Competitive, Monopolistic, and Monopolistically Competitive Markets

1. CHAPTER 6
Market Structure
Competitive, Monopolistic, and
Monopolistically Competitive Markets

2. PERFECT COMPETITION

3. Learning Objectives
After studying this chapter, you will be able to:
 Explain the concept of market structure and its significance
 Describe the characteristics of the different types of market, Perfect
competition, Monopoly, Monopolistic competition, and oligopoly
 explain the equilibrium conditions for different types of market in terms of
price and output, both in graphical and algebraic terms
 Identify the sources of monopoly power, and marginal principle to
determine the profit maximizing price and output
 Explain firm’s short run and long run profits and whether firms shut down
or continue when firms making loss
2-3

4. Perfect competition
• Perfectly competitive markets are characterized
by:
• many buyers and sellers in the market.
• Each firm in the market produces a homogeneous
(identical) product.
• Buyers and sellers have perfect information.
• No transaction costs.
• Free entry and exit from the market.
• price is determined by the interaction of demand and
supply, firms in the market will be price-takers
• firms earn zero economic profits in the long run.
8-4

5. A VIDEO ABOUT
For more Video on Perfect Competition and
Monopolies
https://www.youtube.com/watch?v=vihuK8JoK14

6. Price and Demand at the Market and Firm
Levels
Market
output
0
Price
𝑃 𝑒
𝐷 𝑓
= 𝑃 𝑒
D
Price
Firm’s
output
S
Market Firm

7. Short-Run Output Decisions
• In the short run some factors of production are fixed.
• To maximize short-run profits, managers must determine
how much output will be produced by changing the
variable inputs when the fixed inputs are given (fixed
costs).
8-7

8. Short-Run Profit Maximization
8-8
Firm’s output
$
0
Revenue
𝑅 = 𝑃 × 𝑄
A
B
Slope of 𝐶 𝑄 = 𝑀𝐶
E
Costs
𝐶 𝑄
Slope of 𝑅 = 𝑀𝑅 = 𝑃
Maximum
profits
𝑄∗

9. Perfect Competitive Demand
• The demand curve for a competitive firm is a horizontal
line at the market price. This price is the competitive firm’s
marginal revenue.
𝐷 𝑓 = 𝑃 = 𝑀𝑅
8-9

10. Profit Maximization under Perfect Competition
Firm’s output
$
0 𝑄∗
𝑃 𝑒
𝑀𝐶 𝐴𝑇𝐶
𝐷 𝑓
= 𝑃 𝑒
= 𝑀𝑅
𝐴𝑇𝐶 𝑄∗
Profit

11. Profit Maximizing Output Rule
• To maximize profits, a perfectly competitive firm produces
the output at which price equals marginal cost.
𝑃 = 𝑀𝐶 𝑄
8-

12. Short-Run Loss Minimization
Firm’s output
$
0 𝑄∗
𝑃 𝑒
𝑀𝐶
𝐴𝑇𝐶
𝐷 𝑓
= 𝑃 𝑒
= 𝑀𝑅
Loss
𝐴𝑇𝐶 𝑄∗
𝐴𝑉𝐶

13. The Shut-Down Decision
Firm’s output
$
0 𝑄∗
𝑃 𝑒
𝑀𝐶 𝐴𝑇𝐶
𝐷 𝑓 = 𝑃 𝑒 = 𝑀𝑅
Fixed Cost
𝐴𝑇𝐶 𝑄∗
𝐴𝑉𝐶
𝐴𝑉𝐶 𝑄∗
Loss if produce
Loss if shut down

14. Short-Run Output Decision for a competitive firm
• To maximize short-run profits, a perfectly competitive
firm should produce in the range of increasing marginal
cost where 𝑃 = 𝑀𝐶, provided that 𝑃 ≥ 𝐴𝑉𝐶. If 𝑃 < 𝐴𝑉𝐶,
the firm should shut down its plant to minimize it losses.
• The short-run supply curve for a perfectly competitive
firm is its marginal cost curve above the minimum point
on the 𝐴𝑉𝐶 curve
8-

15. Firms Short-Run Supply Curve
Firm’s output
$
0 𝑄0
𝑃0
𝑀𝐶
𝐴𝑉𝐶
𝑃1
𝑄1
Short-run supply
curve for individual firm

16. Market Supply Curve
Market output
P
0 1
$10
$12
Market supply
curve
Individual firm’s
supply curve
𝑀𝐶𝑖
500
S

17. Long-Run Competitive Equilibrium
Firm’s output
$
0 𝑄∗
𝑃 𝑒
𝑀𝐶
𝐴𝐶
𝐷 𝑓 = 𝑃 𝑒 = 𝑀𝑅
Long-run competitive
equilibrium
𝑃 = 𝑀𝐶
𝑃 = 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑜𝑓 𝐴𝐶

18. CHAPTER 6
Market Structure
Competitive, Monopolistic, and
Monopolistically Competitive Markets

19. MONOPOLY

20. Monopoly and Monopoly Power
• A single firm serves an entire market for a
good that has no close substitutes.
• Barriers to entry: Only seller of a good in a
market gives that firm with greater market
power.
• To maximize profits, a monopoly will chose the
output at which marginal revenue equals
marginal costs
• The demand curve is downward-sloping so
marginal revenue is less than market price.
8-

21. A VIDEO ABOUT
For more Video on Monopoly
https://www.youtube.com/watch?v=Sb_-wfmJnHA

22. Sources of Monopoly Power
• Economies of scale
• Economies of scope
• Cost complementarity
• Patents and other legal barriers
8-

23. Elasticity of Demand and Total Revenues
Q0
Revenue
𝑃0
𝑄0
Price
Firm’s
output
0 𝑄0
Unitary
Unitary
Elastic
Inelastic InelasticElastic
Maximum revenues
𝑃0
× 𝑄0
𝑅0
MR

24. Marginal Revenue and Elasticity
• The monopolist’s marginal revenue function is
𝑀𝑅 = 𝑃
1 + 𝐸
𝐸
, where 𝐸 is the elasticity of demand for the monopolist’s product
and 𝑃 is the price charged.
• For 𝑃 > 0
• 𝑀𝑅 > 0 when 𝐸 < −1.
• 𝑀𝑅 = 0 when 𝐸 = −1.
• 𝑀𝑅 < 0 when −1 < 𝐸 < 0.
8-

25. Monopolist’s Output Rule
• A profit-maximizing monopolist should produce the output,
𝑄 𝑀
, such that marginal revenue equals marginal cost:
𝑀𝑅 𝑄 𝑀 = 𝑀𝐶 𝑄 𝑀
8-

26. Costs, Revenues, and Profit
Output
$
0
𝐶 𝑄
Cost function
𝑄 𝑀
Slope of
𝐶 𝑄 = 𝑀𝐶
Slope of
𝑅 = 𝑀𝑅
𝑅 = 𝑃 𝑄 × 𝑄
Revenue function
Maximum
profit

27. Price
Quantity
Demand
MR
MC
𝑄 𝑀
𝑃 𝑀
ATC
𝐴𝑇𝐶(𝑄 𝑀
)
Profits
𝑃𝑟𝑜𝑓𝑖𝑡𝑠 =
𝑃 𝑀
− 𝐴𝑇𝐶 𝑄 𝑀
× 𝑄 𝑀
Profit Maximization
8-

28. Monopolist’s Pricing Rule
• Given the level of output, 𝑄 𝑀
, that maximizes profits, the
monopoly price is the price on the demand curve
corresponding to the 𝑄 𝑀 units produced:
𝑃 𝑀 = 𝑃 𝑄 𝑀
8-

29. Monopolist’s Supply Curve
• In perfectly competitive markets, price is equal to marginal
cost (𝑃 = 𝑀𝐶).
• Thus, a supply curve exists in perfectly competitive markets.
• A monopolist’s market power implies 𝑃 > 𝑀𝑅 = 𝑀𝐶.
• Thus, there is no supply curve for a monopolist
8-

30. Multiplant Output Decisions
• Monopolist produces output in different locations.
• Manager has to determine how much output will be
produced at each plant.
• Consider a monopolist producing output at two plants:
• The cost of producing units at plant 1 is , and the cost of producing
at plant 2 is .
• When the monopolist produces a homogeneous product, the per-
unit price consumers are willing to pay for the total output produced
at the two plants is , where .
8-

31. Multiplant Output Rule
• Let 𝑀𝑅 𝑄 be the marginal revenue of producing a total of
𝑄 = 𝑄1 + 𝑄2 units of output. Suppose the marginal cost of
producing 𝑄1 units of output in plant 1 is 𝑀𝐶1 𝑄1 and that
of producing 𝑄2 units in plant 2 is 𝑀𝐶2 𝑄2 . The profit-
maximizing rule for the two-plant monopolist is to allocate
output among the two plants such that:
𝑀𝑅 𝑄 = 𝑀𝐶1 𝑄1
𝑀𝑅 𝑄 = 𝑀𝐶2 𝑄2
8-

32. Production with two plants
2-
Quantity
$/Q
D = AR
MR
MC1 MC2
MCT
MR*
Q1 Q2 QT
P*

33. Barriers to Entry and Monopolist’s
profit
• A monopolist may earn positive economic profits, because
barriers to entry prevents other firms from entering the
market to reap a portion of those profits.
• Monopoly profits will continue over time provided the
monopoly maintains its market power.
• Monopoly power, however, does not guarantee positive
profits.
• Profits depend on the average total cost curve
• When the optimal price exactly equals the average total
cost of production
• In the short run, monopoly earns a zero economic profits
or even experience losses.
8-

34. Price
Quantity
Demand
MR
MC
𝑄 𝑀
𝑃 𝑀
= 𝐴𝑇𝐶(𝑄 𝑀
)
ATC
Zero-Profit Monopolist
8-

35. The Social Costs of Monopoly Power
• The consumer and producer surplus that is lost due to the
monopolist charging a price in excess of marginal cost.
• Social cost of monopoly is likely to exceed the deadweight
loss
• Rent Seeking
• The larger the transfer from consumers to the firm, the
larger the social cost of monopoly
8-

36. Price
Quantity
Demand
MR
MC
𝑄 𝑀
𝑃 𝑀
Deadweight Loss of Monopolist
8-
𝑄 𝐶
𝑃 𝐶 Deadweight loss

37. CHAPTER 6
Market Structure
Competitive, Monopolistic, and
Monopolistically Competitive Markets

38. MONOPOLISTIC
COMPETITION

39. Monopolistic Competition
• There are five main conditions for monopolistic
competition to exist:
1. There are many buyers and sellers in the industry.
2. Each firm produces a slightly differentiated product.
3. There are minimal barriers to entry or exit.
4. All firms have identical cost and demand functions.
5. Firms do not take into account competitors’ behaviour in
determining price and output.
 A key difference between monopolistically competitive
and perfectly competitive markets is that each firm
produces a slightly differentiated product.
2-

40. A VIDEO ABOUT
For more Video on Monopolistic Competition
https://www.youtube.com/watch?v=T3F1Vt3IyNc

41. Price
Quantity
Demand
MR
MC
𝑄∗
𝑃∗
ATC
Profit-Maximizing Monopolistically
Competitive Firm
𝐴𝑇𝐶(𝑄∗)
𝑃𝑟𝑜𝑓𝑖𝑡𝑠 =
𝑃∗
− 𝐴𝑇𝐶 𝑄∗
× 𝑄∗
Profits

42. Profit-Maximization Rule
• To maximize profits, a monopolistically competitive firm
produces where its marginal revenue equals marginal
cost.
• The profit-maximizing price is the maximum price per unit
that consumers are willing to pay for the profit-maximizing
level of output.
• the profit-maximizing output, 𝑄∗, is such that 𝑀𝑅 𝑄∗ =
𝑀𝐶 𝑄∗ and the profit-maximizing price is 𝑃∗ = 𝑃 𝑄∗ .
8-

43. Long-Run Equilibrium
• Monopolistically competitive earns short-run
• profits, new firms will enter in the long run to capture some of those
profits.
• some firms will exit the industry in the long run.
• The demand curve will tangential to the average cost curve, firms
earn zero economic profit
• There is no incentive for additional firms to enter the industry
8-

44. Price
Quantity of Brand X
Demand0
MR0
MC
𝑄∗
𝑃∗
ATC
Monopolistically Competitive Market
8-
Demand1
MR1
Due to entry of new
firms selling other brands

45. Price
Quantity of Brand X
MC
𝑄∗
𝑃∗
ATC
Long-Run Monopolistically
Competitive Equilibrium
Demand1
MR1
Long-run monopolistically
competitive equilibrium

46. Long-Run Monopolistic Competition
• In the long run, monopolistically competitive firms produce
a level of output such that:
• 𝑃 > 𝑀𝐶
• 𝑃 = 𝐴𝑇𝐶 > 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑜𝑓 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡𝑠
8-

47. Product Differentiation
• Firms produces differentiated products in monopolistically
competitive markets
• Firms in these industries continually convince consumers
that their products are better than their competitors.
• Two strategies monopolistically competitive firms use to
persuade consumers:
• Comparative advertising: firms attempts to increase the demand for
its brand by differentiation
• Niche marketing: goods and services are tailored to meet the
particular market segment
8-

48. Conclusion
• Firms operating in a perfectly competitive market
take the market price as given.
• Produce output where 𝑃 = 𝑀𝐶.
• Firms may earn profits or losses in the short run.
• But in the long run, entry or exit forces economic profits to zero.
• A monopoly firm, in contrast, can earn persistent
profits provided that the source of monopoly
power is not eliminated.
• A monopolistically competitive firm can earn
profits in the short run, but entry by competing
brands will erode these profits in the long run.
8-

49. CHAPTER 6
Market Structure
Competitive, Monopolistic, and
Monopolistically Competitive Markets

50. RECAP
On Key Terms and Concepts
2-50

51. Key Terms and Concepts
• Brand equity
• Comparative advertising
• Cost complementarities
• Deadweight loss of monopoly
• Economies of scale
• Multiplant monopoly
• Niece marketing
• Patents
• Product differentiation
2-