Profit Maximisation under Perfect Competition and Monopoly

Profit Maximisation under Perfect Competition and Monopoly

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

Alternative Market Structures • The four market structures • perfect competition • monopoly • monopolistic competition • oligopoly

Features of the four market structures

Alternative Market Structures • The four market structures • perfect competition • monopoly • monopolistic competition • oligopoly • Structure  conduct  performance

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

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

Short-run equilibrium of industry and firm under perfect competition MC AC S D = AR Pe AR = MR AC D P £ O O Qe Q (thousands) Q (millions) (a) Industry (b) Firm

Loss minimising under perfect competition AC MC AC D1 = AR1 P1 AR1 = MR1 Qe P £ S D O O Q (thousands) Q (millions) (a) Industry (b) Firm

Short-run shut-down point AVC D2 = AR2 P2 AR2 = MR2 D2 P £ AC MC S O O Q (thousands) Q (millions) (a) Industry (b) Firm

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

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

Long-run equilibrium under perfect competition S1 Se LRAC P1 AR1 D1 PL ARL DL D Profits return to normal Supernormal profits New firms enter P £ O O QL Q (thousands) Q (millions) (a) Industry (b) Firm

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

Long-run equilibrium of the firm under perfect competition (SR)MC (SR)AC LRAC DL AR = MR LRAC = (SR)AC = (SR)MC =MR= AR £ O Q

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

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

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?

Monopoly • Defining monopoly • importance of market power • concentration ratios

Concentration ratios in the UK

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

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

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

AR and MR curves for a monopoly Q (units) TR (£) MR (£) P =AR (£) 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

Monopoly • Equilibrium price and output • MC = MR

Profit maximising under monopoly MC MR £ Qm O Q

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

Profit maximising under monopoly MC MR £ Qm O Q

Profit maximising under monopoly AC AR AC AR £ MC MR Qm O Q

Profit maximising under monopoly Total profit AC AR £ MC AR AC MR Qm O Q

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

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

Equilibrium of industry under perfect competition and monopoly: with the same MC curve MC AR = D MR £ Monopoly P1 Q1 O Q

Equilibrium of industry under perfect competition and monopoly: with the same MC curve P2 £ MC ( = supply under perfect competition) Comparison with Perfect competition P1 AR = D MR Q1 Q2 O Q

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

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

Equilibrium of industry under perfect competition and monopoly: with different MC curves £ MCmonopoly P1 AR = D MR O Q1 Q

Equilibrium of industry under perfect competition and monopoly: with different MC curves MC ( = supply)perfect competition £ MCmonopoly P2 P1 x P3 AR = D MR Q2 Q3 O Q1 Q

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

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

Profit Maximisation under Perfect Competition and Monopoly

Profit Maximisation under Perfect Competition and Monopoly

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