Perfect Competition

and Monopoly
ALTERNATIVE MARKET STRUCTURES

 Classifying markets by degree of competition

number of firms
freedom of entry to industry
nature of product
nature of demand curve
 The four market structures
perfect competition
monopoly
monopolistic competition
oligopoly
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Features of the four market structures
Perfect Competition and Monopoly

Perfect Competition
 PERFECT COMPETITION

 Short-run equilibrium of the firm

P = MC
possible supernormal profits
 Short-run equilibrium of industry and firm under
perfect competition

P £
S MC AC

D = AR
Pe AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 PERFECT COMPETITION

 Short-run equilibrium of the firm

P = MC
possible supernormal profits
possible short-run loss
 Loss minimising under perfect competition

P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 PERFECT COMPETITION

short-run supply curve of firm

 Deriving the short-run supply curve

P S £
MC = S
a D1 = MR1
P1
b D2 = MR2
P2
c D3 = MR3
P3
D1
D2
D3
O O
Q (millions) Q (thousands)

(a) Industry (b) Firm

 PERFECT COMPETITION

 Long-run equilibrium of the firm

all supernormal profits competed away
 Long-run equilibrium under perfect competition
Profits return
Supernormal
New firms enter to normalprofits
P £
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

Long-run equilibrium under perfect competition
£ (SR)MC
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

O Q
 PERFECT COMPETITION

 Long-run equilibrium of the firm

all supernormal profits competed away

long-run industry supply curve

Various long-run industry supply curves under perfect competition

P S1 S2
b

a c
Long-run S

D1 D2

O Q
(a) Constant industry costs
Various long-run industry supply curves under perfect competition

P S1 S2

Long-run S
c
a

D2
D1

O Q
(b) Increasing industry costs: external diseconomies of
Various long-run industry supply curves under perfect competition

P
S1
b S2

a
c
Long-run S

D2
D1

O Q
(c) Decreasing industry costs: external economies of scale
 PERFECT COMPETITION

 Advantages of perfect competition

P = MC
production at minimum AC
only normal profits in long run
responsive to consumer wishes: consumer
sovereignty
competition  efficiency
no point in advertising
 PERFECT COMPETITION

 Disadvantages of perfect competition

 insufficient profits for investment
 lack of product variety
 lack of competition over product design
and specification
Perfect Competition and Monopoly

Monopoly
 MONOPOLY
 Defining monopoly
 Barriers to entry
economies of scale
product differentiation and brand loyalty
lower costs for an established firm
ownership or control over key factors
ownership or control over outlets
legal restrictions
mergers and takeovers
aggressive tactics
 Natural monopoly
 Natural Monopoly
£

b
LRAC

D2 D1

O Q
 MONOPOLY

 The monopolist's demand curve

downward sloping

MR below AR
Average and marginal revenue under monopoly
£

AR
MR
O Q
 MONOPOLY

 Equilibrium price and output

 Profit maximising under monopoly
£ MC

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

AR

AC

AR
MR
O Qm Q
 MONOPOLY

 Disadvantages of monopoly
 high prices / low output: short run
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC

Monopoly
P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC ( = supply under
perfect competition)

Comparison with
P1 Perfect competition

P2

AR = D

MR
O Q1 Q2 Q
 MONOPOLY

 Disadvantages of monopoly
 high prices / low output: short run
 high prices / low output: long run
 lack of incentive to innovate
 X-inefficiency
 MONOPOLY

 Disadvantages of monopoly
 high prices / low output: short run
 high prices / low output: long run
 lack of incentive to innovate
 X-inefficiency
 Advantages of monopoly
 economies of scale
Equilibrium of industry under perfect competition and
monopoly: with different MC curves
£

MCmonopoly

P1

AR = D

MR
O Q1 Q
Equilibrium of industry under perfect competition and
monopoly: with different MC curves
£ MC ( = supply)perfect competition

MCmonopoly

P2

P1
x
P3

AR = D

MR
O Q2 Q1 Q3 Q
 MONOPOLY
 Disadvantages of monopoly
 high prices / low output: short run
 high prices / low output: long run
 lack of incentive to innovate
 X-inefficiency
 Advantages of monopoly
 economies of scale
 profits can be used for investment
 promise of high profits encourages risk
taking