Markets: Perfect Competition & Monopoly

What is a market structure? A market structure – identifies how a market is made up in terms of: The number of firms in the industry The nature of the product produced The degree of monopoly power each firm has The degree to which the firm can influence price Profit levels Firms’ behaviour – pricing strategies, non-price competition, output levels The extent of barriers to entry The impact on efficiency

Market Structures More competitive (fewer imperfections) Perfect Competition Pure Monopoly More competitive (fewer imperfections)

Monopolistic Competition Market Structures Pure Monopoly Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly The further right on the scale, the greater the degree of monopoly power exercised by the firm.

Features of Four Market Structures

Market Structures Why is it important? Degree of competition affects the consumer – will it benefit the consumer or not? Impacts on the performance and behaviour of the company/companies involved

Market Structures Models – a word of warning! Market structure deals with a number of economic ‘models’ These models are a representation of reality to help us to understand what may be happening in real life There are extremes to the model that are unlikely to occur in reality They still have value as they enable us to draw comparisons and contrasts with what is observed in reality Therefore, models help in analysing and evaluating – they offer a benchmark

Market Structures Characteristics of each model: Number and size of firms that make up the industry Control over price or output Freedom of entry and exit from the industry Nature of the product – degree of homogeneity (similarity) of the products in the industry (extent to which products can be regarded as substitutes for each other) Diagrammatic representation – the shape of the demand curve, etc.

Market Structures Characteristics: Look at these everyday products – what type of market structure are the producers of these products operating in? Mercedes CLK Coupe Bananas Canon SLR Camera Vodka Electric Guitar – Jazz Body Remember to think about the nature of the product, entry and exit, behaviour of the firms, number and size of the firms in the industry. You might even have to ask what the industry is??

Perfect Competition One extreme of the market structure spectrum Characteristics: Large number of firms Products are homogenous (identical) – consumer has no reason to express a preference for any firm Freedom of entry and exit into and out of the industry Firms are price takers – have no control over the price they charge for their product Each producer supplies a very small proportion of total industry output Consumers and producers have perfect knowledge about the market Distinction between short and long run normal profits supernormal profits

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 incompatibility of economies of scale with perfect competition Does the firm benefit from operating under perfect competition? 5

Monopoly Pure monopoly – where only one producer exists in the industry In reality, rarely exists – always some form of substitute available! Monopoly exists, therefore, where one firm dominates the market Firms may be investigated for examples of monopoly power when market share exceeds 25% Use term ‘monopoly power’ with care!

Monopoly Monopoly power – refers to cases where firms influence the market in some way through their behaviour – determined by the degree of concentration in the industry Influence prices by influencing output Erect barriers to entry e.g. economies of scale, brand loyalty, aggressive tactics Pricing strategies to prevent or stifle competition May not pursue profit maximisation – encourages unwanted entrants to the market Sometimes seen as a case of market failure

Monopoly Origins of monopoly: Through growth of the firm Through amalgamation, merger or takeover Through acquiring patent or license Through legal means – Royal charter, Nationalisation

A Monopolist Exploits Consumers

Monopoly Summary of characteristics of firms exercising monopoly power: Price – could be deemed too high, may be set to destroy competition (destroyer or predatory pricing), price discrimination possible. Efficiency – could be inefficient due to lack of competition (X- inefficiency) or… could be higher due to availability of high profits

Monopoly Innovation - could be high because of the promise of high profits, Possibly encourages high investment in research and development (R&D) Collusion – possible to maintain monopoly power of key firms in industry High levels of branding, advertising and non-price competition

Monopoly But…note: Monopolies not always ‘bad’ – may be desirable in some cases but may need strong regulation Monopolies do not have to be big – could exist locally

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

AR and MR curves for a Monopoly AR, MR (£) AR Quantity MR

Monopoly Equilibrium price and output MC = MR 8

Profit maximising under Monopoly MC £ MR O Qm Q

Monopoly Measuring level of supernormal profit 8

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 Monopoly versus perfect competition lower output at a higher price Short-run and long-run 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 Comparison with Perfect competition P1 P2 AR = D MR O Q1 Q2 Q

Monopoly Costs under monopoly i.e. the benefits of economies of scale 8

Equilibrium of industry under perfect competition and monopoly: with different MC curves £ MCmonopoly P1 AR = D MR O Q1 Q

MC perfect competition Equilibrium of industry under perfect competition and monopoly: with different MC curves £ MC perfect competition MCmonopoly P2 P1 AR = D MR O Q2 Q1 Q

Market Structures

Market Structures