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Profit Maximisation under Perfect Competition and Monopoly

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Alternative Market Structures - PowerPoint PPT Presentation


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Profit Maximisation under Perfect Competition and Monopoly Alternative Market Structures Classifying markets (by degree of competition) number of firms freedom of entry to industry free, restricted or blocked? nature of product homogeneous or differentiated? nature of demand curve

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alternative market structures
Alternative Market Structures
  • Classifying markets (by degree of competition)
    • number of firms
    • freedom of entry to industry
      • free, restricted or blocked?
    • nature of product
      • homogeneous or differentiated?
    • nature of demand curve
      • degree of control the firm has over price
alternative market structures3
Alternative Market Structures
  • The four market structures
    • perfect competition
    • monopoly
    • monopolistic competition
    • oligopoly
alternative market structures10
Alternative Market Structures
  • The four market structures
    • perfect competition
    • monopoly
    • monopolistic competition
    • oligopoly
  • Structure  conduct  performance
perfect competition
Perfect Competition
  • Assumptions
    • firms are price takers
    • freedom of entry of firms to industry
    • identical products
    • perfect knowledge
  • Distinction between short and long run
    • normal profits
    • supernormal profits
perfect competition12
Perfect Competition
  • Short-run equilibrium of the firm
    • Price
      • given by market demand and supply
    • Output
      • where P = MC
    • Profit
      • (AR – AC) × Q
      • possible supernormal profits
short run equilibrium of industry and firm under perfect competition
Short-run equilibrium of industry and firm under perfect competition

MC

AC

S

D = AR

Pe

AR

= MR

AC

D

P

£

O

O

Qe

Q (thousands)

Q (millions)

(a) Industry

(b) Firm

loss minimising under perfect competition
Loss minimising under perfect competition

AC

MC

AC

D1 = AR1

P1

AR1

= MR1

Qe

P

£

S

D

O

O

Q (thousands)

Q (millions)

(a) Industry

(b) Firm

short run shut down point
Short-run shut-down point

AVC

D2 = AR2

P2

AR2

= MR2

D2

P

£

AC

MC

S

O

O

Q (thousands)

Q (millions)

(a) Industry

(b) Firm

perfect competition16
Perfect Competition
  • Short-run equilibrium of the firm (cont.)
    • short-run supply curve of firm
      • the MC curve
  • Short-run supply curve of industry
    • sum of supply curves of firms
perfect competition17
Perfect Competition
  • The long run
    • long-run equilibrium of the firm
      • all supernormal profits competed away
long run equilibrium under perfect competition
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

perfect competition19
Perfect Competition
  • The long run
    • long-run equilibrium of the firm
      • all supernormal profits competed away
      • LRAC = AC = MC = MR = AR
long run equilibrium of the firm under perfect competition
Long-run equilibrium of the firm under perfect competition

(SR)MC

(SR)AC

LRAC

DL

AR = MR

LRAC = (SR)AC = (SR)MC =MR= AR

£

O

Q

perfect competition21
Perfect Competition
  • The long run
    • long-run equilibrium of the firm
      • all supernormal profits competed away
      • LRAC = AC = MC = MR = AR
    • long-run industry supply curve
perfect competition22
Perfect Competition
  • The long run
    • long-run equilibrium of the firm
      • all supernormal profits competed away
      • LRAC = AC = MC = MR = AR
    • long-run industry supply curve
    • incompatibility of economies of scale with perfect competition
perfect competition23
Perfect Competition
  • The long run
    • long-run equilibrium of the firm
      • all supernormal profits competed away
      • LRAC = AC = MC = MR = AR
    • long-run industry supply curve
    • incompatibility of economies of scale with perfect competition
  • Does the firm benefit from operating under perfect competition?
monopoly
Monopoly
  • Defining monopoly
    • importance of market power
    • concentration ratios
monopoly26
Monopoly
  • Barriers to entry
    • economies of scale
    • product differentiation and brand loyalty
    • lower costs for an established firm
    • ownership/control of key factors or outlets
    • legal protection
    • mergers and takeovers
    • aggressive tactics
monopoly27
Monopoly
  • The monopolist\'s demand curve
    • downward sloping
    • MR below AR
ar and mr curves for a monopoly
AR and MR curves for a monopoly

Q

(units)

P =AR

(£)

8

7

6

5

4

3

2

1

2

3

4

5

6

7

AR, MR (£)

AR

Quantity

ar and mr curves for a monopoly29
AR and MR curves for a monopoly

Q

(units)

TR

(£)

MR

(£)

P =AR

(£)

8

7

6

5

4

3

2

8

14

18

20

20

18

14

1

2

3

4

5

6

7

6

4

2

0

-2

-4

AR, MR (£)

AR

Quantity

MR

monopoly30
Monopoly
  • Equilibrium price and output
    • MC = MR
monopoly32
Monopoly
  • Equilibrium price and output
    • MC = MR
    • measuring level of supernormal profit
profit maximising under monopoly34
Profit maximising under monopoly

AC

AR

AC

AR

£

MC

MR

Qm

O

Q

profit maximising under monopoly35
Profit maximising under monopoly

Total profit

AC

AR

£

MC

AR

AC

MR

Qm

O

Q

monopoly36
Monopoly
  • Equilibrium price and output
    • MC = MR
    • measuring level of supernormal profit
  • Monopoly versus perfect competition
monopoly37
Monopoly
  • Equilibrium price and output
    • MC = MR
    • measuring level of supernormal profit
  • Monopoly versus perfect competition
    • lower output at a higher price
equilibrium of industry under perfect competition and monopoly with the same mc curve
Equilibrium of industry under perfect competition and monopoly: with the same MC curve

MC

AR = D

MR

£

Monopoly

P1

Q1

O

Q

equilibrium of industry under perfect competition and monopoly with the same mc curve39
Equilibrium of industry under perfect competition and monopoly: with the same MC curve

P2

£

MC ( = supply under

perfect competition)

Comparison with

Perfect competition

P1

AR = D

MR

Q1

Q2

O

Q

monopoly40
Monopoly
  • Equilibrium price and output
    • MC = MR
    • measuring level of supernormal profit
  • Monopoly versus perfect competition
    • lower output at a higher price
      • short run and long run
monopoly41
Monopoly
  • Equilibrium price and output
    • MC = MR
    • measuring level of supernormal profit
  • Monopoly versus perfect competition
    • lower output at a higher price
      • short run and long run
    • costs under monopoly
equilibrium of industry under perfect competition and monopoly with different mc curves
Equilibrium of industry under perfect competition and monopoly: with different MC curves

£

MCmonopoly

P1

AR = D

MR

O

Q1

Q

equilibrium of industry under perfect competition and monopoly with different mc curves43
Equilibrium of industry under perfect competition and monopoly: with different MC curves

MC ( = supply)perfect competition

£

MCmonopoly

P2

P1

x

P3

AR = D

MR

Q2

Q3

O

Q1

Q

monopoly44
Monopoly
  • Equilibrium price and output
    • MC = MR
    • measuring level of supernormal profit
  • Monopoly versus perfect competition
    • lower output at a higher price
      • short run and long run
    • costs under monopoly
    • innovation and new products
contestable markets
Contestable Markets
  • Importance of potential competition
    • low entry costs
    • low exit costs
  • Perfectly contestable markets
  • Contestable markets & natural monopolies
  • The importance of costless exit
    • absence of sunk costs
    • hit-and-run competition
  • Assessment of the theory
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