09 monopoly, oligopoly and monopolistic competition
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7/18/2019 09 Monopoly, Oligopoly and Monopolistic Competition
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Monopoly, Oligopoly
and MonopolisticCompetition
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Copyright c 2007 by The McGraw-HillCompanies, nc! "ll rights reser#ed!
$earning Ob%ecti#es
1. Define imperfect competition and compare it to perfectcompetition
2. Define market power and explain how it affects the demandcurve facing the firm
3. Understand and use marginal cost and marginal revenue tomaximize monopolist's profit
4. xplain how start!up costs affect economies of scale andmarket power
". #how how monopol$ alters economic surplus compared toperfect competition
%. Descri&e price discrimination and its effects
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +
Maret *trctres
e know that in realit$( perfect competition( in itsideal text!&ook form( is rare.
hat is far more common are firms with somedegree of market power )power to set prices*. +arket
,ower is a measure of a firm-s a&ilit$ to raise theprice of a good without losing all its sales.
n economics we define market structures &asedmainl$ on the following two dimensions/0um&er of producers in the market )one( few( or( man$*
hether goods produced are homogeneousordifferentiated
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .
Maret *trctres
omogeneous ! dentical Differentiated the goods are similar &ut are
not perfect su&stitutes in the consumer-s mind
)differentiated &$ ualit$( packaging(advertising( etc*
hether a market sells differentiated goods or
homogeneous goods depends on the natureof the good and consumer-s preferencesreakfast cereals versus hammers5
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide /
Maret *trctres
6hus we have one perfectl$ competitive andthree mperfectl$ competitive market forms/
,erfect 7ompetition )homogeneous( man$*
mperfect 7ompetition+onopolistic 7ompetition )differentiated( man$*
8ligopol$ )differentiated9homogeneous( few*
,ure +onopol$ )one firm*
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide
1i))erent (orms o) Competition (rom 3rgman and 4ells
5ot "pplicable
Oligopoly
Monopoly
6er)ect Competition MonopolisticCompetition
How Many6rodcers
Many
(ew
One
"re 6rodcts 1i))erentiated
8es5o
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 7
1i))erent (orms o) mper)ectCompetition
,ure +onopol$ )most inefficient*6he onl$ supplier of a uniue product with no
close su&stitutes
+onopolistic 7ompetition )closest to perfect
competition*: large num&er of firms that produce slightl$
differentiated products that are reasona&l$ close
su&stitutes for one another;ong!run ad
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 9
1i))erent (orms o) mper)ectCompetition
8ligopol$ )t$picall$ more efficient than amonopol$*ndustr$ structure in which a small num&er of
large firms produce products that are eitherclose or perfect su&stitutes
omogeneous )wireless phone service( cement*and differentiated )automo&ile( cigarettes(
detergents* products.
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide :
mper)ect Competition ;s!6er)ect Competition
ith perfect competition/ f the firm raises its price( sales will &e zero.0o incentive to charge a lower price &ecause it can sell
as man$ units as it wants at the current price.
6he firm-s demand curve is the horizontal line at themarket price. t is a price taker.
ith imperfect competition/ 6he firm has some control over price or market power.
f it raises market price( it will not lose all its customers. f it reduces price( it will add customers.
6he firm faces a downward sloping demand curve. t is aprice maker.
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide &0
The 1emand Cr#es (acing 6er)ectlyand mper)ectly Competiti#e (irms
nito)otpt
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide &&
*orces o) Maret 6ower
1. xclusive control of a scarce resource or inputDe eers of #outh :frica a near monopol$= :rediamonds rare> ?em ualit$ diamonds are morecommon than other gem ualit$ colored stones.
2. ?overnment ;icenses or @ranchises lodging and concession operation at 0ational ,arks
3. ,atents and 7op$rights )Drug companies(:uthors*
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide &2
More ?ndring *orces o)Maret 6ower
4. conomies of #cale ! 0atural +onopolies,roduction of electricit$( natural gas( etc. hen natural
gas companies initiall$ started there was competition.ut large fixed costs gave the firm that sold the most the
lowest :67. 0etwork conomies )a product-s ualit$ increases
as the num&er of users increase i.e.( sales volumeincrease* another form of economies of scale+icrosoft( e&a$( @ace&ook( etc.
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07>02>&/*deshna C!Bandyopadhyay
&+
@etrns to *cale
Aeturns to scale is a long run phenomenon. :llinputs are changed in the same proportion.
f output more )less* than dou&les when all
inputs are dou&led( the production function issaid to exhi&it ncreasing )Decreasing* returnsto scale.
f output dou&les when all inputs are dou&led(the production function is said to exhi&it7onstant returns to scale.
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Units ofLabor (L)
@etrns to *cale and $@"TC
Units ofCapital(K)
TotalCost(TC)
OutputunderIRS
OutputunderDRS
OutputunderCRS
1 1 $150 1010 10
2 2 $300 30 15 20
W=$5 and r=$!
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ncreasingretrns
to scale
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07>02>&/*deshna C!Bandyopadhy&
4hy ?conomies o) *cale
#pecialization and Division of la&or $ieldsefficienc$.
+ass production reduces average costs sincethe large set up costs are spread over a largeamount of output. 8nce production is
esta&lished( +7 is ver$ low. xperience leads to Blearning &$ doingC andleads to improvements in efficienc$.
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07>02>&/
*deshna C!
Bandyopadhyay
4hy 1is-economies o) *cale
s there an$thing called Btoo largeC in terms offactor$ size or size of operations>
es. e$ond a certain point &ureaucratic and
managerial inefficiencies creep in. 7ook &ookprocedures replace managerial &rilliance.7oordinating a large la&or force &ecomes
prohi&itivel$ expensive.
&7
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide &9
?conomies o) *cale and themportance o) *tart-Ap Costs
@irms with large fixed costs and low varia&le costs an$ production process that entails large pre!investments in research and development arecharacterized &$/
;arge start up costs;ow marginal costs
:verage total cost declines sharpl$ as output
increases conomies of scale ncreasing returns to scale.
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?conomies o) *cale and *tart-ApCosts
0ew products can have a large fixed developmentcosts
f marginal cost is constant( +arginal cost )+* E:verage varia&le cost
6otal cost is fixed cost )@* plus varia&le cost67 E @ F )+* )G*
6otal cost increases as output increases
:verage total cost is:67 E @ 9 G F +
:verage total cost decreases as output increases
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 20
Total and "#erage Total Costs )or a6rodction 6rocess with ?conomies o) *cale
"#eragecost
B=>nit
ye
ar
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 2&
?conomies o) *cale and themportance o) *tart-Ap Costs
7ost advantages from economies of scaledepends on how large the fixed cost is inrelation to marginal cost.
xample 1/0intendo and ,la$station each have fixed costs of
H2II(III and constant +7E HI.JI per game.
0intendo produces 2IK fewer copies of the videogame compared to ,la$station
3 cent difference in :67 &ecause 6@7967 issmall.
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 22
?conomies o) *cale and themportance o) *tart-Ap Costs
xample 2/0intendo and ,la$station each have fixed costs
of H1I(III(III and constant +7E HI.2I per
game.0intendo produces 2IK fewer copies of the
video game compared to ,la$station
H1.%L difference in :67 &ecause 6@7967 is high.
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 2+
Costs )or Two Compter Game 6rodcers& *mall T(C>TC
5intendo 6laystation
"nnalprodction &,000,000 &,200,000(iDed cost =200,000 =200,000
;ariable cost =900,000 =:0,000
Total cost =&,000,000 =&,&0,000
"#erage total cost per game =&!00 =0!:7
Obser#ationsM(iDed costs are a relati#ely small share o) total costMCost>game is nearly the same
Constant MC = $0.80
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 2.
Costs )or Two Compter Game 6rodcers2 $arge T(C>TC
"nnalprodction &,000,000 &,200,000
(iDed cost =&0,000,000 =&0,000,000;ariable cost =200,000 =2.0,000
Total cost =&0,200,000 =&0,2.0,000
"#erage total cost per game =&0!20 =9!/+
5intendo 6laystation
M(iDed costs are a relati#ely large share o) total costM6laystation has a =&!7 a#erage cost ad#antageM6laystation can lower prices, co#er cost, and attractcstomers
Constant MC = $0.20
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 2/
?conomies o) *cale and themportance o) *tart-Ap Costs
xample 3/ith a H1.%L advantage in :67( ,la$station is
a&le to get a larger market share.
7ost advantage to ,la$station &ecomes larger. xplains wh$ $ou would expect to see
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 2
"nnalprodction /00,000 &,700,000
(iDed cost =&0,000,000 =&0,000,000
;ariable cost =&00,000 =+.0,000Total cost =&0,&00,000 =&0,+.0,000
"#erage total cost per game =20!20 =!09
Costs )or Two Compter Game 6rodcers+ *el) @ein)orcing Cost "d#antage
5intendo 6laystation
M*hi)t o) /00,000 nits to 6laystationM5intendoEs a#erage cost increases to =20!20>nitM6laystation a#erage cost )alls to =!09M" large nmber o) )irms cannot sr#i#e when the costdi))erential is high
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 27
?conomic 5atralist
h$ does ntel sell the overwhelmingma
6he fixed investment needed to produce anew leading edge micro!processor isupwards of H2 &illion while the marginal costis
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 29
6ro)it MaDimiFation )or the Monopolist
: monopolist maximizes profits &$ setting+AE+7
6he :A is falling= so +AN:A
6his implies ,O+AE+7 in euili&rium. uili&rium is inefficient.
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide 2:
The Marginal @e#ene Cr#e )or aMonopolist with a *traight-$ine 1emand Cr#e
6ric
e
1
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +0
The MonopolistEs 6ro)it-MaDimiFing Otpt$e#el
6riceB=>nito)o
tpt
wee
+
&2 2.
Marginal Cost
2
.
MR
9
Obser#ationsM ) ! = =+ Q = &2 MR "MC and otpt sholdbe redced
M6ro)its are maDimiFed
at 9 nits where MR =MC
M! = =. where antitydemanded I antityspplied
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +&
?lasticity o) 1emand and Monopoly
: monopolist-s +A is less than the price this is the essential source of themonopolist-s power. ow much less>Depends on the price elasticit$ of demand.
: monopolist that faces a highl$ elasticdemand curve will &ehave a lot like aperfectl$ competitive industr$.:mtrak has a monopol$ in intercit$ passenger service in
the 0orth!east corridor and $et is not a&le to raise prices&$ restricting service ver$ effectivel$. ?ood su&stitutes cars( planes
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +2
?#en a Monopolist May*))er an ?conomic $oss
6riceB=>min
te
Mintes millions>day
6riceB=>min
te
Mintes millions>day
2.20
0!&2
0!&0 ATC
20
0!090!&0
ATC
?conomic lossI =.00,000>day
?conomic pro)itI =.00,000>day
0!0/ MC
MR
0!0/ MC
MR
Being a monopolist doesnEt garantee an economic pro)it
MB MC
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide ++
+
&2
2.
Marginal cost
The socially optimalamont occrs whereMC = M# J &2 nits
The 1emand and Marginal CostCr#es )or a Monopolist
6riceB=>nito)o
tpt
wee
4hy the n#isible Hand Breas 1own Ander Monopoly
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +.
2
.
MR
9
MThe pro)itmaDimiFing le#elo) otpt o) 9nits, where MR
= MC,is lessthan the sociallyoptimal otpt o)&2
MBetween 9 and&2, M#to society
K MC to societyMCannot increaseotpt becaseMR to the )irmsis less than MC
The 1emand and Marginal CostCr#es )or a Monopolist
6riceB=>nito)o
tpt
wee
&2
2.
4hy the n#isible Hand Breas 1own Ander Monopoly
+
Marginal cost
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +/
2
.
MR
9
MBecase MR " !,the monopolyprodces less thanthe socially optimal
amontMThe deadweightloss o) themonopoly tosociety I &>2=2>nit.nits>wI =.>w!
1eadweight loss
The 1emand and Marginal CostCr#es )or a Monopolist
6riceB=>nito)o
tpt
wee
&2
2.
4hy the n#isible Hand Breas 1own Ander Monopoly
+
Marginal cost
MB MC Asing 1isconts to ?Dpand the
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +
f the monopolist could reduce the price&elow H4 for output sold &e$ond J units( itwould want to expand output closer to theefficient level of 12 units and would have
increased its profits &$ doing so. #ometimes monopolists do that through
,rice Discrimination6he practice of charging different &u$ers different
prices for essentiall$ the same good or service
Asing 1isconts to ?Dpand theMaret
MB MC 6rice discrimination nder
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07>02>&/ *deshna C!Band o adh
+7
6rice discrimination ndermonopoly
e have price discrimination when a monopolist/ charges a different price to different consumers even
when the cost of suppl$ing each consumer is the same.xample discount airfares( discounts on movie tickets
for students and seniors( re&ate coupons.
7harges the same price when the cost of suppl$ingdifferent consumers is different. xample mailing
letters to oston vs. 7hicago sa$ from #t ;ouis.
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +9
h$ do man$ movie theaters offer discount ticketsto students>
6he goal is to get &u$ers who would not &u$without the discount. #tudents have a lower A,
compared to older working adults. 6heater ownersexpand their clientele &$ offering tickets to studentsat a discount. 6here is also no risk )&ecause ofverifia&le Ds* that a student would &u$ the ticket
for a low price and re!sell it to a non!student for ahigher price and pocket the difference.
?conomic 5atralist
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide +:
7arla supplements her income as a 6: &$editing term papers for undergrads. 6hereare J students for whom she might edit andher reservation prices are given on the next
ta&le. 7arla is a profit maximizer. 6he 87 of her
time to edit each paper is H2P.
:ssume that 7arla must charge the sameprice to ever$ &u$er.
6rice 1iscrimination
MB MC
T t l d M i l
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .0
Total and Marginal@e#ene )rom ?diting
@eser#ation 6rice Total @e#ene Marginal re#ene*tdent = per paper = per wee = per paper
A .0 .0
# +9 7
C + &09
+. &+
+2 &0
F +0 &90
% 29 &:
& 2 209
.0
+
+2
29
2.
20
&
&2
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .&
f 7arla maximizes profits( how man$manuscripts should 7arla edit>7ompare +A with 87 of H2P.
7arla will edit 3 papers.
TR = 3 x H3% E H1IJ9wk
TC = 3 x H2P E HJL9wk
conomic profit E H219wk
:ccounting profit E H1IJ9wk as 7arla-s explicitcost E I.
Asing 1iscontsto ?Dpand the Maret
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .2
hat is the sociall$ efficient num&er of manuscriptsfor 7arla to edit( if she must still charge the sameprice to ever$ &u$er>
8pportunit$ cost E H2P
Aeservation price O opportunit$ cost forA to F#ociall$ efficient num&er is %
TR = % x H3I E H1JI
TC = % x H2P E H1L4conomic profit E H1JI ! H1L4 E H%
:ccounting profit E H1JI
Asing 1iscontsto ?Dpand the Maret
MB MC
A i 1i t
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .+
f 7arla can price discriminate( how man$ papersshould she edit if she wants to maximize herprofits>
:gain Aeservation ,rice O 87 forA to F
,rofit maximizing uantit$ is %TRE H4I F H3J F 3% F 34 F 32 F 3I E H21I9wk
TCE H2P x % E H1L4
conomic profit E H3%9wk( H3I more than thesociall$ efficient euili&rium and HP more thanher private profit maximizing euili&rium &ut w9oprice discrimination.
Asing 1iscontsto ?Dpand the Maret
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide ..
6er)ect 6rice 1iscrimination
: monopolist that charges each &u$er exactl$his9her A, is called a ,erfectl$ Discriminating+onopolist.Under perfect price discrimination( the private
profit maximizing euili&rium is exactl$ thesociall$ efficient euili&rium. #o( economicsurplus is maximized.
:ll consumers willing to pa$ a price high enoughto cover +7 will &e served.
7onsumer surplus is zero= conomic surplus Eproducer surplus.
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide ./
n realit$( perfect price discrimination can neveroccur &ecause
#eller will not know each &u$er-s reservationprice.
ven if &u$ers A, is pu&lic knowledge( low price&u$ers could alwa$s resell to other &u$ers at ahigher price and capture a part of the producers-surplus.
mperfect price discrimination is widespread.
6he hurdle method of ,D is aimed at solving thesepro&lems
$imitations to 6rice 1iscrimination
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .
6he hrdle methodof price discrimination isthe practice of offering a discount to all&u$ers who overcome some o&stacle.Ae&ate coupons
6emporar$ #ales
7ommercial airline tickets
ard cover and paper&ack &ooks
7ars with optional add!ons#cratch and Dent appliance sales
+ovies with phased releases
Hrdle Method o) 6rice 1iscrimination
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .7
: ,erfect urdle#eparates &u$ers precisel$ according to
their reservation prices
6he$ don-t exist in realit$.ow much should 7arla charge for
editing if she uses a perfect hurdle>
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .9
:ssume7arla must charge the same price to ever$one
7arla offers a mail in re&ate coupon
#tudents with at least a H3% reservation price
never use the coupon#tudents with a reservation price &elow H3%
alwa$s use the coupon
8pportunit$ cost E H2P
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6rice 1iscrimination
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide .:
6rice 1iscriminationwith a 6er)ect Hrdle
@eser#ation 6rice Total @e#ene Marginal re#ene
*tdent = per paper = per wee = per paper
A .0 .0
# +9 7
C + &09
+. +.
+2 .
F +0 :0
% 29 &&2
& 2 &+0
.0
+
+2
$ist 6rice *bmaret
1iscont 6rice *bmaret
+.
+0
2
22
&9
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide /0
;ist price su&market7arla will service all three students as the +A is
greater than the +7 of H2P. uili&rium priceEH3% )lowest :A of group*
Discount price su&market7arla will onl$ serve students D and . @or
ever$one else +7 is greater than +A.
uili&rium price is H32#o( charge H3% and allow a re&ate coupon for
H4
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide /&
ith ,rice Discrimination/TR = )3*)3%* F )2*)32* E H1L2
TC = )H"*)H2P* E H14"
conomic ,rofit E H2L9wk= 6his is H% more than
ithout ,rice Discrimination#erve students :( and 7 onl$.
TR = )3*)3%* E H1IJ
TC = )H3*)H2P* E HJL
conomic ,rofit E H219wk
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6 i 1i i i ti B d
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
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6he hurdle method raised economic surplus)consumers- and producers- surplus*.
7# and ,# are &oth greater under the hurdlemethod of price discrimination than whenthere is no price discrimination.
s 6rice 1iscrimination Bad
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Chapter &0' Monopoly and Other (ormso) mper)ect Competition
*lide /+
urdle ,rice Discrimination/:( and 7 pa$ H3%= D and pa$ H32.
7# E :/ )4I!3%* F / )3J 3%* F 7/ )3% 3%* F D/ )34 32* F / )32 32* E HJ
,# E 3x)3% ! 2P* F 2)32 2P* E H21 F H% E H2Lconomic #urplus E HJ F H2L E 3"9wk
ithout ,rice Discrimination#erve students :( and 7 onl$.
7# E :/ )4I3%* F / )3J!3%* F 7/ )3%3%* E H%,# E 3x)3%!2P* E H21
conomic #urplus E H% F H21 E 2L9wk
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CarlaLs Choices
6rogram#ocial
8ptimum
6apers ?dited %
6rice H3I
Total @e#ene H1JI
Total Cost H1L4
?conomic 6ro)it H%
?conomic *rpls H3%
urdle
" E )3 F 2*
H3%( H4re&ate
H1L2
H14"
H2L
H3"
,erfectDiscriminator
%
Aeservation
H21I
H1L4
H3%
H3%
#ingle,rice
+onopol$
3
H3%
H1IJ
HJL
H21
H2L
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*lide //
#ummar$#ingle price monopolies are inefficient &ecauseP > MC (=MR).
6he hurdle method of price discrimination
reduces the inefficienc$.6he more finel$ the seller can discriminate( the
smaller the efficienc$ loss.
urdles are not perfect( therefore( there will &esome efficienc$ loss.
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*lide /
h$ might an appliance retailer instructits clerks to hammer dents into thesides of its stoves and refrigerators>
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?nd o)
Chapter
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