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.
