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Profit Maximisation under Perfect Competition and Monopoly

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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Profit Maximisation under Perfect Competition and Monopoly

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  1. Profit Maximisation under Perfect Competition and Monopoly

  2. 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

  3. Alternative Market Structures • 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. Alternative Market Structures • The four market structures • perfect competition • monopoly • monopolistic competition • oligopoly • Structure  conduct  performance

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. Perfect Competition • The long run • long-run equilibrium of the firm • all supernormal profits competed away

  18. 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

  19. Perfect Competition • The long run • long-run equilibrium of the firm • all supernormal profits competed away • LRAC = AC = MC = MR = AR

  20. 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

  21. 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

  22. 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

  23. 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?

  24. Monopoly • Defining monopoly • importance of market power • concentration ratios

  25. Concentration ratios in the UK

  26. 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

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

  28. 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

  29. 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

  30. Monopoly • Equilibrium price and output • MC = MR

  31. Profit maximising under monopoly MC MR £ Qm O Q

  32. Monopoly • Equilibrium price and output • MC = MR • measuring level of supernormal profit

  33. Profit maximising under monopoly MC MR £ Qm O Q

  34. Profit maximising under monopoly AC AR AC AR £ MC MR Qm O Q

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

  36. Monopoly • Equilibrium price and output • MC = MR • measuring level of supernormal profit • Monopoly versus perfect competition

  37. Monopoly • Equilibrium price and output • MC = MR • measuring level of supernormal profit • Monopoly versus perfect competition • lower output at a higher price

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

  39. 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

  40. 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

  41. 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

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

  43. 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

  44. 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

  45. 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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