Perfect Competition and Monopoly Perfect Competition and Monopoly

Perfect Competition and Monopoly

Perfect Competition and Monopoly Alternative Market Structures

Alternative market structures Classifying markets by degree of competition ¡ number of firms ¡ freedom of entry to industry ¡ nature of product ¡ nature of demand curve 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

Features of the four market structures

Alternative market structures Classifying markets by degree of competition ¡ number of firms ¡ freedom of entry to industry ¡ nature of product ¡ nature of demand curve The four market structures ¡ perfect competition ¡ monopoly ¡ monopolistic competition ¡ oligopoly Structure conduct performance

Perfect Competition and Monopoly Perfect Competition

Perfect competition Assumptions ¡ firms are price takers ¡ freedom of entry ¡ identical products ¡ perfect knowledge Short-run equilibrium of the firm ¡ P = MC ¡ possible supernormal profits

Short-run equilibrium of industry and firm under perfect competition Firm is a price taker. Price is given by the market. £ P MC S Pe D = AR = MR AR AC D O O Q (millions) (a) Industry AC Qe Q (thousands) (b) Firm

Perfect competition Assumptions ¡ firms are price takers ¡ freedom of entry ¡ identical products ¡ perfect knowledge Short-run equilibrium of the firm ¡ P = MC ¡ possible supernormal profits ¡ possible short-run loss

Loss minimising under perfect competition Loss is minimised where MC = MR. P £ AC P 1 AC MC S D 1 = AR 1 = MR 1 D O O Q (millions) (a) Industry Qe Q (thousands) (b) Firm

Perfect competition Assumptions ¡ firms are price takers ¡ freedom of entry ¡ identical products ¡ perfect knowledge Short-run equilibrium of the firm ¡ P = MC ¡ possible supernormal profits ¡ possible short-run loss ¡ short-run supply curve of firm

Deriving the short-run supply curve P £ S MC = S a P 1 P 2 b c P 3 D 1 = MR 1 D 2 = MR 2 D 3 = MR 3 D 1 D 3 O Q (millions) (a) Industry D 2 O Q (thousands) (b) Firm

Perfect competition Short-run supply curve of industry Long-run equilibrium of the firm ¡ all supernormal profits competed away

Long-run equilibrium under perfect competition Profits return Supernormal profits New firms enter to normal P £ S 1 Se LRAC P 1 AR 1 D 1 PL ARL DL D O O Q (millions) (a) Industry QL Q (thousands) (b) Firm

Long-run equilibrium under perfect competition £ (SR)MC (SR)AC LRAC DL AR = MR LRAC = (SR)MC = MR = AR O Q

Perfect competition Short-run supply curve of industry Long-run equilibrium of the firm ¡ all supernormal profits competed away Long-run industry supply curve ¡ effect of external economies and diseconomies on the shape of the curve

Various long-run industry supply curves under perfect competition S 1 P S 2 b a c D 1 Long-run S D 2 O Q (a) Constant industry costs

Various long-run industry supply curves under perfect competition P S 2 S 1 b Long-run S c a D 2 D 1 O Q (b) Increasing industry costs: external diseconomies of scale

Various long-run industry supply curves under perfect competition P S 1 S 2 b a c Long-run S D 1 O D 2 Q (c) Decreasing industry costs: external economies of scale

Perfect competition Short-run supply curve of industry Long-run equilibrium of the firm ¡ all supernormal profits competed away long-run industry supply curve ¡ effect of external economies and diseconomies on the shape of the curve Incompatibility of economies of scale with perfect competition

Perfect competition Advantages of perfect competition ¡ P = MC ¡ production at minimum AC ¡ only normal profits in long run ¡ responsive to consumer wishes: consumer sovereignty ¡ competition efficiency ¡ no point in advertising

Perfect competition Disadvantages of perfect competition ¡ insufficient profits for investment ¡ lack of product variety ¡ lack of competition over product design and specification

Perfect Competition and Monopoly

Monopoly Defining monopoly Barriers to entry ¡ economies of scale ¡ product differentiation and brand loyalty ¡ lower costs for an established firm ¡ ownership or control over key factors ¡ ownership or control over outlets ¡ legal restrictions ¡ mergers and takeovers ¡ aggressive tactics ¡ intimidation Natural monopoly

Natural monopoly £ A monopoly can make supernormal profits between a and b. a Two firms sharing the market will both make less than normal profit. b D 2 O LRAC D 1 Q

Monopoly The monopolist's demand curve ¡ downward sloping ¡ MR below AR

Average and marginal revenue under monopoly £ AR MR O Q

Monopoly The monopolist's demand curve ¡ downward sloping ¡ MR below AR Equilibrium price and output ¡ output where MC = MR

Profit maximising under monopoly £ MC Profit maximised at output of Qm (where MC = MR) MR O Qm Q

Monopoly The monopolist's demand curve ¡ downward sloping ¡ MR below AR Equilibrium price and output ¡ output where MC = MR ¡ price given by demand (AR) curve

Profit maximising under monopoly £ MC AC Total profit AR AC AR MR O Qm Q

Monopoly The monopolist's demand curve ¡ downward sloping ¡ MR below AR Equilibrium price and output ¡ output where MC = MR ¡ price given by demand (AR) curve Limit pricing

Limit pricing £ AC new entrant PL AC monopolist Provided price is kept below the limit price (PL), new firms cannot make a profit. O Q

Monopoly Disadvantages of monopoly ¡ high prices / low output: short run

Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ MC Monopoly P 1 AR = D MR O Q 1 Q

Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ MC ( = supply under perfect competition) Comparison with Perfect competition P 1 P 2 AR = D MR O Q 1 Q 2 Q

Monopoly Disadvantages of monopoly ¡ high prices / low output: short run ¡ high prices / low output: long run ¡ lack of incentive to innovate ¡ X-inefficiency Advantages of monopoly ¡ economies of scale

Equilibrium of industry under perfect competition and monopoly: with different MC curves £ MCmonopoly P 1 AR = D MR O Q 1 Q

Equilibrium of industry under perfect competition and monopoly: with different MC curves MC ( = supply)perfect competition £ MCmonopoly Higher price (P 2) under perfect competition P 2 P 1 x … as long as MCmonopoly is below point x AR = D MR O Q 2 Q 1 Q

Equilibrium of industry under perfect competition and monopoly: with different MC curves MC ( = supply)perfect competition £ MCmonopoly P 2 P 1 Monopoly could produce at even lower price by producing where MC = P. x P 3 AR = D MR O Q 2 Q 1 Q 3 Q

Monopoly Disadvantages of monopoly ¡ high prices / low output: short run ¡ high prices / low output: long run ¡ lack of incentive to innovate ¡ X-inefficiency Advantages of monopoly economies of scale ¡ profits can be used for investment ¡ ¡ promise of high profits encourages risk taking

Perfect Competition and Monopoly Contestable Markets

Contestable markets Importance of potential competition ¡ low entry costs ¡ low exit costs Perfectly contestable markets

A contestable monopoly £ P 1 a LRAC D = AR O Q 1 Q

A contestable monopoly £ Supernormal profit P 1 AC 1 a LRAC b D = AR O Q 1 Q

A contestable monopoly £ The threat of entry drives price down to P 2. P 1 AC 1 a LRAC b P 2 =AC 2 c D = AR O Q 1 Q 2 Q

Contestable markets Importance of potential competition ¡ low entry costs ¡ low exit costs Perfectly contestable markets Hit-and-run competition Importance of theory of contestable markets Contestable markets and the public interest similarities with perfect competition ¡ similarities with pure monopoly ¡