Market Structures: Perfect Competition, Monopoly, Monopolistic Competition, and Oligopoly

Perfect Competition

19.1 Demand Curve of a Perfectly Competitive Firm

• Definition: Perfect competition is a market structure characterized by a large number of buyers and sellers trading a homogeneous product, where prices are determined by impersonal forces. There's free entry and exit, and all participants have perfect information.
• Characteristics:
  • Numerous participants: Many buyers and sellers exist.
  • Homogeneity of product: The product is identical across sellers.
  • Price set by impersonal forces: No individual can influence the market price.
  • Free entry and exit: Firms can freely enter or leave the market.
  • Perfect information about the market: All participants have complete knowledge.
• Demand Curve:
  • The individual firm's demand curve is perfectly elastic (horizontal) at the market price, denoted as P*.
  • The market demand curve is downward sloping.

Features of the Firm’s Demand Curve

1. It is the average revenue (AR) curve of the firm
2. It is the marginal revenue (MR) curve of the firm

• For a price taker, Marginal Revenue (MR) equals the market price (P).

  $MR = \frac{\Delta TR}{\Delta Q}$

  $MR = P$

• For a price taker, Average Revenue (AR) also equals the market price (P).

  $AR = \frac{TR}{Q} = P$

• Therefore, for a perfectly competitive firm: $MR = P = AR$

19.2 Short Run Equilibrium of a Perfectly Competitive Firm

• In the short run, a perfectly competitive firm maximizes profit where Marginal Revenue (MR) equals Marginal Cost (MC).
• Total Revenue (TR) and Total Cost (TC) are compared to determine profit. Profit is maximized at the largest vertical distance between TR and TC curves.
• Break-even: Occurs when Total Revenue (TR) equals Total Cost (TC), resulting in normal profit.

Numerical Example:

• Given Price (P) = 4
• Profit is calculated as Total Revenue (TR) minus Total Cost (TC).
• Marginal revenue equals price

Marginal Cost Calculation

$marginal \, revenue = price$
$marginal \, revenue = \frac{change \, in \, total \, revenue}{change \, in \, quantity}$
$marginal \, cost = \frac{change \, in \, total \, cost}{change \, in \, quantity}$

• The profit-maximizing point is where MR = MC.

Graphical Representation

• A graph illustrates Total Cost (TC) and Total Revenue (TR) curves, showing the profit-maximizing quantity where the vertical distance between TR and TC is greatest.
• Marginal Cost (MC) and Demand/Marginal Revenue curves intersect at the profit-maximizing quantity.

19.3 Shut Down Point of a Perfectly Competitive Firm

• Shutdown Condition:
  • A firm should continue operating in the short run if Total Revenue (TR) is greater than Total Variable Cost (TVC): $TR > TVC$
  • A firm should shut down if Total Revenue (TR) is less than Total Variable Cost (TVC): $TR < TVC$
• Graphical Representation:
  • The shutdown point is where the Price is equal to the minimum Average Variable Cost (AVC).
  • The break-even point is where the Price is equal to the Average Total Cost (ATC).

19.4 Short Run Supply Curve of a Perfectly Competitive Firm

• The firm's short-run supply curve is its Marginal Cost (MC) curve above the shutdown point (minimum AVC).

19.5 Short Run Supply Curve of a Perfectly Competitive Industry

• The industry supply curve is the horizontal summation of individual firms' supply curves (MC curves above AVC).

19.6 Short Run Equilibrium of a Perfectly Competitive Industry

• Normal Profit: $AC = AR$
• Loss: $AC > AR$
• Super-normal Profit: $AC < AR$
• In the short run, the industry equilibrium occurs where market demand equals market supply.
• Firms can earn normal profits, losses, or super-normal profits, depending on the relationship between price and average cost.

Graphical Illustration

• Graphs illustrate scenarios of normal profit, loss, and super-normal profit, showing the intersection of MC and AC curves with the demand (AR) curve.

19.7 Long Run Behavior of the Firm and the Industry under Perfect Competition

• In the long run, firms can enter or exit the industry.
• If firms are making super-normal profits, new firms will enter, increasing supply and driving down the price until firms earn only normal profits.
• If firms are making losses, some firms will exit, decreasing supply and driving up the price until firms earn only normal profits.

Graphical Representation

• Graphs show the industry supply and demand curves shifting as firms enter or exit, leading to a long-run equilibrium where firms earn normal profits.
• The single firm is a price taker
• NORMAL profits only in the LONG RUN

19.8 Perfect Competition and Economic Efficiency

• In long-run competitive equilibrium, firms produce at the minimum point on their Average Cost (AC) curve.
• This means that output is produced at the lowest possible cost to society.
• The industry is guided by an invisible hand to produce the amount of output that society wants at the lowest possible cost.

Monopoly

20.1 Causes of Monopoly

• Definition: A market structure with a single firm producing a product with no close substitutes, and where entry is very difficult.
• Characteristics:
  1. Single producer exists in the industry
  2. No close substitutes for the firm’s products
  3. Difficult entry
• Causes of Monopoly:
  1. Legal Restriction
  2. Patents
  3. Control of a scarce resources or input
  4. Technical Superiority
  5. Economies of Scale

20.2 Monopolist's Demand Curve

• The monopolist's demand curve is the market demand curve, which is downward sloping.

20.3 Marginal Revenue Curve Faced by a Monopolist

• The monopolist's Marginal Revenue (MR) curve lies below its demand curve.
• This is because the monopolist must lower the price on all units to sell an additional unit.

Numerical Example

• Total Revenue (TR), Average Revenue (AR), and Marginal Revenue (MR) are calculated at different quantities.

Key Observations

1. The slope of the demand curve is half that of the MR curve
2. MR is positive as long as the demand curve is elastic
3. MR is zero when the price elasticity is equivalent to 1 (unit elasticity)
4. MR is negative when the price elasticity of demand is inelastic or less than 1

20.4 Short-Run Equilibrium of a Monopolist

• The monopolist maximizes profit by producing where Marginal Revenue (MR) equals Marginal Cost (MC).

Numerical Example

• Total Revenue (TR), Total Cost (TC), Marginal Revenue (MR), and Marginal Cost (MC) are calculated.

Profit Calculation

• Profit is Total Revenue (TR) - Total Cost (TC).
• The monopolist earns normal profits if Average Cost (AC) = Average Revenue (AR).
• The monopolist earns super-normal profits if Average Cost (AC) < Average Revenue (AR).
• The monopolist incurs losses if Average Cost (AC) > Average Revenue (AR).

Graphical Representation

• Graphs illustrate scenarios of normal profit, super-normal profit, and loss.

20.5 Long Run Equilibrium of the Monopolist

• In the long run, the monopolist can adjust its plant size to maximize profits.
• The conditions for long-run equilibrium are:
  1. LMC = SMC = MR
  2. LMC & SMC cut MR from below
  3. SAC must be tangential to LAC

20.6 Pricing Strategies of a Monopolist

• Price Discrimination: Selling different units of output at different prices for reasons not associated with differences in costs.

Requirements for Price Discrimination:

1. A buyer in one market should not have access to the other Markets.
2. The price elasticity of demand should be different in different markets.

Types of Price Discrimination:

• First Degree (Perfect Price Discrimination): Charging each customer the maximum price they are willing to pay.
• Second Degree: Price varies according to quantity demanded. Larger quantities are available at a lower unit price.
• Third Degree: Segregating the market into different PEDS (price elasticity of demands) and changes the consumers with different prices, when the goods are identical.

20.7 Welfare Implications of Monopoly

• Monopoly prices are higher and output is lower compared to perfect competition, leading to a deadweight loss.

20.8 Comparison of Monopoly & Perfect Competition

Monopolistic Competition

Definition

• A market structure with a large number of firms, each producing a differentiated product, and where there is freedom of entry and exit.

21.1 Demand Curve Faced by Monopolistically Competitive Firm

• The demand curve is downward sloping, but more elastic than a monopolist's demand curve.

Key Differences from Perfect Competition:

1. The demand curve of a single perfectly competitive firm does not change but the shape of the demand curve of a monopolistically competitive firm could be changed by the marketing strategies used by each single firm.

21.2 Short-Run Equilibrium of a Monopolistically Competitive Firm

• The firm maximizes profit where Marginal Revenue (MR) equals Marginal Cost (MC).

Outcomes:

• Short-Run Economic Profit: Positive economic profit.
• Short-Run Loss: Incurring losses.

21.3 Short-Run Equilibrium of the Monopolistically Competitive Industry

• Assumptions for industry analysis:
  1. The demand curves faced by each firm are similar in their shape.
  2. The cost curves of each firm are similar to each other.

21.4 Long-Run Equilibrium of the Monopolistically Competitive Firm and Industry

• In the long run, entry and exit of firms drive economic profits to zero.
• Firms produce where Average Revenue (AR) equals Average Total Cost (ATC).

21.5 Welfare Implications of Monopolistic Competition

• Monopolistically competitive markets do not have all the desirable welfare properties of perfectly competitive markets.
• Because P > MC, the market quantity is below the socially efficient quantity.

Summary Table: Market Type Comparison

Oligopoly

Definition

• A market structure characterized by a few firms producing either identical or differentiated products, interdependent on each other.

Characteristics:

• Consisted of a very few number of sellers.
• Pricing and output strategies of one firm can influence the actions of others.
• The products of the firms may be identical or differentiated.

Barriers to Entry:

• Economies of scale
• Patents
• Technology
• Name recognition
• Strategic actions

Interdependence

• Your actions affect the profits of your rivals.
• Your rivals' actions affect your profits.

Duopoly Models:

1. The Cournet Model (1938)
2. The Edgeworth Model (F.Y. Edgeworth 1987)
3. Chamberlain Model
4. The Kinked demand Curve Analysis
5. Price Leadership Model

22.1 The Cournet Model (1938)

• Oligopoly model in which firms produce a homogeneous good, each firm treats the output of its competitors as fixed, and all firms decide simultaneously how much to produce.

Assumptions of the Cournot model

• There are two firms and no other firms can enter in the market
• The firms have identical costs
• They sell identical products
• The firms set their quantities simultaneously

22.2 The Edgeworth Model (F.Y. Edgeworth 1987)

22.3 Chamberlain Model

22.4 The Kinked Demand Curve Analysis

• This model explain the price rigidity in the oligopolistic markets

22.5 Price Leadership Model

• Instances where one or two firms set the price and others follow that.

Three different types of price leadership:

• dominant
• Collusive
• Barometric.
• A Cartel is an organization formed by a group of oligopolists to limit the competition among them

22.6 Welfare Implications of Oligopoly

• The oligopolists always attempt to form mutual agreements in order to maximize their profits.
• On the other hand, the oligopolists exercise non-price competition when they decide on a single price. Then aggressive marketing strategies will be largely adopted.