lu 6a perfect competition monopoly(1)

8/10/2019 LU 6a Perfect Competition Monopoly(1)

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Principle of Economics

Market Structure :

Perfect Competition &

Monopoly


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Learning Objectives

At the end of the lecture class, students will beable to:

1. Define the meaning of perfect market

2. Identify the characteristics of perfectcompetition and monopoly3. Illustrate the different type of profit

obtained by firms under two different market4. Distinguished pro and cons between perfect

competition and monopoly market


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Perfect Competition


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Type of

market

Number

of firms

Freedom of

entry

Nature of

product

Examples Implications for

demand curve

faced by firm

Perfect

competition

Very

many UnrestrictedHomogeneous

(undifferentiated)

Tomatoes,

carrots,

e-Commerce

(these are close to

perfectly

competitive)

Horizontal:

firm is a price taker

Monopolisticcompetition

Many /several

Unrestricted Differentiated

Restaurants, hair

salons Downward sloping,but relatively

elastic

Oligopoly Few Restricted

Undifferentiated

or differentiated

Banks, motor

vehicle industry,

TV stations

Downward sloping.

Relatively inelastic

(shape depends on

reactions of rivals)

Monopoly One Restricted or

completely

blocked

Unique

Australia Post,

state water

authorities

Downward sloping:

more inelastic than

oligopoly. Firm has

considerable

control over rice

The Degree of Competition

Not every industry fits neatly into one of these categories; however, this is

a useful framework for thinking about industry structure and behavior.


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WHAT IS A COMPETITIVE

MARKET?

1. A perfectly competitive market has the followingcharacteristics: Firms can freely enter or exitthe market. Sell a standardized or homogeneous product Firms are price takers.

Buyers and sellers are fully informed about theprice and availabilityof all resources and products. There are many buyers and sellers in the market. Absence of any type of intervention (government

or other external factors) toward buyers andsellers decision.

2. As a result of its characteristics each buyer and sellertakes the market price as given.


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When a firm is said to be at equilibrium inthe short run, there are 3 possible profitlevels:1. Supernormal profits2. Subnormal profits (Loss)3. Normal profits (Break even)

WHAT IS A COMPETITIVE

MARKET?

Short run in Perfect Competition

Period during which there is too little time for newfirms to enter the industry

Maximize profit: MR = MC


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(a) Industry

Profit is the shaded rectangle

Supernormal profits

0

$

Q(thousands)0

P

Q(millions)

S

D

Pe

MC

ARD = AR=MR

Qe

AC

AC

where firms AR(P) > firms SRAC.

(b) Firm

z

E


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(a) Industry (b) Firm

Qe

P1D1= AR1= MR1

AR1

O O

P $

Q(millions)

S

D

MC AC

AC

Q(thousands)

Subnormal profits (Loss)

Loss is the shaded rectangle

where firmsAR(P) < firmsSRAC. However it is advisablefor firm to keep on producing as its AR(P) is still greater

than its SRAVC, otherwise, stop producing or leave theindustry.

E

z


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Normal profits (Break even)

where firmsAR(P) = firmsAC. It is advisable at thistime, for firm to replace its capital since it has worn out

already.

Qe

P1 AR1

O O

P $

Q(millions)

S

D

MC

AC

Q(thousands)

D1= AR1= MR1

E


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Calculating TR, AR, MR

Q P (RM) TR (RM) AR (RM) MR (RM)

0 10 n/a

1 10 10

2 103 10

4 10 40

5 10 50 10

Fill in the empty spaces of the table.

0

10

2030

1010

10

10

10

10

1010

-

Notice that

MR= P

TR= Px QTR

QAR=

TR

QMR=


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Profit Maximization

Q TR

(RM)

TC

(RM)

Profit

(RM)

MR

(RM)

MC

(RM)

Profit

(RM)

0 0 5 -

1 10 9 10

2 20 15 103 30 23 10

4 40 33 10

5 50 45 10

At any Qwith MR> MC, increasing Qraises profit.

At any Qwith MR< MC, reducing Qraises profit.

-5

1 4

68

0

12

6

42

0

-2

57

7

5

- -

Profit = TR - TCTC

QMC= Profit= New Profit Old Profit


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Deriving the short-run supply curve

The portion of the marginal-cost curve that liesabove average variable cost is the competitivefirmsshort-run supply curve.

O O

P $

P1

Q(millions)

S

D1

D1= MR1

MC = S

P2D2= MR2

D2

P3D3= MR3

D3

Q(thousands)

a

b

c

Q1Q2Q3

AVC


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Deriving the short-run supply curve

Short run supply curve will be its marginal cost curve ?

Supply curve Marginal Cost

Q -------- P Q -------- MC

P = MR MC = MR

P = MC

Supply curve = Marginal Cost curve


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The Competitive Firms Short RunSupply Curve

Copyright 2004 South-Western

MC

Quantity

ATC

AVC

0

Costs

Firm

shuts

down if

PAVC,firmwill continue toproduce in the

short run.

If P>ATC, the firmwill continue to

produce at a profit.


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Q

$

0

(SR)AC(SR)MC

LRAC

AR = MR

DL

LRAC = (SR)AC = (SR)MC =MR=AR

all supernormal profits competed away

LRAC = AC = MC = MR = AR


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Perfect Competition

Because a competitive firm is a price taker, its revenue

is proportional to the amount of output it produces.

The price of the good equals both the firmsaveragerevenue and its marginal revenue.

To maximize profit, a firm chooses the quantity ofoutput such that marginal revenue equals marginalcost.

This is also the quantity at which price equals marginalcost.

Therefore, the firmsmarginal cost curve is its supplycurve.


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Perfect Competition

In the short run, when a firm cannot recover its fixedcosts, the firm will choose to shut down temporarily ifthe price of the good is less than average variablecost.

In the long run, when the firm can recover both fixedand variable costs, it will choose to exit if the price isless than average total cost.


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Perfect Competition

Is Perfect Competition good for consumers ?

P = MCP > MC ------ Ought to produce moreP < MC ------ Ought to produce less

Price at minimumFirm making only normal profits

Survival of the fittest

Inefficient firms will be driven out of business


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Monopoly


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Monopoly

Monopoly is a market with a single supplier of a goodor service that has no close substitutes and in whichnatural and legal barriers to entry prevent competition.

Since monopoly by definition, supplies the entiremarket, the demand for goods and services produced by a

monopolist is also a market demand (slope downward)

While a competitive firm is a price taker, a monopolyfirm is a price maker.

The government gives a single firm the exclusive rightto produce some good.


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Economies of Scale- If cost go on falling significantly up to the output that

satisfies the whole market, the industry may not beable to support more than one producer

Natural MonopolyLRAC would be lower if an industry were under monopoly

than if it were shared between two or more competitors

Product differentiation and Brand loyalty- Differentiate products where consumers associates

products with the brand

Lower costs for an established firm- developed specialized production and marketing skills- have efficient techniques or access to cheaper finance

Barriers to Entry


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Legal Protection Patent, Copyright, Licensing- Through legislation whereby the rights of the

producers have to be protected.

Control of marketing channels- If the monopolist controls the distribution agents then

rival firms would have difficulty in trying to reach the

consumers, e.g. newspaper vendors, retailers, etc.

Cut throat competition- The monopolist will undercut price so that the rival

firm will not be able to compete at all.

Control of marketing channels- If the monopolist controls the distribution agents then

rival firms would have difficulty in trying to reach theconsumers, e.g. newspaper vendors, retailers, etc.

Barriers to entry


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Legal prohibition

- In some countries, competition is not allowed and thisis set by the government through a certain set ofregulations.

Ownership of certain raw materials- The monopolist may own all the deposits of somemineral resources, or control all or part of thecountry's or region's mineral deposits.

Barriers to entry


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Monopolys Marginal Revenue

A MonopolysMarginal Revenue:-

Marginal revenue is always less than the price of

its good.

The demand curve is downward sloping.

When a monopoly drops the price to sell one more

unit, the revenue received from previously sold unitsalso decreases.

Price maker ------- Market Demand

Demand Curves for


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Demand Curves forCompetitive and Monopoly Firms


(a) A Competitive FirmsDemand Curve

(b) A MonopolistsDemand Curve

0 0Quantity of Output

Demand

Price

Quantity of Output

Price

Demand

Example: Demand and Marginal


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Example: Demand and Marginal-Revenue Curves for a Monopoly


Quantity of Water

Price

$1110987

654321

012

3

4

Demand(average revenue)

MarginalRevenue

1 2 3 4 5 6 7 8


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$

QO

MC

AC

Qm

MR

AR

AC

AR

Total profit

Profit Maximising under Monopoly

The monopolistsdemand curve isdownward slopingand MRbelow AR.

Equilibrium priceand output MC =MR

It then uses thedemand curve tofind the pricethat will induceconsumers to buythat quantity.

B

A

C

E l P fit M i i ti f


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Example : Profit Maximization for aMonopoly


A

Marginal revenue

Marginal

cost

QuantityQ1

Q20

Costs and

Revenue

Demand

Average total cost

Monopolyprice

QMAX

B

1. The intersection of themarginal-revenue curve

and the marginal-cost

curve determines the

profit-maximizing

quantity . . .

2. . . . and then the demandcurve shows the price

consistent with this quantity.

AP*

Pm


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Monopoly versus Perfect

Competition: Which best serves

the public interest?

M l P f t C titi


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Disadvantages of monopoly: High prices / low output: short run & long run

For a competitive firm, price equals marginal cost.

P = MR = MC

For a monopoly firm, price exceeds marginal cost.P > MR = MC

Quantity produced by the monopoly will be less thanthe competitive level of output

The monopoly price level will be higher than the priceunder perfect competition.

PPC= MC PM> MC

Monopoly vs. Perfect Competition:

Short & Long Run Price and Output

Equilibrium of Industry under Perfect Competition


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AR = D

MC

MR m

$

QO Q1

P1

Monopoly

Equilibrium of Industry under Perfect Competition

and Monopoly: with the same MCcurve

$

O

MC = (supply underperfect competition)

Q1

MR m

P1P2

Q2

AR = D (= MRpc)

Comparison withPerfect competition

Q

B

C

C

A

A

M l P f t C titi


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Monopoly versus Perfect Competition:

Long Run

Perfect Competition1. Freedom of entry eliminate supernormal profit

2. Firm to produce at the bottom of their LRAC curve

3. Keep long run prices down

Monopoly

1. Barriers of entry allow profit remain supernormal

2. Firm is not force to produce at the bottom of their LRAC curve

3. Long run prices will tends to be higher and lower output

M l P f t C titi


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Monopoly versus Perfect Competition:

Cost

Perfect Competition

1. Require usage or develop the most efficient techniques:Lower cost

Monopoly1. Barriers of entry and still making profit even though do not use

efficient techniques: Higher cost

BUT

1. Able to achieve substantial economies of scale: Higher output atLower price

2. Use part of the supernormal profit for R&D

Still need to be efficient as subject tocompetition of corporate control


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lu 6a perfect competition monopoly(1)

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