Profit Maximisation under Perfect Competition
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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 l.jpg
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 l.jpg
Alternative Market Structures

  • The four market structures

    • perfect competition

    • monopoly

    • monopolistic competition

    • oligopoly








Alternative market structures10 l.jpg
Alternative Market Structures

  • The four market structures

    • perfect competition

    • monopoly

    • monopolistic competition

    • oligopoly

  • Structure  conduct  performance


Perfect competition l.jpg
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 l.jpg
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 l.jpg
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 l.jpg
Loss minimising under perfect competition 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 l.jpg
Short-run shut-down point competition

AVC

D2 = AR2

P2

AR2

= MR2

D2

P

£

AC

MC

S

O

O

Q (thousands)

Q (millions)

(a) Industry

(b) Firm


Perfect competition16 l.jpg
Perfect Competition 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 l.jpg
Perfect Competition competition

  • The long run

    • long-run equilibrium of the firm

      • all supernormal profits competed away


Long run equilibrium under perfect competition l.jpg
Long-run equilibrium under perfect competition 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 l.jpg
Perfect Competition 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 l.jpg
Long-run equilibrium of the firm under perfect competition competition

(SR)MC

(SR)AC

LRAC

DL

AR = MR

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

£

O

Q


Perfect competition21 l.jpg
Perfect Competition 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 l.jpg
Perfect Competition 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 l.jpg
Perfect Competition 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 l.jpg
Monopoly competition

  • Defining monopoly

    • importance of market power

    • concentration ratios



Monopoly26 l.jpg
Monopoly competition

  • 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 l.jpg
Monopoly competition

  • The monopolist's demand curve

    • downward sloping

    • MR below AR


Ar and mr curves for a monopoly l.jpg
AR competition 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 l.jpg
AR competition 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 l.jpg
Monopoly competition

  • Equilibrium price and output

    • MC = MR


Profit maximising under monopoly l.jpg
Profit maximising under monopoly competition

MC

MR

£

Qm

O

Q


Monopoly32 l.jpg
Monopoly competition

  • Equilibrium price and output

    • MC = MR

    • measuring level of supernormal profit


Profit maximising under monopoly33 l.jpg
Profit maximising under monopoly competition

MC

MR

£

Qm

O

Q


Profit maximising under monopoly34 l.jpg
Profit maximising under monopoly competition

AC

AR

AC

AR

£

MC

MR

Qm

O

Q


Profit maximising under monopoly35 l.jpg
Profit maximising under monopoly competition

Total profit

AC

AR

£

MC

AR

AC

MR

Qm

O

Q


Monopoly36 l.jpg
Monopoly competition

  • Equilibrium price and output

    • MC = MR

    • measuring level of supernormal profit

  • Monopoly versus perfect competition


Monopoly37 l.jpg
Monopoly competition

  • 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 l.jpg
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 l.jpg
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 l.jpg
Monopoly monopoly: with the same

  • 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 l.jpg
Monopoly monopoly: with the same

  • 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 l.jpg
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 l.jpg
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 l.jpg
Monopoly 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 l.jpg
Contestable Markets monopoly:

  • 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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