In a competitive industry each buyer and seller is a price-taker, believing individual actions
have no effect on the market price. Competitive supply is most plausible when many firms
make a standard product, with free entry and exit, and easy verification by buyers that the
products of different firms really are the same.
For a competitive firm, the price is its marginal revenue. Output equates price to marginal
cost. The firm’s supply curve is its SMC curve above SAVC. At a lower price, the firm
temporarily shuts down. In the long run, the firm’s supply curve is its LMC curve above its
LAC curve. At a lower price, the firm eventually exits the industry.
Adding at each price the quantities supplied by each firm, we obtain the industry supply
curve. It is flatter in the long run both because each firm can fully adjust all factors and
because the number of firms in the industry can vary. In the extreme case where all potential
and existing firms have identical costs, the long-run industry supply curve is horizontal at the
price corresponding to the lowest point on each firm’s LAC curve.
An increase in demand leads to a large price increase but only a small increase in quantity.
The existing firms move up their steep SMC curves. Price exceeds average costs and the
ensuing profits attract new entrants. In the long run output increases still further but the
price falls back. In the long-run equilibrium the marginal firm makes only normal profits and
there is no further change in the number of firms in the industry.
An increase in costs for all firms reduces the industry’s output and increases the price. In the
long run the marginal firm must break even. A higher price is required to match the increase
in its average costs.
Markets for the same good in different countries will be closely linked if transport costs are
small and there are no trade restrictions. In a competitive world market each country takes
the world price of the commodity as given. Discrepancies between domestic supply and
domestic demand are met through imports or exports. Foreign trade transmits foreign
shocks to the domestic economy but acts as a shock absorber for domestic shocks.
A pure monopoly is the only seller or potential seller of a good and need not worry about
entry even in the long run. Though rare in practice, this case offers an important benchmark
against which to compare less extreme forms of monopoly power.
A profit-maximizing monopolist has a supply rule – choose output to set MC equal to MR –
but not a supply curve uniquely relating price and output. The relation of price and MR
depends on the demand curve.
Where a monopoly and a competitive industry can meaningfully be compared, the
monopolist produces a smaller output at a higher price. However, natural monopolies with
large economies of scale could not exist as competitive industries.
A discriminating monopolist charges different prices to different customers. To equate the
marginal revenue from different groups, groups with an inelastic demand must pay a higher
price. Successful price discrimination requires that customers cannot trade the product
among themselves.
Monopolies may have more internal resources available for research and may have a higher
incentive for cost-saving research because the profits from technical advances will not be
eroded by entry. Although small firms do not undertake much expensive research, it appears
that the patent laws provide adequate incentives for medium- and larger-sized firms. There is
no evidence that an industry has to be a monopoly to undertake cost-saving research.
