Unit-3

Perfect Competition
• A perfect market has the following conditions:
• 1. Free and Perfect Competition:
• In a perfect market, there are no checks either on the
buyers or sellers. They are free to buy or to sell to any
person. It means there are no monopolies.
• 2. Cheap and Efficient Transport and Communication:
• Uniform price for the commodity would not be
possible if the changes in the prices are not quickly
adjusted or the commodity cannot be quickly
transported. Thus cheap and efficient means of
transport and communication are must.
 3. Wide Extent
• Sometimes wide market is regarded as the same thing as the
perfect market. For wide market, the commodity should have
permanent and universal demand. The commodity should be
portable. Means of transport and communication should be quick.
There should be peace and security and extensive division of labour.
4. Large number of firms:
• In this market, a product is produced and sold by large number of
firms. Since there are large number of firms, therefore each firm is
supplying only a small part of the total supply in the market, thus
no one firm has any market power. It implies that no firm can
influence the price of the product rather each must accept the price
set by the forces of market demand and supply. The firms are price-
takers instead of price-makers.
 5. Large number of buyers:
• In a perfectly competitive market, there are large numbers
of buyers each demanding a small part of the total market
supply of the product. As a result, no single buyer is in a
position to influence the market price determined by the
forces of market demand and supply.
6. Homogeneous Product:
• In a perfectly competitive market, all the firms produce and
supply the identical products. It means that the products of
all the firms are perfect substitutes of each other. As a
result of this, the price elasticity of demand for a firm’s
product is infinite.
 Types of Market
• Perfect Competition
• Perfect competition is a market system characterized by many different
buyers and sellers. In the classic theoretical definition of perfect
competition, there are an infinite number of buyers and sellers. With so
many market players, it is impossible for any one participant to alter the
prevailing price in the market. If they attempt to do so, buyers and sellers
have infinite alternatives to pursue.
• Monopoly
• A monopoly is the exact opposite form of market system as perfect
competition. In a pure monopoly, there is only one producer of a
particular good or service, and generally no reasonable substitute. In such
a market system, the monopolist is able to charge whatever price they
wish due to the absence of competition, but their overall revenue will be
limited by the ability or willingness of customers to pay their price.
• Oligopoly
• An oligopoly is similar in many ways to a monopoly. The primary difference is that rather than
having only one producer of a good or service, there are a handful of producers, or at least a
handful of producers that make up a dominant majority of the production in the market system.
While oligopolists do not have the same pricing power as monopolists, it is possible, without
diligent government regulation, that oligopolists will collude with one another to set prices in the
same way a monopolist would.
• Monopolistic Competition
• Monopolistic competition is a type of market system combining elements of a monopoly and
perfect competition. Like a perfectly competitive market system, there are numerous
competitors in the market. The difference is that each competitor is sufficiently differentiated
from the others that some can charge greater prices than a perfectly competitive firm. An
example of monopolistic competition is the market for music. While there are many artists, each
artist is different and is not perfectly substitutible with another artist.
• Monopsony
• Market systems are not only differentiated according to the number of suppliers in the market.
They may also be differentiated according to the number of buyers. Whereas a perfectly
competitive market theoretically has an infinite number of buyers and sellers, a monopsony has
only one buyer for a particular good or service, giving that buyer significant power in
determining the price of the products produced.
•
• Short run
signifies a
period when a
firm can neither
change the
quantity of
production nor
they can quit.
• New firms can
also not enter
the market.
• In short run the supply can be increased or
decreased by increasing or decreasing the
variable inputs. Therefore the supply curve is
elastic.
• Fig shows the pride determination for the
industry by the demand curve DD and the supply
curve SS at price OP1 or PQ. Price is fixed for all
the firms in the industry.
• Profit is maxm at MR=MC. (AR=MR and AR=PQ)
• Profit= Q(AR-AC)
• AR=EM
• AC=NM
• Q=OM
• Profit=OM(EM-NM)=OM(EN)
• Profit=P1TNE
• Profit is maximum at the level of output where
MR=MC. Price is fixed at PQ AR=PQ.
• If AR is constant then, MR=AR, At E point, MR=MC
determines the profit maximizing output, OM.
• If AR>AC then firms make supernormal profit.
• New firms enter the market, increase in market
supply. Supply curve shifts rightward.
• If AR<AC, then supply curve shifts leftward as firms
make losses and leave the industry causing low
market supply.
• Rightward shift in supply curve reduces prices while
left ward shift causes an increase in the prices.
• At OP1 market price, equilibrium M, OP1=AR’=MR’=LMC.
Firms make an economic supernormal profit of MS.
• More firms enter market, supply shifts to SS2. Prices fall to
OP2. Firms cover only LMC=NQ2, at O/P OQ2.
• Firms make losses as AR<LAC. Firms incurring losses cannot
survive in industry and so exit.
• Total production decreases, supply curve shifts leftward to
SS. Price=OP0, equilibrium E, O/P OQ. Firms at OQ make
normal profits, OP0=AR=MR=LMC=LAC=EQ.
• No firms make economic profit or loss, so no threat of new
entrants and no exit of existing firms.
•
 Monopoly
• “Pure monopoly is represented by a market
situation in which there is a single seller of a
product for which there are no substitutes; this
single seller is unaffected by and does not affect
the prices and outputs of other products sold in
the economy.” Bilas
• “Monopoly is a market situation in which there is
a single seller. There are no close substitutes of
the commodity it produces, there are barriers to
entry”. -Koutsoyiannis
 Features
• 1. One Seller and Large Number of Buyers:
• The monopolist’s firm is the only firm; it is an industry.
But the number of buyers is assumed to be large.
• 2. No Close Substitutes:
• There shall not be any close substitutes for the product
sold by the monopolist. The cross elasticity of demand
between the product of the monopolist and others
must be negligible or zero.
• 3. Difficulty of Entry of New Firms:
• There are either natural or artificial restrictions on the
entry of firms into the industry, even when the firm is
making abnormal profits.
• 4. Monopoly is also an Industry:
• Under monopoly there is only one firm which
constitutes the industry. Difference between firm
and industry comes to an end.
• 5. Price Maker:
• Under monopoly, monopolist has full control over
the supply of the commodity. But due to large
number of buyers, demand of any one buyer
constitutes an infinitely small part of the total
demand. Therefore, buyers have to pay the price
fixed by the monopolist.
 Causes of Monopoly
• Legal Restrictions
• Control over key raw materials
• Efficiency of production
• Economies of scale
Short Run Monopoly
• Price output combination,
MR=SMC
• N ordinate determines the
profit maxmzng output OQ.
• OQ output can be sold at one
price PQ=OP1.
• AR-SAC=PQ-MQ=PM
• TP=PM*OQ
• OQ=P2M
• TP=P2MPP1
 Monopolistic Competition
• Important characteristics of monopolistic competition are as follows:
• 1. Less Number of Buyers and Sellers:
• In this market neither buyers nor sellers are too many as under perfect
competition nor there is only one seller as under monopoly. Mostly, it is a
situation in between. Every producer for his produced commodity has some
special buyers. Every consumer and seller can influence demand and supply
in the market.
• 2. Difference in the Quality and Shape of the Goods:
• Although the commodities produced by different producers can serve as
perfect substitutes to those produced by others, yet they are different in
colour, form, packing, design, name etc. So there is product differentiation in
the market.
• 3. Lack of Knowledge on the Part of Consumers:
• Neither consumers nor sellers have full knowledge of market conditions, so
there is international difference in the price of goods from those of others.
• 4. High Transportation Cost:
• In this high transportation cost play an important role in order to create
discrimination among commodities. Similar goods because of different transport
costs are bought and sold at different prices.
• 5. Advertisement:
• Here, advertisement plays an important role because buyers are influenced to
prefer by advertisement, which plays upon their mind and makes them the
product of one firm to those of another. Through advertisement, they are brought
to his notice through radio, television and other audio-visual aids in a more
pleasing and more forceful manner. Thus, rival firms compete against each other in
quantity, in facilities as well as in price.
6. Ignorance of the Buyers:
• There are some people who think that high priced goods will be better and of
higher quality. So, they avoid buying low priced goods.
• 7. Differences in the Establishment of Industry:
• In the imperfect competitive market, there is neither freedom of entry or exit as is
under perfect competition nor there is perfect control as in monopoly but there
are some restrictions on the entry of industry only.
Cournot Model
Sweezys Kinked Demand curve model
Algebraic solution to Sweezys
Dominant Firm
Prisoner’s Dilemma
Application of Prisoner’s Dilemma in
Oligopoly