PCM - Perfect Competition and Monopoly Overview
Perfect Competition and Monopoly Overview
Introduction
After reviewing the production and cost functions for the typical firm, we can now move into the realm of revenue and profit. While all firms have the same basic cost structures, revenue varies from firm to firm depending upon the market structure in which the firm operates. In this module, we will begin building our theory through the analyzation of perfect competition. From there, we will move to the opposite end of the competitive spectrum to see how revenue and profit for a monopoly differs from that of perfect competition. In the previous module, we evaluated the characteristics and efficiency of the two extremes - perfect competition and monopoly - on the spectrum of competition. However, most goods and services are bought and sold in the two market structures that exist between these extremes. In this module, you will learn about the two variations of these extremes - monopolistic competition and oligopolistic competition. You will learn the characteristics of each, as well as their implications in terms of efficiency in the market.
Essential Questions
In this module, we will study the following topics:
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- What is the difference between accounting profit and economic profit?
- What is normal profit?
- What is the profit maximizing rule for all firms? How is that rule refined for perfectly competitive firms?
- What are the characteristics of perfect competition?
- How does the perfectly elastic demand curve facing perfect competitors impact their power in the market?
- In response to short-run fluctuations, how do entry and exit bring about long run equilibrium for the firm and the market in perfect competition?
- What are the sources of monopoly power?
- What is the relationship between a monopoly's demand and marginal revenue curves?
- Why does a monopoly result in deadweight loss? What does this suggest in terms of allocative efficiency?
- Given that a monopolist does not produce where price = MC = minATC, what are the implications in terms of productive efficiency?
- How does a monopolist's price, output, and profit compare to that of a perfect competitor?
- How can price discrimination improve the allocative efficiency of a monopoly?
Key Terms
Click here to download the key terms document for this module. Links to an external site.
Price Taker – due to the characteristics of a perfectly competitive market, the firm has no ability to set price. It must take the price as given by the market.
Total Revenue – the price of a good multiplied by the quantity sold.
Average Revenue – total revenue divided by quantity sold yields average revenue.
Marginal Revenue – the change in total revenue due to a one unit increase in input yields marginal revenue.
Profit – the difference between revenue and costs for a firm.
Accounting Profit – as viewed by accountants, it is the difference between total revenue and total explicit cost.
Economic Profit – the difference between total revenue and total economic cost (explicit + implicit costs).
Normal Profit –a firm’s profit when economic profit equals 0. It is the opportunity cost of the entrepreneur’s talents.
Average Profit – total profit divided by quantity yields average profit.
Marginal Profit – the change in total profit when an additional unit is sold.
Breakeven Point –the point at which a firm’s average total cost equals average revenue (price). Prices below this point result in the firm earning a loss.
Shutdown Point –the point at which a firm’s average variable cost equals revenue (price). At any price below this point, the firm should shut down in the short run to minimize losses.
Perfect Competition –a market structure in which firms sell identical products and have no price making ability.
Monopoly – a market structure in which one firm is the sole producer of a unique product in a market with extreme barriers to entry.
Price Discrimination – refers to the sale of the same product to different groups of consumers at different prices.
Natural Monopoly - an instance where economies of scale are so extensive that it is less costly for one firm to supply the entire range of demand than for multiple firms to share the market.
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