Similarities and Differences between Perfect Competition and Monopoly

 

Similarities between Perfect Competition and Monopoly

a.      Under both markets, the objective of the firm is to maximize the profit.

b.     Under both markets, the conditions of the equilibrium are same i.e. MR=MC and MC intersect MR from below.

c.      Due to the operation of the law of variable proportions both AC and MC curves are U-shaped on both markets.

d.     In the short-run, both markets have possibilities of abnormal profit, normal profit and loss.

e.      Both markets have large number of buyers.

Difference between Monopoly Market and Perfect Competition

Perfect Competition	Monopoly
i.There are large number of firms.	a.There is only one firm.
ii. The products are homogeneous.	b.The products are unique.
iii.Firms have freedom to enter or exist from the industry under perfect competition.	c.There is complete barrier in the entry and exit of the firm in the industry.
iv.In the long run, the firm earns only normal profit.	d.The firm can enjoy super normal profit even in the long run.
v.AR and MR are equal and are horizontal and parallel to the X-axis.	e.Both AR and MR curves are downward sloping.
vi.The price is stable.	f.The price may change.

 

Monopolistic Market and Price and Output Determination in it

 

It refers to the mixed market structure of the perfect competition and monopoly. It is the market structure with large number of sellers with product differentiation but closed substitutes and free entry and exists of firms are present. Since, each firm under the monopolistic competition does not produce the homogeneous product, the firm combine together to form a group.

Features of Monopolistic Market:
a.      There is large number of buyers and sellers in a group.
b.     There is product differentiation but are closed substitutes.
c.      There is free entry and exit of the firms in the group.
d.     The prices of the factors and technology are given.
e.      The main objective of the firm is profit maximization both in the short-run and long-run.
f.       The AR is highly price elastic and hence, flatter.

Equilibrium Conditions under Monopolistic Competition

The firms under monopolistic competition market attains the equilibrium position when:

a.      MC=MR

b.     MC cuts MR from below.

Short-Run Equilibrium

Under the monopolistic competition market, a firm in the short run can operate in abnormal profit, normal profit or loss. If the demand conditions for the product of a firm is favorable then it operates in the profit and if the demand condition is unfavorable, it operates in loss.

Long-Run Equilibrium

All the firms under the monopolistic market operate in normal profit in the long-run. In the long-run, the firms in loss leave the group whereas if there is abnormal profit, due to the free entry into the groups, the supply of product increases causing fall in the price which wipes out the abnormal profit and maintain equilibrium in the normal profit.

 

Monopoly Market and Price and Output Determination under it

 

It is the market structure in which there is a single producer, no close substitutes of the product and there is restriction in the entry of new firms. In other words, it refers to the single firm which has control over the supply of the commodity which has no close substitutes.

Features of Monopoly Market:

a.      There is single seller and large number of buyers.

b.     There is no close substitutes of the products.

c.      There is restriction in the entry of new firms.

d.     Since the firm has the full control over the supply of commodities, it is the price maker.

e.      It consists of single firm which is an industry in itself.

Price and Output Determination Under Monopoly

a.      Short-Run Equilibrium

Monopolist is a price maker. His/her price and output decision is motivated by profit maximization. Monopolist will adjust the output and price in such a way that the marginal cost and the marginal revenue are equal where monopolist achieves maximum profit. In short-run equilibrium, whether the firm makes abnormal profit, normal profit or loss, it depends upon the level of AC and AR which can be shown in the following ways:

1.     If AR>AC, the firm receives super normal profit.

2.     If AR=AC, the firm receives normal profit.

3.     If AR<AC, the firm bears loss.

Conditions for Equilibrium:

1.     MR=MC

2.     MC must intersect MR from below.

b.     Long-Run Equilibrium

In long-run, the monopolist has enough time to adjust the size of the plant at the certain level of output to maximize its profit. In the monopoly, the entry of new firms being ruled out, the abnormal profit is possible even in the long-run.

Conditions for the Equilibrium:

1.     MR=MC

2.     LMC must intersect MR from below.

Perfect Competition and determination of Price and Output under it

 

It is the market structure where there is large number of buyer and seller with homogeneous product selling at uniform price and characterized by complete absence of rivalry among the individual firms. In this competition, the price of the product is determined by industry with the forces of demand and supply.

Characteristics of Perfect Competition:

a.      There is a large number of buyers and sellers.

b.     There is homogeneous product.

c.      New firm is free to entry and exit.

d.     There is no government intervention.

e.      There is perfect mobility of the factors.

f.       Consumer has the complete knowledge about the market.

g.     There is profit maximization.

Determination of Price and Output under Perfect Competition

Under the perfect competition market, there are large number of buyers and sellers producing identical products. As such an individual firm becomes only the price taker where the price is determined by the industry on the basis of the market demand and market supply is known as equilibrium price and equilibrium quantity.

1.     Short-Run Equilibrium of a Firm

Short-run refers to the time period in which time is so short that a firm cannot change the fixed factors like plant and machinery. As the firm cannot change its production process and there may be abnormal profit or normal profit or even loss depending on the firm’s revenue and cost conditions. The firms that are more efficient may earn abnormal profit by reducing their average cost and inefficient firms having higher average cost may have the loss or some may just earn normal profit.

The profit and loss depend on the nature of AC and AR which can be shown in the following way:

a.      It AR=AC, the firm receives normal profit.

b.     If AR>AC, the firm receives excess profit.

c.      It AR<AC, the firm bears loss.

Conditions for Equilibrium:

The following condition must be fulfilled in order to attain the equilibrium in the perfectly competitive market:

a.      Market supply should be equal to market demand.

b.     MC=MR

c.      MC must intersect MR from below.

 

2.     Long-Run Equilibrium

In the long run, the firm can make choice for entry and exit from the industry depending on the profit situation. If profits are high, the new firms enter the industry. If the firms are in loss in the long-run, they exit from the industry. In this way, both abnormal profit and loss situations are ruled out in the long run and the firm will earn just the normal profit.

Conditions of Equilibrium:

a.      Demand must be equal to supply.

b.     LMC=MR

c.      LMC must intersect MR from below.

Long-Run Cost Curve

 

In the long run, all the factors of production are variable. There are no fixed factors and no fixed costs in the long run.

Types of Long Run Cost Curve:

a.      Long Run Total Cost (LTC)

It is the cost incurred by all the factors of production in the long run.

b.     Long Run Average Cost (LAC)

It is obtained by dividing LTC by the level of output. It shows the functional relationship between the total output and the total cost of production. Mathematically;

LAC=LTC/Q

c.      Long Run Marginal Cost Curve (LMC)

It is defined as the addition in the long run total cost as the result of the increase in the output by one unit.

Mathematically;

LMC=dLTC/dQ

 

Each point of the LAC curve is a point of tangency with the corresponding SAC curve. The point of tangency occurs to the falling part of the SAC curves for points lying to the left of M. since the slope of the LAC is negative up to M, the slope of the SAC cures must also be negative, because at the point of tangency the two curves have the same slope. By the same logic, the point of tangency for outputs larger than Q occurs to the rising part of the SAC curves. Only at the minimum point M of the LAC is the corresponding SAC also at a minimum. At

the falling part of the Lac curve the plants are not worked to full capacity. To the rising part of the LAC curve the plants are overworked. Only at the minimum point M is the plant optimally employed.

The LMC is derived from the SMC curves but does not envelop them. The LMC is formed from points of intersections of the SMC curves with vertical lines drawn from the points of tangency of the corresponding SAC and the LAC curve. So they are equal at a. this implies LMC >SMC1 to the left of a. At a, LMC=SMC1 (the same additional costs accrue to both the short-run and the long-run costs so that SAC1=LAC). To the right of a, LMC<SMC1 (more incremental cost is added to the short-run cost than to the long-run cost). At the minimum point of the LAC, the LMC intersects the LAC. At this point, SAC=SMC=LAC=LMC.

Average Cost and Marginal Cost

 

Average Cost (AC)

It is the ratio between the total cost and quantity produced. It can also be defined a the cost per unit.

Mathematically;

AC= TC/Q

Where;

TC= Total Cot

Q=Quantity

Marginal Cost (MC)

It is the ratio between the change in total cost and change in quantity produced. In other words, MC can be defined as the change in total cost due to the production of one more unit of output.

Mathematically;

MC=dTC/dQ

Or MC=TC2-TC1/Q2-Q1

Where:

dTC= change in total cost i.e. TC2-TC1

dQ= change in quantity i.e. Q2-Q1

Derivation of Average Cost (AC) and Marginal Cost (MC)

Quantity	Total Cot (TC)	Average Cost (AC)	Marginal Cost (MC)
1	10	10	10
2	18	9	8
3	24	8	6
4	28	7	4
5	30	6	2
6	36	6	6
7	49	7	13
8	64	8	15

In the above graph, the initial stage both AC and MC are decreasing as a result the curves are downward sloping. Since, the decreasing rate of MC is greater than AC, it attains the minimum point before AC and lies below AC. While rising, MC cuts the AC at its minimum point where AC=MC.

Relationship between AC and MC:

a.      Both AC and MC are calculated from the TC

b.     Both AC and MC are U-shaped

c.      When AC is falling, MC lies below the AC and MC falls faster than AC

d.     When AC is rising, MC lies above the AC and MC rises faster than AC

e.      When AC is minimum MC equals to AC

f.       MC intersects at the minimum points of AC