9) Market Power and Profit

Perfect Competition in the Short Run

Many Firms, Homogenous product, No barriers to entry, Firms are Price Takers

Optimal production at MR = MC

4 Operating positions (Profit, Normal, Quasi, Shutdown)

Why does PC approach net Zero

Because opportunity for profit attracts new firms, who raise supply and lower the price until there is no incentive to join (Normal profit)

Hence when analysing, we presume starting at breakeven

Analysing Change

Step 1: Assume net zero scenario

Step 2: Graph the changes as effects would happen in the short term

Step 3: Convert to the long term, and back to net zero

Market Power and the Demand Curve

The greater a firms Market power the more inelastic and the MR curve slopes at an even steeper line

Four key market structures

Monopoly

Oligopoly

Monopolistic Competition

Perfect Competition

Features of a Monopoly

Few / One firms controls the market

High barriers to entry

Firms are price makers (High market power)

The market D curve is the firms D curve

The market supply curve is the firms MC curve

Are Monopolies sustainable

Yes, short term profits can be held into the long run

This is dependant on factors establishing the monopoly (time based or not)

Monopolies don’t even have to differentiate their products

Common Entry/Exit Barriers

Government imposed / Legal Barriers (operating licenses, copyright laws, etc)

Control of key resources / materials to produce the good

Important network externalities (the critical scale of users needed)

Economies of scale (when one firm can produce cheaper than the others)

MR and Price (the effects created)

In perfect competition MR equals the price, in monopolies, as they control the price, MR < P

This is because they can raise their quantity, but will have to lower their price to not oversupply

This creates the effects:

• Output Effect: Gain in revenue from selling more Q

• Discount Effect: Loss in revenue from lowering the Price

This makes the point MR = MC the most optimal (getting Price from the D curve)

Measuring Welfare in a Monopoly

Easiest to analyse form the perspective of a Perfect competition turned Monopoly

Monopoly Benefits

Economies of Scale

• Products are often produced as cheaply as possible

Dynamic Efficiency

• Higher ability for R&D