Perfect Competitive Market - Assignment Example

a) Perfect competitive market was first introduced by Adams Smith in his book “Wealth of Nations”. The conception of perfectly competitive market is based on the following assumptions of the firm is a price taker, product is homogeneous etc. A commodity market is the best example of perfect competition as it has large number of buyer and sellers and the supply of the commodities. The equilibrium condition of the PC market is shown in the following diagram:- The condition for profit maximization is MR=MC. The price is constant given the assumption of perfect knowledge. Marginal revenue and Average revenue are constant and equal to price. The optimal level of output is given by Q* where, average variable cost, AVC is minimum. Thus for the competitive firm, the maximising profit condition is AR=P=MR=MC. b) The term monopoly means single to sell and the person who sells is called a monopolist. Monopolists are called “price setter” and there is restriction to entry of innumerable firms in the market. The monopoly market is a one seller market and many buyers. Indian Railways example of monopoly. The main objective of a monopolist firm is to maximize its profit. The monopolist’s profit maximization point is illustrated in the Figure 2: c) Here in short run, SRMC is the short run marginal cost and SRAC is short run average cost curves respectively. The monopoly equates MR=MC to find the optimal output Qm. at price Pm. In case of the cost conditions, if price (P) is less that the average cost, then the firm is experiencing loss and will shut down. In case of Long run equilibrium, monopolist requires LRMC=SRMC=MR and P≥LRAC. d) Monopolistic competition falls between the two extreme economies of Perfect competition and Monopoly. The main characteristics of the monopolistic market is price differentiation , non-price competition as the products are differentiated among themselves, large number of firms in the market and freedom of entry and exit and freedom of the consumers. The monopolistic market faces a serious problem of decrease in the market revenue through price differentiation. The major problem in the monopolistic competition is the introduction of product heterogeneity which makes difficult for the consumers to differentiate among competitive groups. Under monopolistic market is not clear to draw line. 2. The given production function is Q (P) =60-6P and the cost function is C (Q) =9+Q2 Therefore, from the profit maximising condition of a monopolist, MR=MC and π= TR (Q)-TC (Q) So, π= TR (Q)-TC (Q) = PQ-C= {(} q-2) So from the above equation deriving ht FOC, we get, dπ/dq= 10-(7/2)q and SOC is d 2 π/dq 2= - (7/2) which means that the production function is maximum and exhibits increasing returns to scale. 3. A Price Discriminating Monopolist is better than a pure monopolist. Price Discrimination especially of third degree is always desirable from a social welfare point of view as it results in more efficient allocation of resources than a monopoly market. 4. If the price elasticity for a demand of a commodity depends on the degree of responsiveness of the change in price on the change in quantity demanded. Therefore if the price elasticity is given by the following formula: Ep = (-) (ΔQ/ΔP) *(P/Q). Therefore if the elasticity is given as - (1.5) means that prices of that product rises given the quantity sold and will increase the revenue of the producer. 5. Labour and Capital are two important factors of production. They are said to complement each other or supporting inputs and shown by a L-shaped production function. It is shown in the following diagram, where labour and capital are shown in the production function. 6. Labour and Capital are said to be perfect substitutes of each other. An existing example of perfect substitute is 1 technology and 3 workers. Mathematically we can explain the concept of perfect substitutes with the help of an equation- Y=aL+Bk where, L and K are Labour and Capital respectively. It is shown in the following diagram. 7. a) The first production function , Y=a+bL+cK shows a case of perfect substitutes of Labour and Capital. In this case if we consider a production function say, Q=f(L,K). If Labour cost increases then by the idea of perfect substitute the producers use Capital, production output remains same exhibiting Constant returns to Scale and Constant Cost for the producer. b) This shows a Cobb-Douglas Production Function where α and β are parameters which take different values. So in this type of production functions there can be increasing, decreasing and constant returns to scale: If α + β=1, then there is Constant Returns to Scale. If α + β1, then there is Increasing Returns to Scale. 8. The production function is given by Q= LαKβ, where Q=output, L=Labour, K= capital. The marginal productivity of labour is given by MPl. Therefore, MPL= ΔQ/ΔL= Change in output/ Change in Labour Demanded =αL(α-1)Kβ The Marginal Productivity of Capital is given by: MPK= ΔQ/ΔK= Change in output/ Change in Capital =LαβK(β-1) 9. Markets whether perfect competitive or imperfect competitive market has the common objective of profit maximizing. In case of perfect competition market the profit maximization suppose a firm sells an output (Q), then its economic profit is given by- Where, TR (q) is Total Revenue TC (q) is Total Cost Since P is taken as given, firm chooses q to maximize profit. Since firm is a price taker, increase in TR from 1 unit change in Q is equal to P- But in case of imperfect competitive market such as monopoly or monopolistic market is derived mathematically as- Max p(Q) = TR(Q) - TC(Q) where: TR(Q) = QP(Q) and P(Q) is the (inverse) market demand curve. The monopolists profit maximization condition: DTR (Q)/DQ = DTC(Q)/DQ MR (Q) = MC(Q) 10. P=$1.20 Q= K0.5 L0.5 APk= 1.05 elasticity=1.5 Therfore we know that, MR=P(1+1/e)=2.004 So MR=MC is the profit maximizing condition from where we get MC=2.004 and TC= 2Q So under profit maximizing condition, Π= TR (Q)- TC (Q) =1.20*K0.5L0.5-2*K0.5L 0.5. Putting the condition of MR=MC, and the FOC conditions of profit function with respect to Labour and Capital , the profit maximizing condition of Labour and Capital. From APk=1.05, we can derive the returns from Capital. APk= Total Output/Capital=1.05. Therefore the Capital received will be of the form- K=( L0.5/1.05)0.5 References Madala, GS and E.M Miller, (1989) Theory and Applications, McGraw-Hill Rubinfeild , P. (2009) Microeconomic, , 5th edition, Prentice-Hall Read More