7 Perf Comp Pure Monopoly
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Transcript of 7 Perf Comp Pure Monopoly
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The McGraw-Hill Companies, 2005
Chapter 8Perfect competition and pure monopoly
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,8th Edition, McGraw-Hill, 2005
PowerPoint presentation by Alex Tackie and Damian Ward
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The McGraw-Hill Companies, 20051
Perfect competition
many buyers and sellers
so no individual believes that their own action canaffect market price
firms take price as given so face a horizontal demand curve
the product is homogeneous perfect customer information
free entry and exit of firms
Characteristics of a perfectly competitive market
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The McGraw-Hill Companies, 20052
The supply curve under perfect competition (1)
Above price P3 (point C),the firm makes profit
above the opportunitycost of capital in theshort run
At price P3, (point C), thefirm makes NORMAL
PROFITS
P1
Output
SAVC
SMC
Q1
SATC
P3
A
C
Q3
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The McGraw-Hill Companies, 20053
The supply curve under perfect competition (2)
Between P1 and P3, (A
and C), the firm makes
short-run losses, but
remains in the market
Below P1 (the SHUT-
DOWN PRICE), the firm
fails to cover SAVC, and
exits
P1
Output
SAVC
SMC
Q1
SATC
P3
A
C
Q3
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The McGraw-Hill Companies, 20054
The supply curve under perfect competition (3)
showing how much the
firm would produce at
each price level.P1
Output
SAVC
SMC
Q1
SATC
P3
A
C
Q3
So the SMC curve above
SAVC represents the
firms SHORT-RUN
SUPPLY CURVE
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The firm and the industry in the short run underperfect competition (1)
INDUSTRY
Output
Q
P
SRSS
D
Firm
SAC
P
Output
SMC
D=MR=AR
q
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The McGraw-Hill Companies, 20056
The firm and the industry in the short run underperfect competition (1)
INDUSTRY
Output
Q
P
SRSS
D
Firm
Market price is set at industry level at the intersection ofdemand and supply
the industry supply curve is the sum of the individual firmssupply curves
SAC
P
Output
SMC
D=MR=AR
q
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The McGraw-Hill Companies, 20057
The firm and the industry in the short run underperfect competition (2)
INDUSTRYFirm
The firm accepts price as given at P
and chooses output at q where SMC=MR to maximise profits
SAC
P
Output
SMC
D=MR=AR
qOutput
Q
P
SRSS
D
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The McGraw-Hill Companies, 20058
The firm and the industry in the short run underperfect competition (3)
INDUSTRY
Output
Q
P
SRSS
D
At this price, profits are shown by the shaded area.
These profits attract new entrants into the industry.As more firms join the market, the industry supply curve shiftsto the right, and market price falls.
SRSS1
P1
SAC
Firm
P
Output
SMC
D=MR=AR
q Q1
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Long-run equilibrium
INDUSTRYFirm
LAC
P*
Output
LMC
D=MR=AR
q*
The market settles in long-run equilibrium when the typicalfirm just makes normal profit by setting LMC=MR at the minimumpoint of LAC. Long-run industry supply is horizontal.
If the expansion of the industry pushes up input prices (e.g. wages)the long-run supply curve will not be horizontal, but upward-sloping.
SRSS
D
Output
Q
P*LRSS
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The McGraw-Hill Companies, 200510
Adjustment to an increase in market demand:
the short run
Suppose a perfectlycompetitive market startsin equilibrium at P0Q0.
If market demand shifts toD'D' ...
in the short run the newequilibrium is P1Q1 ...
adjustment is throughexpansion of individualfirms along their SMCs.
Q1
P1
Output
D
SRSS
Q0
P0
D
D'
D'
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Adjustment to an increase in market demand:
the long run
In the long run, new firmsare attracted by the profitsnow being made here
Output
D
SRSS
Q0
P0
D
D'
D'
Q1
P1
and firms are able toadjust their input of fixedfactorsIf wages are bid up by thisexpansion, the long-runsupply schedule is upward-sloping
LRSS
and the market finallysettles at P2Q2.
Q2
P2
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Monopoly A monopolist:
is the sole supplier of an industrys product
and the only potential supplier
is protected by some form of barrier toentry
faces the market demand curve directly Unlike under perfect competition, MR is
always below AR.
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Profit maximisation by a monopolist
Profits are maximisedwhere MC = MR at Q1P1.
In this position, AR is
greater than ACso the firm makesprofits above theopportunity cost ofcapital shown by theshaded area.
Entry barriers preventnew firms joining theindustry.
Output
MC=MR
P1
Q1
MC
AC
D = ARMR
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Comparing monopoly with perfect
competition (1)Suppose a competitive industry is taken over by a monopolist:
Output
DMR
SRSS
LRSS
Q1
P1
A
Competitive equilibriumis at A, with output Q1and price P1.
To the monopolist, LRSSis the LMC curve, andSRSS is the SMC curve.
= LMC
=SMC
The monopolistmaximises profits in theshort run at MR = SMCat P2Q2.Q2
P2
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Comparing monopoly with perfect
competition (2)Suppose a competitive industry is taken over by a monopolist:
Output
In the long run the
firm can adjustother inputs ...
to set MR = LMC
at P3Q3.
P3
Q3
DMR
SRSS
LRSS
Q1
P1
A
= LMC
=SMC
Q2
P2
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Comparing monopoly with perfectcompetition (3)
So we see that monopoly compared withperfect competition implies: higher price
lower output Does the consumer always lose from
monopoly? Among other things, this depends on whether the
monopolist faces the same cost structure there may be the possibility of economies of scale.
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Anatural monopoly
This firm enjoys
substantial economies of
scale relative to market
demand
LAC declines right up to
market demand
the largest firm always
enjoys cost leadership
and comes to dominatethe industry
It is a NATURAL
MONOPOLY.
LMC
LAC
DMR
P1
Q1 Output
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Discriminating monopoly Suppose a monopolist supplies two separate
groups of customers with differing elasticities of demand
e.g. business travellers may be less sensitive to airfare levels than tourists.
The monopolist may increase profits bycharging higher prices to the businessmen
than to tourists. Discrimination is more likely to be possible for
goods that cannot be resold e.g. dental treatment.