Monopoly, Monopolistic Competition & Oligopoly Based on Ch. 21 & 22, Economics 9th Ed , R.A. Arnold

Introduction In Ch. 21 and 22 we look at three other types of market: monopoly, monopolistic competition and oligopoly. The characteristics and conditions of these markets are compared with perfect competition (the perfectly competitive market). Remember: A seller in the perfectly competitive market is a price taker and hence P = MR i.e. the demand curve and the marginal revenue curve are the same. Also, P = MC. This is not the case in other markets as we shall see…

Market Characteristics Monopoly (E.g. Water Supply Industry, Electricity Supply Industry, Railway Service) Single seller (the monopolist) Single seller sells a product for which there are no close substitutes High barriers to entry Monopolistic Competition (E.g. Fast food market, Hairdressing market) There are many sellers and buyers Each firm produces and sells a slightly differentiated product There is easy entry and exit Oligopoly (E.g. Telecommunication Industry, Aviation Industry) Few sellers and many buyers Firms producing either homogenous or differentiated products Significant barriers to entry

Pricing (P) and Output (Q) Decisions Monopoly Price searcher (a seller that has the ability to control to some degree the price of the product it sells) P > MR Produces Q at which MR = MC Hence, P > MC Monopolistic Competition Price searcher Oligopoly

Monopoly: Barriers to Entry In the next few slides we discuss the Monopoly Market (e.g. electricity supply and water supply markets; each has one seller DESCO and WASA) In case of a monopoly market it is (almost) impossible for new sellers to enter the market or industry i.e. extremely high barriers to entry. Why? Answer: 1) Legal Barriers (Public Franchise, Patents, Government Licence i.e. rules and restrictions that prevent new sellers from entering the market) and 2) Economies of Scale (Situation where low ATC is achieved from a large factory. Sometimes only one seller can achieve this and is called a natural monopoly. Large factory is costly so new sellers are less willing to enter the market - a barrier to entry).

Output and Price of a Monopolist The Monopolist (the one seller in the monopoly market) wants to maximize profit and hence produces the output Q1 at which MR = MC (where the MR and MC curves meet). The price can be found from the demand curve. The Monopolist will charge a price of P1 which is the highest price buyers are willing to pay for Q1 units. If P1 > ATC, The Monopolist may earn positive profit. The monopolist may make a loss as well if P1 < ATC.

Comparing Monopoly and Perfect Competition Here we are assuming the MC is constant and equal to ATC in both monopoly (M) and perfect competition (PC). D is the demand curve of both the markets and it is also the MR curve of perfect competition. Hence QPC is the output produced in the PC market and QM in the M market (MR = MC at these outputs in the respective markets). P = MC = PPC in PC market and in M market it is = PM.

Consumer Surplus in Monopoly (M) and Perfect Competition (PC) Consumer Surplus (CS) is a measure of the welfare of consumers (buyers). CS = maximum price buyers are willing to pay minus market price. It is equal to the area above the price and below the demand curve on the left of Q. Hence, in a monopoly the consumer surplus is equal to the area PMAC. In perfect competition it is equal to the area PPCBA. So we can see the consumer surplus (welfare of buyers) is greater in perfect competition as compared to monopoly i.e. Buyers benefit more from a perfectly competitive market.

Comparing Producer Surpluses The producer surplus may also be measured from the figure (last slide). Producer Surplus = price received minus minimum selling price, it is a measure of the welfare of producers (sellers) in a market. It is equal to the area below the price and above the ATC curve here on the left of Q. Hence, it is zero in perfect competition and it is equal to the area PCMDCPM in monopoly. Total Surplus (a measure of the welfare of society) = Consumer Surplus + Producer Surplus. As we can see total surplus in Monopoly (M) < total surplus of Perfect Competition (PC). The Deadweight Loss is given by the area DBC and is equal to total surplus of PC market minus total surplus of M market. It is a measure of the loss which the entire society incurs due to the monopoly output.

Continued In the last figure we saw the monopolist charges the same price PM for all its product (i.e the same price for each and every unit). But if the monopolist wants it can sell different units at different prices i.e. it can price discriminate and make more profit. Types of Price Discrimination: First-degree price discrimination i.e. it charges the maximum price that buyers are willing to pay for each and every unit of output. Second degree price discrimination occurs when a seller charges a uniform price per unit for one specific quantity and a lower price for additional quantities). Third degree price discrimination occurs when sellers charges different price in different market segments. E.g. Student discounts.

Monopolistic Competition Since in this market the sellers are selling slightly differentiated products (e.g. coke and pepsi) the sellers in this market are price searchers. They can control the price to some extent (e.g. coke may increase the price and even then some people will still buy coke since it is slightly different from other soft-drinks). If a seller is price searcher this implies P > MR. In the long run this market tends to approach zero economic profit (i.e. P = ATC) because of easy entry. Keeping these two points in mind we study the graph.

Excess Capacity Theorem The seller in the monopolistically competitive market (monopolistic seller) produces an output which is less than the output that minimizes ATC.

Oligopoly and The Cartel Theory There are a few sellers in a Oligopoly Market. It is possible that these few sellers may form a cartel: a group of sellers that reduce (market) output and increase (market) price to increase joint profits. E.g. This usually happens in Bangladesh during Ramadan (food price increases because suppliers reduce supply). Firms may benefit from cartel formation (more profit). But consumers will suffer (more price, less output). Hence, the government may ban cartel formation in certain industries.