Grantham University Short and Long Run Economic Profits Essay
ANSWER
The distinction between short-run and long-run economic profits in different market structures lies in the presence of barriers to entry. Oligopolies, a form of imperfect competition, can sustain both short-run and long-run economic profits due to the significant barriers to entry that prevent new competitors from easily entering the market. This allows existing firms to maintain their market pricing power and enjoy economic profits over an extended period.
In contrast, perfect competition is characterized by no barriers to entry, ensuring that new firms can easily enter the market. In the short run, price-taking firms under perfect competition may experience economic profits if market conditions lead to prices exceeding average total costs. However, in the long run, these economic profits attract new entrants, shifting the supply curve and eventually driving prices down to the point where firms only earn normal profits, covering their opportunity costs but not generating economic profits.
Barriers to entry in imperfectly competitive markets like monopolistic competition, oligopoly, and monopoly create limitations on new entrants, allowing existing firms to exert pricing power and potentially earn economic profits in the long run. Barriers can take various forms such as high startup costs, technological advantages, legal restrictions, or control over essential resources. This lack of competition enables firms to maintain prices above the level where average total costs intersect demand, resulting in ongoing economic profits.
The implications of barriers to entry are twofold. For firms, barriers provide a degree of insulation from competition, allowing them to set prices higher than under perfect competition. This can lead to higher profits and potentially fund innovation or expansion. However, for consumers, barriers to entry reduce choices and may lead to higher prices than would exist in a more competitive market. This can lead to reduced consumer surplus, the difference between what consumers are willing to pay and what they actually pay.
When prices are set above equilibrium due to barriers to entry, consumer surplus decreases, as consumers are paying more for the product than they would in a competitive market. Additionally, the surplus that would have been captured by potential competitors as economic profits in a competitive market is instead retained by the existing firms. This situation highlights the trade-off between producer surplus (benefits for firms) and consumer surplus (benefits for consumers) and underscores the significance of market structure and entry barriers in shaping these outcomes.
In summary, the presence of barriers to entry in imperfectly competitive markets like oligopolies allows firms to earn both short-run and long-run economic profits by maintaining pricing power. In perfect competition, the absence of such barriers restricts firms to short-run economic profits, as new entrants erode profits in the long run. Barriers to entry have implications for both firms and consumers, impacting profits, consumer surplus, and market efficiency.
QUESTION
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Your initial post should be 75-150 words in length.
A profit-maximizing price searcher will expand output as long as marginal revenue either exceeds or is equal to marginal cost, lowering its price or raising its price until the midpoint of their demand curve and highest total revenues are achieved.
Why are oligopolies able to earn both short-run economic profits and long-run economic profits, while price taking firms like perfect competitors can only earn short-run economic profits?
Review the characteristics of perfect competition and imperfect competition (monopolistic competition, oligopoly, and monopoly). Barriers to entry don’t exist for perfect competition, but barriers to entry exist for imperfect competition. What are the implications of barriers to entry to the firm and competition? Review consumer surplus and producer surplus; what happens to consumer surplus is price is above equilibrium, or in this case above normal profits? Please provide original work. No plagiarizing.
Lecture is below:
In Week #5: Price Takers versus Price Searchers, we discussed that markets are most efficient and equitable when perfectly competitive. It was also noted that how competitive a market is determines how much market pricing power firms in aggregate enjoy, as well as the price elasticity of the individual firm’s demand curve. When we assess markets, we base efficiency and equity upon whether it’s a market comprised of price takers or price searchers. Price takers are firms who have no market pricing power, no product differentiation from other competitors, and the market is perfectly competitive and efficient and equitable. Price searchers, on the other hand, are firms who have at least some market pricing power, at least some product differentiation from other competitors, and the market is imperfectly competitive leading to losses in efficiency and equity.
So, let’s talk about price searchers now. Price searching firms are also imperfectly competitive. Firms who produce goods with at least some product differentiation can to a certain amount affect market price. are three types of imperfect competitors: monopolistically competitive, oligopoly, and monopoly. With monopolistically competitive, like the perfectly competitive firm, there are many producers, only short-run economic profits can be attained, and products produced are very similar but do have some relative differentiation. Oligopolies and monopolies, on the other hand, have high barriers to entry, and although for oligopolies there is product differentiation but similar products from competitors, there are too few competitors due to high barriers to entry to deny the oligopolies long-run economic profits.
For the monopolistically competitive market structure, supply and demand determine market equilibrium and allocation of resources. Individual firms do have their own demand curve, and the market demand curve is made up by adding up all the firms’ demand curves. The demand curve for the individual firm will have some downward slope, and there will be a separate downward-sloping marginal revenue curve. The optimal point where monopolistically competitive firms produce is where marginal costs equal marginal revenues, and then price is set from that point up on the X-axis (horizontal axis) until it meets the demand curve. Any price in the short run above the competitive price (perfectly competitive) where marginal costs equal marginal revenues will result in economic profits; due to a lack of barriers to entry, new firms will enter, shifting the demand curves of individual firms in the market leftward, pulling price down to the ATC (average total cost curve) back to equilibrium, thus eliminating economic profits in the long run and normal profits existing thereafter.
In summary, we have four market structures, with perfectly competitive being the benchmark from which efficiency and equity are found. The other three market structures – monopolistically competitive, oligopoly, and monopoly – are not fully efficient and equitable. Oligopoly and monopoly are the least competitive market structures in which long-run economic profits are present due to a downward-sloping demand curve and high barriers to entry, while monopolistically competitive has a downward sloping demand curve but low barriers to entry (low product differentiation) with no long-run economic profits.
In Week #6: Economic Profits versus Normal Profits, we discussed that markets are most efficient and equitable when perfectly competitive. It was also noted that how competitive a market is determines how much market pricing power firms in aggregate enjoy, as well as the price elasticity of the individual firm’s demand curve. When we assess markets, we base efficiency and equity upon whether it’s a market comprised of price takers or price searchers. Price takers are firms who have no market pricing power, no product differentiation from other competitors, and the market is perfectly competitive and efficient and equitable. Price searchers, on the other hand, are firms who have at least some market pricing power, at least some product differentiation from other competitors, and the market is imperfectly competitive leading to losses in efficiency and equity.
Secondly, price searching firms are also imperfectly competitive. Firms who produce goods with at least some product differentiation can to a certain amount affect market price. There are three types of imperfect competitors: monopolistically competitive, oligopoly, and monopoly. With monopolistically competitive, like the perfectly competitive firm, there are many producers, only short-run economic profits can be attained, and products produced are very similar but do have some relative differentiation. Oligopolies and monopolies, on the other hand, have high barriers to entry, and although for oligopolies there is product differentiation but similar products from competitors, there are too few competitors due to high barriers to entry to deny the oligopolies long-run economic profits.
What are some other characteristics of oligopolies that differentiate them from monopolistically competitive. Economies of scale is very high. Usually with oligopolies, the long-run average total cost curve has a relatively long economies of scale section, with relatively smaller constant returns and diseconomies sections. Collusion and mergers tend to pervade this market structure, especially when it becomes difficult to combat diseconomies of scale.
Monopolies, on the other hand, have no close competitors, the market demand curve is its demand curve, and no close substitutes exist. Pure monopolies are rare and are either prevented or eliminated due to anti-trust laws, like the Sherman Anti-trust Act of 1890, which break them up. The government can regulate and allow a firm to operate as a monopoly, but the regulated monopoly will not have pure monopoly pricing power nor ultimate economic profits. A regulate monopoly is called a natural monopoly, and the firm is allowed only a fair price at which price is set at its ATC.
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