Competition, Monopoly and Monopolistic Competition

1
Chapter 8

• Competition, Monopoly and Monopolistic Competition

2
Perfect Competition

• 1. many buyers and sellers (all price takers)
• 2. Firms produce the same product
• 3. perfect information
• 4. no transaction costs
• 5. free entry and exit of firms
• Examples agriculture, stock and commodity
  markets.

3
Implications

• Market price is the market equilibrium price.
  Firms are price takers.
• Firm can sell all it wants at the market price.
  Each firm is small.
• Firm demand is horizontal line at market price.
  P MR.
• Each additional unit of output can be sold at
  this price.

4
Market Determines Price

• Market equilibrium Pe is where supply equals
  demand
• Firm demand is horizontal line price-taker.

QF
QM
5
MR P

• Marginal revenue is equal to the market price
  because the price does not depend on the firms
  production level.
• TR(Q) P?Q
• MR(Q) dTR(Q)/dQ P

6
Maximizing Profits

• Profits total revenue minus total costs
• ?(Q) P?Q TC(Q)
• Setting d?(Q)/dQ 0 gives
• P ? MC(Q) 0
• or P MC(Q).

7
Firm Supply

• The firm supplies the quantity Q at which the
  MC(Q) P.

MC

AVC
P
Q
Q
8
Firm Profits

• If P gt ATC(QF), then
• ? P ? ATC(QF)QF gt 0
• If P ATC(QF), then ? 0.
• This occurs at the min ATC.
• If P min ATC, then ? 0.
• min ATC is where ATC MC.

9

• Firm may produce at a loss in the short run.
• Pe lt ATC so ? lt 0 profits are negative.
• But Pe gt AVC. Revenues cover variables costs.

10
Losses in the short-run

• Firms choice is to produce QF or Q 0
• Better to produce QF gt 0 if
• ?(QF) P?QF ? VC(QF) ? FC gt ?(0) ? FC
• P?QF ? VC(QF) gt 0
• QFP ? AVC(QF) gt 0
• P gt
  AVC(QF)
• If P lt min AVC, then it is better to shut down in
  the short run.

11
Firm Supply

• The firms short-run supply curve is the MC curve
  above min AVC.
• min AVC can be found by setting AVC MC.

12
Market Supply

• Market supply is the horizontal sum of all firm
  supplies in the industry.

13
Algebraic Example

• If TC(Q) 100 10Q2 then MC(Q) 20Q
• and firm supply is
• P 20Q MC and QF P/20.
• If there are 100 firms then market quantity is
• QM 100QF 100P/20 5P
• and market supply is
• P QM/5.

14
Entry and Exit

• In the long-run, firms choose to enter or exit
  the market.
• If ? gt 0 at P0, additional firms will enter.
• Market supply shifts out and the equilibrium
  price falls to P1 where ? 0.

Q
15

• If ? lt 0 at P0, additional firms will exit.
• Market supply shifts back and the equilibrium
  price rises to P1 where ? 0.

16
Long-run Equilibrium

• A long-run equilibrium is P min LAC.
• No firms want to enter or exit.

17
Long-run Efficiency

• Profits are maximize (P LMC) and profits are
  zero (P LAC).
• Economic profits take into account the
  opportunity cost of the owner(s) of the firm.
• The long-run equilibrium Pe can be found by
  setting LAC LMC

18
An Example

• If LRC 100Q 100Q2 ? 5Q3
• Set LAC LMC and solve for Q
• 100 100Q ? 5Q2 100 200Q ?15Q2
• 100Q ? 5Q2 200Q ? 15Q2
• 15Q ? 5Q 10Q 200 ? 100 100
• Q 10 and LAC(10) 600 Pe in the LR.

19
Practice Calculations

• Excel Sheet Make small changes in a,b,c or f to
• check your calculations of minATC and minAVC

20
Gains from Trade

• Because MC MB, gains from trade are maximized
  in a perfectly competitive market.

21
Monopoly

• A monopoly can arise from economies of scale,
  scope or cost complementarities that give one
  firm a cost advantage.
• A monopoly may be licensed or own a patent.
• A monopoly faces the market demand.
• If a monopoly firm wants to sell more of its
  product, it must lower its price.

22
MR lt P

• The change in revenue from selling one more unit
  of output is
• TR(Q01) ? TR(Q0) P1?(Q01) ? P0?Q0
• B ? A P1 ? A lt P1

23
Linear Demand

• If demand is P 100 ? 2 Q then
• TR(Q) P?Q (100 ? 2 Q)?Q 100 Q ? 2Q2.
• MR(Q) dTR(Q)/dQ 100 ? 4 Q.

24

• MR has the same vertical intercept and twice the
  slope as a linear demand
• At Q 25, MR 0, TR is maxd, EP -1

25
Profit maximization

• Set MR(Q) MC(Q).
• If TC(Q) 10 2Q, then
• MC(Q) 2
• Set MR(Q) 100 ? 4 Q 2 MC
• Solve for the optimal Q 24.5.
• Optimal P 100 ? 2(24.5) 5.1

26
There is no supply curve for a monopolist.
27
Implications of Monopoly

• If P gt AC, ? gt 0. No entry of other firms due to
  barriers to entry.

28
Inefficiency

• A lost gains from trade due to QM lt QPC

29
Multiple Plants

• Same product produced by two plants, 1
  and 2.
• ?(Q1,Q2) R(Q1 Q2) ? TC1(Q1) ? TC2(Q2)
• Optimal production implies
• MC1(Q1) MC2(Q2)

30
(No Transcript)
31
(No Transcript)
32
MC Equal Across Plants

• MC1(10) 3?10 30 MC2(30)
• So MC(40) 30 MR(Q) 70 ? Q

33
Monopolistic Competition

• 1. many buyers and sellers (like PC)
• 2. free entry and exit (like PC)
• 3. firms produce differentiated products
• Products are close, not perfect, substitutes
• Common consumer products
• cereals, personal hygiene, detergents
• Each variation designed to fit a niche in
  consumer tastes.
• Product distinctions require advertising.

34

• Each firm faces a negatively sloping demand for
  its product.
• Firms price like monopolists.
• Positive profits lead to entry of firms in the
  LR.
• Entry reduces firms demand.
• Entry and exit imply zero profits in the long run.

35
Positive profits in the SR
36
Zero Profit in LR

• Entry in the long run decreases firms demand

37
Implications

• In the long-run equilibrium, profits are zero but
  P gt MC inefficient
• and AC gt min AC inefficient
• Alternative is a homogeneous product produced by
  all firms.
• This would be a perfectly competitive market.
• Value of variety of products is hard to measure.