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6.1 Perfect Competition in the Long Run: Free Entry and Exit 6.2 Monopoly 6.3 Monopolistic Competition The notion of market structure was introduced in Chapter 4. A perfectly competitive market structure is one that has the following features: (a) there are a large number of sellers and buyers in the market, (b) the product is homogeneous and (c) there is free entry and exit of firms in the long run. In Chapter 4 we saw how (a) and (b) lead to the supply curve, given that the objective of a firm is to maximise profits. In Chapter 5 we studied the interaction between supply and demand curves, and, learnt how the price/market mechanism works. In this chapter we study market structures as such. Having already analysed the implications of (a) and (b) under perfect competition, we begin by analysing the implications of feature (c), i.e., perfect competition in the long run. There are other market structures, which are not perfectly competitive. They go under the name of imperfect competition or imperfectly competitive market . There are three broad forms of imperfectly competitive markets: monopoly , monopolistic competition and oligopoly . In this chapter, we analyse the first two. O THER F ORMS OF M ARKET S TRUCTURE C HAPTER 6
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I NTRODUCTORY M ICROECONOMICS 106 6.1 PERFECT COMPETITION IN THE LONG RUN: FREE ENTRY AND EXIT Before analysing the implications of free entry and exit, we discuss a couple of things. 1. Recall from Chapter 3 that there are no fixed costs in the long run. Moreover, both the Long run Average Cost ( LAC ) and the Long run Marginal Cost ( LMC ) curve are U-shaped. The pattern of returns to scale that is, initially at low levels of output, a firm would experience increasing returns to scale, followed by constant returns to scale and diminishing returns to scale implies the U-shape of LAC curve, which, in turn, implies the U-shape of LMC curve. 2. How does producer’s equilibrium or profit-maximisation happen in the long run? The answer is that it happens the same way in principle as in the short run. Profit is maximised when P = LMC. The economic logic behind it is also parallel to that in the short run. We are now ready to examine the effects of free entry and exit. Suppose that the market price of the product is P 1 , and the firms are producing at the point where the price line intersects the LMC curve. Moreover, suppose that the price, P 1 , is high enough such that, at the profit- maximising level of output, firms are making positive profits. In economics, a positive profit is sometimes referred to as abnormal profit , in the sense that the total cost is assumed to include not just the production costs but also the opportunity cost of the producer herself and hence profits are equal to the producer’s excess earning over her opportunity cost.
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