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We recall that perfect competition was theorised as a market structure where both consumers and firms were price takers. The behaviour of the firm in such circumstances was described in the Chapter 4. We discussed that the perfect competition market structure is approximated by a market satisfying the following conditions:
(i) there exist a very large number of firms and consumers of the commodity, such that the output sold by each firm is negligibly small compared to the total output of all the firms combined, and similarly, the amount purchased by each consumer is extremely small in comparison to the quantity purchased by all consumers together;
(ii) firms are free to start producing the commodity or to stop production;
(iii) the output produced by each firm in the industry is indistinguishable from the others and the output of any other industry cannot substitute this output; and
(iv) consumers and firms have perfect knowledge of the output, inputs and their prices.
In this chapter, we shall discuss situations where one or more of these conditions are not satisfied.
If assumptions (i) and (ii) are dropped, we get market structures called monopoly and oligopoly.If assumption (iii) is dropped, we obtain a market structure called monopolistic competition. Dropping of assumption (iv) is dealt with as ‘economics of risk’. This chapter will examine the market structures of monopoly, monopolistic competition and oligopoly.
SIMPLE MONOPOLY IN THE COMMODITY MARKET
A market structure in which there is a single seller is called monopoly. The conditions hidden in this single line definition, however, need to be explicitly stated. A monopoly market structure requires that there is a
single producer of a particular commodity; no other commodity works as a substitute for this commodity; and for this situation to persist over time, sufficient restrictions are required to be in place to prevent any other firm from entering the market and to start selling the commodity.
In order to examine the difference in the equilibrium resulting from a monopoly in the commodity market as compared to other market structures, we also need to assume that all other markets remain perfectly competitive. In particular, we need (i) that the market of the particular commodity is perfectly competitive from the demand side ie all the consumers are price takers; and (ii) that the markets of the inputs used in the production of this commodity are perfectly competitive both from the supply and demand side. If all the above conditions are satisfied, then we define the situation as one of monopoly in a single commodity market.
Market Demand Curve is the Average Revenue Curve
The market demand curve in Figure 6.1 shows the quantities that consumers as a whole are willing to purchase at different prices. If the market price is at the higher level p0, consumers are willing to purchase the lesser
quantity q0. On the other hand, if the market price is at the lower level p1, consumers are willing to buy a higher quantity q1. That is, price in the market affects the quantity demanded by the consumers. This is also expressed by saying that the quantity purchased by the consumers is a decreasing function of the price.
For the monopoly firm, the above argument expresses itself from the reverse direction. The monopoly firm’s decision to sell a larger quantity is possible only at a lower price. Conversely, if the monopoly firm brings a smaller quantity of the commodity into the market for sale it will be able to sell at a higher price. Thus, for the monopoly firm, the price depends on the quantity of the commodity sold. The same is also expressed by stating that price is a decreasing function of the quantity sold. Thus, for the monopoly firm, the market demand curve expresses the price that is available for different quantities supplied. This idea is reflected in the statement that the monopoly firm faces the market demand curve.
1. What would be the shape of the demand curve so that the total revenue curve is
(a) a positively sloped straight line passing through the origin?
(b) a horizontal line?
2. What is the value of the MR when the demand curve is elastic?
5. If the monopolist firm of Exercise 3, was a public sector firm. The government set a rule for its manager to accept the goverment fixed price as given (i.e. to be a price taker and therefore behave as a firm in a perfectly competitive market), and the government decide to set the price so that demand and supply in the market are equal. What would be the equilibrium price, quantity and profit in this case?
6. Comment on the shape of the MR curve in case the TR curve is a (i) positively
sloped straight line, (ii) horizontal straight line.
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