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Chapter 6Perfect 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

AVC

MCATC

AVC

MR

Q*

P*

MR

D

MC

ATC

Q*

P*

P

QMany Competitors

P

Q

No Competitors

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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, Primestar,

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

1) Agriculture

2) Lumber

1) Fast Food

2) Airlines

1) Cars and Trucks

2) Soft Drinks

1) Windows Operating system

2) Local Residential Utilities

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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

Product Homo/Hetero-geneity

Homogeneous Heterogeneous Heterogeneous N/A

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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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Return on Equity For Various Industries

Industry Rate of ReturnNet Income/(Assets-Liabilities)

Agriculture 8.0%

Manufacturing 14.6%

Transportation and Public Utilities 10.6%

Wholesale and Retail Trade 12.9%

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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

$

Q

MC

ATC

AVC

MR3

MR1

MR2

MR4

Long Run Pressure

Short Run Pressure

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Figure 3 Points of Production in Perfect Competition

$

Q

MC

ATC

AVC

MR4

MR3

MR2

MR1

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Figure 4 Supply in Perfect Competition

$

Q

MC

ATC

AVC

Supply