Topic 9 and 10 Market Structure
Topic 9 Perfect Competition
Perfect Competition
A perfectly competitive industry is one in which many
suppliers, producing an identical product, face many buyers,
and no one participant can influence the market.
Profit maximization is the goal of competitive suppliers – they
seek to maximize the difference between revenues and
costs.
Characteristics of Perfectly Competitive Industry
1. There must be many firms, each one so small that it cannot influence price
or quantity in the industry, and powerless relative to the entire industry.
2. The product must be standardized. Barber shops offer a standard product,
but a Lexus differs from a Ford. Barbers tend to be price takers, but Lexus
does not charge the same price as Ford, and is a price setter.
3. Buyers are assumed to have full information about the product and its
pricing. For example, buyers know that the products of different suppliers
really are the same in quality.
4. There are many buyers.
5. There is free entry and exit of firms.
Example
Supply Decision
• Marginal revenue is the additional revenue accruing to the
firm resulting from the sale of one more unit of output.
• The shut-down price corresponds to the minimum value of
the AVC curve.
• The break-even price corresponds to the minimum of the
ATC curve.
• The firm’s short-run supply curve is that portion of the MC
curve above the minimum of the AVC.
• Industry supply (short run) in perfect competition is the
horizontal sum of all firms’ supply curves.
Industry Equilibrium
• Short-run equilibrium in perfect competition occurs when each firm
maximizes profit by producing a quantity where P = MC, provided the price
exceeds the minimum of the average variable cost.
• Economic (supernormal) profits are those profits above normal profits
that induce firms to enter an industry.
• A long-run equilibrium in a competitive industry requires a price equal
to the minimum point of a firm’s ATC. At this point, only normal profits
exist, and there is no incentive for firms to enter or exit.
• Industry supply in the long run in perfect competition is horizontal at a
price corresponding to the minimum of the representative firm’s long-run
ATC curve.
• Increasing (decreasing) cost industry is one where costs rise (fall) for
each firm because of the scale of industry operation.
Topic 10 Monopoly
Monopoly
• A monopolist is the sole supplier of an
industry’s output, and therefore the
industry and the firm are one and the
same.
• The word monopoly, comes from the
Greek words monos, meaning one, and
polein meaning to sell.
• Monopolies can exist and exert their
dominance in the market place for
several reasons; scale economies,
national policy, successful prevention
of entry, research and development
combined with patent protection.
Types of Monopolies
• The Pure Monopoly - is a single seller in a market or sector
with high barriers to entry such as significant startup costs
whose product has no substitutes.
• Multiple sellers in an industry sector with similar substitutes
are defined as having monopolistic competition. Barriers to
entry are low, and the competing companies differentiate
themselves through pricing and marketing efforts.
• A natural monopoly develops in reliance on unique raw
materials, technology, or specialization. Companies that have
patents or extensive research and development costs such as
pharmaceutical companies are considered natural monopolies.
Types of Monopolies
• Public monopolies provide essential services and goods,
such as the utility industry as only one company commonly
supplies energy or water to a region. The monopoly is
allowed and heavily regulated by government municipalities
and rates and rate increases are controlled.
National and Provincial Policy
• Government policy can foster monopolies.
• The down side of such nationalist policies is that they can
be costly to the taxpayer. Industries that are not subject to
competition can become fat and uncompetitive: Managers
have insufficient incentives to curtail costs; unions realize
the government is committed to sustain the monopoly and
push for higher wages than under a more competitive
structure, and innovation may be less likely to occur.
Maintaining Barriers To Entry
• Patents and copyrights are one vehicle for preserving the
sole-supplier role, and are certainly necessary to
encourage firms to undertake the research and
development (R&D) for new products.
• Predatory pricing is an illegal form of entry barrier.
• Political lobbying is another means of maintaining
monopolistic power.
• Critical networks also form a type of barrier, though not
always a monopoly.
Profit maximizing behavior
• What distinguishes the supply decision for a monopolist from the
supply decision of the perfect competitor is that the monopolist
faces a downward sloping demand. A monopolist is the sole
supplier and therefore must meet the full market demand. This
means that if more output is produced, the price must fall. We will
illustrate the choice of a profit maximizing output using first a
marginal-cost/marginal-revenue approach; then a supply/demand
approach.
• Marginal revenue is the change in total revenue due to selling one
more unit of the good.
• Average revenue is the price per unit sold.
Ouput Inefficiency
• Allocative inefficiency arises when resources are not
appropriately allocated and result in deadweight losses.
• Price discrimination involves charging different prices to different
consumers in order to increase profit.
• The seller must be able to segregate the market at a reasonable
cost.
• The second condition is that resale must be impossible or
impractical.
Cartel
• A cartel is a group of suppliers that colludes to operate like a
monopolist.
Invention, Innovation and Rent Seeking
• Invention is the discovery of a new product or process through
research.
• Product innovation refers to new or better goods or services.
• Process innovation refers to new or better production or supply.
• Patent laws grant inventors a legal monopoly on use for a fixed
period of time.
• Rent seeking is an activity that uses productive resources to
redistribute rather than create output and value.
Imperfect Competition
• Imperfectly competitive firms face a downward-sloping demand
curve, and their output price reflects the quantity sold.
• Oligopoly defines a market with a small number of suppliers.
• Monopolistic competition defines a market with many sellers of
products that have similar characteristics. Monopolistically competitive
firms can exert only a small influence on the whole market.
• Duopoly defines a market or sector with just two firms.
• A differentiated product is one that differs slightly from other
products in the same market.
• A platform describes a technology that is common to more than one
product in a multi-product organization.
Strategic Behavior
• Collusion is an explicit or implicit agreement to avoid competition with a
view to increasing profit.
• A conjecture is a belief that one firm forms about the strategic reaction
of another competing firm.
• A game is a situation in which contestants plan strategically to maximize
their payoffs, taking account of rivals’ behaviour.
• A strategy is a game plan describing how a player acts, or moves, in
each possible situation.
• A dominant strategy is a player’s best strategy, independent of the
strategies adopted by rivals.
• A payoff matrix defines the rewards to each player resulting from
particular choices.
Duopoly or Cournot
• A repeated game is one that is repeated in successive time
periods and where the knowledge that the game will be repeated
influences the choices and outcomes in earlier periods.
• Cournot behavior involves each firm reacting optimally in their
choice of output to their competitors’ output decisions.
• Reaction functions define the optimal choice of output conditional
upon a rival’s output choice.
• Source:Curtis, D. (2017). Principles of Microeconomics.
