Download Document

CHAPTER 8
Perfect competition and pure monopoly
©McGraw-Hill Education, 2014
Perfect competition
Characteristics of a perfectly competitive market:
• many buyers and sellers
– so no individual believes that their own action
can affect market price
• firms take price as given
– so face a horizontal demand curve
• the product is homogeneous
• perfect customer information
• free entry and exit of firms
©McGraw-Hill Education, 2014
The supply curve under perfect
competition (1)
£
• Above price P3 (point
C), the firm makes profit
above the opportunity
cost of capital in the
short run
• At price P3, (point C),
the firm makes NORMAL
PROFITS
C
P3
P1
A
Q1 Q3
Output
©McGraw-Hill Education, 2014
The supply curve under perfect
competition (2)
£
• Between P1 and P3, (A
and C), the firm makes
short-run losses, but
remains in the market
C
P3
P1
A
Q1 Q3
Output
• Below P1 (the SHUTDOWN PRICE), the firm
fails to cover SAVC, and
exits the market
©McGraw-Hill Education, 2014
The supply curve under perfect
competition (3)
£
SMC
C
P3
P1
– showing how much the
firm would produce at
each price level.
A
Q1 Q3
• So the SMC curve
above SAVC represents
the firm’s SHORT-RUN
SUPPLY CURVE
Output
©McGraw-Hill Education, 2014
The firm and the industry in the short
run under perfect competition (1)
£
P
Firm
£
D=MR=AR
INDUSTRY
P
D
Output
Q
Output
Market price is set at industry level at the intersection of demand
and supply. The industry supply curve is the sum of the individual
firm’s supply curves.
©McGraw-Hill Education, 2014
The firm and the industry in the short
run under perfect competition (2)
FIRM
INDUSTRY
£
£
P
P
q
Output
Q
Output
The firm accepts price as given at P and chooses output at q
where SMC=MR to maximize profits.
©McGraw-Hill Education, 2014
Long-run equilibrium
FIRM
£
INDUSTRY
LMC
LAC
£
SRSS
LRSS
P*
P*
D=MR=AR
D
q*
Output
Q
Output
The market settles in long-run equilibrium when the typical firm just
makes normal profit by setting LMC=MR at the minimum point of LAC.
Long-run industry supply is horizontal.
If the expansion of the industry pushes up input prices (e.g. wages) the
long-run supply curve will not be horizontal, but upward-sloping.
©McGraw-Hill Education, 2014
Adjustment to an increase in
market demand: the short run
£
D
D'
Suppose a perfectly
competitive market starts
in equilibrium at P0Q0.
SRSS
If market demand shifts to
D'D'…
P1
…in the short run the new
equilibrium is P1Q1 .
P0
D'
D
Q0 Q 1
Adjustment is through
expansion of individual
firms along their SMCs.
Output
©McGraw-Hill Education, 2014
Adjustment to an increase in market
demand: the long run
£
D
D'
In the long run, new firms are
attracted by the supernormal
Profits now being made here –
and firms are able to adjust
their input of fixed factors.
SRSS
P1
P2
P0
LRSS
D
Q0 Q 1 Q 2
D'
If wages are bid up by this
expansion, the long-run
supply schedule is upwardsloping
– and the market finally
settles at P2Q2.
Output
©McGraw-Hill Education, 2014
Monopoly
• A monopolist
– is the sole supplier of an industry’s product and
the only potential supplier
– is protected by some form of barrier to entry
– faces the market demand curve directly.
– Unlike under perfect competition, MR is always
below AR.
©McGraw-Hill Education, 2014
Profit maximization by a monopolist
Profits are maximized
where MC = MR at Q1P1.
£
MC
AC
P1
MR
Q1
D = AR
Output
©McGraw-Hill Education, 2014
In this position, AR is
greater than AC
so the firm makes
monopoly profits
shown by the shaded area.
Entry barriers prevent
new firms joining the
industry.
Comparing monopoly with perfect
competition (1)
Suppose a competitive industry is taken over by a monopolist:
£
SRSS
P2
Competitive equilibrium
is at A, with output Q1
and price P1.
A
P1
MR
Q2
Q1
D
Output
The monopolist
maximizes profits in the
short run at MR = SMC
at P2Q2.
©McGraw-Hill Education, 2014
Comparing monopoly with perfect
competition (2)
Suppose a competitive industry is taken over by a monopolist.
£
SRSS
P3
P2
to set MR = LMC
A
P1
In the long run the
firm can adjust
other inputs ...
And priceat P3Q3.
Q3 Q 2
Q1
Output
©McGraw-Hill Education, 2014
Comparing monopoly with perfect
competition (3)
• So we see that monopoly compared with perfect competition
implies:
– higher price
– lower output
• Does the consumer always lose from monopoly?
– Among other things, this depends on whether the
monopolist faces the same cost structure.
– there may be the possibility of economies of scale.
©McGraw-Hill Education, 2014
A natural monopoly
• This firm enjoys substantial
economies of scale
relative to market
demand
£
• LAC declines right up to
market demand
P1
D
Q1
• the largest firm always
enjoys cost leadership
LMC
• and comes to dominate
LAC
the industry
Output
• It is a NATURAL
MONOPOLY.
©McGraw-Hill Education, 2014
Discriminating monopoly
• Suppose a monopolist supplies two separate
groups of customers
– with differing elasticities of demand
– e.g. business travellers may be less sensitive to
air fare levels than tourists.
• The monopolist may increase profits by charging
higher prices to the businessmen than to tourists.
• Discrimination is more likely to be possible for
goods that cannot be resold
– e.g. dental treatment.
©McGraw-Hill Education, 2014
Concluding comments (1)
• In a competitive market each buyer and seller is
a price taker.
• For a firm operating in a perfectly competitive
market its price is equal to marginal revenue.
• Adding at each price the quantities supplied by
each firm, we obtain the industry supply curve.
• In long-run equilibrium, the marginal firm makes
only normal profits.
• A profit-maximizing monopolist will select the
level output at which marginal revenue and cost
are equal.
©McGraw-Hill Education, 2014
Concluding comments (2)
• Compared to a perfectly competitive market, a
monopoly creates a deadweight loss.
• A discriminating monopolist charges different
prices to different customers.
©McGraw-Hill Education, 2014