Block 6 & 7 PC & Monopoly PPT PDF

Block 6: Perfect Competition Block 7: Monopoly BVFD Chapter 9  BLOCK 6 PERFECT COMPETITION 1. Introduction: Market Structure Competitiveness in the market depends on the fir...

Block 6: Perfect Competition Block 7: Monopoly BVFD Chapter 9  BLOCK 6 PERFECT COMPETITION 1. Introduction: Market Structure Competitiveness in the market depends on the firm’s power to influence market prices 2. Perfect competition (PC) Features Homogenous (identical) product – all firms product/sell identical products. Many buyers & many sellers – firms has no power to affect price & hence face horizontal DD curve; buyers & sellers are price takers. Perfect information – buyers and sellers know everything about th product. Freedom of entry and exit – no barriers to enter or leave the marke.t 2. Perfect competition (PC) Firms face horizontal demand curve 2. Perfect competition (PC) TR for a PC firm Price is constant → TR rise at a constant rate 2. Perfect competition (PC) Profit maximising output level when MR = MC 2. Perfect competition (PC) Profit maximising output level when MR = MC 2. Perfect competition (PC) Profit maximising output level when MR = MC 2. Perfect competition (PC) Profit maximising output level when MR = MC 2. Perfect competition (PC) 1. Supernormal/ Abnormal profit in the SR (economic profit > 0) 2. Perfect competition (PC) 2. Normal profit in the SR (economic profit = 0) 2. Perfect competition (PC) 2. Subnormal profit (losses) in the SR (economic profit < 0) 2. Perfect competition (PC) Shut down decision when losses incurred in the SR Decision to shut down/ continue to produce → depends on SAVC not SAFC Fixed costs are sunk costs in the SR (i.e., cannot be recovered). Firms have no choice but to pay fixed costs in the SR. When losses incurred, firms consider: 1. If TR > SVC (or P > SAVC) → continue to produce 2. If TR < SVC (or P < SAVC) → shut down 2. Perfect competition (PC) Shut down decision when losses incurred in the SR TR can cover entire SVC and part of the SFC if it continues to produce. Shut down incur even bigger losses (entire of SFC) Better continue to produce. 2. Perfect competition (PC) Shut down decision when losses incurred in the SR TR cannot cover entire SVC. Continue producing incur bigger losses (part of SVC and SFC). Better shut down (losses limited to SFC only). 2. Perfect competition (PC) SR supply curve of a PC firm For a PC firm: MR = P Profit maximising rule: MR = MC Hence, for PC firm: P = MC Therefore, a PC firm’s SR supply curve is the SMC curve above the shut-down point (point A). 2. Perfect competition (PC) LR supply curve of a PC firm In the LR, shutting down means leaving the industry altogether. The firm exits if P < LAC 2. Perfect competition (PC) Adjustment to LR equilibrium of a PC firm 2. Perfect competition (PC) LR response to changes in factor prices (e.g., fall in price of raw material) 2. Perfect competition (PC) LR response to a change in demand assuming no change in factor prices (e.g., demand ) 2. Perfect competition (PC) LR response to a change in demand assuming change in factor prices (e.g., demand ) 2. Perfect competition (PC) Economic efficiency: 1. Productive efficiency - goods & services produced at their lowest cost (i.e., produce on AC curve) - Producing a point ON the PPF. 2. Allocative efficiency - Attained when it is not possible to make someone better off without making someone else worse off. - When producing at P = MC (CS and PS maximised) - A point of PPF represents what the society desire most. 2. Perfect competition (PC) PC and economic efficiency - PC markets achieve both productive and allocative efficiency  BLOCK 7 MONOPOLY 3. Monopoly Features Selling unique product – product with no close substitute No distinction between industry and firm Price setter/ maker – monopolist can determine P or Q (not both) High barriers to entry of competitors – e.g., high set up cost, monopolisation of resources, legal protection etc 3. Monopoly Revenue curves for monopoly AR=P (demand) is downward sloping MR < AR If AR falls, MR falls at faster rate 3. Monopoly Revenue curves for monopoly 3. Monopoly Determining profit maximising output with MR = MC 3. Monopoly 1. Supernormal (Abnormal) Profit in the SR (Economic profit > 0) 3. Monopoly 2. Normal Profit in the SR (Economic profit = 0) 3. Monopoly LR equilibrium - Monopolist can earn normal or supernormal profit in the LR. - However, due high barriers of entry, a monopolist can earn supernormal profit - LR equilibrium is when MR = LR MC. 3. Monopoly Monopolist only produces on elastic portion of DD curve 3. Monopoly Monopolist only produces on elastic portion of DD curve 3. Monopoly Measuring monopoly power 1/|PED| is called Lerner Index → measure mark-up price of MC In PC →|PED| = ; Lerner Index = 0 In monopoly → P > MC & |PED|> 1; 0 < Lerner Index < 1 More elastic DD → Lerner Index  → lower monopoly power 3. Monopoly Natural monopoly Enjoying huge EOS (i.e.,  LAC over an entire range of Q & is always above LMC curve) 1 firm can supply a good/service to the entire market with lower cost than when the market has 2 or more firms. 3. Monopoly Natural monopoly To regulate monopoly: - Marginal cost pricing (point E’) – losses incurred; govt. need to subsidise. - Average cost pricing (point Q) – monopoly can breakeven. 3. Monopoly Monopoly and economic efficiency Achieve productive efficiency (produce on AC) Do not achieve allocative efficiency (produce where P > MC) ▪ PM > PPC ▪ QM < QPC ▪ Consumers are worse off ▪ Monopolist is better off ▪ Deadweight loss 3. Monopoly Price discrimination (PD) Happens when monopolist charges different prices to consumers for reasons not associated with difference in costs. 3. Monopoly 1. First-degree PD Charge each consumer the maximum price he is willing to pay. Zero consumer surplus 3. Monopoly 2. Second-degree PD Charge customer different prices according to how much they purchase (e.g., bulk buying). High price for the first so many units, then lower price for the next so many units. Without PD, TR = $2,000 With PD, TR = ($15x150) + ($10x200) = $2750. There is still CS. 3. Monopoly 3. Third-degree PD Charge certain different groups of consumers different prices. Seller must be able to separate the market. Consumers with inelastic demand → charge higher price. Consumers with elastic demand → charge lower price. 3. Monopoly 3. Third-degree PD 3. Monopoly 3. Third-degree PD 3. Monopoly 3. Third-degree PD Now assume that MC = $6