Perfect competition

1. Perfect competition Everything you ever wanted to know 

2. FOUR CONDITIONS FOR PERFECT COMPETITION • Many buyers and sellers participate in the market • Sellers offer identical products • Buyers and sellers are well informed about products • Sellers are able to enter and exit the market freely

3. 1. Many buyers and sellers • No individual buyer or seller can influence the total market quantity or the market price • Supply and demand determines price without any influence from individual suppliers or consumers • Sellers MUST charge this price or they will sell NONE of their product

4. 2. Identical products • All suppliers offer the same product or service • There are no differences – consumers can’t tell the difference • There is no way to differentiate • Commodity – a product that is considered the same regardless of who makes or sells it • low-grade gasoline, notebook paper, milk • a buyer will not pay extra for one particular company’s goods but will always choose the supplier with the lowest price

5. 3. Informed buyers and sellers • Buyers and sellers know enough about the market to find the best deal they can get • You have full information about the product and its price

6. 4. Free market entry and exit • What are barriers to entry? • How expensive or difficult it is to get into a certain business or to get out of it • Start-up costs – the expenses that a new business must pay before the 1st product reaches the customer • High start-up costs or technological know-how keep many entrepreneurs from entering a market • Ex: less expensive to start up a sandwich shop than a giant supermarket

7. Free market entry and exit, cont… • In perfect competition… • Firms can very easily enter a market when they can make money • Firms can very easily exit a market when they can’t earn enough to stay in business

8. Price and output • So why do we care and why are we starting with perfect competition? • Because of all of the competing sellers: • Perfectly competitive markets are the most efficient • Competition keeps prices and production costs low • Firms have no choice but to use land, labor, organizational skills, machinery, and equipment to their best advantage • Prices that consumers pay are very close to what it cost to produce the good • prices are the lowest possible • prices just cover the most efficient sellers’ costs of doing business

9. MONOPOLY Everything you ever wanted to know 

10. Monopolies… • What is the point of the game Monopoly? How do you win? • What is the problem with monopolies?

11. Imperfect Competition and Market Power • We’ve learned about perfectly competitive markets, so what does it mean when a market is imperfectly competitive? • Firms have some control over the price of their output • Having market power means that a firm is able to raise price without losing all of the quantity demanded for its product.

12. Characteristics of Pure Monopoly • Single firm in an industry • No close substitutes • Significant barriers to entry prevent other firms from entering • Not price-takers, but instead they are price-makers!

13. Barriers to Entry • In real life, a monopoly forms when barriers prevent firms from entering a market that has a single supplier.

14. Sometimes it just makes sense for a monopoly to form. Here are some reasons why…

15. 1. Economies of Scale • A producer’s average cost drops as production rises • High start-up costs can be spread out among more and more goods as production rises • Large, initial fixed costs like paying for a factory and machinery • Would you spend $1 million to build a huge bakery if you were only planning on selling a few dozen cookies each week?

16. Economies of Scale - example • A factory costs $1,000 to build and each unit of output costs $10 to make • Producing 1 unit will cost $1,010 • Producing 2 units will cost $1,020 (or $510 each) • What happens to the costs as this business produces more? • It just makes sense for them to get really big! • Once they are big, it will be hard for others to enter the market and compete with them.

17. 2. Natural Monopolies (mentioned later in chapter) • A market that runs most efficiently when one large firm provides all of the output • Public water or electricity • Would it make sense for there to be more than one firm providing the water or electricity in an area? • Resources would be wasted • The government allows these types of monopolies.

18. 3. Government Monopolies • A monopoly created by the government • There are technological, franchise, license, and industrial organizations

19. Government Monopolies • Technological monopolies • Patent – gives a company exclusive rights to sell a new good or service • Why does the government want to provide patents to pharmaceutical companies or other inventors?

20. Government Monopolies • Franchise – contract issued by a local authority that gives a single firm the right to sell its goods within an exclusive market • Shaler Area has this deal with a soft drink company. Which one? • Not that you would know about this, BUT…in Pennsylvania, what is the only store that is permitted to sell liquor? Why do you think this is?

21. Government Monopolies • License – grants firms the right to operate a business • Radio and tv broadcast frequencies

22. Government Monopolies • Industrial Organizations • Government allows companies in an industry to restrict the number of firms in a market • Major League Baseball and other sports leagues can restrict the number and location of their teams

23. Monopoly Demand • A perfect competitor faced a perfectly elastic demand curve that came from the industry. • There is no distinction between the firm and the industry for a monopolist (they ARE the industry!) • Their demand curve is downward sloping, then. • The monopolist will then choose the point on their demand curve where it wants to be.

24. Price and Output Decision • Will demand = MR (marginal revenue) for a monopolist? • NO!!!

25. OUTPUT DECISIONS FOR A MONOPOLIST • What do you think? Can a monopolist literally charge “the highest price possible?” • We know that monopolists can obviously charge a higher price than a perfect competitor, but they face a dilemma…

26. The Monopolist’s Dilemma… • Even a monopolist faces the law of demand!!! • They can charge a high price, but then they can’t sell all they want (at a higher price, people will not buy as much) • If Duquesne Light quadrupled the price of electricity, what kinds of things would people do?

27. Dilemma…another example • BreatheDeep (asthma medication) – people with severe asthma might pay very high prices for the drug, but people with milder cases may choose a cheaper, weaker medicine if the price rises too high • BreatheDeep will try to figure out the best combination of price and output to maximize their profit. • Higher price = less output • Higher output = lower price

28. Example… • Can they charge the people with severe asthma a high price and people with mild asthma a lower price to entice them to still buy BreatheDeep? • Mostly, the answer is NO. You have to charge every customer the same price. • ***When a monopolist wants to sell more, they must lower the price for all customers.***

29. So…where IS marginal revenue, then? • MR will lie below price b/c • When they sell more (by lowering price for ALL customers), this will bring in more revenue for the business, but this increase is offset somewhat by the lower price charged for all previous units that could have been sold at a higher price. • Therefore, the increase in revenue from increasing output by one more (MR) is less than the price

30. Price and Output Decisions in Pure Monopoly Markets Demand in Monopoly Markets Marginal Revenue and Market Demand At every level of output except 1 unit, a monopolist’s marginal revenue (MR) is below price. This is so because (1) we assume that the monopolist must sell all its product at a single price (no price discrimination) and (2) to raise output and sell it, the firm must lower the price it charges. Selling the additional output will raise revenue, but this increase is offset somewhat by the lower price charged for all units sold. Therefore, the increase in revenue from increasing output by 1 (the marginal revenue) is less than the price.  FIGURE 13.3 Marginal Revenue Curve Facing a Monopolist

31. Profit-Maximization • The profit-maximization rule still holds here! • So the monopolist will set output by producing up to where MC = MR • However, once they choose that level of output, they can charge price by looking at their demand curve!

32. Price and Output Decisions in Pure Monopoly Markets The Monopolist’s Profit-Maximizing Price and Output A profit-maximizing monopolist will raise output as long as marginal revenue exceeds marginal cost. Maximum profit is at an output of 4,000 units per period and a price of $4. Above 4,000 units of output, marginal cost is greater than marginal revenue; increasing output beyond 4,000 units would reduce profit. At 4,000 units, TR = PmAQm0, TC = CBQm0, and profit = PmABC.  FIGURE 13.5 Price and Output Choice for a Profit-Maximizing Monopolist

33. Price and Output Decisions in Pure Monopoly Markets Perfect Competition And Monopoly Compared  FIGURE 13.7 Comparison of Monopoly and Perfectly Competitive Outcomes for a Firm with Constant Returns to Scale In the newly organized monopoly, the marginal cost curve is the same as the supply curve that represented the behavior of all the independent firms when the industry was organized competitively. Quantity produced by the monopoly will be less than the perfectly competitive level of output, and the monopoly price will be higher than the price under perfect competition. Under monopoly, P = Pm = $4 and Q = Qm = 2,500. Under perfect competition, P = Pc = $3 and Q = Qc = 4,000.

34. Monopoly and Profit • Obviously, this is going to generate profit for a monopolist (price will be set far above ATC) • If they were perfect competitors, what would happen in the long run? • Will the same thing happen for the monopolist?

35. The Social Costs of Monopoly Inefficiency And Consumer Loss  FIGURE 13.9 Welfare Loss from Monopoly The triangle ABC roughly measures the net social gain of moving from 2,000 units to 4,000 units (or the loss that results when monopoly decreases output from 4,000 units to 2,000 units).

36. Regulating Monopoly • Two ideas: • Socially Optimal (where S = D or for a monopolist where MC = p) • or • Fair price (where p = ATC) so they can at least break-even like a perfect competitor

37. PRICE DISCRIMINATION • Can you think of a time when you paid more or less for something than someone else? • It happens all the time! Price discrimination is the ability to divide consumers into two or more groups and charge a different price to each group.

38. PRICE DISCRIMINATION • This gives the monopolist the best of both worlds! • They can charge the people willing to pay a lot a very high price • But they can also sell more by charging those willing to pay less a lower price

39. CHARACTERISTICS OF PRICE DISCRIMINATION • Market power- firms must have some control over prices • Distinct customer groups – must be able to identify consumers willing to pay more / less and separate them • Difficult resale • Could you charge lower food prices for children at Heinz Field? • What would people do?

40. CAN YOU THINK OF EXAMPLES? • Airline fares • Coupons / rebates • Senior citizen / student discounts • “Early bird special” • Children fly or stay free promotions

41. Monopolistic Competition And Oligopoly…the other 2 types of competition!

42. What are most businesses? • Most businesses in the world are NOT either of the extremes that we have learned about so far…they are somewhere in between PERFECT COMPETITION and MONOPOLY.

43. Monopolistic Competition • Different from perfect competition in one major way: • You can differentiate your product now! • Examples: fast food industry, clothing stores

44. Four Conditions of Monopolistic Competition: • Many firms (more than 10!) • Few barriers to entry • Slight control over price • You have to keep price similar, but you can charge a slightly different price • Differentiated products • Products are very similar, but you can tell the difference

45. Nonprice Competition • Competition through other ways than lowering prices • Can take different forms: • Physical characteristics • Location • Service level • Advertising, image, status

46. San Francisco Restaurants • How can some charge such high prices and others have to charge similar prices to competition?

47. Other examples of monopolistic competition?

48. Advertising: good or bad thing? • What are the arguments for? • Arguments against?

49. Price and Output • Demand curve for a monopolistic competitor will be slightly less elastic than a perfect competitor (b/c they will have some control over price) • It will definitely be more elastic less than a monopolist, though (a lot more competition than a monopolist)

50. Price and Output • To maximize profits, they will set output by producing up to where MC = MR (any surprise?) • They will charge price off of the demand curve • NOTHING IS NEW HERE!!!!!