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Chapter 8 Perfect competition and pure monopoly

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Chapter 8 Perfect competition and pure monopoly David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9th Edition, McGraw-Hill, 2008 PowerPoint presentation ... – PowerPoint PPT presentation

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Title: Chapter 8 Perfect competition and pure monopoly


1
Chapter 8 Perfect competition and pure monopoly
  • David Begg, Stanley Fischer and Rudiger
    Dornbusch, Economics,
  • 9th Edition, McGraw-Hill, 2008
  • PowerPoint presentation by Alex Tackie and Damian
    Ward

2
Perfect competition
Characteristics of a perfectly competitive market
  • many buyers and sellers
  • so no individual believes that their own action
    can affect market price
  • firms take price as given
  • so face a horizontal demand curve
  • the product is homogeneous
  • perfect customer information
  • free entry and exit of firms

3
The supply curve under perfect competition (1)
  • Above price P3 (point C), the firm makes profit
    above the opportunity cost of capital in the
    short run
  • At price P3, (point C), the firm makes NORMAL
    PROFITS

4
The supply curve under perfect competition (2)
  • Between P1 and P3, (A and C), the firm makes
    short-run losses, but remains in the market
  • Below P1 (the SHUT-DOWN PRICE), the firm fails to
    cover SAVC, and exits

5
The supply curve under perfect competition (3)
  • So the SMC curve above SAVC represents the firms
    SHORT-RUN SUPPLY CURVE
  • showing how much the firm would produce at each
    price level.

6
The firm and the industry in the short run under
perfect competition (1)
INDUSTRY
Firm
SMC

SAC
P
DMRAR
Output
Market price is set at industry level at the
intersection of demand and supply
the industry supply curve is the sum of the
individual firms supply curves
7
The firm and the industry in the short run under
perfect competition (2)
INDUSTRY
Firm
The firm accepts price as given at P
and chooses output at q where SMCMR to
maximise profits
8
The firm and the industry in the short run under
perfect competition (3)
INDUSTRY
Firm

SMC
SRSS1
SAC
P
DMRAR
P1
q
Q1
Output
At this price, profits are shown by the shaded
area.
These profits attract new entrants into the
industry.
As more firms join the market, the industry
supply curve shifts to the right, and market
price falls.
9
Long-run equilibrium
INDUSTRY
Firm
The market settles in long-run equilibrium when
the typical firm just makes normal profit by
setting LMCMR at the minimum point of LAC.
Long-run industry supply is horizontal.
If the expansion of the industry pushes up input
prices (e.g. wages) the long-run supply curve
will not be horizontal, but upward-sloping.
10
Adjustment to an increase in market demand the
short run
Suppose a perfectly competitive market starts in
equilibrium at P0Q0.
If market demand shifts to D'D' ...
in the short run the new equilibrium is P1Q1 ...
adjustment is through expansion of
individual firms along their SMCs.
11
Adjustment to an increase in market demand the
long run
In the long run, new firms are attracted by the
profits now being made here

SRSS
D'
D
and firms are able to adjust their input of
fixed factors
P1
If wages are bid up by this expansion, the
long-run supply schedule is upward- sloping
P0
D'
D
Q0
Q1
Output
12
Monopoly
  • A monopolist
  • is the sole supplier of an industrys product
  • and the only potential supplier
  • is protected by some form of barrier to entry
  • faces the market demand curve directly
  • Unlike under perfect competition, MR is always
    below AR.

13
WHY MONOPOLIES ARISE
  • Barriers to entry have three sources
  • Ownership of a key resource.
  • The government gives a single firm the exclusive
    right to produce some good.
  • Costs of production make a single producer more
    efficient than a large number of producers.

14
Profit maximisation by a monopolist
Profits are maximised where MC MR at Q1P1.
In this position, AR is greater than AC so the
firm makes profits above the opportunity cost
of capital shown by the shaded area.
Entry barriers prevent new firms joining
the industry.
15
Comparing monopoly with perfect competition (1)
Suppose a competitive industry is taken over by a
monopolist
P2
The monopolist maximises profits in the short run
at MR SMC at P2Q2.
Q2
16
Comparing monopoly with perfect competition (2)
  • So we see that monopoly compared with perfect
    competition implies
  • higher price
  • lower output
  • Does the consumer always lose from monopoly?
  • Among other things, this depends on whether the
    monopolist faces the same cost structure
  • there may be the possibility of economies of
    scale.

17
A natural monopoly
  • This firm enjoys substantial economies of scale
    relative to market demand
  • LAC declines right up to market demand
  • the largest firm always enjoys cost leadership
  • and comes to dominate the industry
  • It is a NATURAL MONOPOLY.

18
Discriminating monopoly
  • Suppose a monopolist supplies two separate groups
    of customers
  • with differing elasticities of demand
  • e.g. business travellers may be less sensitive to
    air fare levels than tourists.
  • The monopolist may increase profits by charging
    higher prices to the businessmen than to
    tourists.
  • Discrimination is more likely to be possible for
    goods that cannot be resold
  • e.g. dental treatment.

19
Monopoly and Perfect Competition (Summary)
  • Monopoly versus Competition
  • Monopoly
  • Is the sole producer
  • Faces a downward-sloping demand curve
  • Is a price maker
  • Make supernormal profits. PgtMC
  • Competitive Firm
  • Is one of many producers
  • Faces a horizontal demand curve
  • Is a price taker
  • Make zero (normal) profits. PMC
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