Pricing under

UNIT 12 PRICING UNDER Monopolistic and

Oligopolistic Competition
MONOPOLISTIC AND
OLIGOPOLISTIC COMPETITION
Objectives

After going through this unit, you should be able to:

 describe the concept of the pricing decisions under monopolistic

competition in short run as well as long run;
 explain the concept of product differentiation with special reference to
monopolistic competition;
 differentiate between monopolistic competition and oligopoly;
 apply models of oligopoly behavior to real world situations.

Structure
12.1 Introduction
12.2 Monopolistic Competition
12.3 Price and Output Determination in Short run
12.4 Price and Output Determination in Long run
12.5 Oligopolistic Competition
12.6 Summary
12.7 Key Words
12.8 Self-Assessment Questions
12.9 Further Readings

12.1 INTRODUCTION
Pricing decisions tend to be the most important decisions made by any firm in
any kind of market structure. The concept of pricing has already been
discussed in unit 11. The price is affected by the competitive structure of a
market because the firm is an integral part of the market in which it operates.
We have examined the two extreme markets viz. monopoly and perfect
competition in the previous unit. In this unit the focus is on monopolistic
competition and oligopoly, which lie in between the two extremes and are
therefore more applicable to real world situations.

Monopolistic competition normally exists when the market has many sellers
selling differentiated products, for example, retail trade, whereas oligopoly is
said to be a stable form of a market where a few sellers operate in the market
and each firm has a certain amount of share of the market and the firms 269
Pricing Decisions recognize their dependence on each other. The features of monopolistic and
oligopoly are discussed in detail in this unit.

12.2 MONOPOLISTIC COMPETITON

Edward Chamberlin, who developed the model of monopolistic competition,
observed that in a market with large number of sellers, the product so
individual firms are not at all homogeneous, for example, soaps used for
personal care. Each brand has a specific characteristic, be it packaging,
fragrance, look etc., though the composition remains the same. This is the
reason that each brand is sold individually in the market. This shows that each
brand is highly differentiated in the minds of the consumers. The
effectiveness of the particular brand may be attributed to continuous usage
and heavy advertising.

As defined by Joe S. Bain ‘Monopolistic competition is found in the industry

where there are a large number of sellers, selling differentiated but close
substitute products’. Take the example of soaps L and C. Both are soaps for
personal care but the brands are different. Under monopolistic competition,
the firm has some freedom to fix the price i.e. because of differentiation a
firm will not lose all customers when it increases its price.

Monopolistic competition is said to be the combination of perfect

competition as well as monopoly because it has the features of both perfect
competition and monopoly. It is closer in spirit to a perfectly competitive
market, but because of product differentiation, firms have some control over
price. The characteristic features of monopolistic competition are as follows:

 A large number of sellers: Monopolistic market has a large number

of sellers of a product but each seller acts independently and has no
influence on others.
 A large number of buyers: Just like the sellers, the market has a large
number of buyers of a product and each buyer acts independently.
 Sufficient Knowledge: The buyers have sufficient knowledge about
the product to be purchased and have a number of options available to
choose from. For example, we have a number of petrol pumps in the
city. Now it depends on the buyer and the ease with which s/he will get
the petrol decides the location of the petrol pump. Here accessibility is
likely to be an important factor. Therefore, the buyer will go to the
petrol pump where s/he feels comfortable and gets the petrol filled in
the vehicle easily.
 Differentiated Products: The monopolistic market categorically
offers differentiated products, though the difference in products is
marginal, for example, toothpaste.
 Free Entry and Exit: In monopolistic competition, entry and exit are
quite easy and the buyers and sellers are free to enter and exit the
270 market at their own will.
Nature of the Demand Curve Pricing under
Monopolistic and
The demand curve of the monopolistic competition has the following Oligopolistic Competition

characteristics:

 Less than perfectly elastic: In monopolistic competition, no single

firm dominates the industry and due to product differentiation, the
product of each firm seems to be a close substitute, though not a
perfect substitute for the products of the competitors. Due to this, the
firm in question has high elasticity of demand.

 Demand curve slopes downward: In monopolistic competition, the

demand curve facing the firm slopes downward due to the varied
tastes and preferences of consumers attached to the products of
specific sellers. This implies that the demand curve is not perfectly
elastic.

12.3 PRICE AND OUTPUT DETERMINATION IN

SHORT RUN
In monopolistic competition, every firm has a certain degree of monopoly
power i.e. every firm can take initiative to set a price. Here, the products are
similar but not identical, therefore there can never be a unique price but the
prices will be in a group reflecting the consumers’ tastes and preferences for
differentiated products.

In this case the price of the product of the firm is determined by its cost
function, demand, its objective and certain government regulations, if there
are any. As the price of a particular product of a firm reduces, it attracts
customers from its rival groups (as defined by Chamberlin). Say for example,
if ‘S company’ TV reduces its price by a substantial amount or offers
discount, then the customers from the rival group who have loyalty for, say
‘L TV company’, tend to move to buy ‘S company's’ TV sets.

As discussed earlier, the demand curve is highly elastic but not perfectly
elastic and slopes downwards. The market has many firms selling similar
products, therefore the firm’s output is quite small as compared to the total
quantity sold in the market and so its price and output decisions go unnoticed.
Therefore, every firm acts independently and for a given demand curve,
marginal revenue curve and cost curves, the firm maximizes profit or
minimizes loss when marginal revenue is equal to marginal cost. Producing
an output of Q selling at price P maximizes the profits of the firm.

271
Pricing Decisions Figure 12.1: Short run equilibrium under monopolistic competition

In the short run, a firm may or may not earn profits. Figure 12.1 shows the
firm, which is earning economic profits. The equilibrium point for the firm is
at price P and quantity Q and is denoted by point A. Here, the economic
profit is given as area PAQR. The difference between this and the monopoly
case is that here the barriers to entry are low or weak and therefore new firms
will be attracted to enter. Fresh entry will continue to enter as long as there
are profits. As soon as the super normal profit is competed away by new
firms, equilibrium will be attained in the market and no new firms will be
attracted in the market. This is the situation corresponding to the long run and
is discussed in the next section.

12.4 PRICE AND OUTPUT DETERMINATION IN

LONG RUN
We have discussed the price and output determination in the short run. We
now discuss price and output determination in the long run. You will notice
that the long run equilibrium decision is similar to perfect competition. The
core of the discussion under this head is that economic profits are eliminated
in the long run, which is the only equilibrium consistent with the assumption
of low barriers to entry. This occurs at an output where price is equal to the
long run average cost. The difference between monopolistic competition and
perfect competition is that in monopolistic competition the point of tangency
is downward sloping and does not occur at minimum of the average cost
curve and this is because the demand curve is downward sloping1.

1
. You should appreciate that P=AC is the only compatible long run equilibrium under both perfect
competition and monopolistic competition. The reason is that there are no entry barriers. However,
because the demand curve is downward sloping in monopolistic competition the point at which P= AC
occurs to the left of the minimum point of the average cost curve, rather than at the minimum point, as
in perfect competition
272
Figure12.2: Long run equilibrium under monopolistic competition Pricing under
Monopolistic and
Price & Cost Oligopolistic Competition

LRMC
(Rs.)

P
ATC (LRAC)

AR

MR

0 Q Quantity

Looking at figure 12.2, under monopolistic competition in the long run we

see that LRAC is the long run average cost curve and LRMC the long run
marginal curve. Let us take a hypothetical example of a firm in a typical
monopolistic situation where it is making substantial amount of economic
profits. Here it is assumed that the other firms in the market are also making
profits. This situation would then attract new firms in the market. The new
firms may not sell the same products but will sell similar products. As a
result, there will be an increase in the number of close substitutes available in
the market and hence the demand curve would shift downwards since each
existing firm would lose market share. The entry of new firms would
continue as long as there are economic profits. The demand curve will
continue to shift downwards till it becomes tangent to LRAC at a given price
P and output at Q as shown in the figure. At this point of equilibrium, an
increase or decrease in price would lead to losses. In this case the entry of
new firms would stop, as there will not be any economic profits. Due to free
entry, many firms can enter the market and there may be a condition where
the demand falls below LRAC and ultimately suffers losses resulting in the
exit of the firms. Therefore under the monopolistic competition free entry and
exit must lead to a situation where demand becomes tangent to LRAC, the
price becomes equal to average cost and no economic profit is earned. It can
thus be said that in the long run the profits peter out completely.

One of the interesting features of the monopolistically competitive market is

the variety available due to product differentiation. Although firms in the
long run do not produce at the minimum point of their average cost curve,
and thus there is excess capacity available with each firm, economists have
rationalized this by attributing the higher price to the variety available.
273
Pricing Decisions Further, consumers are willing to pay the higher price for the increased
variety available in the market.

Activity 1

1. It is a usual practice for the customers to go to the market and purchase

household goods like toothpastes, soaps, detergents etc. List (any five)
such branded items along with their competitors having a substantial
share in the market.
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2. ‘In a monopolistic competition, the profits in the long run evade off
completely’. Briefly discuss the statement taking into account the
present trends.
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12.5 OLIGOPOLISTIC COMPETITION

We define oligopoly as the form of market organization in which there are
few sellers of a homogeneous or differentiated product. If there are only two
sellers, we have a duopoly. If the product is homogeneous, we have a pure
oligopoly. If the product is differentiated, we have a differentiated oligopoly.
While entry into an oligopolistic industry is possible, it is not easy (as
evidenced by the fact that there are only a few firms in the industry).

Oligopoly is the most prevalent form of market organization in the

manufacturing sector of most nations, including India. Some oligopolistic
industries in India are automobiles, primary aluminum, steel, electrical
equipment, glass, breakfast cereals, cigarettes, and many others. Some of
these products (such as steel and aluminum) are homogeneous, while others
(such as automobiles, cigarettes, breakfast cereals, and soaps and detergents)
are differentiated. Oligopoly exists also when transportation costs limit the
market area. For example, even though there are many cement producers in
India, competition is limited to the few local producers in a particular area.

Since there are only a few firms selling a homogeneous or differentiated

production oligopolistic markets, the action of each firm affects the other
firms in the industry and vice versa. For example, when automobile company
GM introduced price rebates in the sale of its automobiles, automobile
company F and M immediately followed with price rebates of their own.
Furthermore, since price competition can lead to ruinous price wars,
274
oligopolists usually prefer to compete on the basis of product differentiation, Pricing under
Monopolistic and
advertising, and service. These are referred to as non price competition. Yet,
Oligopolistic Competition
even here, if GM mounts a major advertising campaign, F and M are likely to
soon respond in kind. When softdrink company P mounted a major
advertising campaign in the early 1980s softdrink company C responded with
a large advertising campaign of its own in the United States.

From what has been said, it is clear that the distinguishing characteristic of
Oligopoly is the interdependence or rivalry among firms in the industry. This
is the natural result of fewness. Since an oligopolist knows that its own
actions will have a significant impact on the other oligopolists in the industry,
each oligopolist must consider the possible reaction of competitors in
deciding its pricing policies, the degree of product differentiation to
introduce, the level of advertising to be undertaken, the amount of service to
provide, etc. Since competitors can react in many different ways (depending
on the nature of the industry, the type of product, etc.) We do not have a
single oligopoly model but many-each based on the particular behavioural
response of competitors to the actions of the first. Because of this
interdependence, managerial decision making is much more complex under
oligopoly than under other forms of market structure. In what follows we
present some of the most important oligopoly models. We must keep in mind,
however, that each model is at best in complete.

The sources of oligopoly are generally the same as for monopoly. That is, (1)
economies of scale may operate over a sufficiently large range of outputs as
to leave only a few firms supplying the entire market; (2)huge capital
investments and specialized inputs are usually required to enter an
oligopolistic industry (say, automobiles, aluminum, steel, and similar
industries), and this acts as an important natural barrier to entry; (3) a few
firms may own a patent for the exclusive right to produce a commodity or to
use a particular production process; (4) established firms may have a loyal
following of customers based on product quality and service that new firms
would find very difficult to match; (5) a few firms may own or control the
entire supply of a raw material required in the production of the product; and
(6) the government may give a franchise to only a few firms to operate in the
market. The above are not only the sources of oligopoly but also represent the
barriers to other firms entering the market in the long run. If entry were not
so restricted, the industry could not remain oligopolistic in the long run. A
further barrier to entry is provided by limit pricing, whereby, existing firms
charge a price low enough to discourage entry into the industry. By doing so,
they voluntarily sacrifice short-run profits in order to maximize long-run
profits.

As discussed earlier oligopolies can be classified on the basis of type of

product produced. They can be homogeneous or differentiated. Steel,
Aluminium etc. come under homogeneous oligopoly and television,
automobiles etc. come under heterogeneous oligopoly. The type of product
produced may affect the strategic behaviour of oligopolists. According to 275
Pricing Decisions economists, two contrasting behaviour of oligopolists arise that is the
cooperative oligopolists where an oligopolist follows the pattern followed by
rival firms and the non-cooperative oligopolists where the firm does not
follow the pattern followed by rival firms. For example, a firm raises price of
its product, the other firms may keep their prices low so as to attract the sales
away from the firm, which has raised its price. But as stated above, price is
not the only factor of competition. As a matter of fact other factors on the
basis of which the firms compete include advertising, product quality and
other marketing strategies. Therefore, we normally have four general
oligopolistic market structures, two each under cooperative as well as non-
cooperative structures. We have firms producing homogeneous and
differentiated products under each of the two basic structures. All these
differences exist in the oligopolistic market. This shows that each firm tries to
make an impact in the existing market structure and have an effect on the
rival firms. This tends to be a distinguishing characteristic of an oligopolistic
market.

Activity 2

1. List five products along with the names of the companies following
homogeneous oligopolistic competition.
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2. List five products along with the names of the companies following
heterogeneous oligopolistic competition.
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Price Rigidity: Kinked Demand Curve

Our study of pricing and market structure has so far suggested that a firm
maximizes profit by setting MR=MC. While this is also true for oligopoly
firms, it needs to be supplemented by other behavioural features of firm
rivalry. This becomes necessary because the distinguishing feature of
oligopolistic markets is interdependence. Because there are a few firms in the
market, they also need to worry about rival firm’s behaviour. One model
explaining why oligopolists tend not to compete with each other on price, is
the kinked demand curve model of Paul Sweezy. In order to explain this
characteristic of price rigidity i.e. prices remaining stable to a great extent,
Sweezy suggested the kinked demand curve model for the oligopolists. The
kink in the demand curve a rises from the a symmetric behaviour of the firms.
276 The proponents of the hypothesis believe that competitors normally follow
price decreases i.e. they show the cooperative behaviour if a firm reduces the Pricing under
price of its products whereas they show the non-cooperative behaviour if a Monopolistic and
Oligopolistic Competition
firm increases the price of its products.

Let us start from P1 in Figure 12.3. If one firm reduces its price and the other
firms in the market do not respond, the price cutter may substantially increase
its sales. This result is depicted by the relative elastic demand curve, dd. For
example, a price decrease from P1 to P2 will result in a movement along dd
and increase sales from Q1 to Q2 as customers take advantage of the lower
price and abandon other suppliers. If the price cut is matched by other firms,
the increase in sales will be

Figure 12.3: Demand curve for an Oligopolist

less. Since other firms are selling at the same price, any additional sales must
result from increased demand for the product. Thus the effect of price
reduction is a movement down the relatively inelastic demand curve, DD,
then the price reduction from P1 to P2 only increases sales to .

Here we assume that P1 is the initial price of the firm operating in a non-
cooperative oligopolistic market structure producing Q1 units of output. P is
also the point of kink in the demand curve and is the initial price and DD is
the relatively elastic demand curve above the existing price P1. When the firm
is operating in the non-cooperative oligopolistic market it results in decline in
sales if it changes its price to P1. Now if the firm reduces its price below P1
say P2, the other firms operating in the market show a cooperative behaviour
and follow the firm. This is shown in the figure as the curve below the
existing price P1. The true demand curve for the oligopolistic market is dD
and has the kink at the existing price P1.The demand curve has two linear
curves, which are joined at price P.
277
Pricing Decisions Associated with the kinked demand curve is a marginal revenue function.
This is shown in Figure 12.4. Marginal Revenue for prices above the kink is
given by MR1 and below the kink as MR2. At the kink, marginal revenue has
a discontinuity at AB and this depends on the elasticity of the different parts
of the demand curve.

Therefore, in the presence of a kinked demand curve, firm has no motive to

change its price. If the firm is a profit maximizing firm where MR=MC, it
would not change its price even if the cost changes. This situation occurs as
long as changes in MC fall within the discontinuous range i.e. AB portion.
The firm following kinked model has a U-shaped marginal cost curve MC.
The new MC curve will be MC1 or MC2 and will remain in the discontinued
area and the equilibrium price remains the same at P.

Figure 12.4 Kinked demand curve

/AR

Price Competition: Cartels and Collusion

Cartel Profit Maximization

We already know now that in an oligopolistic competition, the firms can

compete in many ways. Some of the ways include price, advertising, product
quality, etc. Many firms may not like competition because it could be
mutually disadvantageous. For example, advertising. In this case many
oligopolies end up selling the products at low prices or doing high advertising
resulting in high costs and making lower profits than expected. Therefore, it
is possible for the firms to come to a consensus and raise the price together,
278
increasing the output without much reduction in sales. In some countries this Pricing under
Monopolistic and
kind of collusive agreement is illegal e.g. USA but in some it is legal. The
Oligopolistic Competition
most extreme form of the collusive agreement is known as a cartel.

A cartel is a market sharing and price fixing arrangement between groups of

firms where the objective of the firm is to limit competitive forces within the
market. The forms of cartels may differ. It can be an explicit collusive
agreement where the member firms come together and may reach a
consensus regarding the price and market sharing or implicit cartel where
the collusion is secretive in nature.

Throughout the 1970s, the Organization of Petroleum Exporting Countries

(OPEC) colluded to raise the price of crude oil from under $3 per barrel in
1973 to over $30 per barrel in 1980. The world awaited the meeting of each
OPEC price-setting meeting with anxiety. By the end of 1970s, some energy
experts were predicting that the price of oil would rise to over $100 per barrel
by the end of the century. Then suddenly the cartel seemed to collapse. Prices
moved down, briefly touching $10 per barrel in early 1986 before recovering
to $18 per barrel in 1987. OPEC is the standard example used in textbooks
when explaining cartel behaviour. The cartel profit maximizing theory can be
explained using figure 12.5.

Figure 12.5: Cartel profit maximization

/AR

The market demand for all members of the cartel is given by DD and
marginal revenue (represented by dotted line) as MR. The cartels marginal
cost curve given by MCc is the horizontal sum of the marginal cost curves of
the member firms. In this the basic problem is to determine the price, which
maximizes cartel profit. This is done by considering the individual members
of the cartel as one firm i.e. a monopoly. In the figure this is at the point
where MR= MCc, setting price = P. The problem is regarding the allocation
of output within the member firms. Normally a quota system is quite popular, 279
Pricing Decisions whereby each firm produces a quantity such that its MC = MCc. One serious
problem that arises from this analysis is that while the joint profits of the
cartel as a whole are maximized, each individual member of the cartel has an
incentive to cheat on its quota. This is because the price for the product is
greater than the members marginal cost of production. This implies that an
individual member can increase its profit by increasing production. What
would happen if all members did the same? The market sharing arrangement
will breakdown and the cartel would collapse. Here lies the inherent
instability of cartel type arrangement and can be summarized as follows.

There is an incentive for the cartel as a whole to restrict output and raise
price, there by achieving the joint profit maximizing result, but there is an
incentive on the part of the members to increase individual profit. If this kind
of situation occurs, it leads to break-up of the cartel. The difficulty with
sustaining collusion is often demonstrated by a classic strategic game known
as the prisoner’s dilemma.

Game theory (Prisoner’s dilemma)

The story is something like this. Two KGB officers spotted an orchestra
conductor examining the score of Tchaikovsky’s Violin Concerto. Thinking
the notation was a secret code, the officers arrested the conductor as a spy. On
the second day of interrogation, a KGB officer walked in and smugly
proclaimed, “OK, you can start talking. We have caught Tchaikovsky”.

More seriously, suppose the KGB has actually arrested someone named
Tchaikovsky and the conductor separately. If either the conductor or
Tchaikovsky falsely confesses while the other does not, the confessor earns
the gratitude of the KGB and only one year in prison, but the other receives
25 years in prison. If both confess each will be sentenced to 10 years in
prison; and if neither confesses each receives 3 years in prison. Now consider
the outcome.

The conductor knows that if Tchaikovsky confesses, he gets either 25 years

by holding out or 10 years by confessing. If Tchaikovsky holds out, the
conductor gets either 3 years by holding out or only one year confessing.
Either way, it is better for the conductor to confess. Tchaikovsky, in a separate
cell, engages in the same sort of thinking and also decides to confess. The
conductor and Tchaikovsky would have had three-years rather than 10-year
jail sentences if they had not falsely confessed, but the scenario was such
that, individually, false confession was rational. Pursuit of their own self
interests made each worse off.

CONDUCTOR
Cooperate Confess
3.3 25.1
Cooperate
TCHIKOVSKY 1.25 10,10
Confess
280
This situation is the standard prisoner’s dilemma and is represented in the Pricing under
Monopolistic and
above matrix. This first payoff in each cell refers to Tchaikovsky’s, and the
Oligopolistic Competition
second is the conductors. Examination of the payoffs shows that the joint
profit maximizing strategy for both is (Cooperate-Cooperate). 2 The
assumption in this game is that both the parties decided their strategies
independently. Let us assume both parties are allowed to consult each other
before the interrogation. Do you think cooperation will be achieved? It is
unlikely since each of them will individually be concerned about the worst
outcome that is 25 years in jail. Cooperation in this prisoner’s dilemma
becomes even more difficult, because it is a one shot game.

This scenario is easily transferred to the pricing decision of a company.

Consider two companies setting prices. If both companies would only keep
prices high, they will jointly maximize profits. If one company lowers price,
it gains customers and it is thus in its interests to do so. Once one company
has cheated and lowered price, the other company must follow suit. Both
companies have lowered their profits by lowering price. Clearly, companies
repeatedly interact with one another, unlike Tchaikovsky and the conductor.
With repeated interaction, collusion can be sustained.

Robert Axelrod, a well-known political scientist, claims a “tit-for-tat”

strategy is the best way to achieve co-operation. A tit-for-tat strategy always
co-operates in the first period and then mimics the strategy of its rival in each
subsequent period.

Axelrod likes the tit-for-tat strategy because it is nice, retaliatory, forgiving

and clear. It is nice, because it starts by co-operating, retaliatory because it
promptly punishes a defection, forgiving because once the rival returns to co-
operation it is willing to restore co-operation, and finally its rules are very
clear: precisely, an eye for an eye.

A fascinating example of tit-for-tat in action occurred during the trench

warfare of the First World War. Front-line soldiers in the trenches often
refrained from shooting to kill, provided the opposing soldiers did likewise.
This restraint was often indirect violation of high command orders.

Price Leadership

Price leadership is an alternative cooperative method used to avoid tough

competition. Under this method, usually one firm sets a price and the other
firms follow. It is quite popular in industries like cigarette industry. Here any
firm in the oligopolistic market can act as a price leader. The firm, which is
highly efficient, and having low cost can be a price leader or the firm, which
is dominant in the market acts as a leader. Whatever the case may be, the
firm, which sets the price, is the price leader. We have two forms of price
leadership-Dominant price leadership and Barometric price leadership.

2
Remember the payoffs in the matrix are years in jail, thus the lesser the better. 281
Pricing Decisions In dominant price leadership, the largest firm in the industry sets the price. If
the small firms do not conform to the large firm, then the price war may take
place due to which the small firms may not be able to survive in the market.
It is more or less like a monopoly market structure. This can be seen in the
airlines industry in India where the dominant Airlines Firms sets prices and
the others Subordinate Airlines Firms follow the price changes of dominant
Airlines Firms.

Barometric price leadership is said to be the simpler of the two. This

normally occurs in the market where there is no dominant firm. The firm
having a good reputation in the market usually sets the price. This firm acts
as a barometer and sets the price to maximize the profits. Here it is important
to note that the firm in question does not have any power to force the other
firms to follow its lead. The other firms will follow only as long as they feel
that the firm in action is acting fairly. Thought his method is quite ambiguous
regarding price leadership, it is legally accepted. These two forms are an
integral part of different types of cooperative oligopoly. Barometric price
leadership has been seen in the automobile sector.

ILLUSTRATION

Reestablishing Price Discipline in the Steel industry

A US steel company S was the leader in setting prices in the steel industry.
However, in 1962, a price increase announced by S company provoked so
much criticism from customers and elected officials, that the firm became
less willing to act as the price leader. As a result, the industry evolved from
dominant firm to barometric price leadership. This new form involved one
firm testing the waters by announcing a price change and then S. Steel
company either confirming or rejecting the change by its reaction.

Later S company found that its market share was declining. The company
responded by secretly cutting prices to large customers. This action was soon
detected by Steel company B which cut its posted price of steel from $113.50
to $88.50 per ton. Within three weeks, all of the other major producers, S
Steel included, matched Steel company B's new price.

The lower industry price was not profitable for the industry members.
Consequently, U.S. Steel signaled desire to end the price war by posting a
higher price. Steel company B waited nine days and responded with a slightly
lower price than that of S. Steel. S. Steel was once again willing to play by
industry rules.

Steel company B announced a price increase to $125 per ton. All of the other
major producers quickly followed suit, and industry discipline was restored.
Note that the price of $125 patron was higher than the original price of
$113.50.

Source: Peterson and Lewis, 2002. Managerial Economics. Pearson

282 Education Asia.
Activity 3 Pricing under
Monopolistic and
Suppose a firm is operating in a non-cooperative oligopolistic market Oligopolistic Competition

structure. It produces 400 units of output per period and sells them at Rs. 5
each. At this stage its total revenue is Rs. 2,000. The firm now thinks of
changing its price and increases it from Rs. 5 to Rs. 6. The rivals do not
change the price and the sales dip from 400 units to 200 units.

Now the firm decides to decrease the price of the product from Rs. 5 to Rs. 4
and expects the rivals to match the price decrease so as not to lose sales. Now
the sales increase marginally from 400 units to 450 units.

a) Find the total revenue of the firm when its price increases from Rs. 5 to
Rs.6.
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b) Find the total revenue of the firm when the price decreases from Rs.5 to
Rs.4.
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c) Plot the changes along with the initial price and quantity sold according
to the concept to price rigidity under oligopoly.
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Pricing Decisions
12.6 SUMMARY
In this unit we have tried to explain the concept of pricing with special
reference to monopolistic and oligopolistic competition. The effort has also
been made to include the application part of the concept of product
differentiation in monopolistic competition and the oligopolistic competition.
Talking about monopolistic competition, we have seen that in monopolistic
competition, the firm's economic profit is evaded off completely in the long
run. In the short run monopolistic competition is quite similar to monopoly.
We have discussed the oligopolistic competition in brief. The main
characteristic of oligopolistic competition seems to be mutual
interdependence and this factor decides the nature of oligopolistic
competition.

We can summarize the whole unit by saying that the basis of differentiation
between different types of competitions comprises of the number of sellers,
the number of buyers, product differentiation, and barriers to entry. These
factors decide the nature of competition in a particular market structure.

12.7 KEY WORDS

Marginal Revenue is the revenue obtained from the production and sale of
one additional unit of output.

Marginal cost is the cost arising due to the production of one additional unit
of output.

Economic profit is also known as the pure profit and is the residual left after
all contractual costs have been met.

Price leadership a firm setting up the price at profit maximizing level and
other firms following it.

Non-price competition is a form of competition used in Oligopolistic

competition where price change by firms is not involved.

12.8 SELF-ASSESSMENTQUESTIONS
1. Distinguish between perfect competition and imperfect competition,
giving examples.
2. Which of the following markets could be considered monopolistically
competitive? Explain.
Cable Television
Ball pens (low priced)
Food joints
Automobiles
3. Take the case of a monopolistically competitive firm and describe the
284 steps involved in attaining long- run equilibrium for the firm.
4. Explain whether the firms producing differentiated products are more Pricing under
Monopolistic and
likely to face price competition than the oligopolists producing
Oligopolistic Competition
homogeneous products.

5. Write short notes on:

Dominant price leadership
Barometric price leadership

6. Which of the following markets could be considered oligopolistically

competitive? Explain.
Theaters
Automobiles
Aircrafts
Restaurants
Oil producing companies
Yarns
Newspapers
Garments
Cereals
Branded products like Photo film
7. Suppose production decisions of two members of OPEC, say Iran and
Iraq are as follows. Each has just two production levels, either 2 or 4
million barrels of crude oil a day. Depending on their decisions, the total
output on the world market will be 4, 6, or 8 million barrels. Suppose the
price will be $25, $15, and $10 per barrel, respectively. Extraction costs
are $2 per barrel in Iran and $4 per barrel in Iraq.
1. Represent the game in the form of a Prisoner’s Dilemma.
2. If Iran were to cheat successfully, what would be the daily increase in
Iran’s profits?
3. If Iraq were to cheat successfully, what would be the daily increase in
Iraq’s profits?
4. For which of the countries is the cost of cheating higher. Why?
5. If it takes Iraq a month to detect Iran’s cheating and respond, how many
days will it take for the extra profits of Iran to be wiped out?
6. What are some of the mechanisms you can think of that will entice co-
operation from the two countries.

12.9 FURTHER READINGS

Mote, V. L., Paul, S., & Gupta, G. S. (2016). Managerial Economics:
Concepts and Cases, Tata McGraw-Hill, New Delhi.

Maurice, S. C., Smithson, C. W., & Thomas, C. R. (2001). Managerial

Economics: Applied Microeconomics for Decision Making. McGraw-Hill
Publishing. 285
Pricing Decisions Dholakia, R., & Oza, A. N. (1996). Microeconomics for Management
Students. Oxford University Press, Delhi.

Lewis, W. C., Jain, S. K., & Petersen, H. C. (2005). Managerial Economics

(4th ed.). Pearson

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