Perfect Competition• Many (small) firms, producing a homogeneous (identical) product, none ofwhich having an impact on the price; each firms product is non-distinguishablefrom 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 leavethe industry or new firms can come into the industry freely.• d. No interference in the market process: No price control or restrictions onproduction• e. All firms have equal and complete access to the available inputs (inputmarkets) and production technology; all firms have the same production andcost 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 intothe industry. Firms that have losses shut down and leave the industry in thelong run.
How is the market price Determined?• Market Supply:The (horizontal) sum of individual supply curves• Market Demand:The (horizontal) sum of individual demand curves
P P0 0Q QDmSmopop1Sm1DoD1Sqoq1Market A typical firm
Perfect Competition:Profit Maximization in the Short Run• An individual firm takes the market price asgiven; the demand each individual firmfaces is horizontal.• MR = P: Demand• Set the price equal to MC• In the short- run the firm could have aneconomic profit
0Q$SMCSATCAVCPmabcQeDf, MRProfit Maximization in theShort Run
Adjustments in the Long Run• If economic profits are present new firmswill come into the industry• The Market price will fall• The profit shrinks• Input prices may go up• Firms try to stay profitable by takingadvantage of economies of scale• Firms adopt an optimal size• Economic profits tend toward zero
Long-Run Equilibrium in a Perfectly Competitive Marketo o Q$P $DmSmLATCSATC1SATC2SATC3DfQePeMC2Market A typical firm
Long-Run Equilibrium under Perfect Competition• Many “optimal-size” firms, each producing atthe minimum long run average cost and chargingthe market price where:P = MR= MC = SATC = LATC• Allocative efficiency: MC = P• Productive efficiency: MC= SATC = LATC• Zero economic profit (normal profit) : P = ATC
Pure Monopoly• A single firm producing a homogenous ordifferentiated (unique) good and facing themarket demand.• No substitutes• No new entries allowed• The monopoly is a price maker• P>MR• Possibility of a sustained economic profit
What circumstances lead to theformation of a monopoly?• Extensive economies of scale: natural monopolies• Exclusive patent rights• Copy rights to intellectual properties• Government franchises• Exclusive access to a essential resource (input)• CartelsA monopoly is a profit maximizer too!
The Dynamics of a Monopolistic Market• As a profit maximizer a monopoly may tryto take advantage of economies of scale• A monopoly tends to try to protect itsmonopolistic position• A monopoly may take advantage oftechnological advances• A monopoly may face changes in demand• A monopoly may try to promote its productto maintain demand
Monopolies and Profit Maximization• A monopoly faces the industry demand curve• To maximize profit: MR = MCP = 80 - .0008Q ; MR = 80 - .0016QTC = 10,000 + .0092Q2; MC = .0184 QSet MR = MC Q = 4000; P = 76.8Profit = 307,200 – 147,200 – 10,000 = 150,000• Profit = (P- ATC). Q
Things Change• Demand may go down• Cost could increase• In an attempt to keep the potential competitorsout, the monopolist may lower its price to nearits average cost• Rent seeking: an attempt to maintain itsmonopolistic position by influencing thepolitical processes-e.g., zoning laws• Closer substitutes may emerge
SMCSATCDMRPQeQ$oLATCL-R Zero Economic ProfitATC>MC, P>MR, P>MC, P = ATC
The Case of Natural Monopolies• A natural monopoly emerges out of competitionamong firms in an industry with extensiveeconomies of scale; the downward-slopingsegment of the LATC curve extends to or beyondthe market capacity (or market demand).• Smaller firms are gradually driven out by thelarger (more efficient) firms.• The surviving firm would become a (natural)monopoly.• If unchecked, a natural monopoly behaves like amonopoly; it under-produces and overcharges.
Price Discrimination• Segmenting the market into separateclassifications or regions• Assuming that each class of consumers havedifferent demand, a monopoly can chargedifferent prices in each market segmentTo price-discriminate• The firm must identify consumer groups/classes with differentdownward-sloping demand curves• The firm must be able to prevent consumers of one class fromreselling its product to the consumers of another class; nointermarket redistribution of the product is allowed