UNIT 10 THEORY OF MONOPOLISTIC COMPETITION

Structure
10.0 Objectives
1 0.1 Introduction

10.2 Meaning of Monopolistic Competition

1 0.3 Product Differentiation

10.4 Price and Output Decisions of mono pol is tic all^ C'om~~etit~i
e 1 11.1ii\
10.4.1 Demand Curve of Monopolistically Cornpctit~~c
I Irm\
10.4.2 Short-rum Equilibrium ofa Monopolistic C'onlpctit~~e
I irm
10.4.3 Long-rum Equilibrium ofa Monopolist~cCompetit~~c
I II m
10.5 Cornpasison of Monopolistic Competition with Perfkc1 C'ompctit~on
10.6 Economic Effects of Monopolistic Competition

10.7 Policy Variables fora Monopolistically Conipetiti\e Fimi

10.7.1 Selling Cost as a Policy Variable
10.8 Summa~yof Monopolistic Competition
1 0.9 Oligopoly

10.10 Let Us Sum Up

1 0.1 1 Sonie Usefill Books

10.12Ans\vcr/Hints to Check Your Progress Exercises

10.0 OBJECTIVES
1 his iuiit aims at acquainting you with two market fol~ns.which lie between the polar
cases of perfect cornpetition and monopoly. The cases we intend to deal with are:
one where a large iii~liiberof firms exist. aiid another where there are only a few
timis. After stildyiiig this unit, you should be able to:
7

define lnollopolistic competition:

explain tlie concept of product differentiation:
describe the main decision variables of monopolistic competition:
compare monopolistic competition \villi perfi-ct competition;
analyst: tlie economic effects of nioiiopolistic competition; and
define oligopoly and distinguish it fi-om ~iionopolisticcompetition proper

10.1 INTRODUCTION
In earlier units (Units 8 and 9). wc discussed the pricing and ou1p111decisions under
~tvoimportant niarket structures -perfect competition and monopoly. Both these
are estreme forms in the sense that tliey are somewhat far froiii reality. 'l'lie conditiola

of perfect competition such as large number of producers producing homogenous

products having perfect knowledge of the inarltet are seldom fulfilled in the real
world. Sin~ilarly,monopoly. or a single producer producing a commodity, which
does not have close substitute is also rarely found. The intermediate situation described
as imperfect or moilopolistic competition is inor'e prevalent in a modem economy.
Imperfect competition includes all forms of market structure other than perfect
cornpetition and monopoly.
In today's world. generally. a fir111is neither a price maker in the sense that it has full
control n\er the price and need not worry a b o ~co~npetitor
~t
nor a price taker, in the
sense of no control over the price. The theory of n~onopolisticcompetition combines
the elements of periect competition and pure monopoly to reflect a realistic market
structure.As uill be explai~wdbelow, film operating under monopolistic competition
enjoys some degree of~ilnnopoly.But it faces intense colnpetitionfrom other firms
producing prodi~ctsthat are close substitutes.
The monopolistic conlpetition recognises the fact that lnany policy options such as
changing expenditure on adve~tisementand sales pronlotion are available to firms.
This market structure not only explains pricing and output decisions ofa fir111but
also takes into account other important business policy variables such as advertising
and sales promotion. product development and quality variation ol'the prodi~cts.
Imperfect competition covers a wide range of market structures. which may be
broadly divided into:
i)

Oligopoly. or co~npetitionamong few. and

ii)

Competition among many sellers, or the 'large group' case, popularly known
as nlo~lopolisticcompetition.

In case of oligopoly, there are few firnls producing a product. The most significant
feature of oligopoly is the interdependence anlong different firms in respect of the
price and other policy decisions. In other words, demand for the product of one
ti1111 depends not only on its price but also on tlie prices charged by other competing
iinns. Any change in tlie policy of one fin11 affects tlie rival firms significantly and
they react. Without maliing some assumptions regarding the beliaviour or reaction
of the ribals. it is not possible to predict the impact of change in the price or other
variables on the demand for the product oi'the ti^-111. As different types of behaviour
can be expected among oligopolists, there cannot be
or reactions by different ti]-INS
just a single nlodel of oligopoly.
But tlie type of interdependence seen is absent in the case ol' 'large group' or
inollopolisticcompetition. In such kind of a marltet str~~cture,
there are a large number
of producers, change in the price or other policy variables do not affect rival firms
significantly. Thus. they do not react. Consecluently. the policy decisioils of fil~ns
such as deter~ninationoi'price and output can be treated as independent of one
t
ly deals with this type of "large groap" case.
another. This ~ u i iprimari

10.2 MEANING OF MONOPOLISTIC

COMPETITION
Monopolistic competition rel'ers to a market structure in which there are many iirins
selling closely related, similar but not identical products. l'he main assumptions of
mol~opolisticcolnpetition are the same as those of pure competition (see Unit 8)
except the liomogei~ousproduct. These are listed below:

i)

Large Number of Sellers and Buyers: In this market, there are large number
of producers and buyers. The number of producers is large enough to allow
individual producer taking policy decisions regarding pricing, output and other
variables, independent of others, without fear of any reaction. 111other words,
action of one producer does not affect others significantly. As a result they do
not react. This requirement is similar to that of the perfect competition.

ii) Differentiated Products that are Close Substitutes: The producers under
n~onopolisticcompetition produce differentiated products. But the product
offered by each producer is a close substitute of another. By product
differentiation we mean that consumers have their own rankings or preferences
for the products produced by different firms based on physical attributes of
products or on her own perception about products. This point is discussed in
more detail later in this unit (see Section 10.3).
iii) Free Entry and Exit from the Market: There is freedom for potential sellers
to join the market. Similarly, there are no restrictions on the existing Iinns to
leave the market.
iv) Perfect Knowledge of the Market: The firm is assumed to behave as if it
knew its deina~ldand cost curves with certainty.
v) Uniform Cost and Demand Conditions for all the Firms: This characteristic
is due to Chamberlain who assumed that both demand and cost curves for all
'products' are unifo~mthroughout the group. The in~plicationof this assumption
is (a) that consumers' preferences are evenly distributed among diff'crcnt sellers.
and (b) that the differences between the products do not give rise to dil'i'crcnccs
in costs.

10.3 PRODUCT DIFFERENTIATION

In comparison to perfect competition, monopolistic competition is charnctcriscd by
heterogeneity of products. Thus. consunlers have definite preferences Sol the
particular variety or brand of products offered for sale by sellers. The products are
said to be differentiated, if consumers distinguish the product of one producer from
that of another while making their purchases. For example, consumers have
preferences for a particular brand of toothpaste. They are willing to pay somewhat
higher piice for their preferred brand. In other words, the products of different films
under non no pol is tic conlpetition are treated by consumers as different comn~odities.
This particular characteristic lends a type of 'monopoly power' to the firnls.
1'1.oduct differentiation can be 'real' in the sense that the inherent characteristics of
the products are different. For example, ruaterials used, workmauship, durability
a ~ ?strength
d
inay not be alike. The product nlay be different in size. colour, shape,
style and packing. 'The location oftlle seller, the qualities like promptness. cou-tesy.
good deliveiy of service, favourable credit terrns could be sources of real product
diflerentiatiou.
Fancied difkrentiation is created in the mind of the co~~sluner
through advertisement,
diffi-rences in packaging and design, or by brand name. The purpose of product
differentiation is to make the product ~ u ~ i q in
u ethe miud of the consumer. This special
status ofthe commodity manufact~rredby a producer. ultimately. persuades the
consuimer to pay a relatively higher price for it.

The element ofproduct differentiationcauses some consumers preferring the products

of aparticular firm to that of others. Each firm obtains a kind of limited monopoly for
its unique version of the product. It gives the firm limited influence over the price it
charges for the output and in a restricted sense makes it a 'price maker'. However,
the monopolistically competitivefirm faces stif'fcompetition fkom the close substitutes
offered by others. So, its control over the price is limited. The price elasticity of
demand between products ofmo~~opolistically
competitive firms is quite high, though
not infinite, as under perfect competition.
On account of product differentiation, monopolistic competition provides fertile
ground for non-price competition among fimls. They compete with one another
partially up011 price and partially upon non-price modes like product quality, senice
and other conditions of sales. and sales promotion. A firm can simultaneously
undertake three strategies for influencing its sales volume. First, it can change the
price charged - the strategy of price competition. Second, it can modifjl the nature
of its product - the strategy of product variation. Third, it can revise its sales promotion
tactics - the strategy of promotional competition. The first strategy represents an
attempt to move along the demand curve wlrereas the last two involve an attempt to
shift the demand curve hced by a firm.
Check Your Progress 1
1 ) Define moilopolistic competition and give a few examples of it.

2) ldentifjr the competitive and monopolistic elements ofmonopolistic competition.

...................................................................................................................
3) Which of the folloming assumptions ofperfect competition does not apply to
monopolisticcon~petition?

i)

Many buyers and sellers

ii) Free entry and exit

iii) Homogenous product
iv) Both (ii) and (iii)

4) In moilopolistic competition. we have

a) few firms selling a differentiated product;
b) many firms selling a homogenous product;
c) few iirms selling a l~omogenousproduct, or
d) many firms selling a differentiated product.

Theory of ~ l u n o p o l i s t i c
Con~petition

5) Product differentiation means that consumers do not view the product of one
firm as exactly identical to the product of another firm. Elaborate.
...................................................................................................................

...................................................................................................................

...................................................................................................................

10.4

PRICE AND OUTPUT DECISIONS OF

MONOPOLISTICALLYCOMPETITZVEFIRMS

10.4.1 Demand Cuwe of Monopolistically Competitive Firms

The demand curve faced by a monopolistically competitive finn slopes downwards
and is flatter than that under pure n~onopoly.'l'his is because ofthe brand loyalty of
consumers created by product differentiation. As stated above, the n~ollb~olistic
coilrpetition conlbines the elements of both perfect competition and monopoly.
On account of product differentiation, a monopolistically competitive firm has a
small measure of discretion, that is, moilopoly power in determining the price of its
product. If the firm sets its price sonlewhat below the prices of other firms, some
customers are induced to buy its product when it is a good substitute for the products
of its competitors. But some consumers continue to buy the products ofother firms
even at a relatively higher price because of their brand loyalty. On the other hand.
incraase in price by a f i m ~
rcsults in significantdecline in sales as many of its customers
nlay switch over to lmv-priced substitutes. But sonle continue to buy the product of
this firm eben at a relat~velyhigher price because they rate its product higher.
Therefore, it may be said that the firin cannot raise prices without losing sales.
However, it cannot gain sales without charging a lower price. Ofcourse, it does not
lose all the customers by raising the price. Thus, the f m ' s demand culve is dowilward
sloping but not perfectly elastic. hdoreover, the presence ofclose substitutes makes
the dcn~andcurve ofa particular firm highly elastic. The demand cure for such a firnl
is shown in Fig. 10.1.

It may be recapitulated that, when the finll's demand curve is downward sloping. its
marginal revenue curve does not coincide with average revenue (AR) cLuve and lies
below it. If the firm's AR cunJeis assumed to be linear and down\vard sloping. MR
curve will also be linear and downward sloping and will have a slope twice that of
AR curve as shown in the above figure.

pI

Fig. 10.1

As depicted in Fig. 10.1, a firm in a monopolistically competitive industry faces a highly

elastit but negatively sloped demand curve for its product. The larger the number of
competitors and weaker the product differentiation, the greater the price elasticity of
demand fora firm's product.

10.4.2 Short - run Equilibrium of a Monopolistic Competitive

Firm
A firm is to decide the lixation of price of its product in order to maximise profit.
While doing this it has already decided about the type or quality ofthe product to be
produced and the amount of selling cost to be incurred. The average cost curve of
the firm is taken to be U- shaped. Given AR. MR and AC and MC curves. the
profits are maximised at output level where MC and MR are equal, and MC intersects
MR from below. This is illustrated in Figures 10.2 a. and 10.2b. Short-run profits
~ L I OQ
~
as given by the intersection of MR and MC
are maximised at O L I ~ ~ICVCI
curves. It is a stable ccluilibriiun because MC exceeds MR for an output greater
than OQ. At this equilibl-ii~moutput, the maximum price as given by AR curve is
OP. Since AR is greater than AC, the firm is earning super-normal profit equlal to
the area PRN I' I.
Fig. 10.2 (b)

Fig. 10.2 (;I)

AC'.

AC, AVC, MC, AR, MR

MC',AR. MR

SMC

*
SMC

(2

SAC

SAC

"
,

---

Qurultity

Quantity

Fig. 10.2 (;I): S l ~ o \ \sl~ol-f

s
1.1111 ~ ( l ~ ~ i l i b r iFig.lO.2
u ~ n (b): S ~ I O Wthe
S case when fil-n~is
of a
~~~o~~ol,trIistically
not able to cover average cost
c o n ~ p e t i ~lir111.
~ g Sllort run AR
ill the short run, but continues
= I) c i ~ nlic above short run AC.
to be in the market so long as
I h t , cquilibriun~is, as usual,
its average variable costs a r e
t l e t e r ~ ~ ~ 2i11~ poir~t
~ c t l E wl~cre
covered. If I ~ o w e v e r ,t h e
rising M C (SMC) cuts fallir~g
demand curve falls below the
MI< (SMIt). O ~ r t l ) ~ar t that
SAVC, the firm will have to
point is OQ. Tlrc fir111is able
skut down. This is the reason
to charge 01' or-ice for this
we call this output level as the
q u a ~ ~ t i t Herc,
j , . total 1-evcnuc
'shutdown point's.
csccctls total costs by PRNPI,
which is called 'extra norrnal
1"-ofrt'.

IHouever, ifthe denland is ~ceal,.the monopolistically competitive f i i ~ may

u not be
able to make a super-normal profit, or even a norliial profit. In case the demand is
too weak to reccxer variable costs, the film would prefer to sliu~tdown its operations.
Like perfect co~i~pctition.
a monopolistically co~iipetitivefirm remains in the busiiless
in the short period if:
i)

AR > AC, earning supemomial profits, or

ii) AR = AC. maltingj ~1stnormal profits, or

T l ~ c o r ?01' Xlonopoli$tic
('ompetition

iii) AR< AC but greater than, or equal to the AVC, thus, minimising losses associated
with s h ~down.
t

10.4.3 Long-run Equilibrium of a Monopolistic Competitive

Firm
You have learnt in Unit 8 tliat with fiee entry and exit, firms in aperfectly competitive
industry are able to earn only normal profit in the long period. Similar forces are
present uiider monopolistic competition also. The process of long-n~nadii~stnients
in a ~~ionopolistic
competitive 'gro~lp'is analogous to tliat of perfcctlj competitive
i11dust1-y.When short-run super-~ior~nal
profit (economic protitlextra profit) exists,
new firms are motivated to enter the 'group'. The entry of new rivals. assuming
constant rndrliet demand for the product ofthe indushy (group) will cause the demand
cuive ofeach film to shifi to the lefi. Each firm will have a siliallcr market share sincc
morc firms will be dividing the relatively constant total market among tlicmselves.
Moreover, the demand curve is likely to become somewhat more elastic owing to
tlie presenceof a larger number ofclose substitutes. These shifts in de~na~:d
tend to
narrow profit niargins and cause economic profit to dissipate. There exists atenclency
forecono~nicprofits to be eliminaled in tlie long run.
Fig. 10.3

LAC. LMC. LAR, LMR

Fig.lO.3 illustrates tile long-run equilibriu~n11ositio11of tile r e p r e s e ~ ~ t s t i vfir111.

c
AR
C I I I - \ ~ Ci s s l ~ o \ vtallgent
~l
to LAC cur\,eat the prolit-maxirnisirtgoutput. Outptrt
Q , is tile long-run equilibrium outpot,and pricc P I is the long-rt~ncqt~ilihrit~ln
price. Since priceequals L A C a t Q, units o f o t ~ t p u tthe
, tirln is just co\,ering all
its costs, including implicit and opportunity costs. Since profits a r e just nor~nal,
there will be 110 furtiler entry iuto the industry. The equilibriual is stable, sillcc
aag devi;ition from an output of Ql and price of PI \rill yield revcnlles, w l ~ i carc
l~
insuflicic~~t
to cover all production costs i n c l u d i ~ ~a grior~nalprofit.

Cheek Your Progress 2

1 ) Will Ihc denia~~d
curve fora firm i~ndernio~~opolistic
competition bc horizontal
or do\vn\val.d slop in^'?

2) Showthe short-runequilibriumposition for a firm under monopolistic competition

such that the fm makes some abovenomlal profits. Explain why it is a temporary
equilibrium.
The short-runequilibriumlevel of output for a monopolistic competitor is given
by the point where
a) P = SMC
b) P = SAC
c) MR cunreintersects SMC
d) MR curve intersects SMC curve Lrom below and P > or = AVC

3) Show that in the long-run equilibriuin in monopolistic competition each firm

makes zero profits? (Reference is to economic or super normal profits)

10.5 COMPARISON OF MONOPOLISTIC

COMPETITION WITH PERFECT
COMPETITION
The long-run equilibriuin of inonopolistic conlpetitive firm as well as perfectly
competitive fill11 is defined by the point oftangency ofdemand curve to LAC curve.
At this point, in the case of monopolistic competition, MC = MR and AC = P, but
P > MC. 0 1 7 the other hand. in perfect competition, the long-run equilibrium
condition is MC =R/IR =AC = P. Ail important implication ofthe long-run equilibrium
of the firnl under n~onopolisticcompetition as given by the tangency between AR
and AC curves is that equilibrium output will ilecessarily be less than the least-cost
output ofthe firm. This is because a downward-slopingAR curve can be tangent to
U-shaped cost curve only at some point to the left of the lowest point ofAC curve.
This i~npliesthat even in the long-run equilibrium position, all the economies of scale
are not fully exploited by the firm. The firm will always have some unutilised or
'excess capacity'. I11 Fig. 10.4, excess capacity is represented by Q Q, amount of
output.

1
F

I
I

A fin11 operating under nloilopolistic competition will have some excess capacity in
the loilg run. The firin may be using the most econo~llicalplant for producing the
output that it can sell but without exploiting f~illythe economies of scale, i.e.. the
plant will not be used to its optimum capacity.

T h e o r y of Monopolistic
Competition

\larket Structure

Fig. 10.4

LAC, LMC, LAR, LMR

LAC

0
Fig. 10.4:

Q1

Quantity

Line PP= A R = MRshows the perfect competition demand curve, while the
line ARI shows thesame for monopolistic competition. The former is tangent
to tlie long run average cost curve LAC at its lowest point M, AR1 is tangent
to this LAC at a point which is higher, the point N.Thus, the firm under
monopolistic competition produces an output OQ, that is smaller than the
colnpctitive output OQ.

10.6 ECONONIIC EFFECTS OF MONOPOLISTIC

COMPETITION
It will be useful to point out two major eco~loinicconsequences of monopolistic
competition at this point. First, tlie allocation of resources in tlie economy is lionoptimal since price is greater than marginal cost. For optimal allocation of resources.
price must be equal to marginal cost in tlie case of every product.
Second, monopolistic competition gives rise to a great deal of social waste arising
out of selling cost or advertisement expenditure. Advertisemeilt,which is essential
and profitable from tlie point ofview of an indikidual fi~lli,is a waste fi'om the social
point of view.
social wclfarc would have gone up had tlte resources devoted to
advei-tisementbeen used towards i~lcreasiiigthe quantity or improving tlie quality of
tlie goods supplied by the ~llonopolisticcompetitive firnls.

10.7 POLICY VARIABLES FOR A

MONOPOLISTICALLYCOMPETITIVE FIRM
The policy-relatedvariables for a nioiiopolistically conipetitive fi111i are piice, product
variation, and selling expenses. Product variation and selling expeilses are referred
to as non-price co~iipetitiveefforts on the part of the firm to increasc sales or liiake
tlie demand curves that they face less elastic.

10.7.1 Selling Costs as a Policy Variable

Product differentiation is the basic feature of the nlonopolistic competitive market
structure. Consequently selling costs occupy an important place for creating and

maintaining product differentiationin the minds of consumers. Let us remember that

selling costs are incurred to adapt demand to what is being produced by the firm.
On the other hand, production costs are incurred to adapt production to demand.
Selling costs are incurred to bring the product to the notice of the consumers and to
systematically make place for the product in the mind of consumers. The basic
purpose and effect of advertising is to increase demand, that is, to shift the demand
curve rightwards and also to make it less elastic. Initially, increases in selling costs
may result inmore than proportionate increase in demand, because, some minimum
advertising outlay enables the firm to reach the public at large and to attract them to
the product. IIowever, subsequent increases in advertising expenditure may not
induce the buyers as much, thus, may yield less than proportionate increase in
demand. The effect of selling cost on the demand for the product is illustrated in Fig.
10.5.
AR, MR, AC, MC
I

Fig. 10.5

Quantity
I

Fig.10.5 shows that selling costs shift the demand curve to the right. AR was the demand
curve before the firm started incurringexpendifyre on salesefforts. I t shifted to
new position AR,. You can check that ARI is lesk elasticat any given priceOP,.

Sales promotion adds to tirni's costs on the one hand and shift its demand (AR
curve) to right on the other. As long as the revenue increases by more than
promotional expenditure, it would improve the profit position of the firm and
advertising may be considered to be a wise move. This is depicted in Fig. 10.6. AR
is ~~~idertaken
and AC is the average
is the demand curve before any advertise~iic~it
costs, which do not include any advertisement costs. The initial equilibriumposition
where profits are being maximised is at output level OQ and price OP. Let us
assume that firm spends some amount on advertising.The advertisingcost is treated
as fixed cost. ACI is the new average cost curve, wliicli includes both average
production cost and average advertising cost. As a result of sales promotion, the
new demand AR, has shitted to the riglit of AR. It would be wise to incur expenditure
on advertiseme~ltifprofits are larger in the new equilibrium than they were in the
original one. 0 1 1the same line, the firm would repeat the examinationwhether increase
in advertising expenditure leads to a further increase in profit or not. It can go on

T b e o r y of hlonopolistic
Competition

increasing selling costs so long as each increment of advertising expenditure adds

more revenue than costs. The profit will be 'maximum' only when additional revenue
generated equals the extra amount spent on selling costs.
Please note fhat in the figure, the equilibrium output is determined at the point of
intersection of NlR and MC curves, whether the firm advertises or not. Selling costs
do not affect MC, but a shift in AR (to AR,) definitely implies that there shall be a
new marginal revenue curve MR, and post-advertising equilibrium will take place at
a point where old MC cuts MR.,
,

AR, MR, AC, MC

Fig. 10.6

Fig. 10.6: As the f i r m incurs some selling expenditure, its average cost shifts f r o m AC t o
A C , , These selling costs are treated as fixed costs, therefore, the fil-~ii'smarginal
co\t curves remains unchanged. T h e sellingcosts shift the demand c u r v e f o r
t l ~ c firm's
.
output upwards to ARl. New total revenue o f the f i r m will beOP1EIQI,
w h i c h is l a r g e r t h a n the o l d t o t a l revenue given b y OPEQ. T h e f i r m can go on
increasing the p r o m o t i o n a l outlay so l o n g as this rise i n t o t a l revenuc e r c e e t l ~
the outlay HJEIPI,a n d not beyond that.

10.8 SUMMARY OF MONOPOLISTIC

COMPETITION
In this section, we attempt to capture the monopolistic co~npetitionin brief. The
distinguishmg features ofmonopolistic competition are:

1) Inany finns selling differentiated, yet similar products:

2) the ability of each film1to influence its sale by changing its price;
3) downward sloping. but highly elastic, denlaud curves faced by the firms:
4) firn~scan enter and leave the industly c~ it11 relative ease;

5 ) the actions of any one firm have a small effect upon rival firn~s;and
6) finns seek to maximise profit.

Theory of hlonopolistir
Competition

When large numbers of small firms sell a homogenous product, the market structure
tends to be perfectly competitive,where large numbers of small firms sell differentiated
product, the model of monopolistic competition prevails.
Monopolisticallycompetitive firms may earn profits or incur losses in the short-run
but fiee entry and exit limits the possibilities of earning economic profitsand economic
losses in the long run.
To maxirnise profits, monopolisticallycompetitive firms pursue three strategies: price
changes, product variation and variation in selling costs. Each possible combination
of price, product variation and promotional outlay poses a different demand and
cost situation for the firm. Therefore, to arrive at an output level and price which
maxinlise profit is a con~plexissue in monopolisticcompetition.
If consumers accept honloge~lousproducts, a perfectly competitive market structure
drives prices to the level of minimum average cost. Each firm operatesat the minimum
point of its short-run and long-run average cost curve and the firms, which fail to
attain the lowest possible unit cost, are thrown out ofthe industry. Consequently,
resources tend to be enlployed at maximum production efficiency in a perfectly
co~npetitiveindustry.
I

I lornever. if consumers have preference for differentiated products, then

monopolistically competitive conditions produce consumer's benefits in the sense
that competition is strong enough to keep prices down close to cost and to eliminate
excess profits. But mono pol is tic all^ cc~mpetitivefirms tehd-to produce at less than
opti~ni~nl
level since the demand iurvc is tangent to the downwards slopingportion
of the long-run average cost curve.

10.9 OLIGOPOLY
l,ct us have a brief overview ofthe inarket structure known as oligopoly. Oligopoly
is synonymous with competition among few. Markets are said to be oligopolistic
wherever small number of firms supply the dominant share ofan industry's total
Olltpllt.
I

'I
t

i
C

The principal effect ofthcre being a few firnls is that it gives each firm a prominent
market position such that its decisions and actions have significantrepercussionson
rival fiitns. Ifone fi1111 announces a price change, introduces a new product, changes
product design or steps up its advertising, other firms take note and chalk out their
strategies to match the rivals' action. Note that each firm recognises that its best
course of action depends on the action of its rival. Thus producers' actions become
interdependent which extends to all facets ofcompetition in an oligopoly market
structure. The anticipation of actions and reactions ofrival firms introduces a nev?
and exceedingly complex dinlension to the firm's decision process. The
interdependenceof the fimns' actions, and conseqi~entlyindetem-inate demand curve
is the key feature ofoligopoly.
If the firms in an industry produce a standardised product, the indust~yis culled a
pure oligopoly. On the other l~ald.if few firms dominate the market for a dificrentiated
product, the industry is called a differentiated oligopoly.
It is difficult. but not impossible, to enter an oligopolistic industry. Presence of
substantial ecollon~iesofscale, complex technology, production ofhighly advertised
product by existing fil-111~.work against the successful entry ofnew firms.

In an oligopolistic market structure, there is no clear-cut equilibrium position towards

which all finns tend to move. In this market structure,several courses ofaction are
open to firms selectingacompetitive strategy. What firms will decide to do and how
their rivals will react are open-ended. A number of outcomes are possible, and no
single theory of oligopolistic behaviour can be postulated. It may be interesting to
note that these days, most of the consumers products' markets may appear to be
oligopolistic in nature. Analysis of strategic options available under such market
condition will take us closer to understandingof actual working of the markets. But
you are not exposed to such analyses presently.
Check Your Progress 3

1) In what respects the monopolistic competition differs from perfect competition?

Explain with help of some suitable diagram.

2) What are the policy variables for a monopolistically competing fim~?Rring out
the eef'fect of selling / promotional costs / advertising outlay on price and outpiit
under lnonopolistic competition.

3) What are the main characteristics of the oligopoly form of market?

10.10 LETUSSUMUP
This unit was the second successive one that dealt with market forms, which are
different from perfect competition.Unlike the preceding unit that was on-monopoly,
thi$one dealt with market forms that lie between the polar cases of perfect competition
and monopoly. Here we consider two more market forms viz., monopolistic
competition and oligopoly. Monopolisticcompetition was considered in greater detail
than the latter and consequently more space was devoted to the former. The main
cl~aracteristicsofmonopolistic competition were spelt out, and it was also seen as
to how moi~opolisticcompetition compares with perfect competition. We then looked
at some policy variables concerning monopolistic competition. We also touched
i~pon.briefly. that usually a unique equilibrium does not exist under oligopoly.

10.11 SOME USEFUL BOOKS

Varian. Hal (I 997). Infermediate Microeconomics, W.W. Norton & Co, New
Pindyck, Robert S. and Daniel Rubinfeld (1 989) Microeconon7ic~,Collier
Macmillan. London

10.12 ANSWERS 1HINTS TO THE CHECKYOUR

PROGRESS EXERCISES
Check Your Progress 1
1) Read Section 10.1,10 2 and ansvver.

2) Read Section 10.2, 10.3 and answer

5) Read Section 10.3 and answer.

Check Your Progress 2
1) Read Sub-section 10.4.1 and answer.

2) See Sub-section 10.4.2 and answer.

4) Read Sub-section 10.4.3 and answer.

Check Your Progloss 3

1) Read Section 10.5 and answer.

2) Read Section 10.7 and answer.

3) Read Section 10.9 and answer.

'I'l~coryol hlonopolistic
(:oniprtition