1. Market Structure: Monopoly and Monopolistic Competition
Chapter 8

2. Firms With Market Power
The ability of a firm to influence the prices of its products and develop other competitive strategies that enable it to earn large profits over longer periods of time.
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The Monopoly Model
A market structure characterized by a single firm producing a product with no close substitutes.
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4. Monopoly Model - GraphicalQ PM QM
ATC P
LOSS
ATCM D MR MC
ATC
PROFIT MC
ATCM PM
A monopolist's marginal revenue is always less than or equal to the price
of the good. Marginal revenue is the amount of revenue the firm receives for
each additional unit of output. It is the difference between total revenue { price
times quantity { at the new level of output and total revenue at the previous
output (one unit less).
Therefore the monopolist's marginal cost curve lies below its demand curve.
Another way to see this:
When a monopoly increases amount sold, it has two e ects on total revenue:
{ the output e ect: More output is sold, so Q
is higher.
{ the price e ect: To sell more, the price must decrease, so P
is lower.
For a competitive rm there is no price e ect. The competitive rm can sell
all it wants at the given price.
For a monopoly there is a price e ect. It must reduce price to sell additional
output. So the marginal revenue on its additional unit sold is lower than the
price, because it gets less revenue for previous units as well (it has to reduce
price to the same amount for all units).
Marginal revenue can even become negative { that is, the total revenue
decreases from one output level to the next. D MR QM Q
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5. Comparing Monopoly and Perfect Competition
The Perfectly Competitive Firm
At QPC :
MR = MC
P = ATC
P = MC
Minimum Point of ATC Curve
Price-Taker
Firm Has Supply Curve
The Monopoly Firm
At QM :
MR = MC
P > ATC
P > MC
Not at Minimum Point of ATC
Price-Searcher
Firm Has No Supply Curve
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6. Comparing Monopoly and Perfect Competition - GraphicalMC
ATC
D = P = MR PC QC P Q PM QM
ATC MC D MR
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7. Another Look at Monopoly vs. Perfect Competition$ Q PM PC
AC=MC D MR QM QC
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8. Sources of Market Power
Economies of scale –banking sector, large fixed cost, example: Emirates NBD
Barriers created by government
Input barriers
Brand loyalties
Consumer lock-in and switching costs
Network externalities
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Economies of Scale
Economies of scale can act as a barrier to entry in different industries because only large-scale firms can achieve the cost-reduction benefits of these economies.
Merger has increased market power and reduced cost in banking industry.
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10. Barriers Created by Government
Licenses – Psychiatrist and psychologist
Patents and Copyrights – Pharmaceuticals – monopolies more conducive to innovation than perfect competition
Government may block a sector for national security.
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Input Barriers
Other barriers to entry include control over raw materials or other key inputs in a production process and barriers in financial capital markets.
Example: De beers, Southwest Airline for Midway, Emirates for DXB?
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Brand Loyalties
The creation of brand loyalties through advertising and other marketing efforts is a strategy that many managers use to create and maintain market power.
i.e. Starbucks, Al Ain water, iPhone…
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13. Consumer Lock-In and Switching Costs
Barriers to entry can also result if consumers become locked into certain types or brands of products and would incur substantial switching costs if they changed.
i.e. windows vs mac
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14. Network Externalities
Network externalities act as a barrier to entry because the value of a product to consumers depends on the number of customers using the product.
i.e. Microsoft, blackberry, msn..
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15. Examples of Shifting Market Power
Shifting Demand for Kleenex: Product differentiation.
Competition between retailers. Online versus brick and mortar retailers
Borders Bookstores’ Online Strategy: more online book sales.
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16. Measures of Market Power
Lerner Index
Cross Price Elasticity of Demand
Concentration Ratios
The Herfindahl-Hirschman Index
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Lerner Index (LI)
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Lerner Index
It shows by how much P deviates from MC.
LI for a perfectly competitive =0 because P=MC.
The higher the LI the higher the market power and the lower the elasticity of the demand.
If MC =$5 and Price =$10, then LI =50%.
This means that the price is higher than the MC by 50%.
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19. Cross Price Elasticity of Demand
The higher the cross-price elasticity of demand, the greater the potential substitution between the goods (the lower the market power).
The smaller the cross-price elasticity of demand, the lower the potential substitution between the goods (the greater the market power for the firm)
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Concentration Ratios
Measure market power by focusing on the share of the market held by the x largest firms, where x typically equals four, six or eight.
The percentage could be for the sales or production.
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Concentration Ratios
Sales of Firm 1= 150,000, Firm 2 =100,000, Firm3=80,000, Firm4=70,000, Firm5=50,000, Firm6=30,000.
Total sales =480,000, the sales for the largest 4 firms= 400,000/480,000=83.3%.
The 4 firms control 83.3% of the market sales. This market is concentrated
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22. The Herfindahl-Hirschman Index
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HHI
If HHI is below 1000 the market is not concentrated.
If HHI is between 1000 and 1800 the market is moderately concentrated.
If HHI is above 1800 the market is highly concentrated
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HHI
If we have a market consist of 5 firms and their market share as follows: F1=40%, F2=30%, F3=20%, F4=9%, and F5=1%.
HHI = 40SQ +30SQ+20SQ+9SQ+1SQ = 2982.
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Antitrust Laws
The governments have issued the Antitrust Laws to limit the market power and enhance competition.
In UAE, Law number 4 for 2012.
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26. Monopolistic Competition
A market structure characterized by a large number of small firms that have some market power from producing differentiated products.
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27. Characteristics of Monopolistic Competition
Product differentiation exists among firms
There are a large number of firms in the product group
No interdependence exists among firms
Entry and exit by new firms is relatively easy
They advertise to shift their demand to the right.
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28. Monopolistic Competition – Short-Run
At Q1:
MR = MC
P > ATC
P > MC
ATC Not at Minimum Point
Positive profits $ Q MR MC D
ATC P1 Q1
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29. Monopolistic Competition – Long-Run
At Q2 :
MR = MC
P = ATC
P > MC
ATC Not at Minimum Point
π=0 MC
ATC D MR P2 Q2
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30. Examples of Monopolistically Competitive Behavior
Drugstores
Hardware Stores
Bookstores
Restaurants
Barber shops
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