Chapter 9

The competitive and Monopoly

Models

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 Two broad scenarios
• Price taking scenario: Firms in Perfect
competition

• Price finding scenario: imperfect

competition- each firm has a unique
downward sloping demand curve-
Monopolistic competition, oligopoly and
monopoly

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 Characteristics of a Perfectly
competitive Market
• Large number of sellers. Each seller is
therefore a price taker
• Large number of buyers
• Homogeneous product- hence uniform price
• Perfect information
• Free entry and exit- so no supernormal profits

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 Industry Equilibrium – Long run
and Short run
• Short run Long run
Rs/unit
SRSS

LRSS
LRDD
SRDD

Q Q

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 Interference with Equilibrium

Pc-Price ceiling: Situation of D > S- Shortage

Pf
Pf- Price floor: S>D- excess supply
P*
Govet has to offset the shortage and excess.
Pc

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Output decision for a firm in Perfect
competition
• Marginal Output Rule:
MR = MC
• Shut-down Rule:
If P (price) is less than Min AC , then
SHUT DOWN

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 Optimal Output for a firm

MC AC
P,ac,mc

P P = MC =MR

Q* Q

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 Uses of the competitive model
• Tax burden assessment
Economic incidence of a tax is inversely
related to the price elasticity of demand for
the consumer and, the price elasticity of
supply for the seller.
Consumer’s burden/seller’s burden = Pe of
supply/Pe of demand

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 Normative analysis of Perfect
Competition
• Total Surplus is maximum

SS
A

B
DD

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 Monopoly

• A single firm faces the entire demand - Price

finder
• No role for strategy
• No substitutes
• No entry

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Pricing and Output decisions of a
Monopolist
• Downward sloping demand curve or AR
curve
• Hence a falling MR curve
• MC=MR at E MC

E
AR
MR
Q

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 Monopoly Vs Competitive Solution

• Output lower and price higher in a monopoly than

in competition.
• This is because :
MR = P in Competition and MR < P in Monopoly
In competition, MC =MR =P.
In monopoly, MC=MR and MR < P

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 Taxing a monopolist
• A monopolist may or maynot be able to
pass the burden of the tax to the buyer.
Why?

Depends on the elasticity of Demand of the

buyers! Only if it is inelastic, the burden
can be transferred entirely to the buyer.

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 Normative analysis of a Monopoly
• With P > MC, there is a Dead weight Loss.
P> MC results in reduction of Consumer’s
Surplus.
Some of this is accounted for by increase in
Producer’s surplus.
But some of this reduction in consumer’s
surplus is ‘lost’ and has to be borne by the
society as DWL
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 Regulation of Monopoly
• Regulation of prices
• Antitrust Policies – to prevent the monopolist
from exercising Monopoly Power.
• In India , we had the MRTP Act of 1969
• We now have the competition Act 2002
• Patent Policy

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 Rationale behind Price
Discrimination

• To transfer as much as possible of the

consumers surplus over to the seller

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 Price Discrimination

• Practice of charging different prices in

different markets for the same product
• The seller should be a price finder
• Price elasticity of demand has to be different
for different market segments
• The different market segments should be
insulated

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 Price discrimination
• First degree Price discrimination
• Second degree price discrimination

• Third degree price discrimination

First degree P discrimination results in no
DWL.
DWL is lesser with Price discrimination than
without.

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 Breakeven Analysis
• Qb = TFC / ( P – AVC)
P – AVC is “ Contribution”
• Quantity at which a target profit can be
earned:
Q = TFC + Profit Target / Contribution

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