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Profit Maximisation under

Perfect Competition

and Monopoly



Alternative Market Structures

•

Classifying markets (by degree ofcompetition)

– number of firms

– freedom of entry to industry

• free, restricted or blocked?

– nature of product

• homogeneous or differentiated?

– nature of demand curve

• degree of control the firm has over price




•

The four market structures – perfect competition

– monopoly

– monopolistic competition

– oligopoly



Features of the four market structures

Type of market

Number of firms

Freedom of entry

Nature of product

Examples Implications for demand curve

faced by firm

Perfect

competition

Very

many UnrestrictedHomogeneous

(undifferentiated)

Cabbages, carrots

(approximately)

Horizontal:

firm is a price taker

Monopolistic competition

Many /several

Unrestricted Differentiated Builders,restaurants

Downward sloping,but relatively elastic

Oligopoly Few Restricted

Undifferentiated

or differentiated

Cement

cars, electrical

appliances

Downward sloping.

Relatively inelastic

(shape depends on

reactions of rivals)

Monopoly One Restricted or

completely

blocked

Unique

Local water

company, train

operators (over

particular routes)

Downward sloping:

more inelastic than

oligopoly. Firm has

considerable

control over price




Type of market

Number of firms

Freedom of entry

Nature of product

Examples Implications for demand curve

faced by firm

Perfect

competition

Very


(undifferentiated)

Cabbages, carrots

(approximately)

Horizontal:



Many /several




Undifferentiated

or differentiated

Cement

cars, electrical

appliances

Downward sloping.


(shape depends on



completely

blocked

Unique

Local water

company, train

operators (over

particular routes)

Downward sloping:

more inelastic than

oligopoly. Firm has

considerable

control over price




Type of market Number of firms Freedom of entry Nature of product Examples Implications for demand curve

faced by firm

Perfect

competition

Very


(undifferentiated)

Cabbages, carrots

(approximately)

Horizontal:



Many /several




Undifferentiated

or differentiated

Cement

cars, electrical

appliances

Downward sloping.


(shape depends on



completely

blocked

Unique

Local water

company, train

operators (over

particular routes)

Downward sloping:

more inelastic than

oligopoly. Firm has

considerable

control over price





faced by firm

Perfect

competition

Very


(undifferentiated)

Cabbages, carrots

(approximately)

Horizontal:



Many /several




Undifferentiated

or differentiated

Cement

cars, electrical

appliances

Downward sloping.


(shape depends on



completely

blocked

Unique

Local water

company, train

operators (over

particular routes)

Downward sloping:

more inelastic than

oligopoly. Firm has

considerable

control over price





faced by firm

Perfect

competition

Very


(undifferentiated)

Cabbages, carrots

(approximately)

Horizontal:



Many /several




Undifferentiated

or differentiated

Cement

cars, electrical

appliances

Downward sloping.


(shape depends on



completely

blocked

Unique

Local water

company, train

operators (over

particular routes)

Downward sloping:

more inelastic than

oligopoly. Firm has

considerable

control over price





faced by firm

Perfect

competition

Very


(undifferentiated)

Cabbages, carrots

(approximately)

Horizontal:



Many /several




Undifferentiated

or differentiated

Cement

cars, electrical

appliances

Downward sloping.


(shape depends on



completely

blocked

Unique

Local water

company, train

operators (over

particular routes)

Downward sloping:

more inelastic than

oligopoly. Firm has

considerable

control over price




•

The four market structures – perfect competition

– monopoly

– monopolistic competition

– oligopoly

• Structure conduct performance



Perfect Competition

•

Assumptions – firms are price takers

– freedom of entry of firms to industry

– identical products

– perfect knowledge

•

Distinction between short and long run – normal profits

– supernormal profits



Perfect Competition

•

Short-run equilibrium of the firm – Price

• given by market demand and supply

– Output

• where P = MC

– Profit

• (AR – AC ) × Q

• possible supernormal profits



O

£

(b) Firm

Q (thousands)

O

(a) Industry

P

Q (millions)

S

D

P e

MC

AR D = AR= MR

Qe

AC

AC

Short-run equilibrium of industry and firm under perfect

competition



Qe

P 1D1 = AR 1

= MR 1 AR 1

O O

(a) Industry

P £

Q (millions)

S

D

(b) Firm

MC AC

AC

Q (thousands)

Loss minimising under perfect competition



D2

Short-run shut-down point

O O

(a) Industry

P £

P 2

Q (millions)

S

(b) Firm

AR 2

D2 = AR 2

= MR 2

MC AC

AVC

Q (thousands)



Perfect Competition

• Short-run equilibrium of the firm (cont.)

– short-run supply curve of firm

• the MC curve

• Short-run supply curve of industry

– sum of supply curves of firms



Perfect Competition

•

The long run – long-run equilibrium of the firm

• all supernormal profits competed away



O O

P £

Q (millions)

S1

D

LRAC

P L

P 1

QL

Se

AR 1 D1

AR L DL

Q (thousands)

Long-run equilibrium under perfect competition

New firms enterSupernormal profitsProfits return

to normal

(a) Industry (b) Firm



Perfect Competition

•

The long run – long-run equilibrium of the firm


• LRAC = AC = MC = MR = AR



£

QO

(SR)AC

(SR)MC

LRAC

AR = MR

DL

LRAC = (SR)AC = (SR)MC = MR = AR

Long-run equilibrium of the firm under perfect competition



Perfect Competition

• The long run

– long-run equilibrium of the firm


•LRAC = AC = MC = MR = AR

– long-run industry supply curve



Perfect Competition

• The long run





– incompatibility of economies of scale with

perfect competition



Perfect Competition

• The long run





– incompatibility of economies of scale with

perfect competition

• Does the firm benefit from operatingunder perfect competition?



Monopoly

• Defining monopoly

– importance of market power

– concentration ratios



Concentration ratios in the UK

Industry 5-firm ratio Industry 5-firm ratio

Chilled Indian ready meals 89.3 Bottled water (still) 58.0

Frozen Indian ready meals 75.0 Bottled water (sparkling) 35.0

Record companies 73.9 Frozen foods 34.4

Batteries 70.9

Skin care products 64.4 3-firm ratio

Jeans retail 39.0 Chocolate manufactures 76.0

Book publishing 37.6 Breakfast cereals 69.0



Monopoly

•

Barriers to entry – economies of scale

– product differentiation and brand loyalty

– lower costs for an established firm

– ownership/control of key factors or outlets

–

legal protection – mergers and takeovers

– aggressive tactics



Monopoly

• The monopolist's demand curve

– downward sloping

– MR below AR

AR d MR f l



-4

-2

0

2

4

6

8

1 2 3 4 5 6 7

AR and MR curves for a monopoly

Q

(units)

1

23

4

5

6

7

P =AR

(£)

8

76

5

4

3

2

AR A R , M

R ( £ )

Quantity




-4

-2

0

2

4

6

8

1 2 3 4 5 6 7

Q

(units)

1

23

4

5

6

7

P =AR

(£)

8

76

5

4

3

2

TR

(£)

8

1418

20

20

18

14

MR

(£)

64

2

0

-2

-4

MR

A R , M

R ( £ )

Quantity

AR


M l



Monopoly

•

Equilibrium price and output – MC = MR

Profit maximising under monopoly




MR

£

QO

MC

Qm

M l



Monopoly

•


– measuring level of supernormal profit





MR

£

QO

MC

Qm




£

QO

MC

AC

Qm

MR

AR

AC

AR





£

QO

MC

AC

Qm

MR

AR

AC

AR

Total profit


M l



Monopoly

•



• Monopoly versus perfect competition

M l



Monopoly

•




– lower output at a higher price

Equilibrium of industry under perfect competition and



AR = D

MC

MR

£

QO Q1

P 1

Monopoly


monopoly: with the same MC curve




£

QO

MC ( = supply under

perfect competition)

Q1

MR

P 1

P 2

Q2

AR = D

Comparison withPerfect competition


monopoly: with the same MC curve

Monopoly



Monopoly

•





•

short run and long run

Monopoly



Monopoly

• Equilibrium price and output

– MC = MR




•


– costs under monopoly




£

QO Q1

MR

P 1

MC monopoly

AR = D


monopoly: with different MC curves




£

QO

MC ( = supply)perfect competition

Q1

MR

P 1

P 2

Q2

MC monopoly

AR = D

x

Q3

P 3


monopoly: with different MC curves

Monopoly



Monopoly

• Equilibrium price and output

– MC = MR




•


– costs under monopoly

– innovation and new products

Contestable Markets



Contestable Markets

• Importance of potential competition

– low entry costs

– low exit costs

• Perfectly contestable markets

• Contestable markets & naturalmonopolies

• The importance of costless exit

– absence of sunk costs

– hit-and-run competition

• Assessment of the theory