IMPERFECT COMPETITION

Presented By :P SIVAKUMAR

Imperfect Competition

A market is imperfectly competitive if some individual sellers have some degree of control over price of the product. Markets are classified on the basis of the number of sellers & buyers & the nature of product being sold in the market.

Types of Imperfect Markets

Monopoly Monopolistic competition Oligopoly Duopoly bilateral monopoly Oligopsony monopsony

Modern Analysis of Markets

Three criteria (a) Substitutability of products

(b) Interdependence of firms

(c) The ease of entry

Substitutability of products

Degree of substitutability can be measured by cross elasticity E > 1 products are close substitutes E = - products are perfect substitutes E = +ive & finite differentiated goods E = 0 Unrelated goods

Interdependence of firms

Higher elasticity stronger interdependence Zero elasticity- independent firms (large no of firms) Elasticity is finite interdependence is noticeable (small no of firms)

The Ease of Entry

Bains concept on the entry Pa - Pc E = ------------Pc Pa- actual price Pc- pure competition price

The Herfindahls Index

It measures market concentration H = S12 + S22 + S32.+ Sn2 s1 = market share of the largest firm s2 = market share of IInd largest firm Each S can vary from 100 down to zero Largest value = 1002 = 10,000 Lowest value = 100

Concentration Ratio

It is the indicator of competitiveness It is tool to determine the industry is dominated by a small number of firms & the importance of Oligopoly. C Ratio is the percentage of total industry sales made by the four or eight largest firms of an industry. It can vary from 100 to zero

Concentration Ratio

Higher the ratio - more chance for collusion Lower the ratio less chance for collusion Not a perfect measure of competitiveness & does not reveal the elasticity of products

Sources of market imperfections

Barriers to Entry Legal Restriction High cost industry Advertising & product differentiation

Features of Monopoly

One seller and many buyer No close substitute of product Monopolist can either fix price or supply Price discrimination Barriers on entry

Natural Monopoly

Ownership of raw materials & exclusive knowledge of production process Patent rights Government restrictions Size of the market may not allow the existence of more than a single large plant

Price

Qd

TR

MR

18

18

18

B
C D

16
14 12

2
3 4

32
42 48

14
10 6

E
F G

10
8 6

5
6 7

50
48 42

2
-2 -6

H
I

4
2

8
9

32
18

-10
-14

P,MR

MR o Q

AR

Equilibrium condition

MC = MR( it satisfies the I order condition i.e., I derivative is = 0).

MC should cut the MR from below( it satisfies II order condition i.e., II derivative >0)

Properties of Equilibrium under monopoly

Monopoly can get 1 super normal profits 2 Normal profit 3 Minimum loss When monopolist produce at the minimum point of the AC, he will earn more than normal profits

In short run monopoly can get losses but in the long run he will get either normal profit or super normal profits Perfect competition Price = AR =MR = MC Monopoly Price = AR >MR= MC. The excess of price over MC denotes the degree of monopoly power

When p = MC no monopoly The greater the difference, the greater is the strength of the monopolist. Lerner measure P MC P It is the inverse of elasticity (1/|e|) Higher elasticity lower the monopoly power Lower elasticity - higher the monopoly power

If the MC is a horizontal straight line, equi in perfect competition is not posssible. In monopoly it is not a problem Monopolist always fixes a price where elasticity is greater than one (when e = 1 then MR = 0)

Average and Marginal Revenue in Monopoly

P

price
AR/D MR

Qd

P
Pm C MC 0 MR AC

D=AR

profit = TR - TC = AR(Q) -AC(Q) is shown by the shaded area

Monopoly & normal profit

P

Pm

AC

Monopolist normal profit is greater than perfect competitions normal profit

MC MR

D=AR

Qm

Monopoly & minimum loss

P

MC AC

D=AR MR
0 Q

Where MC = MR, losses are minimal`

Absence of the supply curve under monopoly

In perfect competition the supply curve can be determined by MC curve. In monopoly the supply curve is indeterminate It may happen that a monopolist is producing the same quantity at two different prices or producing two different quantities at the same price depending on the position of the MR curve.

Same quantity at different prices

p

p1

E
MR MR1 AR

MC
AR1

Same price &different quantities

mc

B1 AR1 E1 MR1 MR AR

Effect of a shift in demand curve

Demand curve shifts upward & MC remains the same will increase Equi output. The effect on the price is indeterminate The price may increase or decrease or it may be constant

Effect of shift in cost

Increase in fixed cost will not have any effect on marginal cost Increase in variable cost leads to shift of Mc to the left. Price of the commodity will increase & total output will decrease The extent of change in P & Q depends on slope of MR curve

Imposition of tax under monopoly

Lump sum tax : increase in FC reduction in excess profit MC is not affected Equilibrium will not be affected Profit tax : effects will be same as lump sum tax

Specific sales tax

It affects Mc. It shifts upward There will be a change in equilibrium Price will be higher & quantity will be smaller The change in price may be smaller, equal or greater than specific tax.

Specific tax

If MC curve has a positive slope, the increase in price will be smaller than tax. If MC curve is horizontal, the monopolist will raise the price, but not by the full amount of tax.

Measurement of Monopoly power

Lerners Measure

Cross Elasticity

Rothchild Index

Lerners Measure

Using of perfect competition price to measure the monopoly power. P = MR= MC = AR ( P = MC) Monopoly power = inverse of elasticity L = P MC / P ( 0 < L < 1) L lies between Zero to one.

Cross Elasticity of Demand

Prof.Triffin concept Pure monopoly : E = 0 Perfect market : E = infinity If E = finite : neither pure competition nor pure monopoly Lower E higher the monopoly power & vice versa

Rothchilds Index

It shows how far a firm controls the market for a particular good. The index consists of two demand curves

The dd shows qd at different prices assuming that only the individual firm changes the price & other firms do not change their prices. (perceived or subjective demand)

DD shows the quantities the firm sell at different prices assuming that all firms charge the same price. It is proportional demand curve or share of the market demand curve

D
Q

represents the absolute value of the slope of the dd & represents slope of DD curve Rothchild index = / In pure monopoly index is equal to unity because there is only one firm in the market so dd coincides with DD In perfect market dd is horizontal so that = 0. Hence the index is zero under perfect market & unity under pure monopoly

Monopoly VS Perfect competition

Goals of firm Assumptions Behavioral rules of firm Comparison of Long run Equilibrium Comparison of production

Monopoly VS competition

Goals : profit maximization & no separation of Ownership and Management] Goods No of sellers Entry Cost curves

Monopoly VS competition
Behavioral rules firm Demand curve Decision making- Selling of products, price, R & D Equilibrium conditions Static models- decisions taken in one period do not affect the profits in other periods

Long Run Equilibrium

Price is higher & TQ is lesser Market elasticity may assume any value in PC but in monopoly it is > 1 Production of goods @ optimal cost Supply curve Profits

Comparison of production

Perfect market Increase in DD results in increase in P & TQ in short run Long run if TQ is large then P to goes initial price(cc) & remain above initial P(Ic) or fall below the original P(dc)

Monopoly No distinction about SR & LR A shift in DD results in higher TQ but P may be same or higher or lower depends on extent of shift in DD & change in Elasticity

Shifts in costs
Increase in FC Short run will not affect TQ but in Long run if Fc is not covered then close down Increase in VC MC affected, TQ falls, price going up

No change of TQ in short run or long run Increase in FC wipes out abnormal profits Same effect

Price Discrimination
When the monopolist charges different price form different consumer or places for the same product.
Price discrimination is made possible by three factors:

Consumers preferences
The nature of the product

Distance and frontier barriers

Types of Price Discrimination

First Degree Price Discrimination Second Degree Price Discrimination Third Degree Price Discrimination

Price discrimination & Industry

Some time the total demand curve will below the LAC of the firm Production can not take place if you follow same price for all sub markets If you go for price discrimination then production & some times profit also possible

Monopsony

Single buyer & many sellers One company & laborers Demand for labor = marginal factor cost MFC will lie above supply curve MRP marginal revenue product is the demand curve for labor

Monopsony equilibrium
MFC S b wage W W1 c MRP L1 L labor a

Bilateral monopoly

Single buyer & single seller in a market Company & Trade union or company Collective bargaining Monopoly will select a point on buyers demand function that maximize his profit Monopsony will select a point on his sellers supply function that maximize his profit But there no supply or demand function to exploit

Three possible outcomes 1. one of the participants may dominate & force other to accept his price or TQ 2.Collusion to set a price or quantity 3. The market mechanism may break down

Equilibrium in bilateral monopoly

non economic factors like bargaining power, negotiating skills plays important role Monopolist equilibrium = MC = MR Monopsonist equilibrium = ME = AR ME = marginal expenditure & MC is the supply curve for monopsonist He will like to purchase additional units of Q until ME = price

ME MC h E MR Q1 Q Q* Quantity AR

E1
p Price P* p p11 g