Perfect Competition

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  • Topic: Economics, Perfect competition, Monopoly
  • Pages : 10 (2539 words )
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  • Published : May 15, 2013
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(a)Distinguish between perfect competition, monopolistic competition and oligopoly. [12]

b) To what extent is it true to assert that monopolies are against public interest? [13]

In the perfectly competitive market, all firms are price takers. They can sell all the output they produce at the going market price and none at all at even a slightly higher price.

The product sold is homogeneous. Even if there are a hundred or more separate firms producing the good, each unit is identical to another.

Every buyer and seller is quite aware of the price and quality of the product offered for sale in every part of the market. This means that if one seller will offer a slightly higher price, no one will buy from him. Knowing this fact, no seller will be tempted to sell at a price other than the market price. A higher price will make him lose customers unnecessarily, whereas if he were to charge a smaller price he would make losses compared to the other competitors, since he could have sold all his goods at the market price anyway.

Finally, any number of firms may enter the industry or leave at any time without any restriction, legal or otherwise.

The demand curve faced by one firm in an industry in a perfectly competitive market is a straight line parallel to the quantity axis. Since the firm is a price taker, it accepts to sell any amount it can produce at the price determined by the forces of demand and supply at the industry level. Such a demand curve is said to be perfectly elastic. It is a straight line which is horizontal at the level of the price. [Fig.2(b)]. In such conditions, the average revenue [AR] is equal to the marginal revenue [MR] and both the AR curve and the MR curve coincide with the demand curve.

PriceS Price

P0P0 D = MR = AR

O Q Quantity O Quantity Fig.2(a) : Industry equilibrium Fig. 2 (b) : Firm’s demand curve

In a monopolistically competitive market, there is a large number of firms which compete with one another. But, every firm in the industry produces a good which is slightly differentiated. Consequently, they are not perfect substitutes for one another. This means that though they may be producing the same good, in the minds of the consumers they are perceived as not being fully identical. The firms, therefore, are not price takers. Each one can raise the price of its product without losing all its sales to its competitors or lower it to sell more. In the industry, there is freedom of entry and exit. The average firm faces a downward sloping demand curve which is fairly flat, showing that it is rather elastic because of the large number of substitutes in the market.

An example of a monopolistically competitive industry is the soap industry, where different brands of the product are produced in different sizes, colours, fragrances and packages. Some consumers may get used to the fragrance of one brand and stick to buying it even if its price changes. This is called brand loyalty. The firm selling the good, thus exercises monopoly power to some extent on the loyal purchasers.

Price MC ACMC

AC

p s

a t
AR = D
AR

MRMR

O qo Quantity Fig.1 : Demand curve...
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