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Imperfect Competition Occurs when firms in a market or industry have some control over the price of their output Monopoly, Oligopoly, and Monopolistic Competition 1 Pure Monopoly • An industry with a single firm that produces a product for which there are no close substitutes, and • where significant barriers to entry prevent other firms from entering the industry to compete for profits. 2 Barriers to Entry • Government franchises • Patents and Copyright laws • Economies of scale and other cost advantages – Natural Monopoly (Water, electricity) • Ownership of a scarce factor of production – The De Beers Diamond Company 3 Firms in a Perfectly Competitive Market Take the market price as a given and decide: • How much output to produce • How to produce output (what combination of labor and capital to use) • How much to demand in each input market (How many workers to hire) 4 Monopolists must decide: • How much output to produce • How to produce output • How much to demand in each input market • What price to charge for output 5 Price and Output Decisions in Pure Monopoly Markets Basic assumptions: • Entry to the market is strictly blocked. • Firms act to maximize profits. • The monopolistic firm cannot price discriminate. – Must charge only ONE price. • The monopoly faces a known demand curve. 6 Consider this hypothetical data for a demand curve: Quantity Price 0 11 1 10 2 9 3 8 4 5 6 7 8 Can you7 calculate total 6 and marginal 5 revenue for the firm?4 Total Revenue Marginal Revenue P x Q DTR /DQ 3 9 2 10 1 7 MR decreases when In Perfect Quantity Price Total Q increases Competition Revenue P = MR 0 11 0 X 1 10 10 X 2 9 18 X As Price 3decreases, 8 24 Sell more 7 4 increase, 28 TR units a by 5 reach 6 30 reducing maximum 6 5 Price 30 > MR price (30) and 7 then 4 28 8decrease 3 24 9 2 18 10 1 10 = = = DTR/DQ Marginal Revenue 10/1 = 10 8/1= 8 6/1= 6 4/1= 4 2/1= 2 0/1= 0 -2/1= - 2 -4/1= - 4 -6/1= - 6 -8/1= - 8 Price per unit ($) We can plot demand and marginal revenue as follows: 12 10 8 6 4 2 0 -2 0 -4 -6 -8 Market Demand 1 2 Marginal Revenue 3 4 5 6 7 8 9 10 MR<Price Adding the total revenue curve: 30 25 TR Max MR = zero 20 15 10 TR 5 Demand 0 -5 0 -10 1 2 3 4 5 6 7 8 9 10 MR Units of output Q 10 The monopolist’s profitmaximizing output and price: Choose Q such that MR = MC The maximum price this monopolist can charge for Q units is P. $ MC P ATC Go up to the demand curve to set the price D Q MR Q 11 The monopolist’s profit-maximizing output and price TC = ATC x Q Profit = TR - TC MC ATC Pm Profit TR = P x Q ATC TR TC D Q Qm MR 12 Monopolist Sets Price Above MC This markup over MC $ Price > MC To find a firm that has market power: $P Look for firms that charge a price that $ATC is higher than their MC of production $MC is the signature of a monopolist MC ATC This is the “mark-up” above cost resulting from monopoly’s market power D Qm MR Q 13 In Monopoly... • The monopolist has no supply curve; there is no unique relationship between price and quantity supplied. • Since entry is blocked, the monopolist can earn economic profits in the long run. • Monopolists can have losses in the short run if demand is not sufficient or if costs are too high. 14 Comparison of Monopoly and Perfect Competition $ MC Pm=$4 Ppc=$2 MR These are theabove Price Sum of MC Monopolist restricts and Quantity under AVC for all firms in a output and charges PerfectPerfectly Competition a higher price than Competitive industry under Perfect = Market Supply Competition D 2000 Qm 4000 Qpc Units of output, Q 15 Natural Monopoly An industry where the technological advantages of large-scale production allow a single firm to produce at a lower cost than many smaller companies. 16 S MC ATC1 5 This Demand can be supplied 40 Firms selling 400,000 by many perfectly competitive units at $5/unit firms each with a small plant of size ATC1 ONE firm selling Or Demand can be supplied 500,000 units atby ONE firm with a large plant of $3/unit size ATC5 3 MC ATC5 D 10,000 400,000 500,000 D Government Monopolies Since a large firm can supply the entire market at a lower cost, governments have two choices: • Allow a private monopoly to exist under government regulation or • Government ownership of the industry. – Most public services are state owned monopolies in most countries. 18 The Social Costs of Monopoly • Prices are higher when a market is monopolized than when it is perfectly competitive. • Output is lower when a market is monopolized than when it is perfectly competitive. • Some consumer surplus is reallocated to producers when a market is monopolized. • Some consumer surplus is lost when a market is monopolized. 19 Consumer surplus in a Perfectly Competitive market: Consumer Surplus MC Ppc=$2 D MR 4000 Qpc Units of output, Q 20 Consumer surplus in a monopoly market: $ Consumer Surplus Pm=$4 MC Ppc=$2 D MR 2000 Qm 4000 Qpc Units of output, Q 21 Producer Surplus under Perfect Competition MC CS Lost CS Ppc=$3 PS PS D 2000 Qm 4000 MR Qpc 22 Producer Surplus Under Monopoly MC CS Ppc=$4 Lost CS PS D 2000 Qm 4000 MR Qpc 23 Perfect Competition $ MC CS Ppc=$2 PS D MR 4000 Qpc 24 Q Monopoly Ppc=$4 MC CS Lost CS PS D 4000 Qpc 25 Lost Consumer Surplus due to Monopoly MC CS Pm=$4 D 2000 Qm 4000 MR Qpc 26 Q Part of the Consumer’s Loss becomes Producer’s Surplus MC CS Ppc=$4 PS CS LOST Lost D 2000 Qm 4000 MR Qpc 27 Q Part of the Producer’s Surplus is Lost MC CS Ppc=$4 Lost CS PS Net Loss PS D 2000 Qm 4000 MR Qpc 28 Q What would happen if the Monopolist Price Discriminates? MC P1 P2 P3 P4 Lost CS becomes PS Lost CS P1xQ1 D Q1 Q2 Q3 Q4 MR 29 When Monopolist Price Discriminates There is No Net Loss to Society 30 Price Discrimination • Airline Tickets – Weekend Stay tickets cheaper • Movie Tickets – Senior Citizen Discount • Groceries – Supermarket Coupons • Tuition – Scholarships • Books – Hardcover vs. Soft cover 31