Pure, Perfect &

Imperfect
Competition
What is a firm?
A Firm is a group of people, with
production tools, located in some
premises, who, with work, transform
raw materials into goods and
services,
Firm and sell them
 What is an industry?
The Firm and Industry are two
different entities but co-related.
A group of firms producing a
homogenous product is called an
Industry". Conversely, we can say
that firm operates within the industry
to create a Product.
You can presume KFC as one firm,
but all the fast food restaurants and
their suppliers would make up the
 Pure & Perfect
Competition
A market structure in which a large
number of firms all produce the same
product and no single seller controls
supply or prices.
It is a market structure where there
is a perfect degree of competition
and single price prevails. This type of
market is hypothetical market where
competition is at its greatest possible
level.
Features of Pure & Perfect
Competition
Large No of Buyers & Sellers
An individual seller cannot fix the
price. Similarily no single buyer can
fix the price. Price of a product is
determined by the interaction of total
demand & total supply in the market.
Homogenous Products
All the products sold by different
sellers are homogenous i.e. alike in
quality.
Features of Pure & Perfect
Competition
Free entry & exit of firms
There is no hindrance to the entry of
new firms & exit of existing firms, the
total no of firms remains very large.
Perfect Knowledge
Every seller knows the total quantity
supplied & sold on a particular day.
Similarly, every buyer knows about
the price of product & related
information.
Features of Pure & Perfect
Competition
No discrimination
No seller can discriminate between
the buyers. Similarily a buyer has no
reason to discriminate between
sellers as long as sellers are charging
the same price.
No cost of transportation
Under perfect competition, it is
assumed that the cost of
transportation does not exist for
 Features of Pure & Perfect
Competition
Mobility of factors of production
For e.g. worker from one industry can
be diverted to another industry if the
return on investment is going to be
higher. There is no hindrance to the
movement of factors of production.
Automated Price Mechanism
Price of a product is determined by the
interaction of total demand and total
supply in the market. No individual
Examples of Perfectly
Competitive Markets?

Agricultural markets
Pig farming, cattle
Farmers markets for apples,
tomatoes
Wholesale markets for vegetables,
fish, flowers
Street food markets in developing
countries
Total, Average, and
Marginal Revenue for a
Competitive Firm
Quantity
(Q)
1
2
3
4
5
6
7
8
Price
(P)
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$12.00
$18.00
$24.00
$30.00
$36.00
$42.00
$48.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
TR/Q
Total Revenue Average Revenue Marginal Revenue
(TR=PxQ) (AR=TR/ Q) (MR=

$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
)
 Total, Average, and
Marginal Revenue for a
Competitive Firm
AR(Average revenue) curve and
MR(Marginal Revenue) curve under
perfect competition becomes equal
to D(Demand) curve and it would be
a horizontal line or parallel to the X-
axis
Marginal Revenue &
Marginal Cost
Marginal revenue (MR) It is the
change in total revenue from an
additional unit sold.
MR =TR/ Q
The demand, marginal revenue, and
average revenue curves are
horizontal at the market price P. All
three curves coincide
Marginal cost (MC) the change in
total cost associated with a change
 Equilibrium under
Perfect Competition
So the Firms Equilibrium means, the
level of output where the firm is
maximizing its profits and therefore,
has no tendency to change its
output.
MR=MC , and when these are equal
profit is maximum.
Equality of MR and MC is necessary
but not sufficient, so the sufficient
condition is that MC curve should cut
 Firm Equilibrium under
Two Time Periods-Short
& Long
The price of a good is determined at
a point where its demand is equal to
supply and so further it depends on
the time taken by the demand and
supply to adjust themselves.
So this time element plays a vital
role in determination of price of the
goods
So the two time periods are :

Short run Equilibrium

Condition
In Short run, the Firm output (supply)
can be changed only by the variable
factors (like labor force through
overtime), fixed factors (like
machinery) cant be changed
There is not enough time for new
Firms to enter the Industry.
Further, if the demand is increased,
the supply can be increased only up
to its existing production capacity
Short run Equilibrium
Condition
Market forces
MC
Price determine the Price
price MS AC

P1

MD

Output Output
Short run Equilibrium
Condition
Market forces
MC
Price determine the Price
price MS AC

P1

MD

Output Output
Short run Equilibrium
Condition
Market forces
MC
Price determine the Price
price MS AC

Price
P1 Taking

MD

Output Output
Short run Equilibrium
Condition
Market forces
MC
Price determine the Price
price MS AC

Price
P1 AR=MR
P1 Taking

MD

Output Output
Short run Equilibrium
Condition
Market forces Assume profit MC
Price determine the Price maximising
price MS firms
AC

P1 AR=MR
P1

MD

Output Output
Short run Equilibrium
Condition
Market forces Assume profit MC
Price determine the Price maximising
price MS firms
AC

P1 AR=MR
P1

MD

Output Q1 Output
Short run Equilibrium
Condition
MC
Price Price
MS MR=MC AC
Maximum
Profits

P1 AR=MR
P1

MD

Output Q1 Output
Short run Equilibrium
Condition
MC
Price Price
MS MR=MC AC
Maximu
m
Profits

P1 AR=MR
P1

AC1

MD

Output Q1 Output
Short run Equilibrium
Condition
MC
Price Price
MS Profits = AC
(P1-AC1)
x Q1

P1 AR=MR
P1

AC1

MD

Output Q1 Output
Normal Profits
Normal profitis
aneconomiccondition occurring
when the difference between a firm's
total revenue and total cost is equal
to zero.
Simply put,normal profitis the
minimum level ofprofitneeded for a
company to remain competitive in
the market.
Since the firm is earning only normal
profits, there would be no reason for
Normal Profits
 Loss Condition
The firm shuts down if the revenue it
gets from producing is less than the
variable cost of production.
At this stage, the firm cannot leave
the market because by shutting
down it can only save its variable
costs but not its fixed costs. So it
decides to continue the production in
order to save its variable costs.
In this case AC>AR.(AC-AR=Loss)
Loss Condition
What is a Long Run
Equilibrium?
In Long run, the Firms output (supply) can
be changed by both the variable factors
and fixed factors i.e. all factors become
variable
There is enough time for new Firms to
enter the Industry
Further, if the demand is increased, the
supply can be increased or decreased
according to the demand
For Long run equilibrium, long run marginal
cost (LMC) is equal to MR and LMC curve
cut the MR curve.
Long run equilibrium price
MC
Price Price
MS AC

P1 AR=MR
P1

MD

Output Output
Long run equilibrium price
MC
Price Price
MS AC

MS2
P1 AR=MR
P1

P2

MD

Output Output
Long run equilibrium price
MC
Price Price
MS AC

MS2
P1 AR=MR
P1

AR2=MR2
P2

MD

Output Output
Long run equilibrium price
MC
Price Price
MS AC

MS2
P1 AR=MR
P1

AR2=MR2
P2

MD

Output Q2 Output
The long run equilibrium
MC
Price Price In the long run
MS equilibrium, AC
normal profits
are made i.e.
price = average
MS2 cost

AR2=MR2
P2

MD

Output Q2 Output
Real world imperfect competition!
1. Most suppliers have a degree of control over
market supply.

2. Some buyers have power against suppliers

because they purchase a significant percentage
of total demand

3. Most markets have heterogeneous products

due to product differentiation and constant
innovation

4. Consumers nearly always have imperfect

information and their preferences and choices
can be influenced by the effects of persuasive
marketing and advertising.
 Monopoly
Monopoly is a market situation where there is
only a single seller with complete control over
an industry. Monopoly is the polar opposite of
perfect competition

Features of Monopoly-
Single seller
No Close Substitutes
Unique Product
Entry is Restricted
Price Maker
 Monopoly
Monopolies exist because of barriers to entry into
a market that prevent competition. Barriers to
entry include legal barriers, sociological barriers,
and natural barriers.

Legal barriers- such as patents, prevent others

from entering the market until the patent expires.
Sociological barriers not everyone has the
brains to win a Nobel Prize nor the skill to slam-
dunk a basketball.
Natural barriers where the firm has economies
of scale to produce what others cannot duplicate.
 Monopoly vs.
Competition
Monopoly
Is the sole producer
Faces a downward-sloping demand curve
Is a price maker
Reduces price to increase sales

Competitive Firm
Is one of many producers
Faces a horizontal demand curve
Is a price taker
Sells as much or as little at same price
 Demand Curves for Competitive and
Monopoly Firms

(a) A Competitive Firm demand curve (b) A Monopolist demand Curve

Price Price

Demand

Demand

0 Quantity of Output 0 Quantity of Output

 A Monopoly Revenue
Total Revenue
P*Q = TR
Average Revenue
TR/Q = P
Marginal Revenue
d TR/d Q = MR
 Monopolys Total,
Average and Marginal
Revenue
Quantity Total Average Marginal
of Product Price Revenue Revenue Revenue
Q P P*Q TR/Q dTR/dQ
0 11 0 _
1 10 10 10 8
2 9 18 9 6
3 8 24 8 4
4 7 28 7 2
5 6 30 6 0
6 5 30 5 -2
7 4 28 4 -4
8 3 24 3
 Demand and Marginal-Revenue Curves
for a Monopoly

Price
$11
10
9
8
7
6
5
4
3 Demand
2 Marginal (average
1 revenue revenue)
0
1 1 2 3 4 5 6 7 8 Quantity of Water
2
3
4

Copyright 2004 South-Western

Profit Maximization for a
Monopoly
A monopoly maximizes profit by
producing the quantity at which
marginal revenue equals marginal
cost.
It then uses the demand curve to find
the price that will induce consumers
to buy that quantity.
 Profit Maximization for a
Monopoly

Costs and
Revenue The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
B profit-maximizing
Monopoly quantity . . .
price

Average total cost

A

Marginal Demand
cost

Marginal revenue

0 Q QMAX Q Quantity
 The Monopolists Profit

Costs and
Revenue

Marginal cost

Monopoly E B
price

Monopoly Average total cost

profit

Average
total D C
cost
Demand

Marginal revenue

0 QMAX Quantity

Copyright 2004 South-Western

 Monopolistic Profit
The monopolist will receive economic
profits as long as price is greater
than average total cost.
 Welfare Cost of a
Monopoly
In contrast to a competitive firm, the
monopoly charges a price above the
marginal cost.
From the standpoint of consumers,
this high price makes monopoly
undesirable.
However, from the standpoint of the
owners of the firm, the high price
makes monopoly very desirable.
 The Efficient Level of
Output

Price
Marginal cost

Value Cost
to to
buyers monopolist

Demand
Cost Value (value to buyers)
to to
monopolist buyers

0 Quantity

Value to buyers Value to buyers

is greater than is less than
cost to seller. cost to seller.
Efficient
quantity
Copyright 2004 South-Western
 The Dead Weight Loss
Because a monopoly sets its price above
marginal cost, it places a wedge between the
consumers willingness to pay and the
producers cost.
This wedge causes the quantity sold to fall
short of the social optimum
The deadweight loss caused by a monopoly is
similar to the deadweight loss caused by a tax.
The difference between the two cases is that
the government gets the revenue from a tax,
whereas a private firm gets the monopoly profit.
 The Inefficiency of
Monopoly

Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity

Copyright 2004 South-Western

Public Policies Towards
Monopoly
Government responds to the problem of
monopoly in one of four ways.
Making monopolized industries more
competitive.
Regulating the behavior of
monopolies.
Turning some private monopolies into
public enterprises.
Doing nothing at all.
 Making Monopolized Industries More Competitive.

Antitrust laws are a collection of statutes

aimed at curbing monopoly power.
Antitrust laws give government various
ways to promote competition.
They allow government to prevent mergers.
They allow government to break up
companies.
They prevent companies from performing
activities that make markets less competitive.
 Regulating
the Behavior of Monopolies

Government may regulate the prices that

the monopoly charges.
The allocation of resources will be efficient
if price is set to equal marginal cost.

In practice, regulators will allow monopolists

to keep some of the benefits from lower
costs in the form of higher profit, a practice
that requires some departure from marginal-
cost pricing.
 Marginal-Cost Pricing for a Natural
Monopoly

Price

Average total
cost Average total cost
Loss
Regulated
price Marginal cost

Demand

0 Quantity

Copyright 2004 South-Western

 Turning Some
Private Monopolies Into Public Enterprises

Rather than regulating a natural

monopoly that is run by a private
firm, the government can run the
monopoly itself (e.g. in the United
States, the government runs the
Postal Service, In India Indian Railway
).
 Doing Nothing
Government can do nothing at all if
the market failure is deemed small
compared to the imperfections of
public policies.
 Price Discrimination
A firm price discriminates when it
charges different prices to different
consumers for reasons that do not
fully reflect cost.
It does not occur in perfectly
competitive markets
Involves extracting consumer surplus
from buyers and turning into
additional revenue and profit
(producer surplus)
 Price Discrimination-
Conditions
The business must be operating in an
imperfect competition market.
There must be at least 2 consumer
groups with different elasticity's of
demand.
The firm must prevent consumers in
one group selling to consumers
consumers in the other (i e. . there
must be no market arbitrage or
market seepage)
 First Degree Price
Discrimination
Every customer charged their
willingness to pay
So there is no consumer surplus in
the transaction
More goods are sold in total; but the
price is higher to some customers
First Degree Price
Discrimination
 Second Degree Price
Discrimination
The monopolist charges consumers
not individual wise but group wise.
Thus he may classify the customers
into rich, middle class & poor
customers.
Example is the Indian Railways that
charges different prices to I,II,III class
customers.
 Third Degree
Different Prices are charged in
different markets.
The example is dumping where a
lower price is charged in the
international market and a high price
is charged in the home market.