Chapter Outline
Chapter 5
Perfect Competition,
Monopoly, and Economic vs.
Normal Profit
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
• From Perfect Competition to
Monopoly
• Supply Under Perfect Competition
McGraw -Hill/Irwin
From Perfect Competition to
Monopoly
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Picking the Quantity to Maximize Profit
The Perfectly Competitive Case
P
•
•
•
•
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
MC
ATC
AVC
P*
MR
Q*
Q
Many Competitors
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw -Hill/Irwin
Characteristics of Perfect
Competition
Picking the Quantity to Maximize Profit
The Monopoly Case
P
MC
ATC
P*
AVC
D
MR
Q*
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
• 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
Q
No Competitors
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
1
Monopoly
Monopolistic Competition
• 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.
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
• 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.
McGraw -Hill/Irwin
Oligopoly
Which Model Fits Reality?
• 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.)
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
• 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.
McGraw -Hill/Irwin
Examples of Different Market
Forms
Perfect
Competition
1)
2)
Monopolistic
Competition
Agriculture 1)
Lumber
2)
Fast Food
Long
Distance
Service
Oligopoly
Monopoly
1)
1)
2)
Cars and
Trucks
Soft
Drinks
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
2)
Windows
Operating
system
Local
Residential
electric
power
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Distinguishing Characteristics Between
Market Forms
Perfect
Monopolistic
Competition 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
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
2
Concentration Ratios For Various
Manufacturing Industries
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).
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Industry Group
Concentration Ratios
4 Largest Firms
Breakfast
Cereals
8 Largest Firms
50 Largest Firms
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
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
Supply Under Perfect
Competition
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
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%
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
When and Why Economic
Profits Go to Zero
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
3
Market Forms and Economic Profits
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
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
• 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.
McGraw -Hill/Irwin
Figure 2 The Pressures on Price in Perfect
Competition
$
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Figure 3 Points of Production in Perfect
Competition
$
Long Run
Pressure
MC
MR4
MC
MR4
Short Run
Pressure
ATC
ATC
AVC
AVC
MR3
MR3
MR2
MR2
MR1
MR1
Q
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Q
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Figure 4 Supply in Perfect Competition
$
MC
Supply
ATC
AVC
Q
McGraw -Hill/Irwin
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
4