Managerial Economics in A Global Economy, 5th Edition by Dominick Salvatore

Managerial Economics in a
Global Economy, 5th Edition

by
Dominick Salvatore
Chapter 8
Market Structure: Perfect
Competition, Monopoly and
Monopolistic Competition
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 1
Market Structure
Competitive
Less
Perfect Competition
Monopolistic
Competitive
Competition
Oligopoly
More
Monopoly
Perfect Competition
• Too Many buyers and too many sellers
• Buyers and sellers are price takers
• Product is homogeneous
• Perfect mobility of resources
• Economic agents have perfect
knowledge
• Example: Stock Market
• Many sellers and buyers
• Differentiated product
• Perfect mobility of resources
• Example: Fast-food outlets
Oligopoly
• Few sellers and many buyers
• Product may be homogeneous or
differentiated
• Barriers to resource mobility
• Example: Automobile manufacturers
Monopoly
• Single seller and many buyers
• No close substitutes for product
• Significant barriers to resource mobility
– Control of an essential input
– Patents or copyrights
– Economies of scale: Natural monopoly
– Government franchise: Post office
Perfect Competition:
Price Determination
Price Determination
QD  625  5P QD  QS QS  175  5P
625  5 P  175  5 P
450  10P
P  $45
QD  625  5 P  625  5(45)  400
QS  175  5 P  175  5(45)  400
Short-Run Equilibrium
Firm’s Demand Curve = Market Price
= Marginal Revenue
Firm’s Supply Curve = Marginal Cost

where Marginal Cost > Average Variable Cost
Long-Run Equilibrium
Quantity is set by the firm so that short-run:
Price = Marginal Cost = Average Total Cost
At the same quantity, long-run:

Price = Marginal Cost = Average Cost
Economic Profit = 0
Problem 1: Perfect Market Firm
• Suppose the demand curve market faces is P=1000-2Q,
and the supply curve is P=100+Q. If the Total Cost
curve of a representative firm faces is 100+q2+q, where
q is the quantity of production of the firm, what is the
equilibrium of the market and the firm? How much is
profit or loss of the firm? Show the long run equilibrium
of the firm and the market. Compare between short run
and long run market equilibrium.
• Answer:
• The equilibrium of the market with Pd=Ps gives us an
equilibrium Q=300, and the equilibrium price is
$400.
• The MC is the first difference of TC, So. MC=2q+1, MR is the equilibrium
price or $400. So, MC=MR solves with q=199.5 which is the equilibrium
quantity of the firm.
• To find out the profit or loss, we need to find out ATC since AR is already
known which is equal to price.
• ATC=TC/q=(100+q2+q)/q or, 100/q+q+1, and at a q=199.5, We can derive
AC =100/199.5+199.5+1=$201.00125.
• Per unit profit turns up, (AR-AC)=$400-$201.00125
• =$198.99875,
• The total profit with a q=199.5 is (195.5*198.99875)= $39,700.5
• In total approach,
• Profit=TR-TC
• TR=400*199.5=$79,800
• TC=100+199.52+199.5=$40,099.75
• Total Profit=$79,800-$40,099.75=$39,700.25, this must be short run profit.
• Long run equilibrium of firm: MC=MR=ATC
• ATC=TC/q=(100+q2+q)/q=100/q+q+1
• Find out the q that equates MC=ATC, 2q+1=100/q+q+1, So, q=10
• MC=2*10+1=$21
• ATC=100/10+10+1=$21
• Show TR=TC,
• TC=$21*10=$210
• TR=Price*quantity=$21*10=$210
• So, TR equals TC and profit is zero.
• Long run market equilibrium: With a price of $21, the equilibrium
quantity of the market turns up: P=1000-2Q, replacing the P by
$21, the quantity is 489.5
• Effect in the long run: The price goes down from $400 in the short
run to a paltry $21 in the long run and number of firms are higher
as well. In the market demand curve P=1000-2Q, if we replace by
the price $21 then the equilibrium quantity is 489.5 units in the
long run, compared to 300 units in the short run.
• Given TC=2q2+5q+50 and market demand function of price1025-2Q,
where Q represents market quantity and q represents the firm
quantity.
• a) find out the average cost curve.
• Answer: AC=TC/q=2q+5+50/q
• b) What is the long run equilibrium in this market?
• Answer: Since the supply curve of the market is not given so we have
to define equilibrium price from MC=ATC=Price.
• MC derived from first order differentiation of TC with respect to q,
MC=4q+5. ATC has been derived as 2q+5+50/q. Solving q for
MC=ATC, q=5. Putting q into MC, or into ATC, price is $25.
• With an equilibrium price of $25, the market demand curve gives us
the equilibrium quantity of the market:
• P=$25=1025-2Q, find out the Q that solves 25, which is 500 and that
is the equilibrium quantity of the market. Assuming a typical firm
shares 5 units each, we can find out the number of firms as 100.
• Suppose the market demand curve follows the price=100-4Q, and the
supply curve follows the price=Q. The TC of the firm follows=50+4q+2q2.
• a) What is the market equilibrium price and quantity?
• Answer: Pd=Ps solves the equilibrium quantity of the market of 20. Putting
the quantity in either demand price or supply price curve the equilibrium
price turns up to be $20.
• b) What are the equilibrium quantity of the firm and profit or loss?
• Answer: Equilibrium condition, MC=MR
• MC derived from first difference of TC is 4q+4, and MR equals the
equilibrium price of $20. By solving the q to satisfy MC=MR, q is 4.
• TR=P*q= $20*4=$80
• TC=50+4(4)+2(4)2= $98.
• TC is greater than TR, so there is a loss to an amount of =80-98=-18.
• c) How many firms are there in the market?
• Answer: 20/4=5 assuming the firm is a representative one.
• d) What is the long run equilibrium: For firm equilibrium condition, MC=ATC
solves q=5, and putting q=5 into MC or ATC the price turns up $24.
• Putting a price of $24 into the market demand curve, equilibrium Q=19.
Competition in the
Global Economy
Domestic Supply
World Supply
Domestic Demand
Monopoly
• Single seller that produces a product
with no close substitutes
• Sources of Monopoly
– Control of an essential input to a product
– Patents or copyrights
– Economies of scale: Natural monopoly
– Government franchise: Post office
Monopoly
• Demand curve for the firm is the market
demand curve
• Firm produces a quantity (Q*) where
marginal revenue (MR) is equal to
marginal cost (MC)
• Exception: Q* = 0 if average variable
cost (AVC) is above the demand curve
at all levels of output
Monopoly
Q* = 500
P* = $11
Problem 4: Monopoly
• A monopolist’s cost function is TC=100Q+1500 and the demand function is P=300-5Q. How
much does the monopolist produce? What is the price and profit in the short run?
• For equilibrium, MC=MR
• MC derived from first differentiation of TC with respect to Q turns up like 100.
• Firstly, we need TR, that can be derived through multiplying P or AR by Q and turns up:
TR=300Q-5Q2, and then, MR can be derived as the first differentiation of TR and takes the
form: MR=300-10Q.
• The Q that equates MC=MR is: Q=20
• The second order condition is the first differentiation MC should be greater than that of MR;
d/dQ(MC) is 0 and d/dQ(MR) is -10. Since 0 is greater than -10, so equilibrium quantity is
derived as 20.
• The equilibrium price is derived putting Q into P=AR, like 300-5(20)=$200
• To get AC at the Q, TC is divided by Q: AC=(100Q+1500)/Q= $175.
• Total profit =(200-175)*20=$500.
Problem 5: Monopoly
• Market demand for monopolist: P=100-Q and Average cost (ATC) =
20+(3/10)Q. Evaluate the equilibrium situation. Compare the situation with
regulation imposed by (a) Price=ATC and (b) P=MC.
• First of all we need MC and MR.
• TC can be derived through multiplying ATC by Q and takes the form:
TC=20Q+3/10Q2, and as the first differentiation of TC is MC, so,
MC=20+3/5Q
• TR can be derived through multiplying the price or AR function by Q, like,
TR=100Q-Q2, and as the first differentiation of TR is MR,
• So, MR=100-2Q.
• Equalizing MC and MR, and solving Q we get the equilibrium Q =30.77=31
(approx)
• Putting this Q into price function we get the equilibrium price = $69.
• Total profit=(P-ATC)*Q={69-[20+3/10(31)]}*(31)=$1,230.
Problem 5: Monopoly (Contd.)
• Regulation (a) : P=ATC
• P=100-Q, and ATC=20+(3/10)Q
• Solving Q in P=ATC, we get the equilibrium Q=61.54
• Putting 61.54 into the demand curve, we get the price=$38.5
• At Q=61.54, total profit =(P-ATC)*(Q)=[38.5-20+3/10(61.54)]*(61.54)=0
• Regulation (b) : P=MC
• So, 100-Q=20+3/5Q, So, Q=50
• At Q=50, P=$50.
• Total Profit=(P-ATC)*Q=[50-20+3/10(50)]*50=(50-35)*(50)=750
Normal P=ATC P=MC

Quantity 31 61.54 50
Price $69 $38.5 $50
Profit $1,230 0 $750
Price ($) Graph: Problem 5
69 MC
50 ATC
38
35
29
D=AR
MR
Quantity
31 50 61
Monopoly
Q* = 700
P* = $9
Social Cost of Monopoly
Price Discrimination
• Many sellers of differentiated (similar

but not identical) products
• Limited monopoly power
• Downward-sloping demand curve
• Increase in market share by
competitors causes decrease in
demand for the firm’s product
Profit = 0
Cost with selling expenses
Cost without selling expenses
Oligopoly Market:
Kinked Demand Curve Model
• Proposed by Paul Sweezy
• If an oligopolist raises price, other firms will not
follow, so demand will be elastic
• If an oligopolist lowers price, other firms will follow, so
demand will be inelastic
• Implication is that demand curve will be kinked, MR
will have a discontinuity, and oligopolists will not
change price when marginal cost changes
Kinked Demand Curve Model
Cournot Model
• Proposed by Augustin Cournot
• Example
– Two firms (duopoly)
– Identical products
– Marginal cost is zero
– Initially Firm A has a monopoly and then
Firm B enters the market
Cournot Model
• Adjustment process
– Entry by Firm B reduces the demand for
Firm A’s product
– Firm A reacts by reducing output, which
increases demand for Firm B’s product
– Firm B reacts by increasing output, which
reduces demand for Firm A’s product
– Firm A then reduces output further
– This continues until equilibrium is attained
Cournot Model
Cournot Model
• Equilibrium
– Firms are maximizing profits
simultaneously
– The market is shared equally among the
firms
– Price is above the competitive equilibrium
and below the monopoly equilibrium

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Managerial Economics in A Global Economy, 5th Edition by Dominick Salvatore

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Managerial Economics in a

Global Economy, 5th Edition

Firm’s Supply Curve = Marginal Cost

At the same quantity, long-run:

Normal P=ATC P=MC

• Many sellers of differentiated (similar

Cost with selling expenses

Cost without selling expenses

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