8. Comparative analysis of profit maximization under perfect competition and under pure monopoly

There are 4 market structures:

• Perfect competition

• Monopolistic competition

• Oligopoly

• Monopoly

• And 5 criteria of characterizing market structure:

• Number of producers/firms in the industry

• Control over prices

• Freedom of entry on the industry

• The nature of the product

• Describes to the demand curve

Abstract Models of perfect competition and Monopoly

Perfect Competition Very many firms No price control, a firm is a price-taker (takes the price of the market) Free entry (no restrictions) Product is homogeneous (однородный) (product is not differentiated, U cannot distinguish between units) Demand for a product is a horizontal line

Monopoly Only 1 firm=industry Complete price control, the firm is a price-maker (dictates the price) Entry is blocked Product is unique (no close substitutes) Demand for the firms’ product= demand in the industry, D-curve slopes down

*Monopoly can be a very small firm, not necessary large.

D emand marginal revenue, total revenue and price elasticity of demand under perfect competition and monopoly

I Perfect Competition

Individual firm cannot sell above the market equilibrium, no sense to sell cheaper, as the producer can sell as much as he wants at the current market price. Producers’ output is very small in comparison with the industry output => he can sell whatever he produces at the current market price. D-curve will coincide with the curve of the Marginal revenue and Average revenue. AR= TR/Q= (P*Q)/Q= P; MR=delta TR/delta Q=P (perfect competition)

 

What should be the output level for perfect competition?

MC=MR => equilibrium of the firm MC=P; producer can increase the output up to Qe, after that it is irrationally. The marginal cost curve for a perfect competitive firm characterizes the supply of the firm MC=MR; MR=P=> P=MC

II Monopoly

D-curve slopes downs as it is the same as the demand for the whole industry, to produce and sell more the firm has to decrease price (the price for all the output not only for additional). MR will be below the D-curve.

Monopolistic firm will prefer to operate in the positive part of the MR curve until the point where MR=0.

The 2 parts of MR and TR curves are closely related to the price elasticity of demand.

E>1: when D is elastic TR changes in the same way as quantity (Q increases=> TR increases)

E<1: when D is inelastic P increases =>TR increases

! Monopoly operates only in the elastic demand, only where MR is positive.

P >MR; MC=MR equilibrium rule for monopoly; the equilibrium output is Qe, no rivals=> price maker, highest possible price, but the possibility is dictated by demand. For a monopoly there is no supply curve independent upon the price. A monopoly has to choose a single point on the demand curve where it wants to be. A monopoly has to make a simultaneous decision concerning price and output (they are determined in combination). Monopolistic price is above MR, but MR=MC,=> P>MC (as P is always > MR).