Imperfect Imperfect competition and competition and

monopolymonopolyChapter 9

Patterns of imperfect competitionPatterns of imperfect competition

The major kinds of imperfect competition The major kinds of imperfect competition are;are;

1.1. monopoly, monopoly,

2.2. oligopoly and oligopoly and

3.3. monopolistic competition.monopolistic competition.

Definition of Imperfect competition

If a firm can appreciably affect the market price of its output, the firm is classified as an ‘imperfect competitor’

“Imperfect competition prevails in an industry whenever sellers have some

measure of control over the price of their output”

Imperfect competition does not imply that a firm has an absolute control over the price of its products

• For a perfect competitor, demand is perfectly elastic; • For an imperfect competitor; demand has a finite elasticity

SOURCES OF MARKET IMPERFECTIONS

There are two principles of imperfect competition;

1. Industries tend to have fewer sellers when there are significant economies of large-scale production and decreasing costs.

2. Markets tend towards imperfect competition when there are ‘barriers to entry’ that makes it difficult for new competitors to enter an industry

Cost and market imperfection

If there are economies of scale, a firm can decrease its average costs by expanding its output, at least up to a point. This means bigger firms have an advantage over smaller firms.

When economies of scale prevails, one or a few firms will expand their outputs to the point where they produce most of the industries total output. The industry then becomes imperfectly competitive.

Barriers to entryBarriers to entry

Barriers to entry are factors that make it Barriers to entry are factors that make it hard for new firms to enter an industry. hard for new firms to enter an industry. When barriers are high, an industry may When barriers are high, an industry may have few firms and limited pressure to have few firms and limited pressure to compete. compete. Economies of scaleEconomies of scale act as one act as one common type of barrier to entry.common type of barrier to entry.

Government sometimes legally restricts Government sometimes legally restricts competition in certain industries. Important competition in certain industries. Important legal restriction includes patents, entry legal restriction includes patents, entry restrictions and foreign-trade tariffs and quotas.restrictions and foreign-trade tariffs and quotas.

A A patent patent is granted to an investor to allow is granted to an investor to allow temporary exclusive use of the product or temporary exclusive use of the product or process that is patented.process that is patented.

Government also imposes Government also imposes entry restrictionentry restriction on on many industries. Typically utilities such as many industries. Typically utilities such as telephone, electricity distribution or water. Etc.telephone, electricity distribution or water. Etc.

Government imposes import restrictions to have Government imposes import restrictions to have the effect of keeping out foreign competitors. the effect of keeping out foreign competitors.

High cost of entry:There are economic barriers to entry as well. In some industries the price of entry simply may be very high. For instance commercial aircraft industry has an economic barrier to entry.

Advertising and product differentiation: Companies create barriers to entry for potential rivals by using advertising and product differentiating

Product differentiation can impose a barrier to entry and increase the market power of producers.

THE CONCEPT OF MARGINAL REVENUE

Price, quantity and total revenue

O/P for Max TR

TR = p x Q where

P = a – bQ Hence

TR = (a – bQ) * Q

or TR = aQ – bQ2

& MR = Slope of TR

or MR = a – 2bQ

We know that

TR is Max at O/P when

MR = 0

Hence O/P for Max TR

a – 2bQ = 0 or

Q = a/2b

Marginal revenue (MR) is the change in revenue that is generated by an additional unit of sales. MR can either be positive or negative.

Negative MR means that in order to sell additional unit, the firm must decrease its price on earlier units so much that its total revenue declines

Elasticity and marginal revenue:Marginal revenue is positive when demand is elastic, zero when demand is unit-elastic and negative when demand is inelastic.

Profit maximizing conditions

Maximizing profit will occur when output is at that level where the firm’s marginal revenue is equal to it marginal cost.

The maximum profit price (P*) and quantity (q*) of a monopolist come where the firm’s marginal revenue equals its marginal cost

MR = MC, at maximum profit P* and q*

Monopoly equilibrium in graphs

O/P for Max T.Profit

Total Profit (TP)= TR-TC

TP = aQ – bQ2 – FC - VC

TP = aQ – bQ2 – FC - vQ TP = – bQ2+aQ – vQ - FC

TP = – bQ2+(a – v)Q - FC

& MP = Slope of TP

or MP = - 2bQ + a – v

We know that

TP is Max at O/P when

MP = 0

Hence O/P for Max T.Profit

- 2bQ + a – v = 0 or

Q* = a – v / 2b

Example-1Example-1 Let Demand Function be p = 100 – 2Q per MonthLet Demand Function be p = 100 – 2Q per Month (Where a = 100 and b = 2)(Where a = 100 and b = 2) Let FC = Rs. 10,000 per month & VC = Rs. 40 / unitLet FC = Rs. 10,000 per month & VC = Rs. 40 / unit

The O/P for Max TR = a / 2b or 100 / 2 (2)The O/P for Max TR = a / 2b or 100 / 2 (2) OR OR TR will be maximized when firm produces 25 units per monthTR will be maximized when firm produces 25 units per month..

Similarly O/P for Max T.Profit = a – v / 2b Similarly O/P for Max T.Profit = a – v / 2b or= 100 - 40 / 2 (2)or= 100 - 40 / 2 (2)

OROR TP will be maximized when firm produces 15 units per monthTP will be maximized when firm produces 15 units per month..

Example-2Example-2

Suppose that ABC Corporation has a Suppose that ABC Corporation has a production (and sales)capacity of Rs. production (and sales)capacity of Rs. 1,000,000 per month. Its FC = Rs. 350,000 1,000,000 per month. Its FC = Rs. 350,000 per month and variable costs are Rs. 0.50 per month and variable costs are Rs. 0.50 per rupee of sales.per rupee of sales.

A) Calculate Annual B.E. Point,volume. A) Calculate Annual B.E. Point,volume. Develop graph too.Develop graph too.

B) What would be the effect on B.E.Point if B) What would be the effect on B.E.Point if VC decreases by 25% and FC increases by VC decreases by 25% and FC increases by 10%. 10%.

The profit maximizing point comes at that output where MC = MR

A monopolist will maximize its profits by setting output at the level where MC = MR because the monopolist has a downward-sloping demand curve, this means that P>MR. Because price is above marginal cost for a profit maximizing monopolist, the monopolist reduces output below the level that would be found in a perfectly competitive industry and charges a higher price.

Dead Weight LossDead Weight Loss

Supply

Monopoly and Perfect Competitive Firm Compared

Demand

DWL

Pm

Ppc

0Q

P

a

b

E

c

d

f g

Perfect.Compt.CS = aEPpcPS = bEPpcTotal Sur=aEb

MonopolyCS = adPmPS = bcdPmTotal Sur=abcdDWL=dcE

MR for a perfect competitor: For a perfect competitor the sale of extra unit will never depress price, and the “lost revenue on all previous q” is therefore equal to zero. Price and marginal revenue are identical for perfect competitors.

Under perfect competition P = AR = MR.

MR = P = MC for a perfect competitor: Profit maximization for monopolist applies equally well to perfect competitor, but the result is a little different. Economic logic says that profit is maximized at the output level where MC equals MR.

But for a perfect competitor; MR = P,Therefore MR = MC profit maximization condition becomes the special case of P = MCBecause a perfect competitor can sell all it wants

at the market price, MR = P = MC at the maximum profit level of output.

Perfect competition as a polar case of imperfect competition