MBMC Monopoly and Other Forms of Imperfect Competition Monopoly → Oligopoly → Monopolistic...

MB MC

Monopoly and Other Forms of Imperfect

Competition

Monopoly and Other Forms of Imperfect

Competition

Monopoly → Oligopoly → Monopolistic Comp.→ Perfect Comp.

MB MC

Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 2

Imperfect Competition

Imperfectly Competitive FirmsHave some control over priceLong-run economic profits are possible

* Perfectly competitive firms are price takers (have no control over prices), long-run economic profits are zero.

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Imperfectly Competitive Markets Reduce economic surplus to varying degrees Are very common

Perfect Competition An ideal market that maximizes economic surplus A situation that does not always exist

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Various Forms of Imperfect Competition

Pure Monopoly (most inefficient) The only supplier of a unique product with no close substitutes

Oligopoly (more efficient than a monopoly) A firm that produces a product for which only a few rival firms

produce close substitutes

Monopolistic Competition (closest to perfect competition) A large number of firms that produce slightly differentiated products

that are reasonably close substitutes for one another

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The Essential Difference Between Perfectly and Imperfectly Competitive FirmsThe perfectly competitive firm faces a

perfectly elastic demand for its product.The imperfectly competitive firm faces a

downward-sloping demand curve.

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In perfect competition Supply and demand determine equilibrium price. The firm

has no market power. At the equilibrium price, the firm sells all it wishes. (The

firm’s demand curve is the horizontal line at the market price.)

If the firm raises its price, sales will be zero.

With imperfect competition The firm has some control over price or some market

power. The firm faces a downward sloping demand curve.

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The Demand Curves Facing Perfectly and Imperfectly Competitive Firms

Quantity

$/u

nit

of

ou

tpu

t

Quantity

DMarket price P

rice

D

Perfectly competitive firm Imperfectly competitive firm

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Profit Maximization forthe Monopolist

For a producer to maximize profits:

select the output level that maximizes the difference between TR and TC, where

MB = MC.

MB = Marginal Revenue (MR) or a change in a firm’s total revenue that results from a one-unit change in output

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Marginal Revenue for the MonopolistPerfect competition and monopolies

Both increase output when MR > MC.Calculate MC the same way.Do not have the same MR at a given

price.

In perfect competition: MR = P

In monopoly: MR < P

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The Monopolist’s Benefit from Selling an Additional Unit

Pri

ce (

$/u

nit

)

Quantity (units/week)

D

8

8

2

6

3

5

• If P = $6, then TR = $6 x 2 = $12• If P = $5, then TR = $5 x 3 = $15• The MR of selling the 3rd unit = $3 (15-12)• For the 3rd unit, MR = $3 < P = $5

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Observations MR < P MR declines as quantity

increases MR is the change between

two quantities MR < P because price must

be lowered to sell an additional unit

6 2 12

5 3 15

4 4 16

3 5 15

P Q TR MR

3

1

-1

Marginal Revenue for Monopolist

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Pri

ce &

mar

gin

al r

even

ue

($/u

nit

)


6 2 12

5 3 15

4 4 16

3 5 15

P Q TR MR

3

1

-1

8

8

D

Marginal Revenue inGraphical Form

432-1

3

5

1

MR

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The Marginal Revenue Curve for a Monopolist with a Straight-Line Demand Curve

Pri

ce

QuantityObservations• The vertical intercept, a, is the same for MR and D• The horizontal intercept for MR, Q0/2, is one half the demand intercept, Q0.

D

Q0

a

Q0/2

a/2

MR

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Profit Maximizing Decision RuleWhen MR > MC, output should be increased.When MR < MC, output should be reduced.Profits are maximized at the level of output

for which MR = MC.

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The Monopolist’s Profit-Maximizing Output Level

Pri

ce (

$/u

nit

of

ou

tpu

t)


6

D

3

12 24

Marginal Cost

2

4

MR

8

Observations• If P = $3 & Q = 12 MR < MC

and output should be reduced

• Profits are maximized at 8 units where MR = MC

• P = $4 where quantity demanded = quantity supplied

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Even a Monopolist May Suffer an Economic Loss

Pri

ce (

$/m

inu

te)

Minutes (millions/day)

Pri

ce (

$/m

inu

te)

Minutes (millions/day)2420

0.12

0.10 ATC

20

0.08

0.10

ATC

loss= $400,000

profit= $400,000

D

0.05 MC

MR

D

0.05 MC

MR

Being a monopolist doesn’t guarantee an economic profit

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2

4

MR

8

• The profit maximizing level of output of 8 units, where MR = MC, is less than the socially optimal output of 12

• Between 8 and 12, MB to society > MC to society

• Cannot increase output because MR to the firms is less than MC

The Demand and Marginal Cost Curves for a Monopolist

Pri

ce (

$/u

nit

of

ou

tpu

t)


D

12

6

24

Why the Invisible Hand Breaks Down Under Monopoly

3

Marginal cost

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Monopoly Profits are

maximized where MR = MC.

P > MR P > MC Deadweight loss

Perfect Competition Profits are

maximized where MR = MC.

P = MR P = MC No deadweight loss

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Five Sources of Market Power

Exclusive control over inputs Patents and copyrights Government licenses or franchises Economies of scale (natural monopolies) Network economies

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Economies of Scale and the Importance of Fixed Costs

Firms with large fixed costs and low variable costs Have low marginal costsAverage total cost declines sharply as

output increasesThis is called Economies of scale.

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Economies of Scale due to fixed costs (constant V)

Ave

rag

e co

st (

$/u

nit

)

Quantity

To

tal c

ost

($/

year

)

Quantity

F

Q0

F + Q0

TC = F + MQ

Total cost rises at a constant rate as output rises

ATC = F/Q + M

M

Average costs decline and isalways higher than marginal cost

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Two Producers (an Example with Low Fixed Costs)

Nintendo Playstation

Annual production 1,000,000 1,200,000

Fixed cost $200,000 $200,000

Variable cost $800,000 $960,000

Total cost $1,000,000 $1,160,000

Average total cost per game $1.00 $0.97

V= $ 0.8/unitFixed costs are a relatively small share of total cost•Cost per unit is nearly the same

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Two Producers(an example with High Fixed Costs)

Annual production 1,000,000 1,200,000

Fixed cost $10,000,000 $10,000,000

Variable cost $200,000 $240,000

Total cost $10,200,000 $10,240,000



V= $ 0.2 / unit•Fixed costs are a relatively large share of total cost•Playstation has a $1.67 average cost advantage•Playstation can lower prices, cover cost, and attract customers

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Annual production 500,000 1,700,000

Fixed cost $10,000,000 $10,000,000

Variable cost $100,000 $340,000

Total cost $10,100,000 $10,340,000


Now, Playstation exploits its cost advantage and increases its sales


• Shift of 500,000 units to Playstation• Nintendo’s average cost increases to $20.20/unit• Playstation average cost falls to $6.08• A large number of firms cannot survive when the cost differential is high

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Economies of Scale and the Importance of Fixed Costs

Fixed investment in research and development has been increasing as a share of production costs.

Why does Intel sell the overwhelming majority of all microprocessors used in personal computers?

1984 20% 80%1990 80% 20%

Cost of producing a computerFixed Cost Variable Cost

Software Hardware

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2

4

MR

8

• Because MR < P, the monopoly produces less than the socially optimal amount

• The deadweight loss of the monopoly to society = (1/2)($2/unit)(4units/wk) = $4/wk.

Deadweight loss

The Demand and Marginal Cost Curves for a Monopolist

Pri

ce (

$/u

nit

of

ou

tpu

t)


D

12

6

24


3

Marginal cost

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Difficulties in Reducing the Deadweight Loss of MonopoliesProblems in enforcing antitrust lawsPatents, copyrights, and innovationNatural monopolies


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Price DiscriminationThe practice of charging different buyers

different prices for essentially the same good or service


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Examples of Price DiscriminationSenior citizens and student discounts on

movie ticketsSupersaver discounts on air travelRebate coupons

? Why do many movies offer discount tickets to students?


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Example: Total and MarginalRevenue from Editing

Reservation Price Total Revenue Marginal revenueStudent ($ per paper) ($ per week) ($ per paper)

A 40 40

B 38 76

C 36 108

D 34 136

E 32 160

F 30 180

G 28 196

H 26 208

40

36

32

28

24

20

16

12

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ExampleHow many manuscripts should Dijana edit?

Opportunity cost = $29TR = P x Q, or for 4 papers, 4 x $34 = $136/wkMR is the difference in TR from adding another

studentIf MR > MC: increase output


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Dijana edits 3 paperso TC = 3 x $29 = $87o TR = $108o Economic profit = $108 - $87 = $21/wko Accounting profit = $108

Opportunity cost = $29 Must charge the same price

Reservation price > opportunity cost for student A to F

Socially efficient number is 6o TR = 6 x $30 = $180o TC = 6 x $29 = $174o Economic profit = $180- $174 = $6o Accounting profit = $180

How many manuscripts should Dijana edit?

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ExampleIf Dijana can price discriminate, how many

papers should she edit?Assume Dijana can charge each student the

reservation price.


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Example

ReservationStudent

price

A 40

B 38

C 36

D 34

E 32

F 30

G 28

H 26

• Dijana would edit A to F• TR = $40 + $38… = $210• TC = 6 x $29 = $174• Economic Profit = $210 - $174 = $36/wk

• Economic Profit is $30 more

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Using Discounts to Expand the Market

Perfectly Discriminating MonopolistCharging each buyer exactly their

reservation priceEconomic surplus is maximizedConsumer surplus is zeroEconomic surplus = producer surplus

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Limitations to Perfect Price DiscriminationSeller will not know each buyer’s

reservation price.Low-price buyers could resell to other

buyers at a higher price.


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The Hurdle Method of Price DiscriminationProfit-maximizing seller’s goal is to charge

each buyer his/her reservation price.


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The Hurdle Method of Price DiscriminationThere are two problems to implementing

this pricing strategy.Seller does not know the reservation pricesSeller must separate high and low price buyers

The hurdle method of price discrimination is used to solve these problems.


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The Hurdle Method of Price DiscriminationThe practice involves offering a discount to

all buyers who overcome some obstacle.Example

Offering a rebate to those who mail in a couponWhy might an appliance retailer instruct its

clerks to hammer dents into the sides of its stoves and refrigerators?


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Is price discrimination a bad thing?No. It raises economic surplus.

Price Discrimination and Economic Efficiency

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Examples of Price Discrimination(Seasonal) SalesBook publishers and paperback booksAutomobile producers offer various modelsCommercial air carriersMovie producers


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SummarySingle price monopolies are inefficient

because

P > MR.The hurdle method of price discrimination

reduces the inefficiency.The more finely the seller can discriminate,

the smaller the efficiency loss.


MBMC Monopoly and Other Forms of Imperfect Competition Monopoly → Oligopoly → Monopolistic...

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