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 2

Alternative Market Structures The four market structures perfect competition monopoly monopolistic competition oligopoly 2

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 2

Perfect Competition Assumptions Distinction between short and long run 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 4

Perfect Competition Short-run equilibrium of the firm Price Output given by market demand and supply Output where P = MC Profit (AR – AC) × Q possible supernormal profits 4

Short-run equilibrium of industry and firm under perfect competition AC MC P £ S D AR D = AR = MR Pe AC O O Qe Q (millions) Q (thousands) (a) Industry (b) Firm

Loss minimising under perfect competition AC MC P £ S AC D1 = AR1 = MR1 AR1 Qe P1 D O O Q (millions) Q (thousands) (a) Industry (b) Firm

Short-run shut-down point AVC P £ AC MC S D2 AR2 D2 = AR2 = MR2 P2 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 4

Perfect Competition The long run long-run equilibrium of the firm all supernormal profits competed away 5

Long-run equilibrium under perfect competition Profits return to normal New firms enter Supernormal profits LRAC P £ S1 D Se P1 AR1 D1 PL ARL DL 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 5

Long-run equilibrium of the firm under perfect competition LRAC Long-run equilibrium of the firm under perfect competition (SR)MC £ (SR)AC AR = MR DL 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 5

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 5

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? 5

Monopoly Defining monopoly importance of market power concentration ratios 8

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 8

Monopoly The monopolist's demand curve downward sloping MR below AR 8

AR and MR curves for a monopoly Q (units) P =AR (£) 1 2 3 4 5 6 7 8 7 6 5 4 3 2 AR, MR (£) AR Quantity

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

Monopoly Equilibrium price and output MC = MR 8

Profit maximising under monopoly MC £ MR O Qm Q

Monopoly Equilibrium price and output MC = MR measuring level of supernormal profit 8

Profit maximising under monopoly MC £ MR O Qm Q

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

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

Monopoly Equilibrium price and output MC = MR measuring level of supernormal profit Monopoly versus perfect competition 8

Monopoly Equilibrium price and output MC = MR measuring level of supernormal profit Monopoly versus perfect competition lower output at a higher price 8

Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ AR = D MR Monopoly P1 O Q1 Q

Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ MC ( = supply under perfect competition) Comparison with Perfect competition P1 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 8

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 8

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 8

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 11