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Profit Maximisation under

Perfect Competition
and Monopoly
Alternative Market Structures

• Classifying markets (by degree of


competition)
– 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
Alternative Market Structures

• The four market structures


– perfect competition

– monopoly

– monopolistic competition
– oligopoly
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Alternative Market Structures

• 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
Short-run equilibrium of industry and firm under perfect
competition

P £
S MC AC

D = AR
Pe AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm


Loss minimising under perfect competition

P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm


Short-run shut-down point

P £ AC
S MC
AVC

D2 = AR2
P2 AR2
= MR2
D2
O O

Q (millions) Q (thousands)

(a) Industry (b) Firm


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
Long-run equilibrium under perfect competition
Profits return
Supernormal
New firms enter to normalprofits
P £
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm


Perfect Competition

• The long run


– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR
Long-run equilibrium of the firm under perfect competition
£ (SR)MC
(SR)AC

LRAC

DL
AR = MR

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

O Q
Perfect Competition

• The long run


– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR

– long-run industry supply curve


Perfect Competition

• The long run


– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR

– long-run industry supply curve


– incompatibility of economies of scale with
perfect competition
Perfect Competition

• The long run


– long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC = AC = MC = MR = AR

– long-run industry supply curve


– incompatibility of economies of scale with
perfect competition

• Does the firm benefit from operating


under perfect competition?
Monopoly

• Defining monopoly

– importance of market power

– concentration ratios
Concentration ratios in the UK
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 and MR curves for a monopoly
8 Q P
(units) =AR
1 (£)
8
2 7
6 6
3
4 5
5 4
AR, MR (£)

4 6 3
7 2

2 AR

0
1 2 3 4 5 6 7 Quantity

-2

-4
AR and MR curves for a monopoly
8 Q P TR MR
(units) =AR (£) (£)
1 (£)
8 8
6
2 7 14
6 6 4
3 18
2
4 5 20
0
5 4 20
-2
AR, MR (£)

4 6 3 18
-4
7 2 14

2 AR

0
1 2 3 4 5 6 7 Quantity

-2

-4 MR
Monopoly

• Equilibrium price and output


– MC = MR
Profit maximising under monopoly
£ MC

MR
O Qm Q
Monopoly

• Equilibrium price and output


– MC = MR
– measuring level of supernormal profit
Profit maximising under monopoly
£ MC

MR
O Qm Q
Profit maximising under monopoly
£ MC

AC

AR

AC

AR
MR
O Qm Q
Profit maximising under monopoly
£ MC
Total profit
AC

AR

AC

AR
MR
O Qm Q
Monopoly

• Equilibrium price and output


– MC = MR
– measuring level of supernormal profit

• Monopoly versus perfect competition


Monopoly

• Equilibrium price and output


– MC = MR
– measuring level of supernormal profit

• Monopoly versus perfect competition


– lower output at a higher price
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC

Monopoly
P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC ( = supply under
perfect competition)

Comparison with
P1 Perfect competition

P2

AR = D

MR
O Q1 Q2 Q
Monopoly

• Equilibrium price and output


– MC = MR
– measuring level of supernormal profit

• Monopoly versus perfect competition


– lower output at a higher price
• short run and long run
Monopoly

• Equilibrium price and output


– MC = MR
– measuring level of supernormal profit

• Monopoly versus perfect competition


– lower output at a higher price
• short run and long run

– costs under monopoly


Equilibrium of industry under perfect competition and
monopoly: with different MC curves
£

MCmonopoly

P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with different MC curves
£ MC ( = supply)perfect competition

MCmonopoly

P2

P1
x
P3

AR = D

MR
O Q2 Q1 Q3 Q
Monopoly

• Equilibrium price and output


– MC = MR
– measuring level of supernormal profit

• Monopoly versus perfect competition


– lower output at a higher price
• short run and long run

– costs under monopoly


– innovation and new products
Contestable Markets

• Importance of potential competition


– low entry costs
– low exit costs
• Perfectly contestable markets
• Contestable markets & natural
monopolies
• The importance of costless exit
– absence of sunk costs
– hit-and-run competition
• Assessment of the theory