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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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(a) Industry (b) Firm
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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(a) Industry (b) Firm
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
Copyright 2004 South-Western
(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
Copyright 2004 South-Western
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
Copyright 2004 South-Western
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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