1. Monopoly and imperfect competition

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

3. Imperfect Competition
Imperfectly Competitive Firms
Have some control over price
Price may be greater than the marginal cost of production
Long-run economic profits are possible
Chapter 9: Monopoly and Other Forms of Imperfect Competition

4. Imperfect Competition
Imperfectly Competitive Markets
Reduce economic surplus to varying degrees
Are very common
Chapter 9: Monopoly and Other Forms of Imperfect Competition

5. Forms of Imperfect Competition
Pure Monopoly (most inefficient)
The only supplier of a unique product with no close substitutes
This is the one we’ll pay most attention to
Chapter 9: Monopoly and Other Forms of Imperfect Competition

6. Forms of imperfect Competition
Oligopoly (theoretically more efficient than a monopoly)
A firm that produces a product for which only a few rival firms produce close substitutes
Many major economic sectors
Food, media, banking, energy, garbage, pharmaceuticals, electricity, water, hospitals, etc.
Collusion is a big problem
Oil, Electricity, Vitamins, Archer-Daniels Midland
Chapter 9: Monopoly and Other Forms of Imperfect Competition

7. Forms of imperfect Competition
Monopolistic Competition (closest to perfect competition)
A large number of firms that produce slightly differentiated products that are reasonably close substitutes for one another
Chapter 9: Monopoly and Other Forms of Imperfect Competition

8. Imperfect Competition
The Essential Difference Between Perfectly and Imperfectly Competitive Firms
The perfectly competitive firm faces a perfectly elastic demand for its product.
The imperfectly competitive firm faces a downward-sloping demand curve.
Chapter 9: Monopoly and Other Forms of Imperfect Competition

9. Imperfect Competition
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.
If the firm raises its price, sales will be zero.
The firm’s demand curve is the horizontal line at the market price.
Chapter 9: Monopoly and Other Forms of Imperfect Competition

10. Imperfect Competition
With imperfect competition
The firm has some control over price or some market power.
The firm faces a downward sloping demand curve.
Chapter 9: Monopoly and Other Forms of Imperfect Competition

11. The Demand Curves Facing Perfectly and Imperfectly Competitive Firms
Market price
Price
$/unit of output
Quantity
Quantity
Chapter 9: Monopoly and Other Forms of Imperfect Competition

12. Five Major Sources of Market Power
Market power = barriers to entry
Exclusive control over inputs
Patents and copyrights
Government licenses or franchises
Economies of scale (natural monopolies)
Networked economies
Chapter 9: Monopoly and Other Forms of Imperfect Competition

13. Economies of Scale and the Importance of Fixed Costs
Natural Monopolies: Firms with large fixed costs and low variable costs
e.g. telephones, electric utilities, sewage, etc.
Have low marginal costs
Average total cost declines sharply as output increases
Economies of scale will exist
Chapter 9: Monopoly and Other Forms of Imperfect Competition

14. Chapter 9: Monopoly and Other Forms of Imperfect Competition
Total and Average Total Costs for a Production Process with Economies of Scale 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 is
always higher than marginal cost
Average cost ($/unit)
Total cost ($/year)
Quantity
Quantity
Chapter 9: Monopoly and Other Forms of Imperfect Competition

15. Costs for Computers (Hardware+software): Scenario 1
Mac OSX Windows XP
Annual production ,000, ,200,000
Fixed cost $2,000, $2,000,000
Variable cost $8,000, $9,600,000
Total cost $10,000, $11,600,000
Average total cost per system $ $9.70
Observations
Fixed costs are a relatively small share of total cost
Variable costs are identical
Cost/system is nearly the same
Chapter 9: Monopoly and Other Forms of Imperfect Competition

16. Costs for for Computers (Hardware+software): Scenario 2
Chapter 9: Monopoly and Other Forms of Imperfect Competition

17. Costs for for Computers: scenario 2 after time passes
Chapter 9: Monopoly and Other Forms of Imperfect Competition

18. Economies of Scale and the Importance of Fixed Costs
Fixed investment in research and development has been increasing as a share of production costs.
Cost of producing a computer
Fixed Cost Variable Cost
Software Hardware
% 80%
% 20%
Chapter 9: Monopoly and Other Forms of Imperfect Competition

19. Profit Maximization for the Monopolist
A price taker (perfect competition) and a price setter (imperfect competition) share two economic goals. They want
To maximize profits
To select the output level that maximizes the difference between TR and TC, where MB= MC.
Chapter 9: Monopoly and Other Forms of Imperfect Competition

20. Profit Maximization for the Monopolist
For any producer
MB = Marginal Revenue (MR) or a change in a firm’s total revenue that results from a one-unit change in output
Increase output when MR > MC.
For competitive producer
MR=P
For a monopolist
MR<P
Chapter 9: Monopoly and Other Forms of Imperfect Competition

21. The Monopolist’s Benefit from Selling an Additional Unit3 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 = $5 D 8 2 6
Price ($/unit)
Quantity (units/week)
Chapter 9: Monopoly and Other Forms of Imperfect Competition

22. Chapter 9: Monopoly and Other Forms of Imperfect Competition
Marginal Revenue
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
P Q TR MR 6 2 12 5 3 15 4 16 3 1 -1
Chapter 9: Monopoly and Other Forms of Imperfect Competition

23. Marginal Revenue in Graphical Form8 D 4 3 2 -1 5 1 MR
P Q TR MR 6 2 12 5 3 15 4 16 3 1 -1
Price & marginal revenue ($/unit)
Quantity (units/week)
Chapter 9: Monopoly and Other Forms of Imperfect Competition

24. Profit Maximization for the Monopolist
Profit Maximizing Decision Rule
When 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.
What’s the marginal revenue for a competitive firm?
Chapter 9: Monopoly and Other Forms of Imperfect Competition

25. The Monopolist’s Profit- Maximizing Output LevelD 3 12 24
Marginal Cost 6 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 = $4 where quantity demanded = quantity supplied
Price ($/unit of output)
Quantity (units/week)
Chapter 9: Monopoly and Other Forms of Imperfect Competition

26. The Demand and Marginal Cost Curves for a Monopolist
Why the Invisible Hand Breaks Down Under Monopoly 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) = $4/wk.
Deadweight loss 6
Marginal cost
Price ($/unit of output) 3 D 12 24
Quantity (units/week)
Chapter 9: Monopoly and Other Forms of Imperfect Competition

27. Why the Invisible Hand Breaks Down Under 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
Chapter 9: Monopoly and Other Forms of Imperfect Competition

28. Why the Invisible Hand Breaks Down Under Monopoly
Difficulties in Reducing the Deadweight Loss of Monopolies
Enforcing antitrust laws
Growing concentration in food, media, energy, pharmaceuticals, etc.
Patents, copyrights, and innovation
Natural monopolies
Chapter 9: Monopoly and Other Forms of Imperfect Competition

29. Chapter 9: Monopoly and Other Forms of Imperfect Competition
Price Discrimination
The practice of charging different buyers different prices for essentially the same good or service
E.g. textbooks, medicine
What about re-importing medicine?
Theoretically maximizes economic surplus, but reduces consumer surplus to zero
Chapter 9: Monopoly and Other Forms of Imperfect Competition

30. Public Policy Toward Natural Monopoly
Methods of Controlling Natural Monopolies
State ownership and management
Weighing the benefit of marginal cost pricing versus the cost of less incentive for innovation
Is it true that there is less incentive for innovation? Burlington Electric and VEIC
In a democracy, politicians have to provide public services and keep taxes low to get re-elected
Chapter 9: Monopoly and Other Forms of Imperfect Competition

31. Methods of Controlling Natural Monopolies
State regulation of private monopolies
Cost-plus regulation
High administrative cost
Less incentive for innovation
P does not equate to MC
Chapter 9: Monopoly and Other Forms of Imperfect Competition

32. Methods of Controlling Natural Monopolies
Exclusive contracting for natural monopoly
Competition for the contract theoretically sets P = MC
Example of water in Buenos Aires
Difficulty when fixed costs are high
No incentive to maintain infrastructure when contract nears termination
Chapter 9: Monopoly and Other Forms of Imperfect Competition

33. Methods of Controlling Natural Monopolies
Vigorous enforcement of anti-trust laws
Helps prevent cartels
May prevent economies of scale
Chapter 9: Monopoly and Other Forms of Imperfect Competition