1. Principles of Economics
Imperfect competition:
Monopoly, Oligopoly and Monopolistic competition

2. Perfect competition on a product market
Imperfect competition
Demand
Horizontal (p = constant)
Downward sloping (p(q))
Product
Homogeneous
Heterogeneous
Information
Perfect
Imperfect
Profit
Zero profit
Extra profit
Number of sellers
Many
One or few
Price formation
Price takers
Price makers
Disadvantages:
Smaller total surplus of the economy
Smaller quantity on the market
Advantages:
Technological progress (Schumpeter says innovations overpower negative effect of smaller total surplus – SCHUMPETER HYPOTHESIS)
Economies of scale

3. Market power Market power is analyzed using several indicators:
Share of 4 biggest companies on the market
Herfindahl-Hirschmann index:
where S is a percentage share of each company on the market.
In monopoly HHI = 10000, in perfect competition 0. If HHI > 1800 concentration is high, if HHI < 1000 concentration is low and for 1000<HHI<1800 concentration is medium.

4. Dead weight loss
Imperfect competition causes total surplus decline – DEAD WEIGHT LOSS – it is a difference between total surplus in perfect competition (p = MC) and imperfect equilibrium (MR = MC)

5. Monopoly Properties: 1 seller, no substitutes.
Monopolist can change price.
There are barriers for entry (patents, copyright, large starting investment)
In perfect competition demand is horizontal (p = MR), in monopoly demand is falling (MR < p)
Monopolist maximizes profit: MC = MR < p
(in real life p = AC + margin

6. P MC M AC
DWL
P = AR MR Q

7. Total revenue (TR) and marginal revenue (MR)
TR = p×q
AR = p×q/q = p
MR = ΔTR/ Δq
When demand is falling TR has bell-like form
TR reaches its maximum when │Ed│ = 1
Note that MR and demand are not the same curve as in perfect competition TR
p = AR MR Q P
│Ed │ = 1
│Ed │ < 1
│Ed │ > 1
elastic inelastic

8. Exercise 1
Total cost function of a company is TC=40+2Q and demand function is P=10-0,1Q. If TC=120, what is the monopolist’s profit?

9. TC=40+2Q
120=40+2Q
Q=40
P=10-0,1Q=10-0,1*40=6
Π=TR-TC=P*Q-TC=240-(40+2*40)
Π= =120

10. Exercise 2:
Demand function is Q=200-10P. Marginal revenue is MR=20-0.2Q, average costs are AC=0,05Q+5+225/Q and marginal costs MC=5+0,1Q. Find optimum price, production and profit of this monopolist.

11. Π=TR-TC=P*Q-AC*Q=15*50-(0,05*50+5+225/50)*50=750-600=150
MR=MC
20-0,2Q=5+0,1Q
Q=50
Q=200-10P
P=15
Π=TR-TC=P*Q-AC*Q=15*50-(0,05* /50)*50= =150

12. Exercise 3
Demand is p = 32 – 2q. Find total revenue function. When it reaches its maximum?
Answer:
TR = (32 – 2q)q = -2q2 +32q
TR is at its maximum when Ed = -1, which is exactly at the half-point of a linear demand:
32 – 2q = 0
Q = 16, half-point: q = 8
TR(8) = = 128

13. Oligopoly
Oligopoly is a market structure where there are only few sellers and many buyers.
Demand is falling
Sellers can affect price, but les than monopolist. This interaction is analyzed using game theory
Oligopolist used to compete with prices, today with promotion and differentiation
Pure oligopolies (homogeneous product) and differentiated oligopolies
Duopoly: the simplest oligopoly (only two players)
Price is greater than in perfect competition, smaller than monopolistic price

14. Game theory Players choose between options
Depending on decision of others they have different outcomes (profits)
John Nash won a Nobel prize for analysis of game theory
Nash Equilibrium: nobody can improve its position without change in the opponents decision
Dominant strategy: a company chooses 1 option no matter what the other does
Maximin strategy: traditional (risk averse) strategy
Simultaneous or sequential games
Maximin strategy: (100, 100)
Nash equilibria: blue
No dominant strategy
If A has advantage: (400, 100)
If B has advantage: (300, 350)
Cooperative strategy: (300, 350)
Company B
Cheap product
Quality product
Company A
100
350
300
320 50
400

15. Exercise 4
Air transport compaines’ shares in the USA in 1986 are given with the following table:
a) Find C4 concentration ratio.
b) Find HHI indeks (be careful – “the others” should not be put into the index)

16. a) C4 = P1+P2+P3+P4 Shares should be sorted from biggest to smallest!
Four major air transport companies account for 55% of the American airlines market.

17. b) HHI = P12 + P22 + … Pn2 HHI = 172+152+122+122+92+82+72
HHI = 967 out of 10000
=> Low concentration

18. Monopolistic competition
Many sellers, no barriers for entry
Differentiated product
In the short run companies behave like monopolists and earn extra profit
In the long run newcomers offer substitutes => demand declines, profits fall to zero (p = AC)

19. Short run equilibrium in monopolistic competition
Equilibrium similar to monopolistic (MR = MC)
Extra profit (grey). MC M AC
DWL
P = AR MR Q

20. Long run equilibrium in monopolistic competition
In the long run demand becomes more elastic because of the new companies
MR = MC, P = AC (no profit)
Monopolistic equilibrium (M) worse than perfectly competitive (E) because consumers pay more for less goods in mon.comp. MC AC M
DWL E
P = AR MR Q

21. Exercise 5
Monopolistically competitive company maximizes profit at TR=40 Its marginal revenue is MR=10 and MC=6+0.5Q. If it maximizes profit, what is the optimal price, quantity and MC? If it is a long-run equilibrium what is the value of total cost?

22. MR=MC
10=6+0,5Q
Q=8
TR=P*Q
40=P*8
P=5
TC = 40 since in the long run profits are zero

23. Risk and uncertainty
Speculation is the activity of moving goods from places and times of abundancy to places and times of scarcity
Speculation improves alocation and brings markets to equilibrium
Arbitrage is the activity of simulatenous purchase on one market and sale on the other (riskless speculation)
Hedging is a process of risk neutralization

24. Person is RISK AVERSE if loss displeasure is stronger than gain pleasure
Person is RISK FRIENDLY if gain pleasure is stronger than loss displeasure
Person is RISK NEUTRAL if it regards gains as positive as losses negative.
Insurance spreads risk among many insurance contractees (moral hazard – insurance fraud)

25. Exercise 6 Discuss individuals’ position towards risk:
Agatha would pay 1000$ for the insurance from loss of 10000$ that occurs in 5% of the cases.
Ben would pay no more than 1000$ for the insurance from loss of 10000$ that occurs in 20% of the cases.
Max would pay 1000$ for the insurance from loss of 10000$ that occurs in 10% of the cases.
Agatha: averse, Ben: friendly, Max: neutral