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Pure Competition and Monopolistic Competition Chapter 10. Pure competition is a standard against which other market structures are compared. The product is perfectly undifferentiated .
2005 South-Western Publishing
The forces that determine competitive advantage are:
High capital requirements
Economies of scale
Absolute cost advantages
High switching costs
Lack of access to distribution
Public policy constraints
Branded vs. generic
Intensity of rivalry
Industrial growth rates
Homogeneity of buyers
Potential of integration
Number of suppliers
Supply shortages or surplus
Degree of vertical integration
pCM = ( P – MC )/P.
pCM / (pCM% – .10) < (1 + DQ/Q )
a. the number of firms and their relative sizes.
b. whether the product is differentiated or standardized.
c. whether decisions by firms are independent or coordinated (collusion).
Pure Competition assumes:
1. a very large number of buyers and sellers
2. homogeneous product (standardized)
3. complete knowledge of all relevant market information
4. free entry and exit (no barriers)
These assumptions imply several things about competitive markets, including price equals marginal cost.
1. Only one firm in the market area
2. Low cross price elasticity with other products.
3. No interdependence with other competitors.
4. Substantial entry barriers
These assumptions imply several things about monopolies, including that the monopoly price is well above marginal cost. Monopoly is discussed in full in Chapter 11.
Monopolistic competition assumes:
1. A large number of firms, some of which may be dominant in size
2. Differentiated products
3. Independent decision making by individual firms
4. Easy entry and exit
These assumptions imply several things about monopolistic competition, including that the price in the long run is equal to average cost.
1. Only a few firms in the market area
2. Products may be differentiated or undifferentiated
3. There is a large degree of interdependence with other competitors
These assumptions imply several things about monopolies, including that the monopoly price is well above marginal cost. Chapter 12 discusses oligopoly markets.
Competitive firms attempt to maximize profits.
Competitive firms cannot charge more than the market price of others, since their product is identical to all others.
Hence, competitive firms are price takers.
Total revenue, TR, is P·Q, where price is given. Therefore, marginal revenue, MR, is price, P.
Profit is total revenue minus total cost = TR - TC).
a firmthe industry
CAN EARN ECON PROFITS
IN THE SHORT RUN
1. Competitive firm can earn positive economic profits in the SR
2.If Price < AVC, firm will shut down
so-called “shut down price” is lowest AVC
3.In LR, entry forces price down to the minimum of the AC curve
shut down price
For the industry:
QS = 3000 + 200 P and
QD = 13500 - 500 P
For the firm:
FC = 50
MC = 3 Q
FIND OPTIMAL output for this firm.
we see 3,000 + 200 P = 13,500 - 500 P. This implies:
10,500 / 700 = P = $15.
At this price, the firm produces where P = MC, so
15 =3 Q
Q = 5
not at least cost point of AC curve
Could Avoid Excess Capacity by JOINTLY PRODUCING at the same plant
Kroger Salt & Morton Salt at same plant
Sears’ Kenmore and Whirlpool built at same factory.
Does the expectation of zero profits in the future stifle innovation?
Is there too much product differentiation?Properties of Monopolistic Competition
Contribution Margin = Marginal Cost of Advertising
P – MC = k • DA/DQ
are for the seller onlyNotorious Firm Analysis
Hi Price Low Price
We end in a trap of only
poor quality goods at