Pure Economic (Part - 2), Economy Traditional Notes | Study Indian Economy for UPSC CSE - UPSC

Features of Perfect Competition

• Large Number of Firms or Sellers : The number of firms selling a particular commodity is so large that any increase or decrease in the supply of one particular firm hardly influences the total market supply.
  Accordingly any individual firm fail to make any influence on the price of the commodity.
  It is therefore said that  a firm under perfect competition is price-taker. In other words he has to sell his production at the prevailing market price.
• Large Number of Buyers : Not only is the number of sellers very large, also the number of buyers is very large. Accordingly, like an individual firm, and individual buyer is also not able to influence price of the commodity.
  Any increase or decrease in individual demand will hardly make any difference to the total market demand. Accordingly, and individual buyer under perfect competition is also a price taker.
• Homogeneous Product : All sellers sell identical units of a given product. A important inference drawn from this feature is that buyers will have no reason to prefer the product of one seller to the product of another seller.
  Thus, the price of the product throughout that market will be the same.
  Selling homogeneous product at the given price rules out the possibility of advertisement or other sale-promotion expenses.
• Perfect Knowledge : Buyers and sellers are fully aware of the price prevailing in the market. Buyers know it fully well at what price sellers are selling a given product. As a consequence, only  one price prevails in the market.
• Free Entry and Exit of Firms : A firm can leave any industry. There is no legal restriction on the entry or exit.
• Perfect Mobility : Factors of production are perfectly mobile under perfect competition. Factors will move to that industry which pays the highest remuneration
• No Extra Transport Cost : For one price to prevail throughout the market, it is essential that there is no extra transport cost for the consumers while buying a commodity from different sellers.

Pure and Perfect Competition

• Economists draw a line of distinction between Pure and Perfect Competition. The difference between the two is only of degree and not of kind.
• The concept of pure competition was put forth by Prof. Chamberlin, “According to him, if the following conditions exist in a market then it is a case of pure competition : 

1. Large umber of buyers and sellers; 
2. Homogeneous product; 
3. Free entry or exit of the firms, 
4. Free from restrictions.

Features of Monopoly

1. One Seller and Large Number of Buyers : Under monopoly there should be a single producer of a commodity. He may be alone, or there may be a group of partners or a joint company or a state. Thus, there is only one firm under monopoly. But the buyers of the product are in large number. Consequently, no buyer can influence the price of the product.
2. Restrictions on the Entry of the New Firms : Under monopoly, there are some restrictions on the entry of new firms into monopoly industry. As for instance, there are patent rights, or exclusive control over a technique or raw material.
3. No Close Substitutes : A monopoly firm produces a commodity that has no close substitutes. 
4. Full Control Over Price : Since he alone produces the commodity in the market, a monopolist has full control over its price. A monopolist thus is a price maker. He can fix whatever price he wishes to fix for his product.
5. Possibility or Price Discrimination : Many a time a monopolist charges different prices from different consumers. It is called price discrimination. “Price discrimination refers to the practice by a seller of charging different prices from different buyers for the same good.” In monopoly, there is possibility of price discrimination.

Comparison between Monopoly and Perfect Competition

• Nature of Product : All firms produce homogeneous products under perfect competition. Product may or may not be homogeneous under monopoly. Total supply originates only from one firm under monopoly.
• Number of Sellers and Buyers : There are large number of buyers and sellers of homogeneous product under perfect competition. No single seller by changing his supply  and no single buyer by changing his demand can influence the price. A group of firms producing homogeneous goods is called industry under perfect competition. Under monopoly there is a single seller and difference between firm and industry does not exist.
• Restriction on Entry: New firms are free to enter and old ones are free to quit the industry under perfect competition. On the contrary, there are restrictions on the entry of new firms in case of monopoly.
• Price and Output of the Commodity : A firm is a price-taker under perfect competition and  so cannot influence the price. The only decision that a firm takes is how much to produce at the price which is determined by the industry so that it should be in equilibrium. Under monopoly, a monopolist himself is price-maker.
• Difference Regarding Output and Price : Price under monopoly is higher in the long-run than under perfect competition but output is lower. It is so because in long-run equilibrium situation prices equal to minimum average cost under perfect competition corresponding  to normal profits. But under monopoly it is not so because the monopolist earns super normal profit even in the long run.
• Difference Regarding Profit: Freedom of entry forces profits to come to the normal level under perfect competition. In monopoly, on the other hand, profits continue to be above normal because of barriers  to the entry of new firms.
• Shape of the Demand Curve : While under perfect competition, firm’s demand curve is a horizontal straight line (E_d = ), it slopes downward in case of monopoly (E_d < 1). Accordingly under perfect competition AR = MR, while under monopoly AR > MR.
• Possibility of Price Discrimination : Under perfect competition firms charge uniform price from all buyers. There is no price discrimination. But in monopoly price discrimination is possible. A monopolist can charge different prices for the same commodity from different persons or for different uses from the same persons.

Comparison between Monopolistic Competition and Perfect Competition

• Nature of the Product: Under perfect competition all  firms produce homogeneous product. Under monopolistic competition, firms produce differentiated goods. Due to product differentiation, every firm has limited control over price.
• Determination of Price : Both under perfect competition as well as monopolistic competition, price of the commodity is determined by the forces of market supply and market demand. However, whereas under perfect competition, a producer has absolutely no control over price, under monopolistic competition partial control of price becomes possible through product differentiation.
• Selling Costs : Under perfect competition a producer incurs cost of production alone,but under monopolistic competition a producer incurs in addition to cost of production, selling costs as well.
• Difference Regarding Degree of Knowledge : It is assumed under perfect competition that buyers and sellers have perfect knowledge about market conditions. Under monopolistic competition, the tastes and preferences of the consumers are influenced through product differentiation and advertisement. Thus, there is lack of perfect knowledge.
• Shape of Demand Curve: Firm’s demand curve under perfect competition is a horizontal straight line, but under monopolistic competition, a firm faces a downward sloping demand curve. Accordingly under perfect competition AR = MR, while under monopolistic competition AR > MR.
• Decision of the Firm : Under perfect competition a firm can take decision only with regard to the quantity of output to be produced. It can only decide as to how much to produce at the price determined by the industry so as to be in equilibrium. On the other hand, a firm under monopolistic competition is to decide both about price as well as output.

Comparison between Monopoly and Monopolistic Competition

• Nature of the Product : Product differentiation is a characteristic feature of monopolistic competition but it is not essential under monopoly.
• Number of Sellers : There is a single seller under monopoly but there are many sellers producing close substitutes under monopolistic competition.
• Entry of New Firms : In the long-run entry of new firms in the market is possible under monopolistic competition; but it is not possible under monopoly.
• Selling Costs : A monopolist has to incur cost of production alone, but a firm under monopolistic competition incurs selling costs in addition to production costs. However, while introducing new product in the market, a monopolist might have to incur some advertisement expenditure.
• Demand Curves : Both market situations have downward sloping revenue curves. But under monopolistic competition, average revenue and marginal revenue curves are more elastic. This is because of the availability of large number of close substitutes in monopolistic competition. Both in case of monopoly and monopolistic competition, firm’s demand curve slopes downward. But it is more elastic under monopolistic competition compared to monopoly.
• Difference Regarding Profit : Because of the freedom of entry of new firms, profits under monopolist competition are forced to be normal. But monopolist continues to enjoy above normal profits because of the barriers of entry of new firms.         

Real Cost

• The concept of Real Cost in economic was propounded by Dr. Marshall. The mental and physical efforts and sacrifices undergone with a view to producing a commodity are its real cost. In other words, real cost refers to the pains, the discomfort and disutility involved in supplying the factors of production by their owners.
• In short, real cost is expressed not in money terms but in terms of efforts (of workers) and sacrifices (of capitalists) undergone in producing a commodity. For instance, if a carpenter has to work for eight hours to produce a box, then this labour for eight hours will be the real cost of the box. Concept of real cost is a subjective concept. It is not possible to measure it. Accordingly, it is not of much relevance these days.

Opportunity Costs

• Modern economists give importance to the concept of opportunity cost. Opportunity cost of a factor refers to its value in its next best alternative.
• According to this concept, in an economy, supply of economic resources is limited relative to their demand. As such, when resources are used for producing a given commodity then some amount of other commodities, in whose production these resources could have been helpful, has to be sacrificed. 

Distinction between Fixed Cost and Variable Cost
Fixed Costs

1. Fixed costs do not change with change in quantity of output
2. Fixed costs remain the same whether out put is zero or maximum.
3. Examples are (a) rent, (b) wages of permanent staff, (c) license fee, (d) cost of plant and machinery, etc.  

Variable Costs

1. Variable Costs changes with change in quantity of output.
2. Variable costs are zero when output is zero. These costs increase when output increase and decrease when output decreases.
3. Examples are (a) cost of raw material (b) wage of casual labour (c) expenses on electricity, etc.

Relation between Total, Fixed and Variable Costs

• In the short-period, aggregate of fixed costs and variable costs of different levels of output, is called total costs.
• Holland, “Short-run total costs is equal to fixed costs plus variable costs.” 
• Marginal Cost is the change in total cost by producing one more or one less unit of output.
• Supposing total cost of producing 5 units of a commodity is Rs. 150 and if 6 units are produced, total cost goes upto Rs. 190. Thus the marginal cost of sixth unit will be (Rs. 190 - Rs. 150) =  Rs. 40.

Time Element and Cost

• Time element has an important bearing on the cost and production of commodity. This is discussed with reference to
  (i) very short or Market Period
  (ii) Short Period and
  (iii) Long Period.
• While during the market period, cost factor becomes irrelevant the producer must cover at least variable costs during the short period, and all costs fixed as well as variable during the long period.

Private Cost and Social Cost

• On the basis of the Sacrifice that the society has to make in order to produce goods and services two aspects of cost are considered:
• Private Cost : Private cost is the cost incurred by an individual firm for production a commodity. In the words of Miller, “Private costs are costs incurred by the firm or the individual producer as a result of their own decision.” For example, the expenses incurred by a textile mill on the purchase of raw material , wages, rent, electricity charges etc. to manufacture cloth are called private cost.
• Social Cost : Social cost is the cost incurred by the whole society for producing a commodity. For instance, during the process of manufacturing cloth the smoke emitting from the chimneys of textile mills spoil the garments worn by the people and so they have to spend more on laundry. 
  Pollution of air tells on the health of the people and they have to spend more on medical treatment.
  All these expenses are not incurred by a private firm but by the society as a whole. That is why these expenses are called social costs.