Question

a) Differentiate between monopolistic and monopoly market structures. b) The short-run average total cost curve and the long-run average total cost curve are similarly shaped. What are the causes for the short run and long-run average total cost curve to slope down and up? c) What is natural monopoly and how is it related to economies of scale? d) Mr. Salim has been working at a car manufacturing plant forthe last 4 years. He recently lost his job due to the downsizing of the company he works for due topoor car sales and poor economic performance. What type of unemployment is Salim forced into? Justify your answer.

Answer 1

a. 1.A monopolistic competition is characterized by large number of firms. The size of each firm is small. Each firm has a limited market share. But a monopoly market is characterized by a single firm and the entire market share is controlled by the single seller.

2. Due to the presence of large number of firms and close substitutability of the products there is competition among firms in sales and price under monopolistic competition. But a monopolist is a single seller and there is no close substitutes are available. Thus competition is absent under monopoly. This is one of the best examples of imperfect competition.

3. In a monopolistic competitive market, the firms are free to enter and exit from the market. But under monopoly there are barriers to the entry of new firms.

4. In monopolistic competition the buyers have some control over the price. The buyers cannot influence the market price under monopoly.

5. Under monopolistic competition the profit is shared among large number of firms. But under monopoly the entire profit is earned by a single seller.

6. There is the absence of price discrimination under monopolistic competition. But the monopolist practice price discrimination.

b. The average total cost curve both in shortrun and longrun slopes down initially and then goes up. In other words the average total cost is U shaped both in shortrun and longrun. The reason is that the average total cost will be high at lower levels of output. The average total cost is sum of average fixed cost and average variable cost. These costs will be high when the quantity of output is low. Then as output increasing the fixed cost and variable costs are spread over a large number of outputs. Thus the average total cost decreases. In other words the average total cost initially declines due to increasing returns/economies of scale from the given inputs. This fall in total cost will continue till the fixed and variable cost reaches to its optimum use. After the optimum use of the factors, the expansion of output leads to diseconomies of scale. After the optimum point, the fixed factors are working beyond their capacity and the variable factors become excess in relation to the quantity of fixed factors. Thus the average total cost increase as more and more variable factors is added to given fixed factors. In short the average total cost goes down due to increasing returns in the initial stage and goes up in the later stage of production due to decreasing returns.

c. The basic cause of natural monopoly is the economies of scale. Due to large scale operation these monopolies creates economies of scale. The average total cost continuously declines and give cost advantage to these monopolies. Due to low cost these monopolies are able to meet the entire market demand and deter the rivals.

d. The unemployment caused by ups and downs in business is known as cyclical unemployment. The cyclical unemployment occurs during the contraction phase of the business cycle. When the demand for goods and services decreases during recession, the firms cut off production and lay off the workers. Salim lost his job due to the downswing of the economy and his unemployment is cyclical unemployment.