Pricing and output policies in perfect competition and monopoly

Perfect competition suggests that the perfect or best use of resources is being made by firms in markets where they face many competing firms. The firms providing the best quality goods and services at the lowest prices will be the most successful.

Characteristics of a perfectly competitive market

1. Homogenous products – That means all firms produce the same product. No one produces a unique product.
2. Price takers – There are so many buyers and sellers in the market. No buyer or seller is strong enough to influence the price. They must take the prevailing market price.
3. freedom of entry and exit – There is no barriers to entry. firms can easily enter and leave the industry if they wish.
4. Perfect information – All buyers will know all about the prices and products on sale, and all the sellers have all the information on the latest production techniques.

Economics_Perfect_competition
Since the firms are price takers, their average revenue will also be the same as the marginal revenue, which is also equal to the prevailing market price.
Firms wish to maximise their profit and will produce output at the level where marginal revenue equals marginal cost. From this diagram, you can also see that the firm has to produce at the lowest average cost possible. Demand Curve is perfectly elastic. Demand curve represents price, marginal revenue and the average revenue. They supply the quantity of Q, where MC equals MR.

Characteristics of a monopoly

The opposite extreme to the perfect competition is the situation of monopoly. A firm is a pure monopoly if it is the only supplier of a particular good or service. Let us look at the characteristics of a monopoly.

1. No competition – being the only supplier of a good or service, a monopoly faces no competition from other firms.
2. Abnormal profits – Because there is no competition, the monopolist is able to permanently earn high profits, often known as abnormal profits.
3. Price makers – Because the monopolist produces all of a particular good or service for a market, it can raise the price of its product by supplying less of it.
4. High barriers to entry – It is very difficult to enter and exit the industry. It could be due to high capital investment required. Sometimes other firms are prevented from entry by a firm acquiring parents to be the only producer of a particular product, since they researched and developed it.

monopoly-profits

The monopoly firm supplies the quantity at which level, the marginal revenue equals marginal cost as shown in the diagram. When produced at this level, the resulting price is way too higher than the average cost of the firm, therefore the firm makes an abnormal or economic profit shown by the green area.

Next topic: Main reasons for the different sizes of firms

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