<p>In perfect competition, there are no profits at all. Given the profit function: <span class="math-container">$\Pi = (P-MC)Q $</span>, if <span class="math-container">$P=MC$</span>, then <span class="math-container">$\Pi =0$</span>.</p>
<p>If you believe in the Arrow's replacement effect, the perfectly competitive firm has higher incentives w.r.t. the monopolist to undertake innovation. Indeed, if the monopolist undertakes innovation is going to replace its own already existing profits. In contrast, a competitive firm makes zero profits and has no profits to replace. So, a potential entrant has stronger incentives to undertake an innovation. Of course, in reality, also the monopolist has incentives to undertake an innovation to keep its monopolist power.</p>
<p>If innovation is drastic, the new entrant, i.e. the new monopolist, enjoys a very low MC w.r.t. the perfectly competitive firms and eventually it can fix its price below the MC of the perfectly competitive firms</p>

CC BY-SA 4.0
2022-08-08T09:22:04.280Z
I was taught that the profit of producing Q units under perfect competition is \sum_q=1^Q (P - Cost(q)), where Cost(q) is the cost of producing the q'th unit, and is an increasing function of q, and P = Cost(Q) which is the marginal cost at quantity Q. This profit is greater than 0 because Cost(q) is less than P for all units except when q=Q.
causative
CC BY-SA 4.0
2022-08-08T09:42:40.717Z
It depends on how the MC behaves. If the MC is increasing in q, then you are right. But, if it is fixed for any level of Q, the argument above holds.
Maximilian
CC BY-SA 4.0
2022-08-08T09:04:50.100Z
2022-08-08T09:04:50.100Z
Maximilian
<p>Correct me if I'm wrong, but this is my understanding:</p>
<ul>
<li>In perfect competition, firms set the price at the marginal cost of production. This gives them a relatively low amount of profit.</li>
<li>In monopolistic competition, a firm would set the price higher than the marginal cost of production, and thereby gain more profit.</li>
<li>In a real economy, firms in some industries (e.g. computer software) are more in a state of monopolistic competition, where they may have more profit. Firms in other industries (e.g. gas stations) are closer to perfect competition, with lower profits.</li>
<li>When possible, firms wish to break into industries where firms make more profit. This creates an opportunity cost for staying in the perfectly competitive industry.</li>
<li>Does this opportunity cost drive up prices in the lower-profit, more competitive industry, above the marginal cost of production?</li>
</ul>
<p>So, as a specific example, gas stations pretty much directly compete with nearby gas stations on price. Firms in many other markets have more market power and may make more profit. Does the opportunity cost of not switching to one of those other markets, allow the gas stations to increase the price of gas above the marginal cost (before accounting for that opportunity cost)?</p>

CC BY-SA 4.0
2022-08-08T07:33:28.610Z
Hi! In both the perfect & monopolistic competition models the "supply" of firms is unlimited; a capitalist could potentially have firms both in a perfectly competitive industry and a monopolistically competitive industry. Thus there is no opportunity cost for staying in one.
Giskard
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2022-08-08T07:34:57.053Z
You might mean a more realistic model where a capital supply curve exists, and thus the cost of capital goes up as the number of firms increases. In this case IMO you would need to lay out the precise details of your proposed model, as any potential answer will depend on these details.
Giskard
CC BY-SA 4.0
2022-08-08T07:56:58.047Z
@Giskard I was thinking a capitalist has a fixed amount of money to invest, which could either go to a perfect competition firm, or a monopolistic competition firm for the same cost. Unless the perfect competition firm can operate in a way to give the same profit as the monopolistic one, then the capitalist would always choose to invest the money on the monopolistic firm, because the return is better. So if the perfect competition firm is to get any investment at all, it has to set prices high enough so it has a similar return on investment to the monopolistic firm
causative
CC BY-SA 4.0
2022-08-08T07:57:10.653Z
... even if that is above the marginal cost of production. And it would get away with this because all the other perfect competition firms are under the same pressure to attract investment. They can't set prices lower or their investors/owners would rather invest their money in a different industry.
causative
CC BY-SA 4.0
2022-08-08T08:20:27.970Z
To put it another way:  if one industry fails to make as much profit per dollar of investment as another industry, then any capitalist would prefer to spend their limited money on the second industry rather than the first, and the number of firms in the first industry would shrink, and it would shrink all the way to 0 if the profit situation is not equalized.
causative
CC BY-SA 4.0
2022-08-08T08:31:19.597Z
Again, what you describe is not "perfect competition", the supply of firms/capital is infinite there. Perhaps you mean the demand is perfectly elastic in one market?
Giskard
CC BY-SA 4.0
2022-08-08T09:00:24.783Z
By the way both in perfect competition and monopolistic competition profits economic profits are 0, so your assumption that the monopolistic firm has higher profits is inconsistent with your description of the environment
1muflon1
CC BY-SA 4.0
2022-08-08T09:23:57.657Z
@1muflon1 I've been using the word "profit" in the sense of accounting profit, not economic profit.
causative
CC BY-SA 4.0
2022-08-08T09:25:10.580Z
@causative then can you provide any reference to empirical evidence or theoretical derivation that shows monopolistic firms tend to have higher accounting profit? Also if you are discussing accounting profit, why are you considering opportunity cost at all? OC is excluded from accounting profits
1muflon1
CC BY-SA 4.0
2022-08-08T09:33:31.483Z
@1muflon1 For instance see https://www.kellogg.northwestern.edu/faculty/georgiadis/Teaching/Ec731_Module2.pdf . Intuitively, a monopoly is able to set the price anywhere they want to maximize profit. So they can't do any *worse* than a competitive market would, because they have the option to set the price at the competitive price and get the same profit a competitive firm would. Instead they set the price a bit higher and increase their profits.
causative
CC BY-SA 4.0
2022-08-08T09:35:48.893Z
@Giskard Edited the question to clarify that I'm asking about real-world firms that are merely *close* to perfect competition.
causative
CC BY-SA 4.0
2022-08-08T09:59:09.137Z
@causative but monopolistic competition **is not** monopoly, those are two totally distinct and diametrically different market structure. If you would order classic market structures by competitiveness you would have perfect competition on the left, right next to perfect competition would be monopolistic competition, then far to the right you would have oligopoly and somewhere after oligopoly you would have duopoly and then after it monopoly
1muflon1
<monopoly><competition><opportunity-cost><monopolistic-competition>
Do monopolistic firms indirectly increase prices of products sold by perfectly competitive firms?
causative
# Do monopolistic firms indirectly increase prices of products sold by perfectly competitive firms?

(Asked by: username_0 on 2022-08-08)

Correct me if I'm wrong, but this is my understanding:

* In perfect competition, firms set the price at the marginal cost of production. This gives them a relatively low amount of profit.
* In monopolistic competition, a firm would set the price higher than the marginal cost of production, and thereby gain more profit.
* In a real economy, firms in some industries (e.g. computer software) are more in a state of monopolistic competition, where they may have more profit. Firms in other industries (e.g. gas stations) are closer to perfect competition, with lower profits.
* When possible, firms wish to break into industries where firms make more profit. This creates an opportunity cost for staying in the perfectly competitive industry.
* Does this opportunity cost drive up prices in the lower-profit, more competitive industry, above the marginal cost of production?

So, as a specific example, gas stations pretty much directly compete with nearby gas stations on price. Firms in many other markets have more market power and may make more profit. Does the opportunity cost of not switching to one of those other markets, allow the gas stations to increase the price of gas above the marginal cost (before accounting for that opportunity cost)?

**Tags:** monopoly, competition, opportunity-cost, monopolistic-competition
> **Comments:**
> **username_1**: Hi! In both the perfect & monopolistic competition models the "supply" of firms is unlimited; a capitalist could potentially have firms both in a perfectly competitive industry and a monopolistically competitive industry. Thus there is no opportunity cost for staying in one.  
> **username_1**: You might mean a more realistic model where a capital supply curve exists, and thus the cost of capital goes up as the number of firms increases. In this case IMO you would need to lay out the precise details of your proposed model, as any potential answer will depend on these details.  
> **username_0**: @Giskard I was thinking a capitalist has a fixed amount of money to invest, which could either go to a perfect competition firm, or a monopolistic competition firm for the same cost. Unless the perfect competition firm can operate in a way to give the same profit as the monopolistic one, then the capitalist would always choose to invest the money on the monopolistic firm, because the return is better. So if the perfect competition firm is to get any investment at all, it has to set prices high enough so it has a similar return on investment to the monopolistic firm  
> **username_0**: ... even if that is above the marginal cost of production. And it would get away with this because all the other perfect competition firms are under the same pressure to attract investment. They can't set prices lower or their investors/owners would rather invest their money in a different industry.  
> **username_0**: To put it another way:  if one industry fails to make as much profit per dollar of investment as another industry, then any capitalist would prefer to spend their limited money on the second industry rather than the first, and the number of firms in the first industry would shrink, and it would shrink all the way to 0 if the profit situation is not equalized.  
> **username_1**: Again, what you describe is not "perfect competition", the supply of firms/capital is infinite there. Perhaps you mean the demand is perfectly elastic in one market?  
> **username_2**: By the way both in perfect competition and monopolistic competition profits economic profits are 0, so your assumption that the monopolistic firm has higher profits is inconsistent with your description of the environment  
> **username_0**: @1muflon1 I've been using the word "profit" in the sense of accounting profit, not economic profit.  
> **username_2**: @causative then can you provide any reference to empirical evidence or theoretical derivation that shows monopolistic firms tend to have higher accounting profit? Also if you are discussing accounting profit, why are you considering opportunity cost at all? OC is excluded from accounting profits  
> **username_0**: @1muflon1 For instance see https://www.kellogg.northwestern.edu/faculty/georgiadis/Teaching/Ec731_Module2.pdf . Intuitively, a monopoly is able to set the price anywhere they want to maximize profit. So they can't do any *worse* than a competitive market would, because they have the option to set the price at the competitive price and get the same profit a competitive firm would. Instead they set the price a bit higher and increase their profits.  
> **username_0**: @Giskard Edited the question to clarify that I'm asking about real-world firms that are merely *close* to perfect competition.  
> **username_2**: @causative but monopolistic competition **is not** monopoly, those are two totally distinct and diametrically different market structure. If you would order classic market structures by competitiveness you would have perfect competition on the left, right next to perfect competition would be monopolistic competition, then far to the right you would have oligopoly and somewhere after oligopoly you would have duopoly and then after it monopoly  

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## 1 answers

### Answer by username_3 on 2022-08-08. Score: 0

In perfect competition, there are no profits at all. Given the profit function: $\Pi = (P-MC)Q $, if $P=MC$, then $\Pi =0$.

If you believe in the Arrow's replacement effect, the perfectly competitive firm has higher incentives w.r.t. the monopolist to undertake innovation. Indeed, if the monopolist undertakes innovation is going to replace its own already existing profits. In contrast, a competitive firm makes zero profits and has no profits to replace. So, a potential entrant has stronger incentives to undertake an innovation. Of course, in reality, also the monopolist has incentives to undertake an innovation to keep its monopolist power.

If innovation is drastic, the new entrant, i.e. the new monopolist, enjoys a very low MC w.r.t. the perfectly competitive firms and eventually it can fix its price below the MC of the perfectly competitive firms

> **Comments:**
> **username_0**: I was taught that the profit of producing Q units under perfect competition is \sum_q=1^Q (P - Cost(q)), where Cost(q) is the cost of producing the q'th unit, and is an increasing function of q, and P = Cost(Q) which is the marginal cost at quantity Q. This profit is greater than 0 because Cost(q) is less than P for all units except when q=Q.  
> **username_3**: It depends on how the MC behaves. If the MC is increasing in q, then you are right. But, if it is fixed for any level of Q, the argument above holds.  

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