Large number of buyers and sellers:In this market structure there are large number of buyers and
sellers e.g. many farmers growing wheat. If one of them,
produces more or less that will not affect the market supply or
the market price. In this there are large buyers also. Even the
buyers cannot influence the price by changing their demand
because each buyer and seller is like a drop in ocean
2. Homogeneous product:It is the most important feature. It says that the product which
these large number of buyers buy from large number of sellers are
identical or we can say perfect substitute that means, if one buyer
increase the price the buyer will buy it from other seller as the
products are identical e.g. rice.
3. Free entry and exit of firms:An entrepreneur who has enough capital and still can start the
business and enter the industry and any one who is incurring loss can
stop the production and exit the industry.
4. Firms are price takers:As there are many buyers and sellers nobody can influence the
price or the supply in the industry. They are like drop in the ocean.
Producers are price takers as he cannot affect the market price.
Consumers are price taking consumer as they cannot influence the
price by any of his or her action.
5. Perfect Knowledge:
All the buyers and sellers have perfect knowledge about the market.
A market which comes to exhibit all these conditions is the stock
market. About one stock there are many information available as it is
6. No Cost of Transportation:It is assumed cost of transportation does not exist.
7. Perfect mobility of factors of production:It is assumed that all the factors of production can be migrated
from one place to another. There is no hindrance in the movement.
This helps in entry of new firm and exit of a loss making firm.
Now after discussing the features we will differentiate between perfect
and pure competition. As perfect competition has all the features of
pure competition and some more features. The first three features
given under perfect competition constitutes pure competition (that is
large number of sellers and buyers, free entry and exit and identical
products) where as perfect competition has the features of pure
competition and two more features they are perfect knowledge about
the market and perfect mobility of inputs and output.
Shut Down Point:In short run, firm may continue its production to recover losses in long
run. In short run as we have discussed in cost concept fixed cost is
incurred even if the output is 0. Now when the firm is incurring loss
then it may go on producing till the loss is less then or equal to total
fixed cost. then the firm may go on producing till the loss less is then
and equal to TFC. If the firm is able to cover its variable cost and part
of fixed cost it will go on producing because if it stops, the firm has to
incur the complete fixed cost as loss and as there will be no variable
cost if there is no production but if the loss is more than fixed cost that
is when producers will decide to shut down. Therefore not only the
whole of fixed cost but also the part of variable cost the firm has to
incur from its pocket, not through revenue. It is advisable to shut
down and incur loss equal to fixed cost as there will be no variable cost
when production is nil.
Long Run Equilibrium:We assume that all the firms have identical cost condition in the
industry. In short run the firm will keep on producing even when it is
incurring loss but in long run the firm not even getting normal profits
will shut down. As due feature of free entry and exit when a firm at
shut down point will exit the industry which will decrease the supply
and the profit increase and other firms who where are incurring loss
will start getting normal profit. When most of the firms are incurring
profits the industry looks attractive many new firms enter the industry
which increase the supply in the industry and the profit comes down
and the existing firms will return to normal profits from super norm at
profits so in long run under perfect competition the firm incurs normal
profit there are no super normal profit and no huge loss.
Monopoly is said to exist when one firm is the sole producer or seller
of the product. In case of monopoly, one firm constitutes the whole
industry. Mono means one and Poly means seller.
1. One seller or producer.
2. No close substitutes for the product of that firm should be
3. monopoly implies no competition
4. Other firms for one reason or the other reason are prohibited to
enter the industry. There is strong barrier to the entry of the
Practice of selling the same commodity, at different price to different
buyers by a seller. A seller makes price discrimination between
different buyers, when it is both possible and profitable for him to do
so. Its difficult to charge different price for the identical good from
Three degrees of price discrimination
1. First degree price discrimination – first degree price
discrimination is also called the perfect price discrimination
because this involves maximum possible exploitation of each
buyer in the interest of the seller’s profit. It is said to occur when
the seller is able to sell each separate unit of the product at
different price. So every buyer is forced to pay the price which
is equal to maximum amount he is willing to pay rather than to
go without the good altogether, which means seller leaves no
consumer surplus to the to buyer. Seller makes separate
bargain with each seller instead of setting down with just two or
three few market prices each. In this all and nothing bargain the
total amount of money which the buyer is required to give equal
to the maximum price he is wiling to pay.
2. Second degree price discrimination - second degree price
discrimination will occur if the monopolist is able to charge
separate price in such a way that buyers are divided into
different groups and each group is charged a different price.
The seller divides his market into different group of buyer and
charges different price for each group of buyer.
Third degree price discrimination- when the seller divides his
buyer into two or more than two sub markets or group and
charges a different price in each submarket. The price charged
in each sub market depends upon the output sold in that
submarket and demand condition of that submarket. It is the
most common, e.g. price discrimination found in the practice of
manufacturers who sells his product at a higher price at home
and lower price abroad.
Monopsony refers to a market situation when there is a single buyer
of a commodity or services. It applies to any situation in which there
is a monopoly element in buying. E.g. when a single factory in an
isolated locality is the sole buyer of some grades of labour or when a
individual happens to have a taste for some commodity which no one
else requires. Just as in monopoly seller is able to influence the price
of the product by the amount he offers for sales. Similarly monopsony
buyer is able to influence the supply price of his purchase by the
amount he buys. Monopoly aim to maximum profit and monopsony
aims to maximum consumer surplus.
Bilateral monopoly refers to market situation in which a single
producer (monopoly) of a product faces a single buyer (monopsony)
of that product. There is a single commodity with no close substitutes,
the monopolist is the sole producer and the monopsonist is the only
buyer. Both are firm to maximize their individual profits. The actual
quantity sold and its price depends upon the relative bargaining
strength of the two. The price tends to settle down between the
monopoly price and monopsonist price.
Monopolistic competition is a form of market structure in which a
large number of independent firms are supplying product that are
slightly differentiated from point of view of buyer. This situation arises
when the same commodity is being sold under brand names e.g. lux,
rexona, dove etc. each firm is sole producer of particular brand. They
are monopolist as far as that particular brand is concerned. Since
various brands are close substitutes, there is keen competition with
It does not mean that the product of various firms are altogether
different, they are slightly different which means they are close
substitutes. They are not identical as in perfect competition but
neither are they remote substitutes as in monopoly. The products are
fairly similar and serves as close substitutes for each other
Two bases of product differentiation
1. Characteristic of the product- such as features, trademark,
trade names etc. real quantitative difference like those of
material used, design and workmanship are no doubt important
means of differentiating products. But imaginary difference
created through advertising, the use of attractive package,
brand name are more usual methods by which products are
differentiated even if physically they are identical or almost so.
2. Condition surrounding the sales of the product- the service
rendered in the process of selling the product by one seller is
not identical to that of the other. E.g. seller’s reputation of fair
dealing, efficiency, general terms, his way of doing business,
seller’s location etc.
Selling cost and advertisement
Under monopolistic competition, the firm often competes through
selling cost and advertisement expenditure. To increase the demand
for their product and thereby increase the revenue made. The selling
cost is broader than advertisement expenditure, where as
advertisement expenditure includes cost incurred only on getting the
product advertised in newspaper, magazines, radio, television but
selling cost includes the salaries and wages of salesmen, allowance
to retailers for the purpose of getting their products displayed and so
many types of promotional activities besides advertisement.
Production cost is the cost of production includes all those expenses
which are incurred to manufacture and provide a product to meet the
given demand or want, while the selling cost are those which are
incurred to change, alter or create the demand for the product. It
should however be noted that the distinction between production
costs and selling costs cannot always be sharply made e.g. it is
difficult to say whether the extra cost of attractive packaging is
production cost or selling cost, since purpose of advertisement is to
increase or create the demand for the product.
Importance of selling cost
Under monopolistic competition with product differentiation the
advertisement and other selling cost becomes important as a
competitive weapon at the disposal of the firm to increase the sales at
the expense of the other. This is because the products are close
substitutes; each firm tries to convince the buyer that its product is
better than the other in the industry. A firm under monopolistic
competition may keep its price and product design constant and seek
increase in demand if its product by increasing the amount of
advertisement expenditure and through it persuading the buyers that
his brand is superior to the others.
In oligopoly the competition between the few
1. Interdependence- the most important feature of oligopoly is the
interdependence in decision making between the few firms
which comprises the industry. When the numbers of
competitors are few, any change in price, output etc by a firm
will have direct effect on the rivals which will then retaliate in
changing their own prices.
2. Importance of selling cost and advertisement - a direct effect of
interdependence of oligopolies is that the various firms have to
employ various aggressive marketing weapons to gain a
greater share in the market or to prevent a fall in the share for
which the firms have to incur a great deal of cost on
advertisement and other measures of sales promotion. Thus,
there is great importance for selling cost and advertisement
Group behaviour- perfect competition, monopoly and
monopolistic pose no problem of making suitable assumption
about human behaviour. Assumption of profit maximization
gives overall good results in these situations where mass of
people are involved and there is no interdependence of the
firms. But in oligopoly the theory of group behaviours is
important as there is interdependence between the members of
the group. Do they form a group and agree to pull together in
promotion of common interest or will they fight to promote their
Indeterminateness of demand curve
The demand curve shows what amount of the product a firm will be
able to sell at various prices. In case of other market situation we can
have definite demand curve but under oligopoly the interdependence
of the firm. Under oligopoly the firm cannot assume the rivals will
keep their price unchanged, so the demand curve faced by
oligopolistic firm loses its definiteness. Since, it goes on constantly
shifting as the rivals change the prices in reaction to price changes by
Is price and output under oligopoly indeterminate?
The interdependence of firms and uncertainty about the reaction
patterns of individual reaction patterns of individual rivals, the easy
and determinate solution to the oligopoly problem is not possible
In the market situation wide variety of behaviour pattern are
possible, rivals may decide to get together and co-operate or at
the other extreme, they may try to fight each other to death.
Another difficulty is indetermination of demand curve facing
individual firms, because of the interdependence of oligopolistic
firm cannot assume that its rivals firm will keep their price and
quantity constant, when it makes change in its price. Therefore
an oligopolistic firm cannot have sure and definite demand
curve, since it keeps shifting as the rivals change their prices in
reaction to the price changes made by it.
The determinate solution to the oligopoly problem has been
provided in the following ways –
firm ignores interdependence. Now when
interdependence disappears from decision making of the firms,
the demand curve facing them becomes determinate and can
2. second approach to provide determinate solution to the price
and output problem of oligopoly is to assume that the oligopoly
firm is able to predict the reaction pattern and counter moves of
3. Third approach assumes that the oligopolistic firms realizing
their interdependence will purse their common interest and will
form collusion and enter into agreement and work in common
interest. They will maximize the joint profit and share the profit,
market or output as agreed between them.
4. Another approach is the game theory – in the theory of game,
an firm does not guess at its rivals reaction pattern but
calculates the optimal moves by rival firms that is their best
possible strategies and in view of that adopt its policies and
Setting price independently is rare in oligopoly markets. This
understanding or agreement among the oligopolist may be either
formal or informal. A formal agreement is one when the oligopolist
after consultation and discussion agree to observe certain common
rules of conduct in regard to price. They may make a written
agreement which may also provide for penalties to those who violate
the agreement reached.
Tacit or informal agreement is without face to face contact,
consultation or discussion they come to have some understanding
between them and pursue a uniform policy with regard to price output
etc. in order to avoid price war and cut throat competition, they enter
agreement regarding a uniform price-output policy to be pursued by
Collusive oligopoly is of two types
in cartel type of collusive oligopoly price is jointly fixed and output
policy through agreement.
Joint profit maximization
Let us assume that two firms have formed a cartel by entering into
agreement, we also assume that the cartel will aim at maximizing
joint profit for the member firms. As the demand curve facing a cartel
will be aggregate demand curve facing consumers of the product, it
will be downwards sloping. Joint profits are maximized by fixing the
industry output at the level at which marginal revenue curve
intersects the marginal cost. having decided the output to be
produced, the cartel will a lot output quota to be produced by each
firm as that the marginal cost for each firm is the same, the profit
made by individual firms will not be retained by them but instead they
will be brought under a common pool. These profits will be divided by
the member firms according to the terms of agreement reached
between them at the time of forming the cartel. The allocation of
output quotas of each of them is made on the grounds of minimizing
costs and not as a basis for determining profit distribution.
Market sharing cartels
Under market sharing by non-price competition only on uniform price
is set and member firms are free to produce and sell the amount of
output which will maximize the individual profits. Though the firms
agree not to sell at a price below the fixed price, they are free to vary
the style of their product and advertisement expenditure. Of the
different member firms have identical costs, then the agreed uniform
price will be the monopoly price which will ensure the maximization of
joint profits. But if the cost differs, the cartel price will be fixed by
bargaining between the firms. The level of the price will be such that it
ensures some profits to high cost firms. With cost difference the
cartels are quiet unstable. low cost firms will have incentives to cut he
price and increase their profits and therefore that will led to break
away from cartel. However they will not openly charge low price but
by giving secret price concessions to the buyers, when this is
discovered and open war may commences and the cartel breaks.
Market sharing by quotas
This type of market sharing cartel is the agreement reached between
the firms regarding quota of output to be produced and sold by each
of them agreed price. When costs of member firms are different, the
different quota for various firms will be fixed and therefore their
market share will differ. The quotas and market shares in case of cost
difference are decided by bargaining between the firms. The quotas
and market sharing is the division of market region-wise that is
geographical division of the market between the cartel firms.
Price leadership is the important form of collusive oligopoly
Price leadership by low cost firm – in order to maximize profit
the low cost firm sets a lower price then the profit maximizing
price if the high cost firms. Since the high cost firms will be
unable to sell their product at the higher price, they are forced
to agree to the low price set by the low cost firms. The low cost
leader will ensure that price he sets must yield profits to high
Dominant firm price leadership – this dominant firm yields a
great influence over the market of the product while other firms
are small and are not capable of making any impact on the
market. As a result a dominant firm estimates its own demand
curve and fixes prices which maximize its own profit. The other
firms which are small having no individual influence on the price
follow the dominant firm and accept the price set by him, adjust
their output accordingly.
Barometric price leadership- under which in old, experienced,
largest and the most respected firm assumes the role of
custodian who protects the interest of all. He assesses the
change in the market condition with regard to the demand for
the product, cost of production, competition from the related
product etc and makes changes in the price which are best
from the view point of all firms in the industry.
Exploitation or aggressive price leadership – under which a
very large and dominant firm establishes its leadership by
following aggressive price policies and thus compels the other
firms in the industry to follow him in respect of price. Such a
firm will often initiate a move threaten to compete the other out
of the market, if they don not follow him in setting their price.
Kinked demand curve
In oligopoly price remains sticky that is there is no tendency on the
part of the firm to change price of the commodity even if the
economic condition under go changes.
The demand curve facing an oligopolist has a kink at the level of
prevailing price. The kink is formed at the prevailing price level
because the segment of demand curve above the prevailing price
is highly elastic and the segment of the demand curve below the
prevailing price is less elastic.
A kinked demand curve dD with a kink at point P has be shown.
The prevailing price level is OP and the firm is producing and
selling the output OM. Now, the upper segment dk of the demand
curve dD is relatively elastic and the lower segment KD is
relatively inelastic. Each oligopolist believes that if he lowers the
price below the prevailing price, his competitor will follow him and
will accordingly lower their prices, where as if he raises the price
above the prevailing price level, his competitors will not follow his
increase in price. Rivals will not match his increase in price above
the prevailing level; they will indeed match its price cuts.
Price reduction – if the oligopolist reduce its price below the
prevailing price level on order to increase his sales, the
competitor will fear the customers will go to other firms who has
reduced the price, so to retain the customers he has match the
rice cut. The competitor will quickly follow the reduction in price
by the oligopolist, he will gain in sales only very little, which
means the demand is inelastic below the prevailing price.
Demand from D to k which lies below the prevailing price is
inelastic as very little increase in sales can be obtained by a
reduction in price by an oligopolist.
Price increase – if an oligopolist raises his price above the
prevailing level, there will be substantial reduction in his sales.
This is because as a result rise in price many of his customers
will withdraw from him and will go to his competitor who will
welcome them and will gain in sales. These happy competitors
will have no motive to match the rise in price, so small increase
in price is followed by large reduction in sales above the
prevailing price that is why the demand curve dk tend to be
Price does not always remain sticky
The kinky oligopoly demand curve theory, dose not follow that the
price always remains the same. Whenever the costs and demand
conditions undergo changes and when it is likely to remain inflexible
in the face of changing costs and demand conditions is explained
1. Decline in costs- when the cost of production declines, the
price is more likely to remain stable. When the cost of
production falls, then the segment of demand curve above the
prevailing current price will become more elastic because with
lower costs there is a greater certainty that in increase in price
by oligopolist will not be followed by the rivals and thus will
cause greater loss in sales. On the other hand the lower
segment of the demand becomes more inelastic as there is
great certainty that reduction is price will be followed by the
Rise in price – if there is a rise in the cost, the price is not likely
to stay rigid. When there is rise in the cost of the industry an
oligopolist can reasonably expect that his increase in price will
be followed by the other in the industry. As a result, the
segment of the demand curve above the prevailing price will
become less elastic.
Decrease in demand – prices are likely to remain inflexible
and not fall when the demand decreases, it becomes more
certain that if one oligopolist decreases the price, others will
follow with the reduction, as a result the lower segment of the
demand curve which below the prevailing price becomes more
Increase in demand – when the demand increases, the price
is unlikely to remain stable instead price is likely to rise. An
oligopolist can expect that if initiates the increases in price, his
competitor will most probably follow him. Therefore, the upper
segment of the demand curve will become less elastic.