market profitmax
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Perfect Competition
and
Pure Monopoly
Prof. Deepti Ahuja
E.M.D.M.
PGP/SS/2010-12//SEM1
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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
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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
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Features of the four market structuresFeatures of the four market structures
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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
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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
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Perfect CompetitionPerfect Competition
• 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
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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)
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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
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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)
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Perfect CompetitionPerfect Competition
• 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
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Perfect CompetitionPerfect Competition
•The long run – long-run equilibrium of the firm
• all supernormal profits competed away
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
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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
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Perfect CompetitionPerfect Competition
• The long run – long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
• The long run – long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
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£
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
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Perfect CompetitionPerfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
– 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 equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
– long-run industry supply curve
– incompatibility of economies of scale with perfectcompetition
• Does the firm benefit from operating under perfectcompetition?
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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
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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
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MonopolyMonopoly
•The monopolist's demand curve – downward sloping
– MR below AR
•The monopolist's demand curve – downward sloping
– MR below AR
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-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
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-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
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Profit maximising under monopolyProfit maximising under monopoly
MR
£
QO
MC
Qm
P fi i i i d l
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£
QO
MC
AC
Qm
MR
AR
AC
AR
Total profit
Profit maximising under monopolyProfit maximising under monopoly
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Where MC = MR,losses areminimal
Where MC = MR,losses areminimal
MR
P
0 Q
D=AR
AC
MC
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MC
MR
P
0 Q
D=AR
ACPm
Qm
Here is a monopoly breaking evenHere is a monopoly breaking even
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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.
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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
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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
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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
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P
Q1
P
1
0 AR1MR1qi
AR MR
q2
p2
AR2
MR2Q2
AR
MR MCMR
E
MC
P*
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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
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• 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
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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
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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
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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
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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