Business Economics For Accountants Lecture 8 PDF

MN12217 Business Economics for Accountants Lecture 8 Perfect Competition & Pure Monopoly: the Baseline Models of Market Structure (continued); Monopolistic Competition Dr Tim Wakeley [email protected]  Perfect Competition...

MN12217 Business Economics for Accountants Lecture 8 Perfect Competition & Pure Monopoly: the Baseline Models of Market Structure (continued); Monopolistic Competition Dr Tim Wakeley [email protected]  Perfect Competition LONG RUN EQUILIBRIUM new firms enter Profit so the market maximising supply curve output is £ shifts rightwards where MC = £ S0 S1 MC MR (= PPC’) PPC Firm’s PPC demand ATC AVC curve d0; PPC’ Firm’s new PPC’ MR0 demand Marke curve d1; MR1 t Dema ATC = PPC’ 0 Q0 Q1 nd Q 0 qPC’ qPC q so firm earns (a) THE MARKET (b) THE TYPICAL normal FIRM profits 2  Perfect Competition what happens if the market is in long run equilibrium but then demand £ increases? £ temporary S0 S1 MC above D0 D1 normal b profits P1 P1 d1; MR1 a ATC c AVC P0 P0 d0; MR0 0 Q0 Q1 Q2 Q 0 q0 q1 q (a) THE MARKET (b) THE TYPICAL FIRM 3  the fundamental insight of the model of perfect competition is that an above-normal profit opportunity which is available to everybody is, in the 4  Pure Monopoly Key Assumptions there is one seller serving many buyers the product has no close substitutes totally effective barriers to entry are in place – so no new rivals can enter the market buyers & the seller have full knowledge about price and the availability of resources and products the monopolist seeks to maximise profits while buyers seek to maximise utility from consumption of goods there are no transport costs (so geographical location does not matter) 5  The pure monopoly firm has direct access to the market demand curve i.e. the market demand curve is the demand curve for the monopolist’s output This changes things for the MR curve of the firm cf. perfect competition… Q P TR MR (=PxQ) 10 1 10 8 18 2 9 6 24 3 8 4 28 4 7 2 30 5 6 0 30 6 5 -2 28 7 4 -4 24 8 3 7  Pure Monopoly £ 10 why is MR 9 < P? 8 Because higher quantities of output can only be sold if 7 the price of every unit is 6 lowered (unlike the case of a horizontal demand curve) 5 e.g. at 3 units of output 4 every unit would sell for £8 (TR = £24), while at 4 3 Demand units of output every unit 2 would sell for £7 (TR = £28) so the 4th unit’s addition to 1 TR = £28 - £24 = £4 even 0 though it sells for £7 1 2 3 4 5 6 7 8 9 10 Q -1 -2 Marginal Revenue (MR) 8  Pure Monopoly SHORT RUN & LONG RUN EQUILIBRIUM Because the pure monopolist has direct access to the market demand curve & can ATCM < PM so £ therefore choose its price » “above- it is a “price maker” (but normal” MC choosing a higher price (or “super- The pure means monopolist selling has fewer units) normal”) no need to worry about its profits PM profits attracting long-run entry by potential rivals ATC because it shelters behind ATCM AVC barriers to entry » Profit “blockaded entry” maximising Market Demand output is MR where MC = 0 QM Q MR 9  Pure Monopoly the pure monopoly model is used in economics to illustrate the welfare consequences of markets where one firm has the potential to exercise market power by virtue of the fact that it is the dominant supplier we use the term ‘monopoly’ rather loosely in practice – we rarely actually mean pure monopoly » it is shorthand for any firm that has a degree of potential market power » i.e. it has some discretion over price and doesn’t worry too much about entry dissipating its profits 10  Perfect Competition vs. Pure Monopoly we can say something about the desirability of different market structures by re-visiting two tools we used when looking at the trading experiment: (i) CONSUMER SURPLUS: “the price the buyer is willing to pay minus the amount the buyer actually pays (i.e. the market price)” example: if I am willing to pay £5 for a mug of coffee but I am actually charged £2.90 at the campus coffee shop, my consumer surplus is £5 - £2.90 = £2.10 (ii) PRODUCER SURPLUS: “the price sellers receive for each unit sold (i.e. the market price) minus the price they would be willing to supply each unit for (which is represented by the supply curve)” example: if the campus coffee shop is willing to supply one more 11  Perfect Competition vs. Pure Monopoly Consumer Consumer surplus surplus in in the output £ in perfect monopoly competition range QM to Market supply QPC there are (perf comp) or customers PM MC (monopoly) who are PPC Producersurplus Producer surplus in willing to perfect in monopoly pay more competition than it would MR Market Deadwei cost to Deman ght loss produce the 0 QM QPC d due to product, but Q monopoly they do not get served in monopoly 12  Summary of Basic Principles a firm will maximise its profit by producing the output quantity which coincides with the point where MR = MC we can identify two extreme models of market structure – perfect competition and pure monopoly respectively a firm in a perfectly competitive market has no market power i.e. no discretion over the price it can charge for its product the typical firm under perfect competition earns just normal profits in the long run because there are no barriers to entry a pure monopoly firm has complete discretion over the price of its product (subject to the position of its demand curve), so it has market power a pure monopolist can earn above-normal profits in 13 MONOPOLISTIC COMPETITION  Monopolistic Competition Recall the spectrum of market structures… many rivals no rivals Perfect Monopolis Pure Competitio tic Monopoly n competiti onare essentially the same as perfect The market conditions competition except products are not homogeneous PRODUCT DIFFERENTIATION Combines some elements of perfect competition and monopoly Lies towards the perfect competition side of the spectrum  Monopolistic Competition Thanks to product differentiation, each firm has some discretion over the price it charges (some ‘market power’) The demand curve for the firm’s own output will slope downwards Products are close (but imperfect) substitutes so the firm’s demand curve will be relatively elastic Competition will be based on price, quality, features (characteristics), and marketing Examples: all around us! High street clothing shops; high street restaurants,  Monopolistic Competition Short-run (typical firm) ATC0 < PMC so “above- normal” £ MC (or “super- normal”) PMC Relatively profits (i.e. elastic TC < TR) ATC demand ATC0 curve (because many close Dsubstitutes 0 MR exist) 0 qMC q 17  Monopolistic Competition Long-run (typical firm) £ MC ATC = PMC’ (i.e. PMC TC=TR) so normal profits only PMC’ ATC Markup Entry by rivals - the amount causes the firm’s demand by which curve to shift price D D0 leftwards MR exceeds marginal 0 qMC’qqMC PC 1 q cost excess capacity cf. perfectly competitive firm 18  Monopolistic Competition is monopolistic competition efficient? In perfect competition we see P = MC and there is no excess capacity, but under monopolistic competition we see a markup and excess capacity This is the cost society incurs in order to be able to enjoy VARIETY  Monopolistic Competition Some questions to ask of the model… Which firm is being represented? The model assumes all firms are similar but if they offer differentiated products their cost structures may be different What about industry demand and supply? The analysis is limited to a ‘typical firm’. Are the assumptions valid? Is there perfect information? Is there free entry and exit in such markets? Next week: Oligopoly