market profitmax

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Perfect Competition

and

Pure Monopoly

Prof. Deepti Ahuja

E.M.D.M.

PGP/SS/2010-12//SEM1



Alternative Market StructuresAlternative Market Structures

• Classifying markets (by degree of competition)

– number of firms

– freedom of entry to industry

• free, restricted or blocked? – nature of product

• homogeneous or differentiated?

– nature of demand curve

• degree of control the firm has over price

• Classifying markets (by degree of competition)

– number of firms

– freedom of entry to industry

• free, restricted or blocked? – nature of product

• homogeneous or differentiated?

– nature of demand curve

• degree of control the firm has over price



TYPES OF MARKETTYPES OF MARKET

PERFECT COMPETITION

PURE MONOPOLY

AS WE MOVE GREATER DEGREE OF MONOPOLY WILL BEEXERCISE BY FIRM

LESS COMPETITION WITH GREATER IMPERFECTION

MONOPOLISTIC

COMPETITIONOLIGOPOLY DUOPOLY



Features of the four market structuresFeatures of the four market structures



Alternative Market StructuresAlternative Market Structures

• The four market structures

– perfect competition

– monopoly

– monopolistic competition

– oligopoly

• Structure→ conduct→performance

• The four market structures

– perfect competition

– monopoly

– monopolistic competition

– oligopoly

• Structure→ conduct→performance



Perfect CompetitionPerfect Competition

• Assumptions

– firms are price takers

– freedom of entry of firms to industry

– identical products

– perfect knowledge

• Distinction between short and long run

– normal profits – supernormal profits

• Assumptions

– firms are price takers

– freedom of entry of firms to industry

– identical products

– perfect knowledge

• Distinction between short and long run

– normal profits – supernormal profits




• Short-run equilibrium of the firm

– Price

• given by market demand and supply

– Output

• where P = MC

– Profit

• ( AR – AC ) × Q

• possible supernormal profits

• Short-run equilibrium of the firm

– Price

• given by market demand and supply

– Output

• where P = MC

– Profit

• ( AR – AC ) × Q • possible supernormal profits



O

£

(b) Firm

Q (thousands)

O

(a) Industry

P

Q (millions)

S

D

P e

MC

AR D = AR = MR

Qe

AC

AC

Short-run equilibrium of industry and firm under perfect

competition (profits)

Short-run equilibrium of industry and firm under perfect

competition (profits)



Qe

P 1D1 = AR 1

= MR 1 AR 1

O O

(a) Industry

P £

Q (millions)

S

D

(b) Firm

MC AC

AC

Q (thousands)

Loss minimising under perfect competitionLoss minimising under perfect competition



D2

Short-run shut-down pointShort-run shut-down point

O O

(a) Industry

P £

P 2

Q (millions)

S

(b) Firm

AR 2

D2 = AR 2

= MR 2

MC AC

AV

Q (thousands)




• Short-run equilibrium of the firm (cont.)

– short-run supply curve of firm

• the MC curve

• Short-run supply curve of industry

– sum of supply curves of firms

• Short-run equilibrium of the firm (cont.)

– short-run supply curve of firm

• the MC curve

• Short-run supply curve of industry

– sum of supply curves of firms




•The long run – long-run equilibrium of the firm

• all supernormal profits competed away

• The long run

– long-run equilibrium of the firm




O O

P £

Q (millions)

S 1

D

LRAC

P L

P 1

QL

S e

AR 1 D1

AR L DL

Q (thousands)

Long-run equilibrium under perfect competitionLong-run equilibrium under perfect competition

New firms enterSupernormal profits Profits returnto normal

(a) Industry (b) Firm




• The long run – long-run equilibrium of the firm


• LRAC = AC = MC = MR = AR

• The long run – long-run equilibrium of the firm





£

QO

(SR)AC

(SR)MC

LRAC

AR = MR

DL

LRAC = (SR)AC = (SR)MC = MR = AR

Long-run equilibrium of the firm under perfect competitionLong-run equilibrium of the firm under perfect competition




• The long run




– long-run industry supply curve

– incompatibility of economies of scale with perfectcompetition

• Does the firm benefit from operating under perfectcompetition?

• The long run




– long-run industry supply curve

– incompatibility of economies of scale with perfectcompetition

• Does the firm benefit from operating under perfectcompetition?



MONOPOLYMONOPOLY

MONOPOLY IS THE MARKET STRUCTURE IN WHICHTHERE IS A SINGLE SELLER, NO CLOSESUBSTITUTESFOR THE COMMODITY AND THERE

ARE BARRIERS TO ENTRY

MONOPOLY IS THE MARKET STRUCTURE IN WHICHTHERE IS A SINGLE SELLER, NO CLOSESUBSTITUTESFOR THE COMMODITY AND THERE

ARE BARRIERS TO ENTRY



CAUSES OF MONOPOLYCAUSES OF MONOPOLY

OWNERSHIP OF STRATEGIC RAW MATERIAL

EXCLUSIVE KNOWLEDGE OF PRODUCTIONTECHNIQUES

PATENT RIGHTS

GOVERNMENT LICENSINGSIZE OF MARKET THAT NOT SUPPORT MORE THAN

ONE PLANT OF OPTIMAL – GIVE RISE TO NATURALMONOPOLY

OWNERSHIP OF STRATEGIC RAW MATERIAL

EXCLUSIVE KNOWLEDGE OF PRODUCTIONTECHNIQUES

PATENT RIGHTS

GOVERNMENT LICENSINGSIZE OF MARKET THAT NOT SUPPORT MORE THAN

ONE PLANT OF OPTIMAL – GIVE RISE TO NATURALMONOPOLY



MonopolyMonopoly

•The monopolist's demand curve – downward sloping

– MR below AR

•The monopolist's demand curve – downward sloping

– MR below AR



-2

0

2

4

6

8

1 2 3 4 5 6

AR and MR curves for a monopoly AR and MR curves for a monopoly

Q

(units)

1

23

4

5

6

7

P

=AR

(£)8

76

5

4

3

2

AR AR,M

R ( £ )

Quantity



-2

0

2

4

6

8

1 2 3 4 5 6 7

Q

(units)

1

23

4

5

6

7

P

=AR

8

76

5

4

3

2

TR

8

1418

20

20

18

14

MR

64

2

0

-2

-4

MR

AR,M

R ( £ )

Quantity

AR

AR and MR curves for a monopoly AR and MR curves for a monopoly



Profit maximising under monopolyProfit maximising under monopoly

MR

£

QO

MC

Qm

P fi i i i d l



£

QO

MC

AC

Qm

MR

AR

AC

AR

Total profit

Profit maximising under monopolyProfit maximising under monopoly



Where MC = MR,losses areminimal

Where MC = MR,losses areminimal

MR

P

0 Q

D=AR

AC

MC



MC

MR

P

0 Q

D=AR

ACPm

Qm

Here is a monopoly breaking evenHere is a monopoly breaking even



Price discrimination exists when the same product is soldat different prices to different buyers . The product isbasically the same , produced at the same cost , which is

sold at different prices depending on the preference of thebuyers , their income , their location.

Price discrimination exists when the same product is soldat different prices to different buyers . The product isbasically the same , produced at the same cost , which is

sold at different prices depending on the preference of thebuyers , their income , their location.



The market must be divided into sub markets with differeprice elasticities

There must be effective separation of the sub markets sothat no reselling can take place from a low price market toa high price market

The market must be divided into sub markets with differenprice elasticities

There must be effective separation of the sub markets sothat no reselling can take place from a low price market toa high price market

NECESSARY CONDITIONS



TYPESTYPES

• DISCRIMINATION OWING TO CONSUMER’SPECULARITIES

• DISCRIMINATION OWING TO NATURE OF THEPRODUCT

• DISCRIMINATION OWING TO THE DISTANCE ANDFRONTIER BARRIERS

• DISCRIMINATION OWING TO CONSUMER’SPECULARITIES

• DISCRIMINATION OWING TO NATURE OF THEPRODUCT

• DISCRIMINATION OWING TO THE DISTANCE ANDFRONTIER BARRIERS



EQUILIBRIUMEQUILIBRIUM

• Condition of profitable price discrimination isMR1 = MR2=MC

• The total cost function of monopolist is same

MC

• Price discrimination can be carried on profitably onlyif elasticities are different in two markets

• Condition of profitable price discrimination isMR1 = MR2=MC

• The total cost function of monopolist is same

MC

• Price discrimination can be carried on profitably onlyif elasticities are different in two markets



P

Q1

P

1

0 AR1MR1qi

AR MR

q2

p2

AR2

MR2Q2

AR

MR MCMR

E

Qq

MC

P*



FIRST DEGREE DISCRIMINATION – extreme form of discrimination and is known as perfect

discrimination.

FIRST DEGREE DISCRIMINATION – extreme form of discrimination and is known as perfect

discrimination.

P

Q

DD

0

p

p3

p2

p1

q1q2 q3

e

DEGREES



• Imperfect form of discrimination

• Instead of setting different prices it involves pricing based othe quantities of output purchased by individual consumers

• Imperfect form of discrimination

• Instead of setting different prices it involves pricing based othe quantities of output purchased by individual consumers

p

q

p1

p2

p3

q1 q20

SECOND DEGREE



Most common form of price discrimination

Involves separating consumers or markets in terms of their price elasticity of demand

Discrimination can be based on the nature of use

Market can be segmented based on personalcharacteristics of consumers

Often occurs in the markets that are geographically

separated

Most common form of price discrimination

Involves separating consumers or markets in terms of their price elasticity of demand

Discrimination can be based on the nature of use

Market can be segmented based on personalcharacteristics of consumers

Often occurs in the markets that are geographicallyseparated

THIRD DEGREE

S E l f P i Di i i tiS E l f P i Di i i ti



Some Examples of Price DiscriminationSome Examples of Price Discrimination

– Doctors often charge rich patients more than poor patients

• They may have one price for those with insuranceand another price for those without insurance

– Movies in the evening cost more than those in theearly afternoon

– Senior citizen, youth, and student discounts

– Evening meals in restaurants often cost more than

the same meal at lunch

– Doctors often charge rich patients more than poor patients

• They may have one price for those with insuranceand another price for those without insurance

– Movies in the evening cost more than those in theearly afternoon

– Senior citizen, youth, and student discounts

– Evening meals in restaurants often cost more than

the same meal at lunch

BILATERAL MARKETBILATERAL MARKET



BILATERAL MARKETBILATERAL MARKET

• Consist of a single seller and single buyer

• Equilibrium will not be determined by traditional tools of demand and supply

• Economic analysis can only define the range within whichprice will eventually be settled

• Precise level of price and quantity will be defined by noneconomic factors like bargaining power , skill and other strategies of firm

• Consist of a single seller and single buyer

• Equilibrium will not be determined by traditional tools of demand and supply

• Economic analysis can only define the range within whichprice will eventually be settled

• Precise level of price and quantity will be defined by noneconomic factors like bargaining power , skill and other strategies of firm



Monopsony

Monopsony is a market consisting of single buyer that canpurchase from many sellers

Some buyers may have monopsony power : a buyer’sability to affect the price of a good. Monopsony power

enables the buyer to purchase the good for less than the

price that would prevail in the competitive market

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