Download - Profitmax
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Profit Maximisation under
Perfect Competition
and Monopoly
Profit Maximisation under
Perfect Competition
and Monopoly
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Alternative Market StructuresAlternative 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
• 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
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Alternative Market StructuresAlternative Market Structures
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
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Features of the four market structuresFeatures of the four market structures
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Features of the four market structuresFeatures of the four market structures
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Features of the four market structuresFeatures of the four market structures
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Features of the four market structuresFeatures of the four market structures
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Features of the four market structuresFeatures of the four market structures
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Features of the four market structuresFeatures of the four market structures
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Alternative Market StructuresAlternative Market Structures
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
• Structure conduct performance
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
• Structure conduct performance
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Perfect CompetitionPerfect 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
• 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
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Perfect CompetitionPerfect 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
• Short-run equilibrium of the firm
– Price
• given by market demand and supply
– Output
• where P = MC
– Profit
• (AR – AC) × Q
• possible supernormal profits
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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
Short-run equilibrium of industry and firm under perfect competition
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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 competitionLoss minimising under perfect competition
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D2
Short-run shut-down pointShort-run shut-down point
O O
(a) Industry
P £
P2
Q (millions)
S
(b) Firm
AR2
D2 = AR2
= MR2
MC AC
AVC
Q (thousands)
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Perfect CompetitionPerfect 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
• 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
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Perfect CompetitionPerfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
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O O
P £
Q (millions)
S1
D
LRAC
PL
P1
QL
Se
AR1 D1
ARL DL
Q (thousands)
Long-run equilibrium under perfect competitionLong-run equilibrium under perfect competition
New firms enterSupernormal profitsProfits return
to normal
(a) Industry (b) Firm
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Perfect CompetitionPerfect Competition
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
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£
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 competitionLong-run equilibrium of the firm under perfect competition
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Perfect CompetitionPerfect 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
• The long run
– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
– long-run industry supply curve
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Perfect CompetitionPerfect 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
• 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
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Perfect CompetitionPerfect 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?
• 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?
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MonopolyMonopoly
• Defining monopoly
– importance of market power
– concentration ratios
• Defining monopoly
– importance of market power
– concentration ratios
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Concentration ratios in the UKConcentration ratios in the UK
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MonopolyMonopoly
• 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
• 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
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MonopolyMonopoly
• The monopolist's demand curve
– downward sloping
– MR below AR
• The monopolist's demand curve
– downward sloping
– MR below AR
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-4
-2
0
2
4
6
8
1 2 3 4 5 6 7
AR and MR curves for a monopolyAR and MR curves for a monopolyQ
(units)
1234567
P =AR(£)8765432
ARAR
, MR
(£
)
Quantity
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-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 monopolyAR and MR curves for a monopoly
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MonopolyMonopoly
• Equilibrium price and output
– MC = MR
• Equilibrium price and output
– MC = MR
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Profit maximising under monopolyProfit maximising under monopoly
MR
£
Q O
MC
Qm
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MonopolyMonopoly
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
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Profit maximising under monopolyProfit maximising under monopoly
MR
£
Q O
MC
Qm
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£
Q O
MC
AC
Qm
MR
AR
AC
AR
Profit maximising under monopolyProfit maximising under monopoly
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£
Q O
MC
AC
Qm
MR
AR
AC
AR
Total profit
Profit maximising under monopolyProfit maximising under monopoly
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MonopolyMonopoly
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
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MonopolyMonopoly
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
– lower output at a higher price
• Equilibrium price and output
– MC = MR
– measuring level of supernormal profit
• Monopoly versus perfect competition
– lower output at a higher price
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AR = D
MC
MR
£
Q O Q1
P1
Monopoly
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
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£
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
Equilibrium of industry under perfect competition and monopoly: with the same MC curve
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MonopolyMonopoly
• 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
• 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
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MonopolyMonopoly
• 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
• 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
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£
Q O Q1
MR
P1
MCmonopoly
AR = D
Equilibrium of industry under perfect competition and monopoly: with different MC curves
Equilibrium of industry under perfect competition and monopoly: with different MC curves
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£
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
Equilibrium of industry under perfect competition and monopoly: with different MC curves
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MonopolyMonopoly
• 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
• 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
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Contestable MarketsContestable 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
• 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