3.4 Market Structures Flashcards
Types of efficiency
- allocative efficiency
- productive efficiency
- dynamic efficiency
- X-inefficiency
Allocative efficiency
Shows whether resources allocated at point consumer satisfaction maximised (AR/D = S/MC)
No surpluses of demand or supply = resources allocated most efficiently
This is where demand = supply, maximising sum of both CS and PS, feature of highly comp industry.
At this point of point of production resources are allocated to consumer demand
with consumers what they demand at exact quantity they desire (society surplus is maximised).
Consumer choice is high and prices are low max CS. Quality is great and drive to meet needs and wants of consumers
§ Producers benefit from allocative efficient by getting ahead of rivals who aren’t meeting consumer needs and increase MS- result in higher profits for business
Productive efficiency (with diagram)
Where economies of scale fully exploited, at minimum point of firms AC (average cost) curve
(point A on diagram) MC=AC.
Means full exploitation of EOS - firms can’t increase output and lower AC further. These lower AC may = lower prices = CS increases
So firms more competitive as firms may pass on some of costs savings to consumers in lower prices
Productive efficiency at point A
Producer- lower AC= higher levels of supernormal profits over time. Increases In MS- if EOS benefits translates into lower prices than rivals
Dynamic efficiency
Attained by firm achieving supernormal profits (can be reinvested into firm to increase efficiency & lower costs over time = dynamic efficiency
Firm may achieve supernormal profits in short term but wont be dynamically efficient in long term if don’t reinvest into firm
Supernormal profit is being made in l/r. profit can be reinvested, tech adv, innovation, R&D. Hugely beneficial for consumers – brand new, quality goods. Prices can lower over time, if COP are reduced,
§ Producers= LR profit max= lower costs over time- retain/ inc ms product development, monopoly power esp if products are patented increasing profit making potential. Products can increase MS-crucial in comp industry ahead of rivals. Tech can reduce costs of production – more profitable
X-inefficiency and x efficiency(diagram + why)
Firms are wasteful = higher average cost than could be at quantity level
(operating at point not on AC (average cost) curve, eg. point B)
Why:
- firm in monopoly so low competition so don’t need to lower prices so can be inefficient without being forced out of market
- lack of profit motive in public sector so no motive to lower average costs so inefficiency
Types of market structures (from most to least competitive)
- perfect competition
- monopolistic competition
- oligopoly
- monopoly
Characteristics of perfect competition
- homogenous goods (all goods/services same = price takers as no differentiation so no price setting powers) PRICE TAKERS, taking price set by the market, they have no influence at all in setting prices with no differentiation between products. If firms raised their price- lose all their customers. If firms reduce price, either all firms would follow immediately reducing revenues or revenues will not cover costs= losses that can’t be sustained
- many buyers/sellers (lots of consumer choice) Concentration ration is 0 - firms must compete with each other to survive in the marketplace. Demand for firm’s goods is perfectly elastic, and prices are solely determined by interaction of demand and supply; the firms are price takers.
- no barriers to entry/exit (easily enter & exit market at any time, no LT supernormal profit as market attracts new entrants = increased supply = decrease of price so removal of SP)
- perfect information (for buyers & sellers = know when firm changes prices so consumers will switch firms or all firms will lower prices too = price takers, no competitive advantage)
There are no barriers to entry or exit for firms, meaning entry and exit is completely costless. If firms are attracted by supernormal profits- enter straight away and if firms want to leave due to losses being made, they can do so immediately. This implies that s/r supernormal profit won’t be sustained in the l/r. L/r – normal profit
- firms profit maximise (MC=MR)
Eg. No market completely perfectly competitive, closest is agriculture, bananas (but some gov intervention)
Perfect comp - profit maximising equilibrium in short run
- AR=MR=D line perfectly elastic as firms are price takers
- firm can make normal profit, supernormal profit or a loss
Supernormal profit:
- firms are profit maximisers so set high prices if high demand (MC=MR)
- but due to no barriers to entry/exit & perfect info, new firms enter market to earn same profits = increased supply (AR1 to AR2) so fall in price (P1 to P2) to normal profits
Loss:
- ATC above P1 so making loss
- some firms would leave industry as cant survive = decreased supply = increased prices (P1 to P2) to normal profit
e market equilibrium is at P1. Taking this price, firms will profit maximise where MC=MR producing Q2 units of output. At this level of production, AR> AC, thus the firm is making supernormal profits indicated by the shaded rectangle. Firms are attracted into the industry by the supernormal profits and with no barriers to entry, the supply curve shifts to the right from S1 to S2 thus the market equilibrium price falls. This process continues from P1 to P2 until the demand (AR) curve; for an individual firm is tangential to the AC curve, where normal profit is being made and the firms has returned to a long run stable equilibrium at Q4
Perfect comp - profit maximising equilibrium in long run
Only normal profits can be made in LR as perfect info (if prices change, consumers will know and demand will fall)
Firms produce at MC=MR, price level p1 (firms price takers so same as industry p)
AR=AC so no supernormal profits
What are the advantages and disadvantages of perfectly competitive markets (efficiency)
+ AR=MC in long run so there is allocative efficiency
+ firms produce at bottom of AC curve in SR and LR = productive efficiency
+ supernormal profits obtained in ST = might increase dynamic efficiency through investment (but wiped out fast)
- in LR, dynamic efficiency limited as no supernormal profits, lack of quality However, they are not dynamic efficient . No single firm will have enough for research and development and small firms struggle to receive finance. The existence of perfect information also means one firms’ invention will be adopted by another firm and so the investment will give the firm no competitive benefit. Governments tend to have to do all the research.
- firms are small so few or no economies of scale. Competition should keep costs, and therefore prices, low. However, firms will be unable to benefit from economies of scale and this may mean costs are higher than they otherwise could be.
- model rarely applies in real life (branding,
product differentiation, adverts mean comp is imperfect)
What are the Perfect competition- LONG RUN, PROS, CONS AND EVAL
PROS:
- Allocative efficiency is achieved in S/R and L/R. Firms in perfect competition produce where P=MC at the l/r equilibrium. This is where demand= supply maximising the sum of both CS/ PS – key feature of a highly comp industry. At this point, resources are allocated according to consumer demand - consumers getting what they demand at exact quantity desire. Consumer choice is high & prices = low maximising CS in market. The quality of the product being sold is excellent too given the drive to meet the needs and wants of the consumer
Producers benefit from being allocatively efficient getting ahead of rivals who are not meeting consumer wants and needs= increasing their MS. Overtime = higher profits for business. Perfectly competitive firms must be allocatively efficient otherwise they will lose market share to rivals who are doing so. - Productive efficiency is achieved in the long run. perfectly competitive firms produce at the lowest point of the average cost curve, where MC=AC at the long run equilibrium point of production. This means all possible economies of scale are being exploited as firms cannot increase output and lower their average costs any further. These lower average costs can translate into lower prices for the consumer increasing their consumer surplus
Producer lower average costs- higher levels of supernormal profit over time and increases in market share if economies of scale benefits translate into lower prices than rivals. Perfectly competitive firms must be allocatively efficient otherwise they will lose market share to rivals who are doing so.
CONS:
Dynamic efficiency isn’t being achieve in l/r. Supernormal profits aren’t being made in long run restricting firms ability to reinvest back into business. Over times consumers don’t benefit with no tech advances of innovative new products reducing choice and also preventing price falls in the future
§ For produces the profit making potential reduces without R&D - new product launches which could’ve been patentable providing monopoly power. New products could’ve increase MS- crucial in comp industry. Technology could’ve allowed cost of productions to be reduced and that’s become more profitable overtime
PRODUCT HOMOGENEITY IS NOT IN THE BEST INTEREST OF CONSUMERS- prefer variety rather than having a large number of different sellers all producing same good/ service. Allocative efficiency - not actually maximise benefit of consumers
EVALUATION:
Static versus dynamic efficiency. Perfect competition deliver static efficiency; consumers benefits usually so do producers where market share can rise. However dynamic efficiency is a big loss along with product homogeneity. Consumers may be willing to lose some static efficiency benefits, instead paying slightly higher prices in return for differentiated goods and innovative product development overtime
The notion that firms are always dynamically inefficient and highly competitive industry is due to lack of supernormal profit in the long run may not hold in reality-
Firms may be forced to reinvest whatever profits they are making even normal profits to stay ahead of rivals and compete in such a fiercely competitive market. This
will be in the long-term interest of firms - element of monopoly power - can exploit to increase profit over time
IS IT REAL- Most firms have some degree of price setting power
Homogenous products- patents, control of intellectual property, ignored by perfectly competitive model
Rare for entry and exit in an industry to be cost less
Highly complex products- information gaps facing consumers- live in a world of complex products
Characteristics of monopolistically competitive markets
- product differentiation (similar goods, so firms have some price making powers through design, marketing, quality, demand curves downward sloping but very elastic as small degree so many close substitutes). The fact that many other firms exist selling similar products ensures that prices cannot be increased too high otherwise firms will lose market share as consumers switch to decent alternatives.
- low barriers to entry/exit (new firms seek to differentiate slightly, but still remove supernormal profits in LR)
- many buyers & sellers (each have relatively weak market/price setting power so AR and MR elastic)
- non-price competition (compete through advertising, brand loyalty, quality rather than lowering prices)
- firms profit maximise (MC=MR)
- imperfect knowledge
Eg. Hairdressers, estate agents, takeaways
Monopolistic comp - Profit maximising equilibrium in short run
- AR and MR downwards sloping as firms have some price setting powers but elastic as small degree of profit differentiation (close substitutes)
- profit maximise at MC=MR up to AR gives price P1
- ## C1 below P1 so firms make supernormal profit
Monopolistic comp- Profit maximising equilibrium in long run
- supernormal profit in SR attracts new entrants as low barriers to entry/exit.
This shifts the demand curve for the individual firm to the left, a process that keeps happening until AR is tangential to AC and normal profit is being made.
Firm has now reached a long run stable equilibrium, profit max at normal profit with price P2 and Quantity Q2. Long run in monopolistic competition is therefore denied by Normal profit
- increase in market supply = decrease in price level to normal profits (C1 = P1)
- still profit maximising at MC=MR
Monopolistic comp efficiencies (+ and -)
- not producing at bottom of AC curve so not productivity efficiency in SR or LR
- price above marginal cost, AR ≠ MC so no allocative efficiency in SR or LR
+ likely to have dynamic efficiency as differentiated products so need edge over competitors to make profits BUT as firms are small, and goods close substitutes, may be hard to retain profits needed to invest or finance, not as much motivation - firms less efficient and higher prices but
+ more choice for consumers & may benefit from economies of scale
What is the long run performance in monopolistic competition and evaluate it?
LONG RUN PERFORMANCE:
Monopolistically competitive firms produce outcomes that are allocatively inefficient. Consumers are charged prices greater than marginal cost at the profit maximising level of output. At this point of production, resources are not allocated according to consumer demand with consumers getting a lower quantity than they desire. Consumer choice is restricted and prices are high reducing CS in the market
Firms in monopolistic competition are productively inefficient. They do not produce at the minimum point on the average cost curve choosing instead to voluntarily forgo some E.O.S: Output could be increased further with lower average costs but as this does not correspond with profit maximisation, where MR=MC, productive inefficiency prevails. Consequently- consumers suffer from higher prices lower CS than if all E.O.S were exploited
Dynamic efficiency isn’t being achieve in l/r. Supernormal profits aren’t being made in long run restricting firms ability to reinvest back into business. Over times consumers don’t benefit with no tech advances of innovative new products reducing choice and also preventing price falls in the future/
§ For produces the profit making potential reduces without R&D - new product launches which could’ve been patentable providing monopoly power. New products could’ve increase MS- crucial in comp industry. Technology could’ve allowed cost of productions to be reduce and that’s become more profitable overtime
EVALUATION:
Allocative inefficiency of firms in monopolistic competition arises out of consumer demand for differentiated goods-
Consumers = willing to pay slightly higher prices than MC for product variety and choice -preferring this than product homogeneity (perfect comp) even though there’s static efficiency/ lower prices in perfect comp Furthermore, with many other sellers in the market = price exploitation is slight and much less that in monopoly. The loss of CS = much less of a concern. Consumer service and product quality - likely to also be much better in monopolistic competition given the non-price competition drive that exists. Allocative inefficiency in this sense is purely theoretical; consumers actually gain from greater satisfaction in monopolistic competition.
The productive inefficiency of monopolistic competition again arises from consumer demand for differentiated goods-
The variety that firms give consumers makes it harder to achieve productive efficiency and exploit full E.O.S. However this does not translate into significantly higher prices that perfect comp and loss of efficiency is not as significant as that in monopoly. Consumers = still willing to pay the higher prices without suffering from large losses in CS- enjoying variety and choice that firms in monopolistic competition provide.
The notion that firms are always dynamically inefficient due to a lack of supernormal profit in the long run may not hold in reality-
. Firms may be forced to re-invest short run supernormal profits or even long run normal profits in order to stay ahead of rivals and compete in such a fiercely competitive market. This will also be in the firms long term interest = element of monopoly power which they can exploit to increase their profits over time. Consumers benefit from new tech and innovative new products with prices potentially falling over time
Characteristics of oligopoly
- high barriers to entry & exit (high startup costs eg. expensive planes, high level of sunk costs if firms leave market eg. car product development, market research, tech)
- high concentration ratio (few large dominant firms so lower levels of comp)
- interdependence of firms (firms need to consider reaction of competitors when changing prices, firms often follow each other so overall revenue will fall = prices often rigid. Oligopoly = fight for MS in a race to monopoly power hence firms must think carefully about moves of rivals before making their own decision. Price comp is unlikely as higher prices than rivals will reduce MS and reducing prices lower than rivals will result in a price war. For this reason prices tend to ‘sticky’ or ‘rigid’ in oligopoly.)
- product differentiation (high degree so firms have ability to set price = downward sloping demand curves, compete through non-price factors eg. advertising, brand loyalty)
- firms profit maximise (MC=MR)
Eg. UK Supermarkets, airline industry, car manufacturers
Collusive oligopolies and how they benefit firms within an oligopoly
§ If there are a small number of firms in the industry- makes it easier for firms to organise agreements to fix prices or quantities to make supernormal profits- easier for firms to stay in contact with one another reducing cheating.
§ If firms have similar costs to each other it is easier to agree on a price or quantity to fix thus making Cartel arrangements simpler to facilitate and maintain over time.
§ If entry barriers into the industry are high, the supernormal profits made by cartels can be sustained in the l/t increasing the incentives for firms to get together and fix prices or quantities.
§ If competition policy is ineffective perhaps with weak regulatory bodies in a given industry where cartel agreements can be formed, firms will believe they won’t be caught engaging in illegal anti-competitive practices
§ If consumer brand loyalty is strong towards a give firm, cheating on a collusive pact by reducing prices is not in the best interest of firms as there is no guarantee consumers will switch consumption to the firm that has cheated. Collusive agreements are therefore more likely to last in the long term.
§ If there is strong consumer inertia in the industry when switching suppliers. Cheating on a collusive pact by reducing prices is then not in the best interest of firms as there is no guarantee consumers will switch consumption to the firm that has cheated. Collusive agreements are therefore more likely to last in the long term.
§ If the goods being produced by firms are highly differentiated, it allows a cartel to set high prices much more easily and still expect strong consumer demand, increasing the level of supernormal profit made over time.
Collusive agreements are more likely to be made in oligopolistic markets that are calm and without price volatility.
Whereas markets that are saturated and unstable with lots of price movements and fierce competition is unlikely to lead to cartel agreements being made or lasting over time.
N-firm concentration ratio (calculation and significance)
- measures percentage of total market a particular number of firms have (eg. 3 firm concentration ratio shows percentage of total market held by 3 biggest firms)
- higher concentration ratio in oligopoly = lower levels of comp in market
= (total sales of n firms / total size of market) x 100. Or by adding market share of top n
What are the pros and cons of collusive oligopolies?
PROS: (use monopoly diagram)
Cartels can be dynamically efficient as supernormal profit is being made in l/r. such profit can be reinvested back into company in the form of technology advances, innovative new products and R&D. This is beneficial for consumers who will receives brand-new, better-quality products over times. Prices could be lower over time if tech advances reduces costs for businesses – passed onto consumers. Inc in choice
For the cartel new product development can maintain monopoly power esp. if such products are patentable and better tech can allow a reduction of costs of production inc price making potential of firm over time
Even though cartels are productively inefficient, may still be exploiting greater E.O.S than smaller competitive firms who produce lower levels of output given the ferocity of competition. Costs of production can be lower for cartels compared to competitive firms resulting in lower prices charged and higher quantities produced, actually promoting outcomes the benefit society.
CONS:
Cartels produce outcomes that are allocatively inefficient= exploit consumers by charging prices greater than marginal cost at the profit maximising level of output, Q1. At this point of production, resources are not allocated according to consumer demand with consumers getting a lower quantity than they desire. Consumer choice is restricted and prices are high reducing CS in market. The quality of the product being sold may suffer too given the lack of competitive forces to meet the needs and wants of the consumer.
Cartels are productively inefficient- they do not produce at the minimum point on the average cost curve choosing instead to voluntarily forgo some economies of scale. Output could be Increased further with lower average costs but as this does not correspond with profit maximisation, where MR=MC, productive inefficiency prevails. As a consequence consumers suffer from higher prices and lower CS than if all economies of scale were exploited
Cartels can be x-inefficient- complacent and lazy in the production process allowing waste to creep in at quantity Qcart- consumers= higher prices and lower CS than if excess cost was eradicated
Cartels can be productively inefficient if they become too large and suffer from diseconomies of scale. This occurs when output takes place where average costs are rising due to problems with communication, coordination and or motivation where productivity is reduced due to excess size of firm. Consumers suffer from higher prices and lower consumer surplus than if the monopolist was smaller and benefiting from lower average costs.
Monopoly - profit maximising equilibrium
- operate at profit maximisation (MC=MR) at P1 and Q1
- can fix price but quantity still constrained to law of demand so higher price = lower quantity demanded
- price higher than AC so firms make supernormal profit
- supernormal profits maintained in LR due to high barriers to entry (SR and LR diagram same)
Kinked demand curve to show oligopoly market (interconnectedness of firms and price rigidity)
- firms profit maximise at MC=MR giving P1 and Q1
- kink in AR=D curve shows price rigidity & interconnectedness of firms
- above p1 = price elastic so change in quantity demanded greater than change in price so firms total revenue/profit decreases
- below p1, slightly price inelastic as if 1 firm reduces prices, other firms will follow so firm would gain no price advantage & no large increase in quantity demanded = all firms suffer decrease in revenue/profits = prices rigid, comp through non-price factors
- discontinuity in MR curve = constant price of p1 despite marginal cost changes within discontinuity = prices rigid
Game theory (prisoners dilemma in simple two firm model)
- demonstrates interdependence of firms & price rigidity in oligopoly market
- if both firms raise prices, both firms would make the same high profit (£20 million)
- if firm B raised prices, & firm A reacted by lowering prices, firm B would make less profit (£10 million) and firm A would make more profit (£24 million) & vice versa
- if both firms were to lower prices, both firms would make the same mid profit (£15 million)
Best outcome for both firms with least risk = Nash equilibrium = both lower price (£15 million profit)
Most efficient outcome for both firms = both raise prices (£20 million profit) but need collusion to stop both competitions lowering prices
Monopoly- third degree price discrimination (def, examples, diagram)
= monopoly firm charges different prices to different consumers for the same good/service with no differences in costs of production, firm serve rates market based on different PEDs
Third degree price discrimination occurs when a firm is able to segment the market in two different groups, a group with price elastic demand and a group with price inelastic demand. The groups will have varying elasticities of demand due to differences in age, location and time for example.
Eg. Railway company (peak = inelastic, off peak = elastic). profit maximising price discriminating monopolist could now profit maximise in both markets where MC=MR pricing higher in the peak market and lower in the off-peak market allowing for much greater profit to be made. If a blanket price of P1 is charged in both markets, there would be no demand in the off-peak market reducing profits.
- constant MC
- firm profit maximised at MC=MR
- in inelastic market, charge higher prices so make more supernormal profit at Q1P1
- in elastic market, charge lower prices so make less supernormal profit at Q2P2
- firm maximises joint profit by charging 2 prices
Costs & benefits of monopoly to firms, consumers, employees, suppliers
SUPPLIERS:
Increased sales volume for some suppliers as they are able to supply products that are distributed nationally or internationally
monopoly often has the power to dictate what price they will pay to suppliers. PRICE MAY NOT BE PROFITABLE IN THE LONG RUN.
+ dynamic efficiency (reinvest supernormal profits = innovative new products with higher quality for consumers, better tech, pot lower prices overtime, producers can patent ideas, gain market share, lower costs overtime, higher wages for employees) EVAL: profit can be given to shareholders through higher dividends, repay debts, pay workers higher salaries
+ exploit greater economies of scale due to size eg. Car manufacturing (despite not being productivity efficient, can still have lower P & higher Q than comp market) EVAL depends on size of firm, can be DofS
+ regulated natural monopoly (desirable outcome with less waste & inefficiency in certain markets)
+ cross subsidisation (supernormal profits subsidise loss making good/service that is socially desirable)
- allocative inefficiency (consumers exploited = lower consumer surplus, restrict output & choice, quality issues) = consumer deadweight loss in diagram EVAL what if objective isn’t profit max, may want to be better for society, principal-agent problem
- productive inefficiency (forgo economies of scale, dont minimise costs due to lack of comp) EVAL legal monopoly - only 25% so can still be lots of comp eg. Tesco in supermarket market, prevent inefficiencies, if market is Contestable = threat of comp
- X inefficiency (waste in production process due to lack of comp, produce beyond AC curve) EVAL regulation can reduce inefficiencies
- inequalities in necessity markets (low incomes suffer most eg. food/drink third degree price discrimination (EVAL - type of good/service, if more luxury good, less effect, dont mind paying high prices)
Natural monopoly (def, diagram, examples)
= more efficient for only one firm to operate in market rather than multiple firms competing
(large cost advantage for first firm that enters market due to high fixed costs so large economies of scale can be exploited, new firms pushed out of market)
- Unnecessary duplication of resources is wasteful, increasing comp undesirable, will increase average costs & consumer prices as economies of scale cant be fully exploited (results in allocative & productive efficiency)
- In gov best interest BUT/EVAL regulation needed (quality control & performance targets) to ensure efficiency & no consumer exploitation
- Firms are not allocative or productivity efficient unless regulated by gov
Eg. Rail industry(National Rail), National Grid (electricity distribution)
LRAC & LRMC downward sloping for huge Q range, Minimum efficiency scale point occurs at very high Q level, huge potential for economies of scale at very high Q
Firms profit maximise at MC=MR
Firm makes large supernormal profit but quantity restricted to Q1 (not enough for necessity eg water) so regulation used to bring prices to P=MC (allocative efficiency) at PQ (& productive efficiency)
But AR below AC here so firms make loss at very low prices, often subsidised by gov of ab per unit so firms dont leave market
Characteristics & definition of a monopsony (example & diagram)
= market structure in which there is only one single buyer in a given market
- price/wage makers (no other firm employing same profession of workers/buying some good/service so can determine price or supplier wont earn any revenue)
- profit maximisers (MR=MC), pay suppliers lowest price possible to minimise costs due to power
Eg. Rarely exist irl, but firms may experience monopsony power when buy large % of market (Coal mine owner in town where coal mining is primary source of employment, NHS buy nearly all prescripted medicine from pharmaceutical companies in UK)
Produce at MC=MC/D at Q1P1 (lower prices, lower quantity)
Monopsony in the labour market (diagram)
= sole employer of labour in a given professions (eg. State employ teachers & nurses in UK)
- wage maker
- maximise revenue from workers by hiring where MC=MR
- monopsony will employ workers up till where MRP=MCL at QmWm
- in comp market workers employed at MRP=ACL at QcWc
- so monopsonist reduces employment & lower wages then comp labour marker (Wm also much lower than MRP so very poor) very inefficient & distorted efficient labour market outcomes, lead to trade unions, strikes
(MRP = marginal revenue productivity)
What are the characteristics and conditions of monopsony? WITH DIAGRAM
This is where there is only one buyer in the market, and other than this it has the same basic characteristics as monopoly. They can prevent new firms entering the market and aim to profit maximise.
In real life, pure monopsonies rarely exist but many firms experience monopsony power, when they buy a large percentage of the market. NHS, who pay less for cancer drugs than a number of other high-income countries. Moreover, food retailers have power when purchasing supplies from farmers; farmers can either sell them all their goods at a low price or risk not selling them at all.
They will pay their suppliers the lowest price possible to minimise their costs and make the most of their position as the only buyer. This will enable them to maximise their profit. The value of the goods they buy will depend on how much money they can make with these goods, and this is determined by the demand curve of the goods they make and sell.
Implications of Contestable markets for behaviour of firms (monopoly with diagram)
Contestability can occur in any market structure
Eg. Monopoly market structure:
- monopoly produces at MC=MR (profit max) gives P1Q1 with supernormal profit
- due to low barriers to entry & exit, new entrants can take away LR supernormal profits
- so firms produce at entry ‘limit price point’ (AC=AR in perfectly contestable markets, large threat = closer to this point for markets with diff degrees of contestability) making normal profits (new entrants dont have incentive to enter market, cant compete with low prices)
