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Market Structure Guide: Perfect Competition to Monopoly
- 1. I.) Perfect competition II.) Monopolistic competition III.) Oligopoly IV.) Monopoly Four Market Types Market Structure
- 2. II.) Monopolistic competition Market Structure Easy to enter/exit market Competitive Goods are different Not very efficient allocation
- 3. Market Structure Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Duopoly Monopoly
- 4. Between Monopoly and PC Competition Two extremes I.) Perfect competition: many firms, identical products IV.) Monopoly: one firm In between these extremes: imperfect competition III.) Oligopoly: only a few sellers offer similar or identical products. II.) Monopolistic competition: many firms sell similar but not identical products.
- 5. Characteristics Perfect Competition Monopolistic Competition Oligopoly Monopoly # of sellers Many (price takers) One (no substitutes) Substitution of Product sold Only one product type from all sellers No Substitutes Barriers to entry into market No barriers to enter/ exit Almost impossible for others to enter the market Pricing vs MC and MR P =MC=MR P > MR P > MC Efficiently Efficient with zero econ profit P = ATC P > ATC Big LR profits Many (a few price makers) Imperfect substitutes Weak barriers to enter/ exit P > MR P > MC P = ATC zero econ profits in LR
- 6. When the price of one firm’s product rises, the quantity demanded of that firm’s product decreases. (normal looking demand curve) II.) Monopolistic Competition Product differentiation Four items that are the key to this market structure: Slightly different from competing firms, but it may have close substitutes
- 7. II.) Monopolistic Competition Product differentiation Four items that are the key to this market structure: Even though firms are selling different products there is still highly competitive forces on firms and the decisions they make. Many firms with weak barriers to entry Later this plays into the debate over advertising
- 8. Short Run Firm behavior is very similar to monopoly but with competition If profits in the short run: New firms enter market, taking some demand away from existing firms, prices and profits fall. If losses in the short run: Some firms exit the market, remaining firms enjoy higher demand and prices. II.) Monopolistic Competition Four items that are the key to this market structure:
- 9. Similar to perfect competition.Long Run Entry and exit drive economic profit to zero. II.) Monopolistic Competition Four items that are the key to this market structure: Short Run Firm behavior is very similar to monopoly but with competition
- 10. (MR) Marginal Revenue Profit Maximization ∆TR ∆Q Profit-Maximizing Output: level at which (MR) marginal revenue equals (MC) marginal cost MR = MC We assume all firms are profit maximizing, producing at the point where their profits are at their highest (MC) Marginal Cost ∆TC ∆Q Same answers as before
- 11. IV.) Monopoly Demand Q P ****The important thing to understand is that when a monopoly wants to sell at a larger Q it must lower it’s price on every single unit made, including ones already made D = AR =P To sell a larger Q, the firm must reduce P on all units. Thus, MR ≠ P. 20 40 10 6 Same as for Monopoly
- 12. IV.) Monopoly Demand Q P To sell a larger Q, the firm must reduce P on all units. Thus, MR ≠ P. And will always be, MR < P MR Price: P = D = AR Where average revenue meets the quantity produced MC D = AR =P
- 13. II.) Monopolistic Competition Short Run
- 14. Q P D = AR MR MC Price P = D at MR = MC ATC Difference between AR and ATC Profit Amount Q = ATC Cost MR is below D since have to reduce the price on every extra unit Making an economic (abnormal) profit in the short run II.) Monopolistic Competition Short Run Profit-Maximizing Level MR = MC
- 15. P Q Q Monopoly short run and long run P Monopolistic Competition in the short run A MC firm can make an economic (abnormal) profit in the short run - Output is not productively and not allocatively efficient However the big difference is that MC firms demand curves are usually much more elastic because of competition D MR MC ATC MC ATC II.) Monopolistic Competition Short Run D MR
- 16. P Q Q Monopoly short run and long run P Monopolistic Competition in the short run A MC firm can make an economic (abnormal) profit in the short run - Output is not productively and not allocatively efficient However the big difference is that MC firms demand curves are usually much more elastic because of competition D MR MC ATC MC ATC II.) Monopolistic Competition Short Run D MR the big difference is that MC firms demand curves are usually much more elastic because of competition
- 17. Q P D = AR MR MC Profit-Maximizing Level MR = MC Price P = D at MR = MC ATC Difference between AR and ATC Loss Amount Q = ATC Cost Making an economic loss in the short run II.) Monopolistic Competition Short Run MC short run – losing money
- 18. Q P D = AR MR MC Profit-Maximizing Level MR = MC Price P = D at MR = MC ATC Difference between AR and ATC Loss Amount Q = ATC Cost Making an economic loss in the short run II.) Monopolistic Competition Short Run AVC The same issue of shutting down in the short run if the price is below AVC just like with perfect competition.
- 19. Q P D = AR MR MC Profit-Maximizing Level MR = MC Price P = D at MR = MC ATC Difference between AR and ATC Loss Amount Q = ATC Cost Making an economic loss in the short run II.) Monopolistic Competition Short Run ***Run into the same issue of shutting down in the short run if the price is below AVC just like with perfect competition. AVC
- 20. Similar to perfect competition.Long Run Entry and exit drive economic profit to zero. II.) Monopolistic Competition Four items that are the key to this market structure: Short Run Firm behavior is very similar to monopoly but with competition
- 21. II.) Monopolistic Competition Long Run In the long run a MC firm can only earn a normal profit In the Long Run… Since they are selling slightly different products, there are substitutions for their product if the price is too high and take away some of the firms demand for their good or service. The barriers to entry aren’t very high and if there are abnormal profits then other firms will enter the market and take away some of the firms demand for their G&S. Since there are many sellers, the firm can’t have monopoly-like power and that takes away some of the firms demand for the good or service. So only a normal profit P = ATC
- 22. II.) Monopolistic Competition Long Run In the long run a MC firm can only earn a normal profitIn the long run a MC firm can only earn a normal profit In the Long Run… There are substitutions for their product if the price is too high. ( This can shift the demand for the firm) The barriers to entry aren’t very high. (This can shift the demand for the firm) Since there are many sellers. (This can shift the demand for the firm) So all they can do is make a normal profit means price will equal costs P = ATC
- 23. Q P D = AR MR MC Profit-Maximizing Level MR = MC Price P = D at MR = MC ATC Difference between AR and ATC = 0 (normal profit) Profit Amount Q = ATC Cost *** In the long run the demand curve will be touching the ATC curve at one point on the downward sloping side and that it the long run equilibrium. Making a normal profit in the long run II.) Monopolistic Competition Long Run
- 24. II.) From Short Run to Long Run
- 25. P Q S D Q Market D + S P MC Firm short run MC Other firms notice that there are abnormal profits to be made and would also like to make those profits and so enter the market and shift the supply curve to the left which also decreases the demand for the individual firm and shifts their demand curve to the right ATC MR D II.) From Short Run to Long Run
- 26. P Q S D Q Market D + S P MC Firm Long Run Equilibrium MC Market supply increases Individual firm demand ( not market demand) decreases to point of making a normal profit ATC MR D S1 MR1 D1 II.) From Short Run to Long Run
- 27. P Q D QQ1 P1 Market D + S P MC Firm Long Run Equilibrium MC Market supply increases Individual firm demand ( not market demand) decreases to point of making a normal profit ATC II.) Monopolistic Competition Long Run S1 MR1 D1
- 28. P Q Q MC firm Short Run Equilibrium P MC Firm Long Run Equilibrium MC ATC II.) Monopolistic Competition SR and LR MR D MC ATC MR D Short run is like monopoly, long run is like perfect competition, except the Demand curve is tangent to the ATC curve but not at the lowest ATC point
- 29. II.) Monopolistic Competition Welfare Analysis
- 30. Q P D = AR MR MC ATC Making a normal profit in the long run II.) Monopolistic Competition Welfare Analysis I will remove the ATC curve just to make this easier to read, to find allocative efficiency since it is not a main curve used to figure out surpluses, just know that it is there and makes this not all straight lines Allocative efficiency Most desirable outcome from society’s perspective
- 31. Q P D = AR MR MC Making a normal profit in the long run II.) Monopolistic Competition Welfare Analysis MC firm produces at profit maximizing point of MR = MC For society Allocative efficiency is Profit-Maximizing MR = MC Surplus-Maximizing P = MC Deadweight loss to society Difference of what production society wants but a monopolistic firm actually makes
- 32. Q P D = AR MR MC ATC Making a normal profit in the long run II.) Monopolistic Competition Welfare Analysis Productive efficiency Producing at the most efficient possible amount For productive efficiency I have to leave in the ATC curve because productive efficiency is asking if the firm is producing the good or service at the most efficient point for the firm in regards to society.
- 33. Q P D = AR MR MC Making a normal profit in the long run II.) Monopolistic Competition Welfare Analysis MC firm produces at profit maximizing point of MR = MC Profit-Maximizing MR = MC Deadweight loss to society Difference of what production society wants but monopolistic firm actually makes ATC ***Technically there is no consumer surplus or producer surplus in the long run For society productive efficiency is Surplus-Maximizing Q = min ATC
- 34. P Q QQ1 P1 P Long RunShort Run MC ATC MR D MC ATC MR D1 Abnormal profit - YES Productively - NO Efficient (Q = min ATC ) Allocatively - NO Efficient ( P = MR ) Abnormal profit - NO Productively - NO Efficient (Q = min ATC ) Allocatively - NO Efficient ( P = MR )
- 35. II.) Monopolistic Competition Welfare Analysis Why Monopolistic Competition Is Less Efficient than Perfect Competition Excess capacity Markup over marginal cost monopolistic competitor operates on the downward-sloping part of its ATC curve, produces less than the cost- minimizing output.. Under perfect competition, firms produce the quantity that minimizes ATC. Under monopolistic competition, P > MC. Under perfect competition, P = MC.
- 36. Q P D = AR MR MC Making a normal profit in the long run II.) Monopolistic Competition Welfare Analysis ATC Excess capacity operates on theoperates on the downward-downward- sloping part ofsloping part of itsits ATCATC curvecurve Markup P > MC
- 37. Consumer and Producer surplus is very hard to measure but… II.) Monopolistic Competition Welfare Analysis Problems with Welfare Analysis: *** The inefficiencies of monopolistic competition are subtle and hard to measure. No easy way for policymakers to improve the market outcome. Number of firms in the market may not be optimal, due to external effects from the entry of new firms:: The product-variety externality surplus consumers get from the introduction of new products. The business-stealing externality losses incurred by existing firms when new firms enter market.
- 38. II.) Monopolistic Competition Welfare Analysis So far, we have studied three market structures: perfect competition, monopoly, and monopolistic competition. In each of these, would you expect to see firms spending money to advertise their products? Why or why not? Is advertising good or bad from society’s viewpoint? Try to think of at least one “pro” and “con.” Advertising
- 39. II.) Monopolistic Competition Welfare Analysis So far, we have studied three market structures: perfect competition, monopoly, and monopolistic competition. In each of these, would you expect to see firms spending money to advertise their products? Why or why not? Is advertising good or bad from society’s viewpoint? Try to think of at least one “pro” and “con.” Advertising A point for later…
- 40. II.) Monopolistic Competition A Summary…
- 41. II.) Monopolistic Competition Product differentiation Slightly different from competing firms, but it may have close substitutes Even though firms are selling different products there is still highly competitive forces on firms and the decisions they make. Many firms with weak barriers to entry
- 42. P Q QQ1 P1 P Long RunShort Run MC ATC MR D MC ATC MR D1 Abnormal profit - YES Productively - NO Efficient (Q = min ATC ) Allocatively - NO Efficient ( P = MC ) Abnormal profit - NO Productively - NO Efficient (Q = min ATC ) Allocatively - NO Efficient ( P = MC )
- 43. II.) Monopolistic Competition Welfare Analysis Why Monopolistic Competition Is Less Efficient than Perfect Competition Excess capacity Markup over marginal cost monopolistic competitor operates on the downward-sloping part of its ATC curve, produces less than the cost- minimizing output.. Under perfect competition, firms produce the quantity that minimizes ATC. Under monopolistic competition, P > MC. Under perfect competition, P = MC.
- 44. II.) Monopolistic Competition A Summary…A Summary… A monopolistically competitive market hasA monopolistically competitive market has many firms, differentiated products, and free entry.many firms, differentiated products, and free entry. Each firm in a monopolistically competitive marketEach firm in a monopolistically competitive market has excess capacity – produces less than thehas excess capacity – produces less than the quantity that minimizesquantity that minimizes ATCATC. Each firm charges a. Each firm charges a price above marginal cost.price above marginal cost.
- 45. II.) Monopolistic Competition A Summary…A Summary… Monopolistic competition does not have all of theMonopolistic competition does not have all of the desirable welfare properties of perfect competition.desirable welfare properties of perfect competition. There is a deadweight loss caused by the markupThere is a deadweight loss caused by the markup of price over marginal cost. Also, the number ofof price over marginal cost. Also, the number of firms (and thus varieties) can be too large or toofirms (and thus varieties) can be too large or too small. There is no clear way for policymakers tosmall. There is no clear way for policymakers to improve the market outcome.improve the market outcome.
- 46. II.) Monopolistic Competition A Summary but a part not explained in thisA Summary but a part not explained in this PPT…PPT… Product differentiation and markup pricing lead toProduct differentiation and markup pricing lead to the use of advertising and brand names. Critics ofthe use of advertising and brand names. Critics of advertising and brand names argue that firms useadvertising and brand names argue that firms use them to reduce competition and take advantage ofthem to reduce competition and take advantage of consumer irrationality. Defenders argue that firmsconsumer irrationality. Defenders argue that firms use them to inform consumers and to competeuse them to inform consumers and to compete more vigorously on price and product quality.more vigorously on price and product quality.
- 47. That it for now! Thank you!
Editor's Notes
- In the preceding two chapters, we studied the two extremes of the competition spectrum. This chapter focuses on monopolistic competition, one of the market structures in between the two extremes. Examples of each market type: Perfect competition: wheat, milk Monopoly: tap water, cable TV Oligopoly: tennis balls, cigarettes Monopolistic competition: novels, movies
- Product differentiation is the heart of the space between monopoly and competition. An old ice-cream on the beach analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B. Tell the students that the line represents a long beach along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get most customers because the cost of an ice-cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation— technically, there is minimum differentiation. Now suppose a third and fourth ice-cream vendor come along. Where do they locate? At the ends of the beach at A and B. They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example. Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”
- Product differentiation is the heart of the space between monopoly and competition. An old ice-cream on the beach analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B. Tell the students that the line represents a long beach along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get most customers because the cost of an ice-cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation— technically, there is minimum differentiation. Now suppose a third and fourth ice-cream vendor come along. Where do they locate? At the ends of the beach at A and B. They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example. Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”
- Product differentiation is the heart of the space between monopoly and competition. An old ice-cream on the beach analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B. Tell the students that the line represents a long beach along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get most customers because the cost of an ice-cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation— technically, there is minimum differentiation. Now suppose a third and fourth ice-cream vendor come along. Where do they locate? At the ends of the beach at A and B. They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example. Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”
- Product differentiation is the heart of the space between monopoly and competition. An old ice-cream on the beach analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B. Tell the students that the line represents a long beach along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get most customers because the cost of an ice-cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation— technically, there is minimum differentiation. Now suppose a third and fourth ice-cream vendor come along. Where do they locate? At the ends of the beach at A and B. They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example. Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”
- Product differentiation is the heart of the space between monopoly and competition. An old ice-cream on the beach analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B. Tell the students that the line represents a long beach along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get most customers because the cost of an ice-cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation— technically, there is minimum differentiation. Now suppose a third and fourth ice-cream vendor come along. Where do they locate? At the ends of the beach at A and B. They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example. Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”
- One of these externalities is positive, the other is negative. It’s not clear which one is bigger, and it may in fact differ by industry.
- One of these externalities is positive, the other is negative. It’s not clear which one is bigger, and it may in fact differ by industry.
- One of these externalities is positive, the other is negative. It’s not clear which one is bigger, and it may in fact differ by industry.
- Product differentiation is the heart of the space between monopoly and competition. An old ice-cream on the beach analogy really nails down the idea of product differentiation and explains how monopolistic competition fills the space between monopoly and perfect competition. Draw a line on the blackboard and label the two ends A and B. Tell the students that the line represents a long beach along which beachgoers are uniformly spaced. An ice-cream vendor decides to set up shop on the beach—the only one. Where will she locate? The students will quickly see that the center—midway between A and B is the spot that will get most customers because the cost of an ice-cream is the market price plus the walking time to get it (remind them that the beach is very long!) Now a second ice-cream vendor opens up. Where does he locate? With a bit of help, the students will see that the best spot is right next to the first one. With one producer, there is monopoly and no variety—no product differentiation. With two producers, there is still no differentiation— technically, there is minimum differentiation. Now suppose a third and fourth ice-cream vendor come along. Where do they locate? At the ends of the beach at A and B. They differentiate as much as possible from each other and from the first two. Further entry has new ice-cream vendors locating in the middle of the gaps between the existing ones, always going into the widest gap. If the market could stand the competition, eventually, there would be ice-cream vendors so close to each other all along the beach that the members of any adjacent group were indistinguishable to a customer. Product differentiation would have been pushed to the point that there is no “space” for additional variety and the market would look like perfect competition. Real products are like the beach example. Talk about sports shoes, breakfast cereals, and any other goods that interest you and for which there are good locally observable examples and encourage the students to see that they are like the beach example. The variety of products fill the available variety “space.”