Perfect Competition

1. Many buyers and sellers in the market, each of which is"small" relative to the market
2. Homogenous products
3. Buyers and sellers have perfect information
4. No transaction costs
5. Free entry and exit

Price in a perfectly competitive firm is determined by...

the interaction of all buyers and sellers

Profit maximizing output for perfectly competitive firm...

MR=MC

or

P=MC

Firms operating in a perfectly competitive market earn _________ in the long run.

zero economic profits

The demand curve for a perfectly competitive firm is...

perfectly elastic

In a perfectly competitive firm, when the the MC point is below the ATC but above the AVC the firm is incurring ________

losses

When the MC point lies above the ATC in a perfectly competitive market, the firm is incurring _______.

Profits

In a perfectly competitive firm, if the MC is below the AVC the firm should ________.

Shut down

Short-Run Output Decision Rule under Perfect Competition

To maximize short-run profits, a perfectly competitive firm should produce in the range of increasing MC where P=MC, provided that P≥AVC. If P<AVC, the firm should shut down its plant to minimize its losses.

P.C. firm's short-run supply curve

MC lies above the lowest point on the AVC curve

Shutdown Decision Rule

A firm should continue to operate (sustain short-term losses) if its operating losses is less than its fixed cost

Decision Rule:

-Shutdown when P<min AVC

-Continue operating as long as P≥min AVC

Long run Competitive Equilibrium

1. P=MC
2. P=min. of AC

Monopoly

1. Single firm serves the "relevant market"
2. Most monopolies are "local" monopolies
3. The demand for the firm's product is the market demand curve
4. Firm has control over price

Natural Sources of Monopoly Power

1. Economies of Scale
2. Economies of Scope
3. Cost Complementarities

Economies of Scope

Exists 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

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

Created Sources of Monopoly Power

Patents and other legal barriers

• Tying contracts
• Exclusive contracts
• Collusion

In a monopolistic market, total revenue is maximized where demand is

Unitary elastic

FACT:

For a monopolist, marginal revenue is less than the price charged for the good.

The marginal revenue schedule lies below the monopolist's demand curve.

Monopolist's Marginal Revenue Formula

MR=P[(1+E)/E]

Monopoly Profit Maximization

MR=MC