Perfect Competition and Monopoly
Perfect Competition and Monopoly
Perfect Competition and Monopoly
Perfect Competition
Conditions:
Large number of buyers and sellers
Homogeneous product
Perfect knowledge
Free entry and exit
No government intervention
Key Implications:
Flat firms demand determined by market equilibrium price
Market participants are price takers without any market power to
influence prices (have to charge MR = P = MC)
In the short run firms earn profits or losses or shut down
In the long run profit = normal = 0 (firms operate efficiently)
Unrealistic? Why Learn?
Qf(units)
$ $
SM
Df = Pf = AR = MR
PM
DM
QM(106) Qf(units)
Market Firm
Setting Output
To maximize total profit: T = TR - TC
FONC: dT /dQ = M = MR - MC = 0
In general (including monopoly) MR = MC.
In perfect competition MR = P = MC.
$ $
S
Entry S*
Pe Df
Pe* Df*
QM Qf
Market Firm
Pe Df
Pe* Df*
QL Qf* Q
Key Implications:
Downward sloping firms demand is market demand
Firm has market power and determines market price
(can charge P > MR = MC)
In the short run monopoly earns profit or loss or shuts down
In the long run profit > normal is sustainable indefinitely but even
with profit = normal = 0 (monopoly does not operate efficiently)
Sources of Monopoly Power
Natural:
Economies of scale and excess capacity
Economies of scope and cost complementarities
Capital requirements, sales and distribution networks
Differentiated products and brand loyalty
Created:
Patents and other legal barriers (licenses)
Tying and exclusive contracts
Collusion (tacit or open)
Entry limit pricing (predatory pricing illegal)
Natural Monopoly
Economies of scale exist
over the entire LAC curve.
Price (cents per kilowatt-hour)
PPC
Producer Efficient D = P = MR
surplus quantity
0 QPC Quantity
Inefficiency of Monopoly
Price
Consumer
surplus
MR Producer D=P
surplus
0 QM QPC Quantity
Monopoly in the
Long Run with
Greater than Normal
and Normal Profit
Socially inefficient: P > MR = MC
(QM<QPC, PM>PPC, dead weight loss)
Scale inefficient: P > MC = min AC
(economies of scale still exist)
Misallocated resources: even when
T = normal = 0, P is still > min AC
(because of market power or barriers
to entry opportunity cost < TR)
P = MR = 40 = 8Q = MC MR = 100 - 2Q = 8Q = MC