Perfect Competition - Solving Questions

EssayChat / May 23, 2018

Table of Content:

Question 1: Perfect Competition 2
Question 2: Perfect Competition - (Profit Maximisation) 3 - 4
Question 3 : Perfect Competition (Shut down point) 5
Question 4 : Perfect Competition (Shut down point) 6 - 7
Question 5 8
Question 6 9

Question 1: Perfect Competition

Perfectly competitive markets means a market place where there are large number of buyers and
sellers.

The assumptions are as follows:

- There are large numbers of people seeking to buy at the same time there has large number of
people willing to sell a commodity.

- Products are homogeneous

- There are no discrimination amongst buyers and sellers

- There are opportunity to freely enter the market at any point of time, and at the same time
there is opportunity to exit the market at any point of time.

- There is no hindrances on mobility of buyers and sellers

- Profit maximisation is the main aim of all the sellers present in the market

- There is no selling and distribution cost incurred by firm to sell commodity

- There is no transportation cost incurred by firm to sell commodity since there are no
transportation obligation.

Thus given the above assumptions of a perfectly competitive market, it can be concluded that BP
represents a structure of a perfectly competitive market.

Question 2: Perfect Competition - (Profit Maximisation)

a. Market demand and market supply should always be equal to each other in an equilibrium
situation. Thus to compute equilibrium quantity we ensure that the demand and supply are
equal to each other. By the problem following equation is developed:

1000 - 2Q = 100 + Q

Solving for Q, we get the follows:

Q = 300

Now plotting Q = 300 into the other equation which states about the market curve or the supply curve we get P = 400.

b. We have solved in part a, value of P and Q. From above we can conclude that the market
price at equilibrium would be 400. In other words at 400\$, both demand and supply would be
equal to each other and firm would be earning maximum profit. Any price zone above or
below 400 would make firm move out of its profit maximisation zone. Firms marginal
revenue at equilibrium price is always 400\$. In other words MR is equal to 400\$. Now
following marginal revenue equation we can conclude the following:

MC=MR

This is because at this level marginal revenue (MR) would be equal to marginal cost.
By MC = MR we get the following:

400 = 2q + 1

By solving the above equation we get Q = 199.5

Now with the help of above solution till now we can describe firms equilibrium position. At
equilibrium firm would be selling at a price of 400\$ per unit and it would be selling 199.5
units.

So by the help of above facts it can be established that total revenue at equilibrium is = 199.5
* 400 = 79,800 \$

We can similarly compute total cost by using substitution method. We can substitute q =
199,5 in demand curve equation. The total cost thus arrives to 40,100 \$.

Total revenue at equilibrium zone is 79,800 \$ and total cost is 40,100 \$. Thus profit which is
maximized at equilibrium zone is 39,700\$. This is maximum profit in aggregate and in per
unit terms as well which a firm can earn.

In the long run we all know that profit cannot be so high. There will be new entry of sellers in
the market who would tend to sell products at a cheaper price, thus ultimately puling down
the entire price curve. Such enormous profits will not exits in long run. Entity can enjoy these
profits in short run only. In long run at equilibrium zone profit would tend to be zero.

c. It is clearly evident that long run we all know that profit cannot be so high. There will be new
entry of sellers in the market who would tend to sell products at a cheaper price, thus
ultimately puling down the entire price curve. Such enormous profits will not exits in long
run. Entity can enjoy these profits in short run only. In long run at equilibrium zone profit
would tend to be zero.

d. In long earn all the firms earn 0 profit. In the give situation this profit will be eaten up by
entrance of new sellers at a lower price. So zero profit will occur only in a situation where
Marginal Cost is equal to Average total Cost. Average total cost is derived by dividing total
cost by number of units produced (q).
Thus, 2q + 1 = (100+ q2 +q)/q

Solving for q we get 10.

Now again by substitution method, substituting q into ATC equation we get 21. So in long
run when price is equal 21, the firm is in a no profit no loss zone. Quantity sold would be 10
units. Thus total revenue would be 210 \$ and total cost would be 210 \$. Firm would be zero
profit or only economic profits.

e. The units sold in long run equilibrium zone would also come down and in the long run entity
would be selling only 21 units . this would be profit maximising zone.

Question 3 : Perfect Competition (Shut down point)

a. The major factors which leads profits towards zero in perfectly competitive markets is free
entry and exit of the firm in long run. In the long run any firm is free to enter in the market
and start selling their product at any price. At the same time, any seller from existing sellers
list can decide to shut down its operations and quit the market. Firms tend to enter the market
whenever there are abnormal profits in short run. Their entry lowers the price curve which
ultimately impacts the profit and leads it to 0. They tend to leave the market when they start
earning 0 profit at equilibrium zone. Thus this is a continuous trade off which occurs in the
market.

b. It is seen many a times that a firm incurs loss even at short run. It is not necessary a mandate
that firms will incur profits in short run. Even in loss making situations, firms are advised to
continue working in the hope that these losses would get setted off in the long run. In long run
no firm can incur loss for a continuous period of time and the losses are bound to get set off.
Hence it is advised and encouraged to firms incurring losses at short run to conitue operating
in the hopes of making profits in long run.

Many a times firms are forced to shut down in short run itself. It is seen many a times that a
firm incurs loss even at short run. It is not necessary a mandate that firms will incur profits in
short run. Even in loss making situations, firms are advised to continue working in the hope
that these losses would get setted off in the long run. But the magnitude of loss has to be also
monitored in short run. If the losses are so significant that the firm is unable to recover its
variable cost then firms are encouraged to shut down.

c. The assumptions of profit maximisation in short run or long run are as follows:

- There are large numbers of people seeking to buy at the same time there has large number of
people willing to sell a commodity.

- Products are homogeneous

- There are no discrimination amongst buyers and sellers

- There are opportunity to freely enter the market at any point of time, and at the same time
there is opportunity to exit the market at any point of time.

- There is no hindrances on mobility of buyers and sellers

- Profit maximisation is the main aim of all the sellers present in the market

- There is no selling and distribution cost incurred by firm to sell commodity

- There is no transportation cost incurred by firm to sell commodity since there are no
transportation obligation

In the above diagram it is visible that in the short run the cost curve is U shaped. This is also called
Zucchini Production. In this diagram all the cost curves i.e. average total cost, average variable cost
and marginal cost are in u shaped. As per the theory profit is maximised only when Zucchini
Production produces as per marginal cost curve. It has to be noted that at any point of time if the
production crosses average total cost zone then entity will start making losses. In the short run it is
recommended to produce upto the point of intersection where MC curve cuts across ATC. This zone
is a profit making zone and should be adhered to. The moment it crosses this production line, it will
start making losses in the short run also. Thus entity has to carefully evaluate. Only following the
marginal cost curve can also lead to losses in short run. It is seen many a times that a firm incurs loss
even at short run. It is not necessary a mandate that firms will incur profits in short run. Even in loss
making situations, firms are advised to continue working in the hope that these losses would get setted
off in the long run. In long run no firm can incur loss for a continuous period of time and the losses
are bound to get set off.

In this fig. Point A is the profit maximisation zone. At the level marginal cost is equal to marginal
revenue and here the normal profit is earned. This is an ideal situation of a long run market. All entity
would be making normal profit. PAMO is the total revenue zone.

Question 4 : Perfect Competition (Shut down point)

a. Market demand and market supply should always be equal to each other in an equilibrium
situation. Thus to compute equilibrium quantity we ensure that the demand and supply are
equal to each other.

By the problem following equation is developed:

1000 - 2Q = 100 + Q

Solving for Q, we get the follows:

Q = 300

Now plotting Q = 300 into the other equation which states about the market curve or the
supply curve we get P = 400.

b. We have solved in part a, value of P and Q. From above we can conclude that the market
price at equilibrium would be 400. In other words at 400\$, both demand and supply would be
equal to each other and firm would be earning maximum profit. Any price zone above or
below 400 would make firm move out of its profit maximisation zone. Firms marginal
revenue at equilibrium price is always 400\$. In other words MR is equal to 400\$. Now
following marginal revenue equation we can conclude the following:
MC=MR

This is because at this level marginal revenue (MR) would be equal to marginal cost.
By MC = MR we get the following:

400 = 2q + 1

By solving the above equation we get Q = 199.5

Now with the help of above solution till now we can describe firms equilibrium position. At
equilibrium firm would be selling at a price of 400\$ per unit and it would be selling 199.5
units.

So by the help of above facts it can be established that total revenue at equilibrium is = 199.5
* 400 = 79,800 \$

We can similarly compute total cost by using substitution method. We can substitute q =
199,5 in demand curve equation. The total cost thus arrives to 40,100 \$.

Total revenue at equilibrium zone is 79,800 \$ and total cost is 40,100 \$. Thus profit which is
maximized at equilibrium zone is 39,700\$. This is maximum profit in aggregate and in per
unit terms as well which a firm can earn.

In the long run we all know that profit cannot be so high. There will be new entry of sellers in
the market who would tend to sell products at a cheaper price, thus ultimately puling down
the entire price curve. Such enormous profits will not exits in long run. Entity can enjoy these
profits in short run only. In long run at equilibrium zone profit would tend to be zero.

c. It is clearly evident that long run we all know that profit cannot be so high. There will be new
entry of sellers in the market who would tend to sell products at a cheaper price, thus
ultimately puling down the entire price curve. Such enormous profits will not exits in long
run. Entity can enjoy these profits in short run only. In long run at equilibrium zone profit
would tend to be zero.

d. In long earn all the firms earn 0 profit. In the give situation this profit will be eaten up by
entrance of new sellers at a lower price. So zero profit will occur only in a situation where
Marginal Cost is equal to Average total Cost. Average total cost is derived by dividing total
cost by number of units produced (q).

Thus, 2q + 1 = (100+ q2 +q)/q

Solving for q we get 10.

Now again by substitution method, substituting q into ATC equation we get 21. So in long
run when price is equal 21, the firm is in a no profit no loss zone. Quantity sold would be 10
units. Thus total revenue would be 210 \$ and total cost would be 210 \$. Firm would be zero
profit or only economic profits.

e. The units sold in long run equilibrium zone would also come down and in the long run entity
would be selling only 21 units . this would be profit maximising zone.

Question 5

a. Point of Difference Perfect Competition Monopolistic Competition
Defination Large no of buyers and sellers
each selling the same product

Large buyer and seller, each selling identical product
Product Same product Slightly different product
Price Demand and supply decide the same

Seller decide the same

Entry Exit Free. No hindrances Few hindrance

b. If a firm introduces a new product, in short run profitability shoots up enormously and
there are high short run profit. Because there is one seller and unlimited buyer, so it
becomes monopoly market.

c. In the market there is a situation where there are unlimited brands of breakfast cereals.
This is a negative symbol because of the fact there will be too many products and these
will become slow moving products. The buyers may not buy and ultimately these would
be required to be destroyed and shredded of. Thus it is a negative symbol.

Question 6

a. The main features of an oligopoly market are as follows:

- Interdependence

- Group Behaviour

- Competition

- Barriers to entry of the new players

- Minimal uniformity

- Existence of price rigidity- no firm can reduce price. If a firm reduces prices, it competitors
would move for a higher price reduction.

- There is no fixed way or manner of price behaviour.

Kinked demand curve is very closely linked to demand curve of oligopoly market and monopoly
market. This is because there is some similarity between oligopoly and monopoly market. In both the
market there are barriers or hindrances in entrance of new seller. Existing seller enjoy the power to
determine the price and also manipulate the price. The best example of this type of market is OPEC.
There also we have very few sellers and large number of buyers.

b. OPEC : OPEC stands for Oil producing and exporting entities. There are 6 countries which
produce and export oil to all over the world. They are Kuwait, Iraq, Iran, Ecuador, Angola
and Algeria. Thus from oil as a commodity point the sellers and limited and it has got large
number of buyers. It is exporting to all possible countries. Oil is a very basic commodity
which is needed in each and every country in all forms. The entire economy would come to a
halt if oil is not there. Thus there is a monopolistic competition. Prices are governed by these
sellers and they enjoy the right to modify these prices whenever they want. The demand is
abnormally high and they profit maximisation exists even in long run of the business. This
has been the trend for past several decades and same is continuing.

References:

Simons, N. E., Menzies, B. &amp; Matthews, M. (2001) A Short Course Economics and Business
Application. London, Thomas Telford Publishing

Chhibber, P. K. &amp; Majumdar, S. K. (1999) Foreign ownership and profitability: Property rights,
control, and the performance of firms in Industry. Journal of Law &amp; Economics, 42 (1), 209-238.

Wang, F., Maidment, G., Missenden, J. &amp; Tozer, R. (2007) The novel use of phase change in market
operating style. Part 1: Experimental investigation. Applied Economic factors. 27 (17-18), 2893-2901.