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Thefocusofthislectureisthefourmarketstructures.Studentswilllearnthecharacteristicsofpure
competition,puremonopoly,monopolisticcompetition,andoligopoly.Usingthecostschedulefromthe
previouslecture,theideaofprofitmaximizationisexplored.
OBJECTIVES
1.Identifyvariousmarketstructuresandtheircharacteristics.
2.Beabletocategoryfirmsintofourmarketstructures.
3.Describetheeffectsofimperfectcompetitionuponthemarketandthefirm.
4.Understandthepricingstructureofthefourstructures.
TOPICS
Pleasereadallthefollowingtopics.
PERFECTCOMPETITION
PERFECTCOMPETITIONCONT.
PERFECTCOMPETITIONEXAMPLE
PUREMONOPOLY
MONOPOLYEXAMPLE
PRICEDISCRIMINATION
MONOPOLISTICCOMPETITION
OLIGOPOLY
TECHNOLOGICALDEVELOPMENT
ECONOMICEFFICIENCY
PerfectCompetition
Pureorperfectcompetitionisrareintherealworld,butthemodelisimportantbecauseithelps
analyzeindustrieswithcharacteristicssimilartopurecompetition.Thismodelprovidesacontextin
whichtoapplyrevenueandcostconceptsdevelopedinthepreviouslecture.Examplesofthismodel
arestockmarketandagriculturalindustries.
Characteristics
1.Manysellers:thereareenoughsothatasinglesellersdecisionhasnoimpactonmarketprice.
2.Homogenousorstandardizedproducts:eachsellersproductisidenticaltoitscompetitors.
3.Firmsarepricetakers:individualfirmsmustacceptthemarketpriceandcanexertnoinfluenceon
price.
4.Freeentryandexit:nosignificantbarrierspreventfirmsfromenteringorleavingtheindustry.
Demand
Theindividualfirmwillviewitsdemandasperfectlyelastic.Aperfectlyelasticdemandcurveisa
horizontallineattheprice.Thedemandcurvefortheindustryisnotperfectlyelastic,itonlyappears
thatwaytotheindividualfirms,sincetheymusttakethemarketpricenomatterwhatquantitythey
produce.Therefore,thefirmsdemandcurveisahorizontallineatthemarketprice.
Marginalrevenue(MR)istheincreaseintotalrevenueresultingfromaoneunitincreaseinoutput.
Sincethepriceisconstantintheperfectcompetition.Theincreaseintotalrevenuefromproducing1
extraunitwillequaltotheprice.Therefore,P=MRinperfectcompetition.
ProfitMaximizingOutput
ShortRunAnalysis
Intheshortrun,thefirmhasfixedresourcesandmaximizesprofitorminimizeslossbyadjustingoutput.Firmsshould
produceifthedifferencebetweentotalrevenueandtotalcostisprofitable(EP>0),orifthelossislessthanthefixedcost
(EP> FC).Thefirmshouldnotproduce,butshouldshutdownintheshortrunifitslossexceedsitsfixedcosts.Byshutting
down,itslosswilljustequalthosefixedcosts.Fixedcostinreallifewouldberentoftheoffice,businesslicensefees,
equipmentlease,etc.Thesecostwouldhavetobepaidwithorwithoutanyoutput.Therefore,fixedcostwouldbetheloss
ofshutdownatanytime.Ifbyproducingoneunitofoutput,thislosscouldbelowered,thenthisunitshouldbeproduced
tominimizetheloss.However,ifbyproducingoneunitofoutput,thislosswouldbehigher,thenthisunitshouldnotbe
produced.Thefirmshouldshutdown,justpayforthefixedcost.
IfEP< FC firmshouldshutdown.ThenitslostwillbetheFixedcost.EP= FC.InorderforEP< FC,marketprice,P,must
belowerthantheminimumAVC.
IfEP> FC,firmshouldproduce.ThatiswhenmarketpriceisgreaterthanminimumAVC.
Marginalrevenueandmarginalcost(MC)arecomparedtodecidetheprofitmaximizingoutput.
IfMR>MC,thenthefirmshouldcontinuetoproduce.
IfMR=MC,thenthefirmshouldstopproducingtheadditionalunit.AstheadditionalunitsMCwouldbehigheraccording
tolawofdiminishingreturns,MRwouldbelessthanMC;thatis,thefirmwouldlossprofitbyproducingadditionalunits.
Therefore,thisistheprofitmaximizingoutputlevel.
IfMR<MC,thenthefirmshouldloweritsoutput.
Inconclusion:
Theshutdownpointisthelevelofoutputandpriceatwhichthefirmjustcoversitstotalvariablecost.IftheMRofthe
productislessthantheminimumaveragevariablecost(minAVC),thefirmwillshutdownbecausethisactionminimizes
thefirmsloss.Inthiscase,thefirmseconomiclossequalsitstotalfixedcosts.IfMR<minAVC,theneachadditionalunit
producedwouldincreasetheloss.Forpurecompetition,MRisequaltopriceasthefirmisfacingaperfectlyelastic
demand.Therefore,forshortrun,ifPrice<minAVC,thenthefirmshouldshutdown.IfPrice>minAVC,thenthefirm
shouldproduce.PriceandMCarecomparedtofindtheprofitmaximizingorlossminimizingoutputlevel.Thesupplycurve
ofthepurecompetitionfirmswouldbetheportionoftheMCcurveabovetheminAVC.
1.IfEP< FCorMarketP<MinAVC,firmshouldshutdown.Output=0,andEP=FC
2.IfEP> FCorMarketP>MinAVC,firmshouldproduce.Firm'soutputlevelshouldbeatwhereMR=MCorP=MC.
UseEP=TR TCtogeteconomicprofitofthefirm.
PerfectCompetitionCont.
Followingtherulesdiscussedintheprevioussection.Hereisanexample.
Firmsfixedcostis$100,itsminAVCis$55.
Ifmarketpriceis50whichislessthanminAVC,thefirmwouldloss$5morebyproducingeachunit.Ifthefirmproduces
oneunit,itstotallosswouldbe$5plus$100fixedcost.Ifthefirmdecidestoshutdown,itslosswouldbeonly$100asthe
firmdoesnotneedtopayforthevariablecost.Shutdownwouldbethelossminimizationstrategy.
Ifthemarketpriceis60,thefirmwouldlose$5lessbyproducingeachunit.Ifthefirmproducesoneunit,itstotalcost
wouldbefixedcostless$5,whichis$95.Thefirmisbetteroffbyproducing,notshuttingdown.Whenthemarketpriceis
higherthantheminimumAVC,MRandMCshouldbecomparedtofindouttheoptimallevelofoutput.
LongRunAnalysis
Obviously,thefirmcannotbeinlossforlong.Threeassumptionsaremadeforthelongrunanalysis:
1.Entryandexitaretheonlylongrunadjustments.
2.Firmsintheindustryhaveidenticalcostcurves.
3.Theindustryisinconstantreturntoscale.
Inlongrun,ifeconomicprofitsareearned,firmsentertheindustry,whichincreasesthemarketsupply,causingtheproduct
pricetogodown.Untilzeroeconomicprofitsareearned,thenthesupplywillbesteady.Iflossesareincurredintheshort
run,firmswillleavetheindustrywhichdecreasesthemarketsupply,causingtheproductpricetoriseuntillossesdisappear.
Thismodelisoneofzeroeconomicprofitsinlongrun.Thelongrunequilibriumisachieved,theproductpricewillbeexactly
equalto,andproductionwilloccurat,eachfirmspointofminimumaveragetotalcost.
EfficiencyAnalysis
1. Productiveefficiency:occurswhereP=minATC.Perfectcompetitivefirmswill
achieveproductiveefficiencyasfirmsmustusetheleastcosttechnologyorthey
won'tsurvive.
2.Allocative efficiency: occurswhereP=MC.Pricerepresentthebenefitthatsociety
getsfromadditionalunitsofaproduct,MCrepresentsthecosttosocietyofother
goodsgivenuptoproducethisproduct.Dynamicadjustmentswilloccurinthis
marketstructurewhenchangesindemand,supplyortechnologyoccurs.Perfect
competitivefirmswillachievethisefficiency.Sincenoexplicitordersaregivento
theindustry,"theInvisibleHand"worksinthissystem.
Eventhoughbothefficienciesareachievedinthissystem,theconsumersarefacing
standardproducts,makingshoppingtobenofunatall.Ontheotherhand,the
consumerswillreceivethehighestconsumersurplusinthisstructureasthelongrun
marketpricewillbeattheminATC.Producerswillreceivethelowestproducersurplus
asconsumerscaneasilyfindsubstitutes.
AnExample
Thefollowingdatarepresentsacostfunctionofaperfect
competitivefirm:
TP or Q
AFC
AVC
ATC
MC
0
1
60
45
105
45
30
42.5
72.5
40
20
40
60
35
15
37.5
52.5
30
12
37
49
35
10
37.5
47.5
40
8.57
38.57
47.14
45
7.5
40.63
48.13
55
6.67
43.33
50
65
10
46.5
52.5
75
Ifthemarketprice,P<37;thisfirm'soutput Q=0;firm's
economicprofit,EP=60
Ifthemarketprice,P>37,thisfirm'soutput Q>0;firms'
economicprofit,EP=TR TC.
Forexample,whenP=65,Q=9,EP=$65x9 50X9=135
AnExampleCont.
Bygiventhemarketdemandatvariouspricelevel,amarketequilibriumpricecouldbefound.
TP or Q
AFC
AVC
ATC
MC
0
1
60
45
105
45
30
42.5
72.5
40
20
40
60
35
15
37.5
52.5
30
12
37
49
35
10
37.5
47.5
40
8.57
38.57
47.14
45
7.5
40.63
48.13
55
6.67
43.33
50
65
10
46.5
52.5
75
Onefirm'soutputlevel(column2intheabovetable)is
obtainedbycomparing PandMC.Sinceallfirmsarehaving
thesamecostfunction,themarketoutputlevelisthesumof
individualfirms'output(column4intheabovetable).
Bycomparingthemarketsupplyandmarketdemand,wecan
findthemarketequilibriumat:
P=46and Q=10500
Atthislevel,eachfirmislosing8dollars,indicatinga
contractioninthisindustry.Somefirmsmayleaveinthelong
run,causingthemarketsupplytodecreaseandequilibrium
pricewillincreasetothebreakevenlevel.
PRICE Qs (1 firm's output) PROFIT Qs(1500 firms in the market) / market supply
Qd / market demand
26
-60
17000
32
-60
15000
38
-55
7500
13500
41
-39
9000
12000
46
-8
10500
10500
56
63
12000
9500
66
144
13500
8000
PureMonopoly
Puremonopolyexistswhenasinglefirmisthesoleproducerofaproductforwhichtherearenoclosesubstitutes.Examples
arepublicutilitiesandprofessionalsportsleagues.
Characteristics
1.Asingleseller:thefirmandindustryaresynonymous.
2.Uniqueproduct:noclosesubstitutesforthefirmsproduct.
3.Thefirmisthepricemaker:thefirmhasconsiderablecontroloverthepricebecauseitcancontrolthequantitysupplied.
4.Entryorexitisblocked.
BarrierstoEntry
Economiesofscaleisthemajorbarrier.Thisoccurswherethelowestunitcostand,therefore,lowunitpricesforconsumers
dependontheexistenceofasmallnumberoflargefirms,orinthecaseofmonopoly,onlyonefirm.Becauseaverylarge
firmwithalargemarketshareismostefficient,newfirmscannotaffordtostartupinindustrieswitheconomiesofscale.
Publicutilitiesareknownasnaturalmonopoliesbecausetheyhaveeconomiesofscaleintheextremecase.Morethanone
firmwouldbeinefficientbecausethemazeofpipesorwiresthatwouldresultiftherewerecompetitionamongwater
companiesorcablecompanies.Legalbarriersalsoexistintheformofpatentsandlicenses,suchasradioandTVstations.
Ownershiporcontrolofessentialresourcesisanotherbarriertoentry,suchastheprofessionalsportsleaguesthatcontrol
playercontractsandleasesonmajorcitystadiums.Ithastobenotedthatbarrierisrarelycomplete.Thinkaboutthe
telephonecompaniesacoupledecadesago;therewasnosubstituteforthetelephone.Nowadays,cellularphonesarevery
popular.Itcreatesasubstituteforyourhousephone,causingthetraditionaltelephonecompaniestolosetheirmonopoly
position.
DemandCurve
Monopolydemandistheindustryormarketdemandandisthereforedownwardsloping.Pricewillexceedmarginal
revenuebecausethemonopolistmustlowerpricetoboostsalesandcannotpricediscriminateinmostcases.Theadded
revenuewillbethepriceofthelastunitlessthesumofthepricecutswhichmustbetakenonallpriorunitsofoutput.The
marginalrevenuecurveisbelowthedemandcurve.
ProfitMaximizingOutput&Efficiency
ProfitMaximizingOutput:
TheMR=MCrulewillstilltellthemonopolisttheprofit maximizingoutput.Themonopolistcannotchargethehighest
pricepossible,itwillmaximizeprofitwhereTRminusTCisthegreatest.Thisdependsonquantitysoldaswellasonprice.
Themonopolistcanchargethepricethatconsumerswillpayforthatoutputlevel.Therefore,thepriceisonthedemand
curve.Lossescanoccurinmonopoly,althoughthemonopolistwillnotpersistentlyoperateatlossinthelongrun.
Monopolieswillsellatasmalleroutputandchargeahigherpricethanwouldpurecompetitiveproducerssellinginthe
samemarket.
Incomedistributionismoreunequalthanitwouldbeunderamorecompetitivesituation,unlessthegovernmentregulates
themonopolyandpreventsmonopolyprofits.Ifamonopolycreatessubstantialeconomicinefficiencyandappearstobe
longlasting,antitrustlawscouldbeusedtobreakupthemonopoly.
Efficiency:
1. Productiveefficiency:occurswhereP=minATC.Monopolyfirmswillnot achieveproductiveefficiencyasfirmswill
produceatanoutputwhichislessthantheoutputofminATC.Xinefficiencymayoccursincethereisnocompetitive
pressuretoproduceattheminimumpossiblecosts.
2.Allocative efficiency: occurswhereP=MC.Thisefficiencyisnotachievedbecauseprice(whatproductisworthto
consumers)isaboveMC(opportunitycostofproduct).
Itispossiblethatmonopolyismoreefficientthanmanysmallfirms.Economiesofscale(naturalmonopoly)maymake
monopolythemostefficientmarketmodelinsomeindustries.However,Xinefficiencyandrentseekingcost(lobbying,legal
fees,etc.)canentailsubstantialcosts,causinginefficiency.
Producersurplusissignificantduetolackofcompetition,consumersurplusmaybeminimized.Thismarketstructurewill
notcontributetoafairincomedistributionofoursociety.
AnExample
Inthisexample,thecostfunctionisthesameastheoneusedin the
perfectcompetitionexample.Youcanseefromthefollowinganalysis
thattheoutputlevelandmarketpricearedifferentinmonopoly.
Theoutputlevelislowerthanoutputoftheperfectcompetitive
firm;andpriceishigherthanthepriceofperfectcompetitivefirm.
TP or Q
AFC
Itispossibleforthisfirmtocontinueearningthisprofitinthelong
runastherearenocompetitioninthemarket.
ATC
MC
0
1
60
45
105
45
30
42.5
72.5
40
20
40
60
35
15
37.5
52.5
30
12
37
49
35
10
37.5
47.5
40
8.57
38.57
47.14
45
7.5
40.63
48.13
55
6.67
43.33
50
65
10
46.5
52.5
75
Pd
BycomparingtheMRandMCunitbyunit,wecanfindthisfirm's
outputat:
Q=4,and P=63.Thisistheprofitmaximizationoutputlevel,with
EP=42.
AVC
Qd
TR
MR
EP
115
100
100
100
-5
83
166
66
21
71
213
47
33
63
252
39
42
55
275
23
30
48
288
13
42
294
-35.98
37
296
-89.04
33
297
-153
29
10
290
-7
-235
PriceDiscrimination
Pricediscriminationissellingagoodorserviceatanumberofdifferentprices,andthe
pricedifferencesisnotjustifiedbythecostdifferences.Inordertopricediscriminate,
amonopolymustbeableto
1. beabletosegregatethemarket
2. makesurethatbuyerscannotreselltheoriginalproductorservices.
Perfectpricediscriminationisapricediscriminationthatextractstheentireconsumer
surplusbychargingthehighestpricethatconsumerarewillingtopayforeachunit.
Asaresult,thedemandcurvebecomestheMRcurveforaperfectpricediscriminator.
Firms capturetheentireconsumersurplusandmaximizeeconomicprofit.
MonopolisticCompetition
Monopolisticcompetitionreferstoamarketsituationwitharelativelylargenumberof
sellersofferingsimilarbutnotidenticalproducts.Examplesarefastfoodrestaurants
andclothingstores.
Characteristics
1.Alotoffirms:eachhasasmallpercentageofthetotalmarket.
2.Differentiatedproducts:varietyoftheproductmakesthismodeldifferentfrom
purecompetitionmodel.Productdifferentiatedinstyle,brandname,location,
advertisement,packaging,pricingstrategies,etc.
3.Easyentryorexit.
DemandCurve
Thefirmsdemandcurveishighlyelastic,butnotperfectlyelastic.Itismoreelastic
thanthemonopolysdemandcurvebecausethesellerhasmanyrivalsproducingclose
substitutes;itislesselasticthanpurecompetition,becausethesellersproductis
differentiatedfromitsrivals.
Profit MaximizingOutput
TheMR=MCrulewillgivethefirmstheprofit maximizingoutput.Thepricetheychargewouldbeon
thedemandcurve.
Inthelongrun,thesituationwilltendtobebreakingevenforfirms.Firmscanentertheindustryeasily
andwilliftheexistingfirmsaremakinganeconomicprofit.Asfirmsentertheindustry,thedemandcurve
facingbyanindividualfirmshiftdown,asbuyersshiftsomedemandtonewfirmsuntilthefirmjust
breakseven.Ifthedemandshiftsbelowthebreakevenpoint,somefirmswillleavetheindustryinthe
longrun.
Therefore,mostmonopolisticcompetitivefirmsshouldexperiencebreakeveninthelongrun
theoretically.Inreality,somefirmsexperienceprofitastheyabletodistinguishthemselvesfromthe
othersandbuildaloyalcustomerbase;suchassomenamebrandapparelcompanies.Somefirms
experiencelostinlongrunbutmaycontinuethebusinessastheyarestillearningnormalprofit.These
firmownersusuallyliketheflexiblelifestyleandwillingtoearnanormalprofitthatislowerthantheir
opportunitycost.
Priceexceedsmarginalcostinthelongrun,suggestingthatsocietyvaluesadditionalunitswhicharenot
beingproduced.Averagecostsmayalsobehigherthanunderpurecompetition,duetoadvertisingcost
involvedtoattractcustomersfromcompetitors.Thevarioustypes,styles,brandsandqualityofproducts
offersconsumerschoices.However,economicinefficiencyistheresult.Theexcesscapacity(producingat
thequantitythatafirmproducesislessthanthequantityatwhichATCisaminimum)existsinthis
industry.
Oligopoly
Oligopolyexitswherefewlargefirmsproducingahomogeneousordifferentiated
productdominateamarket.Examplesareautomobileandgasolineindustries.
Characteristics
1.Fewlargefirms:eachmustconsideritsrivalsreactionsinresponsetoitsdecisions
aboutprices,output,andadvertising.
2.Standardizedordifferentiatedproducts.
3.Entryishard:economiesofscale,hugecapitalinvestmentmaybethebarriersto
enter.
DemandCurve
Facingcompetitionorintacitcollusion,oligopoliesbelievethatrivalswillmatchany
pricecutsandnotfollowtheirpricerise.Firmsviewtheirdemandsasinelasticfor
pricecuts,andelasticforpricerise.Firmsfacekinkeddemandcurves.Thisanalysis
explainsthefactthatpricestendtobeinflexibleinsomeoligopolisticindustries.
Efficiency&Advertisement
1. Productiveefficiency:occurswhereP=minATC.
Monopolisticcompetitivefirmswillnot achieveproductiveefficiencyasfirmswill
produceatanoutputwhichislessthantheoutputofminATC.Productdifferentiationis
themajorcauseofexcesscapacity.
2.Allocative efficiency: occurswhereP=MC.
Thisefficiencyisnotachievedbecauseprice(whatproductisworthtoconsumers)is
aboveMC(opportunitycostofproduct).
Advertisementisverycrucialforeachfirminthismarketstructureasfirmsneed
exposuretogetconsumer'sattention.However,toomuchspendingwillresultinhigher
cost,andlowerprofit.Price,productattributes,andadvertisementarethreemain
factorsthatproducershavetoconsider.Theperfectcombinationcannotbeforecasted
easily.
GameTheory&Cartel
Gametheorysuggeststhatcollusionisbeneficialtotheparticipatingfirms.Collusionreducesuncertainty,increasesprofits,
andmayprohibitentryofnewrivals.
Considerthefollowingpayoffmatrixinwhichthenumbersindicatetheprofitinmillionsofdollarsforaduopoly(GMand
Ford)basedoneitherahighpriceoralowpricestrategy. ThisexampleillustratedthatGMorFordwillearnthehighest
individualprofitwheneachadoptslowpricestrategywhileotherfirmcontinueswiththehigherpricestrategy(inBorC).
Butfirmswillearnthehighesttotalprofitwhenbothadoptthehighpricestrategy(A).Whenfirmsformacartel,theyare
actingasoneentity(A).Theywillperformastheyarealargemonopoly,earningthehighesttotalprofitpossible.However,
membersdohaveanincentivetocheatasindividualscanincreasetheirownprofitsbycheatinginshortrun(BorC).When
othermembersareawareofthecheating,theymaycarryoutthesamepractice,sometimesitmayresultinapricewarand
allmembersloss(D).
Duopoly
GM
Ford
High-price
Low-price
Profit Analysis
High-price
A: GM=$50M Ford=$50M
C: GM=$20M Ford=$60M
Low-price
B: GM=$60M Ford=$20M
D: GM=$30M Ford=$30M
GM Profit
Earns $50M
Ford Profit
Earns $50M
Increased to $60 M
Dropped to $20M
Dropped to $20 M
Increased to $60M
Earns $30M
Earns $30M
TheOrganizationofPetroleumExportingCountries(OPEC)isacartel.Theelevencountriesagreedontheoutputamount
andworkingtogethertocontroltheworldscrudeoilsupply.InUS,antitrustlawhassetupguidelinesforcorporationsto
followtoavoidcollusionoflargefirmsinthesameindustryandprotectconsumerrights.
TechnologicalDevelopment
Technologicaladvanceisathreestepprocessthatshiftstheeconomysproductionpossibilitiescurve
outwardenablingmoreproductionofgoodsandservices.
1.Invention:isthediscoveryofaproductorprocessandtheproofthatitwillwork.
2. Innovation:isthefirstsuccessfulcommercialintroductionofanewproduct,thefirstuseofanew
method,orthecreationofanewformofbusinessenterprise.
3. Diffusion:isthespreadofinnovationthroughimitationorcopying.
Expendituresonresearchanddevelopment(R&D)includedirecteffortsbybusinesstowardinvention,
innovation,anddiffusion.GovernmentalsoengagesinR&D,particularlyfornationaldefense.Finding
theoptimalamountofR&Disanapplicationofbasiceconomics:marginalbenefitandmarginalcost
analysis.OptimalR&Dexpendituresoccurwhentheinterestratecostoffundsisequaltotheexpected
rateofreturn.
Manyprojectsmaybeaffordablebutnotworthwhilebecausethemarginalbenefitislessthanmarginal
cost.OftentheR&Dspendingdecisioniscomplexbecausetheestimationoffuturebenefitsishighly
uncertainwhilecostsareimmediateandmoreclearcut.
TheRoleofMarketStructure
1.Purecompetition:thesmallsizeofcompetitivefirmsandthefacthattheyearnzero
economicprofitinthelongrunleadstoseriousquestionsastowhethersuchproducerscan
financesubstantialR&Dprograms. Thefirmsinthismarketstructurewouldspendno
significantamount. However,firmsofthesameindustrymaygathertheirresourcesand
developR&Dprograms.
2.Monopolisticcompetition:thereisastrongprofitincentivetoengageinproduct
developmentinthismarketstructureasthefirmsdependonproductdifferentiationtostand
outfromalargenumberofrivals.However,mostfirmsremainsmallwhichlimitstheirability
tosecureinexpensivefinancingforR&Dandanyeconomicprofitsareusuallytemporary.
Therefore,spendingonR&Dislimitedinthismarketstructure.
3.Oligopoly:manyofthecharacteristicsofoligopolyareconducivetotechnicaladvances
including:theirlargesize,ongoingeconomicprofits,theexistenceofbarrierstoentryanda
largevolumeofsales.FirmsinoligopolyspentthehighestamountonR&Damongthefour
differentmarketstructures.
4.Puremonopoly:monopolyhaslittleincentivetoengageinR&Dastheprofitisprotectedby
absolutebarrierstoentry,theonlyreasonforR&Dwouldbedefensive toreducetheriskofa
newproductorprocesswhichwoulddestroythemonopoly.
EconomicEfficiency
Economicsisascienceofefficiencyintheuseofscarceresources.Efficiencyrequiresfullemploymentofavailable
resourcesandfullproduction.Fullemploymentmeansallavailableresourcesshouldbeemployed.Fullproduction
meansthatemployedresourcesareprovidingmaximumsatisfactionforourmaterialwants.Fullproductionimpliestwo
kindsofefficiency:
1.Allocativeefficiencymeansthatresourcesareusedforproducingthecombinationofgoodsandservicesmostwanted
bysociety.Forexample,producingcomputerswithwordprocessorsratherthanproducingmanualtypewriters.
2.Productiveefficiencymeansthatleastcostlyproductiontechniquesareusedtoproducewantedgoodsandservices.
Fullefficiencymeansproducingthe"right"(Allocativeefficiency)amountinthe"right"way(productiveefficiency).
Purecompetition:
Productiveefficiencyoccurswherepriceisequaltominimumaveragetotalcost(minATC);atthispointfirmsmustuse
theleasecosttechnologyortheywontsurvive.
Underpurecompetition,thisoutcomewillbeachieved,asthelongrunequilibriumpriceofpurecompetitivefirms
wouldbeattheminATC.
Allocativeefficiencyoccurswherepriceisequaltomarginalcost(P=MC),becausepriceissocietysmeasureofrelative
worthofaproductatthemarginoritsmarginalbenefit.AndthemarginalcostofproducingproductXmeasuresthe
relativeworthoftheothergoodsthattheresourcesusedinproducinganextraunitofXcouldotherwisehaveproduced.
Inshort,pricemeasuresthebenefitthatsocietygetsfromadditionalunitsofgoodX,andthemarginalcostofthisunit
ofXmeasuresthesacrificeorcosttosocietyofothergoodsgivenuptoproducemoreofX.
Underpurecompetition,thisoutcomewillbeachieved.Dynamicadjustmentswilloccurautomaticallyinpure
competitionwhenchangesindemandorinresourcessupply,orintechnologyoccur.Disequilibriumwillcauseexpansion
orcontractionoftheindustryuntilthenewequilibriumatP=MCoccurs.
EfficiencyCont.
Nonperfectcompetition:
Priceofnonperfectcompetitivefirmswillexceedmarginalcost,becausepriceexceedsmarginalrevenueandthefirms
producewheremarginalrevenue(MR)andmarginalcostareequal.Thenthefirmscanchargethepricethatconsumerswill
payforthatoutputlevel.Allocativeefficiencyisnotachievedbecauseprice(whatproductisworthtoconsumers)isabove
marginalcost(opportunitycostofproduct).Ideally,outputshouldexpandtoalevelwhereP=MC,butthiswilloccuronly
underpurecompetitiveconditionswhereP=MR.Productiveefficiencyisnotachievedbecausethefirmsoutputisless
thantheoutputatwhichaveragetotalcostisminimum.
Economiesofscale(naturalmonopoly)maymakemonopolythemostefficientmarketmodelinsomeindustries.X
inefficiency,theinefficiencythatoccursintheabsenceoffearofentryandrivalry,mayoccurinmonopolysincethereisno
competitivepressuretoproduceattheminimumpossiblecosts.Rentseekingbehavioroftenoccursasmonopoliesseekto
acquireormaintaingovernmentgrantedmonopolyprivileges.Suchrentseekingmayentailsubstantialcost(lobbying,
legalfees,publicrelationsadvertisingetc.)whichareinefficient.
Thereareseveralpolicyoptionsavailablewhenmonopolycreatessubstantialeconomicinefficiency:
1.Antitrustlawscouldbeusedtobreakupthemonopolyifthemonopolysinefficiencyappearstobelonglasting.
2.Societymaychoosetoregulateitspricesandoperationsifitisanaturalmonopoly.
3.Societymaysimplyignoreitifthemonopolyappearstobeshortlivedbecauseofchangingconditionsortechnology.
EfficiencyVstechnologicaladvances:
Allocativeefficiencyisimprovedwhentechnologicaladvanceinvolvesanewproductthatincreasestheutilityconsumers
canobtainfromtheirlimitedincome.Processinnovationcanlowerproductioncostandimproveproductiveefficiency.
Innovationcancreatemonopolypowerthroughpatentsortheadvantagesofbeingfirst,reducingthebenefittosociety
fromtheinnovation.Innovationcanalsoreduceorevendisintegrateexistingmonopolypowerbyprovidingcompetition
wheretherewasnone.Inthiscaseeconomicefficiencyisenhancedbecausethecompetitiondrivespricesdowncloserto
marginalcostandminimumaveragetotalcost.