Managing in Competitive,

Monopolistic, and Monopolistically

Competitive Markets
Chapter 8
 Learning Objectives

1. Identify the conditions under which a firm operates as perfectly

competitive, monopolistically competitive, or a monopoly.
2. Identify sources of (and strategies for obtaining) monopoly power.
3. Apply the marginal principle to determine the profit-maximizing price and
output.
4. Show the relationship between the elasticity of demand for a firm’s
product and its marginal revenue.
5. Explain how long-run adjustments impact perfectly competitive,
monopoly, and monopolistically competitive firms; discuss the
ramifications of each of these market structures on social welfare.
6. Decide whether a firm making short-run losses should continue to
operate or shut down its operations.
7. Illustrate the relationship between marginal cost, a competitive firm’s
short-run supply curve, and the competitive industry supply; explain why
supply curves do not exist for firms that have market power.
8. Calculate the optimal output of a firm that operates two plants and the
optimal level of advertising for a firm that enjoys market power.
PERFECT COMPETITION

The key conditions for perfect competition are as follows:

1. There are many buyers and sellers in the market, each of which
is “small” relative to the market.
2. Each firm in the market produces a homogeneous (identical)
product.
3. Buyers and sellers have perfect information.
4. There are no transaction costs.
5. There is free entry into and exit from the market.
Firm demand curve

The demand curve for an individual firm’s product; in a perfectly

competitive market, it is simply the market price.
Short-Run Output Decisions
The demand for an individual firm’s
Maximizing Profits
product is the market price of output.

There is a linear
relation between
revenues and the
output of a
competitive firm

Marginal revenue is
the change in
revenue
attributable to the
last unit of output.
Price = MR
Minimizing Losses

Short-Run
Operating
Losses.

Price = MC
The Decision
to Shut Down
The Firm’s Short-Run Supply
Curve The short-run supply curve
for a perfectly competitive firm is
its marginal cost curve above
the minimum point on the AVC
curve, as illustrated in Figure 8–6.
Figure 8–7 illustrates the relation
between an individual firm’s supply
curve (MCi) and the market supply
curve (S) for a perfectly competitive
industry composed of 500 firms.
When the price is $10, each firm
produces zero units, and thus total
industry output also is zero. When
the price is $12, each firm produces 1
unit, so the total output produced by
all 500 firms is 500 units.
Long-Run Decisions

Free entry and exit

 In the long run,
perfectly
competitive firms
produce a level of
output such that
1. P MC
2. P minimum of
AC

At the price of Pe, each firm receives just enough to cover the average costs
of production (AC is used because in the long run there is no distinction
between fixed and variable costs), and economic profits are zero. If economic
profits were positive, entry would occur and the market price would fall until
the demand curve for an individual firm’s product was just tangent to the AC
curve. If economic profits were negative, exit would occur, increasing the
market price until the firm demand curve was tangent to the AC curve.
MONOPOLY A market structure in which a single firm
serves an entire market for a good that has
no close substitutes.

Perfectly elastic
Sources of Monopoly Power

Economies of
Scale - Exist
whenever long-
run average costs
decline as output
increases.

Diseconomies of
Scale Exist
whenever long-
run average costs
increase as output
increases.
 Cont.
Economies of Scope Exist when
the total cost of producing two
products within the same firm is
lower than when the products are
produced by separate firms.

Cost complementarities Exist

when the marginal cost of
producing one output is reduced
when the output of another
product is increased.

Patents and Other Legal Barriers

The patent system gives the inventor of a
new product the exclusive right to
sell the product for a given period of time
Maximizing Profits
profit-maximizing manager of a
monopoly should continue to
expand output when MR > MC
Implications of Entry
Barriers

Earns zero economic profits, because the optimal price exactly

equals the average total cost of production. Moreover, in the short
run a monopolist may even experience losses.
The first thing to notice
about monopoly is that
price exceeds the
marginal cost of
production: PM > MC.

Deadweight loss of
monopoly
The consumer and
producer surplus that is
lost due to the
monopolist charging a
price in excess of
marginal cost.
MONOPOLISTIC COMPETITION

An industry is monopolistically competitive if:

1. There are many buyers and sellers.
2. Each firm in the industry produces a differentiated product.
3. There is free entry into and exit from the industry.
Profit Maximization MR = MC
Long-Run Equilibrium
Implications of Product Differentiation

Comparative Advertising - A form of Brand Equity - The additional

advertising where a firm attempts to
increase the demand for its brand
by differentiating its product from
competing brands.
Niche Marketing A marketing
strategy where goods and
services are tailored to
meet the needs of a particular
segment of the market.
value added to a product
because of its brand.
Green Marketing A form of
niche marketing where
firms target products toward
consumers who are
concerned about
environmental issues.

Brand Myopic A manager or company that rests on a brand’s

past laurels instead of focusing on emerging industry trends or
changes in consumer preferences.
SUMMARY:
In this chapter, we examined managerial decisions in
three market environments: perfect competition,
monopoly, and monopolistic competition. Each of
these market structures provides a manager with a
different set of variables that can influence the firm’s
profits. A manager may need to pay particularly close
attention to different decision parameters because
different market structures allow control of only
certain variables. Managers who recognize which
variables are relevant for a particular industry will
make more profits for their firms.
Managers in perfectly competitive markets should concentrate
on producing the proper quantity and keeping costs low.
Because perfectly competitive markets contain a very large
number of firms that produce perfect substitutes, a manager in
this market has no control over price.

A manager in a monopoly, in contrast, needs to recognize the

relation between price and quantity. By setting a quantity at
which marginal cost equals marginal revenue, the manager of a
monopoly will maximize profits. This is also true for the
manager of a firm in a monopolistically competitive market,
who also must evaluate the firm’s product periodically to
ensure that it is differentiated from other products in the
market. In many instances, the manager of a monopolistically
competitive firm will find it advantageous to slightly change the
product from time to time to enhance product differentiation.
 Profit Maximizing Output: Pure Competition

Quan Total Fixed Varia Total P= MC AC Profit/ Total

tity Reven Cost ble Cost MR Unit Profit
ue Cost

0 P0 P200 P0 P200 P131 0 0 0 0

2 262 P200 180 380 P131 P90 P190.00 - P59.00 - P118
4 524 P200 340 540 P131 P80 P135 - P4.00 - P16
6 786 P200 480 680 P131 P70 P113.33 P17.67 P106

8 1048 P200 600 800 P131 P60 P100.00 P31.00 P248

10 1310 P200 740 940 P131 P70 P94.00 P37.00 P370
12 1572 P200 900 1100 P131 P80 P91.67 P39.33 P472
14 1834 P200 1080 1280 P131 P90 P91.43 P39.57 P554
16 2096 P200 1300 1500 P131 P110 P93.75 P37.25 P596
18 2358 P200 1560 1760 P131 P130 P97.78 P33.22 P598
20 2620 P200 1860 2060 P131 P159 P103.00 P28.00 P560
 Revenue and Cost Data of a Pure Monopolist

Price Cost Quantit Total Margina Total Marginal Average Profit

y Revenu l Cost Cost
e revenue

P80.00 0 - - P60.00 - - (P60.00)

70.00 1 P70.00 P70.00 80.00 P20.00 P80.00 (P10.00)
60.00 2 120.00 50.00 90.00 10.00 45.00 30.00
55.00 2.5 137.50 35.00 100.00 20.00 40.00 37.50

50.00 3 150.00 25.00 120.00 40.00 40.00 30.00

40.00 4 160.00 10.00 200.00 80.00 50.00 (40.00)
30.00 5 150.00 (10.00) 350.00 150.00 70.00 (200.00)