NIT - KKR

Equilibrium of Firm Under

Alternative Forms of Market
B Sarah Mathew

B Sarah
 NIT - KKR

Demand Curve
• Perfect Competition
• Monopoly
• Monopolistic Competition
• Oligopoly

B Sarah
 NIT - KKR

Perfect Competition

Shape of DD Curve: Horizontal line parallel to Qty axis

Perfectly Elastic DD Curve
Price elasticity of DD = Infinite

B Sarah
 NIT - KKR

Monopolistic Competition Monopoly

Downward sloping DD curve :

In order to sell more units of a
commodity, Firm must lower its
Price

Shape of DD Curve: Downward Sloping Shape of DD Curve: Downward Sloping

Relatively Flat Relatively Steep
(More Elastic) Relatively Elastic DD Curve Relatively (Less Elastic) Inelastic DD Curve -
Price elasticity of DD = > 1 Price elasticity of DD = < 1
B Sarah
 NIT - KKR
Oligopoly
Indeterminateness of Demand Curve

Demand Curve: Oligopolist Firm faces an Indeterminate DD Curve

Firms are interdependent - Decision taken by one firm will affect others and they react.
But the firm cannot assume the reaction of other firms in terms of price change.
This makes the DD curve indefinite and shifting, depending upon reaction of rival firms

Perfect competition, Monopoly & Monopolistic Competition:

Firm faces Determinate DD (AR) curve

B Sarah
Equilibrium of Firm Under Alternative Forms of Market NIT - KKR

Producer’s Equilibrium
PE: Maximization of output for a given cost outlay.
Least cost combination of factors of production to produce a given level of output

• There are various combination of factors which can produce a given level of output. A
rational producer will choose the most efficient combination of factors of production
to produce the product. A profit maximizing producer would select the combination
of factors which is optimum to produce that given level of output.
• Optimum Combination is achieved when the given level of output is produced with
maximum cost or minimum output is produced with a given cost of production. This
optimum combination of factors of production is called Producers’ Equilibrium.
Mathew B S
 NIT - KKR
Equilibrium of Firm Under Alternative Forms of Market
Profit: Profit equals Total revenue (TR) less Total Cost (TC). i.e., TR – TC.
TR means the total value of output produced and TC means all costs, including both fixed and variable
costs.
Therefore, Profit is maximum when (TR -TC) is maximum.
Gross Profit: GP equals Total Revenue (TR) less Total Variable cost (TVC). i.e., Gross Profit = TR – TVC
Since TC – TVC = TFC (Total fixed cost), Gross Profit includes TFC
Therefore, Profit = Gross Profit – TFC

Necessary and Sufficient Conditions of Profit Maximization of a Firm

1. Necessary Condition: Marginal Cost must be equal to Marginal Revenue, i.e., MC = MR
MC Curve intersect MR Curve
2. Sufficient Condition: MC must be greater than MR after the point of equilibrium. i.e., MC > MR
MC Curve intersect MR Curve from below
Mathew B S
 NIT - KKR

Equilibrium of Firm Under Alternative Forms of Market

1. Perfect Competition
2. Monopoly
3. Monopolistic Competition

Producer’s Equilibrium
1. TR –TC Approach
2. MR – MC Approach

Mathew B S
 Equilibrium of Firm Under Alternative Forms of Market NIT - KKR

Producer’s Equilibrium: TR –TC Approach

Total Revenue Total Cost
Total sale proceeds from the sale of all the units Cost incurred in the production

Output TR Output TC
1 5 1 7
2 10 2 11
3 15 3 15
4 20 4 16
5 25 Difference between 5 25
6 30 TR & TC gives Profit 6 35

Mathew B S
B Sarah
 NIT - KKR
TR –TC Approach

Producer’s Equilibrium is attained when

positive difference between TR & TC is maximum

Output TR TC TR – TC= Profit

1 5 7 -2
2 10 11 1
3 15 15 0
4 20 16 4
5 25 25 0
6 30 35 -5
Mathew B S

B Sarah
Producer’s Equilibrium TR – TC Approach NIT - KKR

Producer’s equilibrium is
attained when positive
difference between
TR & TC is maximum

B Sarah
 NIT - KKR

Perfect Competition

B Sarah
 Perfect Competition: Producer’s Equilibrium NIT - KKR

TR –TC Approach MR –MC Approach

B Sarah
Perfect Competition: SR & LR Equilibrium Conditions MR – MC Approach NIT - KKR

Short Run Equilibrium Conditions In SR, it is SAVC

1. SMR = SMC Whereas, in LR, it is only LAC;
2. SMC should be upward sloping because all factors are variable in LR

3. Price should be = or > minimum of SAVC

Long Run Equilibrium Conditions
1. LMR = LMC
2. LMC should be upward sloping
3. Price should be = or > minimum of LAC

Minimum of SAC - Determines TC of production (Fixed = Variable)

Minimum of SAVC - Determines TVC of production
Price Line or SMR Line – Determines TR earned Mathew B S
 Perfect Competition: SR Conditions MR – MC Approach NIT - KKR

Short Run Equilibrium: Condition 1 Mathew B S

1. SMR = SMC

Equilibrium Point E
Equilibrium Output OQ2

Case A: at Output OQ1 Case B: at Output OQ3

Price or SMR (KQ1) > SMC (LQ1) Price or SMR (HQ3) < SMC (GQ3)
Condition 1 is not met - OQ1 is not profit maximizing output Condition 1 is not met - OQ3 is not profit maximizing output
Firm can increase its profit by increasing output to OQ2 Firm can increase its profit by decreasing output to OQ2
 Perfect Competition: SR Conditions MR – MC Approach NIT - KKR

Short Run Equilibrium: Condition 2 Case A: at Point Z (Output OQ0)

1. SMR = SMC 1. SMR = SMC Condition 1: satisfied
2. SMC should be upward sloping 2. SMC is falling Condition 2: unsatisfied
Case B: at Point E (Output OQ2)
1. SMR = SMC Condition 1: satisfied
2. SMC is rising Condition 2: satisfied
Why firm will raise production from OQ0 to OQ2 ?
Beyond OQ0
MC < MR (Price)
Additional cost < Additional revenue
Firms find profitable to raise production
Production continues to rise till OQ2
Beyond OQ2
MC > MR
So firm will not raise production
 Perfect Competition: SR Conditions MR – MC Approach NIT - KKR

Short Run Equilibrium Condition 3

Mathew B S
1. SMR = SMC
2. SMC should be upward sloping
3. Price should be = or > minimum of SAVC

at Output OQ1
1. SMR = SMC Condition 1: satisfied
2. SMC is rising Condition 2: satisfied
3. P = or > Min. of SAVC Condition 3: satisfied
Perfect Competition: SR Conditions MR – MC Approach NIT - KKR

When P < Min SAVC ?

Case A: With Production- at Output OQ1
TR = area OPLQ1
TC = area ONKQ1 + area NKRS
Loss = area PNKL (variable cost)+ area NKRS (fixed cost)

Case B: No Production – at Zero Output

TR = zero
TC = zero + area NKRS
Loss = area NKRS (fixed cost)

When P < Min SAVC

Loss associated with production > Loss associated without production
Therefore, a firm should stop production
the moment price falls below minimum of SAVC curve
Hence, the third condition of equilibrium of firm is
P is either = or > Min. of SAVC
Perfect Competition: LR Conditions MR – MC Approach NIT - KKR

1. LMR = LMC
2. LMC should be upward sloping
3. Price should be = or > minimum of LAC
 NIT - KKR

Monopoly
Monopoly: SR & LR Equilibrium Conditions NIT - KKR

LR Equilibrium
MR – MC Approach
1. LMR = LMC
2. LMC should be upward sloping
3. Price should be > minimum of LAC
(Condition 1 & 2 are same as PC)

SR Equilibrium
TR – TC Approach : Maximum Profit
MR – MC Approach
1. SMR = SMC
2. SMC should be upward sloping
3. Price should be = or > minimum of SAVC
( Same as PC)
 NIT - KKR

Monopolistic Competition
Monopolistic Competition: Equilibrium Conditions NIT - KKR

SR EQUILIBRIUM

1. SMR=SMC
2. SMC should be upward sloping
3. Price > or = minimum of SAVC
Same as PC & M

LR EQUILIBRIUM
1. LMR=LMC
2. LMC should be upward sloping
3. Price = minimum of LAC
1st & 2nd conditions are same as PC & M
But 3rd condition is different
Perfect Competition: P > or = min of LAC
Monopoly: P > min. of LAC
 Monopolistically Competitive Firm Vs Perfectly Competitive Firm

Monopolistically Competitive Firm Perfectly Competition Firm

Perfect Competition: Firm produces at the efficient scale, where AC is minimized. Price equals MC
Monopolistic Competition: Firm produces at less than efficient scale. Price is above MC