Chapter 5 Perfect Competition, Monopoly, and Economic versus Normal Profit Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Dec 21, 2015
Chapter 5Perfect Competition,
Monopoly, and Economic versus
Normal Profit
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
5-2
Chapter Outline
• From Perfect Competition to Monopoly
• Supply Under Perfect Competition
5-3
You Are Here
5-4
From Perfect Competition to Monopoly
• Perfect Competition• Monopolistic Competition• Oligopoly• Monopoly
5-5
Picking the Quantity to Maximize Profit The
Perfectly Competitive Case
MC ATC
AVC
MR
Q*
P*
P
QMany Competitors
5-6
AVC
MR
D
MC
ATC
Q*
P*
P
Q
No Competitors
Picking the Quantity to Maximize Profit The Monopoly
Case
5-7
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
5-8
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.
5-9
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. McDonald’s has a monopoly on the “Happy Meal” but has much competition in the market to feed kids burgers and fries.
5-10
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.)
5-11
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.
5-12
Examples of Different Market Forms
Perfect Competition
Monopolistic Competition
Oligopoly Monopoly
1) Agriculture2) Lumber
1) Fast Food
2) Long Distance Service
1) Cars and Trucks
2) Soft Drinks
1) Windows Operating system
2) Local Residential electric power
5-13
Distinguishing Characteristics Between
Market FormsPerfect competition
Monopolistic Competition
Oligopoly
Monopoly
Number of Firms
Many-often thousands or even millions
Several* Few* One
Barriers to Entry
None Few Substantial
Insurmountable, at least in the short run
Product Similarity
Identical Similar but not identical
Similar or Identical
N/A
* The line between “several” and “few” is not definite
5-14
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).
5-15
Concentration Ratios For Various Manufacturing Industries
Industry Group Concentration Ratios
4 Largest Firms 8 Largest Firms 50 Largest Firms
Breakfast Cereals
78.4% 91.1% 100.0%
Ice Cream 48.0 64.4 93.1
Beer 90.8 93.8 98.1
Clothing 17.3 21.3 38.7
Computers and Peripherals
40.5 65.2 88.3
Furniture 11.0 18.0 30.6
Long Distance 59.7 80.9 92.5
Cellular Service 61.7 81.7 90.0
5-16
Supply Under Perfect Competition
5-17
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
5-18
Return on Equity For Various Industries
Industry Rate of ReturnNet Income/(Assets-Liabilities)
Agriculture 3.1%
Manufacturing 21.8%
Transportation and Public Utilities
8.2%
Retail Trade 16.1%
5-19
When and Why Economic Profits Go to Zero
5-20
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
5-21
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 doesn’t occur so prices do not fall.
5-22
Figure 2 The Pressures on Price in Perfect Competition
$
Q
MC
ATC
AVC
MR3
MR1
MR2
MR4
Long Run Pressure
Short Run Pressure
5-23
Figure 3 Points of Production in Perfect Competition
$
Q
MC
ATC
AVC
MR4
MR3
MR2
MR1
5-24
Figure 4 Supply in Perfect Competition
$
Q
MC
ATC
AVC
Supply