6/6/23, 7:57 PM
Chapter 7 notes
EKN 110
Vivian Y.
Chapter 7: Pure Competition and Pure Monopoly
1. Four Market Models
- Pure competition, monopolistic competition, oligopoly & pure monopoly (last 3 =
imperfect competition)
- Differentiate: number of firms in industry, production of standardised or
differentiated product, difficulty to enter industry
a. Pure Competition
- Large number of firms, standardised product (identical to other producers), easy
entry
b. Pure Monopoly
- One firm is sole seller, entry of additional firms is blocked, unique product
c. Monopolistic Competition
- Large number of sellers, differentiated products, non-price competition, easy
entry/exit
d. Oligopoly
- Few sellers, standardised product
2. Pure Competition: Characteristics & Occurrence
- Large number of independently acting sellers (national/international markets)
- Standardised product (identical/homogenous), if price same – consumers are
indifferent about which seller to buy from (perfect substitutes)
- Price takers – exert no significant control over product price, small fraction of
market produced by each firm, cannot change market price
- Free entry/exit – no significant legal, technological, financial obstacles
3. Demand: Pure Competition
a. Perfectly elastic demand
- Firm cannot obtain higher price by restricting its output, nor can it increase its
sales volume by increasing its price – price takers
- Market demands are down sloping curves: an entire industry can still affect price
by changing the total output, individual firm’s demand curve is straight
horizontal line (perfect price elasticity)
b. Average, total & marginal revenue
i. Average Revenue
- Firm’s demand schedule = AR curve à price per unit =
revenue per unit (AR)
- AR= TR/Q = P*Q/Q = P (constant for firm)
ii. Total Revenue
- TR = P*Q
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Chapter 7 notes
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- Increases by constant amount – straight line, slopes upward, constant
iii. Marginal Revenue
- Change in TR from selling 1 more unit of output
- MR = ∆TR/∆Q = ∆(P*Q)/∆Q = P*∆Q/∆Q = P (constant)
4. Profit Maximisation in Short-run
a. TR-TC approach
- Firm is price taker à maximise economic profit by
adjusting output à changes in amount of variable
resources (fixed plant)
- Profit/loss = TR – TC = P*Q – (TFC + TVC) à profit
maximisation = total economic profit is at its maximum
- Break-even point: output at which firm makes normal profit but not an
economic profit, TR covers TC, any output between break-even points will
produce economic profit
- Maximum profit is where vertical distance between TR and TC curves is greatest
b. MR-MC approach
- Producing is preferable to shutting down – produce any output whose MR>MC =
gain in revenue
- If MC>MR – firm should not produce à adds more costs than revenue, profit
would decline/ loss would increase
- Initial stages of production – output is low, MR>MC (usually); later stages –
output is high, rising MC>MR
- Maximise profit/ minimise loss by producing output where MR = MC à firm
should produce last complete unit of output where MR>MC (P=MC)
i. Profit-Maximising case
- Per unit profit = (Price – ATC)*Q à x total units of output =
Profit
- Firm is happy to accept lower profit per unit as it still adds to
total profit
ii. Loss-Minimising case
- Very early stages of production MP is low, MC is high à firm
would still produce because loss is less than firms total fixed
costs, want to cover average variable costs
iii. Shutdown case
- Will not produce when AVC>P, smallest loss will be greater than
fixed costs
5. Marginal Cost & Short-run Supply
- Quantity supplied increases as price increases à economic profit is higher at
higher prices
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Chapter 7 notes
EKN 110
Vivian Y.
Price P1 < min. AVC à Qs = 0
Price P2 = min. AVC à Q2 units is supplied (MR2=MC) – just covers
TVC, loss = fixed costs – indifferent to shutting down/supplying
- Price P3 > min. AVC à Q3 units minimise short-run losses
(MR=MC)
- Price P4 à break even à supply Q4 = normal profit (no economic
profit) TR =TC and MR = ATC
- Price P5 = economic profit à Q5
6. Pure Monopoly
- Single seller: single firm is sole producer (firm & industry are synonymous)
- No close substitutes (product is unique) - the consumer who chooses not to buy
the monopolized product must do without it
- Price maker – firm controls total quantity supplied, controls price à change its
product price by changing quantity supplied, downward-sloping product demand
curve
- Blocked entry – no immediate competitors à Economic, technological, legal or
other type of barriers
- Non-price competition – product is standardised/differentiated
a. Examples
- Govt.-regulated public utilities – ESKOM, SA Postal Services
- Near-monopolies (firm has bulk of sales in specific market)– SAB, De Beers
diamonds
b. Monopoly Demand
i. Assumptions
- Patents, economies of scale or resource ownership secure the
monopolist’s status
- No governmental regulation
- Firm is a single-price monopolist (no price discrimination)
- Demand curve = market demand curve (pure monopolist = industry) –
down-sloping, quantity demanded increases as price decreases
ii. MR is less than Price
- Increase sales by charging lower price à MR is less than Price (AR)
– each additional unit sold increases total revenue by its price à TR
increases at a diminishing rate
- MR curve is below demand curve à MR< Price
- MR is +ve while TR is increasing. When TR reaches max. – MR=0.
When TR is diminishing – MR is –ve
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iii. Monopolist is price maker
The monopolist will never choose a price-quantity combination
where price reductions cause TR to decrease (MR<0).
Chooses prices in elastic region – decrease in price = increase in TR
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MR=MC rule – maximise profit must produce up to output
where MR =MC
- No supply curve, no unique relationship between P & Qs
iv. Economic effects of Monopoly
- Price, output & efficiency: monopolist if profitable when selling
smaller output at higher prices – no productive or allocative
efficiency – P > min. ATC– triangle abc = efficiency loss (P>MC;
P> min. ATC) à sum of consumer surplus & producer surplus is not maximised
7. Regulated Monopoly
a. Natural monopolies
- Subject to price regulation, deregulate parts of industries where
competition seems possible
b. Socially Optimal Price: P=MC
- Price that achieves allocative efficiency
c. Fair-return price: P=ATC
- Price where normal profit is obtained
d. Dilemma of regulation
- When price is set to achieve allocative efficiency – might suffer losses
(would need subsidies to survive)
Monopolistic competition
o Characteristics
§ Large number of sellers
• Not as many as in pure competition
•
•
Small market shares: small % of total market à limited control
over market price
No collusion
Independent action: no interdependence, each firm can
determine own pricing policy – unnoticeable effect on
competitors
Differentiated Products
• Product attributes (features, materials, design), service, location
(accessibility & proximity), brand names & packaging (enhance
appeal), some control over price (due to differentiation)
Easy Entry & Exit
• Competitors are typically small firms
• Economies of scale are few
•
§
§
§
• Capital requirements are low
• Small financial barriers from differentiation
Advertising
• Make consumers aware of product differentiation
•
Non-price competition
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Chapter 7 notes
EKN 110
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Vivian Y.
Oligopoly
o Characteristics
§ Few large producers
• Few huge firms dominate local market
§ Homogenous/ differentiated product
• Many industrial products are standardised products
• Many consumer goods are differentiated à non-price
competition (advertising)
§ Control over price but mutual interdependence
• Firms are price makers
•
needs to consider how its rivals will react to any change in its
price, output, product characteristics or advertising
Strategic behavior: self-interested behaviour that takes into
account the reaction of others
• Mutual interdependence: each firm’s profit depends not entirely
on its own price and sales strategies but also on those of the other
firms
Entry barriers
• same as in monopoly
•
§
•
•
•
•
§
economies of scale
high costs to enter
large expenditure for capital (plant & equipment)
ownership & control of raw materials
• pre-emptive & retaliatory pricing & advertising strategies
Mergers
• Some oligopolies were created through the growth of the
dominant firms in an industry but others through mergers
• Mergers increase the market shareà greater economies of scale
• “Desire for monopoly power”: the larger the firm has greater
control over market supply and price of the product
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