Non-Competitive Markets

Simple Monopoly In The Commodity Market

In stark contrast to perfect competition, a Monopoly is a market structure characterized by a single seller producing a product that has no close substitutes. This sole firm constitutes the entire industry. The existence of a monopoly is predicated on the presence of strong barriers to entry, which prevent other firms from entering the market and competing.

These barriers can arise from several sources:

• Legal Barriers: Patents, copyrights, and government licenses (e.g., the exclusive right granted to Indian Railways (IRCTC) for rail transport in India).
• Control over Key Resources: A firm may own or control a crucial raw material necessary for production.
• Natural Monopoly: A situation where the economies of scale are so large that a single firm can supply the entire market at a lower average cost than two or more firms. (e.g., electricity distribution).

Since the monopolist is the only producer, it is a price maker, not a price taker. It can influence the market price by changing the quantity of output it supplies.

Market Demand Curve Is The Average Revenue Curve

Under monopoly, the firm is the industry. Therefore, the monopolist faces the entire market demand curve. To sell more of its product, the monopolist must lower the price. This means the demand curve faced by a monopolist is downward sloping.

As we know, Average Revenue (AR) is the revenue per unit, which is simply the price of the product ($AR = TR/q = (P \times q)/q = P$). Since the demand curve shows the relationship between price (P) and quantity (q), and AR is always equal to P, the market demand curve is also the monopolist's Average Revenue (AR) curve.

Total, Average And Marginal Revenues

The revenue concepts for a monopolist differ significantly from those under perfect competition because the price is not constant.

• Total Revenue (TR): $TR = P \times q$. Since the monopolist must lower the price to sell more, the TR curve first rises, reaches a maximum, and then starts to fall.
• Average Revenue (AR): $AR = P$. The AR curve is the downward-sloping demand curve.
• Marginal Revenue (MR): It is the change in TR from selling one more unit. Because the price must be lowered on all units to sell an additional unit, the marginal revenue is always less than the price (or AR). The MR curve lies below the AR curve and is steeper.

Marginal Revenue And Price Elasticity Of Demand

There is a precise mathematical relationship between MR, AR (Price), and the price elasticity of demand ($e_d$).

Derivation:

$ MR = \frac{\Delta TR}{\Delta q} = \frac{\Delta(P \cdot q)}{\Delta q} = P \frac{\Delta q}{\Delta q} + q \frac{\Delta P}{\Delta q} = P + q \frac{\Delta P}{\Delta q} $

$ MR = P \left( 1 + \frac{q}{P} \frac{\Delta P}{\Delta q} \right) $

We know that $ e_d = (-) \frac{\Delta q}{\Delta P} \cdot \frac{P}{q} $. Therefore, $ \frac{1}{e_d} = (-) \frac{\Delta P}{\Delta q} \cdot \frac{q}{P} $. Substituting this in the MR equation:

$ MR = P \left( 1 - \frac{1}{e_d} \right) $ or $ MR = AR \left( 1 - \frac{1}{e_d} \right) $

This relationship implies:

• When demand is elastic ($e_d > 1$), MR is positive.
• When demand is unit elastic ($e_d = 1$), MR is zero (and TR is maximum).
• When demand is inelastic ($e_d < 1$), MR is negative.

A profit-maximising monopolist will always choose to operate on the elastic portion of the demand curve, where MR is positive.

Short Run Equilibrium Of The Monopoly Firm

The monopolist maximises profit by producing the level of output where Marginal Revenue equals Marginal Cost (MR = MC) and the MC curve cuts the MR curve from below. The price is then determined by extending a vertical line from this equilibrium quantity up to the demand (AR) curve.

In the short run, a monopolist can be in one of three situations:

1. Supernormal Profit: If Price (AR) > Average Cost (AC) at the equilibrium output.
2. Normal Profit: If Price (AR) = Average Cost (AC).
3. Loss: If Price (AR) < Average Cost (AC). The firm will continue to produce as long as P ≥ AVC.

In The Long Run

In the long run, due to strong barriers to entry, new firms cannot enter the market to compete away profits. Therefore, a monopolist can continue to earn supernormal profits even in the long run, unlike a firm in perfect competition. The monopolist will adjust its plant size to the optimal scale to produce the profit-maximising output.

Other Non-Perfectly Competitive Markets

Between the two extremes of perfect competition and monopoly lie two other important market structures: Monopolistic Competition and Oligopoly.

Monopolistic Competition

This market structure, first described by Edward Chamberlin, has elements of both monopoly and perfect competition. It is the most common market structure for many consumer goods.

Defining Features:

1. Large Number of Buyers and Sellers: Similar to perfect competition, there are many firms and buyers.
2. Product Differentiation: This is the key feature. Firms produce products that are similar but not identical. They are close substitutes. Differentiation can be based on branding (e.g., Nike vs. Adidas shoes), packaging, design, or service.
3. Freedom of Entry and Exit: Similar to perfect competition, there are no significant barriers to entry or exit.
4. Selling Costs: Because products are differentiated, firms engage in advertising and other sales promotion activities (selling costs) to attract customers.

Firm's Behaviour and Equilibrium:

• Because of product differentiation, each firm has a mini-monopoly over its own brand. This gives it a downward-sloping demand (AR) curve, which is highly elastic due to the availability of close substitutes.
• Short-Run: The equilibrium is identical to a monopoly. A firm produces where MR=MC and can earn supernormal profits, normal profits, or incur losses.
• Long-Run: If firms are earning supernormal profits, new firms will be attracted to the market (due to free entry). This will shift the demand curve of existing firms to the left until it becomes tangent to the Long-Run Average Cost (LRAC) curve. In the long-run equilibrium, firms earn only normal profit (P = LRAC).

A key outcome is excess capacity. The firm produces at a point to the left of the minimum of the LRAC curve, meaning it is not producing at the most efficient scale.

How Do Firms Behave In Oligopoly?

Oligopoly is a market structure dominated by a few large firms. The products can be either homogeneous (e.g., steel, cement) or differentiated (e.g., automobiles, soft drinks).

Defining Features:

1. Few Firms: The market is controlled by a small number of large sellers.
2. Interdependence: This is the most crucial feature. Each firm's decisions regarding price, output, or advertising have a significant impact on its rivals, and each firm must consider the potential reactions of its rivals when making its own decisions.
3. Barriers to Entry: Entry is difficult due to factors like economies of scale, patents, and control over resources.
4. Non-Price Competition: Firms often avoid price competition (which can lead to destructive price wars) and compete through advertising, branding, and after-sales service.

Oligopolistic Behaviour:

The strategic interdependence of firms makes it difficult to have a single, determinate model of oligopoly. Firms can either compete or cooperate.

• Collusive Oligopoly (Cooperation): Firms may decide to collude to avoid uncertainty and competition. They can enter into a formal agreement to fix prices and output, effectively acting as a single monopoly. This is called a cartel. The most famous example is the Organization of the Petroleum Exporting Countries (OPEC). Cartels are illegal in most countries, including India (under the Competition Act, 2002).
• Non-Collusive Oligopoly (Competition): If firms decide to compete, they must strategise about their rivals' moves. This leads to phenomena like price rigidity, where firms are reluctant to change prices even when costs change, fearing that if they raise prices, rivals won't follow, but if they cut prices, rivals will match the cut, leading to a price war.

Key Concepts

• Monopoly: A market with a single seller and no close substitutes. The firm is a price maker.
• Barriers to Entry: Obstacles that prevent new firms from entering a market.
• Price Maker: A firm with the power to influence the price of its product.
• Monopolistic Competition: A market with many sellers, product differentiation, and free entry.
• Product Differentiation: The process of distinguishing a product or service from others to make it more attractive to a particular target market.
• Selling Costs: Costs incurred on advertising and sales promotion.
• Excess Capacity: A situation in monopolistic competition where a firm produces at an output level that is less than the socially optimal, cost-minimising output.
• Oligopoly: A market dominated by a few large, interdependent firms.
• Interdependence: The key feature of oligopoly where the decisions of one firm significantly impact the others.
• Cartel: A formal agreement among competing firms to collude on price and output.

Summary

This chapter explored market structures that deviate from the ideal of perfect competition. In a Monopoly, a single firm controls the entire market due to high barriers to entry. As a price maker, it faces the downward-sloping market demand curve, with its marginal revenue curve lying below the average revenue curve. The monopolist maximises profit by producing where MR = MC, and can sustain supernormal profits in the long run.

Monopolistic Competition blends features of both monopoly and perfect competition. Firms gain market power through product differentiation but face competition from numerous rivals. In the long run, free entry ensures that firms only earn normal profits, but they operate with excess capacity, meaning they do not produce at the minimum average cost.

Oligopoly is a market of a few large firms, where the defining characteristic is strategic interdependence. The behaviour of firms can range from intense competition to formal collusion in the form of cartels. These non-competitive market structures generally result in higher prices, lower output, and less efficiency compared to the benchmark of perfect competition.