Many (small) firms, producing a homogeneous (identical) product, none of which having an impact on the price; each firm's product is non-distinguishable from other firms' product.
b. Many buyers none of whom having any effect on the price.
c. No barriers to entry and exit: in the long run firms can shut down and leave the industry or new firms can come into the industry freely.
d. No interference in the market process: No price control or restrictions on production
e. All firms have equal and complete access to the available inputs (input markets) and production technology; all firms have the same production and cost functions.
f. All sellers and buyers have perfect information about the market conditions.
g. Making above-normal profits by existing firms will result in new entries into the industry. Firms that have losses shut down and leave the industry in the long run.
How is the market price Determined?
The (horizontal) sum of individual supply curves
The (horizontal) sum of individual demand curves
P P 0 0 Q Q Dm Sm o p o p 1 Sm 1 D o D 1 S q o q 1 Market A typical firm
Perfect Competition:Profit Maximization in the Short Run
An individual firm takes the market price as given; the demand each individual firm faces is horizontal.
MR = P: Demand
Set the price equal to MC
In the short- run the firm could have an economic profit
0 Q $ SMC SATC AVC Pm a b c Qe D f , MR Profit Maximization in the Short Run
Adjustments in the Long Run
If economic profits are present new firms will come into the industry
The Market price will fall
The profit shrinks
Input prices may go up
Firms try to stay profitable by taking advantage of economies of scale
Firms adopt an optimal size
Economic profits tend toward zero
Sm o Qm Pm1 Pm2 Pm3 Pm4 Sm 1 Sm 2 Sm 3 Sm 4 Q4 Q3 Q2 Q1 Qo $ MARKET o Dm
LATC D Pm Qe Q o SAC 1 SAC 2 SAC 3 SAC 4 A competitive firm’s long-run equilibrium
Long-Run Equilibrium in a Perfectly Competitive Market o o Q $P $ Dm Sm LATC SATC 1 SATC 2 SATC 3 D f Qe Pe MC 2 Market A typical firm
Long-Run Equilibrium under Perfect Competition
Many “optimal-size” firms, each producing at the minimum long run average cost and charging the market price where:
P = MR= MC = SATC = LATC
Allocative efficiency: MC = P
Productive efficiency: MC= SATC = LATC
Zero economic profit (normal profit) : P = ATC
A single firm producing a homogenous or differentiated (unique) good and facing the market demand.
No new entries allowed
The monopoly is a price maker
Possibility of a sustained economic profit
What circumstances lead to the formation of a monopoly?
Extensive economies of scale: natural monopolies
Exclusive patent rights
Copy rights to intellectual properties
Exclusive access to a essential resource (input)
A monopoly is a profit maximizer too!
$ Q Q $ Dm MR 0 0 TR a -2b -b Demand Faced by A Monopoly
SMC SATC D MR P Qe Q $ k m n o c Qc
The Dynamics of a Monopolistic Market
As a profit maximizer a monopoly may try to take advantage of economies of scale
A monopoly tends to try to protect its monopolistic position
A monopoly may take advantage of technological advances
A monopoly may face changes in demand
A monopoly may try to promote its product to maintain demand
SMC SATC D MR P Qe Q $ n o LATC k m L-R Positive Economic Profit ATC>MC, P>MR, P>MC, P>ATC
Monopolies and Profit Maximization
A monopoly faces the industry demand curve
To maximize profit: MR = MC
P = 80 - .0008Q ; MR = 80 - .0016Q
TC = 10,000 + .0092Q 2 ; MC = .0184 Q
Set MR = MC Q = 4000; P = 76.8
Profit = 307,200 – 147,200 – 10,000 = 150,000
Profit = (P- ATC). Q
Demand may go down
Cost could increase
In an attempt to keep the potential competitors out, the monopolist may lower its price to near its average cost
Rent seeking: an attempt to maintain its monopolistic position by influencing the political processes-e.g., zoning laws
Closer substitutes may emerge
SMC SATC D MR P Qe Q $ o LATC L-R Zero Economic Profit ATC>MC, P>MR, P>MC, P = ATC
The Case of Natural Monopolies
A natural monopoly emerges out of competition among firms in an industry with extensive economies of scale; the downward-sloping segment of the LATC curve extends to or beyond the market capacity (or market demand).
Smaller firms are gradually driven out by the larger (more efficient) firms.
The surviving firm would become a (natural) monopoly.
If unchecked, a natural monopoly behaves like a monopoly; it under-produces and overcharges.
SAC 1 SAC 2 SAC 3 o Q $ D Natural Monopolies LAC Q1 Q2 Q3
SAC o Q $ D Natural Monopolies Monopoly Pricing LATC MR SMC LMC Pm Qc Qm AC p
MC Q o Pc Pm Qm Qc A Comparison D MR $
Segmenting the market into separate classifications or regions
Assuming that each class of consumers have different demand, a monopoly can charge different prices in each market segment
The firm must identify consumer groups/classes with different downward-sloping demand curves
The firm must be able to prevent consumers of one class from reselling its product to the consumers of another class; no intermarket redistribution of the product is allowed
$ D MR D` MR MC, ATV o Q Q P` P Q Q Price Discrimination
Monopsony vs. Monopoly MRPL:D L MR L MC L S L Wu o Eu Ec Wc Wm Em
Cartels Q Industry Σ MC Dm MR P,C P,C P o o Firm A Firm B o Q B Q A MC A MC B ATC A ATC B P,C