Chapter 5
Perfect Competition,
Monopoly, and Economic vs.
Normal Profit
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Chapter Outline
• From Perfect Competition to
Monopoly
• Supply Under Perfect Competition
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From Perfect Competition to
Monopoly
•
•
•
•
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
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Picking the Quantity to Maximize Profit
The Perfectly Competitive Case
P
MC
ATC
AVC
P*
MR
Q*
Q
Many Competitors
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Picking the Quantity to Maximize Profit
The Monopoly Case
P
MC
ATC
P*
AVC
D
MR
Q*
Q
No Competitors
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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
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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.
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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.
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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.)
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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.
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Examples of Different Market
Forms
Perfect
Competition
1)
2)
Monopolistic
Competition
Agriculture 1)
Lumber
2)
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Oligopoly
Fast Food 1)
Long
Distance
2)
Service
Cars and
Trucks
Soft
Drinks
Monopoly
1)
2)
Windows
Operating
system
Local
Residential
electric
power
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Distinguishing Characteristics Between
Market Forms
Perfect
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
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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).
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Concentration Ratios For Various
Manufacturing Industries
Industry Group
Concentration Ratios
4 Largest Firms
8 Largest Firms
50 Largest Firms
Breakfast
Cereals
82.9%
93.5%
100.0%
Ice Cream
32.3
48.7
88.3
Beer
89.7
93.4
96.7
Clothing
17.6
23.2
38.8
Computers and
Peripherals
37.0
52.1
86.3
Furniture
11.2
17.6
37.2
Long Distance
47.0
74.9
95.4
Cellular Service
51.4
74.6
88.0
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Supply Under Perfect
Competition
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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
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Return on Equity For Various Industries
Industry
Rate of Return
Net Income/(AssetsLiabilities)
Agriculture
8.0%
Manufacturing
14.6%
Transportation and Public
Utilities
10.6%
Wholesale and Retail Trade
12.9%
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When and Why Economic
Profits Go to Zero
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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
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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.
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Figure 2 The Pressures on Price in Perfect
Competition
$
Long Run
Pressure
MC
MR4
Short Run
Pressure
ATC
AVC
MR3
MR2
MR1
Q
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Figure 3 Points of Production in Perfect
Competition
$
MC
MR4
ATC
AVC
MR3
MR2
MR1
Q
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Figure 4 Supply in Perfect Competition
$
MC
Supply
ATC
AVC
Q
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