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Monopoly and Other Forms of
Imperfect Competition
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Price Taker v. Price Setter
Perfectly Competitive Firm
A firm that must take the price in the
market
A price taker
Imperfectly Competitive Firm
A firm with at least some latitude to set its
own price
A price setter
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Forms of Imperfect
Competition
Pure monopolist
A firm that’s the only supplier of a unique
product with no close substitutes
Oligopolist
A firm that produces a product for which only a
few rival firms produce close substitutes
Monopolistically competitive firm
One of a large number of firms that produce
slightly differentiated products that are
reasonably close substitutes for one another
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Essential Difference
A perfectly competitive firm faces a perfectly
elastic demand curve for its product
Firms take the price in the market, where supply
and demand curves intersect
Charging a higher price or a lower price does not
help increase profits
An imperfectly competitive firm faces a
downward-sloping demand curve
Charging a price different from competitors may
be advantageous
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Fig. 9.1
The Demand Curves Facing Perfectly
and Imperfectly Competitive Firms
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Market Power
Market Power
A firm’s ability to raise the price of a good
without losing all its sales
It does not mean that a firm can sell any
quantity at any price it wishes. [If firms
raise price, quantity demanded falls.]
i.e. they must remember the law of demand
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Sources of Market Power
Market power arises from factors that
limit competition = “barriers to entry”
Exclusive control over inputs
Economies of scale (lower average costs)
Patents
Grant exclusive rights for a specified time period
Promote monopoly but encourage innovation
Government licenses or franchises
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Returns to Scale
Constant returns to scale
When all inputs are changed by a given
proportion and output changes by the
same proportion
Increasing returns to scale
When all inputs are changed by a given
proportion and output changes by a higher
proportion
Also know as Economies of Scale
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Economies of Scale
With Economies of Scale
Average cost of production falls as output
increases
There are high start-up costs
There are low marginal costs
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Fig. 9.2
Total and Average Costs for a
Production Process with Economies of
Scale
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“Natural Monopoly”
In some markets, it makes more sense (is more
efficient) to only have a single provider of the
good.
Economies of scale are so great that the good or
service can be provided at the lowest cost if only
one firm provides it.
E.g. Utilities
How many sets of phone lines, water pipes, cable
wires, electric lines … do we need?
Since monopoly power is dangerous (to consumers)
what must we do with natural monopolies?
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Profit Maximization
Goal of all firms: Maximize profits
Rule
Expand output when MR > MC
Decrease output when MC > MR
Sell the quantity of output where
marginal revenue equals marginal cost,
MR = MC
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Fig. 9.3
The Profit-Maximizing Output Level for
a Perfectly Competitive Watermelon
Farmer
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Monopolist’s
Marginal Revenue
Marginal Revenue
The change in a firm’s total revenue that
results from a one-unit change in output
For a monopolist
marginal benefit of selling an additional
unit is less than the market price
Note that a monopolist can only sell an additional unit if it cuts prices on all units it sells
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Fig. 9.4
The Monopolist’s Benefit from Selling
an Additional Unit
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Fig. 9.5
Marginal Revenue in Graphical Form
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Fig. 9.6
The Marginal Revenue Curve for a
Monopolist with a
Straight-Line Demand Curve
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Profit-Maximizing Rule
Profit is maximized at the level of
output for which MR = MC
A monopolist sets the price off of the
demand curve at its profit-maximizing
output
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Fig. 9.9
The Monopolist’s Profit-Maximizing
Output Level
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Fig. 9.11
The Deadweight Loss from Monopoly
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Monopoly and Efficiency
Recall, the socially efficient level of
output is where MB = MC
The monopolist produces less than socially
efficient level of output
Monopolists are not efficient
Inefficiency is measured by deadweight loss
Monopoly may be socially inefficient,
but the alternatives, like legislation, are
not perfect either
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Price Discrimination
Price Discrimination
The practice of charging different buyers
different prices for essentially the same
good or service
Discounts to senior citizens, children
Super-saver discounts on air travel
Rebate coupons on retail merchandise
Effective when the good or service
cannot be resold
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Types of Price
Discrimination
Perfect price discrimination
A firm that charges each buyer exactly his
or her reservation price
Hurdle method of price discrimination
The practice by which a seller offers a
discount to all buyers who overcome some
obstacle
A rebate that takes time and effort to mail in
Time spent waiting
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Benefits of Price
Discrimination
The number of trades increase
Brings output closer to the socially
efficient level
Reduces deadweight loss and increases
total economic surplus
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