Perfect competition and monopoly Flashcards
Objective of firms
Profit maximising
Equilibrium condition for profit maximising
MR = MC
No incentive to change output.
All market structures can only maximise profit when MR = MC.
MR>MC
Profits rise when output increases.
Fail to profit maximise.
MR
Profits rise when output reduces.
Fail to profit maximise.
Normal profit
The minimum profit a firm must make to stay in business, while being insufficient to attract new firms into the market.
Economists treat as a Cost of Production as must make this normal profit to stay in business.
In LR, firms unable to make normal profit leave the market.
Supernormal profit
Profit over and above normal profit.
In LR, (in absence to barriers of entry) supernormal profit performs the important economic function of attracting new firms into the market.
Condition 1: Perfection Competition
1: Large number of buyers and sellers
Condition 2: Perfection Competition
2: perfect market information
Condition 3: Perfection Competition
3: able to buy/sell as much as they wish at the ruling market price
Condition 4: Perfection Competition
4: unable to influence the ruling market price
Condition 5: Perfection Competition
5: uniform product
Condition 6: Perfection Competition
6: no barriers to entry or exit
AC = MC
Productive efficiency
Long run Perfect Competition
- Can enter and leave
- SR: Make supernormal profit… signals to firms outside the market that profit can be made, provides incentive for new firms to join the market.
- too many enter
- make a loss (Subnormal profit)
- Therefore firms leave, supply shifts left, and normal profit is maintained in the LR.
Subnormal profit
Incentive for firms to leave market
**Providing the firm is a profit maximiser…
The equilibrium MR = MC applies to any firm, whatever the market structure.
Monopoly equilibrium
Does not distinguish between SR & LR as protected from barriers to entry, which prevent new firms entering the market to share the supernormal profit made for by the monopolist.
Entry barriers enable the firm to preserve supernormal profits in the LR as well as the SR. Supernormal profits in perfect competition are temporary, where as in monopoly supernormal profits are often called monopolist profit. The monopolist has market power to reserve profit by keeping competitors out.
Barriers to exit
Fixed assets - capital equipment
Redundancy costs - payments to redundant workers
Closure costs - for cutting contracts short
Profit maximisation
Different between total revenue and total cost is at its greatest.
MR = MC
Revenue maximisation
Occurs at level of output at which marginal revenue is zero
Barriers to entry: Limit pricing
Firms adopt pricing policies by lowering prices to a level which would force new entrant to operate at a loos and in the long run it would be forced out the market.
Barriers to entry: Advertising
Allows firms to establish branded products and win customer loyalty. New entrants must therefore spend substantial amounts on advertising to compete, which could deter entry.
Barriers to entry: Absolute cost advantages
Cut prices and win price wars as have been in market for long time.
Barriers to entry: Sunk costs
Costs unrecoverable once entered the market, therefore disincentive to enter the industry.
