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WEEK 4

MARKET STRUCTURES (contd.)

Content

1. Price and Quantity Determination under Perfect Competition, monopoly, duopoly and oligopoly
2. Price discrimination, causes and control of monopoly

Price and Quantity Determination under Perfect Competition

Price Determination

Under perfect competition, price is determined by the forces of demand and supply since no single firm can dictate the price of its good. Firms in perfect competitive market are price takers. Therefore, firm’s individual demand curve has a horizontal Price line.  The demand curve is perfectly elastic.  This is illustrated in the diagram below:

Quantity Determination

Under perfect competition, profit is maximized at the level of output where marginal cost equals marginal revenue ( ). However, it is possible for the firm to make abnormal profit in the short run.  Since the firm’s marginal and average costs fall with increasing output, he can sell at a price higher than the marginal cost of production, thereby earning abnormal profit.   This is shown in the diagram below:

In the diagram above, while the MC and AC are falling, the firm makes an abnormal profit of PMST.  OPMQ is the total revenue while OTSQ is the total cost of production, hence the profit PMST.

However, in the long run, the abnormal profits of perfect competition firms are wiped off.  He is in equilibrium and makes normal profit. Equilibrium is achieved when the firm produces the level of output at which:   MC = MR = AC =   AR =   MR =   D =   P. The slope of MC must be greater than the slope of MR at equilibrium (i.e., MC must cut MR from below).

This is shown in the diagram below:

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