Perfect Competition
•
Many (small) firms, producing a homogeneous (identical) product, none of
which having an impact on the price; each firm's product is non-distinguishable
from other firms' product.
•
b. Many buyers none of whom having any effect on the price.
•
c. No barriers to entry and exit: in the long run firms can shut down and leave
the industry or new firms can come into the industry freely.
•
•
d. No interference in the market process: No price control or restrictions on
production
e. All firms have equal and complete access to the available inputs (input
markets) and production technology; all firms have the same production and
cost functions.
•
f. All sellers and buyers have perfect information about the market conditions.
•
g. Making above-normal profits by existing firms will result in new entries into
the industry. Firms that have losses shut down and leave the industry in the long
run.
How is the market price Determined?
• Market Supply:
The (horizontal) sum of individual supply curves
• Market Demand:
The (horizontal) sum of individual demand curves
P
P
Smo
Sm1
S
po
p1
Do
D1
Dm
0
Market
Q
0
Q
q1 qo
A typical firm
Perfect Competition:Profit Maximization in the Short Run
• An individual firm takes the market price as
given; the demand each individual firm
faces is horizontal.
• MR = P: Demand
• Set the price equal to MC
• In the short- run the firm could have an
economic profit
$
Profit Maximization in the
Short Run
SMC
SATC
AVC
c
Pm
a
0
Df , MR
b
Qe
Q
Adjustments in the Long Run
• If economic profits are present new firms
will come into the industry
• The Market price will fall
• The profit shrinks
• Input prices may go up
• Firms try to stay profitable by taking
advantage of economies of scale
• Firms adopt an optimal size
• Economic profits tend toward zero
SMC
$
$
SATC
Smo
Sm1
Sm2
Sm3
AVC
c
Pm
Sm4
Df , MR
Pm1
Pm2
Pm3
Pm4
Dm
0
Q
Q4 Q3 Q2 Q1 Qo
o
Qm
MARKET
A competitive firm’s
long-run equilibrium
LATC
SAC1
SAC2
SAC3
SAC4
D
Pm
Q
o
Qe
Long-Run Equilibrium in a Perfectly Competitive Market
$
$P
LATC
SATC3
Sm
SATC1
MC2
SATC2
Pe
Df
Dm
o
o
Market
Qe
A typical firm
Q
Long-Run Equilibrium under Perfect Competition
• Many “optimal-size” firms, each producing at
the minimum long run average cost and charging
the market price where:
P = MR= MC = SATC = LATC
• Allocative efficiency: MC = P
• Productive efficiency: MC= SATC = LATC
• Zero economic profit (normal profit) : P = ATC
Pure Monopoly
• A single firm producing a homogenous or
differentiated (unique) good and facing the
market demand.
• No substitutes
• No new entries allowed
• The monopoly is a price maker
• P>MR
• Possibility of a sustained economic profit
What circumstances lead to the
formation of a monopoly?
•
•
•
•
•
•
Extensive economies of scale: natural monopolies
Exclusive patent rights
Copy rights to intellectual properties
Government franchises
Exclusive access to a essential resource (input)
Cartels
A monopoly is a profit maximizer too!
a
$
Demand Faced by A Monopoly
-2b
-b
MR
0
Dm
Q
$
TR
Q
0
$
SMC
SATC
k
P
n
m
c
D
Q
o
Qe
Qc
MR
The Dynamics of a Monopolistic Market
• As a profit maximizer a monopoly may try
to take advantage of economies of scale
• A monopoly tends to try to protect its
monopolistic position
• A monopoly may take advantage of
technological advances
• A monopoly may face changes in demand
• A monopoly may try to promote its product
to maintain demand
$
ATC>MC, P>MR, P>MC, P>ATC
SMC
P
LATC
k
SATC
n
m
D
Q
o
Qe
L-R Positive Economic Profit
MR
Monopolies and Profit Maximization
• A monopoly faces the industry demand curve
• To maximize profit: MR = MC
P = 80 - .0008Q ; MR = 80 - .0016Q
TC = 10,000 + .0092Q2 ; MC = .0184 Q
Set MR = MC  Q = 4000; P = 76.8
Profit = 307,200 – 147,200 – 10,000 = 150,000
• Profit = (P- ATC). Q
Things Change
• Demand may go down
• Cost could increase
• In an attempt to keep the potential competitors
out, the monopolist may lower its price to near
its average cost
• Rent seeking: an attempt to maintain its
monopolistic position by influencing the
political processes-e.g., zoning laws
• Closer substitutes may emerge
$
ATC>MC, P>MR, P>MC, P = ATC
SMC
LATC
SATC
P
D
o
Qe
L-R Zero Economic Profit
MR
Q
The Case of Natural Monopolies
• A natural monopoly emerges out of competition
among firms in an industry with extensive
economies of scale; the downward-sloping
segment of the LATC curve extends to or beyond
the market capacity (or market demand).
• Smaller firms are gradually driven out by the
larger (more efficient) firms.
• The surviving firm would become a (natural)
monopoly.
• If unchecked, a natural monopoly behaves like a
monopoly; it under-produces and overcharges.
$
SAC1
Natural Monopolies
SAC2
SAC3
LAC
D
o
Q1
Q2
Q3
Q
$
LATC
Natural Monopolies
Monopoly Pricing
p
Pm
SMC
SAC
AC
LMC
D
o
Qm
MR
Qc
Q
$
A Comparison
Pm
MC
Pc
MR
o
Qm
Qc
D
Q
Price Discrimination
• Segmenting the market into separate
classifications or regions
• Assuming that each class of consumers have
different demand, a monopoly can charge
different prices in each market segment
To price-discriminate
• The firm must identify consumer groups/classes with different
downward-sloping demand curves
• The firm must be able to prevent consumers of one class from
reselling its product to the consumers of another class; no
intermarket redistribution of the product is allowed
$
P`
P
MC, ATV
D
D`
Q
MR
MR
Q
o
Q
Price Discrimination
Q
Monopsony vs. Monopoly
MCL
SL
Wu
Wc
Wm
MRPL:DL
MRL
o
Eu Em
Ec
Cartels
P,C
P,C
P,C
ΣMC
P
MCB
MCA
Dm
ATCB
ATCA
MR
o
QA
Firm A
o
QB
Firm B
o
Q
Industry