Perfect Competition vs Monopoly

Question 1

In perfect competition are firms and buyers price takers, or are they price makers?

What do each of these terms mean?

Demand curve in perf comp and why?

Answer 1

They are price takers they can’t set their own price. They charge the market price, charging above it means they’ll have no demand, charging below doesn’t benefit them , they can sell as much Q as they want at the market price.

In perf comp. they sell each unit of quantity at the same price so MR is constant, demand curve is horizontal (perfectly elastic).
This contrasts to in a monopoly, quantity is low when prices are high (think standard demand curve) and output is high when prices are low. so AR falls as quanitity rises (so demand is downward sloping

Question 2

Characteristics of a market with perfect competition?

Answer 2

Competitive supply is most
plausible when:
- many firms that each don’t have a large market share, making a standard identical product
-with free entry and exit into the market
-perfect information, buyers know that the products of different firms really are the same so owners can’t convince them otherwise.

Question 3

In perfect competition price equals what when profit maximising?

Answer 3

For the firm, price is equal to their marginal revenue, which is equal to their marginal cost

Question 4

How do we obtain the supply curve for the industry as a whole?

Does this curve look different in the short vs long term?

Answer 4

Add up all the supply curves for firms in the industry.

Yes in the long term it is flatter as firms supply is more elastic as in the long run they’re able to fully adjust toany changes.

Question 5

What is a pure monopoly?

Answer 5

only seller or potential seller of a good and need not worry
about entry, even in the long run. 
They are price makers 
 (rare in practice)
They set MC=MR to max profits

Question 6

Compare a monopoly and perf comp in terms of P and Q

Answer 6

the
monopolist produces a smaller output at a higher price. Compared to a perfectly
competitive market, a monopoly creates a deadweight loss. This is the loss in
social surplus caused by the monopolist’s restriction of output compared to
perfect competition

Question 7

discriminating monopolist and how are they successful in doing this?

Answer 7

uses price discrimination ,charges different prices to different customers. To
equate the marginal revenue from different groups, groups with high elasticity of
demand must pay a lower price. Successful price discrimination requires that
customers cannot trade the product among themselves

Question 8

Are there any benefits to monopolies?

Answer 8

They make profit unlike in perf comp (profit won’t be eroded by new firms entering market). so may invest this profit into research to improve the product and consumer satisfaction

Question 9

Shut down rule (short run)

Answer 9

In the short run, a firm will exit the market if the price ( revenue per unit for a given quantity sold) is lower than the average variable cost.

This is because fixed costs don’t change with output produced and especially if they can’t be recovered (sunk costs) if the average variable cost is equal to or lower than the price, the firm would miss out on revenue by leaving.

Question 10

Shut down rule (long run)

Answer 10

If TC is higher than TR

Question 11

Why is the demand curve horizontal in perf comp?

Answer 11

All firms are price takers and charge the same price. MR is constant at any level of Quantity, so AR=MR so the demand curve is horizontal.

Question 12

Normal profits

Answer 12

The level of profit that all firms in perfectly competitive markets make.

It’s when accounting profits are 0, but in economic terms it makes normal profits as the business’ opportunity costs just about justify staying in business.

Question 13

Does P=MC in a monopoly?

Answer 13

They are prof maximising MC=MR but P doesnt equal MC , instead, P= MC (1+mark-up)

Question 14

What are the three degrees of price discrimination?

Answer 14

First- the seller charges each person their reservation price (the maximum amount they’re willing to pay, so there is no consumer surplus)

Second- Charging people different amounts based on the quantity they buy

Third- Charging people different amounts based on personal characteristics e.g. charging children a lower amount.

Question 15

Which is inherenty equal to demand? AR or MR?

Answer 15

AR

AR = P as AR= TR/Q= PQ/Q

Don’t need to memorise this:
(Demand curve is a linear curve in the form of y=mx+c
Price= -bQ+a, since Price is the dependent variable that is equal to the demand curve if AR=P, AR=D)

AR=MR when in perf comp.

Question 16

Why are some firms a Natural Monopoly? examples of where this could be the case?

Answer 16

Very very high fixed costs , so for a firm, LRAC curve is downward sloping- economies of scale.

Competition would lead to an unnecessary duplication of resources (the firm already in the market supplies a higher Q at a lower price), a new firm wouldn’t have the same economies of scale as an established one, so they would have have to charge a higher price, ending up being priced out the market (wasting the infrastructure). Then, their rail infrastructure that they put down is left idle- a waste

With competition, each firm shares the market demand so they both produce less than they would if they were the only firm. This means they both face higher fixed cost then otherwise, as they don’t benefit from economies of scale and charge a HIGHER PRICE, economically inefficient (and a waste of resources as one firm could supply the demand at a lower AC).

Or, the regulator could force monopolist to produce where AR=AC, not efficient level, but closer to it compared to if there was no regulator and so reduces deadweight loss.

As long as the monopoly is regulated it is better to have a natural monopoly in such cases

Question 17

Natural Monopoly

Answer 17

Very very high fixed costs , so for a firm, LRAC curve is downward sloping- economies of scale.

Competition would lead to an unecessary duplication of resources (the firm already in the market supplies a higher Q at a lower price), a new firm wouldn’t have the same economies of scale as an established one, so they would have have to charge a higher price, ending up being priced out the market (wasting the infrastructure). Then, their rail infrastructure that they put down is left idle- a waste

Question 18

Examples of natural monopoly

Answer 18

Rail Services, water provision, gas/electricity provision

Question 19

Draw a graph for a natural monopoly

Answer 19

PG 344

LRAC AND LRMC declining, , LRAC above LRMC

Question 20

What point of production is efficient?

Answer 20

When price is set to marginal cost

Question 21

What is the outcome of a natural monopoly without regulation, vs with?

Answer 21

Without regulation, They produce where MR=MC, Charging a higher price and Restricting output below the efficient level where P=AR=MC.

With regulation, they are forced to produce at the efficient level where P=MC=AR, they are making subnormal profits ( a loss) so in the long-run they’ll leave the market (government failure) UNLESS the gov pay them a subsidy, that’s equal to the subnormal profit, so they then make normal profits.