Chapter 5 Perfect Competition, Monopoly, and Economic vs. Normal Profit

Chapter Outline From Perfect Competition to Monopoly Supply Under Perfect Competition

From Perfect Competition to Monopoly Monopolistic Competition Oligopoly Monopoly

Picking the Quantity to Maximize Profit The Perfectly Competitive Case Many Competitors MC ATC AVC Q* P* MR

Picking the Quantity to Maximize Profit The Monopoly Case No Competitors MC D MR ATC Q* P* AVC

Characteristics of Perfect Competition a large number of competitors, such that no one firm can influence the price the good a firm sells is indistinguishable from the ones its competitors sell firms have good sales and cost forecasts there is no legal or economic barrier to its entry into or exit from the market

Monopoly The sole seller of a good or service. Some monopolies are generated because of legal rights (patents and copyrights). Some monopolies are utilities (gas, water, electricity etc.) that result from high fixed costs.

Monopolistic Competition Monopolistic Competition: a situation in a market where there are many firms producing similar but not identical goods. Example : the fast-food industry. McDonald’s has a monopoly on the “Happy Meal” but has much competition in the market to feed kids burgers and fries.

Oligopoly Oligopoly: a situation in a market where there are very few discernible competitors Examples Satellite TV service (Direct TV, Dish Network) Airlines (American, Delta etc.)

Which Model Fits Reality? Perfect competition is rare outside agriculture though it fits some labor markets. Monopolies are common in utilities Major branded companies are typically either in oligopolistic or monopolistically competitive industries.

Examples of Different Market Forms Perfect Competition Monopolistic Competition Oligopoly Monopoly Agriculture Lumber Fast Food Long Distance Service Cars and Trucks Soft Drinks Windows Operating system Local Residential electric power

Distinguishing Characteristics Between Market Forms Perfect Competition Monopolistic Competition Oligopoly Monopoly Number of Firms Many-often thousands or even millions Several* Few* One Barriers to Entry None Few Substantial Insurmountable, at least in the short run Product Similarity Identical Similar but not identical Similar or Identical N/A * The line between “several” and “few” is not definite

Concentration Ratios there is no magic line that separates oligopoly from monopolistic competition. a “concentration ratio” measures the percentage of total market sales for the top firms (from 4 firms to 100 firms).

Concentration Ratios For Various Manufacturing Industries Industry Group Concentration Ratios 4 Largest Firms 8 Largest Firms 50 Largest Firms Breakfast Cereals 82.9% 93.5% 100.0% Ice Cream 32.3 48.7 88.3 Beer 89.7 93.4 96.7 Clothing 17.6 23.2 38.8 Computers and Peripherals 37.0 52.1 86.3 Furniture 11.2 37.2 Long Distance 47.0 74.9 95.4 Cellular Service 51.4 74.6 88.0

Supply Under Perfect Competition

Normal vs. Economic Profit Normal Profit : the level of profit that business owners could get in their next best alternative investment Economic Profit: any profit above normal profit

Return on Equity For Various Industries Industry Rate of Return Net Income/(Assets-Liabilities) Agriculture 8.0% Manufacturing 14.6% Transportation and Public Utilities 10.6% Wholesale and Retail Trade 12.9%

When and Why Economic Profits Go to Zero

Time Horizons Short Run: the period of time where we cannot change things like plant and equipment Long Run : the period of time where we can change things like plant and equipment

Market Forms and Economic Profits Under perfect competition or monopolistic competition, economic profits go to zero because of the entry of new firms increases market supply and lowers prices. Economic profits are under no pressure to shrink under oligopoly or monopoly because entry doesn’t occur so prices do not fall.

Figure 2 The Pressures on Price in Perfect Competition $ Q MC ATC AVC Long Run Pressure MR4 Short Run Pressure MR3 MR2 MR1

Figure 3 Points of Production in Perfect Competition $ Q MC ATC AVC MR4 MR3 MR2 MR1

Figure 4 Supply in Perfect Competition $ Q MC ATC AVC Supply