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Understanding Economics
5th edition
by Mark Lovewell
Copyright © 2009 by McGraw-Hill Ryerson
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5th edition
by Mark Lovewell
Chapter 6
Monopoly and Imperfect
Competition
Copyright © 20109 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives

After this chapter you will be able to:
outline the demand conditions faced by monopolists,
monopolistic competitors, and oligopolists
2. distinguish how monopolists, monopolistic
competitors, and oligopolists maximize profits
3. understand nonprice competition, and the arguments
over industrial concentration
1.
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Monopolist’s Demand

A monopolist’s demand curve is the same as for the
entire market
 it is downward sloping
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Demand Faced by a Monopolist
Figure 6.1, Page 144
Demand Curve for Megacomp
Demand Schedule
for Megacomp
($ millions per
computer)
$160
120
80
(computers
per year)
1
2
3
a
160
Price ($ millions
per computer)
Quantity
Demanded
Price
200
b
120
c
80
D
40
0
1
2
3
4
Quantity (computers per year)
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Monopolistic Competitor’s
Demand

A monopolistic competitor’s demand curve is elastic
because of many substitutes for the business’s product
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Demand Faced by a Monopolist
Competitor
Figure 6.2, Page 145
Demand Curve for Jaded Palate
Demand Schedule for
Jaded Palate
Price
($ per meal)
$11
10
9
8
(meals per
day)
100
200
300
400
Price ($ per meal)
12
Quantity
Demanded
10
8
D
6
4
2
0
100
200
300
400
Quantity (meals per day)
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Oligopolist’s Demand


Oligopolies are characterized by mutual
interdependence.
Oligopolists in a market characterized by rivalry face a
kinked demand curve.
 A business raising price finds rivals keep theirs constant,
so demand is relatively flat.
 A business reducing price finds rivals raise theirs as well,
so demand is relatively steep.
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Actions and Reactions among Rivals in an Oligopoly
Figure 6.3, Page 145
Probable
Response of
Competitors
Effect on
Company A’s
Market Share
raise price
keep prices
constant
product now highpriced, so market
share falls
large increase as
market share lost
to competitors
lower price
match price
drop
since all companies
selling at lower
price, Company A’s
market share stays
constant
small increase as
lower prices for all
companies attract
new buyers
Action of
Company A
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Company A’s
Quantity
Demanded
Demand Faced Among Rivals in an Oligopoly
Figure 6.4, Page 146
Demand Schedule
For Centaur Cars
Demand Curve for Centaur Cars
Price
Quantity
Demanded
($ thousands
per car)
(thousands
of cars per year)
$35
30
20
10
10
20
25
30
Price ($ thousands per car)
40
30
20
D
10
0
10
20
30
Quantity (thousands of cars per year)
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Cooperative Oligopolies

There are various ways that oligopolists can cooperate:
 price leadership
 collusion
 cartel
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Revenue Conditions for a
Monopolist


A monopolist’s average revenue is the same as the
downward-sloping market demand curve.
A monopolist’s marginal revenue is below its demand
curve because demand (average revenue) falls as
quantity increases.
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Revenues for a Monopolist
Figure 6.5, Page 148
Revenue Curves for Megacomp
Revenue Schedules for Megacomp
Price
(P)
Quantity
(Q)
($ millions
per
(computers
computer) per year)
$160
120
80
40
0
1
2
3
4
Total
Revenue
(TR)
(P x Q)
Marginal
Average
Revenue
Revenue
(MR)
(AR)
(ΔTR/ΔQ)
(TR/Q)
($ millions ($ millions
per
per
($ millions) computer) computer)
$ 0
160
240
240
160
$160
80
0
-80
$160/1 =
240/2 =
240/3 =
160/4 =
160
120
80
40
$ Millions per Computer
200
160
120
80
40
D =AR
0
-40
-80
1
2
3
4
MR
Quantity of Computers per Year
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Profit-Maximization for a
Monopolist (a)


A monopolist maximizes profit at the quantity where
marginal revenue and marginal cost are equal. At this
output, the monopolist charges the highest possible
price, as found using the demand curve.
Monopolists meet neither the minimum-cost pricing
nor the marginal-cost pricing conditions.
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Profit Maximization for a Monopolist (b)
Figure 6.6, Page 149
Profit Maximization Table for Megacomp
Price
(P)
(AR)
($ millions per
computer)
Quantity
(Q)
(computers
per year)
0
1
2
3
4
$160
120
80
40
Total Revenue
(TR)
(P x Q)
($ millions)
Marginal Revenue Marginal Cost Average Cost
(AC)
(MR)
(MC)
(ΔTR/ΔQ)
($ millions per
($ millions per ($ millions per
computer)
computer)
computer)
$ 0
160
240
240
160
$160
80
0
-80
$ 60
40
70
150
$ Millions per computer
Profit Maximization Graph for Megacomp
200
MC
160
120
90
80
b
c
40
0
AC
Profit = $60 million
a
1
D
MR
2
Quantity of Computers per Year
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3
4
$140
90
83
100
Other Features of Monopolies


A monopolist charges a higher price and a lower
quantity than would occur if the market were perfectly
competitive.
Regulators of monopolies usually adopt average-cost
pricing in an effort to make regulated monopolies
break even.
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Monopoly versus Perfect
Competition
Figure 6.7, Page 150
7
$ per T-Shirt
S(=MC)
c
a
4
b
D
MR
0
18 000
22 000
Quantity of T-Shirts per Day
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Revenue Conditions for a
Monopolistic Competitor


A monopolistic competitor’s average revenue is the
same as its downward-sloping demand curve.
A monopolistic competitor’s marginal revenue is
below its demand curve because demand (average
revenue) falls as quantity increases.
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Revenues for a Monopolistic Competitor
Figure 6.8, Page 153
Revenue Schedules for Jaded Palate
Price
Quantity
(P)
(Q)
($ meal) (meals per day)
$-11
10
9
8
Total Revenue
(TR)
(P x Q)
Marginal Revenue
(MR)
(ΔTR/ΔQ)
$
0
1100
2000
2700
3200
1100/100 = $11
900/100 = 9
700/100 = 7
500/100 = 5
0
100
200
300
400
Revenue Curves for Jaded Palate
12
$ per Meal
10
8
D = AR
6
MR
4
2
0
100
200
300
400
Quantity of Meals per Year
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Average Revenue
(AR)
TR/Q)
1100/100 = $11
2000/200 = 10
2700/300 = 9
3200/400 = 8
Profit-Maximization for a
Monopolistic Competitor (a)


The profit-maximizing quantity for a monopolistic
competitor is found where marginal revenue and
marginal cost are equal. Price is found with the aid of
the business’s demand curve.
In the short run a monopolistic competitor may make
a profit or a loss at its profit-maximizing point.
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Profit-Maximization for a
Monopolistic Competitor (b)

In the long run, a monopolistic competitor breaks
even.


If profits (losses) are being made in the short run, new
businesses enter (leave) the industry, pushing
businesses’ demand curves leftward (rightward) and
making them more (less) elastic.
The business meets neither the minimum-cost pricing
nor the marginal-cost pricing rules, since too few units
of output are produced.
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Profit Maximization for a Monopolistic Competitor (c)
Figure 6.9, Page 154
Short-Run Profit Maximization
For Jaded Palate
Long-Run Profit Maximization
For Jaded Palate
MC
$ per Meal
8.00
b
AC
D0
c
MR
200
Quantity of Meals per Day
e
7.50
a
0
MC
minimum point
of AC
D1
$ per Meal
10.00
d
MR
0
150
Quantity of Meals per Day
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AC
Revenue Conditions for an
Oligopolist


For an oligopolist in a market characterized by rivalry,
average revenue is identical with its kinked demand
curve.
This business’s marginal revenue curve has two linear
segments which are below its kinked demand curve
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Profit-Maximization for an
Oligopolist (a)


The profit-maximizing quantity for this type of
oligipolist is found where marginal revenue and
marginal cost are equal. Price is found using the
business’s kinked demand curve.
Oligopolists meet neither the minimum-cost pricing
nor the marginal-cost pricing rules.
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Profit Maximization for an Oligopolist (b)
Figure 6.10, Page 156
Profit Maximization Graph for
Centaur Cars
Profit Maximization Table for Centaur Cars
40
-$35
30
20
10
Quantity
(Q)
0
10
20
25
30
0
350
600
500
300
35
25
-20
-40
15
10
15
25
30
20
19
20
b
30
$ Thousands per car
Total
Marginal Marginal
Average
Revenue Revenue
Cost
Cost
(TR)
(MR)
(MC)
(AC)
(P x Q) (ΔTR/ΔQ)
($ thousands (thousands
($
($
($
of cars per
($
Per car)
thousands thousands thousands
year)
millions) per car)
per car)
per car)
Price
(P)
(=AR)
20
MC
Profit = $200 million
c
10
a
D
0
-10
10
20
30
-20
-30
-40
MR
Quantity (thousands of cars per year)
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AC
Game Theory
 Game theory is the analysis of how mutually
interdependent actors try to achieve their goals
through the use of strategy.
 Originally a field in mathematics, game theory has
become a set of concepts whose use has spread to all
social sciences, especially economics.
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The Prisoner’s Dilemma (a)
 The prisoner’s dilemma is a classic example of how
players’ self-interested actions can be self-defeating.
 It refers to a case in which two arrested men are in
separate cells and are facing the choice of whether or not
to confess. If both confess, each gets a jail time of 5
years. If one confesses and the other doesn’t, the
confessor gets off and the other gets 10 years. If both
don’t confess, they each get one year of jail.
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The Prisoner’s Dilemma (b)
 By following a narrowly self-interested strategy that
minimizes his own potential harm, each prisoner has
an incentive to confess, even though the best possible
result would be if both stayed silent.
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The Prisoner’s Dilemma
Figure 6.11, Page 158
Paul’s Strategies
Don’t Confess
Confess
Don’t Confess
Peter’s Strategies
Confess
Paul: 5
Peter: 5
Paul: 10
Peter: 0
Paul: 0
Peter: 10
Paul: 1
Peter: 1
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Applying the Prisoner’s Dilemma to
Oligopoly (a)
 The prisoner’s dilemma can be applied to
oligopoly by looking at two businesses that have
entered a collusive agreement to charge a high
price.
 If both businesses live by the agreement, they
each make $20 million in profit. If one cheats
and the other doesn’t, the cheater makes $25
million in profit and the other makes $10
million. If both cheat, they each make $15
million.
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Applying the Prisoner’s Dilemma to
Oligopoly (b)
 If price cutting can be accomplished in an
underhanded way, each business has an incentive to
cheat, since the profit for the cheater (when the other
business is living within the agreement) is higher than
otherwise.
 But if both businesses cheat, each makes a lower profit
than they would do if both lived within the agreement.
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The Case of Oligopoly
Figure 6.12, Page 159
Delta’s Strategies
Don’t Cheat
Cheat
D: $20 m.
G: $20 m.
D: 25 m.
G: $10 m.
D: $10 m.
Cheat
Gamma’s Strategies
Don’t Cheat
G: $25 m.
D: 15 m.
G: $15 m.
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Anti-Combines Legislation (a)
 Anti-combines legislation represents laws aimed at
preventing industrial concentration and abuses of
market power.
 The Competition Act of 1986 was a major reform of
Canada’s anti-combines legislation.
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Anti-Combines Legislation (b)
 Criminal offences under the Competition Act include:
 conspiracy
 bid-rigging
 predatory pricing
 abuse of dominant position
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Anti-Combines Legislation (c)
 Civil matters reviewed by the Competition Tribunal
include:
 abuse of dominant position
 mergers



horizontal merger
vertical merger
conglomerate merger
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Nonprice Competition

Nonprice competition by monopolistic competitors
and oligopolists includes:
 product differentiation
 advertising


Nonprice competition raises a business’s revenue and
costs.
Nonprice competition may or may not be beneficial to
businesses and consumers.
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Industrial Concentration

Industrial concentration refers to market domination
by a few large businesses.
 It can provide the consumer with benefits due to
increasing returns to scale.
 It can impose costs on the consumer due to market
power.
 It may or may not encourage technical innovation.
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Concentration Ratios
 Industrial concentration is measured using
concentration ratios.
 The four-firm concentration ratio shows the
percentage of total sales revenue in a market earned by
the four largest business firms.
 Concentration ratios overestimate competition in
localized markets and underestimate it in global
markets.
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Concentration Ratios in Selected Canadian Industries
(1988)
Figure 6.13, Page 165
Share of Industry Sales
by Four Largest Businesses
Tobacco products
Petroleum and coal products
Transportation
Beverages
Metal mining
Paper and allied industries
Electrical products
Printing, publishing, and allied industries
Food
Finance
Machinery
Retail trade
Clothing industries
Construction
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98.9
74.5
68.5
59.2
58.9
38.9
32.1
25.7
19.6
16.4
11.3
9.7
6.6
2.2
Concentration in the Canadian Economy (1999)
Figure 6.14, Page 166
Share of Assets and Share of Revenues for Enterprises
with $75 million or More in Revenues
Assets
Foreign
Canadian
Revenues
18.9
57.8
26.2
30.5
76.7
56.7
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The Games People Play (a)
 Thomas Schelling applied game theory principles to
military strategy, showing how the most effective
deterrence during the nuclear arms race between the
US and the Soviet Union was not first-strike capability,
but second strike capability.
 He explained this using the example of two gunfighters
in a threatened shootout, who would both be loath to
shoot “if both were assured of living long enough to
shoot back with unimpaired aim.”
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The Games People Play (b)
 Schelling also showed how, in many ordinary social
situations, a divergence between what people are
motivated to do individually and what they would like
to accomplish collectively creates conditions for
breaking the laissez faire principle.
 One example is the rationing of electricity during
summer shortages. In this case, rules-based rationing
makes more sense than merely appealing to people’s
civic virtue, says Schelling.
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The OPEC Cartel (a)
(Online Learning Centre)
 The Organization of Petroleum Exporting Countries is
an example of a cartel that has had some success in the
past in influencing the global price of oil.
 During the 1970s, OPEC members used marketsharing agreements to significantly raise this price.
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The OPEC Cartel (b)
(Online Learning Centre)
 In the 1980s, the oil price fell and OPEC’s influence
waned. This was due to:
 a reduction in quantity demanded – a delayed reaction
to the high prices of the 1970s
 increases in quantity supplied by non-OPEC producers
 cheating by some OPEC members, who secretly raised
output to counteract reduced prices, and thereby made
the price reductions even greater
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The OPEC Cartel (c)
(Online Learning Centre)
 During the 1990s and the early 2000s, despite
continuing conflicts within OPEC, oil prices were
driven much higher, due to a variety of factors,
including political considerations:
 the Iraq War and its aftermath
 tensions between the West and Iran
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The Just Price (a)
(Online Learning Centre)
 The medieval philosopher Thomas Aquinas provided a
comprehensive world view that included a treatment
of economic issues.
 He argued that lending for interest was unfair to
borrowers.
 According to this view, interest payments bring into
question the stability of the monetary system, since they
seem to presume that money necessarily depreciates in
value.
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The Just Price (b)
(Online Learning Centre)
 The condemnation of what was then called usury was
virtually impossible to enforce, with interest being
hidden by lenders in other payments made by
borrowers.
 Aquinas extended Aristotle’s theory of exchange by
refining the notion of a just price.
 Whereas Aristotle believed that selling for a price higher
than one paid was unethical, Aquinas recognized traders
deserved a return that covered more than out-of-pocket
costs.
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The Just Price (c)
(Online Learning Centre)
 Aquinas’s followers gradually extended the idea of the
just price so that it came to be seen as the value of an
item that allowed producers to maintain their customary
position in society.
 The notion of the just price is still used today, for
example in markets governed by price controls.
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Chapter 6
The End
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