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Chapter 6
The Two
Extremes: Perfect
Competition and
Pure Monopoly
Learning Objectives
• List the four characteristics of a perfectly
competitive market.
• Describe how a perfect competitor makes the
decision to stay in business or to go out of
business.
• List the characteristics of monopoly.
• Explain the difference between marginal
revenue for a perfect competitor and
marginal revenue for a pure monopolist.
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6-2
Market Structures
• Market structure relates to the number,
size, and interaction of firms in a
particular market.
• One extreme market structure is
perfect competition, when there are
literally thousands of sellers.
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6-3
Market Structures (cont.)
• At the other extreme is pure monopoly,
when there is only one seller of a good
for which there are no close substitutes.
• In between, there are varying degrees
of what is called imperfect competition
(duopoly, oligopoly, and monopolistic
competition).
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6-4
Characteristics of a Perfectly
Competitive Market
• There are a very large number of
relatively small buyers and sellers.
• The product sold by each seller is
virtually identical to the product sold by
other sellers.
• Firms can easily enter or exit the
industry.
• Everybody involved has good
information about price and product
qualities.
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6-5
Demand Curve Faced by
a Perfect Competitor
• A perfect competitor is a price taker.
• He takes the prices determined by
market forces. Therefore, the demand
curve faced by the individual firm in this
market is perfectly elastic.
• This means that customers will buy all
that any individual firm might want to
produce at the going market price and
none at a higher price.
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6-6
Figure 6-2: Demand Curve Facing
the Perfect Competitor
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How Much Should You Produce?
• The decision on how much to produce
is similar to all decisions in economics.
Never do anything past the point at
which marginal benefit equals marginal
cost.
• A perfect competitor produces up to the
point at which marginal benefit equals
marginal cost, or the point at which the
price per unit equals marginal cost.
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6-8
Profit Maximization
• This decision-making process is really one in
which the perfect competitor maximizes
profits.
• If the perfect competitor produced a larger
quantity, marginal costs would exceed the
price per unit.
• If the firm stops producing before marginal
benefit equals marginal cost, then it is
forgoing potential profits on additional units of
output.
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6-9
Marginal Revenue
• Marginal benefit here refers to the firm’s
marginal revenue, defined as the change in
total revenues when there is a one-unit
change in production and sales.
Change in total revenues
Marginal revenue =
Change in output
• Marginal revenue is equal to unit price at all
rates of output for perfect competitors.
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6-10
Figure 6-3: The Perfect Competitor
Determines How Much to Produce
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6-11
Maximizing Profits
• Profit maximization occurs at the rate of
output at which marginal revenue
equals marginal cost.
• For a perfectly competitive firm, this is
at the intersection of the demand
schedule, d, and the marginal cost
curve, MC. As was seen in Figure 6-3.
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6-12
Figure 6-4: Showing Short-Run
Economic Profits
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6-13
When Should a Perfect Competitor
Shutdown?
• Whenever a perfect competitor is
sustaining economic losses in the short
run, it must compare the cost of
producing, while incurring these losses,
with the cost of shutting down.
• Whenever total revenues exceed total
variable costs, the perfect competitor
should still keep production going.
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6-14
Perfect Competitors Generally
Make Zero Economic Profits
• In the short run, even in a perfectly
competitive industry, an individual firm
might make positive economic profits.
• These profits tend to disappear in the
long run. That is, in the long run,
because of so much competition, those
who remain in a perfectly competitive
industry end up making zero economic
profits.
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6-15
Pure Monopoly
• A pure monopoly is a market with a
sole producer of a specific good or
service for which there are no close
substitutes and, no competitors.
• By definition, the pure monopolist is the
entire industry. Therefore, this firm faces
the entire market demand curve.
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6-16
Types of Monopolies
1. Natural Monopoly: usually arises
when there are large economies of
scale relative to the market demand,
such that one firm can produce at a
lower average cost than can be
achieved by multiple firms.
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Types of Monopolies
2. Technological Monopoly: Someone
who invents something that allows for
the creation of a unique product often
has a technological monopoly.
Normally, the government provides a
patent that gives the creator exclusive
right to manufacture, rent, or sell that
invention for 20 years.
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Types of Monopolies
3. Government Monopoly:
Governments—federal, state, and
local—often create their own
monopolies. That is, they decide that
no one else but them lawfully may
provide the production of a good or
service.
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Barriers to Entry
• For any amount of monopoly power to
continue to exist in the long run, the
market must be closed to entry in some
way.
• Two of the barriers to entry that have
allowed firms to reap monopoly profits
in the long run are:
– Ownership of Resources
– Government Regulations.
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6-20
What Kind of Demand Curve Does
the Monopolist Face?
• A pure monopolist is the sole supplier of
one product, good, or service.
• It represents the entire industry.
• Consequently, a pure monopolist faces
a demand curve that is the one for the
entire market. This is a downward
sloping demand curve.
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6-21
Marginal Revenue for the
Monopolist
• Because a pure monopolist faces the
market downward-sloping demand
curve, it can only sell more by charging
less for all units sold. Consequently, for
a pure monopolist, marginal revenue
is always less than price.
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How the Monopolist Maximizes
Profits
• A monopolist always produces at that
rate at which marginal revenue equals
marginal cost.
• However, for the monopolist, marginal
revenue is always less than price.
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6-23
Why Monopolies Are Considered
“Bad”
• Competition leads to lower prices.
• Monopoly, in contrast, implies no
competition. The result, then, is that
monopolists tend to charge higher
prices than would competitors, if they
existed.
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6-24
Key Terms and Concepts
• barriers to entry
• economies of scale
• government
monopoly
• marginal revenue
• market structure
• natural monopolies
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patent
perfect competition
price setter
price taker
pure monopoly
technological
monopoly
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