Chapter 8 Monopoly and Other Forms of Imperfect Competition by wantyou


									Chapter 8: Monopoly and Other Forms of
         Imperfect Competition
I. Imperfect Competition
      A. Price Taker v. Price Setter

Perfectly   Competitive Firm:
   A firm that must take the price in the
   market as a given – i.e. a

Imperfectly   Competitive Firm:
   A firm with at least some latitude to set
   its own price – i.e. a
 B. Forms of Imperfect Competition
Pure  Monopolist:
   A firm that is the only supplier of a
    unique product with no close

   A firm that produces a product for
   which only a few rival firms produce
Monopolistically   Competitive Firm:
   One of a large number of firms that
    produce slightly differentiated
    products that are reasonably close
    substitutes for
         An Essential Difference

A Perfectly Competitive Firm faces a
 perfectly elastic demand curve for its
 product at the market
  Charging a higher or a lower price
     never increases a firm’s
An Imperfectly Competitive Firm faces a
  Charging a price different from its
     competitors may be
Fig. 8.1 The Demand Curves Facing Perfectly
      and Imperfectly Competitive Firms


II. Market Power
                 Market Power

A firm has Market Power – i.e. it can raise
 the price of its output without

“Market  Power” does not mean that a firm
 can sell any quantity at any
      If price is raised, then quantity
       demanded falls – but only somewhat –
       i.e. the quantity demanded does not fall
      the crucial issue is “how much does
       the quantity demanded fall for a given
       change in       ?”
            Sources of Market Power

Marketpower arises from factors that limit
Economies   of Scale
  Natural Monopolies
     Declining costs mean largest firm can
      always undercut
     Example: electricity distribution
  Network Economies
     Compatibility with (& control over)
      established product standards gives

          - Example: Microsoft
      Sources of Market Power

Exclusive   Control over
Patents   and Copyrights
     Grant exclusive rights for a
     Promote monopoly but reward
Licenses   or Franchises
     Government or
III. Economies of scale
      Returns to Scale in Production

Constant Returns to Scale in Production
  When all inputs are changed by a given
   proportion, output changes by the same

Economies   of Scale (Increasing Returns to
 Scale) in Production
  When all inputs are changed by a given
   proportion, output changes by a higher

     Implication: larger firms have a cost
             Returns to Scale

Economies   of Scale (Increasing Returns
 to Scale) cont.
  The technology is such that Average
   Cost of production falls as

  High start-up costs and/or Low
   marginal costs mean that established
   firms can undercut
  Examples: oil refineries, networks,
   automobiles, etc.
Fig. 8.2 Total and Average Costs with
          Economies of Scale

                             ATC = AFC + MC
            TC = TFC + MQ


   TFC                           MC = M = AVC

Table 8.1 Economies of Scale and Fixed Costs
Table 8.2 Economies of Scale and Fixed Costs
IV. Profit Maximization under Imperfect
            Profit Maximization

Goal   of All Firms:
Rules   for Profit Maximization
  Expand output when
  Decrease output when
  Maximize Profit by selling the quantity
   of output such that marginal revenue
   equals marginal cost: MR = MC
    i   i

       Monopolist’s Marginal Revenue

Marginal  Revenue (MR)
   The change in a firm’s Total Revenue that
    results from a one-unit change in
A   Monopolist’s Marginal Revenue
An extra unit can only be sold only if prices
 on ALL preceding units are
Therefore,    the Marginal Revenue is:
       Positive if demand is
       Zero if demand is unit
       Negative if demand is
Fig. 8.4 The Monopolist’s Benefit from Selling an
                Additional Unit

   Profit-Maximizing Rule for Monopolist

As for all firms, Profit is maximized at the
level of output for which
A monopolist is able to set his price along
the demand curve for his output so that he
However, the monopolist is constrained by
the market demand curve – i.e. he can choose
either price or quantity, but not


         Marginal Cost



FIGURE 8.8: Monopoly, A Graphical Summary

             MC                         MC
                                        MC′   ATC′
 PM     B               PM      B
ACM                     P′M

            MR    D                 MR        D
      QM                      QM Q′M
    Monopoly: A Graphical Summary

Panel(a) illustrates the regular profit
  The monopolist finds the output level,
   QM, such that
  The monopolist then charges the
   corresponding price, PM, on the given

  Since the price is greater than the
   corresponding ACM the monopolist is
   making positive
    Monopoly: A Graphical Summary

Panel (b) illustrates the consequence of
 lower costs for the regular profit
  The profit maximizing price is lower as a
   result of lower costs – i.e. it leads higher
   profit if the monopolist passes on in the
   form of lower price at least some of the
   reduction in
        Being a Monopolist Does Not
         Guarantee a Positive Profit!

         Loss                           Economic


                 D                       D

        MR    Quantity            MR Quantity
V. Why the Invisible Hand Breaks Down
           Under Monopoly
        Sub-optimal Production

Monopolist  will restrict output to keep
 price above the competitive
   Maximizes profit for the
   Means that some consumers who would
    have been willing to pay at least as
    much as the actual cost of production
    will do
   Lost Economic Surplus is the result
      “Deadweight Loss of Monopoly”
Monopolist  also appropriates a larger
 share of the total
Fig. 8.9 The Deadweight Loss from Monopoly
        Monopoly and Efficiency

The level of output which is Efficient from a
 Social point of view is
 MB = MC
The monopolist produces less than the
 socially efficient level of
MarginalReturn (to the Monopolist) is less
 than Marginal Benefit (to consumers)
        Monopoly and Efficiency

A monopoly maximizes profit but is not
The loss due to the inefficiency is measured
 by the size of the
Monopoly   profit also redistributes
   Monopoly and Economic Efficiency

A monopoly can only maximize its profits if it
can minimize its costs of production and in
the sense a monopoly is

A monopoly is socially inefficient because it
does not produce the level of output that is
efficient from
Monopoly may be socially inefficient, but the
alternatives, like legislation, public
enterprise and regulation, are not
        VI. Price Discrimination
– Using Discounts to Expand the Market
               Price Discrimination

Price   Discrimination
   The practice of charging different buyers
    different prices for essentially the same

   Compared to a regular monopoly, price
    discrimination works by increasing the
    price to those who have high reservation
    price(s) and lowering price to those with
        Price Discrimination

  Discounts to senior citizens, children
  Super-saver discounts on air travel
  Rebate coupons on retail
Mosteffective when the good or service
 cannot easily be
            Price Discrimination

Compared    to perfect competition, a
 monopolist captures more of the total
 economic surplus – i.e. there is a
 redistribution of economic surplus from the
 consumers to
APrice Discriminating Monopolist captures
 more of the Total Surplus than a Regular
     Types of Price Discrimination

PerfectPrice Discrimination
   The Monopoly charges each buyer
   exactly his or her reservation price.
Perfect Price Discrimination implies that
 output is the same as under perfect
 competition – i.e. the socially optimal

Perfect  price discrimination implies ALL
 the surplus is received by the monopolist
 – i.e. there is NO

    Hurdle Method of Price Discrimination

Hurdle   Method of Price Discrimination
  The practice by which a seller offers a
   discount to all buyers who are willing and
   able to overcome a certain obstacle

  A rebate that is costly to collect (time and
  The buyer has to satisfy certain socio-
   economic criteria (age, student/non-
Hurdle Method of Price Discrimination

The idea is to offer lower prices (or
 discounts) to those who have low
From  an economic efficiency point of
 view, the Hurdle Method is not as good
 as Perfect Price Discrimination but
 better than
  Implications of Price Discrimination

The   number of trades
Brings   output closer to the socially

Reduces  deadweight loss and

          Monopolistic Competition

Many    firms serve the
Firms  sell differentiated products, which
 are fairly close
No   barriers to entry
  Examples: varieties of Scotch whiskey,
   brands of beer

Each   firm faces a downward sloping
 demand curve, but the entry of new firms
 will – in long run equilibrium – compete
FIGURE 8.12: A Monopolistically Competitive
      Firm in Short-Run Equilibrium
       Monopolistic Competition

A monopolistically competitive may earn
 positive economic profits in the.
However,   in the long run new competitors
 will enter and produces products that are
The effect is to reduce the demand for the
 incumbent firm’s product until all
 economic profits have been
FIGURE 8.13: A Monopolistically Competitive
     Firm in Long - Run Equilibrium
            Only Normal Profit

                    MR        D

               Q1                  Q
       Monopolistic Competition

Inthe long run equilibrium, the demand
 curve is tangent to LRAC, the price is
 equal to the LRAC and there is no

However,since the demand curve is
 downward sloping the price is higher than

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