Monopoly, Perfect Competition, Imperfect Competition

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The Theories of the Firm



This document is produced by Learning and Teaching Scotland as part of the National Qualifications support programme for Economics.

First published 2002
Electronic version 2002

© Learning and Teaching Scotland 2002

This publication may be reproduced in whole or in part for educational purposes by educational establishments in Scotland provided that no profit accrues at any stage.

ISBN 1 85955 929 8


Introduction 1

Section 1: The theory of perfect competition 3

Section 2: The theory of monopoly 9

Section 3: The theory of monopolistic
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After a time, the existence of subnormal profits would cause firms to leave the industry. Supply would fall and prices rise. Hence long run equilibrium is one of normal profits only.

Perfect Competition – Long Run


Advantages of perfect competition

• Because firms produce where MC=MR=Price, allocative efficiency is achieved.
• Productive efficiency is also achieved because the firm produces at the lowest point of the AC curve.
• Prices are lower because of increased competition.
• Because of perfect knowledge firms must keep up to date and innovate or they will be forced to leave the industry.
• In the long run all firms will earn normal profits.
• Cartels and other restrictive agreements cannot emerge to exploit consumers.
• Perfect competition can be used as a model in economic analysis.

Disadvantages of perfect competition

• Firms have little time to benefit from inventions because they quickly enter the public domain.
• Since firms make only normal profits they might not have the funds to undertake expensive research that often yields the most outstanding discoveries.
• Firms might not benefit from economies of large-scale production.
• In order to prevent abuse of the consumer, some industries are best run by the state as natural monopolies and so perfect competition would be inappropriate.
• Perfect competition is a goal that cannot be reached in the real world.

Student exercises/activities

1. To what extent does agriculture

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