5
From Perfect Competition to Monopoly
Supply under Perfect Competition
Summary
LO1: Distinguish between perfect competition and monopoly and between normal and economic profit.
LO2: Demonstrate and explain why economic profit disappears under perfect competition but not under monopoly.
LO3: Illustrate why, under perfect competition, the supply curve from Chapter 2 is marginal cost.
Monopolistic competition - a situation in a market where there are many firms producing similar but not identical goods.
Oligopolistic market - a situation in a market where there are very few discernable competitors.
Concentration ratio - a measure of the market power held by the top firms in an industry. For a specific number of firms (n) it is the percentage of total sales in the industry accounted for by top n firms.
Herfindahl-Hirschman Index - a measure of market concentration developed by adding the sum of squared market shares.
Normal profit - the level of profit that business owners could get in their next best alternate investment.
Economic profit - any profit above normal profit.
Short run - the period of time where a firm cannot change things like plant and equipment.
Long run - the period of time where a firm can change things like plant and equipment.

2 Chapter 5
1.
Review the Rules of Production from Chapter 5 in your text. We will now summarize the production rules and the rule to determine if the firm is earning a profit. a. If a firm produces in the short-run, the profit maximizing/ loss minimizing output, Q , can be determined by comparing the MR with the MC.
Given the following conditions, indicate if the firm should produce more, less, or this quantity. i. If MR > MC, the additional revenue is greater than the additional cost, the firm should produce
______________ . ii. If MR = MC, the additional revenue equals the additional cost, the firm should produce ___________ . iii. If MR < MC , the additional revenue is less than the additional cost, the firm should produce _______ . b. To determine if the firm should produce or shutdown in the short-run, compare the P with the AVC.
Given the following conditions, indicate if the firm should produce or shutdown. i. If P < AVC, the firm should ________________ . ii. If P > AVC, the firm should ________________ . c. To determine if the firm is earning a profit or taking a loss in the short run, compare the TR with the TC, or compare the P with the ATC.
Given the following conditions, indicate for the short and long run, if the firm is earning a profit, taking a loss, or if the firm is breaking even. Indicate if the number of firms in a competitive industry and the price of the product will increase, decrease, or remain the same. i. If TR > TC and P > ATC, in the short-run the firm is _____________________________________ .
Under Perfect Competition: In the long run, the firm is _________________________ .
In the long run, the number of firms in the industry will
______ .
In the long run, the price will _______________________ .

Perfect Competition, Monopoly, and Economic versus Normal Profit 3 ii. If TR = TC and P = ATC, in the short run the firm is _____________________________ .
Under Perfect Competition: In the long run, the firm is _________________________ .
In the long run, the number of firms in the industry will ______ .
In the long run, the price will _______________________ . iii. If TR < TC and P < ATC , in the short run the firm is _____________________________ .
Under Perfect Competition: In the long run, the firm is _________________________ .
In the long run, the number of firms in the industry will
______ .
In the long run, the price will _______________________ . d. The long run price of a competitive firm is _______________________________________ . e. The long run economic profit of a competitive firms is _______________________________ .
2. In the next two problems, use the cost data for Michael’s Oak Chair Factory from Chapter 4 to create the short run supply curve for the firm. Assume that Michael sells his chairs in a purely competitive market.
T
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F
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M
ICHAEL
’
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Output Total Total Total Marginal Average Average Average
Variable Fixed Costs Cost Variable Fixed Total
Cost Cost (TC) (MC) Cost Cost Cost
Q TVC TFC (TVC + TFC) (TC /

Q) (AVC/ Q) (AFC/ Q) (ATC/ Q)
0 Units $0 $160 $160
1 30 160 190
2 45
3 75
4 120
5 180
160
160
160
160
205
235
280
340
6 255
7 345
8 455
9 590
10 755
160
160
160
160
160
415
505
615
750
915
$30
15
30
45
60
75
90
110
135
165
$30.00
22.50
25.00
30.00
36.00
42.50
49.29
56.88
65.56
75.50
$160.00 $190.00
80.00 102.50
53.33
40.00
32.00
26.67
22.86
20.00
17.78
16.00
78.33
70.00
68.00
69.17
72.14
76.88
83.33
91.50 a. Determine the profit maximizing/loss minimizing output level for various possible prices by comparing the marginal revenue/price with the marginal cost. First, review some ideas from Chapter 5, which will help you determine where to begin your analysis. i. Would Michael ever stop production at a point, where the next unit costs less to produce than the last unit and the marginal cost is decreasing? _______________________________________ ii. At what point on the marginal cost curve, should you start your analysis? ________________________ iii. What occurs at this point? _____________________________________________________________

4 Chapter 5 b. Assume that the market price of the oak chairs is $90.
What is the profit maximizing/loss minimizing output for the firm if it produces in the short run? ______
Will the firm produce at this price? ____________________________________________
How many chairs will Michael actually produce in the short run? __________________________
The per-unit profit/loss is equal to (P - ATC).
If the firm produces, what is the per-unit profit or loss? ________________________________
The total revenue, TR, is equal to TR = (P

Q).
Estimate the total revenue, TR = _____________________________________________
The total profit/loss is equal to (TR – TC) or [Q

(P – ATC)].
Estimate Michael’s total profit or loss.
__________________________________________
Will the number of firms in this industry increase, decrease, or stay the same? _________________ c. Illustrate your results on the diagram below.
Draw in a marginal revenue line at the market price of $90 and label the line P .
Label the output level on the diagram Q .
At the output level, draw a line connecting the price, P , and the ATC to indicate the per-unit profit or loss.
Draw two horizontal lines from P and the ATC back to the y-axis to create a rectangle. The area of this rectangle represents the total profit or loss of the firm at the market price of $90.
(If the firm finds it necessary to shut down, simply draw in the marginal revenue line at the price below the
AVC, and mark the output level, Q, at zero.)
A PURELY COMPETITVE FIRM
Price = $90
$200
MC
$150
ATC
$100
$50
$0
0 2 4
Output
6 8
AVC
10

Perfect Competition, Monopoly, and Economic versus Normal Profit 5 d. Assume that the market price of the oak chairs has changed, and it is now $45.
If it produces in the short run, what is the profit maximizing/loss minimizing output for the firm? ______
Will the firm produce at this price? _____________________________________________
How many chairs will Michael actually produce in the short run? __________________________
If the firm produces, what is the per-unit profit or loss? ________________________________
Estimate the total revenue, TR = _____________________________________________
Estimate Michael’s total profit or loss. ___________________________________________
Will the number of firms in this industry increase, decrease, or stay the same? __________________ e. Draw in the MR line at the market price of $45. Label P and Q . If possible, illustrate the profit or loss.
A PURELY COMPETITVE FIRM
Price = $45
$200
MC
$150
ATC
$100
$50
AVC
$0
0 2 4
Output
6 8 10 f. Assume that the market price of the oak chairs is $15.
What is the profit maximizing/loss minimizing output for the firm if it produces in the short run? ______
Will the firm produce at this price? _____________________________________________
How many chairs will Michael actually produce in the short run? __________________________
If the firm produces, what is the per-unit profit or loss? ________________________________
Estimate the total revenue, TR =
_____________________________________________
Estimate Michael’s total profit or loss. __________________________________________
Will the number of firms in this industry increase, decrease, or stay the same? __________________

6 Chapter 5 g. Draw in the MR line at the market price of $15, label P and Q , and if possible, illustrate the profit or loss.
A PURELY COMPETITVE FIRM
Price = $15
$200
MC
$150
ATC
$100
AVC
$50
$0
0 2 4
Output
6 8 10 h. Apply the same analytical technique used above to complete the short run supply schedule for the firm and list in the table below.
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UPPLY
S
CHEDULE
F
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M
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HAIR
F
ACTORY
Price
P
Output
Q
Total Profit or Loss
(TR – TC) or Q (P – ATC)
$15 _______ ______
30
45
60
_______
_______
_______
______
______
______
75
90
110
_______
_______
_______
______
______
______
135 _______ ______
165 _______ ______
_____________________________________________________________________________________

Perfect Competition, Monopoly, and Economic versus Normal Profit 7 i. Highlight the portion of the marginal cost curve that coincides with the short run supply curve of
Michael’s Oak Chair Factory.
$200
FIRM'S SHORT RUN SUPPLY CURVE
MC
$150
ATC
$100
AVC
$50
$0
0 2 4
Output
6 8 10
3. Tom, Dick, and Harry own the only book store in a college town. Tom wants to sell as many books as possible without losing money. Dick wants the store to bring in as much revenue as possible. Harry wants to maximize the store’s profits. a. The intersection of what two lines/curves will determine each owner’s position on a graph? b. Under which owner’s strategy is the price the highest? lowest? c. Under which owner’s strategy is the output the highest? lowest?

8 Chapter 5
1.
A firm is earning an economic profit. a.
Therefore, it must be earning an accounting profit. b.
Therefore, it must be earning a normal profit. c.
Both a and b d.
There is insufficient information to determine the answer.
2.
If a perfectly competitive firm is experiencing an economic loss in the short run, a.
the number of firms in the industry will decrease, and the market price will increase. b.
the number of firms in the industry will increase, and the market price will decrease. c.
the number of firms in the industry will increase, and the market price will increase. d.
the number of firms in the industry will decrease, and the market price will decrease.
3.
If a perfectly competitive firm is earning an economic profit in the short run, a.
the number of firms in the industry will decrease, and the market price will increase. b.
the number of firms in the industry will increase, and the market price will decrease. c.
the number of firms in the industry will increase, and the market price will increase. d.
the number of firms in the industry will decrease, and the market price will decrease.
4.
A firm is earning a normal profit, but only a normal profit. a.
The firm is also earning an economic profit. b.
The firm could also be experiencing an economic loss. c.
The firm is breaking even, and it is earning zero economic profit. d. There is insufficient information to determine the answer.
5.
A firm will produce with an economic loss, when a.
(P < AVC) and (P < ATC). b.
(P < AVC) and (P > ATC). c.
(P > AVC) and (P > ATC). d. (P > AVC) and (P < ATC).
6.
A firm will produce with an economic profit, when a.
(P < AVC) and (P < ATC). b.
(P < AVC) and (P > ATC). c.
(P > AVC) and (P > ATC). d. (P > AVC) and (P < ATC).
7.
A firm will shut down, when a.
(P < AVC) and (P < ATC). b.
(P < AVC) and (P > ATC). c.
(P > AVC) and (P > ATC). d. (P > AVC) and (P < ATC).
8.
In the long run, the price of a product in a perfectly competitive market a.
will equal the minimum of the ATC. b.
will equal the minimum of the AVC. c.
will equal the minimum of the MC. d.
There is insufficient information to determine the answer.

Perfect Competition, Monopoly, and Economic versus Normal Profit 9
9.
The short run supply curve for the firm coincides with a.
the marginal cost curve above the minimum of the ATC. b.
the marginal cost curve above the minimum of the AVC. c.
the marginal cost curve above the minimum of the MC. d.
the entire marginal cost curve.
10.
Which of the following statements is correct? a.
A perfectly competitive firm can break even in the short run and earn an economic profit in the long run. b.
A perfectly competitive firm can experience an economic loss in the short run and long run. c.
A perfectly competitive firm can earn an economic profit in the short run and long run. d.
A monopolist can earn an economic profit in the short run and long run.
11.
Which of the following is not a characteristic of oligopoly? a.
Very few discernible competitors in the market. b.
Substantial barriers to entry. c.
Demand curve is perfectly elastic (horizontal). d.
Some firms sell heterogeneous products, some firms sell homogeneous products.
12.
Which of the following is not a characteristic of monopolistic competition? a.
Several firms in the industry. b.
Substantial barriers to entry. c.
Demand curve is downward sloping and very elastic. d.
Firms produce heterogeneous products, which are similar, but differentiated in some way from others.
13.
Which of the following statements about monopoly is true? a.
There is usually only one firm in the market, but the firm often has a few competitors. b.
Many industries can be analyzed by the monopoly model. c.
The firm faces a perfectly elastic (horizontal) demand curve. d.
If the market is unregulated, the firm has complete control over price by adjusting output level.
14.
Monopolies and oligopolies are similar in that a.
there are substantial barriers to entry that keep out competitors. b.
both have horizontal demand curves. c.
in each of these market structures there are several competitors. d.
both of these types of firms produce homogeneous products.
15.
Perfectly competitors and monopolistic competitors are different in that a.
perfectly competitive firms maximize profit and monopolistically competitive firms maximize sales. b.
both types of firms face a great deal of competition. c.
the demand curve of these firms are both perfectly inelastic. d.
products of the former are homogeneous, while that of the latter are differentiated.
16.
An oligopoly a.
has many competitors in the market. b.
has a perfectly inelastic demand curve. c.
sells only homogeneous products. d.
has substantial barriers to entry into the market, resulting in a small number of competitors.

10 Chapter 5
17.
Which of the following is an example of a long run adjustment? a.
A firm doubles the size of its plant. b.
Because of an increase in orders, a firm adds on a second shift of workers. c.
During the summer a firm hires fifty students. d.
A farm orders three times its usual amount of fertilizer in anticipation of a strike by delivery service people.
18.
Which of the following is an example of a short-run adjustment? a.
A hospital adds a new cancer-treatment wing. b.
A firms closes down only its unprofitable manufacturing plant, but continues operating its profitable lines. c.
The Economics Department hires two student aides. d.
The local real estate office acquires the 2,000 square foot office next door.
19.
Which of the following is correct? a.
McDonald’s is an example of a firm in an monopoly market. b.
Coca-Cola is an example of a firm in an oligopoly market. c.
Laundromats are examples of firms in perfectly competitive markets. d.
General Motors is an example of a monopolistic competitor.
20.
Which of the following is correct? a.
The demand curve for a monopoly is upward sloping, and the marginal revenue curve is upward sloping and to the left of it. b.
The demand curve of a perfectly competitive firm is infinitely inelastic and the supply curve is also inelastic. c.
The demand curve of a perfectly competitive firm is infinitely elastic and the marginal revenue is downward sloping. d.
The supply curve of a perfectly competitive firm is the marginal cost curve.
21. What aspect of a competitive market makes it “perfectly” competitive? a. Every firm charges a different price. b. Every firm charges the same price. c. No one firm has any influence on market price. d. There is more than one firm in the market.
22. What aspect of a monopoly tends to frustrate consumers the most? a. Lack of variety in products. b. Too much variety in products. c. The profits earned by the monopolist. d. The lower quantity of output produced.

Perfect Competition, Monopoly, and Economic versus Normal Profit 11
T F 1. In the short run there is sufficient time to build a new factory.
T F 2. Under monopolistic competition there is only one firm in the industry.
T F 3. Competition will eliminate economic profits or losses in the long run for any firm that is in a perfectly competitive market.
T F 4. If the firm’s economic profit equals zero, its normal profit must also be zero.
T F 5. Under perfect competition the price and the marginal revenue are equal.
T F 6. The supply curve of a perfectly competitive firm is also the marginal cost curve above the minimum average variable cost curve.
T F 7. A pure monopoly usually makes profits by setting MR > MC.
T F 8. The clothing industry is a good example of an oligopoly.
T F 9. Oligopolies and monopolistic competitive industries produce differentiated products.
T F 10. Most firms can vary both fixed and variable inputs in the short run.

12 Chapter 5
1 . a. More; this quantity; less b. Shut down; produce c. i. earning a profit; increase; decrease; breaking even ii. breaking even; stay the same; stay the same; breaking even iii. taking a loss; decrease; increase; breaking even d. Equal to the ATC at the minimum of the ATC e. Zero.
2. a. i. No ii. At the minimum of the MC iii. Diminishing returns set in at the minimum of the MC b. 7
Yes, since P> AVC. $90 > $49.29
7
Per-Unit profit = (P – ATC) = 9 0 – 72.14 = $17.86
TR = (P

Q) = 90

7 = $630
Profit = (TR – TC) = (630 – 505) = $125 or Profit = Q (P – ATC) = 7 (17.86) = $125.02
(The difference in the two profit calculations is due to rounding error.)
Increase c.
A PURELY COMPETITIVE FIRM
Price = $90
$200
MC
$150
MR
P
$100
/ / / PROFIT / / / / / / / / / / / / / ATC
$50 AVC
$0
0 2 4
Output d. 4
Yes, since P > AVC. $45 > $30
4
Per-Unit profit = (P – ATC) = (45 – 70.00) = $-25.00
6
Q
8 10

Perfect Competition, Monopoly, and Economic versus Normal Profit 13 e.
TR = (P

Q) = (45

4) = $180
Loss = (TR – TC) = (180 – 280) = $-100 or Loss = Q (P – ATC) = 4 (-25.00) = $-100.00
Decrease
A PURELY COMPETITIVE FIRM
Price = $45
$200
MC
$150
$100
ATC
/ / / / LOSS/ / / / / /
P
$50
AVC
$0
0 2 4
Q
Output
6 8 f. 2
No, firm will shut down, since P < AVC. $15 < $22.50
Zero
Not applicable
TR = (P

Q) = (15

0) = $0
Loss = (TR – TC) = (0 – 160) = $-160 or Loss = (- Fixed Cost ) = $-160.
Decrease g.
MR
10
A PURELY COMPETITIVE FIRM
Price = $15
$200
MC
$150
ATC
$100
$50
P
$0
0
Q
2 4
Output
6
AVC
8
MR
10

14 Chapter 5 h.
T
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HORT
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UPPLY
S
CHEDULE
F
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M
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C
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F
ACTORY
Price
P
Output
Q
Total Profit or Loss
(TR – TC) or Q (P – ATC)
$15
30
45
60
0
3
4
5
$-160
-145
-100
-40 i.
75
90
110
135
6
7
8
9
35
125
265
465
165 10 735
_____________________________________________________________________________________________________________________
FIRM'S SHORT RUN SUPPLY CURVE
$200
$150
SR Supply
$100
ATC
AVC
$50
MC
$0
0 2 4
Output
6 8
3. a. Tom’s position is where the ATC curve intersects the firm’s AV or demand curve.
Dick’s position is where the MR curve intersects the quantity axis.
Harry’s position is where the MR intersects the MC curve. b. The price is highest under Harry’s strategy and lowest under Tom’s strategy. c. The output is highest under Tom’s strategy and lowest under Harry’s strategy.
1. C
2. A
3. B
4. C
5. D
6. C
7. A
8. A
9. B
10. D
11. C
12. B
13. D
14. A
15. D
16. D
17. A
18. C
19. B
20. D
21. C
22. A
10

1. F
2. F
3. T
4. F
5. T
6. T
7. F
8. F
9. T
10. F
Perfect Competition, Monopoly, and Economic versus Normal Profit 15