Analysis Of Perfect Competition And Monopoly Markets

Shareholders of BP and Perfect Competition

Question 1

It is claimed that the market for various stocks and shares represent Perfect Competition. Using the assumptions used to build the perfect competition model, justify the case that shareholders of BP represent a structure that is almost the same as perfect competition.

Question 2

New Zealand egg market represents a perfectly competitive industry where almost all the firms are identical with identical cost structures. The industry consists of many thousands of small farms and a representative firm’s total cost is given by the equation TC = 100 + q2 + q where q is the quantity of output produced by the firm.

Eggs are sold in cartons of 125 one dozen boxes.

The market demand for eggs is given by the equation P = 1000 – 2Q where Q is the market quantity and the market supply is represented by the equation P = 100 + Q.

1. Formulate an equation to illustrate the New Zealand egg market and calculate the equilibrium quantity and price in this market.
2. Victor owns one of the egg farms in Tauranga. The firm’s MC equation is based upon its TC equation and MC = 2q + 1. Given this information and your answer in part (a), derive the firm’s profit maximizing level of production, total revenue, total cost and the profit
3. Evaluate your answer in (b) and justify whether it is short-run or long-run equilibrium. Appraise the firm’s situation in the long run
4. Predict the long-run equilibrium price and quantity that can be achieved for Victor’s egg farm. Support your answer using the theory of the firm. Assume quantity (q) is equal to 10 boxes and Average Total Cost

(ATC) = (100+q2+q)/q (5 marks)

1. Given the long-run equilibrium price you calculated in part (d), predict the number of egg boxes produced in this market? (5 marks)

Question 3

1. a) Evaluate the factors that drive profits to zero in perfectly competitive markets and the incentives that drive the market to a long run equilibrium. (5 marks)
2. b) Analyze the following scenarios.
3. a firm choosing to operate at a loss in the short run. (3 marks)
4. a firm deciding to shut down production in the short run. (3 marks)
5. c) Evaluate the perfectly competitive market, using a graph to illustrate the short run supply curve. Explain the relationship between the short run supply curve and the scenarios discussed in parts (bi) and (bii)?

Question 4

Ferry Services from Auckland to Waiheke Island in the Auckland Hauraki Gulf and the Waitemata harbour is operated by the Fullers Group of ferries. Since there are no competitors this is an example of a monopoly

Following information is provided about the cost structure of the firm

• The firm’s total cost is given by the equation TC = 100 + Q2 + Q (where Q is the quantity of output (number of trips) produced by the firm).
• The firm’s MC equation is based upon its TC equation is MC = 2Q + 1.
• Market demand for this product is given by the equation P = 1000 – 2Q (where Q is the market quantity).

1. a) Fullers Ferry Services is a single price monopoly,
2. construct the marginal revenue curve of the firm
3. Illustrate the profit maximizing quantity and price.
4. b) Using your answer in part (a) estimate the firm’s total revenue, total cost and profit at this profit maximizing price and quantity. Evaluate whether this is a short-run or long-run equilibrium.
5. c) Analyze the long run situation in this market

Question 5

1. a) Using Auckland City’s Café Market as an example, compare and contrast the characteristics of a monopolistically competitive market with that of perfect competition . (3 marks)
2. b) Demonstrate what happens to the equilibrium price and quantity in such a market if one firm introduces a new, improved product?
3. c) Justify the monopolistically competitive firm’s demand curve is flatter than the total market demand curve in a monopolistic competition market.
4. d) Some experts have argued that there are too many brands of breakfast cereal in the market and signals a situation of inefficiency. Discuss the validity of this statement

Question 6

1. a) Airline industry in New Zealand Provide a good example of an Oligopoly. Evaluate the specific characteristics of the oligopoly market and demonstrate the relevance of the ‘kinked demand curve’ principle in oligopoly markets
2. b) Distinguish and evaluate the reasons as to why the OPEC oil cartel succeeded in raising prices substantially while the CIPEC copper cartel has not? Examine the conditions that are necessary for successful cartelization and outline the organizational problems that have to be overcome by cartel?

The shareholders of BP also represent a structure which is same as that of perfect competition. This is due to the fact that, the share market has a structure similar to that of a market structure of perfect competition. One of the main assumptions of the perfect competition is that there are a huge number of buyers and sellers in the market. Likewise, the number of potential shareholders and the companies which are selling the share is also very huge. McKenzie and Lee (2016) stated that one of the unique features of perfect competition, that is absent from the other market structure is the lack of power to the buyers and the sellers to control the price. The shareholders and the company management of BP both do not have any control over the prices of the share. The share prices of BP depend on the interaction of the shared demand and the share supply in the market just like the case of perfect competition. Another similarity that exists in the share market is the free entry exits which allow any of the company to offer their company to stake to the potential shareholders who can choose to sell and exit the market anytime they wish.

1. a) The demand is P= 1000-2Q and the supply of the market is P=100+Q

Now the market is in equilibrium when the supply is equal to the demand

1000-2Q= 100+Q

=>3Q= 900 => Q=300

Now put the value of Q in the demand equation,

P=1000-2*(300) = 400

Therefore the equilibrium quantity is 300 egg cartons and the price is 400 units.

1. b) The profit maximisation condition for the perfect competition is

P=MC

Answer from the part (a) is that P= 400

=> 400= 2q+1

=> q= 199.5

Total revenue = (400*199.5) = 79800

Total cost= 100+(199.5)^2+199.5= 40099.75

The total profit = TR- TC= (79800-40099.75) = 39700.25

1. c) The above profit maximisation of the seller is in the short run where it is able to earn a supernormal profit. However, in the long run, the number of a seller in the market would rise leading to an increase in the supply. These would reduce the gap between the total revenue and the total cost of the firm and hence it would not earn a supernormal profit in the long run.
2. d) The long-run profit maximisation is where the,

MR=MC= ATC

=> 2q+1= (100+q^2+q)/q

=> 2q^2+q= 100+q^2+q

=> q^2=100 => q= 10

Putting the value on the demand equation P= 100+10= 110

1. e) Given the prices calculated in the part d) the number egg boxes produced in the market would be q= 10.

1. a) One of the major factors that drive the profit in the perfectly competitive market, in the long run, is the free entry and exit. The short run supernormal profit attracts new sellers in the market increasing the supply. Apart from that, the diseconomies of scale also do not bring down the cost of operation leading to a situation where the profit, in the long run, is zero.
2. b) i) This situation is a situation where the price is less than the average total cost but more than the average variable cost so that the firm can continue operating in the short run.

Figure 1: The perfect competition

(Source: McKenzie and Lee, 2016)

1. ii) This situation is where the price is below the average variable cost of the firm and firm cannot continue the production.
2. c) The short-run supply curve is the marginal cost curve of the seller. The point from where the firm can continue operating is after the intersection of MC and AVC. In the situation (ii), the equilibrium (P=MC) is left of the intersection and hence the production stops. On the other hand, the scenario (i) the equilibrium lies to the left of the intersection and hence firm continue to operate even after incurring a loss.

1. a)

i)

from the information,

P=1000-2Q

Total revenue is P*Q

=> 1000Q-2Q^2

Marginal revenue= 1000-4Q

That means marginal revenue curve has a higher slope than the demand

Figure 2: the marginal revenue of the company

(Source: Developed by the learner)

1. ii) For the monopoly, the profit maximisation is where MR=MC

=> 1000-4Q= 2Q+1

=> Q= 999/6 =166.5

Figure 3: the short run profit maximisation of a monopolist

(Source: Baumol and Blinder, 2015)

Putting the value on the demand curve,

P= 1000-2(166.5)= 667

Thus equilibrium price is 667 and quantity is 166.5

1. b) P= 667 and Q= 166.5

Now the total revenue= (667*166.5)= 111055.5

Total cost = 100+ (166.5)^2+166.5= 27988.75

Profit= (111055.5-27988.75) = 83066.75

This is the short-run equilibrium of the market where the monopoly where the average cost curve is more u shaped.

1. c) The long run and the short run of the monopoly is somewhat same to each other, however, in the long run, the monopolist enjoys a reduced average cost of the production due to the economies of scale and hence supernormal profit increases in the long run for the monopolist.

1. a) One of the main differences between the two market structures is that product in perfect competition is homogenous whereas, the products of the monopolistic competition have their own uniqueness. Nevertheless, the number of sellers and buyers in both markets is very high. Friedman (2017) commented that due to the differentiated product the degree of power over the price for the monopolistically competitive firm is more than that of the perfectly competitive firm.
2. b) If a firm introduces the new improved product in the market, overall demand and the price increases slightly due to the fact that, the sellers of the market are price takers.
3. c) Although the products of the monopolistically competitive market are differentiated, the other products are a close substitute. Therefore the demand for the product for each of the firm is relatively elastic. When considered all the products of the market, they are inelastic in demand and hence total market demand curve is steeper and the individual demand curve is flatter.
4. d) The statement is not valid due to the fact an increased number of sellers increases the competition in the market. Therefore, supernormal profit enjoyed by these firms reduces with the increase in the number of firms and hence the cost of operation reduces. This also leads to higher welfare and hence results in efficiency.

1. a) One of the major features of the oligopolistic market is the interdependence of the firms in the market where the decision of one firm influences the operation of the other firm. In the oligopolistic setting, the sellers of the market can sell differentiated products which can be substituted by the consumers of the market. The kinked demand curve of the market shows the stability of the price of the oligopolistic market.
2. b) The cartel is a situation where the oligopolistic players of the market collaborate with each other in order to keep the price of the market same. This cartel paves the way for the nonprice war among the sellers in form of competition in the market. However, if any of the sellers in the cartel breaches, the price may reduce increasing the market share for that player. In the case of OPEC, the strong legal contract between the members did not allow them to reduce the price in return of market share (Bauer, 2018). Each of the players shared the overall market share. However, in the case of CIPEC, members reduced the price of the copper breaching the contract in order to increase market share. This reduced the overall price of the market breaking the cartel among the oligopolistic firms.

Reference

Bauer, M.J.R., 2018. Principles of microeconomics.

Baumol, W.J., and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage Learning.

Friedman, L.S., 2017. The microeconomics of public policy analysis. Princeton University Press.

McKenzie, R.B., and Lee, D.R., 2016. Microeconomics for MBAs. Cambridge University Press.