Teaching PowerPoint Slides - Chapter 7

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2013 7– 1

CHAPTER 7
MARKET STRUCTURE 1:
PERFECT COMPETITION
AND MONOPOLY

DEFINITION AND
OBJECTIVES OF A FIRM
 Definition of a Firm
– A firm is an institution that buys or hires factors of
production and organizes them to produce and
sell goods and services.
– A firm is an independent unit of producing goods
and services for sale.
 Objectives of a Firm
– The main goal or objective of a firm is to
maximize profit and to minimize the cost.

ECONOMIC PROFIT AND
ACCOUNTING PROFIT
Economic Profit Accounting Profit

Economic profit is defined Accounting profit is defined
as the total revenue minus as the firm’s total revenue
the implicit and explicit minus the explicit cost.
cost.
• Consider both explicit • Consider only explicit
and implicit cost cost
EC= TR – [Explicit Cost + AC = TR – Explicit Cost
Implicit Cost]

TOTAL APPROACH
TR, TC
TC
Total approach is the simplest way
TR
to determine the equilibrium of a firm.
Highest vertical Under Perfect Market:

differences
TR curve is straight line through origin.
The firm maximum profits at ON output
because the vertical distance between
Quantity TR and TC curve is maximum.
0 N
TR, TC
TC
TR Under Imperfect Market:
Total revenue (TR) curve continues to rise
from left to right at a less than proportionate
Highest vertical rate. A rational firm will choose the output
differences
when the vertical distance between TR and
TC is at maximum, ON.
Quantity
O
N

MARGINAL APPROACH
MR, MC
MC
A firm is said to be in equilibrium when marginal
revenue is equal to marginal cost.
P* MR=AR MARGINAL REVENUE = MARGINAL COST
Under Perfect Market:

MR curve is horizontal.
Quantity When MR is equal to MC,
Q*
MR, MC a firm is in equilibrium
MC
Under Imperfect Market:

P* MR curve is downward
sloping. Same as perfect
AR=DD market, when MR is equal to
MC, a firm is in equilibrium.
MR
Quantity
Q*

MARKET STRUCTURE
 Definition of a Market
– An arrangement that facilitates buying and selling of a good,
service, factor of production or future commitment.
OR
– A market is a place where the buyers and sellers meet with one
another and involves transaction.
 Definition of a Market Structure
– Market structure refers to the number and distribution size of
buyers and sellers in the market of a good and service.
– Market structure is an indication of the number of buyers and
sellers; their market shares; the degree of product
standardization and the ease of market entry and exit.

PERFECT COMPETITION MONOPOLY
There are large numbers of buyers and sellers, There is a single seller and a large
buying and selling identical product number of buyers; selling products that has
without any restriction on entry and exit, and no close substitution and has a high
having perfect knowledge of the market at a time. entry and exit barrier.
TYPES OF MARKET
STRUCTURE
MONOPOLISTIC COMPETITION OLIGOPOLY

There are large numbers of sellers, large number There are only a few firms in the industry
of buyers; selling differentiated products due to but a large number of buyers; products can be
branding and labelling and there are no barriers either identical or differentiated, and there are
to entry and exit. barriers to entry and exit.

MARKET STRUCTURE
Market Form Perfect Monopolistic Oligopoly Monopoly
Characterictics Competition Competition
Large number
Number of firms Large Few One
Homogenous Unique: No close

Type of product Homogenous Differentiate or differentiated substitutes
Conditions to entry Very easy Relatively easy Significant Blocked

obstacles
Control over price None Some Some Considerable
Price elasticity of Infinite Large Small Very small

demand
Local phone
Examples Wheat, corn Food, clothing Automobiles, service,
cigarettes electricity
PERFECT COMPETITION
 Definition
– A market in which there are many buyers and sellers, the
products are homogeneous and sellers can easily enter
and exit from the market.
 Characteristics
– Large number of buyers and sellers – firms are price
takers
– Homogenous or standardized product – the buyers do
not differentiate the products of one seller to another seller
– Free of entry and exit into the market
– Role of non-price competition is insignificant

PERFECT COMPETITION
(cont.)
– Perfect knowledge of the market – all the sellers and
buyers in perfect competition market will have perfect
knowledge of that market
– Perfect mobility of factor of production – factor of
production can freely move from one occupation to
another and from one place to another
– Absence of transport cost

PERFECT COMPETITION
(cont.)
The price is determined by Since the firms are price
the intersection of the takers, they face a
market supply curve and horizontal demand curve
Price Demand curve in perfect
the market demand curve. Price
competition is horizontal or
perfectly elastic. Therefore:
SS
Price = MR = AR
RM10
RM10 P = MR = AR
DD
Q* Quantity
Quantity
Market Firm
PROFIT MAXIMIZATION
TOTAL REVENUE – TOTAL COST APPROACH
Using Table:
The profit maximization is
determined by scanning through
the profit at each level, and the
level which gives the highest profit
is the profit maximizing output.
TR, TC
TC
TR Using Graph:
TR curve is a straight line through
the origin. The maximum profit is
Highest vertical where the vertical difference is
differences
the highest.
Quantity
40

PROFIT MAXIMIZATION (cont.)
MARGINAL REVENUE – MARGINAL COST APPROACH
Using Table:
The profit maximizing output
level is obtained following
the MR = MC rule.
MR, MC
MC Using Graph:
MR curve is perfectly elastic
or horizontal to the price.
RM10 MR The profit maximization rule,
MR = MC, where the MC curve
intersects with the MR curve.
Quantity
40

PROFIT MAXIMIZATION IN
SHORT RUN
A competitive firm earns economic profit
At this output, the firm The profit maximizing price The firm’s demand curve
earns economic profit or and output is P* and Q*. is horizontal at the price of
supernormal profit equal to RM20 and AR = MR.
Price (RM)
the shaded area. MC ATC
The marginal cost curve
intersects the demand curve
at point B.
A competitive firm
maximizes its profit when
MR = MC.
20 PROFIT B
P* P = MR = AR
Economic profit or supernormal profit

is the profit earned by a competitive
firm when TR > TC.
Quantity
Q*
SHORT RUN (cont.)
A competitive firm at breakeven
At this output, the firm is at the The profit maximizing price

breakeven or earns normal profit. The firm’s demand curve
and output is P* and Q*.
is horizontal at the price
Price (RM) of RM20 and AR = MR.
MC
Normal profit or breakeven
profit is necessary for a firm to The marginal cost curve
stay in business TR = TC ATC intersects the demand
curve at point B.
A competitive firm
maximizes its profit when
MR = MC.
B
P* 20 P = MR = AR
Quantity
Q*
SHORT RUN (cont.)
A competitive firm suffers economic losses
At this output, the firm suffers The profit maximizing price The firm’s demand curve is
economic losses or subnormal profit and output is P* and Q*. horizontal at the price of
equal to the shaded area. RM20 and AR = MR.
MC
Price (RM)
The marginal cost curve
Economic losses or intersects the demand curve
subnormal profit is the at point B.
losses incurred by a
competitive firm when A competitive firm
TR < TC. ATC maximizes its profit when
MR = MC.
B
P* 20 P = MR = AR
LOSSES
Quantity
Q*
SHORT RUN (cont.)
SHUT DOWN PRICE
If price falls below than RM5, At the price of RM5 per kg, the loss incurred by
operating the firm will incur the firm is equal to the fixed cost.
more losses than the fixed cost
Price (RM) and the firm must shut down. MC A firm will continue
operation even it
Shut down point is the point suffers losses.
where the price is equal to
minimum AVC. A firm can continue with the
production as far as the
price is equal to minimum
ATC
average variable cost (AVC).
B
P = MR = AR
20
AVC
LOSSES
TOTAL FIXED COST
5
Quantity
Q*
SHORT RUN SUPPLY CURVE
The figure shows the AC, AVC and MC. There are The portion of marginal cost curve which lies
five different market prices that show the horizontal above the average variable cost curve is the
demand curve at each price. firm’s supply curve.
Point a is not considered as supply Supply curve of a competitive

Price (RM) curve since at any point below the firm is the upward portion of MC
minimum of AVC, the firm would MC above minimum of AVC as
shut down its operation and thus the shown by Points b, c, d and e.
quantity supplied would be zero.
AC
e
20 P1 = MR1 = AR1
AVC
d
10 P = MR = AR
c P2 = MR2 = AR2
b
5 P3 = MR3 = AR3
a P4 = MR4 = AR4
40 60 Quantity
LONG RUN
EFFECT OF ENTRY Firms that earn supernormal profits
in the short run will only be able to
The economic profit attracts The price is determined by earn normal or zero profits in the
newcomers to the industry. As a the intersection of the long run due to entry of
result, many firms will enter the market supply curve and newcomers.
market and this will lead to an the market demand curve.
increase in supply. The competitive firm sells 60 kg of
chicken and earns an economic
Price (RM) Price (RM)
Supply curve will shift to the right profit shown by the shaded area.
and equilibrium market price will fall
to RM15.
MC
SS AC
SS1
20 20
P = MR = AR
PROFIT
15 P1 = MR1 = AR1
DD
Quantity Quantity
Q* 60
Market Firm
LONG RUN (cont.)EFFECT OF EXIT
The price is The losses in short run forces
determined by the those sellers who cannot The competitive firm sells 60 kg of chicken and
intersection of the cover their AVC or TVC to suffers losses shown by the shaded area.
market supply curve leave the market. As many
and the market firms exit the market, this will
demand curve. Firms that suffer losses in the short
lead to a decrease in the run can still continue their operation
market supply. as in the long run they are able to
Price (RM) earn normal or zero profits due to
Price (RM)
Supply curve will shift to left and equilibrium exit of the firms.
market price will rise to RM15.
SS1 MC AC
SS
15
15 P1 = MR1 = AR1
10 10
LOSSES
P = MR = AR
DD
Quantity Quantity
Q* 60
Market Firm
MONOPOLY
 Definition
– Monopoly is a market structure in which there is a single seller
and large number of buyers and selling products that have no
close substitution and have high entry and exit barrier.
 Characteristics
– One seller and large number of buyers – the monopolist is a
firm as well as an industry by itself
– No close substitution – monopoly firm would sell a product
which has no close substitute
– Price maker – monopolist is a price maker since there is one
seller or producer and it has the market power to control over the
price
– Restriction of entry of new firms
MONOPOLY (cont.)
– Advertising – advertising in monopoly market depends on

the products sold
 Barriers to Entry
– Barriers to entry refer to restriction that prevents other sellers from
entering into a market
1. Control over raw material – a monopoly status can also be maintained through
control over the supply of raw material
2. Patent and Copyright – a patent is an exclusive right to the production of an
innovative product. A copyright is an exclusive right to the author of a book or
composer of a music or producer of a movie
3. Cost of establishing an efficient plant – natural monopoly exists when one firm
can meet the entire market demand with lower price compared to two or more
firms
4. Government Franchises – the government will give exclusive rights to a firm to
sell a certain goods and services in a certain area

PROFIT MAXIMIZATION
TOTAL REVENUE – TOTAL COST APPROACH
Using Table:
The profit maximization is
determined by scanning through
the profit at each level, and the
level which gives the highest
profit is the profit maximizing
output.
TR, TC
TC
TR
Using Graph:
TR curve is increasing and after the
profit maximizing output, the curve
Highest vertical starts to decline. Maximum profit is
differences
where the vertical difference
between TR and TC is the highest.
Quantity

PROFIT MAXIMIZATION (cont.)
MARGINAL REVENUE – MARGINAL COST APPROACH
Using Table:
The profit maximizing output
level is obtained following the
MR = MC rule.
MR, MC
MC
Using Graph:
P* MR curve under imperfect market is
downward sloping as the output
AR=P
increases. The profit maximization
rule, MR = MC, where the MC curve
intersect with the MR curve.
MR
Quantity
Q*

SHORT RUN
Monopoly firm earns economic profit
At this output, the firm earns economic profit or
supernormal profit equal to the shaded area. The profit maximization
level occurs where MR
Price (RM) Economic profit or supernormal MC curve and MC curve
profit is the profit earned by a intersect at Point A.
monopolist when TR> TC. ATC
To find the price, we use the
same vertical line with output
up to the demand curve. The
profit maximizing price and
P*
output is P* and Q*.
PROFIT
AC
A
DD = AR
MR
Quantity
Q*
SHORT RUN (cont.)
Monopoly firm at break-even
At this output, monopolist is at the The profit maximization level
break-even or earns normal profit. occurs where MR curve and MC
curve intersects at Point A.
Price (RM) Normal profit or break-
MC
even is earned when TR = ATC
TC.
The profit maximizing price
and output is P* and Q*.
AC/P*
A
DD = AR
MR
Quantity
Q*
SHORT RUN (cont.)
Monopoly firm suffers economic losses
At this output, monopolist suffers economic losses or subnormal profit equal to the shaded area.
Economic losses or
The profit maximization
subnormal profit is the ATC
Price (RM) level occurs where MR
losses incurred by a MC
monopolist when TR < TC. curve and MC curve
intersect at Point A.
The profit maximizing

AC price and output is P*
and Q*.
P*
LOSSES
DD = AR
MR
Quantity
Q*
SHORT RUN (cont.)
Monopoly firm earns supernormal profit in long run
A monopoly firm earns

economic profits or
supernormal profit in the
Price (RM) LRMC
long run due to the barriers
to entry of new firms.
LRATC
P*
PROFIT
AC A
DD = LRAR
LRMR
Quantity
Q*
PRICE DISCRIMINATION
 Definition
– Price discrimination refers to the selling or charging of
different prices by a firm to different buyers for the
same product.
 Necessary Conditions
– Existence of monopoly power – price discrimination
can occur only if monopoly power exists and there are
no competitors in the market
– Existence of different markets for the same
commodity – a firm should be able to separate
customers according to price elasticity of demand
(cont.)
– Existence of different degree of elasticity of
demand – monopolist can charge higher price for
inelastic market and lower price for elastic market
– Cost of separating market must be low
– No resale – product purchased in the low-priced
market should not be resold in the high-priced market
– Legal sanction – government allows the public utility
firms such as electricity to charge different prices from
different consumers

(cont.)
 First-degree Price Discrimination
– Occurs when a firm charges each consumer the maximum price
that he or she is willing to pay for each unit.
– This price discrimination is also known as perfect price
discrimination.
– The best example for first-degree price discrimination is auction.
 Second-degree Price Discrimination
– Occurs when the products are grouped into blocks and each
block is charged at a different price.
– This type of price discrimination is charged by public utilities
such as electricity charges, water charges, telephone charges
and others.

(cont.)
 Third-Degree Price Discrimination
– Under this price discrimination, the markets are divided
into many submarkets or subgroups.
– Each group is considered as a different market.
– The price charged on products depends on the price
elasticity of demand.
– An example of third-degree price discrimination is the
movie ticket where the adults are charged higher price and
children are charged at lower price.
– Other examples are transportation (air, railways, bus or
LRT), medical, legal and entertainment.

COMPARISON BETWEEN
PERFECT COMPETITION AND
MONOPOLY
Perfect Competition Monopoly
 Large numbers of sellers selling  Only one seller who sells products
homogenous products in perfect that have no close substitutes
competition market
 Price maker
 Price takers
 Earn a supernormal profit since
 Earns a normal profit in the long there are barriers to entry for new
run due to free entry and exit entrants
 In the long run, perfect competitive  Price charged is always higher
firm produces at the lowest point than in perfect competitive market
on the minimum of average cost,
is more efficient  Monopolist does not operate at
the minimum point of ATC curve


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PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

© Oxford Fajar Sdn. Bhd. (008974-T), 2013 7– 1

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Economic Profit Accounting Profit

EC= TR – [Explicit Cost + AC = TR – Explicit Cost

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Highest vertical Under Perfect Market:

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Under Perfect Market:

Under Imperfect Market:

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

MONOPOLISTIC COMPETITION OLIGOPOLY

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Characterictics Competition Competition

Homogenous Unique: No close

Conditions to entry Very easy Relatively easy Significant Blocked

Control over price None Some Some Considerable

Price elasticity of Infinite Large Small Very small

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

Economic profit or supernormal profit

At this output, the firm is at the The profit maximizing price

Point a is not considered as supply Supply curve of a competitive

– Advertising – advertising in monopoly market depends on

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

The profit maximizing

A monopoly firm earns

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved

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