Chapter 8

Managing in Competitive,
Monopolistic, and
Monopolistically Competitive
Markets
 Learning Objectives
Identify Identify the conditions under which a firm operates as perfectly competitive, monopolistically competitive, or a monopoly.

Identify Identify sources of (and strategies for obtaining) monopoly power.

Apply Apply the marginal principle to determine the profit-maximizing price and output.

Show Show the relationship between the elasticity of demand for a firm’s product and its marginal revenue.

Explain how long-run adjustments affect perfectly competitive, monopoly, and monopolistically competitive firms; discuss the ramifications
Explain of each of these market structures on social welfare.

Decide Decide whether a firm making short-run losses should continue to operate or shut down its operations.

Illustrate the relationship between marginal cost, a competitive firm’s short-run supply curve, and the competitive industry supply; explain
Illustrate why supply curves do not exist for firms that have market power.

Calculate Calculate the optimal output of a firm that operates two plants and the optimal level of advertising for a firm that enjoys market power.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-2
 Perfect Competition

Perfectly competitive markets are characterized by:

– The interaction between many buyers and sellers that are “small” relative to the
market.
– Each firm in the market produces a homogeneous (identical) product.
– Buyers and sellers have perfect information.
– No transaction costs.
– Free entry into and exit from the market.
The implications of these conditions are:
– a single market price is determined by the interaction of demand and supply
– firms earn zero economic profits in the long run.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-3
 Demand at the Market and Firm Levels Under
Perfect Competition (Figure 8-1)
Price Price
Market Firm
S

𝑃 𝑒
𝐷𝑓 = 𝑃𝑒

0 Market Firm’s
output output

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-4

 Short-Run Output Decisions
• The short run is a period of time over which some factors of production
are fixed.

• To maximize short-run profits, managers must take as given the fixed

inputs (and fixed costs) and determine how much output to produce by
changing the variable inputs.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-5
Revenue, Costs, and Profits for a Perfectly
Competitive Firm (Figure 8-2)
Costs
$
Revenue

B
Maximum
profits
Slope of
Slope of
A E

Profit –
maximizing
output

0 𝑄∗ Firm’s output

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-6

 Competitive Firm’s Demand

The demand curve for a competitive firm’s product is a horizontal line at

the market price. This price is the competitive firm’s marginal revenue.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-7
Profit Maximization under Perfect Competition (Figure 8-3)
$
𝑀𝐶 𝐴𝑇𝐶

𝑃𝑒 𝐷 𝑓 = 𝑃 𝑒=𝑀𝑅
Profits
𝐴𝑇𝐶 ( 𝑄 )
∗

0 𝑄∗ Firm’s output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-8
 Competitive Output Rule

To maximize profits, a perfectly competitive firm produces the output at

which price equals marginal cost in the range over which marginal cost is
increasing.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-9
 Competitive Output Rule In Action

The cost function for a firm is .

If the firm sells output in a perfectly competitive market and other firms in
the industry sell output at a price of $20, what price should the manager
of this firm charge? What level of output should be produced to
maximize profits? How much profit will be earned?
Answer:
– Charge $20.
– Since marginal cost is , equating price and marginal cost yields: units.
– Maximum profits are: .

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-10
 Short-Run Loss Minimization (Figure 8-4)
$ 𝐴𝑇𝐶
𝑀𝐶 𝐴𝑉𝐶

𝐴𝑇𝐶 ( 𝑄∗ )
𝑃𝑒 Loss 𝐷 𝑓 = 𝑃 𝑒=𝑀𝑅

0 𝑄∗ Firm’s output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-11
 The Shut-Down Case (Figure 8-5)
𝑀𝐶 𝐴𝑇𝐶
$ 𝐴𝑉𝐶

Loss if shut down

𝐴𝑇𝐶 ( 𝑄 )
∗
Fixed Cost
𝐴𝑉𝐶 ( 𝑄 ∗)
𝑃𝑒 𝐷 𝑓 = 𝑃 𝑒=𝑀𝑅
Loss if produce

0 𝑄∗ Firm’s output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-12
 Short-Run Output Decision Under Perfect
Competition
To maximize short-run profits, a perfectly competitive firm should produce
in the range of increasing marginal cost where , provided that . If , the
firm should shut down its plant to minimize it losses.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-13
Short-Run Firm Supply Curve for a Competitive Firm (Figure 8-6)
$
𝑀𝐶
Short-run supply
curve for individual firm
𝐴𝑉𝐶
𝑃1

𝑃0

0 𝑄0 𝑄1 Firm’s output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-14
 The Short-Run Firm and Industry Supply Curves

The short-run supply curve for a perfectly competitive firm is its marginal
cost curve above the minimum point on the curve.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-15
The Market Supply Curve (Figure 8-7)

P
Individual firm’s
supply curve
Market supply
𝑀𝐶𝑖 curve
S

$12

$10

0 1 500 Market output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-16
Entry and Exit: The Market and Firm’s Demand (Figure 8-8)
Market Firm
Price Price
𝑆2
𝑆0
𝐸 𝑥𝑖𝑡 𝐸 𝑛𝑡𝑟𝑦 𝑆1
←
𝑃2 → 𝐷 𝑓 = 𝑃 2=𝑀𝑅 2
0
Exit
𝑃 𝐷 𝑓 = 𝑃 0=𝑀𝑅 0
1 Entry
𝑃 𝐷 𝑓 = 𝑃1 =𝑀𝑅 1

D
0 Market 0 Firm’s
output output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-17
Long-Run Competitive Equilibrium (Figure 8-9)
$
𝑀𝐶

𝐴𝐶
Long-run competitive
equilibrium

𝑃 𝑒 𝐷 𝑓 = 𝑃 𝑒=𝑀𝑅

0 𝑄∗ Firm’s output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-18
 Long-Run Competitive Equilibrium

In the long run, perfectly competitive firms produce a level of output such
that

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-19
 Monopoly and Monopoly Power

Monopoly: A market structure in which a single firm serves an entire

market for a good that has no close substitutes.

Being the sole seller of a good in a market gives that firm greater market
power than if it competed against other firms.
– Implication:
• market demand curve is the monopolist’s demand curve.
– However, a monopolist does not have unlimited market power.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-20
The Monopolist’s Demand (Figure 8-10)

Monopolist’s power is constrained

Price
by the demand curve.

0 A
𝑃

B
𝑃1

𝐷 𝑓 = 𝐷𝑀

0 𝑄0 𝑄1 Output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-21
 Sources of Monopoly Power
Economies of scale: exist whenever long-run average costs decline as output
increases.
– Diseconomies of scale: exist whenever long-run average costs increase as output
increases.
Economies of scope: exist when the total cost of producing two products
within the same firm is lower than when the products are produced by
separate firms.
Cost complementarity: exist when the marginal cost of producing one
output is reduced when the output of another product is increased.
Patents and other legal barriers

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-22
Elasticity of Demand and Total Revenues (Figure 8-12)
Price Revenue
Maximum revenues
Elastic

Unitary

0 Unitary 𝑅0
𝑃

Inelastic Elastic Inelastic

Total Revenue
R(Q)
Demand

0 𝑄0 Q 0 𝑄0 Firm’s
MR output

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-23
 Marginal Revenue and Elasticity

The monopolist’s marginal revenue function is

where is the elasticity of demand for the monopolist’s product and is the price
charged.

– For
• when .
• when .
• when .

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-24
 Marginal Revenue and Linear Demand

Given a linear inverse demand function

where , the associated marginal revenue is

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-25
 Marginal Revenue In Action

Suppose the inverse demand function for a monopolist’s product is given

by . What is the maximum price per unit a monopolist can charge to be
able to sell 3 units? What is marginal revenue when ?

Answer:
– The maximum price the monopolist can charge for 3 units is: .
– The marginal revenue at 3 units for this inverse linear demand is: .

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-26
 Monopoly Output Rule

A profit-maximizing monopolist should produce the output, , such that

marginal revenue equals marginal cost:

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-27
Costs, Revenues, and Profits Under Monopoly
(Figure 8-13)
Cost function
$

Revenue function

Slope of
Slope of
Maximum
profit

0 𝑀 Output
𝑄

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-28

Costs, Revenues, and Profits
Under Monopoly
(Figure 8-13) with Profit Curve

8-29
8-29
Profit Maximization Under Monopoly (Figure 8-14)
Price MC

ATC

𝑃𝑀
Profits
)

Demand

𝑄𝑀 Quantity
MR

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-30

 Monopoly Pricing Rule

Given the level of output, , that maximizes profits, the monopoly price is
the price on the demand curve corresponding to the units produced:

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-31
 Monopoly In Action

Suppose the inverse demand function for a monopolist’s product is given

by and the cost function is .
Determine the profit-maximizing price, quantity and maximum profits.

Answer:
– Profit-maximizing output is found by solving: .
– The profit-maximizing price is: .
– Maximum profits are: .

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-32
 The Absence of a Supply Curve

Recall, firms operating in perfectly competitive markets determine how

much output to produce based on price ().
– Thus, a supply curve exists in perfectly competitive markets.

A monopolist’s market power implies .

– A monopolist determines how much to produce based on marginal revenue which
is less than price; a change in quantity will change market price.
– Thus, there is no supply curve for a monopolist, or in markets served by firms with
market power.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-33
 Multiplant Decisions

Often a monopolist produces output in different locations.

– Implications: manager must determine how much output to produce at each plant.

Consider a monopolist producing output at two plants:

– The cost of producing units at plant 1 is , and the cost of producing at plant 2 is .
– When the monopolist produces identical products at two plants, the per-unit price
consumers are willing to pay for the total output produced at the two plants is ,
where .

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-34
 Multiplant Output Rule

Profit Maximization Rule for a two-plant monopolist: Produce output in

each plant such that MC of producing in each plant = MR of total output

Let be the marginal revenue of producing a total of units of output.

Suppose the marginal cost of producing units of output in plant 1 is and
that of producing units in plant 2 is . The profit-maximizing rule for the
two-plant monopolist is to allocate output among the two plants such
that:

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-35
 Implications of Entry Barriers

A monopolist may earn positive economic profits, which in the presence of

barriers to entry prevents other firms from entering the market to reap a
portion of those profits.
– Implication: monopoly profits will continue over time provided the monopoly
maintains its market power.

Monopoly power, however, does not guarantee positive profits.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-36
A Monopolist Earning Zero Profits (Figure 8-15)
Price MC
ATC

𝑃 𝑀 = 𝐴𝑇𝐶¿ ¿

Demand

𝑄𝑀 Quantity
MR

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-37

 Deadweight Loss of Monopoly

The consumer and producer surplus that is lost due to the monopolist
charging a price in excess of marginal cost.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-38
Deadweight Loss of Monopoly (Figure 8-16)
Price

MC
𝑀
𝑃
𝐶 Deadweight loss
𝑃

Demand
MR

𝑄𝑀 𝑄𝐶 Quantity

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-39

 Monopolistic Competition
An industry is monopolistically competitive if:
– There are many buyers and sellers.
– Each firm in the industry produces a differentiated product.
– There is free entry into and exit from the industry.

A key difference between monopolistically competitive and perfectly

competitive markets is that each firm produces a slightly differentiated
product.
– Implication: products are close, but not perfect, substitutes; therefore, firm’s demand
curve is downward sloping under monopolistic competition.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-40
Profit-Maximization under Monopolistic Competition
(Figure 8-17)

Price MC

ATC

𝑃∗
Profits
𝐴𝑇𝐶 ¿ ¿

Demand

𝑄∗ Quantity
MR

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-41

 Profit-Maximization Rule for Monopolistic
Competition
To maximize profits, a monopolistically competitive firm produces where
its marginal revenue equals marginal cost.

The profit-maximizing price is the maximum price per unit that consumers
are willing to pay for the profit-maximizing level of output.

The profit-maximizing output, , is such that and the profit-maximizing

price is .

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-42
 Long-Run Equilibrium

If firms in monopolistically competitive markets earn:

– short-run profits, additional firms will enter in the long run to capture some of
those profits.

– short-run losses, some firms will exit the industry in the long run.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-43
Effect of Entry on a Monopolistically Competitive
Firm’s Demand (Figure 8-18)
Price MC

ATC

𝑃∗ Due to entry of new

firms selling other brands

Demand1 Demand0

𝑄∗ Quantity of Brand X
MR1 MR0

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-44

Long-Run Equilibrium under Monopolistic Competition
(Figure 8-19)

Price MC

Long-run monopolistically
competitive equilibrium ATC

𝑃∗

Demand1

𝑄∗ Quantity of Brand X
MR1

© 2022 by McGraw-Hill Education. All Rights Reserved. 8-45

 The Long-Run and Monopolistic Competition

In the long run, monopolistically competitive firms produce a level of

output such that:

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-46
 Implications of Product Differentiation

The differentiated nature of products in monopolistically competitive

markets implies that firms in these industries must continually convince
consumers that their products are better than their competitors.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-47
 Implications of Product Differentiation
Two strategies monopolistically competitive firms use to persuade consumers:
– Comparative advertising: form of advertising where a firm attempts to increase the demand for
its brand by differentiating its product from competing brands
• Brand equity is the additional value added to a product because of its brand

– Niche marketing: a marketing strategy where goods and services are tailored to meet the needs of
a particular segment of the market.
• Green marketing targets consumers who are concerned about environmental issues

Successful differentiation and branding strategies can make managers brand

myopic, resting on the brand’s past laurels instead of focusing on industry trends
and changing consumer preferences.

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-48
 Optimal Advertising Decisions

How much should a firm spend on advertising to maximize profits?

– Depends, in part, on the nature of the industry.
– The optimal amount of advertising balances the marginal benefits and marginal
costs.

Profit-maximizing advertising-to-sales ratio is:

• The more elastic the demand for a firm’s product, the lower the optimal advertising-to-sales ratio
• The greater the advertising elasticity, the greater the optimal advertising-to-sales ratio

© 2022 by McGraw-Hill Education. All Rights Reserved.

8-49