Monopoly Ppt

Topic 6

Imperfect Competition

2

Imperfect Competitionand Market Power

An imperfectly competitive industry is an industry in which single firms have some control over the price of their output.

Some examples are Monopoly, Oligopoly and Monopolistic competition.

Market power is the imperfectly competitive firm’s ability to raise price without losing all demand for its product.

3

Price: The Fourth Decision Variable

Firms with market power must decide:1. how much to produce,

2. how to produce it,

3. how much to demand in each input market, and

4. what price to charge for their output.

4

Monopoly

A market structure in which only one producer or seller exists for a product that has no close substitutes

Magic Lamps, Inc.

5

Characteristics of Monopoly

The degree of control over price that is held by the monopolist

The individual supply of the monopolist coincides with the market supply

Market demand equals the demand for the monopolist’s product or service

The monopolist is a “price maker”

6

Sources of Monopoly Economies of scale

In capital intensive industries, the economies of large-scale production may lead to a small number of firms producing the product

Natural monopolies: Public utilities In cases where one or two firms can

adequately supply all the service needed, it may be desirable to limit the number of firms within a given territory Government regulation of these monopoly

franchises

7

Sources of Monopoly Control of raw materials

An effective barrier to entry is ownership or control of essential raw materials

Effective for years in the production of aluminum ALCOA and its control of bauxite

Patents The exclusive right to use, keep, or sell an

invention for a period of 20 years Threat of infringement suits

8

Sources of Monopoly Power

Competitive tactics Aggressive production and

merchandising techniques Illegal predatory pricing policies Aggressive innovation techniques

9

Determining Monopoly Price

The monopolist’s demand curve slopes downward to the right because it is the market demand curve of all consumers

The first question the monopolist asks is, “How many units of my good can I expect to sell at various prices?”

10

Price and Output Decisions in Pure Monopoly Markets

With one firm in a monopoly market, there is no distinction between the firm and the industry. In a monopoly, the firm is the industry.

The market demand curve is the demand curve facing the firm, and total quantity supplied in the market is what the firm decides to produce.

11

Price and Output Decisions in Pure Monopoly Markets

The demand curve facing a perfectly competitive firm is perfectly elastic; in a monopoly, the market demand curve is the demand curve facing the firm.

Monopoly Monopoly Demand CurveDemand Curve

12

The Monopolist’s Demand Curve

Price

Quantity

$12

10

8

0 900 1,000 1,100

D

TR =$10,800

TR = $10,000

TR = $8,800

13

The Monopolist’s Cost Curves

The monopolist’s cost curves reflect the law of diminishing marginal productivity

Thus, the cost curves have the same general shape and characteristics as the cost curves in a competitive industry

14

Marginal Revenue CurveFacing a Monopolist

For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it.

At every level of output except one unit, a monopolist’s marginal revenue is below price.

15

Cost and Revenue Curves for a Monopoly

Quantity

$2019181716151413121110

9876543210 1 2 3 4 5 6 7 8 9 10 11 12 13

Pri

ce a

nd C

ost

B

PURE PROFITB C

P

Q

A

MCATC

AR

MR

Profits maximized where MR = MC

MR will be less than AR or demand

because the monopolist must

lower price to increase sales

If the ATC curve is higher than the AR

curve, the monopolist would incur a loss

16

Facts about Monopoly A monopoly firm has no supply curve that is

independent of the demand curve for its product. A monopolist sets both price and quantity, and the amount

of output supplied depends on both its marginal cost curve and the demand curve that it faces.

Since entry is blocked, the monopolist can earn economic profits in the long run.

Monopolists can earn losses in the short run if demand is not sufficient or if costs are too high.

17

Price and Output Choices for a Monopolist Suffering Losses in the Short-Run

It is possible for a profit-maximizing monopolist to suffer short-run losses.

If the firm cannot generate enough revenue to cover total costs, it will go out of business in the long-run.

18

Perfect Competition andMonopoly Compared

Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits.

19

Monopolistic Competition Monopolistic competition is a common

form of industry (market) structure, characterized by a large number of firms, none of which can influence market price by virtue of size alone.

Some degree of market power is achieved by firms producing differentiated products.

New firms can enter and established firms can exit such an industry with ease.

20

Product Differentiation

Establishment of real or imagined characteristics that identify a firm’s product as unique

Vs.

21

Product Differentiation Reduces the Elasticity of Demand Facing a Firm

Based on the availability of substitutes, the demand curve faced by a monopolistic competitor is likely to be less elastic than the demand curve faced by a perfectly competitive firm, and likely to be more elastic than the demand curve faced by a monopoly.

22

Substitution Effect

A change in quantity demanded of a good due to a change in the price relative to substitute goods

Increased sales at the expense of other firms

23

Monopolistic Competition in the Short Run In the short-run, a monopolistically competitive firm

will produce up to the point where MR = MC.

• This firm is This firm is earning positive earning positive profits in the profits in the short-run.short-run.

24

Monopolistic Competition in the Short-Run

Profits are not guaranteed. Here, a firm with a similar cost structure is shown facing a weaker demand and suffering short-run losses.

25

Monopolistic Competition in the Long-Run

The firm’s demand curve must end up tangent to its average total cost curve for profits to equal zero. This is the condition for long-run equilibrium in a monopolistically competitive industry.

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Short-Run Cost and Revenue Curves: Possible Equilibrium Under Monopolistic Competition

Quantity

D

$Industry

0

S

Quantity

AR

Short-Run Economic Profit

0 30,000

ATC

$

MR

MC

Quantity0 28,000

ATC

$

Long Run

MRAR

MC

The demand curve facing each firm is downward sloping because of product differentiation and is more elastic than with a monopoly the firm will be able to increase sales by lowering price

The general range of prices established in the

industry around the intersection of total supply and demand

A monopolistic competitor that is

earning an economic profit because AR is

higher than ATC

In the long run, the firm in an

monopolistically competitive industry will just earn normal

profits

Profit

27

Economic Efficiencyand Resource Allocation In the long-run, economic profits are eliminated; thus, we

might conclude that monopolistic competition is efficient, however:

• Price is above marginal Price is above marginal cost.cost. More output could be More output could be produced at a resource cost produced at a resource cost below the value that below the value that consumers place on the consumers place on the product.product.

• Average total cost is not Average total cost is not minimized.minimized. The typical firm will The typical firm will not realize all the economies of not realize all the economies of scale available. Smaller and scale available. Smaller and smaller market share results in smaller market share results in excess capacity.excess capacity.

•Notice that the LR equilibrium quantity is to the left of the minimum ATC curve.Notice that the LR equilibrium quantity is to the left of the minimum ATC curve.

28

Oligopoly

A market structure in which relatively few firms produce identical or similar products

Two basic characteristics: Each firm has some ability to influence price The interdependence among firms in setting

their pricing policies Entry barriers exist.

29

Possible Demand Curves for an Oligopolist

Price

Quantity

D

D1

P

D

P

Q

D1The effect on sales when an oligopolist

changes price depends on the reaction of its competitors

Competitors may choose to do nothing

Competitors may match any change in price

Rivals may follow suit for a decrease in price, but ignore an

increase in price

A kinked demand curve results if rivals follow suit for a P but ignore a P

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Competition in Oligopoly Firms in oligopolies tend to

concentrate on nonprice competitive policies like advertising

Frequently use administered prices A predetermined price set by the seller

rather than a price determined solely by demand and supply in the marketplace

Use of nonprice competition eg rebates, promotional deals, etc..

31

Cartel An organization of independent firms that

agree to operate as a shared monopoly by limiting production and charging the monopoly price

Key ingredients for cartel success Small number of firms Substantial barriers to entry Homogenous product Violations of the agreement are

easily detected

32

Three-Firm Cartel

Price

Quantity q1 Qc

P

Dc

d1MR1

MC1FIRM 1 MARKET SHARE

FIRMS 2 + 3 MARKET SHARE

Demand curve for cartel’s product

The demand and marginal revenue curves for one of the three identical firms = one-third of market demand

The firm will maximize profits by equating its MR with MC price equal to P and will produce q1

The end result is that the cartel will charge a monopoly price and restrict output to the

monopoly level (Qc)

33

Measurements of Concentration

Concentration ratio A measure of market power calculated by

determining the percentage of industry output accounted for by the largest firms

Herfindahl Index A measure of market power calculated by summing

the squares of the market shares of each firm in the industry

Gives much great weight to firms with large market shares. A HI value of <1000 indicates a highly competitive industry.

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Ten Highly Concentrated IndustriesPercentage of Value of Shipments Accounted for by the Largest Firms in High-Concentration Industries, 1992

SIC NO.

INDUSTRYDESIGNATION

FOURLARGEST

FIRMS

EIGHTLARGEST

FIRMS

NUMBEROF

FIRMS

2823 Cellulosic man-made fiber 98 100 5

3331 Primary copper 98 99 11

3633 Household laundry equipment 94 99 10

2111 Cigarettes 93 100 8

2082 Malt beverages (beer) 90 98 160

3641 Electric lamp bulbs 86 94 76

2043 Cereal breakfast foods 85 98 42

3711 Motor vehicles 84 91 398

3482 Small arms ammunition 84 95 55

3632 Household refrigerators and freezers

82 98 52

Source: U.S. Department of Commerce, Bureau of the Census, 1992 Census of Manufacturers, Concentration Ratios in Manufacturing, Subject Series MC92-S-2, 1997.

35

Perfect & Imperfect Markets Compared

High degree of competition benefits consumers

Under perfect competition, firm tend to have lower prices, produces more outputs and obtain normal profits in the long run.

Each firm produces at the minimum ATC curve and P (AR) = MC (and ATC).

36

Perfectly Competitive versus Monopolistic Pricing: Possible Long-Run Price Under Monopolistic Competition

Quantity0 Q Q

Pri

ce a

nd C

ost

P

P C

K

B

MC

ATC

ARMR

D´ (MR´ and AR´)

Competitive solution: P`Q`

Monopolistic competitive solution: PQ

37

Perfect Monopoly or Competition Oligopoly

$

0

$

0Q

MC

ATC

Possible Equilibriums Under Perfect Competition, Monopoly, and Oligopoly

Q

AR and MR

100,000 500,000

MRAR

ATC

MC

38

Competition Among Consumers

Monopsony A market structure in which there is a single

buyer (e.g., rural area granary) Oligopsony

A market structure in which there are only a few buyers (e.g., tobacco market)

Monopsonistic competition A market structure in which there are many

buyers offering differentiated conditions to sellers (e.g., toy manufacturers)