Perfect Competition and Monopoly

1. Perfect Competitionand Monopoly

2. Perfect Competition and Monopoly Alternative Market Structures

3. Alternative market structures • Classifying markets by degree of competition • number of firms • freedom of entry to industry • nature of product • nature of demand curve • The four market structures • perfect competition • monopoly • monopolistic competition • oligopoly

4. Features of the four market structures

5. Features of the four market structures

6. Features of the four market structures

7. Features of the four market structures

8. Features of the four market structures

9. Features of the four market structures

10. Features of the four market structures

11. Alternative market structures • Classifying markets by degree of competition • number of firms • freedom of entry to industry • nature of product • nature of demand curve • The four market structures • perfect competition • monopoly • monopolistic competition • oligopoly • Structure  conduct  performance

12. Perfect Competition and Monopoly Perfect Competition

13. Perfect competition • Assumptions • firms are price takers • freedom of entry • identical products • perfect knowledge • Short-run equilibrium of the firm • P = MC • possible supernormal profits

14. Short-run equilibrium of industry and firmunder perfect competition £ MC AC S D = AR Pe AR = MR AC D O Q (thousands) (b) Firm Firm is a price taker. Price is given by the market. P O Qe Q (millions) (a) Industry

15. Perfect competition • Assumptions • firms are price takers • freedom of entry • identical products • perfect knowledge • Short-run equilibrium of the firm • P = MC • possible supernormal profits • possible short-run loss

16. Loss minimising under perfect competition AC MC AC D1 = AR1 P1 AR1 = MR1 Qe Loss is minimised where MC = MR. P £ S D O O Q (thousands) Q (millions) (a) Industry (b) Firm

17. Perfect competition • Assumptions • firms are price takers • freedom of entry • identical products • perfect knowledge • Short-run equilibrium of the firm • P = MC • possible supernormal profits • possible short-run loss • short-run supply curve of firm

18. Deriving the short-run supply curve S MC a P1 b P2 c P3 D1 D2 D3 P £ = S D1 = MR1 D2 = MR2 D3 = MR3 O O Q (thousands) Q (millions) (a) Industry (b) Firm

19. Perfect competition • Short-run supply curve of industry • Long-run equilibrium of the firm • all supernormal profits competed away

20. Long-run equilibrium under perfect competition S1 Se LRAC P1 AR1 D1 PL ARL DL D Profits return to normal Supernormal profits New firms enter P £ O O QL Q (thousands) Q (millions) (a) Industry (b) Firm

21. Long-run equilibrium under perfect competition (SR)MC (SR)AC LRAC DL AR = MR LRAC = (SR)AC = (SR)MC =MR= AR £ O Q

22. Perfect competition • Short-run supply curve of industry • Long-run equilibrium of the firm • all supernormal profits competed away • Long-run industry supply curve • effect of external economies and diseconomies on the shape of the curve

23. Various long-run industry supply curves under perfect competition S2 b c a Long-run S D2 S1 P D1 O Q (a) Constant industry costs

24. Various long-run industry supply curves under perfect competition S2 b Long-run S c D2 P S1 a D1 O Q (b) Increasing industry costs: external diseconomies of scale

25. Various long-run industry supply curves under perfect competition S2 b c Long-run S D2 P S1 a D1 O Q (c) Decreasing industry costs: external economies of scale

26. Perfect competition • Short-run supply curve of industry • Long-run equilibrium of the firm • all supernormal profits competed away • long-run industry supply curve • effect of external economies and diseconomies on the shape of the curve • Incompatibility of economies of scale with perfect competition

27. Perfect competition • Advantages of perfect competition • P = MC • production at minimum AC • only normal profits in long run • responsive to consumer wishes: consumer sovereignty • competition  efficiency • no point in advertising

28. Perfect competition • Disadvantages of perfect competition • insufficient profits for investment • lack of product variety • lack of competition over product design and specification

29. Perfect Competition and Monopoly Monopoly

30. Monopoly • Defining monopoly • Barriers to entry • economies of scale • product differentiation and brand loyalty • lower costs for an established firm • ownership or control over key factors • ownership or control over outlets • legal restrictions • mergers and takeovers • aggressive tactics • intimidation • Natural monopoly

31. Natural monopoly A monopoly can make supernormal profits between a and b. a b LRAC D1 D2 £ Two firms sharing the market will both make less than normal profit. O Q

32. Monopoly • The monopolist's demand curve • downward sloping • MR below AR

33. Average and marginal revenue under monopoly £ AR MR O Q

34. Monopoly • The monopolist's demand curve • downward sloping • MR below AR • Equilibrium price and output • output where MC = MR

35. Profit maximising under monopoly MC MR £ Profit maximised at output of Qm (where MC = MR) Qm O Q

36. Monopoly • The monopolist's demand curve • downward sloping • MR below AR • Equilibrium price and output • output where MC = MR • price given by demand (AR) curve

37. Profit maximising under monopoly Total profit AC AR AC AR £ MC MR Qm O Q

38. Monopoly • The monopolist's demand curve • downward sloping • MR below AR • Equilibrium price and output • output where MC = MR • price given by demand (AR) curve • Limit pricing

39. Limit pricing ACnew entrant PL AC monopolist £ Provided price is kept below the limit price (PL), new firms cannot make a profit. O Q

40. Monopoly • Disadvantages of monopoly • high prices / low output: short run

41. Equilibrium of industry under perfect competitionand monopoly: with the same MC curve MC AR = D MR £ Monopoly P1 Q1 O Q

42. Equilibrium of industry under perfect competitionand monopoly: with the same MC curve P2 £ MC ( = supply under perfect competition) Comparison with Perfect competition P1 AR = D MR Q1 Q2 O Q

43. Monopoly • Disadvantages of monopoly • high prices / low output: short run • high prices / low output: long run • lack of incentive to innovate • X-inefficiency • Advantages of monopoly • economies of scale

44. Equilibrium of industry under perfect competitionand monopoly: with different MC curves £ MCmonopoly P1 AR = D MR O Q1 Q

45. Equilibrium of industry under perfect competitionand monopoly: with different MC curves MC ( = supply)perfect competition £ MCmonopoly Higher price (P2) under perfect competition P2 P1 x … as long as MCmonopoly is below point x AR = D MR Q2 O Q1 Q

46. Equilibrium of industry under perfect competitionand monopoly: with different MC curves MC ( = supply)perfect competition £ MCmonopoly P2 Monopoly could produce at even lower price by producing where MC = P. P1 x P3 AR = D MR Q2 Q3 O Q1 Q

47. Monopoly • Disadvantages of monopoly • high prices / low output: short run • high prices / low output: long run • lack of incentive to innovate • X-inefficiency • Advantages of monopoly • economies of scale • profits can be used for investment • promise of high profits encourages risk taking

48. Perfect Competition and Monopoly Contestable Markets

49. Contestable markets • Importance of potential competition • low entry costs • low exit costs • Perfectly contestable markets

50. A contestable monopoly a £ P1 LRAC D = AR Q1 O Q