Managing in Competitive, Monopolistic,
and Monopolistically Competitive
Markets
Francis S. Dela VegaJoniel S. Maducdoc
Marrianne V. Pequeras
OverviewI. Perfect CompetitionCharacteristics and profit outlook.Effect of new entrants.II. MonopoliesSources of monopoly power.Maximizing monopoly profits.Pros and cons.III. Monopolistic CompetitionProfit 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:
Both buyers and sellers are price takers.
The number of firms is large. There are no barriers to entry. The firms’ products are identical. There is complete information. 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.
A retail store is not a price taker but a price maker.
The Necessary Conditions for Perfect CompetitionThe number of firms is large.
Large means that what one firm does has no bearing on what other firms do.
Any one firm's output is minuscule when compared with the total market.
The Necessary Conditions for Perfect CompetitionThere are no barriers to entry.
Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market.
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.
Social forces such as bankers only lending to certain people may create barriers.
The Necessary Conditions for Perfect CompetitionThe firms' products are identical.
This requirement means that each firm's output is indistinguishable from any competitor's product.
The Necessary Conditions for Perfect CompetitionThere is complete information.
Firms and consumers know all there is to know about the market – prices, products, and available technology.
Any technological breakthrough would be instantly known to all in the market.
The Necessary Conditions for Perfect CompetitionFirms are profit maximizers.
The goal of all firms in a perfectly competitive market is profit and only profit.
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, it’s 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 firm’s 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 supply
Marketdemand
1,000 3,000
Price$10
8
6
4
2
0Quantity
Market Firm
Individual firm demand
Market Demand Versus Individual Firm Demand Curve
10 20 30
Price$10
8
6
4
2
0Quantity
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).
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.
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.
Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.
C
AP = D = MR
Costs
1 2 3 4 5 6 7 8 9 10 Quantity
60
50
40
30
20
10
0
AB
MC
Marginal Cost, Marginal Revenue, and Price
0123456789
10
$28.0020.0016.0014.0012.0017.0022.0030.0040.0054.0068.00
Price = MR Quantity Produced
Marginal Cost
$35.0035.0035.0035.0035.0035.0035.0035.0035.0035.0035.00
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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.
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 Firm’s Supply Curve
A
B
CMarginal cost
Cos
t, P
rice
P70
60
50
40
30
20
10
0 1 Quantity2 3 4 5 6 7 8 9 10
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.
TC TR
0
Tota
l cos
t, re
venu
e P385350315280245210175140105
7035
Quantity1 2 3 4 5 6 7 8 9
Profit Determination Using Total Cost and Revenue Curves
Maximum profit =P81
P130
Loss
Loss
Profit
Profit =P45
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Total Profit at the Profit-Maximizing Level of Output
The 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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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.
Drop a line down from where MC equals MR, and then to the ATC curve.
This is the profit per unit. 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.
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.
Firms can earn zero profit or even a loss where MC = MR.
Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.
(a) Profit case (b) Zero profit case (c) Loss case
Determining Profits Graphically
Quantity Quantity Quantity
Price65 60 55 50 45 40 35 30 25 20 15 10
5 0
65 60 55 50 45 40 35 30 25 20 15 10
5 01 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12
D
MC
A P = MR
B ATCAVCE
Profit
C
MC
ATC
AVC
MC
ATC
AVC
Loss
65 60 55 50 45 40 35 30 25 20 15 10 5 0 1 2 3 4 5 6 7 8 910 12
P = MRP = MR
Price Price
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The Shutdown PointThe firm will shut down if it cannot cover
average variable costs. A firm should continue to produce as long as
price is greater than average variable cost.If price falls below that point it makes sense
to shut down temporarily and save the variable costs.
The Shutdown PointThe shutdown point is the point at which
the firm will be better off it it shuts down than it will if it stays in business.
The Shutdown PointIf total revenue is more than total variable
cost, the firm’s best strategy is to temporarily produce at a loss.
It is taking less of a loss than it would by shutting down.
MC
P = MR
2 4 6 8 Quantity
Price
60
50
40
30
20
10
0
ATC
AVC
Loss
A$17.80
The Shutdown Decision
Short-Run Market Supply and Demand
While the firm's demand curve is perfectly elastic, the industry's is downward sloping.
For the industry's supply curve we use a market supply curve.
Short-Run Market Supply and Demand
The market supply curve is the horizontal sum of all the firms' marginal cost curves, taking account of any changes in input prices that might occur.
Long-Run Competitive EquilibriumProfits and losses are inconsistent with
long-run equilibrium.Profits create incentives for new firms to
enter, output will increase, and the price will fall until zero profits are made.
The existence of losses will cause firms to leave the industry.
Long-Run Competitive EquilibriumOnly at zero profit will entry and exit stop.
The zero profit condition defines the long-run equilibrium of a competitive industry.
Long-Run Competitive Equilibrium
MC
P = MR
0
60
50
40
30
20
10
Price
2 4 6 8 Quantity
SRATC LRATC
Long-Run Competitive EquilibriumZero profit does not mean that the
entrepreneur does not get anything for his efforts.
Normal profit – the amount the owners of business would have received in the next-best alternative.
Long-Run Competitive EquilibriumNormal profits are included as a cost and
are not included in economic profit.
Economic profits are profits above normal profits.
Long-Run Competitive EquilibriumFirms with super-efficient workers or
machines will find that the price of these specialized inputs will rise.
Rent is the income received by those specialized factors of production.
Long-Run Competitive EquilibriumThe zero profit condition makes the
analysis of competitive markets applicable to the real world.
To determine whether markets are competitive, many economist focus on whether barriers to entry exist.
Adjustment from the Long Run to the Short Run
Industry supply and demand curves come together to lead to long-run equilibrium.
An Increase in DemandAn increase in demand leads to higher
prices and higher profits.Existing firms increase output.New firms enter the market, increasing
output still more.Price falls until all profit is competed away.
An Increase in DemandIf input prices remain constant, the new
equilibrium will be at the original price but with a higher output.
An Increase in DemandThe original firms return to their original
output but since there are more firms in the market, the total market output increases.
An Increase in DemandIn the short run, the price does more of the
adjusting. In the long run, more of the adjustment is
done by quantity.
ProfitP9
10120
FirmPrice
Quantity
B
A
Market Response to an Increase in Demand
Market
Quantity
Price
0
B
A
C
MC
AC
SLR
S0SR
D0
7
700
P9
8401,200
D1
S1SR
7
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Long-Run Market SupplyIn the long run firms earn zero profits.If the long-run industry supply curve is
perfectly elastic, the market is a constant-cost industry.
Long-Run Market SupplyTwo other possibilities exist:
Increasing-cost industry – factor prices rise as new firms enter the market and existing firms expand capacity.
Decreasing-cost industry – factor prices fall as industry output expands.
An Increasing-Cost IndustryIf inputs are specialized, factor prices are
likely to rise when the increase in the industry-wide demand for inputs to production increases.
An Increasing-Cost IndustryThis rise in factor costs would force costs
up for each firm in the industry and increases the price at which firms earn zero profit.
An Increasing-Cost IndustryTherefore, in increasing-cost industries, the
long-run supply curve is upward sloping.
A Decreasing-Cost IndustryIf input prices decline when industry output
expands, individual firms' marginal cost curves shift down and the long-run supply curve is downward sloping.
A Decreasing-Cost IndustryInput prices may decline to the zero-profit
condition when output rises.
New entrants make it more cost-effective for other firms to provide services to all firms in the market.
An Example in the Real WorldK-mart decided to close over 300 stores
after experiencing two years of losses (a shutdown decision).
K-mart thought its losses would be temporary.
An Example in the Real WorldPrice exceeded average variable cost, so it
continued to keep some stores open even though those stores were losing money.
Price
Quantity
MC
ATC
AVCP = MR
Loss
An Example in the Real World
An Example in the Real WorldAfter two years of losses, its prospective
changed.
The company moved from the short run to the long run.
An Example in the Real WorldThey began to think that demand was not
temporarily low, but permanently low.
At that point they shut down those stores for which P < AVC.
