Chapter 6: Perfect Competition, Monopoly, and Economic vs. Normal Profit

Chapter 6Perfect Competition, Monopoly, and Economic vs. Normal ProfitChapter OutlineFrom Perfect Competition to MonopolySupply Under Perfect CompetitionFrom Perfect Competition to MonopolyPerfect CompetitionMonopolistic CompetitionOligopolyMonopolyPicking the Quantity to Maximize ProfitAVCMCATCAVCMRQ*P*MRDMCATCQ*P*PQMany CompetitorsPQNo Competitors Characteristics of Perfect Competitiona 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 marketMonopolyThe 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.Monopolistic CompetitionMonopolistic Competition: a situation in a market where there are many firms producing similar but not identical goods. Example : the fast-food industry. McDonald’s has a monopoly on the “Happy Meal” but has much competition in the market to feed kids burgers and fries.OligopolyOligopoly: a situation in a market where there are very few discernible competitors Examples Satellite TV service (Direct TV, Primestar, Dish Network)Airlines (American, Delta etc.)Which Model Fits Reality?Perfect competition is rare outside agriculture though it fits some labor markets.Monopolies are common in utilitiesMajor branded companies are typically either in oligopolistic or monopolistically competitive industries.Examples of Different Market FormsPerfect CompetitionMonopolistic CompetitionOligopolyMonopolyAgricultureLumberFast FoodAirlinesCars and TrucksSoft DrinksWindows Operating systemLocal Residential UtilitiesDistinguishing Characteristics Between Market FormsPerfect CompetitionMonopolistic CompetitionOligopolyMonopolyNumber of FirmsMany-often thousands or even millionsSeveralFewOneBarriers to EntryNoneFewSubstantialInsurmountableProduct Homo/Hetero-geneityHomogeneousHeterogeneousHeterogeneousN/ASupply Under Perfect CompetitionNormal vs. Economic ProfitNormal Profit : the level of profit that business owners could get in their next best alternative investmentEconomic Profit: any profit above normal profitReturn on Equity For Various IndustriesIndustryRate of ReturnNet Income/(Assets-Liabilities)Agriculture8.0%Manufacturing14.6%Transportation and Public Utilities10.6%Wholesale and Retail Trade12.9%When and Why Economic Profits Go to ZeroTime HorizonsShort 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 Market Forms and Economic ProfitsUnder 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 doesn’t occur so prices do not fall.Figure 2 The Pressures on Price in Perfect Competition $QMCATCAVCMR3MR1MR2MR4Long Run PressureShort Run PressureFigure 3 Points of Production in Perfect Competition$QMCATCAVCMR4MR3MR2MR1Figure 4 Supply in Perfect Competition$QMCATCAVCSupply