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Image Source/SuperStock 9 Perfect Competition Learning Objectives By the end of this chapter, you will be able to: List the assumptions of perfect...

Analyze the major barriers for entry and exit into the airline industry. Explain how each barrier can foster either monopoly or oligopoly. What barriers, if any, do you feel give rise to monopoly that will allow the government to have to get involved to protect consumers?
Image Source/SuperStock Learning Objectves By the end of this chapter, you will be able to: • List the assumptions of perfect competition. • Diagram the relationship between a firm and the total market. Calculate profits, given quantity, mar- ginal revenue, marginal cost, average cost, and price. Identify the profit-maximizing level of output. • Define the shutdown point in terms of price and average variable costs or total fixed costs and losses. • Describe the long-run supply curve for a constant cost industry, an increasing cost industry, an increasing cost industry, and a decreasing cost industry. • Identify the long-run equilibrium for the firm and the industry under perfect competition. • Explain how economic rent might exist in perfect competition, even in long-run equilibrium.
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Section 9.1 Characteristics of Perfect Competition CHAPTER 9 Introduction C onsider this. . . Some firms, like convenience stores and grocery chains, are open 24 hours a day. Others close at 6:00 or 7:00 P.M. Some bars and restaurants open at 11:00 A.M. to cater to a lunch crowd, while others don’t open until 4:00 P.M. for the happy hour crowd. Some resorts are open year-round, while others close for business during the off-peak season. How can you explain this distinctly different behavior across firms that are in the same industry? Any firm that makes production decisions will relate potential, or forecasted, revenues to costs in order to determine output levels. However, the forecasted revenues will depend on the market conditions faced by the firm. After studying the material in this chapter you will be able to explain why firms in the same industry make different choices, whether they choose to close at 7:00 P.M., close for the winter, or close permanently. This chapter and the next two look at four different models, referred to as market struc- tures. The model discussed in this chapter is perfect competition. Perfect competition is the market structure in which there are many sellers and buyers, firms produce a homo- geneous product, and there is free entry into and exit out of the industry. It is important to keep in mind that this is a theoretical model. Real data does not exist, and the model does not precisely describe reality. The model is useful, however, because it provides a point of reference. It allows the development of tools of analysis that indicate what determines price and quantity when conditions are close to those of perfect competition. The perfectly competitive market is the abstract ideal to which we will compare other market structures. 9.1 Characteristics of Perfect Competition T here are six basic assumptions for the model of perfect competition. In developing the theory, we assume that all firms in the market in which the product is sold pos- sess these six characteristics. The first assumption is that there is a large number of sellers (producers) in the market. A large number means there are so many sellers of the product that no single seller’s decisions can affect price. For example, no single wheat farmer can influence the price of wheat. A farmer could sell the entire crop or none of the crop. The farmer’s decision wouldn’t affect the price of wheat in any per- ceptible manner because the market for wheat is so large relative to any single producer. The second assumption is that there is a large number of buyers (consumers) in the market. A large number means that no one buyer can affect the price in any perceptible way. That is, no single purchaser has any market power . The third assumption is that perfectly competitive firms produce a homoge- neous product . Homogeneous means that the product of one firm is no different from that of other firms in the industry. Since this is the case, purchasers have no preference for one producer over another. If you are a miller and want to
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iStockphoto/Thinkstock Learning Objectves By the end of this chapter, you will be able to: • Define monopoly and calculate average revenue and marginal revenue, given data on price and output. Diagram average revenue, marginal revenue, marginal cost, and average cost curves for a monopolistic firm making an economic profit, a loss, and finally, a normal profit. • Describe the economic role of natural and artificial barriers to entry into an industry. • Explain why firms practice price discrimination. • Discuss how a monopolist misallocates resources in terms of price and costs. • Describe the costs associated with monopoly. • Explain facts and fallacies of monopoly organization.
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Section 10.1 Demand, Marginal Revenue, and Price and Output Under Monopoly CHAPTER 10 Introduction C onsider this. . . Do you ever cut coupons out of the local Value Mailer? Maybe you have a membership tag on your key chain for your local grocery store. No doubt you’ve seen shoppers with their coupons organized into binders and fold- ers by product line so they can maximize the amount of money they save. Some retailers promote double and triple coupon days. There are countless websites devoted to cou- pons: manufacturers’ sites offer printable coupons for their products, social network sites enable shoppers to share current deals, and other sites teach shoppers how to save money on grocery shopping by being very organized in coupon gathering. The author of one such extreme couponing site, a self-described “stay at home mom of two gorgeous baby girls,” (“About Me,” para. 1 ) teaches couponing classes to local community groups. She estimates that she spends 90 minutes each week cutting, filing, and organizing her cou- pons to maximize her budget and estimates that she saves on average $300 a month. For her time and effort, that comes to an equivalent wage of about $50.00 per hour take-home pay. There aren’t many part-time jobs that pay that well! The benefits to the coupon user are obvious. But why do stores issue coupons for a 50 cent discount rather than simply reduce the price of the product by 50 cents for all shoppers? And why doesn’t everybody use coupons? After you study the material in this chapter, you will be able to explain this behavior and analyze why stores and manufacturers use coupons as promotional tactics. Monopoly is at the other end of the market continuum from perfect competition, in the sense that perfect competition involves many firms and monopoly involves just one. The word monopoly is derived from the Greek words mono for “one” and polein for “seller.” Monopoly is the market structure in which there is a single seller of a product that has no close substitutes. Although there are no pure monopolies, there are many firms that have some degree of monopoly power. Monopoly power is the ability to exercise power over market price and output. As you learned in the last chapter, firms in perfect competition are price takers. In this chapter, you will see that, because it has some control over price, a monopoly is a price searcher. A price searcher is a firm that sets price in order to maximize profits. A price-searching firm has monopoly power. It searches for the price–quantity combination that will maximize its profit. 10.1 Demand, Marginal Revenue, and Price and Output Under Monopoly A perfectly competitive firm faces a perfectly elastic demand curve. As a result, price (or average revenue) and marginal revenue are equal. However, a monopolistic firm faces the market demand curve because the firm is the single seller and is, therefore, the market. This distinction is very important because market demand curves have negative slopes. Since the monopolist’s demand curve has a negative slope, its mar- ginal revenue curve will lie below that curve. The commonsense explanation for why the marginal revenue curve lies below the demand curve is that the monopolist can’t simply
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iStockphoto/Thinkstock Learning Objectves By the end of this chapter, you will be able to: • Describe the characteristics of monopolistic competition. • Explain why interdependence is unique to oligopoly. • Understand why government policy is often necessary to assure the success of a cartel. • Use game theory to understand oligopolistic behavior. • Describe how and why equilibrium price and output under monopolistic competition and oligop- oly differ from that of perfect competition.
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Section 11.1 What Is an Industry? CHAPTER 11 Introduction C onsider this. . . What’s in a brand name? Do you have a favorite soap, aspirin, breakfast food, or cola? When you get right down to it, a bar of soap is pretty much a bar of soap. An aspirin is pretty much an aspirin and a cola is pretty much a cola. Maybe including colas is taking it too far—to some people one cola is not the same as any other cola. A few decades ago Coke introduced a new cola, and some of its customers revolted; some of them even hoarded cases of the original version of the cola. Coke even- tually gave up and brought back the old favorite as Coca-Cola Classic . To these consumers, one cola was definitely not the same as any other. To the owner of a brand name, the important question is how much different is the prod- uct that has the brand identification. Is it a quarter different? Would you pay 25 cents more for a bar of Dove soap? Would you pay a dollar more per bar? How much would you be willing to pay to buy Tylenol over the generic acetaminophen? Perhaps two dollars more? Clearly the value of the brand disappears at some price. Even a product with a brand name is still subject to the forces of supply and demand in a competitive market. We have just seen in Chapters 9 and 10 that there are no perfect real-world examples of either perfect competition or monopoly. For many years, however, all real-world indus- tries were analyzed in terms of these two models. In the 1930s, theories were developed that filled out the spectrum between monopoly and perfect competition. Market struc- tures between the two theoretical extremes are called imperfect competition. Economists divide imperfect competition into monopolistic competition and oligopoly. We will study these two market structures in this chapter. 11.1 What Is an Industry? W e have, up to this point, been using the term industry without carefully defin- ing it. In general, an industry is a group of firms producing the same, or at least similar, products. The difficulty with this definition is that it does not specify how dissimilar products must be before they are thought of as being produced in differ- ent industries. Consider containers. Are firms producing glass bottles and aluminum cans similar enough to be included in the container industry? How about firms making paper cups or even pewter mugs? Most consumers regard pewter mugs and paper cups as quite different. If you are willing to pay substantially more for a pewter mug than for a paper cup, you regard them as being distinct products. What about a plastic Ronald McDonald glass? Is it closer to a paper cup or a pewter mug? These questions demonstrate that what- ever scope is assigned to an industry will be arbitrary to some extent. Some people, even some economists, may disagree with a classification of two products as belonging to the same industry or to different industries. Cross elasticity of demand, a concept we discussed earlier, can be useful in determining whether products belong to the same industry. If the cross elasticity of demand between two products is positive, the goods are substitutes. Goods that are close substitutes have
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The major barriers to entry into and exit from airline industry can be enumerated as below:
a. Extremely high capital requirements, both long term and working capital.
b. Stiff rules and...

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