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Page 1: MBMC Monopoly and Other Forms of Imperfect Competition.

MB MC

Monopoly and Other Forms of Imperfect

Competition

Monopoly and Other Forms of Imperfect

Competition

Page 2: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 2

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

Imperfectly Competitive FirmsHave some control over pricePrice may be greater than the cost of

productionLong-run economic profits are possible

Page 3: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 3

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

Perfect CompetitionAn ideal market that maximizes economic

surplusA situation that does not always exist

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 4

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

Imperfectly Competitive MarketsReduce economic surplus to varying

degreesAre very common

Page 5: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 5

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

Various Forms of Imperfect CompetitionPure Monopoly (most inefficient)

The only supplier of a unique product with no close substitutes

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 6

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

Various Forms of Imperfect CompetitionOligopoly (more efficient than a monopoly)

A firm that produces a product for which only a few rival firms produce close substitutes

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 7

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

Different Forms of Imperfect CompetitionMonopolistic Competition (closest to

perfect competition)A large number of firms that produce slightly

differentiated products that are reasonably close substitutes for one another

Page 8: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 8

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

The Essential Difference Between Perfectly and Imperfectly Competitive FirmsThe perfectly competitive firm faces a

perfectly elastic demand for its product.The imperfectly competitive firm faces a

downward-sloping demand curve.

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 9

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

In perfect competition Supply and demand determine equilibrium

price. The firm has no market power.At the equilibrium price, the firm sells all it

wishes.

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 10

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

With perfect competition 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.

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 11

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Imperfect Competition

With imperfect competition The firm has some control over price or

some market power.The firm faces a downward sloping

demand curve.

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 12

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

The Demand Curves Facing Perfectly and Imperfectly Competitive Firms

Quantity

$/u

nit

of

ou

tpu

t

Quantity

DMarket price P

rice

D

Perfectly competitive firm Imperfectly competitive firm

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 13

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Five Sources of Market Power

Exclusive control over inputs Patents and copyrights Government licenses or franchises Economies of scale (natural monopolies) Network economies

Page 14: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 14

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Economies of Scale and the Importance of Fixed Costs

Firms with large fixed costs and low variable costs Have low marginal costsAverage total cost declines sharply as

output increasesEconomies of scale will exist

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 15

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Total and Average Total Costs for a Production Process with Economies of Scale

Ave

rag

e co

st (

$/u

nit

)

Quantity

To

tal c

ost

($/

year

)

Quantity

F

Q0

F + Q0

TC = F + MQ

Total cost rises at a constant rate as output rises

ATC = F/Q + M

M

Average costs decline and isalways higher than marginal cost

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 16

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Costs for Two Computer Game Producers (1)

Nintendo Playstation

Annual production 1,000,000 1,200,000

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 $1.00 $0.97

Observations•Fixed costs are a relatively small share of total cost•Cost/game is nearly the same

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 17

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Costs for Two Computer Game Producers (2)

Annual production 1,000,000 1,200,000

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 $10.20 $8.53

Nintendo Playstation

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

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 18

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Annual production 500,000 1,700,000

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 $20.20 $6.08

Costs for Two Computer Game Producers (3)

Nintendo Playstation

• 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

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 19

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Economies of Scale and the Importance of Fixed Costs

Fixed investment in research and development has been increasing as a share of production costs.

1984 20% 80%1990 80% 20%

Cost of producing a computerFixed Cost Variable Cost

Software Hardware

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 20

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Profit Maximization forthe Monopolist

A price taker (perfect competition) and a price setter (imperfect competition) share two economic goals. They wantTo maximize profitsTo select the output level that maximizes

the difference between TR and TC, where MB= MC.

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 21

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Profit Maximization forthe Monopolist

For a producerMB = Marginal Revenue (MR) or a change

in a firm’s total revenue that results from a one-unit change in output

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 22

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Profit Maximization forthe Monopolist

Marginal Revenue for the MonopolistPerfect competition and monopolies

Both increase output when MR > MC.Calculate MC the same way.Do not have the same MR at a given price.

o In perfect competition: MR = Po In monopoly: MR < P

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 23

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

The Monopolist’s Benefit from Selling an Additional Unit

Pri

ce (

$/u

nit

)

Quantity (units/week)

D

8

8

2

6

3

5

• 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

Page 24: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 24

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

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

6 2 12

5 3 15

4 4 16

3 5 15

P Q TR MR

3

1

-1

Marginal Revenue inGraphical Form

Page 25: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 25

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Pri

ce &

mar

gin

al r

even

ue

($/u

nit

)

Quantity (units/week)

6 2 12

5 3 15

4 4 16

3 5 15

P Q TR MR

3

1

-1

8

8

D

Marginal Revenue inGraphical Form

432-1

3

5

1

MR

Page 26: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 26

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

The Marginal Revenue Curve for a Monopolist with a Straight-Line Demand Curve

Pri

ce

QuantityObservations• 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.

D

Q0

a

Q0/2

a/2

MR

Page 27: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 27

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Profit Maximization forthe Monopolist

Profit Maximizing Decision RuleWhen 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.

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 28

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

The Monopolist’s Profit-Maximizing Output Level

Pri

ce (

$/u

nit

of

ou

tpu

t)

Quantity (units/week)

6

D

3

12 24

Marginal Cost

2

4

MR

8

Observations• If P = $3 & Q = 12 MR < MC

and output should be reduced

• Profits are maximized at 8 units where MR = MC

• P = $4 where quantity demanded = quantity supplied

Page 29: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 29

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Even a Monopolist May Suffer an Economic Loss

Pri

ce (

$/m

inu

te)

Minutes (millions/day)

Pri

ce (

$/m

inu

te)

Minutes (millions/day)2420

0.12

0.10 ATC

20

0.08

0.10

ATC

Economic loss= $400,000/day

Economic profit= $400,000/day

D

0.05 MC

MR

D

0.05 MC

MR

Being a monopolist doesn’t guarantee an economic profit

Page 30: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 30

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

D

3

12

6

24

Marginal cost

The socially optimalAmount occurs whereMC = D(MB) @ 12 units

The Demand and Marginal Cost Curves for a Monopolist

Pri

ce (

$/u

nit

of

ou

tpu

t)

Quantity (units/week)

Why the Invisible Hand Breaks Down Under Monopoly

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Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 31

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

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

• Cannot increase output because MR to the firms is less than MC

The Demand and Marginal Cost Curves for a Monopolist

Pri

ce (

$/u

nit

of

ou

tpu

t)

Quantity (units/week)

D

12

6

24

Why the Invisible Hand Breaks Down Under Monopoly

3

Marginal cost

Page 32: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 32

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

2

4

MR

8

• Because MR < P, the monopoly produces less than the socially optimal amount

• The deadweight loss of the monopoly to society = (1/2)($2/unit)(4units/wk) = $4/wk.

Deadweight loss

The Demand and Marginal Cost Curves for a Monopolist

Pri

ce (

$/u

nit

of

ou

tpu

t)

Quantity (units/week)

D

12

6

24

Why the Invisible Hand Breaks Down Under Monopoly

3

Marginal cost

Page 33: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 33

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Why the Invisible Hand Breaks Down Under Monopoly

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

Page 34: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 34

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Difficulties in Reducing the Deadweight Loss of MonopoliesEnforcing antitrust lawsPatents, copyrights, and innovationNatural monopolies

Why the Invisible Hand Breaks Down Under Monopoly

Page 35: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 35

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Price DiscriminationThe practice of charging different buyers

different prices for essentially the same good or service

Why the Invisible Hand Breaks Down Under Monopoly

Page 36: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 36

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Examples of Price DiscriminationSenior citizens and student discounts on

movie ticketsSupersaver discounts on air travelRebate coupons

Why the Invisible Hand Breaks Down Under Monopoly

Page 37: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 37

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Economic NaturalistWhy do many movie theaters offer

discount tickets to students?

Why the Invisible Hand Breaks Down Under Monopoly

Page 38: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 38

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Using Discounts to Expand the Market

Perfectly Discriminating MonopolistCharging each buyer exactly their

reservation priceEconomic surplus is maximizedConsumer surplus is zeroEconomic surplus = producer surplus

Page 39: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 39

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Limitations to Perfect Price DiscriminationSeller will not know each buyer’s

reservation price.Low price buyers could resell to other

buyers at a higher price.

Using Discounts to Expand the Market

Page 40: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 40

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Public Policy TowardNatural Monopoly

Methods of Controlling Natural MonopoliesState regulation of private monopolies

Cost-plus regulationo High administrative costo Less incentive for innovationo P does not equate to MC

Page 41: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 41

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Public Policy TowardNatural Monopoly

Methods of Controlling Natural MonopoliesExclusive contracting for natural monopoly

Competition for the contract sets P = MCDifficulty when fixed costs are high such as

electric utilities

Page 42: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 42

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Public Policy TowardNatural Monopoly

Methods of Controlling Natural MonopoliesVigorous enforcement of anti-trust laws

Helps prevent cartelsMay prevent economies of scale

Page 43: MBMC Monopoly and Other Forms of Imperfect Competition.

Chapter 9: Monopoly and Other Forms of Imperfect Competition Slide 43

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Copyright c 2004 by The McGraw-HillCompanies, Inc.  All rights reserved.

Public Policy TowardNatural Monopoly

What do you think?Should we regulate natural monopolies?

Page 44: MBMC Monopoly and Other Forms of Imperfect Competition.

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Chapter