Perfect Competition Vs Monopoly
Essay by Aamitabh Devi • January 20, 2016 • Essay • 9,533 Words (39 Pages) • 1,276 Views
Theory of market
Perfect Competition vs Monopoly
Comparison | Parameter | Perfect Competition | Monopoly |
1. Long Run | Output | Higher because full capacity utilization and price is low. | Lower because he earns supernormal profits. |
Price | Lower because production is at min(LAC) and he earns only normal profits. | Higher because he earns supernormal profit. | |
Profit | Only normal profits. | Abnormal profits in LR possible. | |
Capacity Utilization | Full capacity utilized. | He may have excess capacity, use full capacity or over-produce depending upon the market demand. | |
2. Shift in Market Demand | In SR, output and price will be higher. In LR,output will be higher but price may be same (constant costs industry), higher (increasing cost industry) or lower (decreasing cost industry). | 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. | |
3. Shift in costs | Fixed costs | No impact in SR. In LR, SS curve shifts left as firms exit (being unable to recover normal profits). | No impact in SR. In LR, no impact if monopolist continues to earn supernormal profit. If can't earn even that, he closes down. |
Variable Costs | It pushes MC higher, hence SS left. Thus price increases, output decreases. | Pushes MC higher, price increases, output decreases. But the change in price and output is < perfect competition. | |
4. Imposition of tax | Lump sum tax | Same as ∆FC. | Same as ∆FC. |
Profits tax | Same as ∆FC. | Same as ∆FC. | |
Specific sales tax | Same as ∆MC. The degree to which tax can be passed on to consumers depends on elasticity of supply curve given market demand. | Even if MC is perfectly elastic, monopolist will have to bear the partial burden of the ∆tax. |
Perfect Competition
Supply Curve
[pic 1]
- Above is the short run supply curve in a perfect competition. w is the shutdown point so the supply curve starts from here.
Firm's Long Run Equilibrium
- Firms produce at the minima of LAC which is the price as well. All firms in the industry have the same minima of LAC. But this doesn't mean they have the same size or efficiency. They can employ different technologies or different factors of production but the more productive the hired factors are, the more they have to be paid. Thus the firms which are more efficient i.e. use less resources to achieve same output have to pay out higher factor costs and hence their LAC is higher as well. So in the industry LAC is same for all firms.
Shift in market demand
Short Run
[pic 2]
- As the demand shifts from D0 to D1, a movement occurs along the industry supply curve (S0). Thus the price rises from P0 to P1. For an individual firm, the demand curve goes up, it overworks its resources, SMC increases and the output increases as well (from q0 to q1). Firms earn supernormal profits at this stage.
Long Run
(a) Constant Cost Industry
[pic 3]
- In such a case we assume that when there is an increased demand for the factors of production, their prices don't go up. So new firms which enter the industry due to the existence of supernormal profits and the old ones which expand their capacity can pay the same factor prices for the additional hired factors.
- The LAC curve remains unchanged, firms continue to operate at the initial LAC minima points and the supply curve of the industry is flat. The prices come back to original level.
(b) Increasing Cost Industry
[pic 4]
- Here we assume that as the demand for the factors of production increases, their prices also increase. This would mean that for the existing firms, their LACs would shift up and the new firms too would have higher LACs. But the market price has also gone up which sustains the new higher LAC.
- Supply curve of the industry is upward sloping. The new equilibrium prices are higher.
(c) Decreasing Cost Industry
[pic 5]
- Here we assume that as the demand for factors increases, the suppliers of factors innovate and the new unit prices are lower. Thus there is a downward shift in the LACs of the firms and hence the supply curve becomes downward sloping and the new equilibrium price is lower.
Increase in Fixed Costs / Imposition of Lump Sum Tax / Imposition of Income Tax (% of net profits)
Short Run
- No impact since the SMC remains unchanged. Just that the firms now earn supernormal losses.
Long Run
[pic 6]
- As loss making firms exit, the normal profit situation is restored. This is achieved as due to the exit of firms, the supply curve of the industry shifts to left, there is an increase in the prices due to short supply.
Increase in Variable Costs / Imposition of Sales Tax
- Both in short run as well as long run, the marginal cost curve shifts left and there is a reduction in output by each firm. As a result of reduction in output, the industry supply curve shifts left and the price increases and a new price is set at equilibrium.
Monopoly
Q. A supply curve is not used to determine the equilibrium price and quantity in a market under monopoly because
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