Chapter 5

Perfect Competition,
Monopoly, and Economic
versus Normal Profit

McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter Outline

From Perfect Competition to

Monopoly
Supply Under Perfect Competition

5-2
You Are Here

5-3
 From Perfect Competition to
Monopoly
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly

5-4
Picking the Quantity to Maximize
Profit The Perfectly Competitive
P
Case
MC ATC

AVC
P* MR

Q*
Q
Many Competitors
5-5
Picking the Quantity to Maximize
Profit The Monopoly Case
P

MC

ATC

P* AVC

D
MR

Q* Q
No Competitors
5-6
 Characteristics of Perfect
Competition
a large number of competitors, such that no
one firm can influence the price
the good a firm sells is indistinguishable
from the ones its competitors sell
firms have good sales and cost forecasts
there is no legal or economic barrier to its
entry into or exit from the market

5-7
 Monopoly

The sole seller of a good or service.

Some monopolies are generated
because of legal rights (patents and
copyrights).
Some monopolies are utilities (gas,
water, electricity etc.) that result from
high fixed costs.

5-8
 Monopolistic Competition
Monopolistic Competition: a
situation in a market where there are
many firms producing similar but not
identical goods.
Example : the fast-food industry.
McDonalds has a monopoly on the
Happy Meal but has much
competition in the market to feed kids
burgers and fries.
5-9
 Oligopoly

Oligopoly: a situation in a market

where there are very few discernible
competitors
Examples
Satellite TV service (Direct TV, Dish
Network)
Airlines (American, Delta etc.)

5-10
 Which Model Fits Reality?

Perfect competition is rare outside

agriculture though it fits some labor
markets.
Monopolies are common in utilities
Major branded companies are typically
either in oligopolistic or
monopolistically competitive
industries.
5-11
 Examples of Different Market
Forms

Perfect Monopolistic Oligopoly Monopoly

Competition Competition

1) Agriculture 1) Fast 1) Cars and 1) Windows

2) Lumber Food Trucks Operating
2) Long 2) Soft system
Distance Drinks 2) Local
Service Residenti
al electric
power

5-12
 Distinguishing Characteristics
Between Market Forms
Perfect Monopolistic Oligopoly Monopoly
competition Competition

Number Many-often Several* Few* One

thousands or
of Firms even millions

Barriers None Few Substantial Insurmountable

, at least in the
to Entry short run

Product Identical Similar but not Similar or N/A

identical Identical
Similarity

* The line between several and few is not definite

5-13
 Concentration Ratios

there is no magic line that separates

oligopoly from monopolistic competition.
a concentration ratio measures the
percentage of total market sales for the
top firms (from 4 firms to 100 firms).

5-14
 Concentration Ratios For Various
Manufacturing Industries
Industry Group Concentration Ratios
4 Largest Firms 8 Largest Firms 50 Largest Firms

Breakfast 78.4% 91.1% 100.0%

Cereals
Ice Cream 48.0 64.4 93.1
Beer 90.8 93.8 98.1
Clothing 17.3 21.3 38.7
Computers and 40.5 65.2 88.3
Peripherals
Furniture 11.0 18.0 30.6
Long Distance 59.7 80.9 92.5

Cellular Service 61.7 81.7 90.0

5-15
Supply Under Perfect Competition

5-16
 Normal vs. Economic Profit

Normal Profit : the level of profit

that business owners could get in
their next best alternative
investment
Economic Profit: any profit above
normal profit

5-17
 Return on Equity For Various
Industries
Industry Rate of Return
Net Income/(Assets-
Liabilities)

Agriculture 3.1%
Manufacturing 21.8%
Transportation and Public 8.2%
Utilities
Retail Trade 16.1%

5-18
When and Why Economic Profits
Go to Zero

5-19
 Time Horizons

Short Run: the period of time where

we cannot change things like plant and
equipment
Long Run : the period of time where
we can change things like plant and
equipment

5-20
 Market Forms and Economic
Profits
Under perfect competition or
monopolistic competition, economic
profits go to zero because of the entry of
new firms increases market supply and
lowers prices.
Economic profits are under no pressure
to shrink under oligopoly or monopoly
because entry doesnt occur so prices do
not fall.

5-21
 Figure 2 The Pressures on Price in
Perfect Competition

$
Long Run
MC Pressure
MR4
Short Run
ATC Pressure
AVC
MR3
MR2

MR1

Q
5-22
Figure 3 Points of Production in Perfect
Competition

MC
MR4

ATC
AVC
MR3
MR2

MR1

Q
5-23
 Figure 4 Supply in Perfect
Competition
$
MC

Supply
ATC
AVC

Q
5-24