Session 4 (Source: Sloman J.

2006, Economics, FT Pearson,

Harlow) Chapter 6
 Learning Objectives
At the end of the lesson, students will be able to:
1. Describe the characteristics of perfect
competition.
2. Understand why the perfect competitive firm
faces a perfectly elastic demand curve even
though the market demand curve is downward
sloping.
3. Explain profit maximisation under perfect
competition.
4. Explain the meaning of economic profit, normal
profit and economic loss.
5. Describe the equilibrium position of the
perfectly competitive firm in the short run and
in the long run
 Learning Objectives
6. Describe the characteristics of monopoly.
7. Explain the meaning of barriers to entry in
the monopoly industry.
8. Explain profit maximization under
monopoly.
9. Describe the equilibrium position of the
monopoly in the short run and the long
run.
10. Compare the equilibrium positions of a
perfect competitive industry and a
monopoly.
Perfect Competition and Monopoly

Alternative Market
Structures
ALTERNATIVE MARKET STRUCTURES

• Classifying markets by degree of competition

– number of firms
– freedom of entry to industry
– nature of product
– nature of demand curve

• The four market structures

– perfect competition
– monopoly
– monopolistic competition
– oligopoly
 Features of the four market structures

Type of Number Freedom of Nature of Examples Implications for

market of firms entry product demand curve
faced by firm

Perfect Very Homogeneous Cabbages, carrots Horizontal:

competition many Unrestricted (undifferentiated) (approximately) firm is a price taker

Monopolistic Many / Builders, Downward sloping,

Unrestricted Differentiated but relatively elastic
competition several restaurants

Undifferentiated Cement Downward sloping.

Oligopoly Few Restricted Relatively inelastic
or differentiated cars, electrical (shape depends on
appliances reactions of rivals)

Local water Downward sloping:

Monopoly One Restricted or Unique company, train more inelastic than
completely operators (over oligopoly. Firm has
blocked particular routes) considerable
control over price
 Features of the four market structures

Type of Number Freedom of Nature of Examples Implications for

market of firms entry product demand curve
faced by firm

Perfect Very Homogeneous Cabbages, carrots Horizontal:

competition many Unrestricted (undifferentiated) (approximately) firm is a price taker

Monopolistic Many / Builders, Downward sloping,

Unrestricted Differentiated but relatively elastic
competition several restaurants

Undifferentiated Cement Downward sloping.

Oligopoly Few Restricted Relatively inelastic
or differentiated cars, electrical (shape depends on
appliances reactions of rivals)

Local water Downward sloping:

Monopoly One Restricted or Unique company, train more inelastic than
completely operators (over oligopoly. Firm has
blocked particular routes) considerable
control over price
 Features of the four market structures

Type of Number Freedom of Nature of Examples Implications for

market of firms entry product demand curve
faced by firm

Perfect Very Homogeneous Cabbages, carrots Horizontal:

competition many Unrestricted (undifferentiated) (approximately) firm is a price taker

Monopolistic Many / Builders, Downward sloping,

Unrestricted Differentiated but relatively elastic
competition several restaurants

Undifferentiated Cement Downward sloping.

Oligopoly Few Restricted Relatively inelastic
or differentiated cars, electrical (shape depends on
appliances reactions of rivals)

Local water Downward sloping:

Monopoly One Restricted or Unique company, train more inelastic than
completely operators (over oligopoly. Firm has
blocked particular routes) considerable
control over price
 Features of the four market structures

Type of Number Freedom of Nature of Examples Implications for

market of firms entry product demand curve
faced by firm

Perfect Very Homogeneous Cabbages, carrots Horizontal:

competition many Unrestricted (undifferentiated) (approximately) firm is a price taker

Monopolistic Many / Builders, Downward sloping,

Unrestricted Differentiated but relatively elastic
competition several restaurants

Undifferentiated Cement Downward sloping.

Oligopoly Few Restricted Relatively inelastic
or differentiated cars, electrical (shape depends on
appliances reactions of rivals)

Local water Downward sloping:

Monopoly One Restricted or Unique company, train more inelastic than
completely operators (over oligopoly. Firm has
blocked particular routes) considerable
control over price
 Features of the four market structures

Type of Number Freedom of Nature of Examples Implications for

market of firms entry product demand curve
faced by firm

Perfect Very Homogeneous Cabbages, carrots Horizontal:

competition many Unrestricted (undifferentiated) (approximately) firm is a price taker

Monopolistic Many / Builders, Downward sloping,

Unrestricted Differentiated but relatively elastic
competition several restaurants

Undifferentiated Cement Downward sloping.

Oligopoly Few Restricted Relatively inelastic
or differentiated cars, electrical (shape depends on
appliances reactions of rivals)

Local water Downward sloping:

Monopoly One Restricted or Unique company, train more inelastic than
completely operators (over oligopoly. Firm has
blocked particular routes) considerable
control over price
 Features of the four market structures

Type of Number Freedom of Nature of Examples Implications for

market of firms entry product demand curve
faced by firm

Perfect Very Homogeneous Cabbages, carrots Horizontal:

competition many Unrestricted (undifferentiated) (approximately) firm is a price taker

Monopolistic Many / Builders, Downward sloping,

Unrestricted Differentiated but relatively elastic
competition several restaurants

Undifferentiated Cement Downward sloping.

Oligopoly Few Restricted Relatively inelastic
or differentiated cars, electrical (shape depends on
appliances reactions of rivals)

Local water Downward sloping:

Monopoly One Restricted or Unique company, train more inelastic than
completely operators (over oligopoly. Firm has
blocked particular routes) considerable
control over price
Perfect Competition and Monopoly

Perfect Competition
 PERFECT COMPETITION

• Assumptions
– firms are price takers
• Have to sell at the fixed price determined by the market
since its output is so small relative to the size of the
industry.
– freedom of entry
• There are no barriers to entry.
– identical products
• Demand curve is perfectly elastic as each firm’s products
are perfect substitutes for one another.
– perfect knowledge
• Producers and consumers have perfect knowledge of
prices, quality and availability of products..
 PERFECT COMPETITION

• Short
Short--run equilibrium of the firm
– P = MC
• Since price remains unchanged regardless of
amount sold, P = AR = MR
• Also, profit maximisation rule means that MR =
MC, so
P = AR = MR = MC = D (Demand)
– 3 possible profit outcomes
• Supernormal profits (economic profits)
• Normal profits (‘break-
(‘break-even’ point)
• Subnormal profits (economic losses)
 Short-run equilibrium of industry and firm under
perfect competition – supernormal profits
Firm is a price taker. Price
is given by the market.
P £
S MC AC

Pe D = AR
AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)
(a) Industry (b) Firm
 Loss minimising under perfect competition –
subnormal profits
Loss is minimised
where MC = MR.
P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 PERFECT COMPETITION

• Short
Short--run supply curve of firm
– The firm’s short run supply curve is its
marginal cost curve above the minimum
point of the AVC.
– In the next slide, if price = P1, profits would
be maximised at Q1 where P1 = MC. Thus
point a is one point on the supply curve.
– At price = P2, Q2 would be produced and
point b is the point on the supply curve,
and so on.
– The supply curve is upward sloping
portion of the MC curve above point c.
 Deriving the short-run supply curve

P S £
MC = S
AVC
a D1 = MR1
P1
b D2 = MR2
P2
c D3 = MR3
P3
D1
D2
D3
O O Q3 Q2 Q1
Q (millions)
Q (thousands)
(a) Industry (b) Firm
 PERFECT COMPETITION
• Short
Short--run supply curve of industry
– Sum of the SR supply curves (and hence MC
curves) of all the firms in the industry.

• Long
Long--run equilibrium of the firm
– If firms are making supernormal profits, new firms
will be attracted into the industry.

– Industry supply increases, fall in market price until

all firms are making normal profits only.
only.

– The firm’s long run equilibrium position will be at

LRAC = AC = MC = MR = AR
 Long-run equilibrium under perfect competition
Profits return
Supernormal
New firms enter profits
to normal
P £
S1 LRMC
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

Long-run equilibrium under perfect competition
£ (SR)MC
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

O Q
 PERFECT COMPETITION
• Long
Long--run industry supply curve
– The shape of the LR industry supply curve
depends on the effect of external economies
and diseconomies.
– Constant cost industry: price falls back to its
original level.
– Increasing cost industry: factor prices are
bided up, external diseconomies of scale
occur.
– Decreasing cost industry: Expansion of
infrastructure as output expands. External
economies of scale occurs.
Various long-run industry supply curves under perfect competition

P S1 S2
b

a c
Long-run S

D1 D2

O Q
(a) Constant industry costs
Various long-run industry supply curves under perfect competition

P S1 S2

Long-run S
c
a

D2
D1

O Q
(b) Increasing industry costs: external
diseconomies of scale
Various long-run industry supply curves under perfect competition

P
S1
b S2

a
c
Long-run S

D2
D1

O Q
(c) Decreasing industry costs: external economies of scale
Perfect Competition and Monopoly

Monopoly
 MONOPOLY
• Defining monopoly
– A single firm selling a product that has no
closed substitutes.
• Barriers to entry
– economies of scale
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership or control over key factors
– ownership or control over outlets
– legal restrictions
– mergers and takeovers
– aggressive tactics
– intimidation
 Common Barriers to Entry
The main cause of monopolies is barriers
to entry – other firms cannot enter the
market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The govt gives a single firm the exclusive
right to produce the good.
E.g., patents, copyright laws
 Common Barriers to Entry
3. Natural monopoly: a single firm can produce
the entire market Q at lower cost than could
several firms.
Example: 1000 homes
need electricity Cost Electricity
ATC slopes
ATC is lower if downward due
one firm services to huge FC and
all 1000 homes $80 small MC
than if two firms $50 ATC
each service
Q
500 homes. 500 1000
 Characteristics of a Monopolist
• Single seller
seller..
• No close substitutes for the product (Unique
product)
• Entry is restricted
restricted..
• Firm and market demand are the same
same..
• The firm is a price setter I.e. it has market
power..
power
In Singapore, examples of monopolies are:
1) Singapore Press Holdings (SPH) in print media.
2) Power Supply in utility industry.
 MONOPOLY

• The monopolist's demand curve

– downward sloping
– MR below AR

• Equilibrium price and output

– output where MC = MR
– price given by demand (AR
(AR)) curve
– Possible for the supernormal profits
earned to continue in the long run due to
barriers to entry.
Average and marginal revenue under monopoly
£

AR
MR
O Q
 Profit maximising under monopoly
£ MC
Profit maximised
at output of Qm
(where MC = MR)

AR

MR
O Qm Q
 Profit maximising under monopoly
£ MC
Total profit
AC

AR

AC

AR
MR
O Qm Q
Equilibrium of industry under perfect competition and
monopoly: with the same MC curve
£ MC ( = supply under
perfect competition)

Comparison with
Perfect competition
P1

P2

AR = D

MR
O Q1 Q2 Q
Comparison of Monopoly and Perfect
Competition

Monopoly Perfect competition

• Lower output • Higher output
• Higher price • Lower price
• P > MC • P = MC
• Supernormal profits • Normal profits only
even in the long run. in the long run.
 Tutorial question 1
A perfectly competitive firm faces a price of £14
per unit. It has the following short-run cost
schedule:
0 1 2 3 4 5 6 7 8

TC (£) 10 18 24 30 38 50 66 91 120
Tutorial question 1 (ct’d)
 Tutorial question 2
Sean runs a newspaper stand in the city. His newspaper stand
is one of the many newspaper stands found in the city. The
diagram shows the daily cost curves of his newspaper stand in
the short run.
 Tutorial question 2 (ct’d)

(i) If the market price for one copy of newspaper

is $3.50, calculate
(a)Marginal revenue
(b)Profit maximizing output
(c)Economic profit
for Sean’s newspaper stand.
(ii) Determine the breakeven price and quantity.
 Tutorial question 3
Zenga drug company is a single price monopoly that
manufactures a non-drowsy formula for the common cold.
It faces the following market demand schedule.

Price (dollars per Quantity demanded

box) (boxes per hour)
10 0
8 1
6 2
4 3
2 4
0 5
 Tutorial question 3 (ct’d)

(a) Calculate Zenga’s total revenue schedule.

(b) Calculate its marginal revenue schedule.
(c) Why is Zegna’s marginal revenue less than price?
(d) Draw a graph of the market demand curve and
Zegna’s marginal revenue curve.
Tutorial question 3 (ct’d)
 Tutorial question 4
Refer to tutorial question 3. Zegna drug company faces
the following total cost schedule.

Quantity produced Total cost (dollars)

(boxes per hour)
0 1
1 3
2 7
3 13
4 21
5 31
 Tutorial question 4 (ct’d)

(a) Calculate the marginal cost of producing each output

listed in the table.
(b) Calculate Zegna’s profit maximizing output and price.
(c) Calculate the economic profit.
 Tutorial question 5
State if the following statements are true or false.
Explain.
(a)Like perfectly competitive firms, monopolies
charge a price equal to marginal cost.
(b)Monopolies should continue to operate in the
short run when variable costs is larger than
total revenue.
End of Unit 4