1. Market Structure: Perfect Competition

2. Perfect Competition Many buyers and sellers
Buyers and sellers are price takers
Product is homogeneous
Perfect mobility of resources
Economic agents have perfect knowledge

3. Perfect Competition: Price Determination
INDUSTRY
FIRM

4. The MC is the cost of producing additional (marginal) units of output
The MC is the cost of producing additional (marginal) units of output. It falls at first (due to the law of diminishing returns) then rises as output rises.
Diagrammatic representation
Given the assumption of profit maximisation, the firm produces at an output where MC = MR (Q1). This output level is a fraction of the total industry supply.
The industry price is determined by the demand and supply of the industry as a whole. The firm is a very small supplier within the industry and has no control over price. They will sell each extra unit for the same price. Price therefore = MR and AR
Cost/Revenue
At this output the firm is making normal profit. This is a long run equilibrium position. MC AC
The average cost curve is the standard ‘U’ – shaped curve. MC cuts the AC curve at its lowest point because of the mathematical relationship between marginal and average values.
P = MR = AR Q1
Output/Sales

5. Perfect Competition Diagrammatic representation MC MC1 AC AC1
Because the model assumes perfect knowledge, the firm gains the advantage for only a short time before others copy the idea or are attracted to the industry by the existence of abnormal profit. If new firms enter the industry, supply will increase, price will fall and the firm will be left making normal profit once again.
Average and Marginal costs could be expected to be lower but price, in the short run, remains the same.
Perfect Competition
The lower AC and MC would imply that the firm is now earning abnormal profit (AR>AC) represented by the grey area.
Diagrammatic representation
Now assume a firm makes some form of modification to its product or gains some form of cost advantage (say a new production method). What would happen?
Cost/Revenue MC
MC1 AC
AC1
P = MR = AR
Abnormal profit
AC1
P1 = MR1 = AR1 Q1 Q2
Output/Sales

6. Perfect Competition: Price Determination

7. Perfect Competition: Short-Run Equilibrium
Firm’s Demand Curve = Market Price
= Marginal Revenue
Firm’s Supply Curve = Marginal Cost
where Marginal Cost > Average Variable Cost

8. Equilibrium in Perfect Competition
Total Profits = TR -TC d = d(TR) - d(TC) = 0 dQ dQ dQ MR - MC = 0 MR = MC d(TR) = d(PQ) = P = MR dQ dQ

9. Perfect Competition: Short-Run Equilibrium

10. Perfect Competition: Short-Run Equilibrium

11. Losses and Shutdown Decision

12. Losses and Shutdown Decision

13. Losses and Shutdown Decision12
Price, cost
per unit 10 8 MC 6 C
ATC 5 4
AVC
3.35 2 1 2 3 4 5 6 7 8 9 10
Quantity per period

14. Losses and Shutdown Decision12
Price, cost
per unit 10 8 MC 6 C
ATC 5 4
AVC B
3.35 2 1 2 3 4 5 6 7 8 9 10
Quantity per period

15. Losses and Shutdown Decision
Price, cost
per unit MC C
ATC 5
AVC B
3.35 A
Quantity per period

16. Perfect Competition: Long-Run Equilibrium

17. Consumer Surplus
Price per unit S P1 C Pe D Qe
Quantity per period

18. PROFIT MAXIMISATION P = 45 - 0.5Q TC = Q3 - 8Q2 + 57Q + 2
d = 15Q Q2 dQ
Q = 1 and Q = 4
d2 = -6Q + 15
dQ2
d2 = d2 = -9
dQ dQ2

19. Advantages of Perfect Competition
High degree of competition helps allocate resources to most efficient use
Price = marginal costs
Normal profit made in the long run
Firms operate at maximum efficiency
Consumers benefit

20. Monopoly Single seller and many buyers
No close substitutes for product
Significant barriers to resource mobility
Control of an essential input (OPEC)
Patents or copyrights (Medicines/drugs)
Economies of scale at large output (China)
Government franchise
Abnormal profits in long run
Possibility of price discrimination
Prices in excess of MC

21. Monopoly Short-Run Equilibrium
Demand curve for the firm is the market demand curve
Firm produces a quantity (Q*) where marginal revenue (MR) is equal to marginal cost (MC)

22. Relation between Demand curve and Marginal Revenue Curve
P = a - bQ TR = PQ = (a - bQ)Q = aQ - bQ2 MR = d(TR) = a - 2bQ dQ

23. Monopoly Short-Run EquilibriumD O Q MR

24. Monopoly Short-Run EquilibriumAC MC Pm D O Q Qm MR

25. Monopoly Short-Run Equilibrium

26. Monopoly Long-Run Equilibrium

27. Advantages: Disadvantages: Encourages R&D Encourages innovation
Economies of scale can be gained – consumer may benefit
Disadvantages:
Exploitation of consumer – higher prices
Potential for supply to be limited - less choice
Potential for inefficiency

28. Social Cost of Monopoly

29. Monopolistic Competition
Many sellers of differentiated (similar but not identical) products
Limited monopoly power (based on the uniqueness of their product)
Dominoes : quick delivery
Maggi : 2 minutes
Dettol : Hygiene
Perfect mobility of resources
Downward-sloping demand curve
Increase in market share by competitors causes decrease in demand
Easy entry and exit
Differentiated products : Advertising costs

30. Monopolistic Competition Short-Run Equilibrium

31. Monopolistic Competition Long-Run Equilibrium
Profit = 0

32. Monopolistic Competition Long-Run Equilibrium
Cost with selling expenses
Cost without selling expenses

33. In Mumbai, the movie market is monopolistically competitive
In Mumbai, the movie market is monopolistically competitive. The long run demand equation & AC is given
P = 5 – 0.002Q
AC = 6 – 0.004Q Q2
To maximize profits, what should be the price & Q. (Q = 1000 & P = 3)
How much profit will the firm earn? (0)

34. Few Examples
Hyundai has taken Mahindra Renault to High Court objecting to Mahindra’s plan to launch a compact car with the name 'Sandero' alleging that Mahindra is trying to cash on its popular brand Santro.
Asian Paints (label "Utsav”) vs Jaikishan Paints & Allied Products (label “ Utkarsh”) with similar name, color, layout.

35. Oligopoly -Characteristics
Few sellers of a product
Duopoly - Two sellers
Pure oligopoly - Homogeneous product
Differentiated oligopoly - Differentiated product
Non-price competition
Barriers to entry
High degree of interdependence between firms
Abnormal profits
Potential for collusion?

36. Sources of Barriers to Entry
Economies of scale (Exide: distribution, Walmart)
Large capital investment required (Steel)
Patented production processes (Drugs)
Brand loyalty (Tata Salt)
Control of a raw material or resource (Cement)
Government franchise (Licenses)

37. Cartels Collusion Examples: OPEC De Beers
Cooperation among firms to restrict competition in order to increase profits
Market-Sharing Cartel
Collusion to divide up markets
Centralized Cartel
Formal agreement among member firms to set a monopoly price and restrict output
Examples: OPEC
De Beers

38. Centralized Cartel

39. Weakness Firms can ask for an equitable distribution of profits.
Cartel members have a strong incentive to cheat by selling more.
Monopoly profits may attract other firms.