Chapter 4 : Market Structure

1-1
 Market Structure
Market : Any arrangement that enables buyers and sellers
to contact for transactions.
The term market is derived from the Latin word Marcatus
which means merchandise or trade.
Market is an area or atmosphere of potential exchange -
Phillip Kotler
Market structure identifies how a market is made up in
terms of:
The number of firms in the industry
The nature of the product produced
The degree of monopoly power each firm has
The degree to which the firm can influence price
Firms behavior pricing strategies, non-price competition, output
levels, Profit levels
The extent of barriers to entry
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 Market Structure
Market contains 2 kinds of competition :
1) Price competition - Seller competes among each
other by setting a lower price.

2) Non-price competition - Sellers compete in area like

product quality, advertising, packaging and service
other than price.

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 Market Classification

1-4
 Market Structure
There are 2 types of Market Structure:
1) Perfect Competition
2) Imperfect Competition

1)Perfect Competition and its features

Homogenous Products: The goods are sold by
different sellers as exactly alike from the consumers
regard. Consumer has no reason to express a
preference for any firm.

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 1)Perfect Competition
Free entry and exit: Firms are free to enter or leave
the market. They do not face restriction on
competing with other sellers.

Perfect Information: All the buyers and sellers know

the aspects of the market, including price, quality
and quantity of the good. Consumers and producers
have perfect knowledge about the market.

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 1)Perfect Competition
Individual sellers have no influence on the market: In a
perfectly competitive market, there are many buyers
and sellers, since all the buyers and sellers know the
aspects of the market, goods are homogenous, so no
individual seller can affect the market price, because
his output just takes up a little part of the whole market
output. Firms are price takers as they have no control
over the price they charge for their product. Each
producer supplies a very small proportion
of total industry output.

Every firm has only one goal of maximising its profits.

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 Demand Curve

https://www.youtube.com/watch?v=ZhGDce_a5eE
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 Demand Curve
The demand curve for an individual firm is different from
a market demand curve. The market demand curve slopes
downward, while the firm's demand curve is a horizontal line.
The market demand curve is a downward sloping line, reflecting
the fact that as the price of an ordinary good increases, the
quantity demanded of that good decreases.
Price is determined by the intersection of market demand and
market supply; individual firms do not have any influence on the
market price in perfect competition.
Once the market price has been determined by market supply
and demand forces, individual firms become price takers.
Individual firms are forced to charge the equilibrium price of the
market or consumers will purchase the product from the
numerous other firms in the market charging a lower price.
The demand curve for an individual firm is thus equal to the
1-9 equilibrium price of the market .
 Price Determination
The twin forces of market demand and market supply
determine price.
The level of price at which demand and supply curves
interact each other will finally prevail in the market.
The price at which quantity demanded equals quantity
supplied is called equilibrium price.
The quantity of the good bought and sold at this price is
called equilibrium price.
Thus the interaction of demand and supply curves
determines price-quantity equilibrium.
At the equilibrium price the buyers and sellers are satisfied.
https://www.youtube.com/watch?v=XIyv7_WhkGo
https://www.khanacademy.org/economics-finance-domain/microeconomics/perfect-
competition-topic/perfect-competition/v/perfect-competition
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 AR and MR Curves
AR(Average revenue) curve and MR(Marginal Revenue)
curve under perfect competition becomes equal to
D(Demand) curve and it would be a horizontal line or
parallel to the X-axis
The curve simply implies
that a firm under perfect Perfectly Elastic Demand
competition can sell Curve(AR=MR=D)
as much quantity as Price D
it likes at the given
price determined by the
industry
i.e. a perfectly 0 1 2 3 4
elastic demand curve Commodity
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 Firm Equilibrium
Firms Equilibrium means, the level of output where the
firm is maximizing its profits and therefore, has no
tendency to change its output.
In this situation either the Firm will be earning maximum
profit or incurring minimum loss i.e. it refers to the profit
maximization
In the words of Hansen, A Firm will be in equilibrium when
it is of no advantage to increase or decrease its output.
Profit of a Firm is equal to the difference between its total
revenue (TR) and the total cost (TC) i.e., (Profit=TR-TC)
and so for the equilibrium of the Firm it should be
maximum
Marginal cost should be equal to Marginal revenue
1-12 (MC=MR). And when these are equal profit is maximum
 Change in Equilibrium
Equilibrium can change when demand or supply change.
Change in Demand will have 2 possibilities
1. Demand increases It happens when income of the
buyer increases, substitutes become less available or more
expensive, number of consumers increase, information
about the product increases the desire for it, buyers have an
expectation of higher future price of the good, etc.

As the demand increases, the

demand curve moves to the right
(the purple curve), the
equilibrium price increases to P2
and the quantity increases to
Q2. Buyers buy more of the
good, but must pay a higher
1-13 price to get it.
 Change in Equilibrium
2. Demand decreases if incomes of buyers are
decreased, substitutes become less expensive or more
available, number of consumers decreases (due to
population, demographics), fashions, tastes and attitudes
make the good less popular, information about the good
(advertising) decreases desire for the good, buyers have
an expectation of lower future price for the good, etc

As the demand decreases,

demand curve moves to the left
(the purple curve), the
equilibrium price decreases to
P2 and the quantity decreases
to Q2. Buyers buy less of the
good, and pay a lower price to
1-14 get it.
 Change in Equilibrium
Change in Supply will also have 2 possibilities

1. Supply can increase (moving the supply curve

to the right) if costs are lower due to lower
resource prices, new technology for producing is
used, larger number of sellers, favorable
environment for producing or selling, lower
taxes, etc.
When supply increases for one of these
reasons, it will move the equilibrium, and thus
decrease the price and increase the quantity
traded of the good
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 Change in Equilibrium
The original equilibrium
occurs at the price of P1
and quantity of Q1.
As the supply curve
moves (to the purple
curve), the equilibrium
price decreases to P2
and the quantity
increases to Q2.
Sellers sell more of the
good, but get paid a
lower price to sell it.

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 Change in Equilibrium
2. Supply can decrease (moving the supply
curve to the left) if costs are higher due to
higher resource prices, smaller number of
sellers, unfavorable environment for
producing or selling, higher taxes, etc.
When supply decreases for one of these
reasons, it will move the equilibrium, and
thus increase the price and decrease the
quantity traded of the good

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 Change in Equilibrium

The original equilibrium

occurs at the price of
P1 and quantity of Q1.
As the supply curve
moves (to the purple
curve), the equilibrium
price increases to P2
and the quantity
decreases to Q2.
Sellers sell less of the
good, but get paid a
higher price to sell it.

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 Summary

Effect on Quantity
Event Effect on Price
bought and sold
Demand
Price Increases Quantity Increases
Increases

Demand
Price Decreases Quantity Decreases
Decreases

Supply
Price Decreases Quantity Increases
Increases
Supply
Price Increases Quantity Decreases
Decreases

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 What if more than
one thing is
changing?

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 The other possibilities
Effect on Quantity
Event Effect on Price
bought and sold
Price Decreases or
Demand Increases Price Increases or
while Price stays the same Quantity Increases
Supply Increases (depends on which
changes the most)
Quantity Decreases or
Demand Increases
Quantity Increases or
while Price Increases
Quantity stays the same
Supply Decreases
(depends on which changes the most)
Quantity Decreases or
Demand Decreases
Quantity Increases or
while Price Decreases
Quantity stays the same
Supply Increases
(depends on which changes the most)
Price Decreases or
Demand Decreases Price Increases or
while Price stays the same Quantity Decreases
Supply Decreases (depends on which
1-21 changes the most)
 Equilibrium position of a firm
In order to attain equilibrium, a firm has to satisfy 2 conditions:
MR= MC since profits are maximum at this point.
MC curve should cut MR curve from below i.e. MC should have a
positive slope.
MC curve in the figure cuts MR at two place i.e. T and R. At T,
it is cutting MR from above and its not the equilibrium point as
it doesnt satisfy 2nd condition. At R, MC is cutting MR curve
from below. Hence R is the point of equilibrium.

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 Can a competitive firm earn profit?
In a short run, a firm can attain equilibrium and earn
supernormal profits, normal profits or losses depending
upon the cost conditions.
Normal profit is defined as the minimum reward that is just
sufficient to keep the entrepreneur supplying their
enterprise. In other words, the reward is just covering
opportunity cost - that is, just better than the next best
alternative. This exists when total revenue TR, equals
total cost TC.
If a firm makes more than normal profit it is called super-
normal profit. Supernormal profit is also called economic
profit, and abnormal profit, and is earned when total revenue
is greater than the total costs.

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 Short run equilibrium: Supernormal profits
Suppose the cost of producing 1000 units of a product by a firm is Rs
15000. The entrepreneur has invested Rs 50000 in the business and
normal rate of return in the market is 10%. Thus the entrepreneur must
earn at least Rs 5000. Total cost of production is Rs15000+Rs5000=Rs
20000. If the firm is selling the product at Rs 20, it is earning normal
profits because AR (Rs 20)=ATC (Rs 20). If the firm is selling at Rs 22,
its AR (Rs 22) > ATC (Rs 20) and it is earning supernormal profit at rate
of Rs 2 per unit.

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 Short run equilibrium : normal profits
When a business just meets its ATC, it earns
normal profits. Here AR = ATC. MR=MC at E. the
equilibrium output is OQ. Since AR=ATC or
OP=EQ, the firm is earning just normal profits.

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 Long run equilibrium
Long run equilibrium of the firm :
In the long run, the firms are in equilibrium when they
have adjusted their plant so as to produce at the
minimum point of their long run AC curve. In the long
run, the firms will be earning only normal profits.
If they are making super normal profits in the short run,
new firms will be attracted in the industry which will lead
to a fall in price and an upward shift of the cost curves
due to increase in the prices of the factors as the
industry expands.
If the firm makes losses in the short term, they will leave
the industry in the long run. This will raise the price and
costs may fall as the industry contracts.
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 Long run equilibrium
Long run equilibrium of the industry:
A perfectly competitive industry is in long run equilibrium
when:
1. all the firms are earning normal profits only i.e. all the
firms are in equilibrium
2. There is no further entry or exit from the market.
The following conditions are associated with the long run
equilibrium of the industry:
1. The output is produced at the minimum feasible cost.
2. Consumers pay the minimum possible price which just
covers the Marginal cost i.e. MC=AC
3. Firms earn only normal profits i.e. AC=AR
4. Firms maximise profits(i.e. MC=MR) but the level of
1-27 profits will be just normal.
 Closing Thoughts
It should be remembered that
the perfectly competitive market
is a myth.
This is because the assumptions
on which this system is based
are never found in the real
market conditions.

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 Imperfect
Competition

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 Monopoly
The word monopoly is derived from two Greek words-Mono
and Poly. Mono means single and Poly means 'seller.
Monopoly is a situation in which there is a single seller of a
product which has no close substitute.
Under monopoly there is no rival or competitors. The
degree of competition in monopoly is nil. Thus if the buyers
is to purchase the commodity, he can purchase it only from
that seller.
The seller dictates the price to consumers. Unlike perfect
competition a monopolist can fix up the price.
As monopoly is a form of imperfect market organization,
there is no difference between firm and industry. A
monopoly firm is said to be an industry.
1-30 Eg: Railways, electricity
 Monopoly
Features:
Single seller of the product In a monopoly market,
there is only one firm producing and selling a
product. This single firm constitutes the industry as
there is no distinction between firm and industry.
Restrictions to entry There are strong barriers to
entry to this market. It could be economic,
institutional or legal. Entry is almost blocked.
No close substitutes This market sells a product
which has no close substitute.
The products sold in a monopoly market may be
homogenous or heterogeneous.
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 Monopoly
Information of the market is imperfect: No perfect
information in the market. Neither the sellers nor
buyers know all aspects of the market.

The monopolist is a price searcher: A monopolist

faces the entire market demand. He needs to find
out the price that he can earn the most and sell most
of its product.

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 Price Discrimination in monopoly
The monopolist may use his monopolistic power in any manner in
order to realize maximum revenue. He may also adopt price
discrimination.
One of the important feature of monopoly is price discrimination i.e.
charging different prices for same product from different consumers.
Price discrimination is a method of pricing adopted by the
monopolist in order to earn abnormal profits.
Eg : The family doctor in your neighborhood charges a higher fees
from a rich patient compared to the fees charged from a poor patient
even though both are suffering from viral fever. Electricity
companies sell electricity at cheaper rates for home consumption in
rural areas than for industrial use.
Price Discrimination cannot persist under perfect competition
because the seller has no influence over market determined rate.
Price Discrimination requires an element of monopoly so that the
seller can influence the price of his product.
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 Price Discrimination in monopoly
Conditions for price discrimination:
The seller should have some control over the supply of his product i.e.
monopoly power in some form is necessary to discriminate price.
The seller should be able to divide his market into 2 or more sub
markets.
It should not be possible for the buyers of low priced market to resell
the product to the buyers of high-priced market.
The price elasticity of the product should be different in different sub
markets. The monopolist fixes a high price for his product for those
buyers whose price elasticity of demand for the product is less than
one. This means that if monopolist charges high price from them, they
do not significantly reduce their purchases in response to high price.

A monopolist charges higher price in a market which has a relatively

inelastic demand. The market which is highly responsive to price
changes is charged less. On the whole, the monopolist benefits from
1-34 such a discrimination.
 Objectives of Price discrimination
To earn maximum profit
To dispose off surplus stock
To enjoy economies of scale
To capture foreign markets
To secure equity through pricing

Price discrimination is carried out to capture consumer

surplus that is enjoyed by consumers. Consumer surplus is
the difference between the total amount that consumers are
willing and able to pay for a good or service and the total
amount that they actually do pay (i.e. the market price).
Professor Pigou classified 3 degrees of price discrimination.

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 Degrees of Monopoly
First degree Price Discrimination Under the first degree
price discrimination, the monopolist will fix a price which will
take away the entire consumers surplus i.e. their maximum
willingness to pay. It is also known as perfect price
discrimination. Eg: Auctions
Second Degree Price Discrimination - Under the second
degree price discrimination, he will take away only a part of
the consumers surplus. Here price varies according to the
quantity sold. Larger quantities are available at lower unit
price.
Third Degree Price Discrimination - Under third degree price
discrimination, the price varies by attributes such as location
or by consumer segment. Here the monopolist, will divide the
consumers into separate sub markets and charge different
prices in different sub- markets. Eg: Dumping, Bus passes
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 Price and Output determination
The aim of a monopolist is to maximize his profits. For that, he
has 2 choice:
1. He can fix the price for his good and leave the market to decide
what output will be required.
2. Or he can fix the output and leave the price to be determined by
the interaction of supply and demand.
In other words, he can either fix the price or the output. If the
demand for the commodity is elastic, the monopolist cannot fix a
very high price because a rise in price may result in a fall of
demand. So he cannot sell much and he may not get large
profits. In such a case, the monopolist will fix a low price.
If the commodity has inelastic demand, the monopolist may fix a
high price. Even if the price is high, there will not be a fall in
demand. Then the monopolist will get maximum profits by fixing
a high price.
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 Demand Curve of monopoly
Since the monopolist firm is assumed to be the only producer of a
particular product, its demand curve is identical with the market
demand curve for the product.
The demand curve is downward sloping because of law of demand.

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 Demand Curve of monopoly
The seller cant sell anything if he charges Rs10. If he wishes to sell 10 units, he needs
to sell it at Rs 5.
In perfect competition, AR and MR are identical, but this isnt true in monopoly as the
monopolist can increase the sales by decreasing the price of the product.
Hence MR is less than the price, because firm has to lower the price to sell an extra unit.
The relationship between AR and MR of a monopoly firm can be stated as follows:
1. AR and MR are both negatively sloped.
2. MR curve lies half way between AR curve and Y.
3. AR can not be zero but MR can be zero or negative.

1-39
 Difference Between a Monopolist
and a Perfect Competitor
A monopolistic firms marginal revenue is not its
price. Marginal revenue is always below its price.
Marginal revenue changes as output changes and
is not equal to the price
A monopolistic firms output decision can affect
price.
There is no competition in monopolistic markets so
monopolists see to it that monopolists, not
consumers, benefit.

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 Equilibrium of the monopoly firm
Firms in a perfectly competitive market are price
takers so they are only concerned about
determination of output. But this isnt a case with a
monopolist. A monopolist not only has to determine
his output but also the price of his product.
Since he faces downward sloping demand curve, if
he raises the price of his product, his sales will go
down. On the other hand, if he wants to improve his
sales volume, he will have to be content with lower
price.
He will try to reach the level of output at which the
profits are maximum i.e. he will try to attain the
equilibrium level of output.
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 Short run equilibrium
Conditions for equilibrium: The twin conditions for
equilibrium in a monopoly market are:
i) MC=MR and ii) MC Curve must cut MR curve from below
The figure shows that MC curve cuts MR curve at E. That
means at E, the equilibrium price is OP and equilibrium
output is OQ.
https://www.youtube.com/watch?v=s49P6yN-_pk

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 Short run equilibrium
In order to know whether the monopolist is making profits or losses in
the short run, we need to introduce the ATC curve.
MC cuts MR at E to give equilibrium output as OQ. At OQ, price charged
is OP ( we find it by extending line EQ till it touches AR/demand curve).
Also, at OQ, the cost per unit is BQ. Therefore, profit per unit is AB and
total profit is ABCP.

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 Can a monopolist incur losses?
One of the misconceptions about a
monopolist is that it always makes profit.
It is to be noted that nothing guarantees that
a monopolist makes profit.
It all depends on his demand and cost
conditions.
If he faces very low demand for his product
and his cost conditions are such that
ATC>AR, he will not be making profits,
rather he will incur losses.
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 Long run equilibrium
Long run is a period long enough to allow the
monopolist to adjust his plant size or use his
existing plant at any level that maximises his
profit.
In the absence of competition, the monopolist
need not produce at optimal level.
The monopolist will not continue if he makes
losses in the long run.
He can make super normal profits in the long
run as the entry of outside firms are blocked.

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 Monopolistic Competition
Monopolistic competition is another type of
imperfect competition other than monopoly
Monopolistic Competition refers to a market
situation in which there are large numbers of
firms which sell closely related but differentiated
products. Markets of products like soap,
toothpaste AC, etc. are examples of monopolistic
competition.
Monopoly + Competition = Monopolistic
Competition

1-46
 Features of Monopolistic market
Features of both perfect competition and monopoly are
present.
Similar features to perfect competition
1. A large no. of sellers and buyers In a monopolistic
market, there are large number of sellers who individually
have a small share in the market. Eg: Hundreds of hair
salons and boutiques in Surat.
2. Free entry and exit :New firms have to compete with
existing firms for business. Entry and exit is not restricted.

Different features from perfect competition

3. Imperfect information of the market: Neither the sellers nor
buyers know all aspect of the market.
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 Features of Monopolistic market
4. The goods sold are heterogeneous: The product
sold by different sellers are different. The
differentiation may rise from differences in quality,
package design, advertisements, etc. Product
differentiation gives rise to an element of monopoly to
the producer over the competing product. The
producer of a brand can raise the price of his product
knowing that he will not lose all the customers to
other brands because of lack of perfect
substitutability.

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 Features of Monopolistic market
5. Non price competition: In addition to price
competition, non-price competition also exists under
monopolistic competition. Non-Price Competition refers
to competing with other firms by offering free gifts,
making favorable credit terms, etc without changing
prices of their own products. Firms under monopolistic
competition compete in a number of ways to attract
customers.
6. Pricing Decision: A firm under monopolistic
competition is neither a price- taker nor a price-maker.
However, by producing a unique product or establishing
a particular reputation, each firm has partial control over
the price. The extent of power to control price depends
upon how strongly the buyers are attached to his brand.
1-49
 Example of Monopolistic Competition: Toothpaste
Market:
When you walk into a departmental store to buy
toothpaste, you will find a number of brands, like
Pepsodent, Colgate, Neem, Babool, etc.
i. On one hand, the market for toothpaste seems to be full
of competition, with thousands of competing brands and
freedom of entry.
ii. On the other hand, its market seems to be monopolistic,
due to uniqueness of each toothpaste and power to charge
different price.
Such a market for toothpaste is a monopolistic competitive
market.
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 Demand Curve in Monopolistic market
Under monopolistic competition, large number of firms
selling closely related but differentiated products makes the
demand curve downward sloping. It implies that a firm can
sell more output only by reducing the price of its product.
At OP price, a seller can sell OQ
quantity. Demand rises to OQ1,
when price is reduced to OP1. So,
demand curve under monopolistic
competition is negatively sloped as
more quantity can be sold only at a
lower price. As a result, revenue
generated from every additional unit
is less than price of the product.
Hence MR < AR just like it is in
monopoly.
1-51
 Demand Curve: Monopolistic
Competition Vs. Monopoly:
The demand curve of monopolistic competition
looks exactly like the demand curve under
monopoly as both faces downward sloping
demand curves.
However, demand curve under monopolistic
competition is more elastic as compared to
demand curve under monopoly.
This happens because differentiated products
under monopolistic competition have close
substitutes, whereas there are no close
substitutes in case of monopoly.

1-52
 Price and output determination
In a monopolistically competitive market, each firm is a price maker
since the product is differentiated.
The 2 conditions of price and output determination and equilibrium of a
firm are MC = MR and MC curve should cut MR curve from below.
At E, the equilibrium price is OP and the equilibrium output is OM. Per
unit cost is SM, per unit super normal profit is QS and the total
supernormal profit is PQSR.

1-53
 Price and output determination
Monopolistic firms may also incur losses in short term.
Per unit cost HN is higher than OT/KN and the loss per unit
in KH. The total loss is GHKT.

1-54
 Price and output determination
Long run equilibrium :
If the firms in the industry earn super normal
profits in the short run, there will be an incentive
for new firms to enter the industry.
As more firms enter, profits per firm will go on
decreasing as the total demand for the product will
be shared among large number of firms.
This will happen till all the profits are wiped away
and all the firms earn only normal profits. Thus in
the long run all the firms will earn only normal
profits.
1-55
 Oligopoly
Oligopoly is described as competition among the few.
An oligopoly is a market structure in which a few firms
dominate. When a market is shared between a few firms, it is
said to be highly concentrated. Although only a few firms
dominate, it is possible that many small firms may also operate
in the market.
For example, major airlines like British Airways and Air
France operate their routes with only a few close competitors,
but there are also many small airlines catering for the
holidaymaker or offering specialist services.
An oligopoly is similar to a monopoly, except that rather than
one firm, two or more firms dominate the market. There is no
precise upper limit to the number of firms in an oligopoly, but
the number must be low enough that the actions of one firm
significantly impact and influence the others.
1-56
 Features of Oligopoly
1. Interdependence: The most important feature of
oligopoly is the interdependence in decision making of the
few firms which comprise the industry. This is because
when the number of competitors is few, any change in
price, output, product etc. by a firm will have a direct effect
on the fortune of its rivals, which will then retaliate in
changing their own prices, output or products as the case
may be. It is, therefore, clear that the oligopolistic firm must
consider not only the market demand for the industrys
product but also the reactions of the other firms in the
industry to any action or decision it may take.
Oligopolies tend to compete on terms other than price.
Loyalty schemes, advertisement, and product differentiation
are all examples of non-price competition.
1-57
 Features of Oligopoly
2. Group Behavior: Oligopoly market is about group
behavior not of mass or individual behavior. There are few
firms in a group which are very much interdependent.
Each oligopolist closely watches the business behavior of
other oligopolists in the industry and designs his moves
on the basis of how they behave or likely to behave.
3. Barriers to entry: The main reason for few firms under
oligopoly is the barriers, which prevent entry of new firms
into the industry. Patents, requirement of large capital,
control over crucial raw materials, etc are some of the
reasons which prevent new firms from entering into
industry. Only those firms enter into the industry which are
able to cross these barriers.

1-58
 Features of Oligopoly
4. Importance of advertising and selling costs: In an oligopoly
market, firms have to employ various aggressive and defensive
marketing weapons to gain a greater share in the market or to
prevent a fall in their market share. For this various firms have to
incur a good deal of costs on advertising and on other measures of
sales promotion.
Under perfect competition, advertising by an individual firm is
unnecessary. A monopolist may perhaps advertise when he has to
inform the public about his introduction of a new model of his
product or he may advertise in order to attract potential consumers
who have not yet tried his product. Under monopolistic competition
advertising plays an important role because of the product
differentiation that exists under it, but not as much important as
under oligopoly.
Under oligopoly, advertising can become a life-and-death matter
where a firm which fails to keep up with the advertising budget of its
1-59 competitors may find its customers drifting off to rival products.
 Types of Oligopoly
1. Pure or Perfect Oligopoly: If the firms produce homogeneous
products, then it is called pure or perfect oligopoly. Though, it is
rare to find pure oligopoly situation, yet, cement, steel, aluminum
and chemicals producing industries approach pure oligopoly.
2. Imperfect or Differentiated Oligopoly: If the firms produce
differentiated products, then it is called differentiated or imperfect
oligopoly. For example, cigarettes or soft drinks. The goods
produced by different firms have their own distinguishing
characteristics, yet all of them are close substitutes of each other.
3. Open Vs Closed Oligopoly: This classification is made on the
basis of freedom to enter into the new industry. An open
Oligopoly is the market situation wherein firm can enter into the
industry any time it wants, whereas, in the case of a closed
Oligopoly, there are certain restrictions that act as a barrier for a
new firm to enter into the industry.
1-60
 Types of Oligopoly
4. Partial Vs Full Oligopoly: This classification is done on
the basis of price leadership. The partial Oligopoly refers to
the market situation, wherein one large firm dominates the
market and is looked upon as a price leader. Whereas in full
Oligopoly, the price leadership is conspicuous by its
absence.
5. Collusive Vs Non-Collusive Oligopoly: This
classification is made on the basis of agreement or
understanding between the firms. In Collusive Oligopoly,
instead of competing with each other, the firms come
together and with the consensus of all fixes the price and
the outputs. Eg: OPEC. Whereas in the case of a non-
collusive Oligopoly, there is a lack of understanding among
the firms and they compete against each other to achieve
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 Collusive oligopoly
Collusion refers to the agreement between few firms of an
industry. It may either be formal or tacit agreement. If it is a
tacit one the firms follow a secret agreement. Here there is
no direct conduct among firms. But in a formal agreement all
conditions and conducts are open. So, they take decisions
jointly by a direct discussion or meeting.

Why Collusion?: Few firms in an Oligopoly industry collude

on the basis of certain agreements. So, they may have the
following purposes.
a) Reduce the competition between themselves and
increase profits.
b) To create a collective or group monopoly and thereby
create a barrier for new firms which want to enter to the
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 Pricing under perfect collusion
There are two types of collusion in a oligopoly market.
1. Cartel : A oligopoly industry can be said to be cartel when
all the individual firms are running on the basis of the
agreements. So, each firm can earn monopoly profits by
cooperating with other firms in the agreement. It may be
either international or domestic cartel. Oil and Petroleum
Exporting Countries (OPEC) is an example for international
cartel.
2. Price Leadership: Price leadership is another form of
collusion of Oligopoly firms. One firm assumes the role of a
price leader and fixes the price of the product on the entire
industry. All the firms in the Oligopoly industry will follow the
rules fixed by the leader. Here there is no possibility of
competition between leader and individual firms.
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 Price Leadership
Generally three types of price leadership can be seen-
i) low cost price leadership - It can be seen in an industry where
each firm produces homogenous products with various costs. So, it
is easier to sell large quantity for the firm who produce with low
cost. So, other firms may suffer losses.
ii) Dominant price leadership - In some market, we can see that,
a few firms are producing large amount of commodity and by
getting huge market share. So, they will fix their own prices and
related things. Here any small firm cannot influence to fix the price.
So, all the firms will follow the price which fixed by the dominant
firm in the industry.
iii) Barometric price leadership - Here a firm acts as a leader of
others. The leader considered as the large or most experienced or
an old firm. Such firm has enough knowledge about market. So, all
other firms follow his actions in price. It may be a low cost firm or a
1-64 dominant firm.
 Demand Curve of oligopoly
The demand curve dD has a kink at a point P. Upper portion from point P is
more elastic because it is made on the assumption that when one firm changes
its price, others will keep their price constant. Firm loses market share.
Lower portion from point P is less elastic because it is made on the assumption
that all the firm will change their price. Hence there will be little increase in the
sale of the firms. Little gain in market share.
When an oligopolistic firm changes its price, its rival firms will retaliate/react
and change their prices which in turn effects the demand of the former firm.
Therefore an oligopolistic firm can not 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.

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 A quick comparison

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 Summary

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