chapter 6 the two extremes: perfect competition and pure monopoly

Chapter 6

The Two Extremes: Perfect Competition and Pure Monopoly

Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 6-2

Learning Objectives

• List the four characteristics of a perfectly competitive market.

• Describe how a perfect competitor makes the decision to stay in business or to go out of business.

• List the characteristics of monopoly. • Explain the difference between marginal

revenue for a perfect competitor and marginal revenue for a pure monopolist.


Market Structures

• Market structure relates to the number, size, and interaction of firms in a particular market.

• One extreme market structure is perfect competition, when there are literally thousands of sellers.


Market Structures (cont.)

• At the other extreme is pure monopoly, when there is only one seller of a good for which there are no close substitutes.

• In between, there are varying degrees of what is called imperfect competition (duopoly, oligopoly, and monopolistic competition).


Characteristics of a Perfectly Competitive Market

• There are a very large number of relatively small buyers and sellers.

• The product sold by each seller is virtually identical to the product sold by other sellers.

• Firms can easily enter or exit the industry.• Everybody involved has good information

about price and product qualities.


Demand Curve Faced by a Perfect Competitor

• A perfect competitor is a price taker. • He takes the prices determined by

market forces. Therefore, the demand curve faced by the individual firm in this market is perfectly elastic.

• This means that customers will buy all that any individual firm might want to produce at the going market price and none at a higher price.


Figure 6-2: Demand Curve Facing the Perfect Competitor


How Much Should You Produce?

• The decision on how much to produce is similar to all decisions in economics. Never do anything past the point at which marginal benefit equals marginal cost.

• A perfect competitor produces up to the point at which marginal benefit equals marginal cost, or the point at which the price per unit equals marginal cost.


Profit Maximization

• This decision-making process is really one in which the perfect competitor maximizes profits.

• If the perfect competitor produced a larger quantity, marginal costs would exceed the price per unit.

• If the firm stops producing before marginal benefit equals marginal cost, then it is forgoing potential profits on additional units of output.


Marginal Revenue

• Marginal benefit here refers to the firm’s marginal revenue, defined as the change in total revenues when there is a one-unit change in production and sales.

• Marginal revenue is equal to unit price at all rates of output for perfect competitors.

Change in total revenuesMarginal revenue =

Change in output


Figure 6-3: The Perfect Competitor Determines How Much to Produce


Maximizing Profits

• Profit maximization occurs at the rate of output at which marginal revenue equals marginal cost.

• For a perfectly competitive firm, this is at the intersection of the demand schedule, d, and the marginal cost curve, MC. As was seen in Figure 6-3.


Figure 6-4: Showing Short-Run Economic Profits


When Should a Perfect Competitor Shutdown?

• Whenever a perfect competitor is sustaining economic losses in the short run, it must compare the cost of producing, while incurring these losses, with the cost of shutting down.

• Whenever total revenues exceed total variable costs, the perfect competitor should still keep production going.


Perfect Competitors Generally Make Zero Economic Profits

• In the short run, even in a perfectly competitive industry, an individual firm might make positive economic profits.

• These profits tend to disappear in the long run. That is, in the long run, because of so much competition, those who remain in a perfectly competitive industry end up making zero economic profits.


Pure Monopoly

• A pure monopoly is a market with a sole producer of a specific good or service for which there are no close substitutes and, no competitors.

• By definition, the pure monopolist is the entire industry. Therefore, this firm faces the entire market demand curve.


Types of Monopolies

1. Natural Monopoly: usually arises when there are large economies of scale relative to the market demand, such that one firm can produce at a lower average cost than can be achieved by multiple firms.


Types of Monopolies

2. Technological Monopoly: Someone who invents something that allows for the creation of a unique product often has a technological monopoly.

Normally, the government provides a patent that gives the creator exclusive right to manufacture, rent, or sell that invention for 20 years.


Types of Monopolies

3. Government Monopoly: Governments—federal, state, and local—often create their own monopolies. That is, they decide that no one else but them lawfully may provide the production of a good or service.


Barriers to Entry

• For any amount of monopoly power to continue to exist in the long run, the market must be closed to entry in some way.

• Two of the barriers to entry that have allowed firms to reap monopoly profits in the long run are: – Ownership of Resources– Government Regulations.


What Kind of Demand Curve Does the Monopolist Face?

• A pure monopolist is the sole supplier of one product, good, or service.

• It represents the entire industry.

• Consequently, a pure monopolist faces a demand curve that is the one for the entire market. This is a downward sloping demand curve.


Marginal Revenue for the Monopolist

• Because a pure monopolist faces the market downward-sloping demand curve, it can only sell more by charging less for all units sold. Consequently, for a pure monopolist, marginal revenue is always less than price.


How the Monopolist Maximizes Profits

• A monopolist always produces at that rate at which marginal revenue equals marginal cost.

• However, for the monopolist, marginal revenue is always less than price.


Why Monopolies Are Considered “Bad”

• Competition leads to lower prices.

• Monopoly, in contrast, implies no competition. The result, then, is that monopolists tend to charge higher prices than would competitors, if they existed.


Key Terms and Concepts

• barriers to entry • economies of scale• government

monopoly • marginal revenue • market structure • natural monopolies

• patent • perfect competition • price setter • price taker• pure monopoly • technological

monopoly

chapter 6 the two extremes: perfect competition and pure monopoly

Documents

marginal cost curve

marginal costs

perfect competitor shutdown

firms marginal revenue

perfect competitors

perfect competitorhow

competitive market

going market price