Characteristics of Perfect Competition and Monopoly Market

This article discusses the characteristics of perfect competition and monopoly market, including the number of buyers and sellers, nature of the product, price determination, entry barriers, and short run and long run profit loss. It also explores the price and output under monopoly and perfect competition, and the consumer surplus, producer surplus, and deadweight loss.

Running head: ECONOMICS FOR MANAGERS
Economics for Managers
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Answer 1
Characteristics of perfect competition and monopoly market
Perfect competition refers to a market having a large group of buyers and sellers
selling homogenous or identical product in the market. Monopoly in contrast refers to a
market where a single seller in the market sells a unique product to numerous buyers. The
two market differs in terms of number of buyers and sellers, nature of produce sold and other
characteristics. The distinguishing features of perfect competition and monopoly market are
evaluated below.
Number of buyers and sellers
The perfect competition is characterized as having a large group of buyers and sellers.
As there are various sellers in the market, each seller constitutes only a small part of the
market and hence, has no market power (Baumol & Blinder, 2015).
Monopoly on the other hand is characterized to have a single seller and various
buyers. Only one seller controls the entire market and has considerable market power.
Nature of the product
Under perfect competition, firms sell homogenous or identical product. If one seller
increase price, then buyers can go to other seller as goods are perfect substitutes.
In contrast, product sold by the monopolist has no close substitutes (Mahanty, 2014).
This further increase monopoly power of the seller.
Price determination

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With large group of buyers and sellers under perfect competition, neither buyers nor
the sellers can influence price. Buyers and sellers have to accept the price determined by the
independent forces of demand and supply. Sellers in the market are price takers.
The monopolist has considerable market power and hence, determines price of own
product in the market (Nicholson & Snyder, 2014). The single seller in the monopoly market
is the price maker.
Entry barriers
Firms under perfect competition face no forms of barriers to enter or exit the market.
During economic profits, new firms enter the market while in times of economic loss,
existing firms leave the industry.
Opposite is the case for monopoly. New firms face strict entry barriers to enter the
market. Either natural or regulatory barriers prevent entry of new firms.
Short run and long run profit loss under monopoly and perfect competition
Short run
Under perfect competition, each firm faces a perfectly elastic demand curve. The
demand curve is shown the horizontal line parallel to quantity axis. As firms in perfect
competition act as price takers, marginal revenue is same as average revenue which is same
as price. Firms maximizes profit where firms earn marginal revenue equivalent to marginal
cost in the production process (Cowen & Tabarrok, 2015). In the perfect competition, as
marginal revenue is same as price, the profit maximization condition becomes price =
marginal cost. In order to ensure equilibrium at this point, it is necessary that marginal cost
curve passes through marginal revenue curve from the below. In a perfectly competitive

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market, firms in the short run can earn more than normal profit or suffer from an economic
loss or acquire just normal profit.
Figure 1: Competitive firms earning more than normal profit
Figure 2: Competitive firms earning just normal profit

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Figure 3: Competitive firms suffering economic loss
The objective of the monopolist is to maximize profit. This is same as to minimize
loss. Monopoly firm in the short run operates where addition revenue from last unit sold is
same as the added cost of producing that unit. Unlike perfectly competitive firms, firm is
price maker in the market. Firms here face a downward sloping demand curve (Sloman &
Jones, 2017). Monopolist mostly earn economic profit in the market. However, in some
situation is might continue operation with economic loss in the short run if all the variable
costs are covered.

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Figure 4: Economic profit in the short run
Long run
The long run situation is very much different between perfect competition and
monopoly. In a perfectly competitive market, firms in the long run enjoy only a normal profit.
This is because of free entry and exist of firms in the industry. Consider a situation of
supernormal profit in the short run. Short run profit in the industry attracts new firms to enter
the industry (Friedman, 2017). As new firms enter, there is an increase in supply in the
industry. The excess supply reduces market price and profit. In times of economic loss, firms
leave the industry, market supply reduces resulting in an increase in profit. The mechanism of
entry or exit continues unless the industry only has normal profit. This happens when price
equals minimum point of long run average cost.
Figure 5: Long run normal profit under perfect competition
The situation is different for the monopolist. With strict entry barriers, monopoly firm
can sustain economic profit in the long run. The monopolist does not necessarily operate at
the minimum point of average cost in the long run. It is free to expands plant size depending
on the profit motive.

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Figure 6: Long run economic profit for monopolist
Price and output under monopoly and perfect competition
Firms under perfect competition have no market power. Hence, they produce at a
socially efficient scale. Competitive firms produce socially efficient output and charges an
efficient price. Firms under perfect competition operate where market price equals the
marginal cost of production (Mankiw, 2014). In the figure below, Pc shows price under
perfect competition and Qc is the corresponding output. Monopolist however does not
operate at the socially efficient point. It choses price and output by condition of equalizing
marginal revenue and marginal cost. Price in the monopoly market is PM and associated
equilibrium output is QM. As the monopolist charges higher price and sells a relatively
smaller output, there is misallocation of resources resulting in efficiency loss or deadweight
loss.

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Figure 7: Price and output in monopoly and perfect competition
Consumer surplus, producer surplus or deadweight loss
Figure 8: CS, PS and deadweight loss
As discussed in the previous section, in the monopoly market consumers face a higher
price compared to that of a perfectly competitive market. The higher price puts consumers at
a disadvantageous position in terms of reducing their surplus. The consumer surplus is larger
in under perfect competition (A+B+E) compared to area A under a monopoly market.

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Producer surplus in the competitive market is presented as C+D+F. Under monopoly market,
producer surplus is obtained by the area B+C+D. Loss in consumer surplus is the area B+E.
While B goes to the producers, the area E remained unexplained (Maurice & Thomas, 2015).
Loss in producer surplus is F. The net loss in social welfare is the area E+F. This is referred
to as deadweight loss.
Answer b
Characteristics of oligopoly market
Oligopoly market belongs to the category of market having imperfect competition. In
this market, there is a few sellers dominate majority of the market. The relatively small
number of sellers engage in intense competition in the market (Belleflamme & Peitz, 2015).
The dominance of few large sellers indicates that each of the firm has a considerably large
market share. With significant market share, each firm has some control on the market. The
distinctive characteristics of oligopoly market are given below.
Small number of sellers
Number of firms in the oligopoly market is relatively small. The few sellers enjoy a
dominating share in the market.
Number of buyers
Buyers in the oligopoly market belongs to a large group (Stiglitz & Rosengard, 2015).
The dominating firms serve a large group of buyers and hence, has control over a large share.
Nature of the product
Oligopolistic firms can sell products that are either homogenous or differentiated.
Oligopoly firms selling homogenous products is known as pure oligopoly. Differentiated
oligopoly is the market where firms sell products that are slightly differentiated.

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Interdependence among firms
Firms in the oligopoly market depends on each other in determining their marketing
strategy. Each rivals have a close watch on the strategy of others. Knowing the strategy of
other firms, each takes a counteractive strategy (Chan, Narasimhan & Yoon, 2017). Price war
is the result of intense rivalry and interdependence among firms. Firms in the oligopoly
market often collude and form a cartel to act as a monopoly.
Barriers to entry
New firms face strict barriers to enter the market. Barriers can exit in the form of
government regulation, patent or copyright, high fixed cost, dominance of large firms and
others natural or regulatory barriers.
Advertising
Advertising plays an important role in the oligopoly market. Because of intense
competition among rival firms, firms have to adapt aggressive and defensive marketing
strategy. In order to maintain a relatively large share in the market firms incur a significantly
high cost for advertising spending. The importance of advertisement in the market depends
on varying degree of product differentiation. Firms can adapt either persuasive or information
advertisement depending on market condition and buyers’ demand (Han, Heywood & Ye,
2017). New and innovative advertisements helps to attract more customers. Advertising helps
firms to establish a separate identity and brand value for their products. Not only sellers but
also customers are benefitted from advertising and other promotional strategies. Through
advertising firms can convey information of the product sold in the market in a cost-efficient
manner (Schroeder & Tremblay, 2016). The intense rivalry and high degree of product
differentiation makes advertisement an integral part of oligopoly market.
Oligopoly in Australian supermarket

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In Australia, an example of oligopoly market is the grocery retail sector. Like
oligopoly market, few large firms dominate the market of retail supermarket chain. The
important players in the supermarket oligopoly are Woolworths, Coles, Aldi, IGA and others.
In the market, Coles and Woolworth enjoy approximately 80 percent share in the
market. These firms are engaged in intensive competition. This is similar to that of the
oligopoly market. Location gives oligopolistic firms special power to dominate the industry.
The operation of Woolworths is limited to New Zealand and Australia only (Jericho, 2018).
Nature of product is another important characteristic of oligopoly market form. Firms in the
food retail sectors sell almost similar but differentiated product and have the power to affect
market price.
In the supermarket chain, advertising plays an important role. Coles and Woolworths
makes considerable investment for advertising. An important part of Coles advertising and
promotional strategy is to encourage customers to share their positive experience with other
customers. Both Woolworth and Coles include celebrities and sports start as part of their
advertisement strategy (news.com.au, 2015). Recently, Coles and Woolworths have taken the
strategy to reduce their advertisement spending. In contrast to this, another competitor Aldi
has increased its advertisement spending. Aldi’s advertisement spending amounted to be
$34.7 million. Advertisement spending of Aldi has increased by nearly 17 percent.
Advertisement related to Aldi’s product are broadcasted in newspaper, magazines, radio,
television and other online media (adnews.com.au, 2019). Digital advertising is the most
preferred medium of advertisement in the market.
In the retail supermarket industry, advertising plays an important role to attract new
customers. Advertisement though is an important part of marketing strategy of oligopoly
firms, it is not always necessary for oligopoly firms to spend huge amount on advertising.

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This depends on the nature of product sold in the market. One such example is oligopoly in
Australian banking industry. The dominance of four major banks make the industry an
oligopoly market. The four dominating players in the industry are Australia and New Zealand
Banking Group, National Australian Banks, Commonwealth Bank of Australia and Westpac.
These four banks together constitute 80 percent of market share. The advertisement spending
in the baking industry is relatively less compared to other oligopoly business. This is because
of the importance of various banking service in the everyday life. Product and services are
not much differentiated and hence, there is not much need of advertisement.
Answer c
Housing affordability crisis in Australia
Accommodation counts as one of the necessities of human being. Finding house at an
affordable price especially in the capital cities of Australia has become the biggest challenge
today. The pressure from growing demand associated with limited supply causes housing
price to rise at an excessively high rate. The two important capital cities of Australia,
Melbourne and Sydney experience huge crisis of housing affordability. House price nearly
double or more than doubled in these areas since 2009. Data reveals that price of houses
increase increases faster than the growth in real wage (Birrell & McCloskey, 2016). This
forces people to borrow credit for financing expenditures in the housing market. An
associated problem with the housing affordability crisis is the growing debt burden of
Australia. The share of household debt in the GDP of Australian constitute an increasing
trend. The rapidly growing housing price thus has become a major problem for the economy
of Australia as a whole.

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Figure 8: House price growth in Australia
(Source: rba.gov.au, 2016)
The crisis in housing market resulted from both supply and demand side factors.
Demand side factors
On the demand side, the acting forces contributing to crisis in the housing market are
as follows. The composition of population or demographics changes overtime. The first
problem is the size of households in Australia are squeezing day by day. This increase
demand for housing (McLaren, Yeo & Sweet, 2016). With several small-sized household
demanding for separate houses creates considerable demand side pressure. Factor like late
marriage, separation or divorce give rise smaller sized household. Another serious problem of
demographics that capital cities are suffering from the ageing population. It has been found
that in many of the middle and inner suburbs areas, the older population occupies the
detached houses. This aggravates the problem of housing shortage for younger generation.

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Another factor encouraging housing demand is the high average income of citizens
especially those living in the capital cities. Real income has risen due to uninterrupted growth
of Australian economy (Baker et al., 2016). The proportion of double income household in
the economy has already been increasing pushing up demand in the housing market.
Faster growth in house rent is another factor causing encouraging household to
demand their own house. Anther supporting factor for growth of housing demand is the
persistently low interest rate in the economy. The low inters rate and easy access to borrowed
fund highly increases hosing demand.
Supply side factors
On the supply side, several factors are responsible for holding back sufficient supply
of housing. The planning procedure for constructing new houses is time consuming and
complex (Gurran & Bramley, 2017). Uncertainty in the planning procedure, insufficient
coordination among the suppliers and delay in government’s process to supply necessary
utility services become major barriers to increase housing supply. The local opposition
further delay the housing construction.
The supply of land in an economy is limited by the geographical bound. The
relatively inelastic supply of land restricts availability of land for expanding housing supply.
The housing supply is limited not only because of limited supply of land but also because of
lack of skilled workers having construction knowledge and proper planning (Jacobs, 2015).
Additionally housing supply is also restricted due to lack of proper infrastructural
facilities such as water and sewage system, energy and transport.
Policies undertaken to address housing affordability crisis

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Growing demand and insufficient supply of houses results in housing affordability
crisis in Australia. Measures are taken to address both demand and supply side issues related
to housing market. A considerably large share of government budget has been spent to
mitigate the problems in the housing market. Some of these policies taken to address housing
crisis are as follows.
National Rental Affordability Scheme
In 2008, Australian government came with this scheme. The scheme offered financial
incentives to suppliers that extends for a period of ten years. Objective of the proposed policy
was to boost the supply of rented house at an affordable price. At the end of 2018, there were
122 individual participant under NRA scheme. Those who received the financial incentives
are obliged to rent their house at a rate, which is 20 percent below the market rate.
Downsize of household
This is an important part to address the issue of housing affordability in Australia.
Government allows people with age 65 or above to make non-concessional contribution from
the earning received from selling their own house. The contribution for each person is limited
up to $300,000 (Yates, 2016). Through this scheme, government aims to downsize household
and makes available more homes for younger population.
Impediments for foreign investors
In order to increase domestic availability of houses several restrictions have been
imposed on foreign investors in the housing market. In the residential property, a cap of 50
percent has been imposed on the foreign ownership. Government introduces a charge for
vacant properties held by the foreigners. This helps to increase housing supply in domestic
rental market. Tax rate on the capital gains has also been increased to prevent reselling of
houses.

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First homebuyers grant
In Australia, the first homeowners grant was introduced in 2000. This is a direct
subsidy given to the buyers to assist them in achieving their goals of first home ownership.
There was a gradual increase in first homeowners grant in the government budget stimulus.
The legislative authorities of resect state and union territories fund this scheme (Taylor &
Dalton, 2015). The subsidy mount however varies across Australian states and Territories.
A perfectly inelastic supply curve is one where supply remain fixed despite changes
in price. A vertical line parallel to the price axis shows such a supply curve. A given subsidy
encourages demand and shifts the demand curve to the right. As supply cannot change the
equilibrium number of houses. Price received by the sellers increases by the amount of
subsidy.
Figure 9: First homebuyers’ grant with perfectly inelastic supply
A perfectly elastic supply is where supply change infinitely for slight or no change in
equilibrium price. Supply curve here is a horizontal straight line parallel to quantity axis.

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With the given subsidy, demand curve shifts rightward by the amount of subsidy. The
equilibrium price remain unchanged after the subsidy while equilibrium quantity expands.
Figure 10: First homebuyers’ grant with perfectly elastic supply
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