lecture 4 monopoly and monopolistic competition

Lecture 4.1: Chapter 8

Monopoly Markets

Learning Objectives

1. Define monopoly.

2. Explain three reasons why monopolies arise.

3. Explain how a monopoly determines price and output.

4. Use a graph to illustrate how a monopoly affects economic efficiency.

5. Discuss government policies towards monopolies.

6. Monopoly and Price discrimination

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Narrow definition of monopoly: A firm is the only seller of a good or service which does not have a close substitute. This implies that a monopoly can ignore the actions of all other firms.– For example, the government water authority can ignore the

price of bottled water.

Broad definition of monopoly: This means that other firms in the market are not close enough substitutes to compete away economic profits in the long run.– For example, the only pizza shop may have a monopoly,

although burgers may be a substitute.

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Is any firm ever really a monopoly?

Monopolies emerge due to a lack of competition created by barriers to entry.

Three reasons for high barriers to entry are:

1. Government blocks the entry of more than one firm into a market.

2. One firm has control of a key raw material necessary to produce a good.

3. Economies of scale are so large that one firm has a natural monopoly.

Where do monopolies come from?

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1. Government blocks entry in three main ways:

i. By License (e.g. Taxis; Australian Medical Association);

ii. By granting a patent or copyright to an individual or firm, which gives the exclusive right to produce a product or service for a period of time.

iii. By granting a firm a public franchise, which makes it the exclusive legal provider of a good or service. Example, Australia Post

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2. Another way for a firm to become a monopoly is by controlling a key resource.

Example

During the last century, De Beers owner 90 percent

of the world’s diamonds.

China owns 95 per cent of the world’s rare earth metals which it has nationalised.

Firms use rare earth metals to produce 17 chemicals that are used in the production of many goods including mobile phones and laptops.

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Like every other firm, a monopoly maximises profit at the output when marginal revenue equals marginal cost (MR = MC).

However, the difference is that a monopoly’s demand curve is the same as the demand curve for the product (downward sloping).

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How does a monopoly choose price and output?

Monopoly is a price maker. It does not face a horizontal demand curve.

In fact, both its demand curve and marginal revenue curve are downward-sloping; and

Its marginal revenue curve is positioned below its demand curve.

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How does a monopoly choose price and output?

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Demand and Marginal Revenue

44

60

50

48

DMR

c

Total revenue loss $4

Total revenue gain $48

Marginal revenue $ 44

2 3Quantity (subscriptions)

Pri

ce &

mar

gina

l rev

enue

(dol

lars

per

sub

scri

ptio

n)

To sell more, the price must be lowered. The marginal revenue curve will be below the demand curve.

Price and cost

Quantity

Demand

MR0

MC$60

42

6

27

Profit-maximising quantity

Profit-

maximising

priceB

A

Profit-maximising quantity and price for a monopoly: Figure 8.3a

10 Copyright © 2013 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442558069/Hubbard and O'Brien/Essentials of Economics/2e

Price and cost

Quantity

Demand

MR0

MC$60

42

6

30

Profit-maximising quantity

B

A

ATCProfit

Profits for a monopoly: Figure 8.3b

Profit-

maximising

price


We know that equilibrium in a perfectly competitive market results in the greatest amount of economic surplus, or total benefit to society, from the production of a good or service.

However, a monopoly will produce less and charge a higher price than would a perfectly competitive industry producing the same good.

Does monopoly reduce economic efficiency?

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(b) Monopoly

0

(a) Perfect competition

Quantity

Supply

Demand

PC

Demand

1. If the industry becomes a monopoly, the supply curve becomes the monopolist’s marginal cost curve.

QC

Price and cost per unit

Quantity0 QC

PC

If the industry is perfectly competitive, the intersection of the demand and supply curves determines equilibrium price and quantity.

Price and cost per unit

PM

QM

MC

MR

2. The monopolist reduces output to the level where MR = MC,…

3. …and charges a higher price.

What happens if a perfectly competitive industry becomes a monopoly?: Figure 8.4


The effects of monopoly can be summarised as follows:

1. Monopoly causes a reduction in consumer surplus.

2. Monopoly causes an increase in producer surplus.

3. Monopoly causes a deadweight loss, which represents a reduction in economic efficiency; allocative inefficiency occurs.

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Does monopoly reduce economic efficiency?

Price and cost

Quantity

DemandMR

0

MC

PM

PC

QC

MCM

Transfer of consumer surplus to monopoly

BA

QM

C

Deadweight loss from a monopoly (B + C)

Marginal cost of the last unit produced by the monopoly

The inefficiency of a monopoly: Figure 8.5


Market power and technological change

Market power: The ability of a firm to charge a price greater than marginal cost.

The introduction of new products requires firms to spend funds on research and development.

Because firms with market power are more likely to earn economic profits, they are also more likely to introduce new products.

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Gains from Monopoly

Government Policy

Toward

Monopoly

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Collusion: An agreement among firms to charge the same price, or to otherwise not compete.

In Australia, trade practices laws are used to deal with monopolies, collusion and other forms of anti-competitive behaviour.

The laws usually make it illegal for large firms with market power to collude, and firms wishing to merge or take over another firm must apply for permission to do so.

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Government policy toward monopoly

In Australia, competitive behaviour is monitored by the Australian Competition and Consumer Commission (ACCC).

The major regulatory law regarding trade practices is the Competition and Consumer Act 2010. It covers the following seven key areas:

– Anti-competitive agreements, such as price fixing.

– Exclusive dealing, such as: (i) market sharing arrangements; and (ii) third line forcing.

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– Misuse of market power, such as predatory pricing.

– Boycotts, such as an agreement between some suppliers and purchasers not to supply to, or purchase from, a particular firm or competitor.

– Resale price maintenance.

– Unconscionable and misleading conduct, such as deceiving people into signing contracts that they do not understand.

– Product safety and reliability.

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Monopoly

&

Price Discrimination

21

Price discrimination: Charging different customers different prices for the same product when the price differences are not due to differences in production costs.

Monopoly & Price Discrimination

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There are three requirements for successful price discrimination:

1.A firm must possess market power.

2.The firm must know what different consumers are willing to pay.

3.The firm must be able to divide (segment) the market for the product, and prevent resale between these segments.

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Price discrimination

Price discrimination by a cinema: Figure 8A.1


Airlines: The kings of price discrimination

– Business travellers—more price inelastic

– Holiday travellers—more price elastic

– Economy, business and first class

– Day and time

– Season

Yield management: Continually adjusting prices to take into account fluctuations in demand.

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Perfect price discrimination: This occurs when each consumer has to pay a price equal to the consumer’s maximum willingness to pay (no consumer surplus).

Two key outcomes of price discrimination are:

– Firm profits increase

– Consumer surplus decreases

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Perfect price discrimination: Figure 8A.2


Lecture 4.2: Chapter 9

Monopolistic Competition

PowerPoint to accompany:

1. Explain why a monopolistically competitive firm has downward-sloping demand and marginal revenue curves.

2. Explain how a monopolistically competitive firm maximises profit in the short run.

3. Analyse the situation of a monopolistically competitive firm in the long run.

4. Compare the efficiency of monopolistic competition and perfect competition.

Learning Objectives


Monopolistic competition: A market structure in which barriers to entry are low, and many firms compete by selling similar, but not identical, products.

Differentiated products

Positive economic profit in the short run


Starbucks has been competing in a highly contested market for over three decades, but was able to maintain profits and expand its operation across the globe thanks to successful differentiation strategy. It is only recently that Starbucks ran into trouble, with its strategy no longer successful in all markets.

Starbucks: Growth through product differentiation—decline through competition



Demand and revenue at a Starbucks coffee house: Table 9.1

Price

Quantity

Demand

MR0


The demand and marginal revenue curves for a monopolistically competitive firm: Figure 9.3

Demand and marginal revenue for a firm in a monopolistically competitive market

Marginal revenue for a firm with a downward-sloping demand curve

Every firm that has the ability to affect the price of the good or service it sells will have a marginal revenue curve that is below its demand curve.


Another way to calculate profit is using the following formula:

Profit = (P - ATC) x Q

where P is price, ATC is average total cost and Q is quantity traded.

Note: P - ATC provides ‘profit per unit’.

Remember: Profit is maximised or loss is minimised when MR = MC.

How a monopolistically competitive firm maximises profits in the short run


To maximise profit, the Starbucks coffee house wants to sell caffe lattes up to the point where the marginal revenue from selling the last caffe latte is just equal to the marginal cost.

As the information in the table in the textbook shows, this happens with the fifth caffe latte A —which adds $1.50 to the firm’s costs and $1.50 to its revenues. The firm then uses the demand curve to find the price that will lead consumers to buy this quantity of caffe lattes (point B).

How a monopolistically competitive firm maximises profits in the short run


5

B

A

ATC

Profit


Maximising profit in a monopolistically competitive market:

Price (dollars per cup)

Quantity (cups per week)MR

0

$6.00

3.50

2.50

MC

Demand

Starbucks’ Short-run profit equals $1 × 5 = $5.00. (i.e. (P-ATC) x Q)

What happens to profits in the long run?

How does entry of new firms affect the profits of existing firms?

Entry of new firms will shift the existing firm’s demand curve to the left.

The firm will sell fewer products at every price.

The demand curve will also become more price elastic.


Demand(Short run)MR(Short run)

0

MC

P(Short run)

Q (Short run)

A

ATCShort-run profit


Quantity (cups per week)39 Copyright © 2013 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442558069/Hubbard and O'Brien/Essentials of Economics/2e

A monopolistic competitor may earn a short-run profit: Figure 9.5a

Demand(Short run)MR(Short run)

0

MC

P(Short run)

Q(Short run)

A


Quantity (cups per week)

Demand(Long run)MR(Long run)

BP(Long run)


A monopolistic competitor’s profits are eliminated in the long run: Figure 9.5b

ATC

Q(Long run)

Is zero economic profit inevitable in the long run?

Relatively easy entry into the market causes the disappearance of economic profits in the long run.

Exception: If a firm finds new ways of differentiating its product or finds new ways of lowering the cost of producing its product, it can maintain economic profits, even in the long run.

Copyright © 2013 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442558069/Hubbard and O'Brien/Essentials of Economics/2e 41

What happens to profits in the long run?

Comparing perfect competition and monopolistic competition

There are two important differences between long-run equilibrium in the two markets.

1. Monopolistically competitive firms charge a price greater than marginal cost.

2. Monopolistically competitive firms do not produce at minimum average total cost.


Excess capacity under monopolistic competition

As a monopolistically competitive firm produces at P > minimum ATC, the firm has excess capacity; if it increased its output it could produce at a lower average cost.



0


MC

P = MC

QPC

Price and cost

ATC

(Productively efficient)


Comparing long-run equilibrium under perfect competition and monopolistic competition: Figure 9.6

Quantity

D=MR

(b) Monopolistic competition

0


P = MC

D

QPCQuantity0 QPC

MC

Price and cost

P

QMC

MC

MR

ATC

ATC

Excess capacity


Comparing long-run equilibrium under perfect competition and monopolistic competition: Figure 9.6

(Productively efficient)

Quantity

Price and cost

MC

D=MR

Is monopolistic competition inefficient?

Monopolistic competition is inefficient in terms of allocative and productive efficiency.However, it is likely to be more efficient in terms of dynamic efficiency.

How consumers benefit from monopolistic competition.

From being able to purchase a product that is differentiated and more closely suited to their tastes. That is, consumers enjoy product variety.



lecture 4 monopoly and monopolistic competition

Documents

monopoly marketscopyright

natural monopoly

narrow definition of

broad definition of

monopolys demand curve

horizontal demand curve

price discrimination

price maker