Theory of Market:

Perfectly
Competitive &
Monopoly

©
© 2002
2002 by
by Nelson,
Nelson, aa division
division of
of Thomson
Thomson Canada
Canada Limited
Limited
In
In this
this chapter
chapter you
you will…
will…
•• Learn
Learn what
what characteristics
characteristics make
make aa market
market
competitive.
competitive.
•• Examine
Examine how
how competitive
competitive firms
firms decide
decide
how
how much
much output
output to
to produce.
produce.
•• Examine
Examine how
how aa monopoly
monopoly operates.
operates.
•• Examine
Examine how
how monopoly
monopoly andand perfectly
perfectly
competitive
competitive markets
markets vary
vary in
in functions.
functions.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 2
 WHAT
WHAT IS
IS A
A COMPETITIVE
COMPETITIVE
MARKET
MARKET
•• AA perfectly
perfectly competitive
competitive market
market hashas
the
the following
following characteristics:
characteristics:
––There
There are
are many
many buyers
buyers and and sellers
sellers
in
in the
the market.
market.
––The
The goods
goods offered
offered byby the
the various
various
sellers
sellers are
are largely
largely the
the same.
same.
––Firms
Firms can
can freely
freely enter
enter or or exit
exit the
the
market.
market.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 3
 WHAT
WHAT IS
IS A
A COMPETITIVE
COMPETITIVE
MARKET
MARKET
•• A
A competitive
competitive market
market has
has many
many
buyers
buyers andand sellers
sellers trading
trading identical
identical
products
products so so that
that each
each buyer
buyer and
and
seller
seller is
is aa price
price taker.
taker.
––Buyers
Buyers and and sellers
sellers must
must accept
accept the
the
price
price determined
determined by by the
the market.
market.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 4
 The
The Revenue
Revenue of
of aa Competitive
Competitive
Firm
Firm
•• Total
Total revenue
revenue for
for aa firm
firm is
is the
the selling
selling
price
price times
times the
the quantity
quantity sold.
sold.
TR (P  Q)
TR == (P Q)
•• Total
Total revenue
revenue isis proportional
proportional to to the
the
amount
amount of of output.
output.
•• Average
Average revenue
revenue tells
tells us
us how
how much
much
revenue
revenue aa firm
firm receives
receives forfor the
the typical
typical unit
unit
sold.
sold.
•• Average
Average revenue
revenue is is total
total revenue
revenue divided
divided
by
by the
the quantity
quantity sold.
sold.
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 5
 The
The Revenue
Revenue of
of aa Competitive
Competitive
Firm
Firm
•• In
In perfect
perfect competition,
competition, average
average revenue
revenue
equals
equals the
the price
price of
of the
the good.
good.

T o ta l re v e n u e
A v e ra g e R e v e n u e =
Q u a n tity

P ric e  Q u a n tity

Q u a n tity

 P ric e
Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 6
 The
The Revenue
Revenue of
of aa Competitive
Competitive
Firm
Firm
•• Marginal
Marginal revenue
revenue isis the
the change
change in in
total
total revenue
revenue from
from an
an additional
additional unit
unit
sold.
sold.
•• For
For competitive
competitive firms,
firms, marginal
marginal
revenue
revenue equals
equals the
the price
price of
of the
the good.
good.

MR =TR/ Q

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 7
Table
Table 14-1:
14-1: Total,
Total, Average,
Average, and
and Marginal
Marginal
Revenue
Revenue for
for aa Competitive
Competitive Firm
Firm
Quantity Total Average Marginal
(in litres) Price Revenue Revenue Revenue
(Q) (P) (TR = P x Q) (AR = TR/ Q) (MR = ∆TR/∆Q)

1 $6 $6 $6 $6
2 6 12 6 6
3 6 18 6 6
4 6 24 6 6
5 6 30 6 6
6 6 36 6 6
7 6 42 6 6
8 6 48 6

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 8
 PROFIT
PROFIT MAXIMIZATION
MAXIMIZATIONAND
AND THE
THE
COMPETITIVE
COMPETITIVE FIRM’S
FIRM’S SUPPLY
SUPPLY CURVE
CURVE

•• The
The goal
goal of
of aa competitive
competitive firmfirm is
is to
to
maximize
maximize profit,
profit, which
which equals
equals total
total
revenue
revenue minus
minus total
total cost.
cost.
•• This
This means
means that
that the
the firm
firm will
will want
want to to
produce
produce thethe quantity
quantity that
that maximizes
maximizes
the
the difference
difference between
between total
total revenue
revenue
and
and total
total cost.
cost.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 9
 PROFIT
PROFIT MAXIMIZATION
MAXIMIZATIONAND
AND THE
THE
COMPETITIVE
COMPETITIVE FIRM’S
FIRM’S SUPPLY
SUPPLY CURVE
CURVE

•• Profit
Profit maximization
maximization occurs
occurs at at the
the
quantity
quantity where
where marginal
marginal revenue
revenue
equals
equals marginal
marginal cost.
cost.
•• When
When MRMR >> MC  increase
MC  increase Q Q
•• When
When MRMR << MC  decrease
MC  decrease Q Q
•• When
When MRMR == MC  Profit
MC  Profit is
is
maximized.
maximized.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 10
 Figure
Figure 14-1:
14-1: Profit
Profit Maximization
Maximization for
for aa
Competitive
Competitive Firm
Firm
The firm maximizes
Costs profit by producing
and the quantity at which
Revenue
marginal cost equals
marginal revenue.

MC
MC2

ATC
P = MR1 = MR2 P = AR = MR
AVC

MC1

0 Q1 Q MAX Q2
Quantity

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 11
 Monopoly
Monopoly
•• While
While aa competitive
competitive firm
firm is
is aa
price
price taker,
taker, aa monopoly
monopoly firm
firm isis aa
price
price maker.
maker.
•• AA firm
firm is is considered
considered aa monopoly
monopoly
ifif .. .. ..
––itit isis the
the sole
sole seller
seller of
of its
its product.
product.
––its
its product
product does
does not
not have
have close
close
substitutes.
substitutes.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 12
Why
Why Monopolies
Monopolies arise?
arise?
•• The
The fundamental
fundamental cause
cause ofof
monopoly
monopoly is
is barriers
barriers to
to entry.
entry.
•• Barriers
Barriers to
to entry
entry have
have three
three sources:
sources:
–– Ownership
Ownership of of aa key
key resource.
resource.
–– The
The government
government gives gives aa single
single firm
firm the
the
exclusive
exclusive right
right toto produce
produce some
some good.
good.
–– Costs
Costs of
of production
production make make aa single
single
producer
producer more
more efficient
efficient than
than aa large
large
number
number ofof producers.
producers.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 13
Profit
Profit maximization
maximization
•• AAmonopoly
monopoly maximizes
maximizes profit
profit by
by
producing
producing the the quantity
quantity at
at which
which marginal
marginal
revenue
revenue equals
equals marginal
marginal cost.
cost.
•• ItIt then
then uses
uses the
the demand
demand curve
curve to
to find
find the
the
price
price that
that will
will induce
induce consumers
consumers to to buy
buy
that
that quantity.
quantity.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 14
Profit
Profit maximization
maximization
•• Comparing
Comparing Monopoly
Monopoly and and Competition
Competition
–– For
For aa competitive
competitive firm,
firm, price
price equals
equals
marginal
marginal cost.
cost.
PP== MR
MR == MC
MC
–– For
For aa monopoly
monopoly firm,
firm, price
price exceeds
exceeds
marginal
marginal cost.
cost.
PP>> MR
MR == MC
MC

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 15
Monopoly
Monopoly profit
profit in
in diagram
diagram

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 16
A
A market
market for
for drugs
drugs
•• AAnew
new drug
drug discovery
discovery gives
gives rise
rise to
to aa
patent
patent and
and gives
gives the
the firm
firm aa monopoly
monopoly on on
the
the sale
sale of
of that
that drug.
drug.
•• When
When the
the patent
patent expires
expires and
and any
any company
company
can
can make
make oror sell
sell the
the drug.
drug.
•• The
The market
market switches
switches fromfrom being
being
monopolistic
monopolistic to to being
being competitive.
competitive.

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 17
 THE END

Mankiw et al. Principles of Microeconomics, 2nd Canadian Edition Chapter 14: Page 18