Markets: Perfect Competition & Monopoly

1. Markets: Perfect Competition & Monopoly

2. What is a market structure? • A market structure – identifies how a market is made up in terms of: • The number of firms in the industry • The nature of the product produced • The degree of monopoly power each firm has • The degree to which the firm can influence price • Profit levels • Firms’ behaviour – pricing strategies, non-price competition, output levels • The extent of barriers to entry • The impact on efficiency

3. Market Structures Perfect Competition Pure Monopoly More competitive (fewer imperfections)

4. Market Structures Pure Monopoly Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly The further right on the scale, the greater the degree of monopoly power exercised by the firm.

5. Features of Four Market Structures

6. Market Structures Why is it important? • Degree of competition affects the consumer – will it benefit the consumer or not? • Impacts on the performance and behaviour of the company/companies involved

7. Market Structures • Models – a word of warning! • Market structure deals with a number of economic ‘models’ • These models are a representation of reality to help us to understand what may be happening in real life • There are extremes to the model that are unlikely to occur in reality • They still have value as they enable us to draw comparisons and contrasts with what is observed in reality • Therefore, models help in analysing and evaluating – they offer a benchmark

8. Market Structures • Characteristics of each model: • Number and size of firms that make up the industry • Control over price or output • Freedom of entry and exit from the industry • Nature of the product – degree of homogeneity (similarity) of the products in the industry (extent to which products can be regarded as substitutes for each other) • Diagrammatic representation – the shape of the demand curve, etc.

9. Electric Guitar – Jazz Body Vodka Mercedes CLK Coupe Canon SLR Camera Bananas Market Structures Characteristics: Look at these everyday products – what type of market structure are the producers of these products operating in? Remember to think about the nature of the product, entry and exit, behaviour of the firms, number and size of the firms in the industry. You might even have to ask what the industry is??

10. Perfect Competition • One extreme of the market structure spectrum • Characteristics: • Large number of firms • Products are homogenous (identical) – consumer has no reason to express a preference for any firm • Freedom of entry and exit into and out of the industry • Firms are price takers – have no control over the price they charge for their product • Each producer supplies a very small proportion of total industry output • Consumers and producers have perfect knowledge about the market • Distinction between short and long run • normal profits • supernormal profits

11. 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

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

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

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

15. 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

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

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

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

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

20. Perfect Competition • The long run • incompatibility of economies of scale with perfect competition • Does the firm benefit from operating under perfect competition?

21. Monopoly • Pure monopoly – where only one producer exists in the industry • In reality, rarely exists – always some form of substitute available! • Monopoly exists, therefore,where one firm dominates the market • Firms may be investigated for examples of monopoly power when market share exceeds 25% • Use term ‘monopoly power’ with care!

22. Monopoly • Monopoly power – refers to cases where firms influence the market in some way through their behaviour – determined by the degree of concentration in the industry • Influence prices by influencing output • Erect barriers to entry e.g. economies of scale, brand loyalty, aggressive tactics • Pricing strategies to prevent or stifle competition • May not pursue profit maximisation – encourages unwanted entrants to the market • Sometimes seen as a case of market failure

23. Monopoly • Origins of monopoly: • Through growth of the firm • Through amalgamation, merger or takeover • Through acquiring patent or license • Through legal means – Royal charter, Nationalisation

24. A Monopolist Exploits Consumers

25. Monopoly • Summary of characteristics of firms exercising monopoly power: • Price – could be deemed too high, may be set to destroy competition (destroyer or predatory pricing), price discrimination possible. • Efficiency – could be inefficient due to lack of competition (X- inefficiency) or… • could be higher due to availability of high profits

26. Monopoly • Innovation - could be high because of the promise of high profits, Possibly encourages high investment in research and development (R&D) • Collusion – possible to maintain monopoly power of key firms in industry • High levels of branding, advertising and non-price competition

27. Monopoly • But…note: • Monopolies not always ‘bad’ – may be desirable in some cases but may need strong regulation • Monopolies do not have to be big – could exist locally

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

29. AR and MR curves for a Monopoly AR, MR (£) AR Quantity MR

30. Monopoly • Equilibrium price and output • MC = MR

31. MC MR £ Profit maximising under Monopoly Qm O Q

32. Monopoly • Measuring level of supernormal profit

33. AC AR AC AR £ MC Profit maximising under Monopoly MR Qm O Q

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

35. Monopoly • Monopoly versus perfect competition • lower output at a higher price • Short-run and long-run

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

37. P2 Equilibrium of industry under perfect competition and monopoly: with the same MCcurve £ MC Comparison with Perfect competition P1 AR = D MR Q1 Q2 O Q

38. Monopoly • Costs under monopoly i.e. the benefits of economies of scale

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

40. Equilibrium of industry under perfect competition and monopoly: with different MC curves MC perfect competition £ MCmonopoly P2 P1 AR = D MR Q2 O Q1 Q

41. Market Structures

42. Market Structures