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A COLLECTION
OF FIRMS
PRODUCING THE
SAME
GOOD/SERVICE.
THE PERFECT MARKET COMPETITION
GENERAL DESCRIPTION:
A VERY LARGE NUMBER OF SMALL FIRMS IN THE INDUSTRY;
ENTRY AND EXIT TO THE INDUSTRY IS EASY;
GOODS SOLD ARE PERFECT SUBSTITUTES (FIRMS PRODUCE AN IDENTICAL
PRODUCT), AND
EACH BUYER AND SELLER HAS NO CONTROL OVER THE MARKET PRICE (THIS
MEANS THAT EACH FIRM IS A PRICE TAKER THAT FACES A HORIZONTAL
DEMAND CURVE FOR ITS PRODUCT).
DEMAND CURVE IN A PERFECT COMPETITIVE MARKET
P Supply
Demand
70
Demand
curve
50
30
20
Q
1,000 2,000 3,000 10 20 30 40
Industry Output Firm output
Demand curve perfectly
THE PROFIT-MAXIMIZING LEVEL OF OUTPUT
THE GOAL OF A FIRM IS TO MAXIMIZE PROFITS;
A FIRM NEEDS TO KNOW AT WHAT QUANTITY OF OUTPUT IT EARNS PROFIT
MOST.
PROFIT IS THE DIFFERENCE OF TOTAL REVENUE (TR) AND TOTAL COST (TC).
TO KNOW THE RATE OF CHANGE IN PROFIT FOR EVERY EXTRA
OUTPUT IS PRODUCED, WE CALCULATE MARGINAL REVENUE (MR) AND
MARGINAL COST (MC).
MR- IS THE CHANGE IN TR ASSOCIATED WITH A CHANGE IN QUANTITY.
MC- IS THE CHANGE IN TC ASSOCIATED WITH A CHANGE IN QUANTITY.
MR AND MC ARE THE KEY CONCEPTS IN DETERMINING PROFIT-
MAXIMIZING OR LOSS-MINIMIZING LEVEL OF OUTPUT OF ANY FIRM.
PROFIT MAXIMIZATION IN A PERFECT
COMPETITIVE MARKET
IN A PERFECT COMPETITIVE MARKET, A FIRM MAXIMIZE PROFIT
WHEN MC = MR OR MC = P.
SINCE EVERY FIRM IN THIS MARKET STRUCTURE IS A PRICE
TAKER, THE MR OF THE FIRM IS SIMPLY THE MARKET PRICE, MR =
P.
MARGINAL REVENUE, MARGINAL COST, AND
PRICE
Price = Q TFC AFC TVC AVC TC MC ATC TR TF
MR
P35 0 P40 - 0 P40 - 0 -P40
35 2 40 20 48 24 88 20 44 70 -18
35 5 40 8 90 18 130 12 26 175 45
NATURAL MONOPOLY
A MONOPOLY THAT ARISES BECAUSE OF THE EXISTENCE OF ECONOMIES OF
SCALE OVER THE ENTIRE RELEVANT RANGE OF OUTPUT.
A LARGER FIRM WILL ALWAYS BE ABLE TO PRODUCE OUTPUT AT A LOWER COST
THAN COULD A SMALLER FIRM.
ONLY A SINGLE FIRM CAN SURVIVE IN A LONG-RUN EQUILIBRIUM.
FINDING A MONOPOLISTS OUTPUT, PRICE AND
PROFIT
1. DRAW THE MARGINAL REVENUE
Price
D MR
Quantity
FINDING A MONOPOLISTS OUTPUT, PRICE AND
PROFIT
1. DRAW THE MARGINAL REVENUE
2. DETERMINE THE OUTPUT THE MONOPOLIST WILL PRODUCE: THE PROFIT
MAXIMIZING LEVEL OF OUTPUT IS WHERE MR & MC CURVES INTERSECT.
Price
MC
D MR
Quantity
FINDING A MONOPOLISTS OUTPUT, PRICE AND
PROFIT
3. DETERMINE THE PRICE THE MONOPOLIST WILL CHARGE: EXTEND A LINE
FROM WHERE MR = MC UP TO THE DEMAND CURVE. WHERE THIS INTERSECTS
THE DEMAND CURVE IS THE MONOPOLISTS PRICE.
P
m
MR
Q
m
FINDING A MONOPOLISTS OUTPUT, PRICE AND
PROFIT
4. DETERMINE THE PROFIT THE MONOPOLISTS WILL EARN: SUBTRACT THE ATC
FROM PRICE AT THE PROFIT MAXIMIZING LEVEL OF OUTPUT TO GET PROFIT
PER UNIT. MULTIPLY PROFIT PER UNIT BY QUANTITY OF OUTPUT TO GET THE
TOTAL PROFIT.
ATC
P
m
Cm
MR
Q
m
FINDING A MONOPOLISTS OUTPUT, PRICE AND
PROFIT
MONOPOLIT HAS 0 PROFIT/BREAK EVEN
ATC
P
m
MR
Q
m
FINDING A MONOPOLISTS OUTPUT, PRICE AND
PROFIT
MONOPOLIT MAKE A LOSS
ATC
P
m
MR
Q
m
MONOPSONY
MONOPOLY OCCURS WHEN THERE IS A SINGLE SELLER; THERE ARE ALSO MARKETS
IN WHICH THERE IS A SINGLE BUYER. SUCH MARKETS ARE CALLED MONOPSONIES.
AN EXAMPLE OF A MONOPSONY IS A COMPANY TOWN IN W/C A SINGLE FIRM IS
THE ONLY EMPLOYER. WHEREAS A MONOPOLIST TAKES INTO ACCOUNT THE FACT
THAT IF IT SELLS MORE IT WILL LOWER THE MARKET PRICE, A MONOPSONIES TAKES
INTO ACCOUNT THE FACT THAT IT WILL RAISE THE MARKET PRICES IF IT BUYS MORE.
THUS, IT BUYS LESS AND PAYS LESS.
MC
Pm
D
M
R
Qm
OUTPUT, PRICE & PROFIT OF A MONOPOLISTIC
COMPETITOR
B. A MONOPOLISTIC COMPETITOR IS NOT ONLY A MONOPOLIST BUT ALSO A
COMPETITOR. COMPETITION IMPLIES ZERO (0) ECONOMIC PROFIT IN THE LONG RUN.
ECONOMIC PROFITS ARE DETERMINED BY ATC CURVE. IN THE LONG-RUN EQUILIBRIUM,
ATC IS EQUAL TO PRICE. IT EQUAL TO PRICE ONLY IF ATC CURVE IS TANGENT TO THE
DEMAND CURVE AT THE OUTPUT IT CHOOSES.
MC ATC
Pm
D
M
R
Qm
COMPARING MONOPOLISTIC COMPETITION WITH
MONOPLY
AN IMPORTANT DIFFERENCE BETWEEN A MONOPOLIST AND MONOPOLISTIC
COMPETITOR IS IN THE POSITION OF THE ATC CURVE IN LONG-RUN
EQUILIBRIUM. FOR A MONOPOLIST, ATC CURVE SHOULD BE A POSITION
BELOW
OLIGOPOLY
A SMALL NUMBER OF FIRMS PRODUCE MOST OUTPUT (BECAUSE THERE ARE
SO FEW FIRMS, EVERY COMPETITOR MUST THINK CONTINUALLY ABOUT THE
ACTIONS OF ITS RIVALS WHAT EACH DOES COULD MAKE OR BREAK THE
OTHERS)
THE PRODUCT MAY BE EITHER STANDARDIZED OR DIFFERENTIATED,
THERE ARE SIGNIFICANT BARRIERS TO ENTRY, AND
RECOGNIZED INTERDEPENDENCE EXISTS (I.E., EACH FIRM REALIZES THAT ITS
PROFITABILITY DEPENDS ON THE ACTIONS AND REACTIONS OF RIVAL FIRMS).
OLIGOPOLISTIC FIRMS ARE MUTUALLY INTERDEPENDENT.
MODELS OF OLIGOPOLY BEHAVIOR
1. CARTEL
A CARTEL IS A COMBINATION OF FIRMS THAT ACTS AS IF IT WERE A
MONOPOLY
THE LEADING FIRMS IN AN INDUSTRY BAND TOGETHER TO RESTRICT OUTPUT
AND, CONSEQUENTLY, INCREASE PRICES AND PROFITS
IF THE DEMAND IS THERE, OLIGOPOLISTIC FIRMS CAN OPENLY COLLUDE TO
CONTROL SUPPLY AND, TO A LARGE DEGREE, MARKET PRICE
A CARTEL IS THE MOST EXTREME CASE OF OLIGOPOLY.
IMPLICIT PRICE COLLUSION
MULTIPLE FIRMS MAKE THE SAME PRICING DECISIONS EVEN THOUGH THEY
HAVE NOT EXPLICITLY CONSULTED ONE ANOTHER.
ONE OF THE CHARACTERISTICS OF INFORMAL COLLUSIVE BEHAVIOR IS THE
PRICE TEND TO BE STICKY.
PRICE IS STICKY BECAUSE OF THE PERCEIVED KINKED DEMAND CURVE. IF
THE FIRM RAISES ITS PRICE, OTHER FIRMS WONT GO ALONG AND THE FIRM
WONT GAIN MARKET SHARE. THUS, THE FIRM HAS STRONG REASONS NOT
TO CHANGE ITS PRICE IN EITHER DIRECTION.
CONTESTABLE MARKET MODEL
Strategic Pricing decision- firms set price based on the expected reactions of the other
firms.