Perfect and Imperfect Competition

Perfect Competition

• Many buyers, no one of which is large relative to the overall market

• Many sellers, no one of which is large relative to the overall market

• The outputs of different sellers are homogeneous (products are exactly the same)

• Buyers are well informed about the offerings of competing suppliers

• Neither technological nor legal barriers to entry exist

Imperfect Competition

• In most situations, firms can differentiate their products from those of their competitors

• Many firms are price setters - they have at least some latitude to set their own prices

• They have market power – they have the ability to raise the price of a good without losing all of its sales

Perfect Competiton vs Imperfect Competition

Perfect competition:

• Demand curve is perfect elastic - no matter how many units of product the firm produces, the market price won’t be affected at all

• If price increases you may lose all customers

• Price taker

Imperfect competition:

• Demand curve is downwards sloping - if output level increases, market price decreases

• If price increases you will not immediately lose all consumers

• Price setter

Forms of Imperfect Competition

• Pure Monopoly - A market in which a single firm (monopolist) is the only seller of a unique product. It is the polar opposite to perfect competition

• Oligopoly - A market structure in which only a few firms (oligopolists) sell a given product

• Monopolistic competition - Competition consists of a relatively large number of firms that sell the same product with slight differentiations

Monopoly

• Many buyers, no one of which is large relative to the overall market 

• One seller 

• There are no close substitutes 

• Buyers are well informed about the offerings of competing suppliers 

• Either technological or legal barriers completely block entry

Relationship between Average and Marginal Revenue in Monopoly

• Marginal revenue has same intercept but slope is twice as deep as average revenue

• If given average revenue and need marginal revenue just multiply gradient by 2

Marginal Revenue when Total Revenue is Maximised

=0

• If producer makes more the marginal revenue will be negative

• Less money - total revenue will drop

Total Revenue

Given by average revenue times quantity sold, TR = aq – bq^2

 Marginal Revenue

Given by the rate of change of total revenue with respect to quantity sold (differentiation)

MR = d(TR)/d(q)

Cost

The shape of total costs is determined by the law of diminishing marginal product (in the short run) and by economies and diseconomies of scale (in the long run). Typically total costs are an inverse-S shape

More you produce - more total cost you have

The more you produce the less you need to pay per unit of product up to a certain point where it increases again

Marginal cost always intersects at the minimum point of the average cost

• If marginal cost is below average cost the average cost decreases

• If marginal cost is above average cost the average cost increases

Profit Maximisation

When marginal revenue = marginal cost profit can be maximised

Profits are maximised where TR>TC and the vertical distance between TR and TC is greatest

Find this at the point where the TR slope = TC slope, where they are in parallel

TR slope = marginal revenue

TC slope = marginal cost

Therefore when they are equal is where profit is maximised

Why is Monopoly Inefficient

Demand curve: quantity = Q* and price = p*

Total revenue = p* Q 

Total cost = AC (at Q*) Q

Profit = total revenue - total cost (blue rectangle)

there is no profit therefore no producer surplus

larger than the total surplus (consumer surplus + profit in monoploy)

therefore monopoly is ineffient as it has less overall surplus/profit

Price Discrimination

he case where customers are charged different prices for the same good

Conditions necessary for profitable price discrimination:

1. The firm must be a price maker

2. The firm must be able to identify which consumer is which

3. Consumers must not be able to arbitrage 

Arbitrage

The process whereby customers to whom the firm charges low price make purchases that they then resell to customers who would otherwise have to pay high prices

First Degree Price Discrimination (Perfect Price Discrimination)

• The monopolist knows exactly the willingness to pay of each consumer in the market

• It then sell each unit of output at a price just equal to the buyer’s maximal willingness to pay for that unit

  • Everyone ends up paying a different price for the same product

  • Efficient in the way that the producer gets all the surplus - no consumer surplus

Second Degree Price Discrimination

• The monopolist knows that its customers have different willingness to pay but it cannot tell who is who

• The same price schedule is offered to all buyers but they sort themselves through self selection

  • E.g. hiding promo codes only for people who are willing/have time to search online for them

Third Degree Price Discrimination

• The monopolist does not know each consumer’s willingness to pay. Instead, the monopolist sees an observable characteristic (such as age, gender, race, and so on) of its consumers that is related to their willingness to pay

• The monopoly then charge different prices based on these

  • E.g. charging older people more than younger people as they stereotypically have more money - 18-25 railcard discounts