Professional Assignment 1 -(CLOs covered : CLO 1, CLO 2)
Chapter 5 Perfect Competition, Monopoly, and Economic vs. Normal Profit
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CHAPTER OUTLINE
From Perfect Competition to Monopoly
Supply Under Perfect Competition
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From Perfect Competition to Monopoly
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
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Picking the Quantity to Maximize Profit The Perfectly Competitive Case
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ATC
AVC
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Q*
P*
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Many Competitors
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AVC
MR
D
MC
ATC
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P*
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No Competitors
Picking the Quantity to Maximize Profit The Monopoly Case
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Characteristics of Perfect Competition
a large number of competitors, such that no one firm can influence the price
the good a firm sells is indistinguishable from the ones its competitors sell
firms have good sales and cost forecasts
there is no legal or economic barrier to its entry into or exit from the market
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Monopoly
The sole seller of a good or service.
Some monopolies are generated because of legal rights (patents and copyrights).
Some monopolies are utilities (gas, water, electricity etc.) that result from high fixed costs.
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Monopolistic Competition
Monopolistic Competition: a situation in a market where there are many firms producing similar but not identical goods.
Example : the fast-food industry. McDonald’s has a monopoly on the “Happy Meal” but has much competition in the market to feed kids burgers and fries.
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Oligopoly
Oligopoly: a situation in a market where there are very few discernible competitors
Examples
Satellite TV service (Direct TV, Dish Network)
Airlines (American, Delta etc.)
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Which Model Fits Reality?
Perfect competition is rare outside agriculture though it fits some labor markets.
Monopolies are common in utilities
Major branded companies are typically either in oligopolistic or monopolistically competitive industries.
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Examples of Different Market Forms
| Perfect Competition | Monopolistic Competition | Oligopoly | Monopoly |
| Agriculture Lumber | Fast Food Clothing | Smart-phones Soft Drinks | Windows Operating system Local Residential electric power |
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Distinguishing Characteristics Between Market Forms
| Perfect Competition | Monopolistic Competition | Oligopoly | Monopoly | |
| Number of Firms | Many-often thousands or even millions | Several* | Few* | One |
| Barriers to Entry | None | Few | Substantial | Insurmountable, at least in the short run |
| Product Similarity | Identical | Similar but not identical | Similar or Identical | N/A |
* The line between “several” and “few” is not definite
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Concentration Ratios
there is no magic line that separates oligopoly from monopolistic competition.
a “concentration ratio” measures the percentage of total market sales for the top firms (from 4 firms to 100 firms).
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Herschfeld-Herfindahl Index
Sum of Squared Market Share
0 Perfect Competion
10,000 Monopoly
(10,000/N) N equally sized firms
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Concentration Ratios For Various Manufacturing Industries
| Industry Group | Concentration Ratios | ||
| 4 Largest Firms | 8 Largest Firms | 50 Largest Firms | |
| Breakfast Cereals | 80.4 | 91.9 | 100.0 |
| Ice Cream | 52.7 | 66.3 | 93.6 |
| Beer | 89.5 | 91.5 | 96.3 |
| Clothing | 7.9 | 14.1 | 39.2 |
| Computers and Peripherals | 63.4 | 71.8 | 89.3 |
| Furniture | 21.2 | 27.0 | 53.2 |
| Cellular Service | 80.2 | 90.7 | 97.9 |
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Herschfeld-Herfindahl Index
| Industry Group | HHI |
| Breakfast Cereals | 2425.5 |
| Ice Cream | 954.1 |
| Beer | * |
| Clothing | 44.0 |
| Computers and Peripherals | 2030.7 |
| Furniture | 328.7 |
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Supply Under Perfect Competition
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Normal vs. Economic Profit
Normal Profit : the level of profit that business owners could get in their next best alternative investment
Economic Profit: any profit above normal profit
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When and Why Economic Profits Go to Zero
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Time Horizons
Short Run: the period of time where we cannot change things like plant and equipment
Long Run : the period of time where we can change things like plant and equipment
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Market Forms and Economic Profits
Under perfect competition or monopolistic competition, economic profits go to zero because of the entry of new firms increases market supply and lowers prices.
Economic profits are under no pressure to shrink under oligopoly or monopoly because entry doesn’t occur so prices do not fall.
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Figure 2 The Pressures on Price in Perfect Competition
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MR3
MR1
MR2
MR4
Long Run Pressure
Short Run Pressure
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Figure 3 Points of Production in Perfect Competition
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MR4
MR3
MR2
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Figure 4 Supply in Perfect Competition
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AVC
Supply
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