Chapter 7

Principles of Economics second edition All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 7: 1

CHAPTER 7
MARKET STRUCTURE:
PERFECT COMPETITION
AND MONOPOLY

DEFINITION AND OBJECTIVES OF A
FIRM
Definition of a Firm
 A firm is an institution that buys or hires factors of
production and organizes them to produce and sell
goods and services.
 A firm is an independent unit of producing goods and
services for sale.
Objectives of a Firm
 The main goal or objective of a firm is to maximize
profit and to minimize the cost.

PRINCIPLES
© Oxford Fajar Sdn. Bhd. (008974-T) 2010 OF ECONOMICS 3
Ch. 7: 3
ECONOMIC PROFIT AND
ACCOUNTING PROFIT
Economic Profit Accounting Profit

Economic profit is defined Accounting profit is defined
as the total revenue minus as the firm’s total revenue
the implicit and explicit minus the explicit cost.
cost.
• Consider both explicit • Consider only explicit
and implicit cost cost
EC= TR – [Explicit Cost + AC = TR – Explicit Cost

Implicit Cost]

TOTAL APPROACH
TR, TC
TC Total approach is the simplest way

TR
to determine the equilibrium of a firm.
Under Perfect Market:

Highest vertical
differences
TR curve is straight line through origin.
The firm maximum profits at ON output
because the vertical distance between
TR and TC curve is maximum.
Quantity
0 N
TR, TC
TC
TR Under Imperfect Market:
Total revenue (TR) curve continues to rise
from left to right at a less than proportionate
Highest vertical
differences rate. A rational firm will choose the output
when the vertical distance between TR and
TC is at maximum, ON.
Quantity
O
N

MARGINAL APPROACH
MR, MC
MC
A firm is said to be in equilibrium when marginal
revenue is equal to marginal cost.
MARGINAL REVENUE = MARGINAL COST
P* MR=AR
Under Perfect Market:

MR curve is horizontal.
Quantity When MR is equal to MC,
Q*
a firm is in equilibrium
MR, MC
MC
Under Imperfect Market:

P*
MR curve is downward
AR=DD
sloping. Same as perfect
market, when MR is equal to
MC, a firm is in equilibrium.
MR
Quantity
Q*

MARKET STRUCTURE
Definition of a Market
 An arrangement that facilitates buying and selling of a good,
service, factor of production or future commitment.
OR
 A market is a place where the buyers and sellers meet with one
another and involves transaction.
Definition of a Market Structure

 Market structure refers to the number and distribution size of buyers
and sellers in the market of a good and service.
 Market structure is an indication of the number of buyers and
sellers; their market shares; the degree of product standardization
and the ease of market entry and exit.

PERFECT COMPETITION MONOPOLY
There are large numbers of buyers and sellers, There is a single seller and a large
buying and selling identical product number of buyers; selling products that has
without any restriction on entry and exit, and no close substitution and has a high
having perfect knowledge of the market at a time. entry and exit barrier.
TYPES OF MARKET
STRUCTURE
MONOPOLISTIC COMPETITION OLIGOPOLY

There are only a few firms in the industry
There are large numbers of sellers, large number
but a large number of buyers; products can be
of buyers; selling differentiated products due to
either identical or differentiated, and there are
branding and labelling and there are no barriers
barriers to entry and exit.
to entry and exit.

MARKET STRUCTURE
Market Form Perfect Monopolistic Oligopoly Monopoly

Competition Competition
Characterictics
Large number
Number of firms Large Few One
Homogenous Unique: No close

Type of product Homogenous Differentiate or differentiated substitutes
Conditions to entry Very easy Relatively easy Significant Blocked

obstacles
Control over price None Some Some Considerable
Price elasticity of Infinite Large Small Very small

demand
Local phone
Examples Wheat, corn Food, clothing Automobiles, service,
cigarettes electricity
PERFECT COMPETITION
Definition
 A market in which there are many buyers and sellers, the products are
homogeneous and sellers can easily enter and exit from the market.
Characteristics
 Large number of buyers and sellers – firms are price takers
 Homogenous or standardized product – the buyers do not differentiate
the products of one seller to another seller
 Free of entry and exit into the market
 Role of non-price competition is insignificant
 Perfect knowledge of the market – all the sellers and buyers in perfect
competition market will have perfect knowledge of that market
 Perfect mobility of factor of production – factor of production can freely
move from one occupation to another and from one place to another
 Absence of transport cost
PERFECT COMPETITION
Since the firms are price

The price is takers, they face a
determined by the horizontal demand curve
Price intersection of the Demand curve in perfect
market supply curve Price competition is horizontal or
and the market perfectly elastic. Therefore:
demand curve.
Price = MR = AR
SS
RM10
RM10 P = MR = AR
DD
Q* Quantity
Quantity
Market Firm
PROFIT MAXIMIZATION
TOTAL REVENUE – TOTAL COST APPROACH
Quantity Total Revenue Total Cost Profit/Loss

Using Table:
0 0 60 −60 The profit maximization is
1 100 140 −40
2 200 210 −10
determined by scanning through
3 300 290 10 the profit at each level, and the
4 400 390 10
5 500 500 0
level which gives the highest profit
6 600 630 −30 is the profit maximizing output.
7 700 800 −100
TR, TC
TC
TR Using Graph:
TR curve is a straight line through
the origin. The maximum profit is
Highest vertical where the vertical difference is
differences the highest.
Quantity
40
PROFIT MAXIMIZATION
MARGINAL REVENUE – MARGINAL COST APPROACH
Quantity Total Marginal Total Marginal Profit/Loss

Revenue Revenue Cost Cost
0 0 - 60 - −60 Using Table:

1 100 10 140 8 −40 The profit maximizing output
2 200 10 210 7 −10
3 300 10 290 8 10 level is obtained following
4 400 10 390 10 10 the MR = MC rule.
5 500 10 500 11 0
6 600 10 630 13 −30
7 700 10 800 17 −100
MR, MC
Using Graph:
MC MR curve is perfectly elastic
or horizontal to the price.
The profit maximization rule,
RM10 MR MR = MC, where the MC curve
intersects with the MR curve.
Quantity
40

PROFIT MAXIMIZATION IN
SHORT RUN
A competitive firm earns economic profit
At this output, the firm The profit maximizing price The firm’s demand curve
earns economic profit or and output is P* and Q*. is horizontal at the price of
supernormal profit equal to RM20 and AR = MR.
Price (RM)
the shaded area. MC ATC
The marginal cost curve
intersects the demand curve
at point B.
A competitive firm
maximizes its profit when
MR = MC.
20
PROFIT B
P* P = MR = AR
Economic profit or supernormal profit

is the profit earned by a competitive
firm when TR > TC.
Quantity
Q*
SHORT RUN (cont.)
A competitive firm at breakeven
At this output, the firm is at the The profit maximizing price

breakeven or earns normal profit. The firm’s demand curve
and output is P* and Q*.
is horizontal at the price
Price (RM) MC
of RM20 and AR = MR.
Normal profit or breakeven
profit is necessary for a firm to The marginal cost curve
stay in business TR = TC ATC intersects the demand
curve at point B.
A competitive firm
maximizes its profit when
MR = MC.
B
P* 20 P = MR = AR
Quantity
Q*
SHORT RUN (cont.)
A competitive firm suffers economic losses
At this output, the firm suffers The profit maximizing price The firm’s demand curve is
economic losses or subnormal profit and output is P* and Q*. horizontal at the price of
equal to the shaded area. RM20 and AR = MR.
MC
Price (RM)
The marginal cost curve
Economic losses or intersects the demand curve
subnormal profit is the at point B.
losses incurred by a
competitive firm when A competitive firm
TR < TC. ATC maximizes its profit when
MR = MC.
B
P* 20 P = MR = AR
LOSSES
Quantity
Q*
SHORT RUN (cont.)
SHUT DOWN PRICE
If price falls below than RM5, At the price of RM5 per kg, the loss incurred by the
operating the firm will incur firm is equal to the fixed cost.
more losses than the fixed cost
Price (RM) and the firm must shut down. MC A firm will continue
operation even it suffers
Shut down point is the point losses.
where the price is equal to
minimum AVC. A firm can continue with the
production as far as the price
is equal to minimum average
ATC
variable cost (AVC).
B
P = MR = AR
20
AVC
LOSSES
TOTAL FIXED
COST
5
Quantity
Q*
SHORT RUN SUPPLY CURVE
The figure shows the AC, AVC and MC. There are The portion of marginal cost curve which lies
five different market prices that show the horizontal above the average variable cost curve is the
demand curve at each price. firm’s supply curve.
Point a is not considered as supply Supply curve of a competitive

Price (RM) curve since at any point below the firm is the upward portion of MC
minimum of AVC, the firm would MC above minimum of AVC as
shut down its operation and thus the shown by Points b, c, d and e.
quantity supplied would be zero.
AC
e
20 P1 = MR1 = AR1
AVC
d
10 P = MR = AR
c P2 = MR2 = AR2
b
5 P3 = MR3 = AR3
a P4 = MR4 = AR4
40 60 Quantity
LONG RUN
EFFECT OF ENTRY Firms that earn supernormal
profits in the short run will only be
The economic profit attracts The price is determined by able to earn normal or zero
newcomers to the industry. As a the intersection of the profits in the long run due to entry
result, many firms will enter the market supply curve and of newcomers.
market and this will lead to an the market demand curve.
increase in supply. The competitive firm sells 60 kg of
chicken and earns an economic
Price (RM) Price (RM)
Supply curve will shift to the right profit shown by the shaded area.
and equilibrium market price will fall
to RM15.
MC
SS AC
SS1
20 20
P = MR = AR
PROFIT
15 P1 = MR1 = AR1
DD
Quantity Quantity
Q* 60
Market Firm
LONG RUN (cont.)
EFFECT OF EXIT
The price is
determined by the The losses in short run forces
those sellers who cannot The competitive firm sells 60 kg of chicken and
intersection of the
cover their AVC or TVC to suffers losses shown by the shaded area.
market supply curve
and the market leave the market. As many
demand curve. firms exit the market, this will Firms that suffer losses in the short
lead to a decrease in the run can still continue their operation
market supply. as in the long run they are able to
Price (RM) Price (RM) earn normal or zero profits due to
Supply curve will shift to left and equilibrium exit of the firms.
market price will rise to RM15.
SS1 MC
AC
SS
15
15 P1 = MR1 = AR1
10 10
LOSSES
P = MR = AR
DD
Quantity Quantity
Q* 60
Market Firm
MONOPOLY
Definition
 Monopoly is a market structure in which there is a single seller and
large number of buyers and selling products that have no close
substitution and have high entry and exit barrier.
Characteristics
 One seller and large number of buyers – the monopolist is a firm as
well as an industry by itself
 No close substitution – monopoly firm would sell a product which has
no close substitute
 Price maker – monopolist is a price maker since there is one seller or
producer and it has the market power to control over the price
 Restriction of entry of new firms
 Advertising – advertising in monopoly market depends on the
products sold
MONOPOLY (cont.)
Barriers to Entry
 Barriers to entry refer to restriction that prevents other sellers from
entering into a market
1. Control over raw material – a monopoly status can also be
maintained through control over the supply of raw material
2. Patent and Copyright – a patent is an exclusive right to the
production of an innovative product. A copyright is an exclusive right
to the author of a book or composer of a music or producer of a movie
3. Cost of establishing an efficient plant – natural monopoly exists
when one firm can meet the entire market demand with lower price
compared to two or more firms
4. Government Franchises – the government will give exclusive rights
to a firm to sell a certain goods and services in a certain area

PROFIT MAXIMIZATION
TOTAL REVENUE – TOTAL COST APPROACH
(1) (2) (3) (4) (5)

Quantity Price Total Total Cost Profit
(Q) (P) Revenue (TC) (TR – TC)
(TR)
0 340 0 200 −200
Using Table:
1 340 340 400 −60 The profit maximization is
2 330 660 560 100 determined by scanning through
3 320 960 700 260
4 310 1240 800 440 the profit at each level, and the
5 300 1500 900 600 level which gives the highest
6 290 1740 1040 700
7 280 1960 1200 760 profit is the profit maximizing
8 270 2160 1400 760 output.
9 260 2340 1800 540
10 240 2400 2400 0
TR, TC
TC
Using Graph:
TR
TR curve is increasing and after the
profit maximizing output, the curve
Highest vertical starts to decline. Maximum profit is
differences where the vertical difference
between TR and TC is the highest.
Quantity
PROFIT MAXIMIZATION (cont.)
MARGINAL REVENUE – MARGINAL COST APPROACH

Quantity Price Marginal Marginal Cost
(Q) (P) Revenue (MC)
(MR)
0 340
1 340 340 200
2 330 320 160
3 320 300 140
4 310 280 100 Using Table:
5 300 260 100
6 290 240 140
The profit maximizing output
7 280 220 160 level is obtained following the
8 270 200 200
9 260 180 400
MR = MC rule.
10 240 60 600
MR, MC
MC
Using Graph:
MR curve under imperfect market is
P* downward sloping as the output
increases. The profit maximization
AR=P
rule, MR = MC, where the MC curve
intersect with the MR curve.
MR
Quantity
Q*
PROFIT MAXIMIZATION IN SHORT
RUN
Monopoly firm earns economic profit
At this output, the firm earns economic profit or
supernormal profit equal to the shaded area. The profit maximization
level occurs where MR
Price (RM) Economic profit or supernormal MC curve and MC curve
profit is the profit earned by a intersect at Point A.
monopolist when TR> TC. ATC
To find the price, we use the
same vertical line with output
up to the demand curve. The
profit maximizing price and
P*
output is P* and Q*.
AC
PROFIT
A
DD = AR
MR
Q*
Quantity
RUN (cont.)
Monopoly firm at break-even
At this output, monopolist is at the The profit maximization level
break-even or earns normal profit. occurs where MR curve and MC
curve intersects at Point A.
Price (RM) Normal profit or break-
MC
even is earned when TR = ATC
TC.
The profit maximizing price
and output is P* and Q*.
AC/P*
A
DD = AR
MR
Quantity
Q*
RUN (cont.)
Monopoly firm suffers economic losses
At this output, monopolist suffers economic losses or subnormal profit equal to the shaded area.
Economic losses or
The profit maximization
subnormal profit is the ATC
Price (RM) level occurs where MR
losses incurred by a MC
monopolist when TR < TC. curve and MC curve
intersect at Point A.
The profit maximizing

AC price and output is P*
and Q*.
LOSSES
P*
DD = AR
MR
Quantity
Q*
RUN (cont.)
Monopoly firm earns supernormal profit in long run
A monopoly firm earns

economic profits or
supernormal profit in the
Price (RM) LRMC
long run due to the barriers
to entry of new firms.
LRATC
P*
PROFIT
AC A
DD = LRAR
LRMR
Quantity
Q*

PRICE DISCRIMINATION
Definition
 Price discrimination refers to the selling or charging of different prices
by a firm to different buyers for the same product.
Necessary Conditions
 Existence of monopoly power – price discrimination can occur only if
monopoly power exists and there are no competitors in the market
 Existence of different markets for the same commodity – a firm should be
able to separate customers according to price elasticity of demand
 Existence of different degree of elasticity of demand – monopolist can
charge higher price for inelastic market and lower price for elastic market
 Cost of separating market must be low
 No resale – product purchased in the low-priced market should not be resold
in the high-priced market
 Legal sanction – government allows the public utility firms such as electricity
to charge different prices from different consumers
PRICE DISCRIMINATION (cont.)
First-degree Price Discrimination

 Occurs when a firm charges each consumer the maximum price that
he or she is willing to pay for each unit.
 This price discrimination is also known as perfect price discrimination.
 The best example for first-degree price discrimination is auction.
Second-degree Price Discrimination

 Occurs when the products are grouped into blocks and each block is
charged at a different price.
 This type of price discrimination is charged by public utilities such as
electricity charges, water charges, telephone charges and others.

PRICE DISCRIMINATION (cont.)
Third-Degree Price Discrimination

 Under this price discrimination, the markets are divided into many
submarkets or subgroups.
 Each group is considered as a different market.
 The price charged on products depends on the price elasticity of
demand.
 An example of third-degree price discrimination is the movie ticket
where the adults are charged higher price and children are charged at
lower price.
 Other examples are transportation (air, railways, bus or LRT), medical,
legal and entertainment.

PRINCIPLES
© Oxford Fajar Sdn. Bhd. (008974-T) 2010 OF ECONOMICS 31
Ch. 7: 31
COMPARISON BETWEEN PERFECT
COMPETITION AND MONOPOLY
Perfect Competition Monopoly

 Large numbers of sellers selling  Only one seller who sells products
homogenous products in perfect that have no close substitutes
competition market
 Price maker
 Price takers
 Earn a supernormal profit since
 Earns a normal profit in the long there are barriers to entry for new
run due to free entry and exit entrants
 In the long run, perfect competitive  Price charged is always higher
firm produces at the lowest point than in perfect competitive market
on the minimum of average cost,
is more efficient  Monopolist does not operate at
the minimum point of ATC curve


Chapter 7

Uploaded by

Copyright:

Available Formats

You might also like

Chapter 7

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 7

Uploaded by

Copyright:

Available Formats

Principles of Economics second edition All Rights Reserved

© Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 7: 1

Principles of Economics second edition All Rights Reserved

Principles of Economics second edition All Rights Reserved

Economic Profit Accounting Profit

EC= TR – [Explicit Cost + AC = TR – Explicit Cost

Principles of Economics second edition All Rights Reserved

TC Total approach is the simplest way

Under Perfect Market:

Principles of Economics second edition All Rights Reserved

Under Perfect Market:

Under Imperfect Market:

Principles of Economics second edition All Rights Reserved

Definition of a Market Structure

Principles of Economics second edition All Rights Reserved

MONOPOLISTIC COMPETITION OLIGOPOLY

Principles of Economics second edition All Rights Reserved

Market Form Perfect Monopolistic Oligopoly Monopoly

Homogenous Unique: No close

Conditions to entry Very easy Relatively easy Significant Blocked

Control over price None Some Some Considerable

Price elasticity of Infinite Large Small Very small

Since the firms are price

Quantity Total Revenue Total Cost Profit/Loss

MARGINAL REVENUE – MARGINAL COST APPROACH

Quantity Total Marginal Total Marginal Profit/Loss

0 0 - 60 - −60 Using Table:

Principles of Economics second edition All Rights Reserved

Economic profit or supernormal profit

At this output, the firm is at the The profit maximizing price

Point a is not considered as supply Supply curve of a competitive

Principles of Economics second edition All Rights Reserved

(1) (2) (3) (4) (5)

MARGINAL REVENUE – MARGINAL COST APPROACH

The profit maximizing

A monopoly firm earns

Principles of Economics second edition All Rights Reserved

First-degree Price Discrimination

Second-degree Price Discrimination

Principles of Economics second edition All Rights Reserved

Third-Degree Price Discrimination

Principles of Economics second edition All Rights Reserved

Perfect Competition Monopoly

Principles of Economics second edition All Rights Reserved

You might also like