Question

The market for wheat is supplied by a large number of small price taking firms. a) Suppose there is only one large buyer (a Monopsony). How will the price, quantity, PS, and CS differ from the case of a perfectly competitive market? b) Suppose that the majority of wheat is used by firms that produce bread. How will the wheat market be affected if the local bread market is supplied by a Monopoly. c) How would the market for wheat be affected if the government placed a price ceiling in the market for bread.

Answer 1

• In a perfectly competitive market, there are many producers and consumers, no barriers to exit and entry into the market, perfectly homogenous goods, perfect information, and well-defined property rights. In a perfectly competitive market, price equals marginal cost and firms earn an economic profit of zero.Perfect competition produces an equilibrium in which the price and quantity of a good is economically efficient.
• A monopoly exists when there is only one producer and many consumers. In a monopoly, the price is set above marginal cost and the firm earns a positive economic profit. Monopolies produce an equilibrium at which the price of a good is higher, and the quantity lower, than is economically efficient. For this reason, governments often seek to regulate monopolies and encourage increased competition.

• While competitive firms experience marginal revenue that is equal to price – represented graphically by a horizontal line – monopolies have downward-sloping marginal revenue curves that are different than the good’s price.
• For monopolies, marginal revenue is always less than price.
• Therefore, a monopoly selects a higher price and lesser quantity of output than a price-taking company
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• Perfect competition will have no dead weight loss.
• Since, most of the wheat is supplied by monopoly market to bread producers, bread producers will get lesser quantity of wheat at higer prices which will increase cost of bread in the market.

• Price ceilings prevent a price from rising above a certain level.

• When a price ceiling is set below the equilibrium price, quantity demanded will exceed quantity supplied, and excess demand or shortages will result.

• When a price ceiling is set, a shortage occurs. For the price that the ceiling is set at, there is more demand than there is at the equilibrium price. There is also less supply than there is at the equilibrium price, thus there is more quantity demanded than quantity supplied. An inefficiency occurs since at the price ceiling quantity supplied the marginal benefit exceeds the marginal cost. This inefficiency is equal to the deadweight welfare loss.
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• Price ceiling on bread market will create Shortages wheat market as well. If you mandate a price ceiling which is lower than the demand, then you will have a shortage, since producers can’t charge enough to make as much of a profit, while likewise quality will drop as producers cut corners to lower production-costs.