Chapter 8

Managing in Competitive, Monopolistic, and Monopolistically Competitive MarketsFrancis S. Dela Vega Joniel S. Maducdoc Marrianne V. Pequeras

Overview

I. Perfect Competition Characteristics and profit outlook. Effect of new entrants. II. Monopolies Sources of monopoly power. Maximizing monopoly profits. Pros and cons. III. Monopolistic Competition Profit maximization. Long run equilibrium.

Perfect CompetitionThe concept of competition is used in two

ways in economics.Competition as a process is a rivalry among

firms. Competition as the perfectly competitive market structure.

A Perfectly Competitive MarketA perfectly competitive market is one in

which economic forces operate unimpeded.

A Perfectly Competitive MarketA perfectly competitive market must meet

the following requirements:

q Both

buyers and sellers are price takers. q The number of firms is large. q There are no barriers to entry. q The firms products are identical. q There is complete information. q Firms are profit maximizers.

The Necessary Conditions for Perfect CompetitionBoth buyers and sellers are price takers.A price taker is a firm or individual who

takes the market price as given. In most markets, households are price takers they accept the price offered in stores.

The Necessary Conditions for Perfect CompetitionBoth buyers and sellers are price takers.The retailer is not perfectly competitive.

qA

retail store is not a price taker but a price maker.

The Necessary Conditions for Perfect CompetitionThe number of firms is large.

q Large

means that what one firm does has no bearing on what other firms do. q Any one firm's output is minuscule when compared with the total market.

The Necessary Conditions for Perfect CompetitionThere are no barriers to entry.

q Barriers

to entry are social, political, or economic impediments that prevent other firms from entering the market. q Barriers sometimes take the form of patents granted to produce a certain good.

The Necessary Conditions for Perfect CompetitionThere are no barriers to entry.Technology may prevent some firms from

entering the market.

q Social

forces such as bankers only lending to certain people may create barriers.

The Necessary Conditions for Perfect CompetitionThe firms' products are identical.

q This

requirement means that each firm's output is indistinguishable from any competitor's product.

The Necessary Conditions for Perfect CompetitionThere is complete information.

q Firms

and consumers know all there is to know about the market prices, products, and available technology. q Any technological breakthrough would be instantly known to all in the market.

The Necessary Conditions for Perfect CompetitionFirms are profit maximizers.

q The

goal of all firms in a perfectly competitive market is profit and only profit. q The only compensation firm owners receive is profit, not salaries.

The Definition of Supply and Perfect CompetitionIf all the necessary conditions for perfect

competition exist, we can talk formally about the supply of a produced good.

The Definition of Supply and Perfect CompetitionSupply is a schedule of quantities of goods

that will be offered to the market at various prices.

The Definition of Supply and Perfect CompetitionWhen a firm operates in a perfectly

competitive market, its supply curve is that portion of its short-run marginal cost curve above average variable cost.

Demand Curves for the Firm and the IndustryThe demand curves facing the firm is

different from the industry demand curve. A perfectly competitive firms demand schedule is perfectly elastic even though the demand curve for the market is downward sloping.

Demand Curves for the Firm and the IndustryIndividual firms will increase their output in

response to an increase in demand even though that will cause the price to fall thus making all firms collectively worse off.

Market Demand Versus Individual Firm Demand CurveMarket Market supply Price $10 8 6 4 Market demand 2 1,000 Quantity 3,000 0 10 20 30 Quantity Firm

Price $10 8 6 4 2 0

Individual firm demand

Profit-Maximizing Level of OutputThe goal of the firm is to maximize profits. Profit is the difference between total

revenue and total cost.

Profit-Maximizing Level of OutputWhat happens to profit in response to a

change in output is determined by marginal revenue (MR) and marginal cost (MC).

s

A firm maximizes profit when MC = MR.

Profit-Maximizing Level of OutputMarginal revenue (MR) the change in

total revenue associated with a change in quantity.

s

Marginal cost (MC) the change in total cost associated with a change in quantity.

Marginal RevenueA perfect competitor accepts the market

price as given. As a result, marginal revenue equals price (MR = P).

Marginal CostInitially, marginal cost falls and then begins

to rise. Marginal concepts are best defined between the numbers.

Profit Maximization: MC = MRTo maximize profits, a firm should produce

where marginal cost equals marginal revenue.

How to Maximize ProfitIf marginal revenue does not equal

marginal cost, a firm can increase profit by changing output. The supplier will continue to produce as long as marginal cost is less than marginal revenue.

How to Maximize ProfitThe supplier will cut back on production if

marginal cost is greater than marginal revenue.

s

Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.

Marginal Cost, Marginal Revenue, and PriceQuantity Price = MR Produce $35.00 0 d Margi nal Cost Costs

MC

35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00 35.00

1 2 3 4 5 6 7 8 9 10

$28.00 20.00 16.00 14.00 12.00 17.00 22.00 30.00 40.00 54.00 68.00

60 50 40 30 20 10 0 1 2 3 4 5 6 7 8 910Quantity A A C B P=D= MR

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The Marginal Cost Curve Is the Supply CurveThe marginal cost curve is the firm's supply

curve above the point where price exceeds average variable cost.

The Marginal Cost Curve Is the Supply CurveThe MC curve tells the competitive firm

how much it should produce at a given price.

s

The firm can do no better than produce the quantity at which marginal cost equals marginal revenue which in turn equals price.

The Marginal Cost Curve Is the Firms Supply CurveP70 60 50 40 30 20 10 0 1 2 3 4 5 6 7 8 9 10 Quantity B A C Marginal cost

Cost, Price

Firms Maximize Total ProfitFirms seek to maximize total profit, not profit

per unit.Firms do not care about profit per unit. As long as increasing output increases total

profits, a profit-maximizing firm should produce more.

Profit Maximization Using Total Revenue and Total CostProfit is maximized where the vertical

distance between total revenue and total cost is greatest. At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal.

Profit Determination Using Total Cost and Revenue CurvesTC Loss P385 350 315 Maximum profit =P81 280 245 210 P130 175 140 105 Profit =P45 70 Loss 35 0 TR Profit

Total cost, revenue

1 2 3 4 5 6 7 8 9

Quantity

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2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Total Profit at the ProfitMaximizing Level of OutputThe P = MR = MC condition tells us how much

output a competitive firm should produce to maximize profit. It does not tell us how much profit the firm makes.

Determining Profit and Loss From a Table of CostsProfit can be calculated from a table of

costs and revenues. Profit is determined by total revenue minus total cost.

Costs Relevant to a Firm

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2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Costs Relevant to a Firm

McGraw-Hill/Irwin

2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Determining Profit and Loss From a GraphFind output where MC = MR.The intersection of MC = MR (P) determines

the quantity the firm will produce if it wishes to maximize profits.

Determining Profit and Loss From a GraphFind profit per unit where MC = MR.

q Drop

a line down from where MC equals MR, and then to the ATC curve. q This is the profit per unit. q Extend a line back to the vertical axis to identify total profit.

Determining Profit and Loss From a GraphThe firm makes a profit when the ATC curve

is below the MR curve.

s

The firm incurs a loss when the ATC curve is above the MR curve.

Determining Profit and Loss From a GraphZero profit or loss where MC=MR.

q Firms

can earn zero profit or even a loss where MC = MR. q Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.

Determining Profits Graphically

MC MC MC Price Price Price 65 65 65 60 60 60 55 55 55 ATC 50 50 50 ATC 45 45 45 40 40 D A P = MR 40 Loss P = MR 35 35 35 P = MR Profit 30 30 30 B ATC AVC 25 25 C 25 AVC AVC E 20 20 20 15 15 15 10 10 10 5 5 5 0 0 0 1 23 4 567 89 1 12 1 23 4 5 67 891012 1 23 4 5 67 891012 Quantity Quantity Quantity 0 (b) Zero profit case a) Profit case (c) Loss caseIrwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2000

The Shutdown PointThe firm will shut down if it cannot cover

average variable costs.A