unit iv: imperfect competition characteristics of monopolies
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Unit IV: Unit IV: Imperfect CompetitionImperfect Competition
Characteristics Characteristics of Monopoliesof Monopolies
5 Characteristics of a Monopoly5 Characteristics of a Monopoly
3. “Price Maker”
2. Unique good with no close substitutes
• The firm can change the price by changing the quantity it produces (ie. shifting the supply curve to the left).
• The Firm IS the Industry
1. Single Seller• One Firm controls the vast majority of a market
5. Some “Nonprice” Competition
4. High Barriers to Entry
• No immediate competitors
• Despite having no close competitors, monopolies still advertise their products in an effort to increase demand.
5 Characteristics of a Monopoly5 Characteristics of a Monopoly
• New firms CANNOT enter market
Examples of Examples of MonopoliesMonopolies
Four Origins of MonopoliesFour Origins of Monopolies1. Geographical MonopoliesEx: Nowhere gas stations, De Beers Diamonds, San Diego
Chargers, Cable TV, Qualcomm Hot Dogs…-Location or control of resources limits competition and leads to one supplier.
2. Government MonopoliesEx: Water Company, Firefighters, The Army,
Pharmaceutical drugs, rubix cubes… -Government allows monopoly for public benefits or
to stimulate ingenuity. -The government issues patents to protect inventors
and forbids others from using their invention. (They last 20 years)
Four Origins of MonopoliesFour Origins of Monopolies3. Technological MonopoliesEx: Microsoft, Intel, Frisbee, Band-Aide…-Patents and widespread availability of certain products
lead to only one major firm controlling a market.
4. Natural MonopoliesEx: Electric Companies (SDGE)• If there were three competing electric companies
they would have higher costs.• Having only one electric company keeps prices low-Economies of scale make it impractical to have
smaller firms. -Low average total costs act as a barrier to entry for
other firms.
Ave
rag
e T
ota
l C
ost
Quantity
$20
15
10
0 50 100 200
LRATC
Electric companies have economies of scale. The more they produce the lower the average cost.
•If there are 4 firms, the ATC is $20•If there are 2 firms the ATC is $15•If there is 1 firm the ATC is $10
Assume that 200 units need to be
produced
Drawing Drawing MonopoliesMonopolies
Good news…1. Only one graph because the firm
IS the industry.2. The cost curves are the same3. The MR= MC rule still applies4. Shut down rule still applies
• Unlike perfect competition, all imperfectly competitive firms have downward sloping demand curve.
• To sell more a firm must lower its price.
D
Combine the Demand of an industry with the costs of a firm.
Quantity
Co
sts
(do
llar
s)
ATC
MC
What about MR?
To sell more a firm must lower its price. What happens to Marginal Revenue?
Price Quantity
Demanded
Total Revenue
Marginal Revenue
$6 0
$5 1
$4 2
$3 3
$2 4
$1 5
Does the Marginal Revenue equal the price?
To sell more a firm must lower its price. What happens to Marginal Revenue?
Price Quantity
Demanded
Total Revenue
Marginal Revenue
$6 0 0
$5 1 5
$4 2 8
$3 3 9
$2 4 8
$1 5 5
Does the Marginal Revenue equal the price?
To sell more a firm must lower its price. What happens to Marginal Revenue?
Price Quantity
Demanded
Total Revenue
Marginal Revenue
$6 0 0 -
$5 1 5 5
$4 2 8 3
$3 3 9 1
$2 4 8 -1
$1 5 5 -3
Plot Demand and Marginal Revenue Curves
MR DOESN’T EQUAL PRICE
Plot Demand and Marginal Revenue CurvesQuantity Price TR MR
0 $16 0 -
1 15 15 15
2 14 28 13
3 13 39 11
4 12 48 9
5 11 55 7
6 10 60 5
7 9 63 3
8 8 64 1
9 7 63 -1
10 6 60 -3
Plot Demand and Marginal Revenue CurvesQuantity Price TR MR
0 $16 0 -
1 15 15 15
2 14 28 13
3 13 39 11
4 12 48 9
5 11 55 7
6 10 60 5
7 9 63 3
8 8 64 1
9 7 63 -1
10 6 60 -3
Why is MR below Demand?
1 2 3 4 5 6
P
Q
$100 90
60
40D
As price decreases from$100 to $90...
revenue will increase with the
additional unit sold.
TR=$300
TR = $360
1 2 3 4 5 6
P
Q
$100 90
60
40D
TR=$300
TR = $360
Loss = $30
But a lower price results in a loss of the $30 that was earned when
price was $10 higher
Gain = $90
Why is MR below Demand?
1 2 3 4 5 6
P
Q
$100 90
60
40D
TR=$300
TR = $360
Loss = $30
Marginal Revenue is ADDITIONAL REVENUE MR= (Price –Loss from lowering price)
MR= $90 - $30 = $60
Gain = $90
Why is MR below Demand?
1 2 3 4 5 6
P
Q
$100 90
80
60
40D
Loss= $40
Gain = $80
MR= $80 – 40 = $40
As price decreases from$90 to $80 TR increases
Why is MR below Demand?
1 2 3 4 5 6
P
Q
$100 90
80
60
40D
MR
Why is MR below Demand?
Why is MR below Demand?
1 2 3 4 5 6
P
Q
$100 90
80
60
40D
MR
MR CURVE IS LESS THAN
DEMAND CURVE!!!
Elastic vs. Inelastic Elastic vs. Inelastic Range of Demand Range of Demand
CurveCurve
Do
llar
sD
oll
ars
$200
150
100
50
$750
500
250
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
Elastic and Inelastic Range
Elastic and Inelastic Range
Do
llar
sD
oll
ars
$200
150
100
50
$750
500
250
MR
Elastic
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
DQ
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
TR
Q
Total Revenue TestIf price falls and
TR increases then demand is
elastic.
Q
Do
llar
sD
oll
ars
$200
150
100
50
$750
500
250
TR
MR D
InelasticElastic
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Elastic and Inelastic Range
Total Revenue TestIf price falls and
TR falls then demand is inelastic.
When MR goes negative, TR will fall
Total Revenue TestIf price falls and
TR increases then demand is
elastic.
Putting Putting Demand, MR, Demand, MR,
and Cost and Cost TogetherTogether
What output should this monopoly produce?
D
MC
ATC
MR
Profit =$5
MR = MC
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Pri
ce,
cost
s, a
nd
rev
enu
e
$9
8
7
6
5
4
3
2
How much is the TR, TC and Profit or Loss?
D
MRQ
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Pri
ce,
cost
s, a
nd
rev
enu
e
$9
8
7
6
5
4
3
2
Conclusion: A monopolists produces where MR=MC, buts charges the price consumer are willing to pay identified by the demand curve.
MC
ATC
What if cost are higher?
D
MCATC
MR
140 Loss
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Pri
ce,
cost
s, a
nd
rev
enu
e
AVC
Q
Minimum AVC is shut down point
How much is the TR, TC, and Profit or Loss?
D
MC
MR
$110
$130
TR=TC=
Profit/Loss=Profit/Loss per Unit=
Identify and Calculate:
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Pri
ce,
cost
s, a
nd
rev
enu
e
$780
$180$600
ATC
$30
Are Are Monopolies Monopolies Efficient?Efficient?
Monopolies are inefficient because they…1. Charge a higher price2. Under produce• Not allocativly efficiency
3. Produce at higher costs • No productive efficiency
4. Have little incentive to innovate
Why?Because there is little external
pressure to be efficient
Q
INEFFICIENCY OF PURE MONOPOLY
P
D
S = MC
Pc
Qc
An industry in pure competition
CS
PS
Q
INEFFICIENCY OF PURE MONOPOLYP
DMR
S = MC
Pc
Pm
QcQm
At MR=MCA monopolist will sell less units at a
higher price than in competition
Q
CS and PS of a MonopolyP
DMR
S = MC
Pc
Pm
QcQm
Result is DEADWEIGHT LOSS
to society
CS
PS
Q
CS and PS of a MonopolyP
DMR
S = MC
Pc
Pm
QcQm
Result is DEADWEIGHT LOSS
to society
CS
PS
Monopoly pricing causes consumers to overpay so CS becomes PS
D
MC
MR
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Pri
ce,
cost
s, a
nd
rev
enu
eAre Monopolies Productively Efficient?
Does Price = Min ATC?
ATC
No. They are not producing at the lowest
cost (min ATC)
D
MC
MR
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Pri
ce,
cost
s, a
nd
rev
enu
eDo Monopolies Have Allocative Efficiency?
Does Price = MC?
ATC
No. Price is greater. The monopoly is under
producing.
Regulating Regulating MonopoliesMonopolies
How do they regulate?•Use Price controls: Price Ceilings•Why don’t taxes work?•Taxes limit supply-that’s the problem
Why Regulate?Why would the government regulate
an monopoly? 1. To keep prices low 2. To make monopolies efficient
1.Socially Optimal PriceP = MC (Allocative Efficiency)
Where should the government place the price ceiling?
2. Fair-Return Price (Break–Even)
P = ATC (Normal Profit)
OR
Q
D
MR
MCATC
P
Pri
ce a
nd
Co
sts
Monopoly PriceMR = MC
Qm
Pm
REGULATED NATURAL MONOPOLY
Q
D
MR
MCATC
P
Pri
ce a
nd
Co
sts
Fair-Return PriceNormal Profit Only
Qf
Pf
TR = TC
REGULATED NATURAL MONOPOLY
Q
D
MR
MCATC
P
Pri
ce a
nd
Co
sts
Socially-OptimumPrice
P = MC
Qr
Pr
REGULATED NATURAL MONOPOLY
Q
D
MR
MCATC
P
Pri
ce a
nd
Co
sts
MR = MC
Fair-Return Price
Socially-OptimumPrice
Qm Qf Qr
Dilemma of RegulationWhich Price?
Pm
Pf
Pr
REGULATED NATURAL MONOPOLY
Price Price DiscriminationDiscrimination
Requires the following conditions:•Firm must have monopoly power•Firm must be able to segregate the market •Consumers must not be able to resell product
PRICE DISCRIMINATION
Definition:Practice of selling the same products to different buyers at different prices
PRICE DISCRIMINATION
Examples:
•Price discrimination seeks to charge each consumer what they are willing to pay in an effort to increase profits.
•Airline Tickets (vacation vs. business)•Movie Theaters (child vs. adult) •All Coupons (spenders vs. savers) •SPHS soda machine (students vs. teachers)
•Those with inelastic demand are charged more than those with elastic
Q
DMR
MC
ATC
P
Q1
Pri
ce a
nd
Co
sts
Economic profits witha single MR=MC
price
PRICE DISCRIMINATION
Q
D
MC
ATC
P
Q1
Pri
ce a
nd
Co
sts
Q2
A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand
MR=D
Q
D
MC
ATC
P
Pri
ce a
nd
Co
sts
What output do they make? Where is Consumer Surplus?
Q2
MR=D
Q
D
MC
ATC
P
Q1
Pri
ce a
nd
Co
sts
Profit withprice discrimination
Where is the Profit?
Q2
MR=D
What’s the Point?•Perfectly price discriminating firms:•Make more profit•Produce more•Produce at allocative efficiency
Q
D
MC
ATC
P
Q1
Pri
ce a
nd
Co
sts
Price = MC
Allocative Efficiency
Q2
MR=D
Can You Do The Following?
1.Draw a monopoly making a profit at long-run equilibrium and identify price, quantity, and profit.
3. Draw a price discriminating monopoly at equilibrium and label price, quantity, MR, and profit
2. Draw a perfectly competitive industry AND firm at long-run equilibrium
Monopolistic CompetitionMonopolistic Competition
Market Structure Continuum
PureCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
FOUR MARKET MODELSMonopolistic Competition:
•Relatively Large Number of Sellers•Differentiated Products•Some control over price•Easy Entry and Exit•Extensive non-price competition
Examples:1. Fast Food Restaurants2. Furniture companies3. Jewelry stores4. Hair Salons5. Clothing Manufacturers
Monopolistic Qualities• Control over price of own good due
to differentiated product.• D > MR • Plenty of non-price competition• Not efficient
“Monopolistic” +”Competition”
Perfect Competition Qualities• Large number of smaller firms• Relatively easy entry and exit• Zero Economic Profit in Long-Run
since firms can enter.
Differentiated Products•Goods are NOT identical.•Firms seek to capture a piece of the
market by making unique goods.•Since these products have substitutes,
firms use NON-PRICE Competition • Brand Names and Packaging• Product Attributes • Service• Location• Advertising (Two Goals)
1. Increase Demand 2. Make demand more INELASTIC
Drawing Drawing Monopolistic Monopolistic CompetitionCompetition
D
MR
$4
ATCP
rice
an
d C
ost
s
Q1
Short-RunEconomic
Profits
What Happens?
PRICE AND OUTPUT INMONOPOLISTIC COMPETITION
$2
MC
Quantity
$4
$2
D
MR
ATCP
rice
an
d C
ost
s
Q1
New Firms Enter
Quantity
MC
Short-RunEconomic
Profits
In the long-run, new firms will enter, driving down the DEMAND for firms
already in the market.
PRICE AND OUTPUT INMONOPOLISTIC COMPETITION
D
MR
$4
ATCP
rice
an
d C
ost
s
Q1
Short-RunEconomic
Profits
What will happen?
$2
MC
PRICE AND OUTPUT INMONOPOLISTIC COMPETITION
Quantity
D
MR
$4
ATCP
rice
an
d C
ost
s
Q1
Normal Profit
$2
MC
$1
LONG- RUN EQUILIBRIUM
Quantity
Why does DEMAND shift?• When short-run profits are made… –New firms enter–New firms mean more close substitutes and
less market shares for each existing firm.–Demand for each firm falls
• When short-run losses are made…– Firms exit –Result is less substitutes and more market
shares for remaining firms.–Demand for each firm rises
D
MR
$7
Pri
ce a
nd
Co
sts
Q1
Short-RunEconomic
Loss
What happens? MC
$1
PRICE AND OUTPUT INMONOPOLISTIC COMPETITION
With economic losses, firms willexit the market – stability occurswhen economic profits are zero.
ATC
Quantity
D
MR
ATC
Pri
ce a
nd
Co
sts
Q1
Short-RunEconomic
Loss
What happens? MC
$1
PRICE AND OUTPUT INMONOPOLISTIC COMPETITION
$7
Quantity
D
MR
MC
ATCP
rice
an
d C
ost
s
Q3
Quantity
Long-Run EquilibriumNormalProfitOnly
PRICE AND OUTPUT INMONOPOLISTIC COMPETITION
$7
MONOPOLISTIC MONOPOLISTIC COMPETITIONCOMPETITION
AND EFFICIENCYAND EFFICIENCY
MONOPOLISTIC COMPETITIONAND EFFICIENCY
• Not Productively Efficient Minimum ATC
• Not Allocatively EfficientPrice MC
• Firm has Excess Capacity
Graphically…
D
MR
MC
P3 = A3
ATCP
rice
an
d C
ost
s
Q3
Quantity
Long-Run EquilibriumPrice is Not= Minimum
ATC
Price MC
MONOPOLISTIC COMPETITIONAND EFFICIENCY
Excess Capacity• The gap between the minimum
ATC output and the profit maximizing output• Given current resources, the firm
can produce at minimum ATC, but they decide not to.
MONOPOLISTIC COMPETITIONAND EFFICIENCY
D
MR
MC
P3 = A3
ATCP
rice
an
d C
ost
s
Q3
Quantity
Long-Run Equilibrium
Excess Capacity
MONOPOLISTIC COMPETITIONAND EFFICIENCY
• Large number of firms and product variation meets societies needs• Nonprice Competition (product
differentiation and advertising) may result in sustained profits for some firms.
Ex: Nike might continue to make above normal profit because they are a well known brand.
Advantages ofMONOPOLISTIC COMPETITION
Oligopoly
Market Structure Continuum
PureCompetition
PureMonopoly
MonopolisticCompetition Oligopoly
FOUR MARKET MODELSOligopoly:•A Few Large Producers• Identical or Differentiated Products•Control Over Price, But Mutual
Interdependence•Firms use Strategic Pricing
•High Entry Barriers•Examples: OPEC, Cereal Companies,
Car Producers
Oligopolies occur when only a few large firms start to control an industry.
High barriers to entry keep others from entering.
Types of Barriers to Entry•Economies of Scale•High Start-up Costs•Ownership of Raw Materials
HOW DO OLIGOPOLIES OCCUR?
Game Theory
What is game theory?
The study of how people behave in strategic situations
A thorough understanding of game theory helps firms in an oligopoly
maximize profit.
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 as to avoid economic losses. •Game theory helps us analyze their strategies.
SIMULATION!!!!!
The Prisoner’s DilemmaCharged with a crime, each
prisoner has one of two choices: Deny or Confess
Prisoner 2
Prisoner 1
Both Deny = 3 Years in jail each
Both Confess= 5 Years in jail each
Deny Confess
Deny
ConfessConfess = 1 Year
Deny = 7 Years
Confess =1 Year
Deny =7 Years
Strategic PricingEach firm has one of two choices:
Price High or Price Low.
Firm 2
Firm 1
Both High = 2 Each
Both Low= 1 each
High Low
High
LowLow = 3High = 0
Low = 3High = 0
OLIGOPOLY BEHAVIORA Game-Theory Overview
High
Low
High LowU
pto
wn
’s P
rice
Str
ateg
yRareAir’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
High
Low
High LowU
pto
wn
’s P
rice
Str
ateg
yRareAir’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
Greatest Combined Profit if both Sell High
OLIGOPOLY BEHAVIOR
High
Low
High LowU
pto
wn
’s P
rice
Str
ateg
yRareAir’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
Each firm recognizes that more profit is made if they lower price
OLIGOPOLY BEHAVIOR
High
Low
High LowU
pto
wn
’s P
rice
Str
ateg
yRareAir’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
BUT if both lower price they end up in the Worst Case
OLIGOPOLY BEHAVIOR
High
Low
High LowU
pto
wn
’s P
rice
Str
ateg
yRareAir’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
To make more profit, firms may try to cooperate (collude)
OLIGOPOLY BEHAVIOR
High
Low
High LowU
pto
wn
’s P
rice
Str
ateg
yRareAir’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
OLIGOPOLY BEHAVIORTo make more profit, firms may try to cooperate (collude)
High
Low
High LowU
pto
wn
’s P
rice
Str
ateg
yRareAir’s Price Strategy
BA
DC
$12 $15
$12 $6
$6 $8
$8$15
But now each firm has the incentive to cheat.
OLIGOPOLY BEHAVIOR
What did we learn?1. Oligopoly pricing must be
strategic2. Oligopolies have a tendency to
collude to gain profit.(Collusion is the act of cooperating
with rivals in order to “rig” a situation.)
3. Collusion results in the incentive to cheat.
Oligopoly Graphically
Not one standard model due to...Complications of Interdependence
1 – Price Leadership (no graph)2 – Cartels and Collusion (known graph)3 – Kinked Demand Curve (new graph)
THREE OLIGOPOLY MODELS
Instead there are 3 Alternative Models:
Price Leadership
PRICE LEADERSHIP MODEL
•Collusion is ILLEGAL.•Firms CANNOT set prices.•Price leadership is a strategy used by firms to coordinate prices without outright collusion
General Process: 1. “Dominant firm” initiates a price change2. Other firms follow the leaderExample: 3 competing gas stations.
PRICE LEADERSHIP MODEL
Breakdowns in Price Leadership •Temporary Price Wars may occur if other firms don’t follow price increases of dominant firm.•Each firm tries to undercut each other.
Example: Employee Pricing for Ford
Cartels and Collusion
A cartel is a group of producers that create a formal agreement to fix prices high. Examples: 1. Overt Collusion- OPEC ( Organization of Petroleum Exporting Countries) 11 countries set limits on the supply of oil2. Covert Collusion- In 1998, Toys R’ Us and Toy manufacturers were sued by the government for having secret price fixing meetings.
Cartel = Colluding Oligopoly
CARTELS AND COLLUSION
1. Cartels set price and output at an agreed upon price
2. Firms require identical or highly similar demand and costs
3. Cartel must have a way to punish cheaters
4. Together they act as a monopoly
Characteristics of Cartels
Graphically…
Colluding Oligopolists WillSplit the Monopoly Profits.
D
MC
ATC
MR
EconomicProfit
MR = MC
Pri
ce a
nd
co
sts
Q0
P0
A0
CARTELS AND OTHER COLLUSION
Kinked Demand Curve
1. Match price-If one firm cuts it’s prices, then the other firms follow suit causing inelastic demand
Kinked Demand Curve Model
Noncollusive firms are likely to react to competitor’s pricing in two ways:
2. Ignore change-If one firm raises prices, others maintain same price causing elastic demand
The kinked demand curve model is a graphic portrayal of the interdependency of noncollusive firms.
D1
MR1Quantity
KINKED DEMAND THEORY:
Pri
ce
The demand and MR curves if other firms match lower pricing
If this firm lowers its price and
others follow, Qd will increase
mildly
MR2
D2
Quantity
KINKED DEMAND THEORY:
Pri
ce
The demand and MR curves if other firms ignore higher pricing
If this firm increases its price and others ignore it, Qd for this firm will decrease significantly
MR2D1
D2
MR1Quantity
Two sets of curves based on the pricing decisions of other firms
Pri
ce
The firm’s demand andmarginal revenue curves
MR2D1
D2
MR1Quantity
Pri
ce
Rivals tend tofollow a price cut
Two sets of curves based on the pricing decisions of other firms
MR2D1
D2
MR1Quantity
Pri
ce
Rivals tend tofollow a price cut
or ignore aprice increase
Two sets of curves based on the pricing decisions of other firms
MR2D1
D2
MR1Quantity
Effectively creatinga kinked demand curve
Pri
ce
Two sets of curves based on the pricing decisions of other firms
D
Quantity
Effectively creatinga kinked demand curve
Pri
ce
Two sets of curves based on the pricing decisions of other firms
MR2D1
D2
MR1Quantity
What about MR?
Pri
ce
Two sets of curves based on the pricing decisions of other firms
D
MR1Quantity
Since we use sections of both MR curves, the MR has a
vertical gap. P
rice MR2
Two sets of curves based on the pricing decisions of other firms
D
Quantity
Profit maximizationMR = MC occurs
at the kink.
KINKED DEMAND THEORY:NONCOLLUSIVE OLIGOPOLY
Pri
ce MR2
MR1
D
Quantity
Notice that changes in costs don’t easily change profit maximizing
output.
KINKED DEMAND THEORY:NONCOLLUSIVE OLIGOPOLY
Pri
ce
MC2
MC1
MR2
MR1
D
Quantity
The result is stable (or sticky) prices for noncolluding firms.
KINKED DEMAND THEORY:NONCOLLUSIVE OLIGOPOLY
Pri
ce
MC2
MC1
MR2
MR1
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