Monopoly and Other Forms of Imperfect Competition

1. Monopoly and Other Forms of Imperfect Competition

2. Price Taker v. Price Setter • Perfectly Competitive Firm • A firm that must take the price in the market • A price taker • Imperfectly Competitive Firm • A firm with at least some latitude to set its own price • A price setter

3. Forms of Imperfect Competition • Pure monopolist • A firm that’s the only supplier of a unique product with no close substitutes • Oligopolist • A firm that produces a product for which only a few rival firms produce close substitutes • Monopolistically competitive firm • One of a large number of firms that produce slightly differentiated products that are reasonably close substitutes for one another

4. Essential Difference • A perfectly competitive firm faces a perfectly elastic demand curve for its product • Firms take the price in the market, where supply and demand curves intersect • Charging a higher price or a lower price does not help increase profits • An imperfectly competitive firm faces a downward-sloping demand curve • Charging a price different from competitors may be advantageous

5. Fig. 9.1The Demand Curves Facing Perfectly and Imperfectly Competitive Firms

6. Market Power • Market Power • A firm’s ability to raise the price of a good without losing all its sales • It does not mean that a firm can sell any quantity at any price it wishes. [If firms raise price, quantity demanded falls.] • i.e. they must remember the law of demand

7. Sources of Market Power • Market power arises from factors that limit competition = “barriers to entry” • Exclusive control over inputs • Economies of scale (lower average costs) • Patents • Grant exclusive rights for a specified time period • Promote monopoly but encourage innovation • Government licenses or franchises

8. Returns to Scale • Constant returns to scale • When all inputs are changed by a given proportion and output changes by the same proportion • Increasing returns to scale • When all inputs are changed by a given proportion and output changes by a higher proportion • Also know as Economies of Scale

9. Economies of Scale • With Economies of Scale • Average cost of production falls as output increases • There are high start-up costs • There are low marginal costs

10. Fig. 9.2 Total and Average Costs for a Production Process with Economies of Scale

11. “Natural Monopoly” • In some markets, it makes more sense (is more efficient) to only have a single provider of the good. • Economies of scale are so great that the good or service can be provided at the lowest cost if only one firm provides it. • E.g. Utilities • How many sets of phone lines, water pipes, cable wires, electric lines … do we need? • Since monopoly power is dangerous (to consumers) what must we do with natural monopolies?

12. Profit Maximization • Goal of all firms: Maximize profits • Rule • Expand output when MR > MC • Decrease output when MC > MR • Sell the quantity of output where marginal revenue equals marginal cost, MR = MC

13. Fig. 9.3The Profit-Maximizing Output Level for a Perfectly Competitive Watermelon Farmer

14. Monopolist’s Marginal Revenue • Marginal Revenue • The change in a firm’s total revenue that results from a one-unit change in output • For a monopolist • marginal benefit of selling an additional unit is less than the market price • Note that a monopolist can only sell an add-itional unit if it cuts prices on all units it sells

15. Fig. 9.4The Monopolist’s Benefit from Selling an Additional Unit

16. Fig. 9.5Marginal Revenue in Graphical Form

17. Fig. 9.6The Marginal Revenue Curve for a Monopolist with a Straight-Line Demand Curve

18. Profit-Maximizing Rule • Profit is maximized at the level of output for which MR = MC • A monopolist sets the price off of the demand curve at its profit-maximizing output

19. Fig. 9.9The Monopolist’s Profit-Maximizing Output Level

20. Fig. 9.11The Deadweight Loss from Monopoly

21. Monopoly and Efficiency • Recall, the socially efficient level of output is where MB = MC • The monopolist produces less than socially efficient level of output • Monopolists are not efficient • Inefficiency is measured by deadweight loss • Monopoly may be socially inefficient, but the alternatives, like legislation, are not perfect either

22. Price Discrimination • Price Discrimination • The practice of charging different buyers different prices for essentially the same good or service • Discounts to senior citizens, children • Super-saver discounts on air travel • Rebate coupons on retail merchandise • Effective when the good or service cannot be resold

23. Types of Price Discrimination • Perfect price discrimination • A firm that charges each buyer exactly his or her reservation price • Hurdle method of price discrimination • The practice by which a seller offers a discount to all buyers who overcome some obstacle • A rebate that takes time and effort to mail in • Time spent waiting

24. Benefits of Price Discrimination • The number of trades increase • Brings output closer to the socially efficient level • Reduces deadweight loss and increases total economic surplus