Transcript Chapter 9 Perfect competition and monopoly

Chapter 8
Perfect competition and pure monopoly
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
8th Edition, McGraw-Hill, 2005
PowerPoint presentation by Alex Tackie and Damian Ward
©The McGraw-Hill Companies, 2005
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
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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
SMC
P3
P1
C
SATC
SAVC
A
Q1 Q3
Output
2
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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
£
SMC
P3
P1
C
• Below P1 (the SHUTDOWN PRICE), the firm
fails to cover SAVC, and
exits
SATC
SAVC
A
Q1 Q3
Output
3
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The supply curve under perfect competition (3)
£
• So the SMC curve above
SAVC represents the
firm’s SHORT-RUN
SUPPLY CURVE
– showing how much the
firm would produce at
each price level.
SMC
P3
P1
C
SATC
SAVC
A
Q1 Q3
Output
4
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The firm and the industry in the short run under
perfect competition (1)
Firm
INDUSTRY
SMC
£
£
SRSS
SAC
P
P
D=MR=AR
D
q
Output
Q
5
Output
©The McGraw-Hill Companies, 2005
The firm and the industry in the short run under
perfect competition (1)
Firm
INDUSTRY
SMC
£
£
SRSS
SAC
P
P
D=MR=AR
D
q
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
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The firm and the industry in the short run under
perfect competition (2)
Firm
INDUSTRY
SMC
£
£
SRSS
SAC
P
P
D=MR=AR
D
q
Output
Q
Output
The firm accepts price as given at P
– and chooses output at q where SMC=MR to maximise profits
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The firm and the industry in the short run under
perfect competition (3)
Firm
INDUSTRY
£
£
SRSS
SMC
SRSS1
SAC
P
D=MR=AR P
1
P
D
q
Q Q1
Output
Output
At this price, profits are shown by the shaded area.
These profits attract new entrants into the industry.
As more firms join the market, the industry supply curve shifts
to the right, and market price falls.
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Long-run equilibrium
Firm
INDUSTRY
LMC
£
LAC
£
SRSS
LRSS
P*
P*
D=MR=AR
D
Q
Output
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.
q*
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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
Q0 Q1
– adjustment is through
expansion of individual
firms along their SMCs.
D'
Output
10
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Adjustment to an increase in market demand:
the long run
£
D
D'
SRSS
P1
P2
P0
LRSS
D
Q0 Q1 Q 2
D'
In the long run, new firms
are attracted by the profits
now being made here
– and firms are able to
adjust their input of fixed
factors
If wages are bid up by this
expansion, the long-run
supply schedule is upwardsloping
– and the market finally
settles at P2Q2.
Output
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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.
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Profit maximisation by a monopolist
£
MC
AC
P1
MR
MC=MR
Q1
D = AR
Profits are maximised
where MC = MR at Q1P1.
In this position, AR is
greater than AC
so the firm makes
profits above the
opportunity cost of
capital shown by the
shaded area.
Entry barriers prevent
new firms joining the
industry.
Output
13
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Comparing monopoly with perfect
competition (1)
Suppose a competitive industry is taken over by a monopolist:
SRSS =SMC
£
P2
A
P1
LRSS
= LMC
MR
Q2
Q1
D
Output
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Competitive equilibrium
is at A, with output Q1
and price P1.
To the monopolist, LRSS
is the LMC curve, and
SRSS is the SMC curve.
The monopolist
maximises profits in the
short run at MR = SMC
at P2Q2.
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Comparing monopoly with perfect
competition (2)
Suppose a competitive industry is taken over by a monopolist:
£
SRSS
=SMC
P3
P2
A
P1
LRSS
= LMC
MR
Q3 Q2
Q1
In the long run the
firm can adjust
other inputs ...
to set MR = LMC
at P3Q3.
D
Output
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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.
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A natural monopoly
• This firm enjoys
substantial economies of
scale relative to market
demand
£
• LAC declines right up to
market demand
P1
LMC
LAC
MR
Q1
D
Output
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• the largest firm always
enjoys cost leadership
• and comes to dominate
the industry
• It is a NATURAL
MONOPOLY.
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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.
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