Market Structures: Perfect Competition & Monopolistic Competition PDF

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Taught by Natalie Moore...

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Lecture 8 – Market Structures: Perfect Competition & Monopolistic Competition The Four Types of Market Structure

more inefficient Profit Maximisation    

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This graph shows that profit is maximised at quantity 3 Profit = TR – TC Total revenue is P x Q After the profit maximising point, you may be selling more but price will begin to decrease because of the law of demand so revenue will start to decrease even though you are selling more At the highest point of the profit curve you have maximised profit The points at which the profit curve is 0 is where TR = TC

Structure Conduct Performance Paradigm 

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offers a causal theoretical explanation for firm performance through economic conduct E.g. perfect competition has many firms, no barriers to entry and no product differentiation However, structure and size doesn’t always dictate your conduct and performance

Perfect Competition Industry vs. Firm

Long-Run  There is still a horizontal demand curve  But now the average cost curve is in the same place for the profit maximising quantity  The only way you can get zero economic profit is the point at which LRMC = MR

An Increase in Demand in the Short Run and Long Run

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In perfect competition the market sets the price At point A, the market has decided that they are producing at quantity Q 1 and at price P1 All firms have to take this price because they are price takers When you look at this firm at price P1, the firm is making zero economic profit (there should be a demand curve at this point) Demand increases in the market, because consumers want more for example or a complementary good gets cheaper, so the demand curve shifts to the right The equilibrium is now at quantity Q2 and at price P2 so all firms are now charging the higher price of P2 – point B The firm now has a new, higher demand curve so the firm is now making a profit because AR is higher than ATC Profit being made sends a signal out to the market place that it is good to be in this market and more firms can be accommodated in this market

More firms enter the market which shifts the supply curve to the right because more firms are now producing the product This changes the equilibrium to point C where quantity Q 3 is produced at price P1 where we started The market now says that everyone has to take price P 1 Therefore, the firm now has a lower demand curve again and is making zero economic profit

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Your long run supply curve becomes horizontal because firms in perfect competition will always make zero economic profit in the long run because firms will enter and exit the market depending on whether a profit or loss is being made in the short run

Monopolistic Competition       

Many sellers. There are many firms competing for the same group of customers e.g. books, CDs, restaurants. Product differentiation. Each firm produces a product that is at least slightly different from those of other firms. Rather than being a price taker, each firm faces a downward-sloping demand curve. Free entry and exit. Firms can enter or exit the market without restriction.

Short Run - Profit Short-run economic profits encourage new firms to enter the market. This:  Increases the number of products offered.  Reduces demand faced by firms already in the market.  Incumbent firms’ demand curves shift to the left.  Demand for the incumbent firms’ products fall, and their profits decline.

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This shows economic profit being made in the short run If more firms enter the market, the demand curve will shift to the left because there are more firms for consumers to buy from therefore each firm will receive less demand

Short Run – Loss Short-run economic losses encourage firms to exit the market. This:  Decreases the number of products offered  Increases demand faced by the remaining firms.  Shifts the remaining firms’ demand curves to the right.

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Increases the remaining firms’ profits.

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Competitors leave the market because there is a loss being made in the market This causes the demand curve to shift to the right Therefore, in the long run, zero economic profit will be made by each firm

Long Run Firms will enter and exit until the firms are making exactly zero economic profits. The firm produces where MC = MR  In the long run, the price equals ATC so zero economic profit is made  However, at this point, ATC is not minimised because the price is not equal to MC so the firm is not efficient  The firm is profit maximising by making zero economic profit but you are negatively affecting social surplus Because of the price mark up, you don’t maximise consumer or producer surplus 

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Two characteristics: 

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As in a monopoly, price exceeds marginal cost: o Profit maximisation requires marginal revenue to equal marginal cost. o The downward-sloping demand curve makes marginal revenue less than price. As in a competitive market, price equals average total cost: o Free entry and exit drive economic profit to zero.

Monopolistic Competition vs. Perfect Competition

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Perfect competition has a horizontal demand curve, you minimise the ATC and you make zero economic profit Monopolistic competition doesn’t have a horizontal demand curve, you make zero economic profit but ATC is not minimised and you don’t get the efficient outcome o The price doesn’t equal the marginal cost so you have a deadweight loss Mark up: o Firms that have power can charge a price above their marginal cost curve o In monopolistic competition, price is higher than marginal cost so this is the mark up o In perfect competition, price equals marginal cost which shows that they are not marking up their price because they are price takers

Monopolistic Competition: Welfare or Society Externalities of entry include:  The product-variety externality o Because consumers get some consumer surplus from the introduction of a new product, entry of a new firm conveys a positive externality on consumers.  The business-stealing externality o Because other firms lose customers and profits from the entry of a new competitor, entry of a new firm imposes a negative externality on existing firms. Advertising and Branding 

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When firms sell differentiated products and charge prices above marginal cost, each firm has an incentive to advertise in order to attract more buyers to its particular product. Firms that sell highly differentiated consumer goods spend a lot on advertising. Firms that sell industrial products typically spend very little on advertising. Firms that sell homogeneous products spend nothing at all.

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Advertising can be used as a barrier to entry – advertising can stop firms from wanting to come into the market because the existing firm is already established in the market They may also already have brand loyalty which is another barrier to entry

Advertising Debate Critics of advertising argue that:  Firms advertise in order to manipulate people’s tastes. 

It impedes competition by implying that products are more different than they really are.

Defenders argue that advertising:  Provides information to consumers.  Increases competition by offering a greater variety of products and prices.  The willingness of a firm to spend advertising dollars can be a signal to consumers about the quality of the product being offered....