SHORT RUN EQUILIBRIUM UNDER MONOPOLY

A monopolist being the single seller can either control the supply of his good or can fix the price for his good based on the elasticity of demand.  In the short period if there is demand for his good, a monopolist  enjoys super normal profits.  On the other hand if there is less demand he may suffer loss.  But he would continue to produce as long as the price is above the average variable costs. 

In the short period a monopolist attains equilibrium when two conditions are met:  a)  MC= MR   and

          b)  MC should MR from below.  This is explained with the help of a diagram below.

In the above diagram, OX axis measures the output and OY axis measures the revenue and cost.  The AR curve slopes downwards from left to right.  The AR curve of the monopolist is the demand curve which shows that a monopolist can sell additional units of the commodity only when he reduces the price.  The MR curve slopes downwards from left to right because the AR curve slopes downwards.  E is the point of equilibrium at which the conditions of equilibrium are fulfilled namely, MC=MR and MC cuts MR from below.  To know whether the firm attains super normal profits or loss, the AC is important.  In the above diagram, the AC curve lies below the AR curve.  In other words, The AR is greater than AC.  The revenue per unit is OP and the total revenue is OP x OQ= OPAQ.

The cost per unit is OC and the the total cost is OC x OQ=OCBQ. So the total profit will be TR-TC, i.e, OPAQ – OCBQ =PABC (rectangle box)  which is the super normal profits earned by the monopolist during the short period.

Oligopoly

Oligopoly refers to a market situation in which a small number of (3-10) large firms sell either identical goods or differentiated goods.

Features

1.   Few sellers

Under Oligopoly there are few sellers dealing in homogeneous or slightly differentiated products.

2.   Interdependence of firms

Under Oligopoly each firm controls a large share of the market and can influence the industry price and output.  Hence each firm takes into consideration the actions and reactions of other firms while determining its price and the level of output.

3.   Collusion or Group Behaviour

Under Oligopoly, collusion among firms is possible.  Hence each firm has monopoly power and may charge higher price.

4.   Price Rigidity

Under Oligopoly, price of a product tends to be rigid.  If any firm tries to reduce its price, the rival firms will retaliate by a higher reduction in their prices.  If any firm increases its price, the other firms will not follow the same.

5.   Advertisement

Under Oligopoly, each firm has to stick to its prevailing price.  So, it has to spend a lot on advertisements to increase its sales.

MONOPOLY

Monopoly refers to a market situation where a single seller controls the supply of a commodity which has no close substitutes.

Features

1.      Single seller: There is single seller for a product in the market.

2.     Absence of competition: Since there is a single seller in the market, there is absence of competition.

3.     No close substitutes:  The commodity sold by the monopolist doesn’t have any close substitutes.

4.     High barriers to entry: New firms cannot enter the market.  Monopolist has complete control over the supply in the market. Ex. Indian Railways.

5.     Price Maker:  The monopolist fixes the price of his product and has full control over price and output decisions.

6.     Perfect knowledge:  Monopolists have perfect knowledge about the market conditions, types of demand prevailing at different market segments and accordingly varies price of their products.

7.     Price discrimination or uniform price:  A monopolist firm can charge different prices for the same product to different buyers or may charge a uniform price.

8.     No difference between firm and industry: There is no difference between firm and an industry under Monopoly. It is a single firm industry.

9.     Super Normal Profits: Existence of Supernormal profits is common under monopoly as the market price is higher than the cost of production.

10. Nature of Demand curve:  The demand curve of a monopolist slopes downwards indicating that he can sell more at a lower price.

MONOPOLISTIC COMPETITION

Monopolistic competition is a form of market in which there are many sellers selling differentiated products.  Each seller has monopoly control over trade but faces stiff competition from rival sellers. Hence it is a combination of monopoly and competition. 

Features

1.    Large number of  Buyers and Sellers

There are fairly large number of buyers and sellers in the market.  The sellers are in a position to control the supply of goods and influence the price.

2.    Close substitutes

The products sold by the different sellers are very close substitutes.

3.   Product Differentiation

The Products sold by the sellers are differentiated from one another by the use of brands, labels, designs of packing etc.  Product differentiation may be real (use of different materials, design, colour etc) or imaginary (brand name, trademark etc).

4.    Selling Costs

The firms incur Selling costs.  Selling costs are those expenses of the producer (such as advertisement, attractive packing etc) incurred on marketing of goods produced.

5.    Free Entry and exit of firms

New firms can enter the industry and existing firms can leave the industry.

6.    Downward sloping demand curve

The demand curve of a firm under monopolistic competition slopes downwards to the right.  A reduction in price leads to increase in sales and vice-versa.

7.    Price maker

Each firm can fix the price for its products.

8.    Transport cost

The sellers incur transport cost in getting the goods to the market.

9.    Lack of perfect knowledge

The buyers and sellers in the monopolistic market do not have perfect knowledge of the market conditions and the prices prevailing in the market.

The law of supply

The quantity of a commodity which the sellers offer for sale varies directly with its price.  When the price of a commodity rises in the market, the sellers are willing to sell larger quantities of that commodity and so the supply of that commodity expands. On the other hand when the price of that commodity falls in the market, the sellers offer only lesser quantities and so the supply falls.  This tendency is known as the law of supply.  The law of supply can be stated as follows:  Other things being equal, when the price of a commodity raises, its supply rises, and as the price falls, the supply also falls.
The law of supply is valid only under the following assumptions ( Determinants of supply)

1.      The number of firms producing a particular commodity remains constant.

2.     The level of technology remains the same.

3.     The supply doesn’t depend on the price of related commodities.

4.     The seller doesn’t expect any changes in the price of the commodity he sells.

5.     Geographical factors remain constant.

6.     No labour unrest is expected.

7.     No change in government policy

8.     No change in transport and communication.

The law of supply can be explained with the help of a schedule.

Market demand schedule

Price of onion per Kg in Rs	Number of Kilos supplied
1	20
2	40
3	60
4	80
5	100

When the price of onion per kg is Rs 1, the quantity supplied is 20 kgs,

When the price rises to Rs 2 per kg, the quantity supplied is 40 kgs, when the price rises to Rs 3 per kg, the quantity supplied is 60 kgs and so on.

The above schedule can be shown in a diagram.

In the above diagram along the ox axis, quantity supplied is measured and along OY axis, price is measured.  When the price of Onion is Rs 1 per kg, the quantity supplied is 20 kgs, when the price rises to Rs 2 per kg, the quantity supplied is 40 kgs, when we plot all the points and join the points we get SS the supply curve, which slopes upwards from left to right indicating the direct relationship between price and the quantity supplied.

THE THEORY OF THE FIRM AND PERFECT COMPETITON

Define the term market.

In Economics the word ‘Market’ refers to the direct or indirect contact between the buyers and sellers of a particular commodity at a price and at a place which could be even the world.

The following requirements are to be met for the existence of a market.  

1.  Existence of a commodity which will be bought and sold. 

2.  Existence of buyers and sellers.

3.  Prevalence of a price.

4.  A place, which could be a region, country or the entire world through which exchange takes place. Ex: internet.       

  

Distinguish between a firm and industry.

A firm is a single producing unit where as group of firms constitutes the industry.   Ex. TVS motors, Bajaj, Hero motors, are firms and together they constitute the automobile industry.

Explain the Features of Perfect Competition.

Meaning:  It refers to a Market situation in which there are a large Number of Buyers and sellers who deal with identical products at an equilibrium price which is determined by the market forces of demand and supply.

Features:

1.  There are a large number of Buyers and Sellers in the market.

2.  There is free competition among the buyers and sellers.

3.  No individual buyer or seller can influence the price of the commodity by his own action.

4.  Products of all firms will be identical.

5.  There is one price for a commodity throughout the market.

6.  Any new firm is free to enter the industry and any existing firm is free to leave the industry.

7.  All the buyers and sellers have perfect market information.

8.  Each firm is a Price taker.

9.  There is absence of Transport Cost.

10.There is free mobility of factors of production.

11.The demand for the product is perfectly elastic.

Explain how price and output is determined under Perfect Competition. or

Show how the invisible hand guides both producers and consumers towards equilibrium.

The process of determination of price by the forces of demand and supply is called Price mechanism.  Prof. Adam smith referred this as invisible hand which directs and guides both the producers and consumers towards equilibrium.

Equilibrium means a state of rest.  At Equilibrium price, quantity of demand and supply will be equal.  Market equilibrium is determined by the forces of market (total) demand and market (total) supply.

     The market supply curve slopes upwards from left to right and the market demand curve slopes downwards from left to right.  These two curves intersect at a point which determines the equilibrium price and the equilibrium output.

     The following table shows the demand and supply schedule for sugar.

Price sugar in Rs	QD ( in tones)	QS( in tones)
10	100	20
20	80	40
30	60	60
40	40	80
50	20	100

When Price of sugar per kg is Rs 10, the quantity demanded is 100 tonnes and the quantity supplied is 20 tonnes.  When price increases to Rs. 20, the quantity demanded is 80 tonnes and the quantity supplied is 40 tonnes.  At Rs 30 per Kg, quantity demanded is equal to the quantity supplied at 60 tonnes.  Therefore, Rs 30 is the equilibrium price and 60 tonnes of sugar is the equilibrium output.  Any price higher than Rs 30 leads to excess supply and lower than Rs 30 leads to excess demand.  This is explained with the help of a diagram. 

In the diagram, quantity of demand and supply is measured on OX axis and price is measured on OY axis.  SS is the Supply curve and DD is the demand curve.  E is the intersection point, where the quantity demanded is equal to the quantity supplied. OM is the Equilibrium quantity and OP is the equilibrium price.  If price falls to OP1, Demand is greater than supply by Kl.  The sellers want to supply only OM1 quantity of supply but demand will be OM2.  The buyers now compete with each other in order to obtain the goods and are ready to pay a higher price than OP1.  so price starts rising till OP level is reached, where quantity supplied will be equal to the quantity demanded.

If the price rises to OP2, then demand will be less than supply by NM.  In order to dispose this excess supply the sellers will compete with each other and bring down the price to OP.  Thus if price is above or below the equilibrium price, the invisible hand will operate to bring the price to the level at which the quantity supplied will be equal to quantity demanded.