Imperfect Competition Unit 4: Imperfect Competition FOUR MARKET STRUCTURES Imperfect Competition Perfect Competition Pure Monopoly Monopolistic Oligopoly 1

Memorizing vs. Learning 12-35711131-71923 Try memorizing the above number How effective is memorizing it? The point: If you try to MEMORIZE all the graphs of economics you will forget them. You must LEARN them! Trick: The number is made up of the first ten prime numbers

Imperfect Competition FOUR MARKET STRUCTURES Imperfect Competition Perfect Competition Pure Monopoly Monopolistic Oligopoly Every product is sold in a market that can be considered one of the above market structures. For example: Fast Food Market The Market for Cars Market for Operating Systems (Microsoft) Strawberry Market Cereal Market

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5 Characteristics of a Monopoly 1. Single Seller One firm controls the vast majority of a market The firm IS the Industry 2. Unique good with no close substitutes 3. “Price Maker” The firm can manipulate the price by changing the quantity it produces (ie. shifting the supply curve to the left). Ex: California electric companies 4. High Barriers to Entry New firms can NOT enter market No immediate competitors Firm can make profit in the long-run 5. Some “Nonprice” Competition Despite having no close competitors, monopolies still advertise their products in an effort to increase demand. 5

Examples of Monopolies What do you already know about monopolies? True or False? All monopolies make a profit. Monopolies are usually efficient. All monopolies are bad for the economy. All monopolies are illegal. Monopolies charge the highest price possible The government never prevents monopolies from forming. All are False 6

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4 types of monopolies Geographical Government Technological Natural

4 types of monopolies Geographical Technological Government Natural Location or control of resources limits competition and leads to one supplier. Ex: Nowhere gas stations, De Beers Diamonds, San Diego Chargers, Cable TV, Qualcomm Hot Dogs…

4 types of monopolies Technological Geographical Technological Government Natural Location or control of resources limits competition and leads to one supplier. Patents and widespread availability of certain products lead to only one major firm controlling a market. Ex: Nowhere gas stations, De Beers Diamonds, San Diego Chargers, Cable TV, Qualcomm Hot Dogs… Ex: Microsoft, Intel, Frisbee, Band-Aide…

4 types of monopolies Government Geographical Technological Government Natural Location or control of resources limits competition and leads to one supplier. Patents and widespread availability of certain products lead to only one major firm controlling a market. Government allows monopoly for public benefits or to stimulate innovation. The government issues patents to protect inventors and forbids others from using their invention. (They last 20 years) Ex: Nowhere gas stations, De Beers Diamonds, San Diego Chargers, Cable TV, Qualcomm Hot Dogs… Ex: Microsoft, Intel, Frisbee, Band-Aide… Ex: water company, firefighters, the army, pharmaceutical drugs, rubix cubes…

4 types of monopolies Natural Geographical Natural Government Technological Government allows monopoly for public benefits or to stimulate innovation. The government issues patents to protect inventors and forbids others from using their invention. (They last 20 years) Economies of scale make it impractical to have smaller firms. Natural Monopoly- It is NATURAL for only one firm to produce because they can produce at the lowest cost. Location or control of resources limits competition and leads to one supplier. Patents and widespread availability of certain products lead to only one major firm controlling a market. Ex: water company, firefighters, the army, pharmaceutical drugs, rubix cubes… Ex: Electric Companies (SDGE) If there were three competing electric companies they would have higher costs. Having only one electric company keeps prices low Ex: Microsoft, Intel, Frisbee, Band-Aide… Ex: Nowhere gas stations, De Beers Diamonds, San Diego Chargers, Cable TV, Qualcomm Hot Dogs…

Drawing Monopolies Good news… Only ONE graph because the firm IS the industry. The cost curves are the same The MR=MC rule still applies Shut down rule still applies 13

THE MARGINAL REVENUE DOES NOT EQUAL THE PRICE! The Main Difference Monopolies (and all imperfectly competitive firms) have downward sloping demand curve. Which means, to sell more a firm must lower its price. This changes MR… THE MARGINAL REVENUE DOES NOT EQUAL THE PRICE! 14

Combine the Demand of an industry with the costs of a firm. MR < Demand What about MR? MC ATC Costs (dollars) D MR Quantity

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $8 $7 $6 $5 $4 16

Why is MR less than Demand? MR IS LESS THAN PRICE P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $8 $7 $6 $5 $4 17

Why is MR below Demand? How many units can be sold for a price of $100? As price decreases from $100 to $90... P Revenue will increase with the additional unit sold. But a lower price results in a loss of the $30 that was earned when price was $10 higher. Marginal Revenue is ADDITIONAL REVENUE =? = $360-$300 = $60 = $90-$30 $100 90 60 40 Loss=$30 Gain $90 D TR=$360 TR=$300 Q 0 1 2 3 4 5

This is why MR is below Demand MR CURVE IS LESS THAN DEMAND CURVE!!! Why is MR below Demand? This is why MR is below Demand P As price continuously decreases from $90 to $80, Revenue will… Increase How about the loss, gain & MR? MR = $400-$360 = $40 = $80-$40 $100 90 80 60 40 Loss=$40 Gain $80 D TR=$400 TR=$360 MR Q 0 1 2 3 4 5

Calculating Marginal Revenue

Calculate TR and Marginal Revenue Quantity Price TR MR $16 - 1 15 2 14 3 13 4 12 5 11 6 10 7 9 8 Quantity Price TR MR $16 - 1 15 2 14 28 3 13 39 4 12 48 5 11 55 6 10 60 7 9 63 8 64 Quantity Price TR MR $16 - 1 15 2 14 28 13 3 39 11 4 12 48 9 5 55 7 6 10 60 63 8 64 -1 -3 Quantity Price TR MR $16 - 1 15 2 14 28 13 3 39 11 4 12 48 9 5 55 7 6 10 60 63 8 64 -1 -3 21

What happens to TR when MR hits zero? Demand & MR Curves Plot the Demand, MR & TR Curves What happens to TR when MR hits zero? $15 10 5 Dollars D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 MR $64 40 20 When MR goes negative, TR will fall Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12

Elastic vs. Inelastic Range of Demand Curve 23

A monopoly will only produce in the elastic range Elastic vs. Inelastic Range $200 150 100 50 Elastic Inelastic Total Revenue Test If price & TR demand is… Dollars ELASTIC D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 MR $750 500 250 Total Revenue Test If price & TR demand is… Dollars A monopoly will only produce in the elastic range INELASTIC TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14

How much is the TR, TC and Profit or Loss? What output should this monopoly produce? Maximizing Profit MR = MC How much is the TR, TC and Profit or Loss? $9 8 7 6 5 4 3 2 Q 0 1 2 3 4 5 6 7 8 9 10 Price Conclusion: A monopolists produces where MR=MC, but charges the price consumer are willing to pay identified by the demand curve. MR D MC ATC Profit =$6

How much is the TR, TC and Profit or Loss? What if cost is higher? How much is the TR, TC and Profit or Loss? ATC MC Q 0 1 2 3 4 5 6 7 8 9 $90 80 70 60 50 40 30 20 10 AVC D MR Costs Loss Price Minimum AVC is shut down point

Price, costs, and revenue Quiz Time TR = TC = Profit/Loss = Profit/Loss per Unit = ----------------- $780 ----------------- $600 ---------- $180 --- $30 Q 0 1 2 3 4 5 6 7 8 9 Price, costs, and revenue D MR $175 150 125 100 75 50 MC ATC $130 $110 Profit=$180 TR=$780 TC=$600

Are Monopolies Efficient?

Efficiency of Perfect Competition CS and PS of a Perfect Competition S = MC P An industry in perfect competition sells where supply & demand are equal CS Pc PS D Q Qc

Monopolies underproduce & over charge, decreasing CS & increasing PS. INEFFICIENCY OF MONOPOLY Monopolies underproduce & over charge, decreasing CS & increasing PS. CS and PS of a Monopoly Result is DEADWEIGHT LOSS to society S = MC P MR At MR=MC, A monopolist will produce less and charge higher price CS Pm Qm Pc PS D Q Qc

Graphically it is where… Graphically it is where… MONOPOLIES AND EFFICIENCY Productive Efficiency The production of a good in a least costly way. (minimum amount of resources are being used) Graphically it is where… Price = Minimum ATC Allocative Efficiency The apportionment of resources towards the production of products most wanted by society (as measured by their price). Graphically it is where… Price = MC

Price, costs, and revenue Are Monopolies Efficient? Does Price = Minimum ATC? Monopolies are NOT productive efficient! Monopolies are NOT allocative efficient! Does Price = MC? Q 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 Price, costs, and revenue MC MR ATC D

Because there is little external pressure to be efficient Are Monopolies Efficient? Monopolies are NOT efficient! Monopolies are inefficient because… They charge a higher price They don’t produce enough No allocative efficiency They produce at higher costs No productive efficiency They have little incentive to innovate Why? Because there is little external pressure to be efficient 33

Natural Monopoly One firm can produce the socially optimal quantity at the lowest cost due to economies scale. P It is better to have only one firm because ATC is falling at socially optimal quantity MC ATC MR D Q Qsocially optimal 34

Regulating Monopolies

Regulating Monopolies Why would the government regulate an monopoly? To keep prices low To make monopolies efficient How do they regulate? Use Price controls: a. Price Ceiling b. Price Floor Why don’t taxes work? Taxes limit supply and that’s the problem

The firm would make a loss and would require a subsidy REGULATING MONOPOLY What happens if the government sets a price ceiling to get the socially optimal quantity? Dilemma of Regulation Which Price? The firm would make a loss and would require a subsidy P Monopoly or Unregulated Price MR = MC Fair-Return Price Normal Profit Only TR = TC ATC MC Qm Pm Price and Costs Qf Pf P = MC Socially-Optimum Price Qs Ps MR D Q

Socially-Optimum Price P = MC (Allocative Efficiency) Where should the government place the price ceiling? Socially-Optimum Price P = MC (Allocative Efficiency) OR Fair-Return Price P = ATC (Normal Profit)

Lump Sum vs. Per Unit Taxes and Subsidies ACDC Econ Video 40

2007 FRQ #1

Price Discrimination

PRICE DISCRIMINATION Conditions Practice of selling specific products to different buyers at different prices. Conditions Firm must have monopoly power Firm must be able to segregate the market Consumers must not be able to resell product

PRICE DISCRIMINATION Price discrimination seeks to charge each consumer what they are willing to pay in an effort to increase profits. Those with elastic demand are charged less than those with inelastic. Examples: Airline Tickets (vacation vs. business) Movie Theaters (child vs. adult) All Coupons (spenders vs. savers) DHS soda machine (students vs. teachers)

Economic profits with a single MR=MC price Monopoly NON-PRICE DISCRIMINATION P D MR MC ATC Economic profits with a single MR=MC price Price Costs Q Q1

Economic profits with price discrimination A perfectly discriminating monopolist has MR=D, producing more product and more profit! P Economic profits with price discrimination MC MR’ D ATC MR Price and Costs Q Q1 Q2

What’s the Point? PRICE DISCRIMINATION A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand What’s the Point? Perfectly price discriminating firms: Make more profit Produce more Produce at allocative efficiency Price Discrimination results in several prices, more profit, No CS, and a higher socially optimal quantity

Can You Do The Following? Draw a monopoly making a profit identify price, quantity, and profit. Draw a perfectly competitive industry firm at long-run equilibrium Draw a price discriminating monopoly at equilibrium and label price, quantity, MR, and profit

Is the firm making a profit or a loss? Why? Side-by-side graph for perfectly completive industry and firm in the LONG RUN Is the firm making a profit or a loss? Why? Industry Firm (Price Taker) MC P S P ATC MR=D $15 $15 D1 D Q Q 5000 49 8

COSTS COMPLICATIONS COST COMPLICATIONS Using your notes from last class, discuss why costs may differ for a monopoly Economies of Scale X-Inefficiency Rent-Seeking Incentives for Innovation

Inefficient internal operation leads to higher-than-necessary costs COST COMPLICATIONS X-Inefficiency Inefficient internal operation leads to higher-than-necessary costs ATCx ATC1 X ATC ATCx’ ATC2 X’ Average total costs Q1 Q2 Quantity

Check next unit of output! MONOPOLY REVENUES & COSTS Revenue Data Cost Data # of output Price TR MR ATC TC MC Profit or Loss $172 $0 - $100 -$100 1 162 $162 $190 190 90 -28 MR = $162 – 0 = $162 MC = $190 – 100 = $90 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

MONOPOLY REVENUES & COSTS Revenue Data Cost Data # of output Price TR MR ATC TC MC Profit or Loss $172 $0 - $100 -$100 1 162 $162 $190 190 90 -28 2 152 304 142 135 270 80 +34 3 426 122 113.33 340 70 +86 4 132 528 102 100 400 60 +128 5 610 82 94 470 +140 6 112 672 62 91.67 550 +122 7 714 42 91.43 640 +74 8 92 736 22 93.73 750 110 -14 9 738 97.78 880 130 -142 10 72 720 -18 103 1030 150 -310 Can you see profit maximization? MR ≥ MC 5 122 610 83 94 470 70 +140

MONOPOLY REVENUES & COSTS $200 150 100 50 Elastic Inelastic Dollars D Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 MR $750 500 250 Dollars TR Q 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14

OUTPUT AND PRICE DETERMINATION Cost Data MR = MC Rule No Monopoly Supply Curve Monopoly Pricing Misconceptions Not Highest Price Total, Not Unit, Profit Possibility of Losses Graphically…

Assume that 200 units need to be produced Electric companies have economies of scale. The more they produce the lower the average cost. Assume that 200 units need to be produced If there are 4 firms, the ATC is $20 If there are 2 firms the ATC is $15 If there is 1 firm the ATC is $10 $20 15 10 Average Total Cost LRATC 0 50 100 200 Quantity