0. Chapter 9 Perfect competition and monopoly: The limiting cases of market structure
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith

1. Perfect competition many buyers and sellers firms take price as given
Characteristics of a perfectly competition market
many buyers and sellers
so no individual believes that their own action can affect market price
firms take price as given
so face a horizontal demand curve
the product is homogeneous
perfect customer information
free entry and exit of firms
See Section 9-1 in the main text.

2. The supply curve under perfect competition (1)
Above price P3 (point C), the firm makes profit above the opportunity cost of capital in the short run
At price P3, (point C), the firm makes NORMAL PROFITS P1
Output
SAVC
SMC Q1
SATC P3 A C Q3
See Section 9-1 in the main text, and Figure 9-2.

3. The supply curve under perfect competition (2)
Between P1 and P3, (A and C), the firm makes short-run losses, but remains in the market
Below P1 (the SHUT-DOWN PRICE), the firm fails to cover SAVC, and exits P1
Output
SAVC
SMC Q1
SATC P3 A C Q3
See Section 9-1 in the main text, and Figure 9-2.

4. The supply curve under perfect competition (3)
So the SMC curve above SAVC represents the firm’s SHORT-RUN SUPPLY CURVE
showing how much the firm would produce at each price level. P1
Output
SAVC
SMC Q1
SATC P3 A C Q3
See Section 9-1 in the main text, and Figure 9-2.

5. The firm and the industry in the short run under perfect competition (1)
SAC P
Output
SMC
D=MR=AR q
Output Q P
SRSS D
See Section 9-3 in the main text.
Market price is set at industry level at the intersection of
demand and supply
– the industry supply curve is the sum of the individual firm’s
supply curves.

6. The firm and the industry in the short run under perfect competition (2)
Output
SMC
D=MR=AR q
INDUSTRY
Output Q P
SRSS D
SAC
See Section 9-3 in the main text.
The firm accepts price as given at P
– and chooses output at q where SMC=MR to maximize profits

7. The firm and the industry in the short run under perfect competition (3)
SAC
Firm P
Output
SMC
D=MR=AR q
INDUSTRY
Output Q P
SRSS D
SRSS1 P1
See Section 9-3 in the main text.
At this price, profits are shown by the shaded area.
These profits attract new entrants into the industry.
As more firms join the market, the industry supply curve shifts
to the right, and market price falls.

8. Long-run equilibrium Firm INDUSTRY P* £ q* £ Q P* D SRSS Output Output
SAC P*
Output
SMC
D=MR=AR q*
Output Q P*
SRSS D
LRSS
See Section 9-3 in the main text.
The market settles in long-run equilibrium when the typical
firm just makes normal profit by setting LMC=MR at the minimum
point of LAC. Long-run industry supply is horizontal.
If the expansion of the industry pushes up input prices (e.g. wages)
then the long-run supply curve will not be horizontal, but upward-sloping.

9. Adjustment to an increase in market demand: the short run
Suppose a perfectly
competitive market starts
in equilibrium at P0Q0.
Output D
SRSS Q0 P0 D'
If market demand shifts to
D'D' ... Q1 P1
in the short run the new
equilibrium is P1Q1 ...
See Section 9-4 in the main text.
– adjustment is through
expansion of individual
firms along their SMCs.

10. Adjustment to an increase in market demand: the long run
In the long run, new firms
are attracted by the profits
now being made here
Output D
SRSS Q0 P0 D'
– and firms are able to
adjust their input of fixed
factors Q1 P1
And the market finally
settles at P2Q2. Q2 P2
LRSS
If wages are bid up by this
expansion, the long-run
supply schedule is upward-
sloping
Notice of course, that if wages are not pushed up by the expansion of the industry,then the LRSS will be horizontal, and we return to the original price P0.
See Section 9-4 in the main text, and Figure 9-10.

11. Monopoly A monopolist: is the sole supplier of an industry’s product
and the only potential supplier
is protected by some form of barrier to entry
faces the market demand curve directly
Unlike under perfect competition, MR is always below AR.
See Section 9-6 in the main text.

12. Profit maximization by a monopolist
Profits are maximized
where MC = MR at Q1P1.
Output P1 Q1 MC AC
D = AR MR
MC=MR
In this position, AR is
greater than AC
so the firm makes
profits above the
opportunity cost of
capital
AC1
shown by the shaded area
See Section 9-6 in the main text, and Figure 9-13.
Entry barriers prevent
new firms joining the
industry.

13. Comparing monopoly with perfect competition (1)
Suppose a competitive industry is taken over by a monopolist:
Output D MR
SRSS
LRSS Q1 P1 A
Competitive equilibrium
is at A, with output Q1
and price P1.
To the monopolist, LRSS
is the LMC curve, and
SRSS is the SMC curve
= LMC
=SMC
The monopolist
maximizes profits in the
short run at MR = SMC
at P2Q2. Q2 P2
See Section 9-8 in the main text, and Figure 9-14.

14. Comparing monopoly with perfect competition (2)
Suppose a competitive industry is taken over by a monopolist: D MR
SRSS
LRSS Q1 P1 A
= LMC
=SMC Q2 P2
In the long run, the
firm can adjust
other inputs ...
At P3Q3. P3 Q3
to set MR = LMC
See Section 9-8 in the main text, and Figure 9-14.
Output

15. Comparing monopoly with perfect competition (3)
So we see that monopoly compared with perfect competition implies:
higher price
lower output
Does the consumer always lose from monopoly?
Among other things, this depends on whether the monopolist faces the same cost structure
there may be the possibility of economies of scale.
See Section 9-8 in the main text.

16. A natural monopoly £ P1 LMC LAC Q1
This firm enjoys substantial economies of scale relative to market demand
LAC declines right up to market demand
the largest firm always enjoys cost leadership
and comes to dominate the industry
It is a NATURAL MONOPOLY
LMC
LAC D MR P1 Q1
Output
Note: we return to this topic in a later chapter.
See Section 9-8 in the main text, and Figure 9-15.

17. Discriminating monopoly
Suppose a monopolist supplies two separate groups of customers
with differing elasticities of demand
e.g. business travellers may be less sensitive to air fare levels than tourists
The monopolist may increase profits by charging higher prices to the businessmen than to tourists.
Discrimination is more likely to be possible for goods that cannot be resold
e.g. dental treatment
See Section 9-9 in the main text.