Market Structure - Assignment Example

Market Structure Under perfect competition the economic welfare of a market structure will greatly determined by those economic circumstances under which a perfectly competitive market thrives. The basic characteristics are: - 1. Large number of sellers and buyers - the firms are infinite such that no individual is able to influence the market i.e. if a customer wants to buy low price the seller can refuse to sell goods to him and if a seller charges higher prices then consumers can go other sellers. Products homogeneity all the firms produce a homogenous product. The above two characteristics imply that the individual firm is a price taker meaning that the individual demand curve is infinitely elastic an indication that he firm can sell any amount of output at the prevailing market prices. (Eaton, Diane and Douglas, 2002 pp.93) Other characteristics include: 2. There is free entry and free entry of firms. 3. There is no government regulation. 4. There are perfect mobility factors or production. 5. There is perfect knowledge in the Market. The Short Term Equilibrium of the Firm The firm is in equilibrium if it maximizes profit defined as the difference between revenues and costs (** = R-C). The equilibrium point is where the firm produces the output that maximizes the difference between TR & TC curves as shown below. The firm is making profit between Q1 and Q2 at point Q* profits are maximized. In the short term the firm will either be making excess profits or losses depending on the position of an AC curves i.e. if the AVC curve lays below the price the firm is making excess profit as shown below. However if the AVC curve lies above the price the firm will be making loses. It is only possible for the firm to be equilibrium. The short run without necessarily breaking even point. However, in the long run the firm will either make neither losses nor excess profit i.e. the break even point will be the equilibrium point for the firm as shown below. MC AVC The supply of such a firm may be derived by the points of intersection of MC curve with the successive demand curve. Assuming that the market prices increase gradually the demand curve will tend to shift upwards. Given the slope of the MC curve is positive each higher demand curve cuts the given MC curve on a point which lies to the right of the previous intersection. This implies that the quantity supplied by firm increases as the price increases. (Eaton, Diane and Douglas, 2002 pp.85) Changing from perfect competition to a monopoly that changes a single price will have associated implications to the firm. This is because as a monopoly market the market structure will consist of one single firm that will deal with products that have no close substitute, there will be no free entry of into the market and the firm will be a price maker meaning that the amount sold in the market will depend on the price Q = F (P) The monopolist will have a normal demand curve Q = a - b P with an option of making either of the following two decisions: (1) the price - in this case the quantity will be determined by the customer (2) the quantity- in this case the price will be determined by the future of demand and supply in the market The demand is equal to the average revenue (P = AR) for the monopolist since: Q = a - b P b p = a - q P = a - Q or a - 1 ____ ____ ____ Q b b b TR = P Q but P = a - 1 ____ ____ Q b b AR = TR = (a/b) Q - (1/b) Q2 = (a/b) - (1-b) Q thus P = AR ________________ Q They all have a common intercept (a/b) with the MR curve being twice as steep as the AR or the Demand curve. P1R a/b AR=P OUT PUT MR MC AC pe c AR=P Q* MR Equilibrium condition requires that:- I). MR=MC ii). The slope of the MC > slope of MR Points Q* meets the above two conditions The monopolist is at equilibrium on the point Q*and the equilibrium price will be given as (pe) while the total cost per unit of producing OQ units=(C) Thus there will be excess profits and the monopolist will never make a loss since he is the price maker. (Ruffin and Paul, 2000 pp.67) However, if the monopolist practices price discrimination i.e. selling the same product at different prices in different markets where the price difference will not be as a result of differences in cost of production but pure discrimination. The monopoly must abide with the three conditions for price discriminations which are 1. The market must be divided into sub markets. 2. The price elasticity of demand must be different in all the sub markets and 3. These must be efficient separation of all the sub market so that no reselling can take place. The equilibrium in this market will require that MR1=MR2=MR n= MC Specifically if there will be two sub markets then MR=P(1-1/R) Given two sub markets then MR1=P1(1-1/e1) MR2=P2(1-1/e2) If at equilibrium MR1=MR2 it would imply that P1(1-1/e1)= P2 (1-1/e2) P1/p2= 1-1/e2 1-1/e1 Suppose e1=e2 it would mean therefore that 1-1/e1=1-1/e2=1 Thus If e1>e2 then 1-1/e2 Read More