1. Unit 4: Imperfect Competition1

2. Unit 4: Imperfect Competition 4.1 Monopolies2

3. Imperfect Competition
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Monopolistic
Competition
Pure
Monopoly
Pure
Monopoly
Oligopoly
Oligopoly
Imperfect Competition
Every product is sold in a market that can be considered one of the above market structures.
Characteristics of Perfect Competition:
Many buyers and sellers
Products identical (or nearly so—substitutes)
Easy entry and exit out of the market 3

4. Imperfect Competition
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Monopolistic
Competition
Pure
Monopoly
Pure
Monopoly
Oligopoly
Oligopoly
Imperfect Competition
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 4

5. Monopoly 5

6. Four Market Structures
Perfect
Competition
Monopolistic
Competition
Monopoly
Oligopoly
Characteristics of Monopoly:
Examples: Idaho Power, De Beers,
One large firm (the firm is the market)
Unique product (no close substitutes)
High Barriers- Firms cannot enter the industry
Monopolies are “Price Makers”
Some advertising

7. 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.
The government never prevents monopolies from forming.
All are False 7

8. Can a monopoly be good for the economy?
Sure, for example: Electric Companies
If there were three competing electric companies they would have higher costs
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. 8

9. Graphing Monopolies 9

10. The 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
Not a firm graph and a market graph 10

11. THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE! DEMAND DOES EQUAL PRICE!
The Main Difference
Monopolies (and ALL imperfectly competitive firms) have downward sloping demand curve.
Which mean to sell more a firm must… lower its price.
So does MR = Price = Demand?
THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE!
DEMAND DOES EQUAL PRICE! 11

12. Why is MR less than Demand?P Qd TR MR
$11 - 12

13. Why is MR less than Demand?P Qd TR MR
$11 -
$10 1 10
$10 13

14. Why is MR less than Demand?P Qd TR MR
$11 -
$10 1 10 $9 2 18 8
$10 $9 $9 14

15. Why is MR less than Demand?P Qd TR MR
$11 -
$10 1 10 $9 2 18 8 $8 3 24 6
$10 $9 $9 $8 $8 $8 15

16. 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
$10 $9 $9 $8 $8 $8 $7 $7 $7 $7 16

17. 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
$10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 17

18. 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
$10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 18

19. 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 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4 19

20. 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 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4 20

21. 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 $9
MR IS LESS THAN
DEMAND $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4 21

22. Calculating Marginal Revenue22

23. Does the Marginal Revenue equal the price?
To sell more a firm must lower its price. What happens to Marginal Revenue?
Price
Quantity
Demanded
Total Revenue
Marginal Revenue $6 $5 1 $4 2 $3 3 $2 4 $1 5
Does the Marginal Revenue equal the price? 23

24. Does the Marginal Revenue equal the price?
To sell more a firm must lower its price. What happens to Marginal Revenue?
Price
Quantity
Demanded
Total Revenue
Marginal Revenue $6 - $5 1 5 $4 2 8 3 $3 9 $2 4 -1 $1 -3
Does the Marginal Revenue equal the price? 24

25. Does the Marginal Revenue equal the price?
To sell more a firm must lower its price. What happens to Marginal Revenue?
Price
Quantity
Demanded
Total Revenue
Marginal Revenue $6 - $5 1 5 $4 2 8 3 $3 9 $2 4 -1 $1 -3
MR DOESN’T
EQUAL PRICE
Does the Marginal Revenue equal the price? 25

26. Moonbuck’s D and MR Curves
P, MR $ 5
1.50 6
2.00 5
2.50 4
3.00 3
3.50 2
4.00 1
$4.50 MR P Q –1 $4
Demand curve (P) 4 MR 3 2 1
The numbers in the table are from the preceding exercise. Students can see either from the table or the graph that, at any Q, MR < P. -1 -2 -3 Q 1 2 3 4 5 6 7

27. Understanding the Monopolist’s MR
Increasing Q has two effects on revenue:
The output effect: Higher output raises revenue
The price effect: Lower price reduces revenue
To sell a larger Q, the monopolist must reduce the price on all the units it sells.
Hence, MR < P
MR could even be negative if the price effect exceeds the output effect (e.g., when Moonbucks increases Q from 5 to 6).
Note that a competitive firm has the output effect but not the price effect: the competitive firm does not need to reduce its price in order to sell a larger quantity, so, for the competitive firm, MR = P.

28. Calculate and Plot the Demand, Marginal Revenue, and Total Revenue Curves$6 5 4 3 2 1 Q TR $9 8 7 6 5 4 3 2 1 Q 28

29. Demand and Marginal Revenue Curves
What happens to TR when MR hits zero?
$15 10 5 P D Q TR MR
$64 40 20
Total Revenue is at it’s peak when MR hits zero TR Q 29

30. Elastic vs. Inelastic Range of Demand Curve30

31. Total Revenue Test to Determine Elasticity
Quiz Yourself:
The total revenue test says that if…
Price Increase and TR Decrease it is Elastic for Demand or
Price Decreases and TR Increases it’s Elastic for Demand
Price Increases and TR Increases it is Inelastic for Demand
Price Decreases and TR Decreases it’s Inelastic for Demand
TR for inelastic good will increase. TR for elastic good will decrease.

32. Total Revenue Test to Determine Elasticity
Relatively Inelastic
Relatively Elastic
MC1
MC1 MC MC D D
TR for inelastic good will increase. TR for elastic good will decrease.
What happens to total revenue for each when price increases?

33. Total Revenue Test Review
Uses elasticity to show how changes in price will affect total revenue (TR).
Inelastic Demand-
Price increase causes TR to increase
Price decrease causes TR to decrease
Elastic Demand-
Price increase causes TR to decrease
Price decrease causes TR to increase
Unit Elastic-
Price changes and TR remains unchanged

34. Elastic and Inelastic RangeP
Elastic
Inelastic
$15 10 5
Total Revenue Test
If price falls and TR increases then demand is elastic. D Q TR
A monopoly will only produce in the elastic range MR
$64 40 20
Total Revenue Test
If price falls and TR falls then demand is inelastic. TR Q 34

35. Maximizing Profit 35

36. Profit-Maximization 1. The profit- maximizing Q is where MR = MC.
Quantity
Costs and Revenue
1. The profit- maximizing Q is where MR = MC.
2. Find P from the demand curve at this Q. D MR MC P Q
Profit-maximizing output

37. The Monopolist’s Profit
Quantity
Costs and Revenue
ATC D MR MC
As with a competitive firm, the monopolist’s profit equals
(P – ATC) x Q P
ATC Q

38. A Monopoly Does Not Have an S Curve
A competitive firm
takes P as given
has a supply curve that shows how its Q depends on P
A monopoly firm
is a “price-maker,” not a “price-taker”
Q does not depend on P; rather, Q and P are jointly determined by MC, MR, and the demand curve.
So there is no supply curve for monopoly.

39. Profit-Maximization MR = MC What output should this monopoly produce?
How much is the TR, TC and Profit or Loss? $9 8 7 6 5 4 3 2 P MC
ATC
Profit =$6 D MR Q 39

40. Conclusion: A monopolists produces where MR=MC, buts charges the price consumer are willing to pay identified by the demand curve. $9 8 7 6 5 4 3 2 P MC
ATC D MR Q 40

41. How much is the TR, TC, and Profit or Loss?
What if cost are higher?
How much is the TR, TC, and Profit or Loss? MC
$10 9 8 7 6 5 4 3 P
ATC
AVC D
TR= $90
TC= $100
Loss=$10 MR Q 41

42. Identify and Calculate:
TR=
TC=
Profit/Loss=
Profit/Loss per Unit=
$50
Identify and Calculate:
$25
$25
Price $5 MC
$10 9 8 7 6 5
ATC D MR Q 42

43. Identify and Calculate:
TR=
TC=
Profit/Loss=
Profit/Loss per Unit=
$54
Identify and Calculate:
$36
$18 $3 P
$10 9 8 7 6 5 4
MC= ATC D MR Q 43

44. Case Study: Monopoly vs. Generic Drugs
The market for a typical drug
Patents on new drugs give a temporary monopoly to the seller.
When the patent expires, the market becomes competitive, generics appear.
Quantity
Price D MR PM QM
PC = MC QC
Here, we assume constant marginal cost, for simplicity.
PM and QM denote the monopoly price and quantity, respectively.
PC and QC denote the competitive price and quantity, respectively.

45. Are Monopolies Efficient?45

46. Monopolies are inefficient because they…
Charge a higher price
Don’t produce enough
Produce at higher costs 46

47. Types of efficiency
Efficient in production is when an economy is producing on the PPC
Efficient in allocation means resources are used so that consumers are as well off as possible 47

48. Consumer Surplus, Producer Surplus and Deadweight Loss
Monopolies vs. Perfect Competition
Test Yourself:
Draw a perfectly competitive market (not firm) showing CS, PS, and Deadweight Loss
Is it allocatively efficient?
Is it productively efficient? 48

49. Monopolies vs. Perfect Competition
S = MC P
In perfect competition, CS and PS are maximized, thus it is allocatively efficient
It is also productively efficient CS
Ppc PS D Q
Qpc 49

50. Consumer Surplus, Producer Surplus and Deadweight Loss
Monopolies vs. Perfect Competition
Test Yourself:
Draw a monopoly showing CS, PS, and Deadweight Loss
Is it allocatively efficient?
Is it productively efficient? 50

51. Monopolies vs. Perfect Competition
S = MC P
At MR=MC,
A monopolist will
produce less and
charge a higher price Pm
Ppc D MR Q Qm
Qpc 51

52. Monopolies vs. Perfect Competition
Where is CS and PS for a monopoly?
S = MC P CS
Total surplus falls.
Now there is DEADWEIGHT LOSS Pm PS
Monopolies underproduce and over charge, decreasing CS and increasing PS. D MR Q Qm 52

53. The Welfare Cost of Monopoly
Competitive eq’m:
quantity = QC
P = MC
total surplus is maximized
Monopoly eq’m:
quantity = QM
P > MC
deadweight loss
Quantity
Price
Deadweight loss D MR MC P MC QM
P = MC QC
It’s worth mentioning the following:
Most people know that monopoly changes the way the economic “pie” is divided: by charging higher prices, the monopoly gets more surplus and consumers get less surplus.
The analysis on this slide shows that the monopoly also reduces the size of the economic pie – by producing less than the socially efficient quantity and causing a deadweight loss.

54. Are Monopolies Productively Efficient?
No. They are not producing at the lowest cost (min ATC)
Does Price = Min ATC? $9 8 7 6 5 4 3 2 P MC
ATC D MR Q 54

55. Monopolies are NOT efficient!
Are Monopolies Allocatively Efficiency?
No. Price is greater. The monopoly is under producing.
Does Price = MC? $9 8 7 6 5 4 3 2 P MC
ATC
Monopolies are NOT efficient! D MR Q 55

56. 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 56