitutes. The demand for the monopoly products is, therefore lesselastic in the short run but in the long run the fear of public opinion emergence of substitutes,

government regulations etc will force the monopolist to set a low price. He will view hisdemand curve as elastic and sell more at a low price.

(B) Control of monopoly through legislation: Government tries to control monopoly byanti-monopoly lows and restrictive trade practices legislation. These measures tend to:

i.Remove restr ictive trade practices and fix high prices.

ii.

Reduce the incidence of market-sharing agreements.iii.

Remove unfair competition.

vidyarthiplus.com

vidyarthiplus.com


26/38


iv.Restrict the control of very large share of the market.v.Prevent unfair price discrimination.

vi.

Restrict mergers in order to avoid market domination.vii.Prohibit exclusive agreements between the producer and retailer to the detriment of other

traders.

(C) Control of monopoly through price regulation and taxation:

i.Regulated monopoly pricing: To regulate monopoly the government imposes price ceiling

so that monopoly price should be near or equal to competitive price. This done when thegovernment appoints a regulating authority or commission which fixes a prices for themonopoly product below the monopoly price, thereby increasing output and lowering the

price for the consumer.

ii.Taxation: Taxation is another way of controlling monopoly power. The tax may be leviedlump sum without any regard to the output of the monopolist or it may be proportional to theoutput the amount of tax rising with the increase in output.

iii.Lump sum tax: By levying a lump sum tax, the government can reduce or even eliminatemonopoly profits without affecting either the price or output of the product.

iv.Specific tax: The government can also reduce monopoly profits by levying a specific or a per

unit tax on the monopolists product.

MONOPOLISTIC COMPETITION

Monopolistic competition refers to a market situation where are many firms selling a

differentiated product.

THE VARIOUS FEATURES OF MONOPOLISTIC COMPETITION

i.Large number of sellers: In monopolistic competition the number of sellers is large. No

seller by changing its price-output policy can have any perceptible effect on the sales ofothers and in turn be influenced by them.

ii.Product Differentiation: One of the most important features of the monopolisticcompetition is product differentiation. A general class of product is differentiated if any

significant basis exists for distinguishing the goods(or services) of one seller from those ofanother .

iii.

Freedom of Entry and Exit of firms: Another features of monopolistic competition is thefreedom of entry and exit of firms. The fact that firms are small size and are capable of

producing close subsitiutes make it possible for them to leave or enter the industry o r groupin the long run. In fact, product differentiation tends to increase rather than reduce the entry

of new firms in the group, for each firm produces a distinct product from the other.

iv.Nature of Demand Curve: Under monopolistic competition no single firm controls more

than a small portion of the total output of a product. No doubt there is an element ofdifferentiation, nevertheless the products are close substitutes. As a result, a reduction in its

price will increase the sales of the firm but it will have little effect on the price-outputconditions of other firms, each will lose only a few of its customers. Likewise, an increase in

its price will reduce its demand substantially but each of its rivals will attracts only a few of

vidyarthiplus.com

vidyarthiplus.com


27/38


its customers. Therefore, the demand curve(average revenue curve) of a firm undermonopolistic competition slopes downward to the right.

PRICE OUTPUT DETERMINATION UNDER MONOPOLISTIC COMPETITION

DURING THE SHORT RUN

Assumptions:

i.

The number of sellers is large and they act independently of each other. Each is a monopolist

in his own sphere.ii.The product of each seller is differentiated from the other product.

iii.The firm has a determinate demand curve (AR) which is elastic.

iv.

The factor services are in perfectly elastic supply for the production of the product inquestions.

v.The short-run cost curves of each firm differ from each other.No new firms enter the industry.


(A) Equilibrium under monopolistic competition during the short run [Monopolistic

firm earning profits]: The monolopolistic firm will earn profits when the Average cost will

be less than average revenue.

X axis = output

Y-axis = cost/revenueAR = Average revenue curveMR = Marginal revenue curve

SAC = Short-run average cost curveSMC = Short-run marginal cost curve

Explanation:

It is seen that during the short run average cost is less than the average revenue. It means thatthe monopolistic firm is earning super normal profits during the short run.

vidyarthiplus.com

vidyarthiplus.com


28/38


(B) Equilibrium under monopolistic competition during the short-run [Monopolistic

firm incurring losses]: The monolopolistic firm will incur losses when the Average cost will

be greater than average revenue. This is explained with the help of a diagram.

X axis = outputY-axis = cost/revenue

AR = Average revenue curveMR = Marginal revenue curveSAC = Short-run average cost curve

SMC = Short-run marginal cost curve

Explanation:

It is seen that during the short run average cost is more than the average revenue. It meansthat the monopolistic firm is incurring losses during the short run.

THE LONG-RUN EQUILIBRIUM OF THE FIRM

The firms under monopolistic competition can earn supernormal profits in the short run. But,in the long-run, such profits disappear. This is because we assume that entry is free and new

firms will enter the industry, if the existing firms are making supernormal profits. As newfirms enter and start production, supply will increase and the price will fall.

The supernormal profits will be competed away and the firms will be earning only normalprofits. If in the short run, firms are realizing losses, then, in the long run, some firms will

leave the industry so that the remaining firms will be earning normal profits.

Therefore, there is equilibrium in the long run under monopolistic competition when,Average Revenue= Average cost. This is explained with the help of a diagram.

vidyarthiplus.com

vidyarthiplus.com


29/38


30/38



Short run equilibrium Long run equilibrium

X axis-> outputY axis-> priceSMR and SAR->Short run marginal revenue curve, Short run average revenue curve

SMC and SAC->Short run marginal cost curve & Short run average cost curveLAR and LMR->Long run average revenue curve & Long run marginal revenue curveLAC and LMC->Long run average cost curve & Long run marginal cost curve

Explanation: Short run equilibrium

i.In the short run, the price is OP; whereas average cost is MN at the output OM where

marginal revenue is equal to the marginal cost.ii.

Hence there is supernormal profit represented by the shaded area PRNP1.

Long run equilibrium:

i.But in the long run, the surplus profit will be competed away.ii.The marginal revenue equals marginal cost at the output level OM1.

iii.The average revenue curve(LAR) is a tangent to the average cost curve(LAC) which means

that the average revenue(ie., price) is equal to average cost and there is no extra profit, i.e.,only normal profit is being made.

SELLING COST

The costs incurred on advertising, publicity and salesmanship are known as selling costs.Selling costs have been defined as the costs necessary to persuade a buyer to buy one

product rather than another or to buy from one seller rather than another. The intervention ofselling costs adds to the difficulty of determining the most profitable output. It is obviousthat higher total selling costs will be necessary to sell a larger output at the same price or the

same output at a higher price. This is explained with the help of a d iagram.

vidyarthiplus.com

vidyarthiplus.com


31/38


X axis = output

Y axis = priceAR = Average revenue curve

MR = Marginal revenue curveMC = Marginal Cost curveAUTC = Average Total Unit Cost

Explanation:

i.DP is the net return per unit of the output OM.ii.Thus, area DEFP indicates the maximum net return in the case i.e., Total revenue OMPF-total

cost OMDE.

THE WASTES OF MONOPOLISTIC COMPETITION (OR) THE CONCEPT OF

EXCESS CAPACITYA firm under monopolistic competition or imperfect competition produces an output in the

long run equilibrium which is less than socially optimum or ideal output. In other words, theydo not produce that level of output at which long-run average cost is minimum. They do notincrease their output, because their profits have already been maximized at the level of output

smaller than at which their long-run average cost would be minimum. This happens at a pointwhere equality between marginal revenue and marginal cost has been attained. The

productive resources of the community are fully utilized only when they are used to producethat level of output which brings down the long-run average cost to the lowest point. But themonopolistic firms produce less than that level of output which is socially optimum or ideal

output. This is explained with the help of a diagram.

Monopolistic Competition Perfect CompetitionFigure (a) Figure (b)

vidyarthiplus.com

vidyarthiplus.com


32/38


X axis = outputY axis = cost/revenue

AR = Average revenueMR = Marginal revenue

LMC = Long-run marginal cost curveLAC = Long-run average cost curve

Explanation: Figure (a):The long-run position of a firm under Monopolistic competition

i.In this case, the long-run equilibrium is achieved at OM output at which the marginal revenueis equal to marginal cost and price is equal to average cost.

ii.Here average revenue curve AR is tangential to average cost curve AC at point F

corresponding to output OM.

iii.

It can be seen that at output OM, average cost is still falling and it continues to fall up to ON

which means that the firm can produce maximum output till ON but it produces only less

output till OM.

iv.This shows that the capacity to produce MN quantity of output has been wasted or unutilized.Hence, the ideal output is ON where the long-run average cost is minimum.

v.This means that this firm is producing MN quantity less than the ideal output. Hence MNoutput represents excess capacity which emerges under monopolistic competition.

Figure (b): The long-run position of a perfectly competitive firm.

i.The firm is in long-run equilibrium at the level of ON output where the long-run average cost

is minimum.ii.At this point, price=MC=AC which means that the double condition of long-run equilibrium

is satisfied. This represents the socially ideal output.

iii.

It means that there is no waste or excess capacity under perfect competition.

CRITICISM OF EXCESS CAPACITY OR WASTES OF MONOPOLISTIC

COMPETITION

i.Restriction of output: One of the workers of imperfect competition is the restriction ofoutput so that price is kept higher than the marginal cost.

ii.

Competitive advertisement: Expenditure on competitive advertisement is usually regardedas a waste of competition.

iii.Cross-Transport: Another similar waste is expenditure on cross-transport.

iv.Specialization:The failure of each firm is an industry to specialization in the production ofthose things for which it is best suited.

v.Valuable resources are wasted: Valuable resources are wasted because of excess capacityresulting in idle plant and manpower in each firm.

vi.

Prevent Standardization: Imperfect competition may prevent that standardization ofcommodities which is essential if the most efficient methods o f production are to be adopted.

vidyarthiplus.com

vidyarthiplus.com


33/38


vii.Excess capacity: Monopolistic competition has also been criticized on the ground that the

firms under this type of market operate with excess capacity.

OLIGOPOLY

It is a market situation in which there are a few firms selling homogenous or differentiated

products. It is difficult to pinpoint the number of firms in the oligopolistic market. There

may be three, four or five firms. It is also known as competition among the few.

CHARACTERISTIC FEATURES OF OLIGOPOLY

i.Interdependence: There is a recognized interdependence among the sellers in the

oligopolistic market.

ii.Advertisement: One producers fortunes are dependent on the policies and fortunes of the

other producers in the industry. It is for this reason that oligopolistic firms spend much on

advertisement and customer services.

iii.Competition: In oligopolistic market, each seller is always on the alert over the moves of its

rivals in order to have a counter-move.

iv.Barriers to Entry of Firms: As there is keen competition in an oligopolistic industry, there

are no barriers to entry into or exit from it.

v.Lack of Uniformity: In oligopoly market, there is a lack of uniformity in the size of firms.

vi.Demand Curve: Under oligopoly, the exact behaviour pattern of a producer cannot be

ascertained with certainty his demand curve cannot be drawn accurately.

vii.No Unique Pattern of Pricing Behaviour: The rivalry arising from interdependence among

the oligopolists leads to two conflicting motives. So it is not possible to predict any unique

pattern of pricing behavior in oligopoly markets.

THE PRICE-OUTPUT DETERMINATION UNDER OLIGOLOPOLY OR THESWEEZY MODEL OF KINKED DEMAND CURVE (RIGID PRICES)

Assumptions

i.

There are few firms in the oligopolistic industry.

ii.The product produced by one firm is a close substitute for the other firms.

iii.

The product is of the same quality. There is no product differentiation.iv.There are no advertising expenditures

v.There is an establishment or prevailing market price for the product at which all the sellers

are satisfied.

vi.

Each sellers attitude depends on the attitude of his r ivals.

vii.Any attempt on the part of a seller to push up his sales by reducing the price of his product

will be counteracted by the other sellers who will follow his move.

viii.

If he raises the price others will not follow him, rather they will stick to the prevailing price

and cater to the customers, leaving the price-raising seller.

ix.

The marginal cost curve passes through the dotted portion of the marginal revenue curve sothat changes in marginal cost do not affect output and price.

vidyarthiplus.com

vidyarthiplus.com


34/38



X axis = output

Y axis = PriceDD= Demand Curve/ Average revenueMR = Marginal revenue curve

MC = Marginal cost curve

Explanation:

i.There are two oligopolistic firms, one facing the elastic demand & the other one facing

inelastic demand.

ii.The fixing of prices under oligopoly is a very difficult situation as the oligopolists will not

agree for a common price.

iii.Therefore, it is said that under oligopoly price is fixed at the kink, where the MC curve cuts

the MR curve from below.

EFFECTS OF OLIGOPOLY

i.Small output and higher prices: Oligopoly results in the restriction of output and changing

of higher prices.

ii.Prices exceed average costs: Owing to restrictions, partial or complete, on the entry of newfirms, the prices fixed, under oligopoly, are higher than the average cost. The consumershave to pay more than is necessary to retain the resources in the industry.

iii.Lower efficiency: There is no tendency under oligopoly, for the firms in the industry to build

optimum scales of plant and operate them at the optimum rates of output. They do not,

therefore attain maximum potential economic efficiency.

iv.Selling costs: In order to snatch markets form their rivals the oligopolistic firms engage inaggressive and extensive sales promotion effort by means of advertisement and by changing

the design and improving the quality of their products.

v.Wider range of products: Oligopoly places at the consumers disposal a wider range of

commod ities. To this extent, it promotes consumers welfare.

vi.Welfare effect: Under oligopoly, since output does not generally correspond to the minimumlong-run unit cost, more units of resources per unit of output are utilized than it its necessary.

vidyarthiplus.com

vidyarthiplus.com


35/38


EVILS OF OILGOPOLY

i.Price war: There is generally a continuous price war which finally results in disastrously lowlevel of prices.

ii.Cut-throat competition: Such cut-throat competition in industries characterized by heavyoverheads and increasing costs proves ruinous to all producers.

iii.

Price agreements: There may tacitly or explicitly enter into price agreements, which may

results in the exploitation of the consumers.

iv.Earn a fair return on past investments: A tendency to earn a fair return on past

investments, resulting in the excessive plant capacity, is detrimental to consumers welfare,because they face scarce output and high prices.

v.Liquidate excess capacity: Hence, cut-throat competition may be, essential to liquidateexcess capacity through losses or sub-normal profits.

vi.

Idle plants:oligopoly, prices stay firm and only output varies resulting in idle plants. This isbad for the society and bad for the government.

REMEDIAL MEASURES TO CONTROL EVILS OF OLIGOPOLY

i.Government regulation is necessary to pull down barriers: To pull down barriers to theentry to new firms.

ii.Government regulation is necessary to grown on collusions: To grown on collusions tomaintain prices and restrict supply.

iii.Government regulation is necessary to break big firms: To break big firms or to preventthem from becoming bigger.

PRICE LEADERSHIP

Under price leadership, one firm assumes the role of a price leader and fixes the price of theproduct for the entire industry. The other firms in the industry simply follow the price leader

and accept the price fixed by him and adjust their output to this price. The price leader isgenerally a very large or a dominant firm or a firm with the lowest cost of production. It

often happens that price leadership is established as a result of price war in which one firm

emerges as the winner.

THE PRICE-OUTPUT DETERMINATION UNDER PRICE LEADERSHIP

Assumptions:

i.

There are only two firms A and B and firm A has a lower cost of production than B

ii.The product of the firms is homogenous or identical so that the consumers are indifferent asbetween the firms.

iii.Both A and B have equal share in the market, i.e., they are facing the same demand curvewhich will be half of the total market demand curve.


vidyarthiplus.com

vidyarthiplus.com


36/38


X axis = QuantityY axis = Price and cost

MR = Marginal revenue curveMCa, & MCb = Marginal cost curve of firms A & B

DD = Demand curve

Explanation:

i.Let us take the firm A first. A will be maximizing its profits by selling output OM and setting

price MP, because at the output OM its marginal cost is equal to its marginal revenue.ii.As regards the firm B, the profits will be maximum when it sells ON output and fixes NK

price, because at this output its marginal cost is equal to its marginal revenue.

iii.It can be seen that the profit-maximizing price MP of the firm A is lower than the profit-maximizing price NK of the firm B.

iv.The two firms will have to charge the same price since the products of the two firms havebeen assumed to be homogenous

v.This means that the firm A, whose price MP is lower, will dictate the price to the firm B

whose profit-maximizing price NK is higher.vi.

In case the firm B refuses to fall in line, it can be ousted by the firm A which will be charging

the lower price.vii.This shows that in this situation, the firm A is the price leader and the firm B has to follow it.

DUOPOLY

Duopoly is a special case of the theory of oligopoly in which there are only two sellers. Boththe sellers are completely independent and no agreement exists between them. Even thoughthey are independent, a change in the price and output of one will affect the other, and may

set a chain of reactions. A seller may however, assume that his rival is unaffected by what he

does, in that case he takes only his own direct influence on the price.

COURNOT MODEL OF DUOPOLY

Assumptions:

i.There are two independent sellers. In other words, interdependence of the duopolists isignored.

ii.

They produce and sell a homogenous product- mineral water.

iii.

The total output must be sold out, being perishable and non-storab le.iv.The number of buyers is large.

v.

Each seller knows the market demand curve for the product.vi.The cost of production is assumed to be zero.

vii.Both have identical costs and identical demands.

vidyarthiplus.com

vidyarthiplus.com


37/38


viii.Each seller decides about the quantity he wants to produce and sell in each period.ix.But each is ignorant about his rivals plan about output.

x.

At the same time, each seller takes the supply output of its rival as constant.xi.Neither of them fixes the p rice for its product, but each accepts the market demand price at

which the product can be sold.xii.The entry of firms is blocked.

xiii.

Each seller aims at obtaining the maximum net revenue or profit.

This is explained with the help of a diagram:

X axis = output

Y axis = Price

Explanation:

i.

It shows how A and B producers share the total market and adjust output and how theymaximize their profits.

ii.SB is the total demand. Let the unit cost be zero i.e., MC=0. Therefore MR is also zero at A.iii.Before B enters the market, A produces OA=Half of OB. The price is OC giving maximum

profits OAPC.iv.Then B enters the market and produces AH = Half of AB, i.e the remaining market.v.This process will continue till equilibrium output and price are achieved. As more and more

firms enter, they will produce output approaching the competitive output. If the number offirms goes up to N they will produce N+1 (N) OB.

THE EDGE WORTH MODEL OF DUOPOLY: This can be explained with the help ofdiagram.

vidyarthiplus.com

vidyarthiplus.com


38/38

X axis = outputY axis = Price

Explanation:

i.It is assumed that each producers capacity is limited to 3/4 thof his entire market and each isconfronted with his own demand curve made up of one half of the consumers. The maximum

output that A can produce is OB and B can produce OB.

ii.

The demand curves of A and B respectively are DT and DH.

iii.The A first enters the market and sets his price P1 he sells the total output aP1.Then B entersthe market and sells at price slightly lower than A and thus captures his market.

iv.B then sells the whole output at P2 and snatches fro m Abb of sales. Now A reacts and

captures Bs market to the extent of CC. v.This process of price-cutting continues until one of them say B fixes his prices at P4.At this

point none can snatch the market from the other by lowering the price.vi.Then A raises the price back to P1 to maximize his profits from his share of the market

knowing that B has already thrown his entire supply, B then follows suit.

vii.

There is thus continual oscillation of price between P1 and P4 i.e., the upper and lower limits.

CHAMBERLIN MODEL OF DUOPOLY: This can be explained with the help of diagram.

X axis = output

Y axis = Price

Explanation:

i.

Suppose the producer A enters the market first DB is the demand curve and OL is the total

output he chooses to produce.ii.It is sold at OA price and the total profit made is OLPA.

iii.Now the producer B enters the market and produces LH quantity.iv.

Now the total quantity produced is OL+LH=OH.

vidyarthiplus.com

UNIT IV-MG2452-Engineering Economics and Financial Accounting Notes.pdf

Documents

Transcript of UNIT IV-MG2452-Engineering Economics and Financial Accounting Notes.pdf