Competitive markets usually do a remarkably effective job of allocating society’s scarce resources to their most highly valued uses. Thus, we begin this chapter by demonstrating how properly functioning markets efficiently allocate resources. We then explore what happens when markets don’t function properly. In some circumstances, economically desirable goods are not produced at all. In other situations, they are either overproduced or underproduced. This chapter focuses on these situations, which economists refer to as market failures. | Chapter 6 Perfect Competition, Monopoly, and Economic vs. Normal Profit Chapter Outline From Perfect Competition to Monopoly Supply Under Perfect Competition From Perfect Competition to Monopoly Perfect Competition Monopolistic Competition Oligopoly Monopoly Picking the Quantity to Maximize Profit AVC MC ATC AVC MR Q* P* MR D MC ATC Q* P* P Q Many Competitors P Q No Competitors 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 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. 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. Oligopoly Oligopoly: a situation in a market where there are very few discernible competitors Examples Satellite TV service (Direct TV, Primestar, Dish Network) Airlines (American, Delta etc.) 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. Examples of Different Market Forms Perfect Competition Monopolistic Competition Oligopoly Monopoly Agriculture Lumber Fast Food Airlines Cars and Trucks Soft Drinks Windows Operating system Local Residential Utilities Distinguishing Characteristics Between Market Forms Perfect Competition Monopolistic Competition Oligopoly Monopoly Number of Firms Many-often thousands or even millions Several Few One Barriers to Entry None Few Substantial Insurmountable Product Homo/Hetero-geneity Homogeneous Heterogeneous Heterogeneous N/A Supply Under Perfect Competition 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 Return on Equity For Various Industries Industry Rate of Return Net Income/(Assets-Liabilities) Agriculture Manufacturing Transportation and Public Utilities Wholesale and Retail Trade When and Why Economic Profits Go to Zero 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 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. Figure 2 The Pressures on Price in Perfect Competition $ Q MC ATC AVC MR3 MR1 MR2 MR4 Long Run Pressure Short Run Pressure Figure 3 Points of Production in Perfect Competition $ Q MC ATC AVC MR4 MR3 MR2 MR1 Figure 4 Supply in Perfect Competition $ Q MC ATC AVC Supply
