Isues in economics today 6th by guell chapter05

Chapter 05
Perfect
Competition,
Monopoly,
and
Economic
versus.
Normal Profit
McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Chapter Outline
• From Perfect Competition to
Monopoly
• Supply Under Perfect
Competition

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-2
1-2


From Perfect Competition to
Monopoly
•
•

•
•

Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-3
1-3


Picking the Quantity to
Maximize Profit The Perfectly
P Competitive Case
MC

ATC
AVC

P*

MR

Q*

Q

Many Competitors
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-4
1-4


Picking the Quantity to Maximize
Profit The Monopoly Case
P
MC
ATC
P*

AVC

D
MR
Q*

Q

No Competitors
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-5
1-5


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

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-6
1-6


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.

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-7
1-7


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.

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-8
1-8


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.)
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-9
1-9


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.

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-10

1-10


Examples of Different Market
Forms
Perfect
Monopolisti Oligopoly
Competitio c
n
Competitio
n
1)
2)

Agricultur 1)
e
2)
Lumber

McGraw-Hill/Irwin

Fast Food 1)
Long
Distance 2)
Service

Monopoly

Cars and 1)
Trucks

Soft
Drinks
2)

Windows
Operating
system
Local
Residentia
l electric
power

©2012 The McGraw-Hill Companies, All Rights Reserved

5-11
1-11


Distinguishing Characteristics
Between Market Forms
Perfect
Competition

Monop Oligopoly
olistic
Compe
tition

Monopoly

Number Many-often
of Firms thousands or

Severa
l*

Few*

One

Barriers None
to Entry

Few

Substantial Insurmounta
ble, at least
in the short
run

Product Identical
Similarit
y

Similar Similar or
but not Identical
identic
al

even millions

N/A

* The line between “several” and “few” is not definite
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-12
1-12


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).
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-13
1-13


Herschfeld-Herfindahl Index
• Sum of Squared Market Share

•0
Perfect Competition
• 10,000 Monopoly
• (10,000/N)
N equally sized firms

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-14
1-14


Concentration Ratios For Various
Manufacturing Industries
Industry Group

Concentration Ratios
4 Largest Firms 8 Largest Firms

50 Largest Firms

Breakfast
Cereals

78.4%

91.1%

100.0%

Ice Cream

48.0

64.4

93.1

Beer

90.8

93.8

98.1

Clothing

17.3

21.3

38.7

Computers and
Peripherals

40.5

65.2

88.3

Furniture

11.0

18.0

30.6

Long Distance

59.7

80.9

92.5

Cellular
Service

61.7

81.7

90.0

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-15
1-15


Supply Under Perfect
Competition

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-16
1-16


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

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-17
1-17


Return on Equity For Various
Industries
Industry

Rate of
Return
Net Income/(AssetsLiabilities)

Agriculture

3.1%

Manufacturing

21.8%

Transportation and
Public Utilities
Retail Trade
McGraw-Hill/Irwin

8.2%
16.1%

©2012 The McGraw-Hill Companies, All Rights Reserved

5-18
1-18


When and Why Economic Profits
Go to Zero

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-19
1-19


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
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-20
1-20

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.

McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-21
1-21


Figure 2 The Pressures on Price in
Perfect Competition
$
MC

Long Run
Pressure

MR4

Short Run
Pressure

ATC
AVC
MR3
MR2
MR1

Q
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-22
1-22


Figure 3 Points of Production in Perfect
Competition
$
MC

MR4
ATC
AVC
MR3
MR2

MR1

Q
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-23
1-23


Figure 4 Supply in Perfect
Competition
$
MC
Supply

ATC
AVC

Q
McGraw-Hill/Irwin

©2012 The McGraw-Hill Companies, All Rights Reserved

5-24
1-24