Profit Maximisation under Perfect Competition

1
Profit Maximisation under Perfect Competition and
Monopoly
2
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

3
Alternative Market Structures

• The four market structures
• perfect competition
• monopoly
• monopolistic competition
• oligopoly

4
Features of the four market structures
5
Features of the four market structures
6
Features of the four market structures
7
Features of the four market structures
8
Features of the four market structures
9
Features of the four market structures
10
Alternative Market Structures

• The four market structures
• perfect competition
• monopoly
• monopolistic competition
• oligopoly
• Structure ? conduct ? performance

11
Perfect Competition

• Assumptions
• 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

12
Perfect Competition

• Short-run equilibrium of the firm
• Price
• given by market demand and supply
• Output
• where P MC
• Profit
• (AR AC) Q
• possible supernormal profits

13
Short-run equilibrium of industry and firm under
perfect competition

P
O
O
Qe
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
14
Loss minimising under perfect competition
P

S
D
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
15
Short-run shut-down point
P

AC
MC
S
O
O
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
16
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

17
Perfect Competition

• The long run
• long-run equilibrium of the firm
• all supernormal profits competed away

18
Long-run equilibrium under perfect competition
Profits return to normal
Supernormal profits
New firms enter
P

O
O
QL
Q (thousands)
Q (millions)
(a) Industry
(b) Firm
19
Perfect Competition

• The long run
• long-run equilibrium of the firm
• all supernormal profits competed away
• LRAC AC MC MR AR

20
Long-run equilibrium of the firm under perfect
competition

O
Q
21
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

22
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

23
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?

24
Monopoly

• Defining monopoly
• importance of market power
• concentration ratios

25
Concentration ratios in the UK
26
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

27
Monopoly

• The monopolist's demand curve
• downward sloping
• MR below AR

28
AR and MR curves for a monopoly
Q (units)
P AR ()
8 7 6 5 4 3 2
1 2 3 4 5 6 7
AR, MR ()
AR
Quantity
29
AR and MR curves for a monopoly
Q (units)
P AR ()
TR ()
MR ()
8 7 6 5 4 3 2
8 14 18 20 20 18 14
1 2 3 4 5 6 7
6 4 2 0 -2 -4
AR, MR ()
AR
Quantity
MR
30
Monopoly

• Equilibrium price and output
• MC MR

31
Profit maximising under monopoly

Qm
O
Q
32
Monopoly

• Equilibrium price and output
• MC MR
• measuring level of supernormal profit

33
Profit maximising under monopoly

Qm
O
Q
34
Profit maximising under monopoly

MC
MR
Qm
O
Q
35
Profit maximising under monopoly

MC
AR
AC
MR
Qm
O
Q
36
Monopoly

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

37
Monopoly

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

38
Equilibrium of industry under perfect
competition and monopoly with the same MC curve

Monopoly
P1
Q1
O
Q
39
Equilibrium of industry under perfect
competition and monopoly with the same MC curve

MC ( supply under perfect competition)
Comparison with Perfect competition
P1
AR D
MR
Q1
Q2
O
Q
40
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

41
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

42
Equilibrium of industry under perfect
competition and monopoly with different MC curves

MCmonopoly
P1
AR D
MR
O
Q
Q1
43
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
Q3
Q
Q1
44
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

45
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