09 monopoly, oligopoly and monopolistic competition

7/18/2019 09 Monopoly, Oligopoly and Monopolistic Competition

1/57

MB MC

Monopoly, Oligopoly

and MonopolisticCompetition


2/57

MB MC

Copyright c 2007 by The McGraw-HillCompanies, nc! "ll rights reser#ed!

$earning Ob%ecti#es

1. Define imperfect competition and compare it to perfectcompetition

2. Define market power and explain how it affects the demandcurve facing the firm

3. Understand and use marginal cost and marginal revenue tomaximize monopolist's profit

4. xplain how start!up costs affect economies of scale andmarket power

". #how how monopol$ alters economic surplus compared toperfect competition

%. Descri&e price discrimination and its effects


3/57

MB MC


Chapter &0' Monopoly and Other (ormso) mper)ect Competition

*lide +

Maret *trctres

e know that in realit$( perfect competition( in itsideal text!&ook form( is rare.

hat is far more common are firms with somedegree of market power )power to set prices*. +arket

,ower is a measure of a firm-s a&ilit$ to raise theprice of a good without losing all its sales.

n economics we define market structures &asedmainl$ on the following two dimensions/0um&er of producers in the market )one( few( or( man$*

hether goods produced are homogeneousordifferentiated


4/57

MB MC



*lide .

Maret *trctres

omogeneous ! dentical Differentiated the goods are similar &ut are

not perfect su&stitutes in the consumer-s mind

)differentiated &$ ualit$( packaging(advertising( etc*

hether a market sells differentiated goods or

homogeneous goods depends on the natureof the good and consumer-s preferencesreakfast cereals versus hammers5


5/57

MB MC



*lide /

Maret *trctres

6hus we have one perfectl$ competitive andthree mperfectl$ competitive market forms/

,erfect 7ompetition )homogeneous( man$*

mperfect 7ompetition+onopolistic 7ompetition )differentiated( man$*

8ligopol$ )differentiated9homogeneous( few*

,ure +onopol$ )one firm*


6/57

MB MC



*lide

1i))erent (orms o) Competition (rom 3rgman and 4ells

5ot "pplicable

Oligopoly

Monopoly

6er)ect Competition MonopolisticCompetition

How Many6rodcers

Many

(ew

One

"re 6rodcts 1i))erentiated

8es5o


7/57

MB MC



*lide 7

1i))erent (orms o) mper)ectCompetition

,ure +onopol$ )most inefficient*6he onl$ supplier of a uniue product with no

close su&stitutes

+onopolistic 7ompetition )closest to perfect

competition*: large num&er of firms that produce slightl$

differentiated products that are reasona&l$ close

su&stitutes for one another;ong!run ad


8/57

MB MC



*lide 9

1i))erent (orms o) mper)ectCompetition

8ligopol$ )t$picall$ more efficient than amonopol$*ndustr$ structure in which a small num&er of

large firms produce products that are eitherclose or perfect su&stitutes

omogeneous )wireless phone service( cement*and differentiated )automo&ile( cigarettes(

detergents* products.


9/57

MB MC



*lide :

mper)ect Competition ;s!6er)ect Competition

ith perfect competition/ f the firm raises its price( sales will &e zero.0o incentive to charge a lower price &ecause it can sell

as man$ units as it wants at the current price.

6he firm-s demand curve is the horizontal line at themarket price. t is a price taker.

ith imperfect competition/ 6he firm has some control over price or market power.

f it raises market price( it will not lose all its customers. f it reduces price( it will add customers.

6he firm faces a downward sloping demand curve. t is aprice maker.


10/57

MB MC



*lide &0

The 1emand Cr#es (acing 6er)ectlyand mper)ectly Competiti#e (irms

nito)otpt


11/57

MB MC



*lide &&

*orces o) Maret 6ower

1. xclusive control of a scarce resource or inputDe eers of #outh :frica a near monopol$= :rediamonds rare> ?em ualit$ diamonds are morecommon than other gem ualit$ colored stones.

2. ?overnment ;icenses or @ranchises lodging and concession operation at 0ational ,arks

3. ,atents and 7op$rights )Drug companies(:uthors*


12/57

MB MC



*lide &2

More ?ndring *orces o)Maret 6ower

4. conomies of #cale ! 0atural +onopolies,roduction of electricit$( natural gas( etc. hen natural

gas companies initiall$ started there was competition.ut large fixed costs gave the firm that sold the most the

lowest :67. 0etwork conomies )a product-s ualit$ increases

as the num&er of users increase i.e.( sales volumeincrease* another form of economies of scale+icrosoft( e&a$( @ace&ook( etc.


13/57

07>02>&/*deshna C!Bandyopadhyay

&+

@etrns to *cale

Aeturns to scale is a long run phenomenon. :llinputs are changed in the same proportion.

f output more )less* than dou&les when all

inputs are dou&led( the production function issaid to exhi&it ncreasing )Decreasing* returnsto scale.

f output dou&les when all inputs are dou&led(the production function is said to exhi&it7onstant returns to scale.


14/57

Units ofLabor (L)

@etrns to *cale and $@"TC

Units ofCapital(K)

TotalCost(TC)

OutputunderIRS

OutputunderDRS

OutputunderCRS

1 1 $150 1010 10

2 2 $300 30 15 20

W=$5 and r=$!


15/57

ncreasingretrns

to scale


16/57

07>02>&/*deshna C!Bandyopadhy&

4hy ?conomies o) *cale

#pecialization and Division of la&or $ieldsefficienc$.

+ass production reduces average costs sincethe large set up costs are spread over a largeamount of output. 8nce production is

esta&lished( +7 is ver$ low. xperience leads to Blearning &$ doingC andleads to improvements in efficienc$.


17/57

07>02>&/

*deshna C!

Bandyopadhyay

4hy 1is-economies o) *cale

s there an$thing called Btoo largeC in terms offactor$ size or size of operations>

es. e$ond a certain point &ureaucratic and

managerial inefficiencies creep in. 7ook &ookprocedures replace managerial &rilliance.7oordinating a large la&or force &ecomes

prohi&itivel$ expensive.

&7


18/57

MB MC



*lide &9

?conomies o) *cale and themportance o) *tart-Ap Costs

@irms with large fixed costs and low varia&le costs an$ production process that entails large pre!investments in research and development arecharacterized &$/

;arge start up costs;ow marginal costs

:verage total cost declines sharpl$ as output

increases conomies of scale ncreasing returns to scale.


19/57

MB MC


?conomies o) *cale and *tart-ApCosts

0ew products can have a large fixed developmentcosts

f marginal cost is constant( +arginal cost )+* E:verage varia&le cost

6otal cost is fixed cost )@* plus varia&le cost67 E @ F )+* )G*

6otal cost increases as output increases

:verage total cost is:67 E @ 9 G F +

:verage total cost decreases as output increases


20/57

MB MC



*lide 20

Total and "#erage Total Costs )or a6rodction 6rocess with ?conomies o) *cale

"#eragecost

B=>nit

ye

ar


21/57

MB MC



*lide 2&


7ost advantages from economies of scaledepends on how large the fixed cost is inrelation to marginal cost.

xample 1/0intendo and ,la$station each have fixed costs of

H2II(III and constant +7E HI.JI per game.

0intendo produces 2IK fewer copies of the videogame compared to ,la$station

3 cent difference in :67 &ecause 6@7967 issmall.


22/57

MB MC



*lide 22


xample 2/0intendo and ,la$station each have fixed costs

of H1I(III(III and constant +7E HI.2I per

game.0intendo produces 2IK fewer copies of the

video game compared to ,la$station

H1.%L difference in :67 &ecause 6@7967 is high.


23/57

MB MC



*lide 2+

Costs )or Two Compter Game 6rodcers& *mall T(C>TC

5intendo 6laystation

"nnalprodction &,000,000 &,200,000(iDed cost =200,000 =200,000

;ariable cost =900,000 =:0,000

Total cost =&,000,000 =&,&0,000

"#erage total cost per game =&!00 =0!:7

Obser#ationsM(iDed costs are a relati#ely small share o) total costMCost>game is nearly the same

Constant MC = $0.80


24/57

MB MC



*lide 2.

Costs )or Two Compter Game 6rodcers2 $arge T(C>TC

"nnalprodction &,000,000 &,200,000

(iDed cost =&0,000,000 =&0,000,000;ariable cost =200,000 =2.0,000

Total cost =&0,200,000 =&0,2.0,000

"#erage total cost per game =&0!20 =9!/+


M(iDed costs are a relati#ely large share o) total costM6laystation has a =&!7 a#erage cost ad#antageM6laystation can lower prices, co#er cost, and attractcstomers

Constant MC = $0.20


25/57

MB MC



*lide 2/


xample 3/ith a H1.%L advantage in :67( ,la$station is

a&le to get a larger market share.

7ost advantage to ,la$station &ecomes larger. xplains wh$ $ou would expect to see


26/57

MB MC



*lide 2

"nnalprodction /00,000 &,700,000

(iDed cost =&0,000,000 =&0,000,000

;ariable cost =&00,000 =+.0,000Total cost =&0,&00,000 =&0,+.0,000

"#erage total cost per game =20!20 =!09

Costs )or Two Compter Game 6rodcers+ *el) @ein)orcing Cost "d#antage


M*hi)t o) /00,000 nits to 6laystationM5intendoEs a#erage cost increases to =20!20>nitM6laystation a#erage cost )alls to =!09M" large nmber o) )irms cannot sr#i#e when the costdi))erential is high


27/57

MB MC



*lide 27

?conomic 5atralist

h$ does ntel sell the overwhelmingma

6he fixed investment needed to produce anew leading edge micro!processor isupwards of H2 &illion while the marginal costis


28/57

MB MC



*lide 29

6ro)it MaDimiFation )or the Monopolist

: monopolist maximizes profits &$ setting+AE+7

6he :A is falling= so +AN:A

6his implies ,O+AE+7 in euili&rium. uili&rium is inefficient.


29/57

MB MC



*lide 2:

The Marginal @e#ene Cr#e )or aMonopolist with a *traight-$ine 1emand Cr#e

6ric

e

1


30/57

MB MC



*lide +0

The MonopolistEs 6ro)it-MaDimiFing Otpt$e#el

6riceB=>nito)o

tpt

wee

+

&2 2.

Marginal Cost

2

.

MR

9

Obser#ationsM ) ! = =+ Q = &2 MR "MC and otpt sholdbe redced

M6ro)its are maDimiFed

at 9 nits where MR =MC

M! = =. where antitydemanded I antityspplied


31/57

MB MC



*lide +&

?lasticity o) 1emand and Monopoly

: monopolist-s +A is less than the price this is the essential source of themonopolist-s power. ow much less>Depends on the price elasticit$ of demand.

: monopolist that faces a highl$ elasticdemand curve will &ehave a lot like aperfectl$ competitive industr$.:mtrak has a monopol$ in intercit$ passenger service in

the 0orth!east corridor and $et is not a&le to raise prices&$ restricting service ver$ effectivel$. ?ood su&stitutes cars( planes


32/57

MB MC



*lide +2

?#en a Monopolist May*))er an ?conomic $oss

6riceB=>min

te

Mintes millions>day

6riceB=>min

te

Mintes millions>day

2.20

0!&2

0!&0 ATC

20

0!090!&0

ATC

?conomic lossI =.00,000>day

?conomic pro)itI =.00,000>day

0!0/ MC

MR

0!0/ MC

MR

Being a monopolist doesnEt garantee an economic pro)it

MB MC


33/57

MB MC



*lide ++

+

&2

2.

Marginal cost

The socially optimalamont occrs whereMC = M# J &2 nits

The 1emand and Marginal CostCr#es )or a Monopolist

6riceB=>nito)o

tpt

wee

4hy the n#isible Hand Breas 1own Ander Monopoly

MB MC


34/57

MB MC



*lide +.

2

.

MR

9

MThe pro)itmaDimiFing le#elo) otpt o) 9nits, where MR

= MC,is lessthan the sociallyoptimal otpt o)&2

MBetween 9 and&2, M#to society

K MC to societyMCannot increaseotpt becaseMR to the )irmsis less than MC


6riceB=>nito)o

tpt

wee

&2

2.


+

Marginal cost

MB MC


35/57

MB MC



*lide +/

2

.

MR

9

MBecase MR " !,the monopolyprodces less thanthe socially optimal

amontMThe deadweightloss o) themonopoly tosociety I &>2=2>nit.nits>wI =.>w!

1eadweight loss


6riceB=>nito)o

tpt

wee

&2

2.


+

Marginal cost

MB MC Asing 1isconts to ?Dpand the


36/57

MB MC



*lide +

f the monopolist could reduce the price&elow H4 for output sold &e$ond J units( itwould want to expand output closer to theefficient level of 12 units and would have

increased its profits &$ doing so. #ometimes monopolists do that through

,rice Discrimination6he practice of charging different &u$ers different

prices for essentiall$ the same good or service

Asing 1isconts to ?Dpand theMaret

MB MC 6rice discrimination nder


37/57

MB MC


07>02>&/ *deshna C!Band o adh

+7

6rice discrimination ndermonopoly

e have price discrimination when a monopolist/ charges a different price to different consumers even

when the cost of suppl$ing each consumer is the same.xample discount airfares( discounts on movie tickets

for students and seniors( re&ate coupons.

7harges the same price when the cost of suppl$ingdifferent consumers is different. xample mailing

letters to oston vs. 7hicago sa$ from #t ;ouis.

MB MC


38/57

MB MC



*lide +9

h$ do man$ movie theaters offer discount ticketsto students>

6he goal is to get &u$ers who would not &u$without the discount. #tudents have a lower A,

compared to older working adults. 6heater ownersexpand their clientele &$ offering tickets to studentsat a discount. 6here is also no risk )&ecause ofverifia&le Ds* that a student would &u$ the ticket

for a low price and re!sell it to a non!student for ahigher price and pocket the difference.

?conomic 5atralist

MB MC


39/57

MB MC



*lide +:

7arla supplements her income as a 6: &$editing term papers for undergrads. 6hereare J students for whom she might edit andher reservation prices are given on the next

ta&le. 7arla is a profit maximizer. 6he 87 of her

time to edit each paper is H2P.

:ssume that 7arla must charge the sameprice to ever$ &u$er.

6rice 1iscrimination

MB MC

T t l d M i l


40/57

MB MC



*lide .0

Total and Marginal@e#ene )rom ?diting

@eser#ation 6rice Total @e#ene Marginal re#ene*tdent = per paper = per wee = per paper

A .0 .0

# +9 7

C + &09

+. &+

+2 &0

F +0 &90

% 29 &:

& 2 209

.0

+

+2

29

2.

20

&

&2

MB MC


41/57



*lide .&

f 7arla maximizes profits( how man$manuscripts should 7arla edit>7ompare +A with 87 of H2P.

7arla will edit 3 papers.

TR = 3 x H3% E H1IJ9wk

TC = 3 x H2P E HJL9wk

conomic profit E H219wk

:ccounting profit E H1IJ9wk as 7arla-s explicitcost E I.

Asing 1iscontsto ?Dpand the Maret

MB MC


42/57



*lide .2

hat is the sociall$ efficient num&er of manuscriptsfor 7arla to edit( if she must still charge the sameprice to ever$ &u$er>

8pportunit$ cost E H2P

Aeservation price O opportunit$ cost forA to F#ociall$ efficient num&er is %

TR = % x H3I E H1JI

TC = % x H2P E H1L4conomic profit E H1JI ! H1L4 E H%

:ccounting profit E H1JI


MB MC

A i 1i t


43/57



*lide .+

f 7arla can price discriminate( how man$ papersshould she edit if she wants to maximize herprofits>

:gain Aeservation ,rice O 87 forA to F

,rofit maximizing uantit$ is %TRE H4I F H3J F 3% F 34 F 32 F 3I E H21I9wk

TCE H2P x % E H1L4

conomic profit E H3%9wk( H3I more than thesociall$ efficient euili&rium and HP more thanher private profit maximizing euili&rium &ut w9oprice discrimination.


MB MC


44/57



*lide ..

6er)ect 6rice 1iscrimination

: monopolist that charges each &u$er exactl$his9her A, is called a ,erfectl$ Discriminating+onopolist.Under perfect price discrimination( the private

profit maximizing euili&rium is exactl$ thesociall$ efficient euili&rium. #o( economicsurplus is maximized.

:ll consumers willing to pa$ a price high enoughto cover +7 will &e served.

7onsumer surplus is zero= conomic surplus Eproducer surplus.

MB MC


45/57



*lide ./

n realit$( perfect price discrimination can neveroccur &ecause

#eller will not know each &u$er-s reservationprice.

ven if &u$ers A, is pu&lic knowledge( low price&u$ers could alwa$s resell to other &u$ers at ahigher price and capture a part of the producers-surplus.

mperfect price discrimination is widespread.

6he hurdle method of ,D is aimed at solving thesepro&lems

$imitations to 6rice 1iscrimination

MB MC


46/57



*lide .

6he hrdle methodof price discrimination isthe practice of offering a discount to all&u$ers who overcome some o&stacle.Ae&ate coupons

6emporar$ #ales

7ommercial airline tickets

ard cover and paper&ack &ooks

7ars with optional add!ons#cratch and Dent appliance sales

+ovies with phased releases

Hrdle Method o) 6rice 1iscrimination

MB MC Asing 1isconts


47/57



*lide .7

: ,erfect urdle#eparates &u$ers precisel$ according to

their reservation prices

6he$ don-t exist in realit$.ow much should 7arla charge for

editing if she uses a perfect hurdle>




48/57



*lide .9

:ssume7arla must charge the same price to ever$one

7arla offers a mail in re&ate coupon

#tudents with at least a H3% reservation price

never use the coupon#tudents with a reservation price &elow H3%

alwa$s use the coupon

8pportunit$ cost E H2P


MB MC

6rice 1iscrimination


49/57



*lide .:

6rice 1iscriminationwith a 6er)ect Hrdle

@eser#ation 6rice Total @e#ene Marginal re#ene

*tdent = per paper = per wee = per paper

A .0 .0

# +9 7

C + &09

+. +.

+2 .

F +0 :0

% 29 &&2

& 2 &+0

.0

+

+2

$ist 6rice *bmaret

1iscont 6rice *bmaret

+.

+0

2

22

&9



50/57



*lide /0

;ist price su&market7arla will service all three students as the +A is

greater than the +7 of H2P. uili&rium priceEH3% )lowest :A of group*

Discount price su&market7arla will onl$ serve students D and . @or

ever$one else +7 is greater than +A.

uili&rium price is H32#o( charge H3% and allow a re&ate coupon for

H4




51/57



*lide /&

ith ,rice Discrimination/TR = )3*)3%* F )2*)32* E H1L2

TC = )H"*)H2P* E H14"

conomic ,rofit E H2L9wk= 6his is H% more than

ithout ,rice Discrimination#erve students :( and 7 onl$.

TR = )3*)3%* E H1IJ

TC = )H3*)H2P* E HJL

conomic ,rofit E H219wk


MB MC

6 i 1i i i ti B d


52/57



*lide /2

6he hurdle method raised economic surplus)consumers- and producers- surplus*.

7# and ,# are &oth greater under the hurdlemethod of price discrimination than whenthere is no price discrimination.

s 6rice 1iscrimination Bad



53/57



*lide /+

urdle ,rice Discrimination/:( and 7 pa$ H3%= D and pa$ H32.

7# E :/ )4I!3%* F / )3J 3%* F 7/ )3% 3%* F D/ )34 32* F / )32 32* E HJ

,# E 3x)3% ! 2P* F 2)32 2P* E H21 F H% E H2Lconomic #urplus E HJ F H2L E 3"9wk

ithout ,rice Discrimination#erve students :( and 7 onl$.

7# E :/ )4I3%* F / )3J!3%* F 7/ )3%3%* E H%,# E 3x)3%!2P* E H21

conomic #urplus E H% F H21 E 2L9wk


MB MC


54/57


CarlaLs Choices

6rogram#ocial

8ptimum

6apers ?dited %

6rice H3I

Total @e#ene H1JI

Total Cost H1L4

?conomic 6ro)it H%

?conomic *rpls H3%

urdle

" E )3 F 2*

H3%( H4re&ate

H1L2

H14"

H2L

H3"

,erfectDiscriminator

%

Aeservation

H21I

H1L4

H3%

H3%

#ingle,rice

+onopol$

3

H3%

H1IJ

HJL

H21

H2L



55/57



*lide //

#ummar$#ingle price monopolies are inefficient &ecauseP > MC (=MR).

6he hurdle method of price discrimination

reduces the inefficienc$.6he more finel$ the seller can discriminate( the

smaller the efficienc$ loss.

urdles are not perfect( therefore( there will &esome efficienc$ loss.


MB MC

?conomic 5at ralist


56/57



*lide /

h$ might an appliance retailer instructits clerks to hammer dents into thesides of its stoves and refrigerators>

?conomic 5atralist


57/57

MB MC

?nd o)

Chapter

09 monopoly, oligopoly and monopolistic competition

Documents