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The elasticity of demand for a perfectly
The elasticity of demand for a perfectly competitive firm is −∞ because in a perfectly competitively industry there is free entry and exit.
True. This is because in a perfectly competitive market structure there are no barriers in entry or exit at the industry. Therefore there are infinite buyers and sellers in the industry willing and able to buy and sell at a certain price. Therefore, a single firm cannot have an influence on the price of commodity in the entire industry. Additionally, a firm, no matter how large it may be, it is small when compared to the entire market and thus no matter how much output it generates, it cannot have an influence on the price of commodity. Of course the size of the firm is assumed to be small and it is this assumption that lends credit to the nature of elasticity of demand for a perfectly competitive firm. Since the perfectly competitive firm faces more than one competitor in the market, it can only set its output but it cannot determine the price for the output since if it sells the output at higher price than normal, it will not be able to make a sale and if it desires to sell its output, it will draw all the buyers in the market. The firm therefore has to be a price taker than a setter and only regulate on its output making the price elasticity of demand for the firm to be horizontal.
A monopoly will always produce on the portion of the demand schedule which is more negative than -1.
True. This is because a monopoly has its optimum level when the marginal revenue is equal to marginal cost. Therefore, if a monopolistic firm produces as not scheduled the marginal cost will be also equal to negative. Again when the prices are at the upper portion of the monopoly demand curve the monopoly firm will have the ability to earn a supernormal profit.
The demand curve for the monopolist is down-sloping, which causes the marginal revenue curve for the monopolist to lie below the monopolist’s demand curve and the monopolist has to equate marginal revenue with marginal cost in order to maximize profits.
A monopoly always faces a cross price elasticity for the products it sell which is positive and greater than 1.
True. Cross price elasticity usually measures the response change on the quantity demanded with the change in price. A monopoly firm is the only firm that produces one specific product that has no any close substitute. Therefore, if the firms decides to increase its prices the quantity demanded will also increase as well, since the buyers will continue to buy at the new price due to lack of close substitute. This makes cross price elasticity of a monopoly firm will be positive and greater than one.
The graph above gives an illustration of the short-run demand curve for the monopolistic firm. In the short-run, the firm does all to maximize its profits by only producing output at a level where the firm’s marginal cost is equated to marginal revenue. It can be seen that the firm easily makes supernormal profits in the short-run when the selling price is greater than average cost hence the shaded area denotes all the supernormal profits the firm generates. This however attracts new entrants into the industry and more substitutes to the firm’s products are supplied into the market. This drives the firm’s demand curve to be more elastic and shifts it further to the left driving down the prices and the meantime eroding the supernormal profits. As it can be seen, the cross-price elasticity will continue growing making the competitive force more live and in the long-run driving down the prices of the monopolistic competitor.
In a monopolistic competition market, a firm sells its products which are deemed to have real or perceived non-price differences. Nevertheless, the non-price differences may not be so great as to completely eliminate substitutes. In fact it is not easy to find a product that does not have its substitutes. Due to presence of these substitutes, the cross-price elasticity of demand for a monopolistic firm is positive rather than zero. It would be expected that it should be zero but the highlighted technicalities that make it impossible to completely eradicate substitutes makes a monopoly to experience a cross price elasticity of demand that is positive.
Usually OPEC countries by targeting price and changing quantities. Their behavior can therefore be analyzed through the lens of either the Cournot or the Bertrand model.
The Bertrand model is a model used to describe the interactions between firms that set prices and the buyers that chooses the quantity at the price set. Cournot model is a model that was formulated to describe the industry structure where firms compete on the amount of produce which they decide independently of each other at the same time. The main aim of OPEC is to secure steady income to member state and also to secure supply of the oil to the consumers. Therefore, there behavior can be analyzed using these two models. Bertrand has an assumption that firms have the same constant unit of production, which means that the average and marginal cost are equal to the competitive price. So as long as the price is set above the unit cost all firms willing to supply any amount demanded will earn a profit on each unit sold. Therefore, this model tends to secure both the suppliers and the buyers so as to OPEC. Cournot model also has an assumption that each firm will aim at maximizing profit such that the firm’s expectation that its output decision will not have an effect on the decision of the other competitors. This model also aims at securing the suppliers and also the consumers by not exploiting either.
OPEC is a form of an oligopoly in the world oil industry and Cournot model would be useful in explaining the behavior of targeting quantity of oil supplied rather than the prices of oil. The Cournot model assumes that OPEC constitutes two competitors that are equally positioned in the oil industry and that the firms compete in terms of the quantity they produce rather than the prices of the commodities. Actually, the behavior of OPEC is construed as assuming that other players in the industry do not make related output decision but rather their output decision is fixed. In this case, the market demand curve is presumed to be linear and the marginal costs are also assumed to be constant. In order to determine the equilibrium of the model, one has to determine how each of the two firms in oligopoly reacts to a change in the output of the other firm.
The equilibrium is reached when a series of actions and reactions lead to a point where a firm is no longer able to react to the actions taken by the other competing firm. For instance, in order to understand this phenomenon on the perspective of the Cournot model we have to create a theoretical situation where we assume that if firm 1’s demand function is defined by P = (M – Q2) – Q1 where M is the market quantity, Q1 and Q2 are the quantities produced by firm 1 and firm 2 respectively.
Firm 1’s total revenue function can be given by:
RT = Q1 P= Q1 (M – Q2 – Q1) = M Q1- Q1 Q2 – Q12
The above function is followed with consideration that the firm will work to follow a profit maximization function of equating marginal cost and marginal revenue. With this in mind, the firm’s marginal revenue function is given by:
Now assuming that the determined market quantity for OPEC (M) is 60 and that the marginal cost CM=12 the single firm OPEC will have to begin the process of profit maximization in the manner indicated below:
RM = CM
M – Q2 – 2Q1 = CM
2Q1 = (M-CM) – Q2
This will elicit a reaction in firm 1 of the following shape:
Q1 = (M-CM)/2 – Q2/2 = 24 – 0.5 Q2
Firm 2in OPEC also to react and does this by reacting following the function below:
Q2 = 2(M-CM) – 2Q2 = 96 – 2 Q1
As the equations above reveal, the behavior of OPEC countries can be explained well by the equations by solving them graphically or simultaneously to establish the equilibrium quantities.
The Bertrand model can also be used to explain the behavior and in fact it is just similar to Cournot model only that the Bertrand model lays emphasis on price of the oil rather than the quantity supplied to the market. Based on the Bertrand model, OPEC firms or players would produce at a constant marginal cost and that the players in the OPEC (which are still assumed to be two in number) choose prices say P1 and P2 simultaneously. The model assumes that if the two set prices equate then the sales are even split. In this model, the only equilibrium point is given by P1 = P2 = MC; where MC is the marginal cost.
A feature of the kinked oligopoly demand curve model is that price may be stable when cost for a single firm changes, but may change rapidly when the whole industry is faced with a change in cost conditions.
True. The conjectural assumption of the kinked demand curve in oligopoly states that, if a firm increases its price beyond the existing current price, the competitors will not abide by and the acting firm will lose market it share. On contrary, if a firm lowers its price the other firms will follow so as to retain their market share and the firm’s output will increase marginally. These assumptions therefore formulate the kinked demand curve of firms in oligopoly.
Part B.
The level of output that the monopoly will maximize its profit is when the marginal revenue curve is equal to marginal cost curve. Since that is the point of profit maximization.
If a monopoly is to set a common price for all the customers, it will set at the profit maximization point which is MR=MC. The price when the marginal revenue will be equal to marginal cost will be the common price.
In market one the monopolist will sell at price B and in market two the monopolist will sell at price J.
The marginal revenue for market one will be MR1 and the marginal revenue for market two will be MR2
If price discrimination is possible the monopolist would increase its profit by selling at the point where the marginal cost (MC) is equal to the average total cost (ATC) since that is the point of profit maximization.
The monopolist will set the price a C. and the amount sold will be at quantity M.
9.
Under a competitive industry the price will be B and the output will be Q
Under monopoly the price will be A and the output will be R.
The deadweight loss will be area PLJ
Area AORJ
Area ABGF
Because in a monopolistic industry there are no competitors they are the only suppliers and sellers therefore there no external forces in the for the firm that may compel its ability in terms of selling and producing while on the other hand, competitive industry has some external forces compelling its ability to sell and produce goods. Therefore, this makes the two industries have different conditions.
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