MONOPOLY

© 2012 Pearson Addison-Wesley eBay, Google, and Microsoft are dominant players in the markets they serve. These firms are not like the firms in perfect competition. How do firms that dominate their markets behave? Do they charge prices that are too high and that damage the interest of consumers? Students get lots of price breaks—at the movie theater and the hairdresser and on the airlines. Why? How can it be profit maximizing to offer lower prices to some customers?

© 2012 Pearson Addison-Wesley A monopoly is a market:  That produces a good or service for which no close substitute exists  In which there is one supplier that is protected from competition by a barrier preventing the entry of new firms. Monopoly and How It Arises

© 2012 Pearson Addison-Wesley How Monopoly Arises A monopoly has two key features:  No close substitutes  Barriers to entry No Close Substitute If a good has a close substitute, even if it is produced by only one firm, that firm effectively faces competition from the producers of the substitute. A monopoly sells a good that has no close substitutes. Monopoly and How It Arises

© 2012 Pearson Addison-Wesley Barriers to Entry A constraint that protects a firm from potential competitors are called barriers to entry. Three types of barriers to entry are  Natural  Ownership  Legal Monopoly and How It Arises

© 2012 Pearson Addison-Wesley Natural Barriers to Entry Natural barriers to entry create natural monopoly. A natural monopoly is a market in which economies of scale enable one firm to supply the entire market at the lowest possible cost. Figure 13.1 illustrates a natural monopoly. Monopoly and How It Arises

© 2012 Pearson Addison-Wesley

One firm can produce 4 millions units of output at 5 cents per unit. Two firms can produce 4 million units—2 units each—at 10 cents per unit. Monopoly and How It Arises

© 2012 Pearson Addison-Wesley In a natural monopoly, economies of scale are so powerful that they are still being achieved even when the entire market demand is met. The LRAC curve is still sloping downward when it meets the demand curve. Monopoly and How It Arises

© 2012 Pearson Addison-Wesley Ownership Barriers to Entry An ownership barrier to entry occurs if one firm owns a significant portion of a key resource. During the last century, De Beers owns 90 percent of the world’s diamonds. Monopoly and How It Arises

© 2012 Pearson Addison-Wesley Legal Barriers to Entry Legal barriers to entry create a legal monopoly. A legal monopoly is a market in which competition and entry are restricted by the granting of a  Public franchise (like the U.S. Postal Service, a public franchise to deliver first-class mail)  Government license (like a license to practice law or medicine)  Patent or copyright Monopoly and How It Arises

© 2012 Pearson Addison-Wesley Monopoly Price-Setting Strategies For a monopoly firm to determine the quantity it sells, it must choose the appropriate price. There are two types of monopoly price-setting strategies: A single-price monopoly is a firm that must sell each unit of its output for the same price to all its customers. Price discrimination is the practice of selling different units of a good or service for different prices. Many firms price discriminate, but not all of them are monopoly firms. Monopoly and How It Arises

© 2012 Pearson Addison-Wesley A Single-Price Monopoly’s Output and Price Decision Price and Marginal Revenue A monopoly is a price setter, not a price taker like a firm in perfect competition. The reason is that the demand for the monopoly’s output is the market demand. To sell a larger output, a monopoly must set a lower price.

© 2012 Pearson Addison-Wesley In Monopoly, Demand Is Always Elastic A single-price monopoly never produces an output at which demand is inelastic. If it did produce such an output, the firm could increase total revenue, decrease total cost, and increase economic profit by decreasing output. A Single-Price Monopoly’s Output and Price Decision

© 2012 Pearson Addison-Wesley MONOPOLISTIC COMPETITION

© 2012 Pearson Addison-Wesley The online shoe store shoebuy.com lists athletic shooes made by 56 different producers in 40 different categories and price between$25 and $850. It offers 1,404 different types for women and 1,757 different types for men. Athletic shoe producers compete, but each has a monopoly on its own special kind of shoe. With so many different types of athletic shoes, the market isn’t perfectly competitive. The model of monopolistic competition helps us to understand the competition that we see in the markets for athletic shoes and most other goods and services we buy.

© 2012 Pearson Addison-Wesley –Monopolistic competition is a market structure in which  A large number of firms compete.  Each firm produces a differentiated product.  Firms compete on product quality, price, and marketing.  Firms are free to enter and exit the industry. What Is Monopolistic Competition?

© 2012 Pearson Addison-Wesley Monopolistic Competition Large Number of Firms –The presence of a large number of firms in the market implies:  Each firm has only a small market share and therefore has limited market power to influence the price of its product.  Each firm is sensitive to the average market price, but no firm pays attention to the actions of others. So no one firm’s actions directly affect the actions of others.  Collusion, or conspiring to fix prices, is impossible.

© 2012 Pearson Addison-Wesley Product Differentiation –A firm in monopolistic competition practices product differentiation if the firm makes a product that is slightly different from the products of competing firms. What Is Monopolistic Competition?

© 2012 Pearson Addison-Wesley Competing on Quality, Price, and Marketing –Product differentiation enables firms to compete in three areas: quality, price, and marketing.  Quality includes design, reliability, and service.  Because firms produce differentiated products, the demand for each firm’s product is downward sloping. But there is a tradeoff between price and quality.  Because products are differentiated, a firm must market its product. Marketing takes the two main forms: advertising and packaging. What Is Monopolistic Competition?

© 2012 Pearson Addison-Wesley Entry and Exit –There are no barriers to entry in monopolistic competition, so firms cannot make an economic profit in the long run. Examples of Monopolistic Competition –Producers of audio and video equipment, clothing, jewelry, computers, and sporting goods operate in monopolistic competition. Monopolistic Competition

© 2012 Pearson Addison-Wesley Long Run: Zero Economic Profit –In the long run, economic profit induces entry. –And entry continues as long as firms in the industry earn an economic profit—as long as (P > ATC). –In the long run, a firm in monopolistic competition maximizes its profit by producing the quantity at which its marginal revenue equals its marginal cost, MR = MC. Price and Output in Monopolistic Competition

© 2012 Pearson Addison-Wesley –As firms enter the industry, each existing firm loses some of its market share. The demand for its product decreases and the demand curve for its product shifts leftward. –The decrease in demand decreases the quantity at which MR = MC and lowers the maximum price that the firm can charge to sell this quantity. –Price and quantity fall with firm entry until P = ATC and firms earn zero economic profit. Price and Output in Monopolistic Competition

© 2012 Pearson Addison-Wesley OLIGOPOLY

© 2012 Pearson Addison-Wesley In some markets, there are only a few firms compete. For example, computer chips are made by Intel and Advanced Micro Devices and each firm must pay close attention to what the other firm is doing. How does competition between just two chip makers work? When a market has only a small number of firms, do they operate in the social interest, like firms in perfect competition? Or do they restrict output to increase profit, like a monopoly? The models of perfect competition and monopoly don’t predict the behavior of the firms we’ve just described. To understand how these markets work, we need the richer models.

© 2012 Pearson Addison-Wesley What Is Oligopoly? –Oligopoly is a market structure in which  Natural or legal barriers prevent the entry of new firms.  A small number of firms compete.

© 2012 Pearson Addison-Wesley Barriers to Entry –Either natural or legal barriers to entry can create oligopoly. –Figure 15.1 shows two oligopoly situations. –In part (a), there is a natural duopoly—a market with two firms. What Is Oligopoly?

© 2012 Pearson Addison-Wesley

–In part (b), there is a natural oligopoly market with three firms. –A legal oligopoly might arise even where the demand and costs leave room for a larger number of firms. What Is Oligopoly?

© 2012 Pearson Addison-Wesley

Small Number of Firms –Because an oligopoly market has only a few firms, they are interdependent and face a temptation to cooperate. –Interdependence: With a small number of firms, each firm’s profit depends on every firm’s actions. –Temptation to Cooperate: Firms in oligopoly face the temptation to form a cartel. –A cartel is a group of firms acting together to limit output, raise price, and increase profit. Cartels are illegal. What Is Oligopoly?