08. profit maximising under perfect competition and monopoly
TRANSCRIPT
Profit Maximisation under
Perfect Competition
and Monopoly
Alternative Market Structures
• Classifying markets (by degree of competition)
– number of firms
– freedom of entry to industry
• free, restricted or blocked?
– nature of product
• homogeneous or differentiated?
– nature of demand curve
• degree of control the firm has over price
Alternative Market Structures
• The four market structures
– perfect competition
–monopoly
–monopolistic competition
– oligopoly
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Alternative Market Structures
• The four market structures
– perfect competition
–monopoly
–monopolistic competition
– oligopoly
• Structure → conduct → performance
Perfect Competition
• Assumptions
– firms are price takers
– freedom of entry of firms to industry
– identical products
– perfect knowledge
• Distinction between short and long run
– normal profits
– supernormal profits
Perfect Competition
• Short-run equilibrium of the firm
– Price
• given by market demand and supply
– Output
• where P = MC
– Profit
• (AR – AC) × Q
• possible supernormal profits
O
£
(b) Firm
Q (thousands)
O
(a) Industry
P
Q (millions)
S
D
Pe
MC
ARD = AR
= MR
Qe
AC
AC
Short-run equilibrium of industry and firm under perfect competition
Qe
P1
D1 = AR1
= MR1
AR1
O O
(a) Industry
P £
Q (millions)
S
D
(b) Firm
MC AC
AC
Q (thousands)
Loss minimising under perfect competition
D2
Short-run shut-down point
O O
(a) Industry
P £
P2
Q (millions)
S
(b) Firm
AR2
D2 = AR2
= MR2
MC AC
AVC
Q (thousands)
Perfect Competition
• Short-run equilibrium of the firm (cont.)
– short-run supply curve of firm
• the MC curve
• Short-run supply curve of industry
– sum of supply curves of firms
Perfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
O O
P £
Q (millions)
S1
D
LRAC
PL
P1
QL
Se
AR1 D1
ARL DL
Q (thousands)
Long-run equilibrium under perfect competition
New firms enterSupernormal profitsProfits return
to normal
(a) Industry (b) Firm
Perfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
£
Q O
(SR)AC
(SR)MC
LRAC
AR = MR
DL
LRAC = (SR)AC = (SR)MC = MR = AR
Long-run equilibrium of the firm under perfect competition
Perfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
– long-run industry supply curve
Perfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
– long-run industry supply curve
– incompatibility of economies of scale with perfect competition
Perfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
– long-run industry supply curve
– incompatibility of economies of scale with perfect competition
• Does the firm benefit from operating under perfect competition?
Monopoly
• Defining monopoly
– importance of market power
– concentration ratios
Concentration ratios in the UK
Monopoly
• Barriers to entry
– economies of scale
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership/control of key factors or outlets
– legal protection
–mergers and takeovers
– aggressive tactics
Monopoly
• The monopolist's demand curve
– downward sloping
–MR below AR
-4
-2
0
2
4
6
8
1 2 3 4 5 6 7
AR and MR curves for a monopolyQ
(units)
1234567
P =AR(£)8765432
ARAR
, MR
(£)
Quantity
-4
-2
0
2
4
6
8
1 2 3 4 5 6 7
Q(units)
1234567
P =AR(£)8765432
TR(£)
8141820201814
MR(£)
6420-2-4
MR
AR
, MR
(£)
Quantity
AR
AR and MR curves for a monopoly
Monopoly
• Equilibrium price and output
–MC = MR
Profit maximising under monopoly
MR
£
Q O
MC
Qm
Monopoly
• Equilibrium price and output
–MC = MR
–measuring level of supernormal profit
Profit maximising under monopoly
MR
£
Q O
MC
Qm
£
Q O
MC
AC
Qm
MR
AR
AC
AR
Profit maximising under monopoly
£
Q O
MC
AC
Qm
MR
AR
AC
AR
Total profit
Profit maximising under monopoly
Monopoly
• Equilibrium price and output
–MC = MR
–measuring level of supernormal profit
• Monopoly versus perfect competition
Monopoly
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
– lower output at a higher price
AR = D
MC
MR
£
Q O Q1
P1
Monopoly
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
£
Q O
MC ( = supply under perfect competition)
Q1
MR
P1
P2
Q2
AR = D
Comparison withPerfect competition
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
Monopoly
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
– lower output at a higher price
• short run and long run
Monopoly
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
– lower output at a higher price
• short run and long run
– costs under monopoly
£
Q O Q1
MR
P1
MCmonopoly
AR = D
Equilibrium of industry under perfect competition and monopoly: with different MC curves
£
Q O
MC ( = supply)perfect competition
Q1
MR
P1
P2
Q2
MCmonopoly
AR = D
x
Q3
P3
Equilibrium of industry under perfect competition and monopoly: with different MC curves
Monopoly
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
– lower output at a higher price
• short run and long run
– costs under monopoly
– innovation and new products
Contestable Markets
• Importance of potential competition– low entry costs
– low exit costs
• Perfectly contestable markets
• Contestable markets & natural monopolies
• The importance of costless exit– absence of sunk costs
– hit-and-run competition
• Assessment of the theory