Essentials of Economics
An Asia-Pacific Perspective, 4th edition
Chapters 6
Firms in Perfectly Competitive and
Monopoly Markets
• Explain what a perfectly competitive market is and
why a perfect competitor faces a horizontal demand
curve.
Learning objectives • Explain how a firm maximizes profit in a perfectly
(1 of 2) competitive market.
• Use graphs to show a firm’s profit or loss.
• Explain why firms may shut down temporarily.
• Explain how entry and exit ensure that perfectly
competitive firms earn zero economic profit in the
long run.
• Explain how perfect competition leads to economic
Learning objectives efficiency.
• Define monopoly.
(2 of 2) • Explain the four main reasons why monopolies
arise.
• Explain how a monopoly chooses price and output.
How Uber brought competition to the taxi
industry
• One by one, state and territory governments, led by the ACT and
Victoria, have legislated for companies like Uber to compete with
taxis, although only taxis are allowed to be hailed by passengers or
use taxi ranks.
© alexeyboldin | 123rf.com
1. Introduction
Market structures (1 of 2)
• Economists group industries into four market
structures:
• Perfect competition
• Monopolistic competition
• Oligopoly
• Monopoly
Market structures (2 of 2)
• The number of firms in the industry.
• The similarity of the good or service produced
by the firms in the industry.
• The ease with which new firms can enter the
industry.
The four market structures: Table 7.1
2. Perfectly
competitive markets
in the short run
• The conditions that make a market perfectly
competitive are:
Perfectly • There are many buyers and sellers, all of whom
are small relative to the market.
competitive • All firms sell identical products.
• There are no barriers to new firms entering the
markets (1 of 2) market or to existing firms leaving the market.
• A perfectly competitive firm cannot affect the
market price
Perfectly • Price taker: A buyer or seller that is unable to affect
competitive the market price.
• The demand curve for a price taker is horizontal, or
markets (2 of 2) perfectly elastic.
A perfectly
competitive firm
faces a
perfectly elastic
demand curve:
Figure 7.1
The market demand for oats versus the demand for one farmer’s oats: Figure 7.2
How a firm maximises profit
in a perfectly competitive
market
Profit: Total revenue (TR) minus
total cost (TC).
Profit = TR − TC
Revenue for a firm in a perfectly competitive
market
Change in total revenue ΔTR
Marginal Revenue = or, MR =
Change in quantity ΔQ
Number of Market price Total Average Marginal Farmer Jones’
revenue from oats
bushels (Q) per bushel revenue revenue revenue
($P) (TR) (AR) (MR)
0 $4 $0 - - farming: Table 7.1
1 4 4 $4 $4
2 4 8 4 4
3 4 12 4 4
4 4 16 4 4
5 4 20 4 4
6 4 24 4 4
7 4 28 4 4
8 4 32 4 4
9 4 36 4 4
10 4 40 4 4
Since producers in a perfectly competitive
Determining the market can sell as much produce as they wish
profit-maximising to at the same constant price:
level of output (1 ▪ Average revenue (AR) = Marginal revenue
of 2) (MR)
▪ Price = AR = MR
18
▪ The profit-maximising level of output is
where the difference between total revenue
Determining the and total cost is the greatest.
profit-maximising ▪ The profit-maximising level of output is also
level of output (2 of where marginal revenue equals marginal
cost, or MR=MC.
2)
Illustrating profit or loss on the
cost curve graph
Profit = (P x Q) − TC
Profit (P Q) TC
= −
Q Q Q or
Profit per unit = Profit
= P − ATC
Q
Total profit = (P − ATC) x Q
The area of
maximum
profit: Figure
7.3
Illustrating when a firm is breaking even or
operating at a loss
▪ If P > ATC; the firm makes a profit.
▪ If P = ATC; the firm breaks even, (its per unit cost equals per unit
revenue. Thus, the firm’s total cost equals its total revenue).
▪ If P < ATC; the firm experiences losses.
A firm breaking even and a firm experiencing
losses: Figure 7.4
• In the short run a firm suffering losses has two
Deciding whether choices:
• Continue to produce
to produce or to • Stop production by shutting down temporarily
shut down in the
short run • Sunk cost: A cost that has already been paid and
cannot be recovered.
• For any given price, the marginal cost curve shows
the quantity of output that a firm will supply.
The supply curve of
• Therefore, the perfectly competitive firm’s
a firm in the short marginal cost curve is also its supply curve—but
only for prices at or above average variable cost.
run (1 of 2)
25
• Even if a firm suffers losses, it should continue to
operate as long as P > AVC.
• Shutdown point: The minimum point on a firm’s
The supply curve average variable cost curve; if the price falls below
this point, the firm shuts down production in the
of a firm in the short run.
• Shutdown point: P < AVC
short run (2 of 2)
The firm’s
short-run
supply
curve: Figure
7.5
Economic profit and the entry
or exit decision
▪ Economic profit: A firm’s revenues minus all its costs, implicit and
explicit.
▪ Economic profit in a perfectly competitive industry is only a short-run
occurrence.
▪ Economic profit leads to the entry of new firms into the industry.
The effect of entry on economic profits:
Figure 7.6
▪ Economic loss: The situation in which a firm’s total revenue is
Economic loss and less than its total cost, including all implicit costs.
the entry or exit ▪ Economic loss in a perfectly competitive industry is only a
short-run occurrence.
decision
▪ Economic loss leads to the exit of some firms from the
industry.
The effect of exit on economic losses: Figure 7.7,
panels (a) and (b)
The effect of exit on economic losses: Figure 7.8,
panels (c) and (d)
3. Perfectly
competitive markets
in the long run
Long-run ▪ Long-run competitive equilibrium: The situation in
equilibrium in a which the entry and exit of firms has resulted in the
typical firm breaking even.
perfectly ▪ The long-run equilibrium market price is at the
competitive minimum point on the typical firm’s average cost
curve.
market (1 of 2)
▪ Long-run supply curve: A curve showing the
Long-run relationship in the long run between market price
and the quantity supplied.
equilibrium in a ▪ The long-run supply curve will be horizontal at the
perfectly market price.
competitive ▪ In the long run, a perfectly competitive market will
supply whatever amount of a good consumers
market (2 of 2) demand at a price determined by the minimum
point on the typical firm’s average cost curve.
The long-run supply curve in a perfectly
competitive industry: Figure 7.9
4. Monopoly
Is any firm ever really a
monopoly?
• Monopoly: The only seller of a good or service that does not
have a close substitute.
• Narrow definition of monopoly: A firm is a monopoly if it can
ignore the actions of all other firms.
• This means that other firms in the market must not be
producing close substitutes. For example, the government
water authority can ignore the price of bottled water.
• Broad definition of monopoly: This means that other firms in
the market are not close enough substitutes to compete away
economic profits in the long run.
• For example, the only pizza shop may have a monopoly,
although burgers may be a substitute.
• Monopolies emerge due to a lack of competition
created by barriers to entry.
• The four main reasons for high barriers to entry are:
• Government blocks the entry of more than one
Where do firm into a market.
monopolies come • One firm has control of a key raw material
necessary to produce a good.
from?
• There are important network externalities in
supplying the good or service.
• Economies of scale are so large that one firm has
a natural monopoly.
Average total cost for a natural monopoly:
Figure 8.1
How does a monopoly
choose price and output?
(1 of 2)
• Like every other firm, a monopoly maximises profit at
the output when marginal revenue equals marginal
cost (MR = MC).
• However, the difference is that a monopoly’s demand
curve is the same as the demand curve for the product
(downward sloping).
How does a monopoly
choose price and output? (2
of 2)
• A monopoly is a price maker. It does not face a
horizontal demand curve.
• In fact, its demand curve and marginal revenue
curve are both downward sloping.
• The marginal revenue curve is positioned below
its demand curve.
Profit-maximising quantity and price for a
monopoly: Figure 8.2
1. Discuss the market structures: perfect competition and
monopoly.
5. Conclusions 2. A perfectly competitive firm cannot affect the market price.
3. A monopoly will produce less and charge a higher price.
• Watch these video: Google threatens to shut down search
in Australia and
• Read the article entitles “Google threatens to dump news”.
• Form a group of two or three students and answer the
Case Study: following questions:
• Why do you think that Google monopolises the Search
Google vs Engine platform? Explian. [Hint: Apply the profit-
maximizing quantity and price for a monopoly concept
Australian shown in Figure 7.11.]
Lawmakers • What is the proposed bargaining code? Why does
Google concern about this code?
• Do you think the regulating the market power of digital
platforms would benefit the Australian society?
Explain. [Hint: Apply the concepts of efficiency and
equity which we have discussed in Module 1]
Extra video: Google and Facebook have an effective duopoly on
online advertising. For the average person, why is that a
problem? Prices haven’t gone up. Why should we care?
In-Class
Exercises
In-Class Exercise 1:
A perfectly competitive firm faces a price of $14 per unit. It has the short-run cost schedule
shown below.
(a) Copy the table and put in additional rows for average cost and marginal cost at
each level of output. (Enter the figures for marginal cost in the space between each
column.)
(b) Plot AC, MC and MR on a diagram.
(c) Mark the profit-maximising output.
(d) How much (supernormal) profit is made at this output?
(e) What would happen to the price in the long run if this firm were typical of others in
the industry? Why would we need to know information about long-run average cost in
order to give a precise answer to this question?
Output 0 1 2 3 4 5 6 7 8
TC ($) 10 18 24 30 38 50 66 91 120
In-Class Exercise 2:
Referring the table below, answer the following questions.
(a) Construct a column of total revenue, total cost, marginal revenue and marginal cost.
(Hint: First, calculate the total cost. Recall AC=TC/Q. To find total cost, TC=AC×Q. Then, calculate
MC=∆TC/∆Output . To find total revenue, recall TR=P×Q. Calculate MR=∆TR/∆Output)
(b) If the company operates as a monopolist, how many good Y should the firm produce to maximise profit?
What would be the price of the good? What is the profit at the output level? (Hint: MR = MC)
(c) Based on your answers in part (b), if the firm operates under a perfect competitive industry, what would be
the equilibrium price and quantity? Should the company operate the business at the price and quantity in the
long-run? Quantity Price ($) = AR Average Cost ($)
0 50 Not available Fixed cost is $10
5 45 32
10 35 28.5
15 30 26.67
20 20 25
25 15 25.2
30 10 25.5
35 5 26.14
3. Refer to Figure 1 below and answer the following questions.
In-Class Exercise 3:
Refer to the figure and answer the following questions.
a.What is the amount of profit if the firm produces Q2 units?
b.Suppose the firm is currently producing Q2 units. What
happens if it expands output to Q3 units?
c.At what output level does the firm break even?
d.What happens if the firm produces more than Q4 units?
e.Why is the total revenue curve a ray from the origin?
