Chapter 6
The Two Extremes: Perfect Competition and Pure Monopoly
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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.
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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.
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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).
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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.
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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.
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Figure 6-2: Demand Curve Facing the Perfect Competitor
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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.
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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.
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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
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Figure 6-3: The Perfect Competitor Determines How Much to Produce
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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.
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Figure 6-4: Showing Short-Run Economic Profits
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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.
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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