Industrial Organization: Contemporary Theory and Empirical Applications, 5th Edition

2

Basic Microeconomics

Considerable time passed before Adam Smith's original and intuitive insights regarding the nature of market behavior and market outcomes were translated into formal models. It then took even more time for that formal understanding to make its way into a standard professional literature. Yet by the late nineteenth century, a rigorous understanding of the benefits of competition versus monopoly had been established as evidenced in particular by the publication of Alfred Marshall's Principles of Economics, Vol. 1 (1890). While we are ultimately interested in modeling the gray area that lies between competition and monopoly, a sound understanding of the perfectly competitive and pure monopolized markets is nevertheless quite insightful. Indeed, these models continue to provide useful starting points for interpreting much of what one reads about in the daily business press. They also reveal the primary intellectual force behind public policies designed to limit monopoly power. For all these reasons, we undertake in this chapter a brief review of the basic models of perfect competition and monopoly.

2.1 COMPETITION VERSUS MONOPOLY: THE POLES OF MARKET PERFORMANCE

We focus on firm profit-maximizing behavior and the resultant market outcome that such behavior implies. We take as given the derivation of an aggregate consumer demand for the product that defines the market of interest. This market demand curve describes the relationship between how much money consumers ...