1. Monopoly 1

2. FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Pure
Monopoly
Oligopoly
Characteristics of a Monopoly:
Single Seller
One firm dominates the market
The firm IS the industry
2. Unique good with no close substitutes
3. The Firm is a “Price Maker”
Because it has no competitors, the firm can decide what price to charge 2

3. 5 Characteristics of Monopoly
4. High Barriers to Entry
New firms can’t easily enter market
No immediate competitors
Firm CAN make economic profit in the long-run
5. Some “Nonprice” Competition
Despite having no close competitors, monopolies still advertise their products in an effort to increase demand 3

4. Real World Examples 1. Public utilities
e.g. natural gas, water, cable, telephone companies, internet service providers
In industries like these, firms have very high fixed costs and relatively low variable costs
Having several firms provide the same product might actually reduce efficiency by raising costs
These are sometimes called natural monopolies

5. Real World Examples 2. Patents
A patent is a license issued by the government which gives an inventor the exclusive right to sell a product s/he invented
A patent protects the inventor from rivals who didn’t share in the costs of developing the invention
The idea is to encourage
people to spend time and
effort developing new
products

6. Real World Examples 3. Awesome Companies
Sometimes a firm simply becomes so good at what it does that it gains a very large market share
e.g. Intel provides 80% of central microprocessors used in PC
90% of internet searches are done on Google

7. 4. Control of Key Resources
Real World Examples
4. Control of Key Resources
If one firm controls most or all of the available resources in the production of the good or service, it will become difficult or impossible for other firms to compete with it
E.g. De Beers Diamond Corporation

8. Review How many firms are there in a monopoly?
True/False: A monopolist is a price taker (it cannot choose where to set the price)
What is a natural monopoly?
What is a patent?
What is DeBeers?

9. Graphing Monopolies 9

10. Good news… Only one graph because the firm IS the industry.
The cost curves are the same
The MR= MC rule still applies 10

11. The Main Difference
Monopolies (and all Imperfectly competitive firms) face a downward sloping demand curve for their products
To sell more, a firm must lower its price
This changes marginal revenue…
Marginal Revenue doesn’t equal Price! 11

13. NO NO

14. My Dad is DEAD?!!!?!!!!

15. Nooooooooooooooooooooooooooooooooooooooo!!!!!

16. Why is MR ≠ D? P Qd TR MR
$11 - 16

17. Why is MR ≠ D? P Qd TR MR
$11 -
$10 1 10
$10 17

18. Why is MR ≠ D? P Qd TR MR
$11 -
$10 1 10 $9 2 18 8
$10 $9 $9 18

19. Why is MR ≠ D? $10 $9 $9 $8 $8 $8 P Qd TR MR $11 - $10 1 10 $9 2 18 8-
$10 1 10 $9 2 18 8 $8 3 24 6
$10 $9 $9 $8 $8 $8 19

20. Why is MR ≠ D? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 P Qd TR MR $11 - $10 1-
$10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28
$10 $9 $9 $8 $8 $8 $7 $7 $7 $7 20

21. Why is MR ≠ D? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 P Qd TR
$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 21

22. Why is MR ≠ D? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5P 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 22

23. Why is MR ≠ D? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5P 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 23

24. Why is MR ≠ D? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5P 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 24

25. MR IS LESS THAN PRICE Why is MR ≠ D? $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6Qd 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
PRICE $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 25

26. Maximizing Profit 26

27. 6
How much output will the firm produce?____________
What price will it charge?____________
How much is its total revenue?_____________
How much is its total cost?_______________
How much profit/loss?__________________ $7
$42
$36 $9 8 7 6 5 4 3 2 $6
A monopolist produces where MR=MC, buts charges the price consumers are willing to pay identified by the demand curve P MC
ATC
Profit =$6 D
TC=$36
TR=$42 MR Q 27

28. 6
How much output will the firm produce?____________
What price will it charge?____________
How much is its total revenue?_____________
How much is its total cost?_______________
How much profit/loss?__________________ $9
$54
$42
$12 P MC
ATC 10 9 8 7 6 D 5 MR Q 28

29. What if costs 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=
TC=
Loss=
$90
$100 MR
$10 Q 29

30. How much output will the firm produce?____________
What price will it charge?____________
How much is its total revenue?_____________
How much is its total cost?_______________
How much profit/loss?__________________ 7
$10
$70
$56
$14 P
$10 9 8 7 6 5 4 MC
ATC D MR Q 30

31. Are Monopolies Efficient?31

32. Perfect Competition S = MC P
In perfect competition, the sum of consumer and producer surplus is maximized
consumer
surplus (CS)
Ppc
producer surplus (PS) D Q
Qpc (perfect competition) 32

33. Monopoly S = MC P Pm Ppc D MR Q Qm Qpc
Because MR is below D, a monopolist’s profit-maximizing quantity (MR=MC) is lower Pm
Ppc D MR Q Qm
Qpc 33

34. Where is CS and PS for a monopoly? Now there is DEADWEIGHT LOSS
S = MC P CS
Total surplus falls.
Now there is DEADWEIGHT LOSS Pm PS
Compared to Perfectly Competitive Markets, Monopolies Produce Less and Charge More, Resulting in a Deadweight Loss to Society D MR Q Qm 34

35. Are Monopolies Productively Efficient?
No. The monopoly does not produce at the lowest cost (min ATC)
Does Q = Min ATC? $9 8 7 6 5 4 3 2 MC
ATC D MR Q 35

36. Monopolies are NOT efficient!
Are Monopolies Allocatively Efficient?
No. Price is greater. The monopoly is underproducing.
Does Price = MC? $9 8 7 6 5 4 3 2 P MC
ATC
Monopolies are NOT efficient! D MR Q 36

37. They don’t have to because they have no competitors!
Monopolies are inefficient because they…
Overcharge
Underproduce
Not allocatively efficient
Produce at higher costs
Not productively efficient
Have little incentive to innovate
Why not?
They don’t have to because they have no competitors! 37

38. Regulating Monopolies38

39. Regulating Monopolies
There are two major ways that governments deal with monopolies:
Break ‘em up! – this is called
antitrust law
2. Restrict how much the monopolist
can charge or force them to produce
a certain quantity
This is the one case where a price ceiling might actually improve economic efficiency 39

40. Antitrust Law Sherman Anti-Trust Act of 1890
The first federal statute to restrict monopolies
Authorized the federal government to investigate and break up large companies
Clayton Anti-Trust Act of 1914
Added further regulations to the Sherman Anti-Trust law by seeking to prevent anti competitive practices

41. Price Ceilings
Where might the government place a price ceiling to promote efficiency?

42. Monopoly Price Ceiling
Where does the firm produce if it is unregulated? P MC Pm
ATC D MR Q Qm 42

43. Monopoly Price Ceiling
Price Ceiling at Socially Optimal
Socially Optimal = Allocative Efficiency P MC Pm
ATC
Pso D MR Q Qm
Qso 43

44. Monopoly Price Ceiling
Price Ceiling at Fair Return
Fair Return means no economic profit P MC Pm
ATC
Pso
Pfr D MR Q Qm
Qso
Qfr 44

45. Monopoly Price Ceiling
Unregulated
Socially Optimal P MC
Fair Return Pm
ATC
Pso
Pfr D MR Q Qm
Qso
Qfr 45

46. Monopolistic Competition

47. Characteristics of Monopolistic Competition:
Perfect
Competition
Monopolistic
Competition
Monopolistic
Competition
Pure
Monopoly
Pure
Monopoly
Oligopoly
Oligopoly
Characteristics of Monopolistic Competition:
Relatively Large Number of Sellers
Differentiated Products
Some control over price
Easy Entry and Exit (Low Barriers)
A lot of non-price competition (Advertising)

48. Differentiated Products48

49. Examples:
Almost everything

51. “Monopoly” + ”Competition”
Monopolistic Qualities
Control over price of own good due to differentiated product
D greater than MR
Plenty of Advertising
Not efficient
Perfect Competition Qualities
Large number of smaller firms
Relatively easy entry and exit
Zero Economic Profit in Long-Run since firms can enter

52. Differentiated Products
Products are NOT identical.
Each firm seeks to capture a piece of the market by making its product unique in some way
Since these products have substitutes, firms use NON-PRICE Competition.
Examples of NON-PRICE Competition
Branding
Unique Product Attributes
Advertising (Two Goals)
1. Increase Demand
2. Make demand more INELASTIC

53. Oligopoly

54. Characteristics of Oligopolies:
FOUR MARKET MODELS
Perfect
Competition
Monopolistic
Competition
Pure
Monopoly
Oligopoly
Characteristics of Oligopolies:
A Few Large Producers
High Barriers to Entry
Control Over Price (Price Maker)
Mutual Interdependence
Firms use Strategic Pricing
Examples: Computer Operating Systems, Car Manufacturers

55. HOW DO OLIGOPOLIES OCCUR?
Oligopolies occur when high barriers to entry keep new firms from entering
Types of Barriers to Entry
1. Economies of Scale/ High Start-Up Costs
e.g. It is very difficult to compete with existing automakers because they have already invested enormous sums to produce at a low average cost
2. Ownership of Raw Materials
e.g. Until recently, OPEC member countries owned most of the world’s known oil reserves

56. The study of how people behave in strategic situations
Game Theory
The study of how people behave in strategic situations
An understanding of game theory helps firms in an oligopoly maximize profit.

57. Why learn about game theory?
Oligopolies are interdependent since they compete with only a few other firms
Their pricing and output decisions must be strategic in order to maximize profit and minimize losses
Game theory helps us analyze their strategies

58. Game Theory Payoff Matrices
A payoff matrix represents the known payoffs to individuals (players) in a strategic situation given choices made by other individuals in the same situation

59. Dominant Strategy
A player’s dominant strategy is the best move for a him/her to make regardless of what the other player does
A player may or may not have a dominant strategy depending on the potential payoffs

60. Example
Suppose Bert and Ernie are arrested on suspicion of manufacturing and distributing crystal meth
They are taken in for questioning in separate rooms
How many years they’ll spend in jail for their crimes depend on whether they confess or deny

61. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
The payoff matrix below shows the number of years that Bert and Ernie will spend in jail based on their decisions
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

62. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Ernie’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

63. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Ernie’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

64. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Ernie’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

65. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Bert’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

66. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Bert’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

67. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What is Bert’s dominant strategy (if any)?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

68. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
What will happen if both Bert and Ernie follow their dominant strategies?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

69. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert
Is this the best outcome for both?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

70. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert Confess Deny Confess
Imagine that you’re Ernie. Suppose that the police leave you and Bert alone for a few minutes in the police station before they begin interrogating you. What might you try to convince Bert to do?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

71. 5, 5 10, 10 20 , 0 0, 20 Payoff Matrix Ernie Bert Confess Deny Confess
Suppose you’re convinced that you’ve persuaded Bert to deny. It is now your turn to be interrogated. What do you do? Do you confess or deny?
Ernie
Confess
Deny
Confess
10, 10
0, 20
Bert
20 , 0
5, 5
Deny

72. Without talking, write down your choice
Example 2:
You and your tablemate are competing firms. You have one of two choices: Price High or Price Low.
Without talking, write down your choice
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

73. What is Firm 1’s dominant strategy?
Example 2:
What is Firm 1’s dominant strategy?
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

74. What is Firm 2’s dominant strategy?
Example 2:
What is Firm 2’s dominant strategy?
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

75. Example 2: Firm 2 Firm 1 $20K, $20K $0, $30K $30K, $0 $10K, $10K
Notice that each player has an incentive to collude (cooperate) but also an incentive to cheat
Firm 2
High
Low
High
$20K, $20K
$0, $30K
Firm 1
$30K, $0
$10K, $10K
Low

76. What is each player’s dominant strategy?
Video: Split or Steal
What is each player’s dominant strategy?
Player 2
Split
Steal
Split
50K, 50K
0, 100K
Player 1
100K, 0
0, 0
Steal

77. What did we learn?
Firms in an oligopoly are mutually interdependent and must behave strategically to maximize profit or minimize losses (they have to worry about the other guy)
Oligopolies have a tendency to collude to increase profit. (Collusion is the act of cooperating with rivals in order to “rig” a market)
Collusion may result in the incentive to cheat