Microeconomics: Unit 3

Imperfect competition Monopoly, monopolistic competition

and oligopoly

Topic 1: Monopoly

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Characteristics of Monopolies

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1. Single Seller• The Firm IS the Industry 2. Unique good with no close substitutes3. “Price Maker”The firm can manipulate the price by changing

the quantity it produces

4. High barriers to entry

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Monopoly: barriers to entry

1. Geography barriers-Location or control of resources limits competition and

leads to one supplier

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2. Legal barriers-Patents/copyrights lead to only one major firm controlling a

market. - Government gives exclusive right to a firm

3. Cost Barriers a single firm is able to supply a product to an entire market

at a lower cost than could 2 or more firms - Natural Monopoly- It is NATURAL for only one

firm to produce because they can produce at the lowest cost. (examples: water and electric co)

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Monopoly pricing strategies

1. Single Price Monopoly

Sells every unit for the SAME price

2. Price Discriminating Monopoly – Able to sell units for different prices to different

groups of people

Topic 2: Focus on Single price Monopoly

Price and Marginal Revenue• In PC : MR = D= AR= P • In monopoly: D=AR=P but NOT MR

MR < D WHY???? Monopoly must lower its price to sell more units (remember LAW of DEMAND)

Q Price Total Revenue

Marginal Revenue

1 10

2 9

3 8

4 7

quantity price Total Revenue

Marginal Revenue

1 10 10 10

2 9 18 8

3 8 24 6

4 7 28 4

Plot Q and P and Q and MR on graph

MR<D=P $10 .

$9 . $8 . $7 . D=P

$6 $5 $4 MR

1 2 3 4

A Single Price Monopoly

MR is NOT = to DARP

MR and DARP are separated

MR < DARP

=AR=P

Elasticity of Demand Review

• Demand can be elastic or inelastic – Elastic demand inelastic demand P TR P TR

P TR P TR

P and TR move in opposite directions

P and TR move in same direction

Elastic range of demand curve

Elastic range will always be in the upper left part of the D curveand the inelastic range will be in the lower right

Monopolies and elasticity

Monopoly – will always price in the elastic portion of the demand curve

Why?? When they lower their price, their TR will increase

Marginal cost and monopolies

• The monopoly’s MC curve is the same as perfect competition (looks like a check mark)

• The MC is also the SUPPLY curve for the firm

= S

Monopolies have control over PRICE & QUANTITY

• How does a monopoly determine the price and quantity that will maximize its profit???

MR<MC = don’t produce MR>MC= produce MR=MC = produce and stop (profit max. point)

Price Q TC TR MR MC

10 0 1 0 --- ---

9 1 1.5 9

8 2 2.5 16

7 3 5.5 21

6 4 10.5 24

5 5 17.5 25

Complete MC and MR Remember: Marginal means additional!

What Q should this firm produce?Why???

What is the profit at this Quantity?Price Q TC TR MR MC

10 0 1 0 --- ---

9 1 1.5 9 9 .5

8 2 2.5 16 7 1

7 3 5.5 21 5 3

6 4 10.5 24 3 5

5 5 17.5 25 1 7

Q of 3; Profit of 15.5

Profit maximization on Monopoly graph

• Monopoly will produce where MR=MC to maximize profits

• Price monopoly charges will be determined by the D curve (D=AR=P)

• D curve in monopoly is STEEP

=AR=P

Monopolies in the short run

• Can earn a profit, loss or break even

Review of PROFIT

• Firm can sell an item at a higher price than it cost to make item

P>ATC

Monopoly making a profit (ATC below P )

=AR=P

TR =$200

TC = $140

Profit = $60

Review of LOSS

• Firm sells the item at a price lower than the cost of making it

P<ATC

Monopoly experiencing a Loss (ATC above P)

=AR=P

TR = $200

TC=$240

Loss = -$40

Monopoly breaking even

• Price = ATC

Monopolies in the LONG RUN

• - All monopolies will make a PROFIT in the long run because they do not face any competition (market is impossible to enter)

Topic 3: Monopoly and Perfect Competition compared

• Perfect competition = efficient productively and allocatively efficient

• Monopoly = Inefficient– Monopoly under-produces and overcharges

If perfect competiton, P & Q would be set by S (MC) and D

• Pc and Qc considered SOCIALLY OPTIMAL

Review of consumer and producer surplus

Consumer surplus: area above Price and below Demand curve; MAXIMINZED in PC & equal to PS

Producer Surplus: area below price and above supply curve; MAXIMIZED in PC & equal to PC

Monopoly creates a deadweight loss and redistributes the consumer surplus

Consumer surplus maximizedIn PC (area above P and under D) Consumer surplus shrinks and

creates DEADWEIGHT LOSS

Producer surplus

CS

Deadweight Loss

Loss of economic efficiency (CS is not at a maximum as it is in

Perfectly competitive industries)

1 What is the socially optimal price?

2 What is the socially optimal quantity?

3 What quantity does the monopoly produce?

4 What price does the monopoly charge?

5 What area represents the SOCIALLY OPTIMAL consumer surplus?

6 What area represents the MONOPOLY’S consumer surplus?

7 What area represents the SOCIALLY OPTIMAL producer surplus?

8 What area represents the MONOPOLY’S producer surplus?

9 What area represents the deadweight loss?

Topic 4: price discriminating Monopoly

• Can sell an item at a number of different prices

• Can make a bigger profit than if they were a SINGLE price monopoly

To be able to price discriminate firm must be able to:

• 1. identify and separate different types of buyers

• 2. Sell product that can’t be resold

Price discriminating Monopoly MR=D=AR=P in price discriminating monopolyWHY???

– Still produces where MR=MC, but firm does NOT have to lower its price to sell more units

– More profit and Less Consumer surplus than a monopoly

CS

Topic 5: Monopolistic Competition

Characteristics of monopolistic competition

1. Large number of firms – No market dominance by one firm – one firm’s actions don’t directly affect the other

firms

• 2. produce differentiated product

• 3. Non-price competition – Competition on quality, services and packaging

• 4. Easy entry and exit

• 5. Price maker

Monopolistic firms have control over price and quantity

How do monopolistic firms determine price and quantity to produce?

MR<MC = don’t produce MR>MC = produce MR=MC= produce (profit max. point)

Monopolistic competition in the short run

• Can earn a profit, loss or break even

• Monopolistic competition graphs look the same as monopoly graph, but demand curve is NOT as steep

Monopolistic Competition

Monopolistic competitive firms in the LONG RUN

• Different from monopoly

• Monopolistic competitive firms earn a NORMAL PROFIT in long run

Why do monopolistic competitive firms earn a normal profit in the long

run??• PROFIT:

encourages entry into market

Prices go down as a result

• LOSS: encourages exit from market

Prices go up as a result

Monopolistic & PC compared

• major difference between monopolistic competition and perfect competition is PRODUCT DIFFERENTIATION!!

This allows them to have slight control over price

Monopolistic competition and perfect competition

• Both have normal profit in the long run; but monopolistic competition DOES NOT have productive of allocative efficiency

Monopolistic competition has: excess capacity and mark up & have a DEADWEIGHT LOSS (they are NOT perfectly efficient)

Excess Capacity • Actual production is less than

what is achievable

• PC firms do produce at their fullest capacity (PCs are productively efficient)

• IN Long run, PC firms produce a Q at their min. ATC, IN LONG RUN Monopolistic competitive firms produce less (price = ATC, BUT not minimum ATC)

MarkupMonopolistic firms charge a higher price than a firm in PC

IN PC, price = MCIn monopolistic competition, P > MC

Topic 6: Oligopoly

• A. Small number of firms• Mutual interdependence; one firm’s actions

impact the decisions of the other firm

• B. Barriers to entry • Natural Oligopoly : a few firms can supply the

market more cheaply than many firms • Legal Oligopoly: legal barrier to entry protects

small # of firms in the market

• *Due to barriers firms in oligopoly can make an economic profit in the long run without triggering entry of additional firms

c. Products may be identical or differentiated

Identical products in oligopoly

Differentiated products in oligopoly

2 types of Oligopolies

1.Colluding oligopolies = Cartel

A cartel is a group of producers that create an agreement to fix prices high.

Together they act as a monopoly

2. Non-Colluding Oligopolies

• If one firm in an oligopoly raises its prices, then none of the other firms in the oligopoly will raise theirs. If 1 firm in an oligopoly lowers its prices, than all of the other firms lower theirs : PRICES WILL BE RIGID

Kinked Demand Curve Model

The kinked demand curve model shows how non-collusive firms are interdependent

(firm’s actions will be dependent upon what other firm(s) are doing)

Curve is fairly flat above current price since a price hike results in a loss of market share.

Curve steep below current price since price reduction results in no increase in market share

Will not have to draw this graph. Just understand why it is KINKED

Example of Oligopoly pricing

Topic 7: Game Theory and Oligopolies

• Game theory = method of analyzing strategic behavior

• Show behavior of oligopoly (DUOPOLY) firms

• Use a payoff matrix to explain Game theory

Prisoner’s dilemma

• What is the BEST outcome for both???

• IF A and B don’t trust each other, what will be the outcome???

Game theory example

Pay-off Matrix: The payoff matrix below shows profits for A and B

RAISE PRICE LOWER PRICERAISE PRICE $15, $15 $10, $20

LOWER PRICE $20, $10 $12, $12

Firm A

Firm B

Nash Equilibrium

• Situation in which each player is doing as well as it can given what the other player is doing

Pay-off Matrix: The payoff matrix below shows profits for A and B

RAISE PRICE LOWER PRICERAISE PRICE $15, $15 $10, *$20

LOWER PRICE *$20, $10 *$12, * $12

Firm A

Firm B

Nash Equilibrium?

Dominant strategy: the best move to make regardless of what your opponent does

A’s dominant strategy? B’s dominant strategy?

Dominate Strategy

The Dominant Strategy is the best move to make regardless of what your opponent does

Maintain Lower price

Maintain * $140, * $150 $120, $110

Lower Price $130, * $120 * $150, $100

Central

North

What is Central’s Dominate Strategy???

What is North’s Dominate Strategy???

Can Yo u Name These Copyrighted Logos?? 1. 2. 3. 4.

5. 6. 7. 8.

9. 10. 11. 12.

13. 14. 15. 16.

17. 18.