1. Monopoly and Other Forms of Imperfect Competition

2. Perfectly Competitive Market
An ideal market that maximizes economic surplus
A situation that does not always exist

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
Reduce economic surplus to varying degrees
Are very common

4. Forms of Imperfect Competition
1. Pure Monopoly
The only supplier of a unique product with no close substitutes
2. Monopolistic Competition
A large number of firms that produce slightly differentiated products that are reasonably close substitutes for one another
Long-run adjustment to zero economic profits
Importance of differentiation

5. Forms of Imperfect Competition
3. Oligopoly
Industry structure in which a small number of firms produce products that are either close or perfect substitutes
Cost advantages from large size may prevent the long-run adjustment to zero economic profit
Undifferentiated and differentiated products

6. 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.

7. The Demand Curves Facing Perfectly and Imperfectly Competitive Firms
Market price
$/unit of output
Price D
Quantity
Quantity

8. Perfectly competitive market
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.
If the firm lowers its price, sales will not increase.
The firm’s demand curve is the horizontal line at the market price.

9. Imperfectly Competitive Markets
The firm has some control over price or some market power.
A firm’s ability to raise the price of a good without losing all its sales
Sellers face a downward sloping demand

10. Sources of Market Power
Exclusive control over inputs
Patents and Copyrights
Government Licenses or Franchises
Economies of Scale (Natural Monopolies)
Network Externalities

11. Economies of Scale and the Importance of Start-Up Costs
Firms with large fixed costs and low variable costs:
Have low marginal costs
Average total cost declines sharply as output increases
Economies of scale will exist

12. Costs for Two Computer Game Producers (1)
Nintendo Playstation
Annual production 1,000, ,200,000
Fixed cost $200,000 $200,000
Variable cost $800,000 $960,000
Total cost $1,000,000 $1,160,000
Average total cost per game $ $0.97
Observations
Fixed costs are a relatively small share of total cost
Cost/game is nearly the same

13. Costs for Two Computer Game Producers (2)
Nintendo Playstation
Annual production 1,000, ,200,000
Fixed cost $10,000,000 $10,000,000
Variable cost $200,000 $240,000
Total cost $10,200,000 $10,240,000
Average total cost per game $ $8.53
Observations
Fixed costs are a relatively large share of total cost
Playstation has a $1.67 average cost advantage
Playstation can lower prices, cover cost, and attract customers

14. Costs for Two Computer Game Producers (3)
Nintendo Playstation
Annual production 500, ,700,000
Fixed cost $10,000,000 $10,000,000
Variable cost $100,000 $340,000
Total cost $10,100,000 $10,340,000
Average total cost per game $ $6.08
Shift of 500,000 units to Playstation
Nintendo’s average cost increases to $20.20/unit
Playstation average cost falls to $6.08
A large number of firms cannot survive when the cost differential is high

15. 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%

16. Profit Maximization for the Monopolist
A price taker (perfect competition) and a price setter (imperfect competition) share the economic goal. They want:
To maximize profits; i.e.,
To select the output level that maximizes the difference between TR and TC, where MB= MC (when quantity is divisible and not producing at all is not optimal).

17. Profit Maximization for the Monopolist
For a producer
MB = Marginal Revenue (MR) or a change in a firm’s total revenue that results from a one-unit change in output

18. Profit Maximization for the Monopolist
Marginal Revenue for the Monopolist
Perfect competition and monopolies
Both increase output when MR > MC.
Calculate MC the same way.
Do not have the same MR at a given price.
In perfect competition: MR = P
In monopoly: MR < P

19. The Monopolist’s Benefit from Selling an Additional Unit8
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 = $5 6 5
Price ($/unit) D 2 3 8
Quantity (units/week)

20. Marginal Revenue in Graphical Form
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
Slide 20

21. Marginal Revenue in Graphical Form
Price & marginal revenue ($/unit)
Quantity (units/week) 8 D 4 3 2 -1 5 1 MR
P Q TR MR 6 2 12 5 3 15 4 16 3 1 -1

22. The Marginal Revenue Curve for a Monopolist with a Straight-Line Demand Curve
Price
a/2 D MR
Q0/2 Q0
Quantity
Observations
The vertical intercept, a, is the same for MR and D
The horizontal intercept for MR, Q0/2, is one half the demand intercept, Q0.

23. 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.

24. The Monopolist’s Profit- Maximizing Output Level
Marginal Cost 6
Observations
If P = $3 & Q = 12, MR < MC and output should reduce
Profits are maximized at 8 units where MR = MC
P = $4 where quantity demanded = quantity supplied 4
Price ($/unit of output) 3 2 D MR 8 12 24
Quantity (units/week)

25. Even a Monopolist May Suffer an Economic Loss
Being a monopolist doesn’t guarantee an economic profit
Economic loss
= $400,000/day
Economic profit
= $400,000/day
0.12
0.10
0.10
ATC
0.08
Price ($/minute)
Price ($/minute)
ATC MC
0.05 MC
0.05 D D 20 MR 20 MR 24
Minutes (millions/day)
Minutes (millions/day)

26. The Demand and Marginal Cost Curves for a Monopolist
Why the Invisible Hand Breaks Down Under Monopoly D 3 12 6 24
Marginal cost
The socially optimal
amount occurs where
MC = 12 units
Price ($/unit of output)
Quantity (units/week)

27. Price ($/unit of output) Quantity (units/week)
The Demand and Marginal Cost Curves for a Monopolist
Why the Invisible Hand Breaks Down Under Monopoly 6
Marginal cost 2 4 MR 8
The profit maximizing level of output of 8 units, where MR = MC, is less than the socially optimal output of 12
Between 8 and 12, MB to society > MC to society
Does not increase output because MR to the firms is less than MC
Price ($/unit of output) 3 D 12 24
Quantity (units/week)

28. Price ($/unit of output) Quantity (units/week)
The Demand and Marginal Cost Curves for a Monopolist
Why the Invisible Hand Breaks Down Under Monopoly 6
Marginal cost 2 4 MR 8
Because MR<P, the monopoly produces less than the socially optimal amount
The deadweight loss of the monopoy to society = (1/2)($2/unit)(4 units/wk) = $4/wk.
Deadweight loss
Price ($/unit of output) 3 D 12 24
Quantity (units/week)
Slide 28

29. 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

30. Why the Invisible Hand Breaks Down Under Monopoly
Difficulties in Reducing the Deadweight Loss of Monopolies
Enforcing antitrust laws
Patents, copyrights, and innovation
Natural monopolies

31. Price Discrimination
The practice of charging different buyers different prices for essentially the same good or service
Examples
Senior citizens and student discounts on movie tickets
Supersaver discounts on air travel
Rebate coupons

32. Food For Thought
Why do many movie theaters offer discount tickets to students?

33. Example: Carla Edit
How many manuscripts should Carla edit?

34. Total and Marginal Revenue from Editing
Reservation Price Total Revenue Marginal revenue
Student ($ per paper) ($ per week) ($ per paper)
A 40 40
B C
D E F G H 40 36 32 28 24 20 16 12

35. Example: Single Price Monopoly
How many manuscripts should Carla edit?
Opportunity cost = $29
TR = P x Q, or for 4 papers, 4 x $34 = $136/wk
MR is the difference in TR from adding another student
If MR > MC: increase output

36. Example: Single Price Monopoly
How many manuscripts should Carla edit?
Carla edits 3 papers
TC = 3 x $29 = $87
TR = $108
Economic profit = $108 - $87 = $21/wk

37. Example: Social Optimal
How many manuscripts should Carla edit?
O.C. of her time per editing= $29
Must charge the same price
Reservation price > opportunity cost for student A to F
Socially efficient number is 6
TR = 6 x $30 = $180
TC = 6 x $29 = $174
Economic profit = $180- $174 = $6

38. Example: Perfect Price Discrimination
If Carla can do perfect price discriminate, how many papers should she edit?
Assume Carla can charge each student the reservation price.

39. Example: Perfect Price Discrimination
Reservation Student price
A 40
B 38 C 36
D 34 E 32 F 30 G 28 H 26
Carla would edit A to F
TR = $40 + $38… = $210
TC = 6 x $29 = $174
Economic Profit = $210 - $174 = $36/wk
Economic Profit is $30 more

40. Perfect Price Discrimination
Perfectly Discriminating Monopolist
Charging each buyer exactly their reservation price
Economic surplus is maximized
Consumer surplus is zero
Economic surplus = producer surplus

41. Limitation to Perfect Price Discrimination
Seller will not know each buyer’s reservation price.
Low price buyers could resell to other buyers at a higher price.

42. The Hurdle Method of Price Discrimination
Profit-maximizing seller’s goal is to charge each buyer his/her reservation price.
There are two problems to implementing this pricing strategy.
Seller does not know the reservation prices
Seller must separate high and low price buyers
The hurdle method of price discrimination is used to solve these problems.

43. The Hurdle Method of Price Discrimination
The practice of offering a discount to all buyers who overcome some obstacle.
Example
Offering a rebate to those who mail in a coupon

44. The Hurdle Method of Price Discrimination
A Perfect Hurdle
Separates buyers precisely according to their reservation prices
What do you think?
Is a perfect hurdle possible?

45. Example: Price Discrimination with a Perfect Hurdle
Question
How much should Carla charge for editing if she uses a perfect hurdle?

46. Example: Price Discrimination with a Perfect Hurdle
Assume
Carla offers a mail in rebate coupon
Students with at least a $36 reservation price never use the coupon
Students with a reservation price below $36 use the coupon
Opportunity cost = $29
Discount coupon = $4

47. Price Discrimination with a Perfect Hurdle
Reservation Price Total Revenue Marginal revenue
Student ($ per paper) ($ per week) ($ per paper)
List Price Submarket 40 36 32
A 40 40
B C
D E F G H
Discount Price Submarket 34 30 26 22 18

48. Example: Price Discrimination with a Perfect Hurdle
Solution
TR = (3)(36) + (2)(32) = $172
MC = ($5)($29) = $145
Economic Profit = $27/wk

49. Price Discrimination with a Perfect Hurdle
Is price discrimination a bad thing?
In fact, the hurdle method raised economic surplus.

50. Calculating Economic Surplus
Economic Surplus Under Price Discrimination with a Perfect Hurdle
Calculating Economic Surplus
Consumer Surplus Reservation Price Actual Price Consumer Surplus
A $40 $36 $4
B $38 $36 $2
C $36 $36 $0
Both
Single price
& discount
Without Discount $6
D $34 $22 $2
With Discount $8
Producer Surplus
Single price = 3( ) = $21/wk
Discount price = 3( ) = $21/wk
2( ) = $6/wk
$27/wk

51. Calculating Economic Surplus
Economic Surplus Under Price Discrimination with a Perfect Hurdle
Calculating Economic Surplus
Consumer Surplus Reservation Price Actual Price Consumer Surplus
A $40 $36 $4
B $38 $36 $2
C $36 $36 $0
Both
Single price
& discount
Without Discount $6
D $34 $22 $2
With Discount $8
Economic Surplus
Single price = $6 + $21 = $27/wk
Discount price = $8 + $27 = $35/wk
Slide 51

52. Food For Thought
Is Carla’s discount rebate completely efficient?

53. Examples of Price Discrimination
Temporary Sales
Book publishers and paperback books
Automobile producers offer various models
Commercial air carriers
Movie producers

54. Single price monopolies are inefficient because P > MR.
Summary
Single price monopolies are inefficient because P > MR.
The hurdle method of price discrimination reduces the inefficiency.
The more finely the seller can discriminate, the smaller the efficiency loss.
Hurdles are not perfect, therefore, there will be some efficiency loss.

55. End