Chapter 6: Competitive, Monopolistic, and Monopolistically Competitive Markets

Competitive, Monopolistic, and Monopolistically Competitive Markets

1. Chapter 6 Market Structure Competitive, Monopolistic, and Monopolistically Competitive Markets

2. Perfect competition

3. Learning Objectives After studying this chapter, you will be able to : Explain the concept of market structure and its significance Describe the characteristics of the different types of market, Perfect competition, Monopoly, Monopolistic competition, and oligopoly explain the equilibrium conditions for different types of market in terms of price and output, both in graphical and algebraic terms Identify the sources of monopoly power, and marginal principle to determine the profit maximizing price and output Explain firm’s short run and long run profits and whether firms shut down or continue when firms making loss 2- 3

4. Perfect competition Perfectly competitive markets are characterized by: many buyers and sellers in the market. Each firm in the market produces a homogeneous (identical) product. Buyers and sellers have perfect information. No transaction costs. Free entry and exit from the market. price is determined by the interaction of demand and supply, firms in the market will be price-takers firms earn zero economic profits in the long run . 8- 4

5. A Video about For more Video on Perfect Competition and Monopolies https://www.youtube.com/watch?v=vihuK8JoK14

6. Price and Demand at the Market and Firm Levels Market output Price     D Price Firm’s output S Market Firm

7. Short-Run Output Decisions In the short run some factors of production are fixed. To maximize short-run profits, managers must determine how much output will be produced by changing the variable inputs when the fixed inputs are given (fixed costs). 8- 7

8. Short-Run Profit Maximization 8- 8 Firm’s output $ Revenue   A B Slope of   E Costs   Slope of   Maximum profits  

9. Perfect Competitive Demand The demand curve for a competitive firm is a horizontal line at the market price. This price is the competitive firm’s marginal revenue.   8- 9

10. Profit Maximization under Perfect Competition Firm’s output $             Profit

11. Profit Maximizing Output Rule To maximize profits, a perfectly competitive firm produces the output at which price equals marginal cost.   8- 11

12. Short-Run Loss Minimization Firm’s output $           Loss    

13. The Shut-Down Decision Firm’s output $           Fixed Cost       Loss if produce Loss if shut down

14. Short-Run Output Decision for a competitive firm To maximize short-run profits, a perfectly competitive firm should produce in the range of increasing marginal cost where , provided that . If , the firm should shut down its plant to minimize it losses. The short-run supply curve for a perfectly competitive firm is its marginal cost curve above the minimum point on the curve   8- 14

15. Firms Short-Run Supply Curve Firm’s output $             Short-run supply curve for individual firm

16. Market Supply Curve Market output P 1 $10 $12 Market supply curve Individual firm’s supply curve   500 S

17. Long-Run Competitive Equilibrium Firm’s output $           Long-run competitive equilibrium  

18. Chapter 6 Market Structure Competitive, Monopolistic, and Monopolistically Competitive Markets

19. monopoly

20. Monopoly and Monopoly Power A single firm serves an entire market for a good that has no close substitutes. Barriers to entry: Only seller of a good in a market gives that firm with greater market power. To maximize profits, a monopoly will chose the output at which marginal revenue equals marginal costs The demand curve is downward-sloping so marginal revenue is less than market price. 8- 20

21. A Video about For more Video on Monopoly https://www.youtube.com/watch?v=Sb_- wfmJnHA

22. Sources of Monopoly Power Economies of scale Economies of scope Cost complementarity Patents and other legal barriers 8- 22

23. Elasticity of Demand and Total Revenues Q Revenue     Price Firm’s output   Unitary Unitary Elastic Inelastic Inelastic Elastic Maximum revenues     MR

24. Marginal Revenue and Elasticity The monopolist’s marginal revenue function is , where is the elasticity of demand for the monopolist’s product and is the price charged. For when . when . when .   8- 24

25. Monopolist’s Output Rule A profit-maximizing monopolist should produce the output, , such that marginal revenue equals marginal cost:   8- 25

26. Costs, Revenues, and Profit Output $ Cost function     Slope of   Slope of   Revenue function   Maximum profit

27. Price Quantity Demand MR MC     ATC )   Profits   Profit Maximization 8- 27

28. Monopolist’s Pricing Rule Given the level of output, , that maximizes profits, the monopoly price is the price on the demand curve corresponding to the units produced:   8- 28

29. Monopolist’s Supply Curve In perfectly competitive markets, price is equal to marginal cost ( ). Thus, a supply curve exists in perfectly competitive markets. A monopolist’s market power implies . Thus, there is no supply curve for a monopolist   8 - 29

30. Multiplant Output Decisions Monopolist produces output in different locations. Manager has to determine how much output will be produced at each plant. Consider a monopolist producing output at two plants: The cost of producing units at plant 1 is , and the cost of producing at plant 2 is . When the monopolist produces a homogeneous product, the per-unit price consumers are willing to pay for the total output produced at the two plants is , where .   8- 30

31. Multiplant Output Rule Let be the marginal revenue of producing a total of units of output. Suppose the marginal cost of producing units of output in plant 1 is and that of producing units in plant 2 is . The profit-maximizing rule for the two-plant monopolist is to allocate output among the two plants such that:   8- 31

32. Production with two plants 2- 32 Quantity $/Q D = AR MR MC 1 MC 2 MC T MR* Q 1 Q 2 Q T P*

33. Barriers to Entry and Monopolist’s profit A monopolist may earn positive economic profits, because barriers to entry prevents other firms from entering the market to reap a portion of those profits. Monopoly profits will continue over time provided the monopoly maintains its market power. Monopoly power, however, does not guarantee positive profits. Profits depend on the average total cost curve When the optimal price exactly equals the average total cost of production In the short run, monopoly earns a zero economic profits or even experience losses. 8- 33

34. Price Quantity Demand MR MC     ATC Zero-Profit Monopolist 8- 34

35. The Social Costs of Monopoly Power The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost. Social cost of monopoly is likely to exceed the deadweight loss Rent Seeking The larger the transfer from consumers to the firm, the larger the social cost of monopoly 8- 35

36. Price Quantity Demand MR MC     Deadweight Loss of Monopolist 8- 36     Deadweight loss

37. Chapter 6 Market Structure Competitive, Monopolistic, and Monopolistically Competitive Markets

38. Monopolistic competition

39. Monopolistic Competition There are five main conditions for monopolistic competition to exist: 1. There are many buyers and sellers in the industry. 2. Each firm produces a slightly differentiated product. 3. There are minimal barriers to entry or exit . 4. All firms have identical cost and demand functions . 5. Firms do not take into account competitors ’ behaviour in determining price and output . A key difference between monopolistically competitive and perfectly competitive markets is that each firm produces a slightly differentiated product. 2- 39

40. A Video about For more Video on Monopolistic Competition https://www.youtube.com/watch?v= T3F1Vt3IyNc

41. Price Quantity Demand MR MC     ATC Profit-Maximizing Monopolistically Competitive Firm     Profits

42. Profit-Maximization Rule To maximize profits, a monopolistically competitive firm produces where its marginal revenue equals marginal cost. The profit-maximizing price is the maximum price per unit that consumers are willing to pay for the profit-maximizing level of output. the profit-maximizing output, , is such that and the profit-maximizing price is .   8- 42

43. Long-Run Equilibrium Monopolistically competitive earns short-run profits, new firms will enter in the long run to capture some of those profits. some firms will exit the industry in the long run. The demand curve will tangential to the average cost curve, firms earn zero economic profit There is no incentive for additional firms to enter the industry 8- 43

44. Price Quantity of Brand X Demand MR MC     ATC Monopolistically Competitive Market 8- 44 Demand 1 MR 1 Due to entry of new firms selling other brands

45. Price Quantity of Brand X MC     ATC Long-Run Monopolistically Competitive Equilibrium Demand 1 MR 1 Long-run monopolistically competitive equilibrium

46. Long-Run Monopolistic Competition In the long run, monopolistically competitive firms produce a level of output such that:   8- 46

47. Product Differentiation Firms produces differentiated products in monopolistically competitive markets Firms in these industries continually convince consumers that their products are better than their competitors. Two strategies monopolistically competitive firms use to persuade consumers: Comparative advertising: firms attempts to increase the demand for its brand by differentiation Niche marketing: goods and services are tailored to meet the particular market segment 8- 47

48. Conclusion Firms operating in a perfectly competitive market take the market price as given. Produce output where . Firms may earn profits or losses in the short run. But in the long run, entry or exit forces economic profits to zero. A monopoly firm, in contrast, can earn persistent profits provided that the source of monopoly power is not eliminated. A monopolistically competitive firm can earn profits in the short run, but entry by competing brands will erode these profits in the long run.   8- 48

49. Chapter 6 Market Structure Competitive, Monopolistic, and Monopolistically Competitive Markets

50. Recap On Key Terms and Concepts 2- 50

51. Key Terms and Concepts Brand equity Comparative advertising Cost complementarities Deadweight loss of monopoly Economies of scale Multiplant monopoly Niece marketing Patents Product differentiation 2- 51