4th (autumn) trimester,
2005-2006 acad.year
Lecture 5 (abstract)
Lecture 5 (abstract)
MARKET MODELS – 1
Table 1
Characteristics of the four basic market models1
Characteristics
Number of
firms
Type of product
Control over
price
Conditions of
entry [and exit]
Non-price
competition
Typical
examples
Pure competition
Market models
Monopolistic
competition
Oligopoly
Pure
monopoly
A very large number
Many
Few
One
Homogenous,
standardized
Differentiated
Homogenous of
differentiated
Unique, no
close
substitutes
No control. Firms
accept the current
price (“price-takers)
Some control, within a
narrow limits
Very easy, no
obstacles
Relatively easy
None
Considerable emphasis
on advertising, brand
names, trade marks, etc.
Agriculture, stock
market, currency
market
Computer software
products, clothes,
footwear
Limited by
interdependence;
significant with
collusion (under
conspiracy)
Significant
obstacles
Very common,
especially with
product
differentiation
Cars, farm
machinery,
diamonds, oil,
steel
Significant,
considerable
Blocked
Mostly
public
relations
advertising
Local
utilities
Characteristics of pure competition:
1.) Very large number of suppliers (as well as of buyers) – every supplier’s output amounts
to an insignificant part of the total output;
2.) Suppliers accept the price as it is. None of them can affect the market price. In the
competitive markets, the suppliers are “price-takers” (сторони, що приймають ціну).
Market has the power over suppliers;
3.) Standardized (homogenous) product – to buyers it does not matter from whom to buy
the product. Homogeneity of the product rules out the so called ….

4.) “Non-price” competition (competition based on different modifications, brand names,
supplementary services, etc);
5.) Easy entry to [and exit from] the market – no legal, technological, financial or other
significant obstacles.
In the conditions of the pure competitive market the demand for a single producer’s
product is very close to absolute inelasticity. A single supplier’s demand curve is horizontal
in the short-term period (short run).
The competitive market demand curve is descendant (down-sloping).
1
Based on the table form McConnell-Brue handbook.
1
4th (autumn) trimester,
2005-2006 acad.year
Lecture 5 (abstract)
If a supplier reaches the amount of output that lets him/her
affect the market price (i.e. exert market power2), then we have a
market model different form pure competition.
Profit maximization in the short-term can be measured in two ways:
1.) TR-TC approach;
2.) MR-MC approach.
Total-revenue-total-cost (TR-TC) approach reveals 3 types of situation:
1.) Profit maximization – TR exceeds TC. TR less TC equals to Economic Profit;
2.) Loss minimization – TC exceeds TR, the total loss does not exceed FC. In this case it is
cheaper to continue the business operation than to stop it;
3.) Close-down – TC exceeds TR, the total loss exceeds FC. In this case the supplier ought to
suspend producing, since it will be cheaper to produce zero units than any at all.
Таблиця 2
Q
P TR=Q*P AR=
MR= FC VC
TC= Profit=
TR/Q dTR/dQ
FC+VC TR-TC
5
0
x
x
3
0
3
-3
5
5
5
5
3
2
5
0
5
10
5
5
3
5
8
2
5
15
5
5
3
9
12
3
5
5
20
5
3 14
17
3
5
25
5
5
3 20
23
2
5
30
5
5
3 27
30
0
5
35
5
5
3 35
38
-3
5
40
5
5
3 44
47
-7
0
1
2
3
4
5
6
7
8
AVC
ATC
MC
x
3,00
1,50
1,00
0,75
0,60
0,50
0,43
0,38
X
2,00
2,50
3,00
3,50
4,00
4,50
5,00
5,50
x
5,00
4,00
4,00
4,25
4,60
5,00
5,43
5,88
X
2
3
4
5
6
7
8
9
Fig.2 : Total costs (TC), fixed cost (FC),
and variable cost (VC)
Fig.1 : Total revenue (TR, price (P),
average revenue (AC) and marginal
revenue (MC)
45
AFC
50
40
40
30
35
P=AR=MR
TR
25
20
cost
price and revenue
45
35
15
30
FC
25
TC
20
VC
15
10
10
5
5
0
0
0
1
2
3
4
5
6
7
0
8
1
2
3
4
5
6
7
8
quantity
quantity
Profit is maximized at the output quantity of 3 and 4 units. If, for example, the fixed cost rises
from 3 up to 9, the losses will be maximized under the same quantity of output (Fig.4).
2
“Market power: The ability to alter the market price of a good or service.” Bradley R. Schiller
2
4th (autumn) trimester,
2005-2006 acad.year
Lecture 5 (abstract)
Fig.3 : Profit maximization via TR-TC
approach (FC=3)
Рис.4 : Loss minimization via TR-TC
approach (FC=9)
50
45
60
40
50
30
40
25
TR
20
TC
TC, TR
TC, TR
35
15
TR
30
TC
20
10
5
10
0
0
1
2
3
4
5
6
7
8
0
quantity
0
1
2
3
4
5
6
7
8
quantity
Fig.6 : Production suspended,
stopped
Fig.5 : Loss minimization, production
continuing
60
80
70
50
60
40
TR
30
TR
50
TC
TC
40
FC
FC
VC
30
VC
20
20
10
10
0
0
0
1
2
3
4
5
6
7
0
8
1
2
3
4
5
6
7
8
THE OTHER APPROACH: Marginal-Revenue–Marginal-Cost Approach.
Profit is maximized in the point in which MR and MC curves cross.
Fig.7 : Profit maximization via MR-MC
approach
Fig.8 : Loss minimization via MR-MC
approach
10
12
9
10
8
7
MR
8
5
MC
AFC
6
4
AVC
6
MC
AFC
AVC
ATC
3
MR
4
ATC
2
2
1
0
0
0
1
2
3
4
5
6
7
0
3
1
2
3
4
5
6
7
4th (autumn) trimester,
2005-2006 acad.year
Lecture 5 (abstract)
IN THE LONG RUN
Fig.9 : Optimization of the output
quantity via MR-MC approach
Fig.10 : Long-term optimum for a
firm under pure competition
10
10
9
revenues, costs
9
8
7
P=5
6
MC
5
P=3
4
P=7
3
2
8
7
6
5
P
4
AC
3
MC
2
1
1
0
0
0
1
2
3
4
5
6
7
0
1
2
3
4
5
6
7
8
quantity
MC curve is in fact a long-term supply curve (Fig.9). Long-term position of a firm is possible
on the condition equal average prices, average costs, and marginal costs, i.e. three points are
crossed/tangent in one.
In the long term period –
1.) Leaving the market (full stop):
TR < TC
TR/Q < TC/Q
P < ATC
2.) Returning to the market
Vice versa:
P > ATC
3.) No incentives to leave, or return to, the market
P = ATC
In the long run:
1.) Entry of new firms leads to elimination of economic profits;
2.) Exodus of operating firms from the market leads to elimination of economic losses.
PURE COMPETITION AND THE MARKET EFFICIENCY
Pure competition ensures the most efficient use of resources for consumers’
satisfaction maximization:
1.) allocative efficiency (ефективність розподілу ресурсів) – If P>MC, then the product is
produced in insufficient amounts. If P<MC, then it is produced in excess, i.e. too much
resources are employed in this business. Therefore, the optimal output is the one for
which the P=MC rule holds;
4
4th (autumn) trimester,
2005-2006 acad.year
Lecture 5 (abstract)
2.) productive efficiency – in the long run, the firms have to target the amount of output
incurring minimal average costs. Thus the P=AC rule holds as well.
In most cases, the competitive market is able to renew the efficiency of the resources
allocation, if it was affected by certain dynamic changes in the economy.
PURE COMPETITION AND EQUITY
1.)
2.)
3.)
4.)
Negative sides of pure competition:
inability to ensure an equitable distribution of income;
inability to resolve the issues related with market failures;
inability to ensure the efficient use of production techniques;
inability to satisfy consumers with a sufficient range of choice.
PURE MONOPOLY
MONOPOLY – in a broader sense – a situation under which a number of supplier is so small
that it empowers any of them or some of them with an ability to affect the price level and the
overall amount of output. OR – a situation when, even with a big number of suppliers, one or
very few of them have obtained the market power.
MONOPOLY – in a narrower sense (pure monopoly) – a market situation when there is one
and the only one supplier.
(If there is one and the only one buyer, then we have a MONOPSONY.)
SEE  Table 1 for the characteristics of the pure monopoly.
Types of obstacles (barriers and limitations) for a business entity to entry:
1.) Legal barriers – patents and licenses, other legal limitations of competition;
2.) Ownership of essential resources, like DeBeers;
3.) Economic – this is related with the economies of scale: one and only one supplier can
provide the good or services to fully meet the market demand at the lowest possible cost.
(e.g. natural monopolies). This allows the producer to set a lower price, thus driving the
competitors, whose amounts of output are not at minimum, out of the market.
4.) Unfair competition – dumping, negative advertising on the competitors’ products, moral
and physical pressure, etc.
NATURAL MONOPOLY
Natural monopolies emerge in the fields where a competition is impossible,
unreasonable, or inexpedient. A perfect example is public utility companies like water
stations, natural gas suppliers, etc.
Local governments have to regulate the operations of local monopolies.
5
4th (autumn) trimester,
2005-2006 acad.year
Lecture 5 (abstract)
MONOPOLY DEMAND
The demand curve for a pure monopoly firm is descendant, since the demand for the
monopolist’s product is equal to that for the total product: The monopolist is the only supplier.
(A REMIND NOT: the demand for a single supplier’s product at the pure competition market
is absolutely elastic)
With an increase in output, a pure-competitive firm gains a marginal revenue equal to
the price, the latter will be the same, since the firm cannot affect the price. The monopolist
will have to lower the price, which will result in the marginal revenue still lower than the new
price. Therefore, in the case of pure monopoly, the marginal revenue curve is steeper than the
demand curve, i.e. “the MR curve lies below the demand (price) curve at every point but the
first” (Schiller).
The monopolist is not a “price-taker”, but a “price-maker”.
The monopolist tends to avoid the inelastic part of the demand curve and reach a
favorable price-quantity combination at the elastic part, where lowering the price leads to
increase in the total revenues.
The monopolist maximizes its revenues at the point MR=MC. The optimal quantity of
output corresponds to the point of MR and MC curves intersection. The price? It’s on the Dcurve, right above the MR=MC point.
Since the MR curve is located below the D-curve, the monopolist supplies less than
optimal for the society and at a the price higher than optimal.
ECONOMIC EFFECTS OF MONOPOLY
1.) Insufficient (from the society’s standpoint) quantity of output and worse-thanoptimal allocation of resources;
2.) Due to economies of scale, the monopolist can reach the lowest possible average
costs and thus drive the competitors out of the market;
3.) The lesser the intensity of competition, the more room for X-inefficiency (when a
firm intentionally keeps to the average costs higher than efficient);
4.) Larger financial resources facilitate implementation of the most advanced
technologies. At the same time, the monopolistic position enables monopolistic
firms to delay with inventions;
5.) Licenses, patents, etc. result in increase in the costs needed for maintaining a
monopolistic position in the market;
6.) Monopolistic markets create grounds for the price discrimination.
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