Perfect Competition and Monopole: Basic Characteristics of Perfect Competition

Running head: ECONOMICS FOR MANAGERS
Economics for Managers
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Question a
Perfect competition and monopoly: Basic characteristics
Perfect competition
Perfect competition signifies a form of market where a considerable large group of
buyers and sellers compete in the market. Sellers compete in the market in terms of selling an
identical product. Some basic characteristics of perfectly competitive market gives as
follows.
Number of buyers and sellers in the market
In the market, there are large number of sellers. Various sellers in the market compete
with each other. Number of buyers in the market are also relatively large. Due to presence of
a significantly large number of buyers and sellers, each has only a small market share and
therefore, does not have significant power to influence the marketing decision.
Nature of product sold
All firms in the market engage in selling similar or identical products (Waldman &
Jensen, 2016). Products sold in the market are perfect substitutes.
Entry barriers
In the competitive market, firms can freely enter or leave the industry. The industry
experience entry of new firms if there is more than normal profit in the market. Existing firms
leave the industry if they suffer economic loss.
Market power
Neither buyers nor sellers have any market powers. Buyers and sellers have to accept
the outcome determined by the free market forces of supply and demand.

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Monopoly
The word monopoly can be separated into two word ‘Mono’ and ‘Poly’. The word
‘Mono’ stands for single while ‘Poly’ stands for control. Monopoly thus refers to a market
situation having only one seller of the commodity in the market (Carlton & Perloff, 2015)
The basic features of monopoly market are given below.
One seller and large group of buyers
Monopolist firm is the single firm. It represents the industry as well. Numbers of
buyers in the market however are assumed to be considerably large. As single firm serves the
large group of buyers, the monopoly firm enjoys significant market power.
Nature of product
Product sold in the monopoly market usually does not have any close substitutes. The
unique product sold by the monopolist further increases market power.
Entry barriers
Like competitive industry, new firms cannot enter the monopoly market freely
(Karier, 2016). There are either legal or natural barriers to the entry of new firms.
Market power
The monopolist firm possesses maximum market power. Monopoly controls the
complete supply in the market. Group of buyers is generally large giving the single firm
maximum market power. Unlike competitive industry, where firms are price takers, the
monopoly firm is price maker.
Short run profit and losses in monopoly and perfect competition
Perfect competition

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Following large number of buyers and sellers in the market, the market demand curve
perfectly elastic for competitive firms. A horizontal line parallel to the output axis represents
the perfectly elastic demand curve. Given that, competitive firms are price takers in the
market marginal revenue and average revenue both equal price (McKenzie & Lee, 2016).
Profit maximizing condition for firm requires marginal revenue and marginal cost are same.
In the competitive market, the profit maximizing condition implies price equals marginal
cost. Corresponding to this point, marginal cost goes through marginal revenue from below.
It is only in the short run where competitive firms can enjoy supernormal profit, loss or
normal profit. Firms earn supernormal profit is price is above the average cost. Firms incur
loss in situations where price is less than average cost. Firms earn only normal profit if price
is just the same as average cost.
Figure 1: Short run profit

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Figure 2: Short run loss
Figure 3: Short run normal profit
Monopoly
Given monopolist is the price maker in the market, the demand curve slopes
downward. The marginal revenue curve lies below the demand curve. The profit maximizing
condition of monopoly firm requires marginal cost to be equal to marginal revenue (Stiglitz
& Rosengard, 2015). At the equilibrium point, marginal cost and marginal revenue intersect
each other from below. Monopolist firm can enjoy profit above the normal level, normal

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profit or suffer economic loss. The monopolist however most likely to earn above normal
profit.
Figure 4: Short run equilibrium under monopoly
Long run profit and losses in monopoly and perfect competition
Perfect competition
In the long run, adjustment in the competitive industry occurs in terms of entry or exit
of firms. Given no entry barriers, new firms freely enter the market if there is more than
normal profit. As new firms enter the industry, market supply increases. This shifts the
market supply curve to the right. The excess supply lowers market price and profit. Firms
leave the industry when they suffer from economic loss (Moulin, 2014) With exit of the
firms, industry supply reduces and the supply curve shifts to the left. This pushes up prices
and loss gradually recovered. The free entry and exit mechanism results in only normal profit
in the industry.

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Figure 5: Perfectly competitive firm in the long-run
Monopoly
Unlike perfect competition, under monopoly entry is completely restricted.
Consequently, monopolist can sustain economic profit in the long run. In the long run, though
the monopolist has sufficient time to increase its plant size, monopolist does not expand the
plant size up to the optimal scale. The monopolist only maximizes profit in the long run.
Figure 6: Monopoly profit in the long run

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Comparison of price and output under monopoly
Figure 7: Market outcome of monopoly and perfect competition
Perfectly competitive markets are more efficient than monopoly in terms of both
allocative and productive efficiency. Competitive firms produce output where price equals
the marginal cost. Price and output in the competitive market shown as P1 and Q1
respectively. Price in the monopoly market is above the marginal cost. The equilibrium
condition for the monopolist is marginal revenue equals marginal cost (Karaer & Erhun,
2015) Price and output in the monopoly market are P2 and Q2 respectively. Price in the
monopoly market thus is higher compared to competitive market. Output in the competitive
market in contrast is larger than monopoly market.
Comparison of consumer, producer and total surplus between monopoly and perfect
competition

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Figure 8: CS, PS and total surplus
Welfare to consumers, producers and the society depend on consumer surplus,
producer surplus and total surplus. Consumers in the monopoly market earns a lower surplus.
The consumer surplus in the monopoly and perfect competition are shown by the respective
areas of a+b+c and a respectively (Hill & Schiller, 2015). Producers surplus under perfect
competition and monopoly market are shown by the respective areas of c+d+f and b+c+d.
Society suffers a welfare loss given by the area e+f. The welfare loss in the monopoly market
signifies the inefficiency in resource allocation termed as deadweight loss.
Question b
Oligopoly market and its characteristic
The word oligopoly has been derived from the two Greek words – ‘Oligi’ ad ‘Polein’.
The first stand for few while the latter implies sell. Oligopoly signifies a form of market that
is characterized by the dominance few large sellers in the market (Cowen & Tabarrok, 2015)
This specific form of market lies between monopoly and monopolistic competition. A pure
oligopoly is one when firms are engage in selling homogenous product. Imperfect or

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differentiated oligopoly refers to an oligopoly market where firms sell differentiated products.
The basic characteristics of oligopoly market are as follows
Few firms and large group of buyers
In the oligopoly market, a relatively small number of firms and a large group of
buyers are found. Few firms thus enjoy considerable market power in the industry.
Interdependence among firms
The small number of firms engage in intense rivalry. The few firms produce either
homogenous or a differentiated product. Each firm enjoys a considerably large market share
and has significant control on price and output. Strategy of one firms depends on strategy of
the rival firms (Mochrie, 2015). Firms always maintain a close watch on the rival’s strategy
and acts accordingly.
Type of product
Sellers in the oligopoly market engage in selling either identical or differentiated
product.
Entry barriers
The primary reason for relatively small number of firms in the oligopoly market is the
barriers to entry. The significant entry barriers in the market prevent new firms’ entry into the
industry. Forms of entry barriers in the market are patents, ownership over strategic raw
materials, huge capital requirement and other regulatory barriers (Helmes & Schlosser, 2015).
Firms who can cross these barriers enter the industry. The entry barriers help firm to maintain
economic profits in the long run.
Role of advertising and selling cost

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Advertisement is more important in the oligopoly market than any other form of
market. The effectiveness of advertisement is subject to product differentiation in the market.
Consumers in the market may have varying preferences related to a particular product but do
not have complete information about the certain brand. Persuasive advertisement is used to
keep a long-term effect on advertising (Cowell, 2018) Sellers use informative advertisement
if they are willing to inform customers detailed about the product. Advertisement in the
oligopoly market helps to increase market share of firms. Advertisement influences demand
for specific products and particularly causes demand to increase. Advertisement helps firm to
build supremacy on one particular brand over the others. Advertisements are designed in such
a way that it ensures consumers that their products are better than their rival is (Baumol &
Blinder, 2015) Advertisement by the rival firms has potential to influence the others. All
these explains why concentration of advertising is high in the oligopoly market compared to
others.
Supermarket oligopoly in Australia
The supermarket in Australia is an oligopoly market. The two large players
Woolworths and Coles have dominating powers in the market. The competition in the market
further increases from intense competition arising from German competitors Aldi and US
competitors Costco. Both these firms ae expanding at a rapid space. Woolworth and Coles
enjoy a market share lies between 70 and 80 percent (themonthly.com.au, 2015). The
remaining 30 percent shares in the market is captured by Aldi, IGA and other independent
small operators.
Like oligopoly market, firms in supermarkets are engaged in intense competition. an
important feature of oligopoly market is the price competition among the rival firms. Under
such a situation first one firm reduces its price, following this other firms also reduce price of

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the goods sold in the market. Similarly, when any of the two firms between Woolworths and
Coles reduce price or takes any promotional strategy then other follows the same
(smh.com.au., 2014) The main reason behind price competition is that reduction in price by
one firm means loss in market share of others.
In the retail business advertising plays an important role. The competing firms invest
a lot of money for advertisement spending (Chan, Narasimhan & Yoon, 2017) For example,
German competitors Aldi has raised its advertisement spending to compete with the
dominating players like Woolworth and Coles. The sector worth $90 billion faces a price war
because Woolworth continuously reduces its price on every basis. In contrast to tightening of
advertisement spending by Woolworths and Coles, Aldi raised its advertisement spending to
capture a larger market share (Heffernan, 2018). Aldi spends around $35 billion to broadcast
advertisements on newspapers, magazines, radios and televisions. During special occasion
like Christmas, competition among the retailers in terms of advertisement spending generally
kicked off (Bennett, 2017). The major players introduce new advertisement campaign for
attracting more customers during the festive seasons.
In contrast to large advertisement expenditure for supermarket retailers, there are
some oligopoly industry that involves very little advertisement expenditure. Australian
banking industry for example despite having oligopoly characteristics do not spend much on
advertising. The four firm dominating Australian banking industry constitutes an example of
oligopoly market. There is however not much room for variation in product or services
offered by the banks and therefore there is not much need of sales promotion or
advertisement.
Question c
Housing affordability crisis in Australia

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Housing affordability refers to the relation between household income and housing
expenditures such as price, rent or mortgage payments. Since 1980s, affordability of housing
in Australia declined significantly. The index that shows ratio of house price to income,
increased by 78 percent between 1980 and 2015. Sydney experienced a significant increase in
price over this period. The ratio of median house price to income increased by 3.3 percent I
1981, which increased to seven percent in 2015.
Figure 9: Ratio of dwelling price to income
(aph.gov.au, 2018)
Most of the growth in housing price in relation to income took place during late
1980s, 1990s and early 2000s.
Table 1: Nominal median house prices

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The rising housing price has the consequence of reducing home ownership in
Australia. In 2014, 64.9 percent houses were owner occupied compared to 68.8 percent in
2001. Such trend is most prevalent in Victoria, New South Wales and South Australia.
Demand and supply side factors contributing to housing crisis
The rising cost of houses in Australia particularly in the capital cities are result of
combining forces of demand and supply (Mankiw, 2015) The rapid increase in demand and
inability of supply to meet the demand put increasing pressure on housing price.
Demand side factors
The primary factors contributing to demand growth of housing resulted from booming
economy of Australia and rapid growth of population. Besides there is a continuous increase
in real income supporting dramatic growth of double income household. The relatively
smaller interest rate in the economy support housing finance in the property market. The tax
system is designed in such a way that it supports debt-financing in the property investment.
Ease of credit access and concession in capital gain tax stimulates housing demand in the

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capital cities. The composition of Australian population is changing towards increasing
number of single parent household and a greater need for ageing care facilities. Hence, there
is a larger need of number of houses and the current stock of housing is not sufficient to
fulfill the demand. Another source of demand side pressure in the housing market is inflow of
migration (Gurran & Phibbs, 2017) The capital cities such as Sydney and Melbourne are the
main sites of settlement for migrants. In total migrant intake of Australia, the share of Sydney
and Melbourne have a respective migrant share of 28 percent and 24 percent. As migrants are
mostly belonging to young cohort, this increases demand pressure of young residents.
Supply side factors
The problem of increasing housing cost is also attributed from different supply side
factors. In the capital cities of Australia, there is a lack of sufficient land for planning
residential development. In the past decade, home ownership in Australia was made possible
because of increasing cheap and sufficient availability of land. Another factor limiting
housing supply is the lack of skilled workers required for housing development such as
construction workers and housing planners (Wang et al., 2018). The problem of skill shortage
increase price of housing construction and lower supply. The residential developers
exacerbate the problem of housing shortage by hoarding land for residential development for
a long period.
Solution toward housing affordability crisis
The Australian government has committed to undertake review of homelessness and
housing policies as part of Federal reform policies. In 2016, government announced to form a
special group named Affordable Housing Working Group. The group has the responsibility
to identify different ways to increase housing supply and make houses available at an
affordable price to the low income household along with implementation of trials of models

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for such arrangements (aph.gov.au, 2018). Once the supply of housing can be increases to
satisfy the medium and long terms demand it affordable housing would remain a problem.
Another initiative taken by the government is imposition of restriction on foreign
ownership related residential property. Government introduces a new condition to current
certification scheme in order to limit the foreign ownership of the dwellings in new
residential development. In the multistoried development project, the new condition puts an
upper limit of 50 percent on foreign ownership receiving approvals from the government.
This measure is taken to ensure a minimum development available for the Australians
(aph.gov.au, 2016). A fee is also imposed on the vacant property of foreign owners in case
the property is not occupied and available for rentals for at least six months. The other private
properties are also made available for rental market. Such a scheme has been designed to
increase available supply in housing.
With the objective of increasing availability of new and affordable rented dwellings
government announced a scheme called National Rental Affordability Scheme (NRAS) in
2008. The scheme provides incentives to developers for an extended period of 10 years. In
return to the financial aid, the participants are required to offer house rentals at a rate below
the current market rate (Dss.gov.au., 2018) As of November 2018, there are 122 approved
participants for NRAS.
A policy that provides direct assistance to home buyers is First Home Owners Grant.
The scheme was first introduced in 2000 with the aim to offset the additional burden of Good
and service tax on price of houses. Respect state and territory government in Australia
administered the grant. At the beginning the grant offered one-time endowment of $7000 to
all the first time buyers of new home, established dwellings or land. In order to be eligible for

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grants in order to purchase new homes, the individual has to purchase a home that had not
been previously occupied or sold.
The first home buyers grant is similar to a subsidy. The general effect of subsidy is to
increase price received by the sellers, lowers the price paid by the buyers and expands market
output. The figure below explains the effect of first home buyers subsidy using standard
demand-supply model.
Figure 10: Effect of first home owners grant
The rewarded subsidy shifts the demand curve to the right. Buyers pay a lower price of Pb
while sellers receive a higher price of Ps. The equilibrium quantity of housing increases from
A to Q’.

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Figure 11: First home buyers’ subsidy and perfectly inelastic supply
The benefits of the subsidy however vary depending on the elasticity. If demand is more
elastic than supply, then sellers receive the larger benefit from the subsidy. For perfectly
inelastic supply, supply does not change in response to price. The given subsidy in this case
only increase price while equilibrium quantity of housing remains unchanged.
Figure 12: First home buyers’ subsidy and perfectly elastic supply

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The situation is opposite with perfectly elastic supply curve. The rewarded subsidy
does not increase equilibrium price. In this buyers are benefitted more from the increasing
number of equilibrium housing.

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