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Chapter 5 Perfect Competition, Monopoly, and Economic Vs Chapter Outline Chapter 5 • From Perfect Competition to Perfect Competition, Monopoly • Supply Under Perfect Competition Monopoly, and Economic vs. Normal Profit McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. From Perfect Competition to Picking the Quantity to Maximize Profit Monopoly The Perfectly Competitive Case P • Perfect Competition MC ATC • Monopolistic Competition AVC • Oligopoly P* MR • Monopoly Q* Q Many 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. Picking the Quantity to Maximize Profit Characteristics of Perfect The Monopoly Case Competition P • a large number of competitors, such that no one firm can influence the price MC • the good a firm sells is indistinguishable ATC from the ones its competitors sell P* AVC • firms have good sales and cost forecasts D • there is no legal or economic barrier to MR its entry into or exit from the market Q* 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. • Monopolistic Competition: a situation in a • Some monopolies are generated market where there are many firms producing similar but not identical goods. because of legal rights (patents and copyrights). • Example : the fast-food industry. McDonald’s has a monopoly on the “Happy Meal” but has • Some monopolies are utilities (gas, much competition in the market to feed kids water, electricity etc.) that result from burgers and fries. high fixed costs. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Oligopoly Which Model Fits Reality? • Oligopoly: a situation in a market • Perfect competition is rare outside where there are very few discernible agriculture though it fits some labor competitors markets. • Examples • Monopolies are common in utilities – Satellite TV service (Direct TV, Dish • Major branded companies are typically Network) either in oligopolistic or monopolistically – Airlines (American, Delta etc.) competitive industries. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Examples of Different Market Distinguishing Characteristics Between Forms Market Forms Perfect Monopolistic Oligopoly Monopoly Perfect Monopolistic Oligopoly Monopoly Competition Competition Competition Competition 1) Agriculture 1) Fast Food 1) Cars and 1) Windows Number Many-often Several* Few* One Trucks Operating of Firms thousands or 2) Lumber 2) Long even millions Distance 2) Soft system Service Drinks 2) Local Barriers None Few Substantial Insurmountable, Residential to Entry at least in the electric short run power Product Identical Similar but not Similar or N/A Similarity identical Identical * 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 Concentration Ratios Manufacturing Industries • there is no magic line that separates Industry Group Concentration Ratios oligopoly from monopolistic competition. 4 Largest Firms 8 Largest Firms 50 Largest Firms • a “concentration ratio” measures the Breakfast 82.9% 93.5% 100.0% percentage of total market sales for the Cereals Ice Cream 32.3 48.7 88.3 top firms (from 4 firms to 100 firms). Beer 89.7 93.4 96.7 Clothing 17.6 23.2 38.8 Computers and 37.0 52.1 86.3 Peripherals 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. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Normal vs. Economic Profit • Normal Profit : the level of profit that Supply Under Perfect business owners could get in their next best alternative investment Competition • Economic Profit: any profit above normal profit 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/(Assets- Liabilities) When and Why Economic Agriculture 8.0% Profits Go to Zero Manufacturing 14.6% Transportation and Public 10.6% Utilities Wholesale and Retail Trade 12.9% McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. 3 Time Horizons Market Forms and Economic Profits • Short Run: the period of time where we • Under perfect competition or monopolistic competition, economic profits go to zero cannot change things like plant and because of the entry of new firms increases equipment market supply and lowers prices. • Long Run : the period of time where we • Economic profits are under no pressure to can change things like plant and shrink under oligopoly or monopoly because equipment entry doesn’t occur so prices do not fall. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. Figure 2 The Pressures on Price in Perfect Figure 3 Points of Production in Perfect Competition Competition $ $ Long Run MC Pressure MC MR 4 MR 4 Short Run ATC Pressure ATC AVC AVC MR 3 MR 3 MR 2 MR 2 MR 1 MR 1 Q Q McGraw -Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. 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.
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