26  Price determination under different market forms: Perfect competition; Monopolistic competition; Oligopoly- Price leadership model; Monopoly; Price discrimination

26.1 Market Forms — A Taxonomy

A market is a set of arrangements through which buyers and sellers exchange goods or services. The behaviour of price and output in any market depends on the number of sellers, the degree of product differentiation, freedom of entry/exit, and the quality of information. The classic four-fold classification — perfect competition, monopolistic competition, oligopoly, monopoly — was given essentially complete shape between Marshall (1890), Chamberlin (1933) and Joan Robinson (1933). A monopsony (one buyer) and bilateral monopoly (one seller and one buyer) are special cases.

TipMarket Forms at a Glance
Form Number of sellers Product Entry Price-setter?
Perfect competition Very large Homogeneous Free Price-taker
Monopolistic competition Many Differentiated Free Some control
Oligopoly Few Homogeneous / Differentiated Restricted Interdependent
Monopoly One Unique; no close substitute Blocked Full control
Monopsony Many sellers, one buyer n.a. n.a. Buyer-side

26.2 Perfect Competition

26.2.1 Features

TipFeatures of Perfect Competition
  • Large number of buyers and sellers — each negligible.
  • Homogeneous product — perfect substitutes.
  • Free entry and exit.
  • Perfect knowledge of prices and products.
  • Perfect mobility of factors of production.
  • No transport cost.
  • No government interference.

26.2.2 Demand and Revenue Curves

Each firm is a price-taker — the firm’s demand curve is horizontal at the market price. Hence: - \(AR = P\) (horizontal). - \(MR = AR = P\).

26.2.3 Short-Run Equilibrium

A firm maximises profit where \(MC = MR = P\), with MC rising. Three possible short-run outcomes:

TipShort-Run Outcomes in Perfect Competition
Outcome Condition Profit
Super-normal profit P > ATC at the equilibrium output Positive economic profit
Normal profit P = ATC Zero economic profit
Loss but operating AVC < P < ATC Loss but variable costs covered
Shutdown P < AVC Firm shuts down

The shutdown price = minimum AVC; break-even price = minimum ATC.

26.2.4 Long-Run Equilibrium

In the long run, free entry/exit drives economic profit to zero: - Profits attract entry → market supply ↑ → price falls. - Losses cause exit → market supply ↓ → price rises. - Equilibrium: $P = MC = AC = $ minimum LRAC = MR. - Each firm operates at its most efficient scale.

26.3 Monopoly

26.3.1 Features

TipFeatures of Monopoly
  • Single seller of a product with no close substitute.
  • Blocked entry due to legal barriers (patents, licences), economies of scale (natural monopoly), control of essential input, or government franchise.
  • Price-maker — firm sets price; demand curve is the market demand (downward-sloping).
  • AR > MR for all positive quantities.
  • No supply curve — monopolist chooses a P-Q combination from the demand curve.

26.3.2 Equilibrium

Profit is maximised at MR = MC, with MC cutting MR from below. Monopoly price > monopoly MC; firm earns positive economic profit if AC < P at equilibrium output.

Compared with perfect competition: monopoly produces less and charges more, generating a deadweight welfare loss.

26.3.3 Price Discrimination

A price-discriminating monopolist charges different prices for the same product in different markets / to different buyers. Three conditions must hold:

TipConditions for Price Discrimination
  • Monopoly power — the firm must be a price-maker.
  • Market separation — buyers in different markets can be separated; no arbitrage.
  • Different price elasticities — different markets must have different elasticities.

26.3.4 Degrees of Price Discrimination (Pigou, 1920)

TipThree Degrees of Price Discrimination
Degree Working content Example
First-degree (perfect) Each unit sold at the consumer’s maximum willingness to pay Personalised auctions; some health-care fees
Second-degree (block / quantity) Different price per unit by quantity Telecom tariff slabs; electricity blocks
Third-degree (group) Different price by market segment Student vs adult cinema tickets; export vs domestic; rural vs urban

For third-degree to be profitable: \(\frac{MR_1}{MR_2} = 1\) but \(P_1 \neq P_2\) if elasticities differ. The market with less elastic demand gets the higher price.

26.4 Monopolistic Competition — Chamberlin (1933)

Edward Chamberlin (The Theory of Monopolistic Competition, 1933) modelled markets like restaurants, retail, branded toothpaste, soap — many firms, differentiated product, free entry.

26.4.1 Features

TipFeatures of Monopolistic Competition
  • Many sellers, but fewer than under perfect competition.
  • Product differentiation — through brand, design, packaging, location, service.
  • Some control over price — each firm faces a downward-sloping (but elastic) demand.
  • Free entry and exit — in the long run.
  • Heavy non-price competition — advertising, branding.
  • Excess capacity in long-run equilibrium.

26.4.2 Short-Run and Long-Run

  • Short run — firm equates MR with MC and can earn supernormal profit, normal profit, or loss.
  • Long run — entry erodes profit to normal (zero economic profit); P = AC at the tangency of demand curve with AC curve.
  • Long-run output is below the minimum-cost level — the firm operates with excess capacity (Chamberlin’s notable insight).

26.5 Oligopoly

26.5.1 Features

TipFeatures of Oligopoly
  • Few sellers — each large enough to affect market price.
  • Mutual interdependence — each firm’s price/output decision depends on rivals’ responses.
  • Barriers to entry — moderate to high.
  • Non-price competition — advertising, product improvement, after-sales service.
  • Price rigidity — prices tend to stick once set.
  • Product can be homogeneous (steel, cement) or differentiated (cars, mobile phones).

26.5.2 Major Oligopoly Models

TipMajor Oligopoly Models
Model Author / Year Key idea
Cournot Duopoly Augustin Cournot, 1838 Each firm chooses output assuming rival’s output is fixed
Bertrand Joseph Bertrand, 1883 Each chooses price assuming rival’s price is fixed → P = MC (paradox)
Stackelberg Heinrich von Stackelberg, 1934 Leader chooses output first; follower reacts
Edgeworth F.Y. Edgeworth, 1925 Cycles in pricing under capacity constraint
Kinked Demand Paul Sweezy (1939), Hall and Hitch Price rigidity — rivals match cuts but not rises
Price Leadership (See below) One firm leads; others follow
Cartel — Collusion to maximise joint profit (e.g., OPEC)
Prisoner’s Dilemma / Game Theory Nash, 1950 Strategic interdependence via Nash equilibrium

26.5.3 Price Leadership Models

TipTypes of Price Leadership
Type Working content
Dominant-firm leadership One large firm sets the price; small firms accept it
Barometric leadership A firm with good market intelligence acts as “barometer”; rivals follow
Collusive leadership Firms agree (tacit or explicit) on a leader
Low-cost leadership The firm with the lowest costs leads price

26.5.4 Kinked Demand — Sweezy (1939)

The Sweezy model explains price rigidity in oligopoly: - If a firm raises its price, rivals do not follow → demand falls sharply → demand curve is elastic above the current price. - If a firm lowers its price, rivals do follow to protect share → demand rises only modestly → demand curve is inelastic below the current price. - The result: a kink at the current price, and a gap in the MR curve at the kinked output, so that the firm has no incentive to change price even when MC shifts within the gap.

flowchart LR
  P[Sweezy Kinked<br/>Demand] --> AB[Above current price<br/>elastic — rivals do not<br/>match price rise]
  P --> BE[Below current price<br/>inelastic — rivals<br/>match price cut]
  AB --> R[Result: price rigidity]
  BE --> R
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

26.6 Comparison of Market Forms

TipEquilibrium Outcomes Across Market Forms
Aspect Perfect Competition Monopolistic Competition Oligopoly Monopoly
Firm’s demand Horizontal Downward, elastic Kinked / strategic Downward, market demand
P vs MC P = MC P > MC P > MC P > MC
Long-run profit Zero Zero Positive Positive
Efficiency At minimum AC Excess capacity Generally inefficient Inefficient (DWL)

26.7 Practice Questions

Q 01 PC Easy

Under perfect competition, the firm's demand curve is:

  • ADownward sloping
  • BHorizontal at the market price
  • CVertical
  • DKinked
View solution
Correct Option: B
Each firm is a *price-taker* — demand horizontal at market price; AR = MR = P.
Q 02 Shutdown Medium

In perfect competition, the *shutdown* price equals:

  • AMinimum ATC
  • BMinimum AVC
  • CMinimum MC
  • DMinimum AFC
View solution
Correct Option: B
Shut down if P < AVC. Break-even = min ATC.
Q 03 Monopolistic Medium

Monopolistic competition was developed by:

  • AAlfred Marshall
  • BEdward Chamberlin (1933)
  • CAugustin Cournot
  • DPaul Sweezy
View solution
Correct Option: B
**Chamberlin (1933)**; Joan Robinson (same year) developed *Imperfect Competition* parallel.
Q 04 Excess capacity Medium

In long-run equilibrium, monopolistic competitors operate with:

  • AZero capacity
  • BExcess capacity
  • CFull capacity at minimum AC
  • DRandom output
View solution
Correct Option: B
Tangency of downward-sloping demand to AC is to the *left* of minimum AC → **excess capacity**.
Q 05 Authors Medium

Match each oligopoly model with its author:

Model Author
(i) Duopoly with output choice (a) Joseph Bertrand
(ii) Duopoly with price choice (b) Heinrich von Stackelberg
(iii) Leader-Follower (c) Paul Sweezy
(iv) Kinked demand (d) Augustin Cournot
  • A(i)-(d), (ii)-(a), (iii)-(b), (iv)-(c)
  • B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
  • C(i)-(b), (ii)-(d), (iii)-(c), (iv)-(a)
  • D(i)-(c), (ii)-(b), (iii)-(d), (iv)-(a)
View solution
Correct Option: A
Cournot — output; Bertrand — price; Stackelberg — leader-follower; Sweezy — kinked demand.
Q 06 Kinked Medium

The kinked-demand model explains:

  • APrice war
  • BPrice rigidity in oligopoly
  • CPerfect competition
  • DMonopoly profit
View solution
Correct Option: B
Sweezy's kink — rivals match cuts but not rises → price tends to stick.
Q 07 Pigou Medium

The three degrees of price discrimination were classified by:

  • AA.C. Pigou (1920)
  • BA. Marshall
  • CJ. Robinson
  • DHicks
View solution
Correct Option: A
**Pigou (1920)** — *Economics of Welfare*; three degrees.
Q 08 PD Conditions Medium

Which is **not** a condition for successful price discrimination?

  • AMonopoly power
  • BDifferent elasticities in different markets
  • CNo arbitrage between markets
  • DPerfectly elastic demand in both markets
View solution
Correct Option: D
Need *different* elasticities; perfectly elastic on both sides would prevent discrimination.
Q 09 PD Match Medium

Match each degree of price discrimination with its example:

Degree Example
(i) First-degree (a) Student vs adult cinema ticket
(ii) Second-degree (b) Block tariff for electricity
(iii) Third-degree (c) Personalised auction price
  • A(i)-(c), (ii)-(b), (iii)-(a)
  • B(i)-(a), (ii)-(b), (iii)-(c)
  • C(i)-(b), (ii)-(c), (iii)-(a)
  • D(i)-(c), (ii)-(a), (iii)-(b)
View solution
Correct Option: A
First — unit-by-unit; Second — block/quantity; Third — group/segment.
Q 10 Pricing Medium

A discriminating monopolist will charge a **higher** price in the market with:

  • AMore elastic demand
  • BLess elastic demand
  • CHigher MC
  • DLower MC
View solution
Correct Option: B
Less elastic ⇒ higher mark-up over MC.
Q 11 Long-run PC Medium

In long-run equilibrium of perfect competition, P equals:

  • AMR only
  • BMR = MC = AC at minimum LRAC
  • CP > MC
  • DP > AC
View solution
Correct Option: B
**P = MR = MC = AC** at minimum LRAC; zero economic profit.
Q 12 Cartel Medium

OPEC is a famous real-world example of:

  • APerfect competition
  • BMonopolistic competition
  • CCartel oligopoly
  • DMonopsony
View solution
Correct Option: C
**OPEC** — collusive oligopoly / cartel of oil exporters.
Q 13 Compare Medium

Compared with perfect competition, monopoly:

  • AProduces more, charges less
  • BProduces less, charges more, generates deadweight loss
  • CHas free entry
  • DCharges P = MC
View solution
Correct Option: B
Monopoly: lower Q, higher P, **deadweight loss** of consumer surplus.
Q 14 Robinson Hard

Imperfect Competition theory was developed parallel to Chamberlin's by:

  • AHicks
  • BJoan Robinson (1933)
  • CCournot
  • DSweezy
View solution
Correct Option: B
**Joan Robinson** — *Economics of Imperfect Competition* (1933).
Q 15 Monopsony Medium

A monopsony is a market with:

  • AOne seller
  • BOne buyer
  • CFew sellers
  • DFree entry
View solution
Correct Option: B
Monopsony — single buyer; common in some labour markets.
Q 16 Leadership Medium

Match each type of price leadership with its definition:

Type Definition
(i) Dominant-firm leadership (a) Firm with good info sets price; rivals follow
(ii) Barometric leadership (b) Large firm sets price; small firms accept
(iii) Low-cost leadership (c) Firm with lowest costs leads the price
  • A(i)-(b), (ii)-(a), (iii)-(c)
  • B(i)-(a), (ii)-(b), (iii)-(c)
  • C(i)-(c), (ii)-(b), (iii)-(a)
  • D(i)-(b), (ii)-(c), (iii)-(a)
View solution
Correct Option: A
Dominant — large firm; barometric — informed firm; low-cost — cost leader.
Q 17 Cournot Hard

The first formal model of duopoly, based on output reaction functions, was given by:

  • AAugustin Cournot (1838)
  • BJoseph Bertrand (1883)
  • CStackelberg (1934)
  • DSweezy (1939)
View solution
Correct Option: A
**Cournot (1838)** — *Researches into the Mathematical Principles of the Theory of Wealth*.
Q 18 Long run MC Hard

In long-run equilibrium under monopolistic competition:

  • AP = MC = AC at minimum AC
  • BP = AC, but above minimum AC; P > MC
  • CP > AC and P > MC
  • DP < AC
View solution
Correct Option: B
Tangency at downward-sloping demand → P = AC (zero profit) but **P > MC**, output below minimum AC ⇒ **excess capacity**.
Q 19 Monopoly Medium

A monopolist maximises profit where:

  • AP = MC
  • BMR = MC, with MC rising
  • CP = AC
  • DP = AR
View solution
Correct Option: B
MR = MC with MC cutting MR from below — universal first-order condition.
Q 20 DWL Hard

The deadweight welfare loss of monopoly arises because:

  • AMonopolist earns supernormal profit
  • BOutput is restricted below the competitive level; P > MC
  • CMarginal cost rises
  • DFixed cost is high
View solution
Correct Option: B
P > MC ⇒ society values extra units more than they cost → restricted output is the source of DWL.

26.8 Quick Recall

ImportantQuick recall
  • Four market forms: Perfect competition, Monopolistic competition, Oligopoly, Monopoly. Plus monopsony (one buyer).
  • Perfect competition: many sellers, homogeneous product, free entry, perfect info; firm is price-taker; AR = MR = P. SR: shutdown if P < min AVC; break-even at min ATC. LR: P = MR = MC = AC at min LRAC.
  • Monopoly: single seller, blocked entry; MR < AR; profit max where MR = MC; lower output, higher price, deadweight loss.
  • Price discrimination (Pigou 1920): First (unit), Second (block/quantity), Third (group/segment). Conditions: monopoly power, market separation, different elasticities. Higher price in less-elastic market.
  • Monopolistic competition (Chamberlin 1933; Joan Robinson 1933 parallel): many firms, product differentiation, free entry; LR — zero profit at tangency of D and AC; excess capacity.
  • Oligopoly: few firms, mutual interdependence. Models: Cournot (1838 — output), Bertrand (1883 — price), Stackelberg (1934 — leader/follower), Sweezy 1939 kinked demand (price rigidity), Cartel (OPEC).
  • Price leadership: dominant-firm, barometric, collusive, low-cost.