14 Perfect competition characteristics Competitive firms are price takers 1 Many buyers sellers 2 The goods offered for sale are largely the same 3 Firms can freely enter or exit the market Total revenue TR P X Q Average revenue AR TR Q P Marginal revenue MR TR Q Change in total revenue from selling one more unit MR P A competitive firm can keep increasing its output without affecting the market price So each one unit increase in Q cause revenue to raise by P MR P only true for firms in competitive markets Profit Maximization If Q increases by one unit revenue rises by MR cost rises by MC If MR MC then increase Q to raise profit If MR MC then reduce Q to raise profit Shutdown vs Exit Shutdown A short run decision not to produce anything because of market conditions Exit A long run decision to leave the market A key difference If shut down in SR must still pay fixed cost If exit in LR zero costs As long as P AVC each firm will produce its profit maximizing quantity where MR MC Recall from Chapter 4 At each price the market quantity supplied is the sum of quantities supplied by all firms Profit maximization MC MR Perfect competition P MR So in the competitive eq m P MC Recall MC is cost of producing the marginal unit P is value to buyers of the marginal unit So the competitive eq m is efficient maximizes total surplus For a firm in a perfectly competitive market price marginal revenue average revenue If P AVC a firm maximizes profit by producing the quantity where MR MC If P AVC a firm will shut down in the short run If P ATC a firm will exit in the long run In the short run entry is not possible and an increase in demand increases firms profits With free entry and exit profits 0 in the long run and P minimum ATC Ch 15 A monopoly is a firm that is the sole seller of a product without close substitutes The key difference A monopoly firm has market power the ability to influence the market price of the product it sells A competitive firm has no market power Why monopolies arise The main cause of monopolies is barriers to entry other firms cannot enter the market Three sources of barriers to entry 1 A single firm owns a key resource E g DeBeers owns most of the world s diamond mines 2 good E g patents copyright laws 3 Natural monopoly Eg Economies of scale The govt gives a single firm the exclusive right to produce the Natural monopoly a single firm can produce the entire market Q at lower cost than could several firms In a competitive market the market demand curve slopes downward But the demand curve for any individual firm s product is horizontal at the market price Competitive firm MR P Demand curve is horizontal A monopolist is the only seller so it faces the market demand curve To sell a larger Q the firm must reduce P Thus MR P Monopolists demand curve slopes down Price discrimination selling the same good at different prices to different buyers In the real world perfect price discrimination is not possible No firm knows every buyer s WTP Buyers do not reveal it to sellers So firms divide customers into groups based on some observable trait that is likely related to WTP such as age Movie tickets Discounts for seniors students and people who can attend during weekday afternoons They are all more likely to have lower WTP than people who pay full price on Friday night Airline prices Discounts for Saturday night stayovers help distinguish business travelers who usually have higher WTP from more price sensitive leisure travelers Public policy towards monopolies Increasing competition with antitrust laws Ban some anticompetitive practices allow govt to break up monopolies e g Sherman Antitrust Act 1890 Clayton Act 1914 Regulation Govt agencies set the monopolist s price For natural monopolies MC ATC at all Q so marginal cost pricing would result in losses If so regulators might subsidize the monopolist or set P ATC for zero economic profit Example U S Postal Service Problem Public ownership is usually less efficient since no profit motive to minimize costs Public ownership Doing nothing The foregoing policies all have drawbacks so the best policy may be no policy Conclusion The prevalence of monopoly In the real world pure monopoly is rare Yet many firms have market power due to selling a unique variety of a product having a large market share and few significant competitors In many such cases most of the results from this chapter apply including markup of price over marginal cost deadweight loss A monopoly firm is the sole seller in its market Monopolies arise due to barriers to entry including government granted monopolies the control of a key resource or economies of scale over the entire range of output A monopoly firm faces a downward sloping demand curve for its product As a result it must reduce price to sell a larger quantity which causes marginal revenue to fall below price Monopoly firms maximize profits by producing the quantity where marginal revenue equals marginal cost But since marginal revenue is less than price the monopoly price will be greater than marginal cost leading to a deadweight loss Monopoly firms and others with market power try to raise their profits by charging higher prices to consumers with higher willingness to pay This practice is called price discrimination Policymakers may respond by regulating monopolies using antitrust laws to promote competition or by taking over the monopoly and running it Due to problems with each of these options the best option may be to take no action Ch 16 Between monopoly and competition Two extremes Perfect competition many firms identical products Monopoly one firm In between these extremes imperfect competition Oligopoly only a few sellers offer similar or identical Monopolistic competition many firms sell similar but not products identical products Characteristics Examples of Monopolistic Competition Characteristics Many sellers Product differentiation Free entry and exit Examples apartments books bottled water clothing fast food night clubs Comparing perfect monopoly competition Comparing monopoly and monopoly competition Short run Under monopolistic competition firm behavior is very similar to monopoly Long run In monopolistic competition entry and exit drive economic profit to zero If profits in the short run New firms enter market taking some demand away from existing firms prices and profits fall If losses in the short run Some firms exit the market remaining firms enjoy higher demand and prices Source of