Download Analyse and comment upon the pricing and output

Analyse and comment upon the pricing and output decisions of
the firm and the industry in perfect competition and
monopoly.
Perfect competition is a market structure which is characterized by many buyers and
sellers. As such, no single buyer or seller can affect the market price taker. In perfect
competition, all firms sell identical or homogenous product. There is also perfect
mobility of resources, free entry and exit of firms and perfect knowledge.
As the individual firm can only contribute a small fraction in the total output of the
industry, its actions cannot affect price. Therefore, the demand curve of an individual
firm is perfectly elastic. It is a horizontal straight line at the prevailing market price
over the range of output that the firm can produce.
Assuming the factor prices remain constant and firms in the competitive industry
simultaneously expand or contract output, the industry’s supply curve is the
horizontal summation of the supply curves of all the producers. Since the firm’s supply
curve is MC curve, the industry supply curve is the aggregate marginal cost curve, as
shown below.
Equilibrium in the market is reached at the point where the demand curve intersects
the supply curve. Thus, as shown in the diagram above, equilibrium price is OP, and
output is OQ1. In the short run, firms in the perfect competitive industry may enjoy
normal, subnormal, or supernormal profits. However, those firms which previously
enjoyed supernormal profits will be able to reap only normal profits in the long run
due the entrance of new firms which were attracted to the industry. To survive the
competition posed by new firms can survive in the long run only if it is producing at
optimum size or at the lower point of the average cost curve. At this equilibrium
point the firm is producing the least cost output at the most efficient plant size. Thus,
the firm is technologically efficient. Since the price equals marginal cost in perfect
competition, this market structure is also allocatively efficient.
A monopoly is a market structure in which a single firm or a combination of firms
collectively as one firm, supplying al the output in the market. Since the firm supplies
all the market output, it can influence either price or the level of output but not at
the same time.
The monopolist is faced with a downward sloping average revenue (AR) curve and
hence his marginal revenue (MR) curve will also slope downwards and lie below the
AR curve.
The monopolies will maximise profit by producing up to the point where marginal cost
equals marginal revenue.
The firm produces 0Q and sells at price 0P and makes supernormal profits at PEFD. In
a monopolistic situation, there are barriers to entry to keep out new competition.
These come in the form of patents, government legislation, huge capital outlay and
poor initial returns. Thus, the monopoly can make supernormal profits in the long run.
Discrimination is also practiced by the monopolist to cream off some of the consumer
surplus. Thus, it would appear that monopoly
leads to a higher price and lower
output than a competitive market.
However, in reality, the monopoly would take advantage of any economies of scale
available. This gives rise to the following situation:
As a result of the economies of scale, marginal cost drops from MC1 to MC2. This
leads to a rise in output to 0Q2, as compared to 0Q1, under perfect competition. Price
also falls to 0P2 compared with the price under perfect competition of 0P1. Thus, it is
possible to have a lower price and larger output under monopoly than under perfect
competition, if economies of scale do exist.