A What are the key differences in a pure monopoly and a pure

A) What are the key differences in a pure monopoly and a pure competition?

B) Why might price collusion occur in oligopolistic industries?

Solution

(A) In pure competition, there are many buyers and sellers in the market, each seller producing identical good. For each firm, market-determined price is the firm\'s price and firms cannot set their own price. So, firm demand curve is its price and marginal revenue curve which is horizontal. Firms maximze profits by equating price with marginal cost. There are no barriers to entry or exit. Even though firms earn short run excess (economic) profit, long run excess profit is zero and firms earn only the normal profit.

In contrast, a monopolist is the single seller in market, who faces a downward sloping demand curve. Price and marginal revenue are different, and firm maximizes profits by equating marginal revenue with marginal cost. Barrier to entry into the market is very high, so monopolist enjoys both short-run and long-run profit.

(B) In oligopoly, price (or output) decisions of firms are interdependent. Therefore, while taking independent pricing decisions, eventually each firm ends up with an output and profit level which are lower. To raise profits, firms may collude in terms of price by charging a uniform price, as a result of which each firm enjoys higher output and higher profit levels than is possible without collusion.