Perfect Competition Vs Monopoly

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(a) a supply curve derived by using relevant cost curves in a market under monopoly may give more than one price for one quantity and also more than one quantity for the same price (2010, I, 10)

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(b) for determining profit maximizing price and quantity of the monopolist, supply curve is not necessary. (2010, I, 10).

Explain above using graphical illustrations.

- He only needs to equate MC with MR.

Shift in Market Demand

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- There is no distinction between SR and LR. Output will be higher but the price may be higher or same depending upon the extent of shift and price elasticity of demand. If it is not a parallel shift then as we can see in the above diagram, the price may remain changed even though the quantity produced is higher.

Increase in Fixed Costs/ Imposition of Lump Sum Tax / Imposition of Income Tax (% of net profits)

Short Run

- There is no change in the MC curve. So no change in either price or output. But the profit of the monopolist will be lower.

Long Run

- In the long run there is no change in the MC curve as well. But a monopolist will never earn losses. So if the fall in supernormal profits is so much that he can't even earn a normal profit, he will shut down and quit.

Increase in Variable Costs / Imposition of a Sales Tax

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- There is no distinction between short run and long run. In both cases, prices would rise and quantity produced will be less. However, a monopolist can not pass on the entire increase in cost (or tax) to the consumers. In fact his ability to pass on the increased cost (or tax) is generally less than that in perfect competition. Even the change in quantity is less than that in perfect competition.

- This is because in a monopoly, equilibrium is where MC intersects MR. Because MR curve is steeper than the demand curve (D). Thus given same unit sales tax, the change in quantity (∆q) will be ∆tax . cot ø. Since ømonopoly > øperfect competition, so ∆qmonopoly perfect competition. And because ∆qmonopoly perfect competition, on the same demand curve, ∆pmonopoly perfect competition.

Multiplant Monopolist

Issues

- How much to produce in total and at what price to maximize overall profit?

- How to allocate the total produce among various plants?

π maximization rule

- He equates the marginal cost in each plant with the marginal revenue.

[pic 10]

Proof

- His aim is to maximize his overall profit. His overall profit = total revenues (TR) - total costs (TC). TR = p.q where q = q1 + q2 and TC = TC1 + TC2. Differentiating the total revenue function and solving for maxima condition we get, ∂(TR)/∂(q1) - ∂(TC1)/∂(q1) - ∂(TC2)/∂(q1) = 0 and ∂(TR)/∂(q2) - ∂(TC1)/∂(q2) - ∂(TC2)/∂(q2) = 0. Now ∂(TR)/∂(q1) = ∂(TR)/∂(q2) = MR (because the product is homogenous). And ∂(TC1)/∂(q2) = 0 and ∂(TC2)/∂(q1) = 0 and ∂(TC1)/∂(q1) = MC1 and ∂(TC2)/∂(q2) = MC2.

- Thus we can write the π max conditions above as: MR = MC1 and MR = MC2. Intuitively, if the production costs in 2 plants are independent of each other and if one of the plants (say plant 1) is operating below MR = MC1 condition, then it will be profitable for the monopolist to produce in this plant.

Measurement of Monopoly Power

- Hirschman-Herfindahl index (H): Let the market share of ith firm in an industry be Si. Then the index is given by (H = ∑Si^2).

- Lerner's index (L): L = It measures monopoly as the excess of price of a commodity over its marginal cost of production. Thus L = (P - MC) / P. It can also be return as 1/ηd because MR = P.(1 - 1/ηd) and MC = MR.

- Lerner's domestic monopoly index (Ld): Ld = (Pdomestic - Pinternational) / Pdomestic.

Bilateral Monopoly

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- The MR curve of the buyer will be the derived demand curve of the seller. Also the MC curve of the seller will be the supply curve of the seller as perceived by the buyer. Since it is upward sloping, so the marginal expense curve or the MC curve of the buyer will have even steeper slope. Thus the buyer will equate his MR and MC curves i.e. his equilibrium will be @ ebuyer where MEbuyer and MRbuyer intersect. He would make a projection on the MC curve of the seller (which is the seller's supply curve according to him) and pay Pbuyer and buy Qb.

- On the other hand the seller takes MR curve of the buyer as his demand curve and draws his own MR curve. This he equates with his MC and the equilibrium is at eseller where he would like to supply Qs @ Pseller price.

- If the buyer makes a vertical backward integration i.e. buys out the seller, the seller's MC cost curve will become his MC curve and he will be able to produce more @ b.

Monopolistic Competition

Chamberlin's Model

Assumptions

- Product differentiation & non price competition: The products of sellers are differentiated yet close substitutes. The product differentiation gives downward sloping curves. Note that the product differentiation may be a result of the characteristic of the product itself or it may be a result of differentiation in the selling conditions. Firms incur a considerable expenditure on advertisements and other selling costs to promote product differentiation. Such expenditure may change the demand curve for its product and it also changes the cost curve. Like any other cost, a seller will spend only enough to maximize his profit.

- Myopia: The long run consists of identical short runs and decisions in one period don't impact decisions in others. This leads to myopic vision of firms.

- Heroic assumption (uniformity assumption): A difficulty in describing the group