monopoly
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MonopolyPrice determination under imperfect competition
Patterns of imperfect competition
The major kinds of imperfect competition are: Monopoly, Oligopoly, and Monopolistic competition
We shall see that for a given technology, prices are higher and outputs are lower under imperfect competition than under perfect competition.
Imperfect competitions also have virtues along with vices. Large firms exploit economies of large-scale production and are responsible for much of the innovation that propels long-term economic growth.
Patterns of imperfect competition
Definition of Imperfect Competition:If a firm can appreciably affect the market price of its output, the firm is classified as an “imperfect competitor.” Imperfect competition prevails in an industry
whenever individual sellers have some measures of control over the price of their output.
It does not imply that a firm has absolute control over the price of its product.
For example Coca-Cola and Pepsi where if the average price in the market is Rs.75, they can sell Rs.70 or 80 and still remain a viable firm.
Patterns of imperfect competition
Definition of Imperfect Competition: The firm could hardly set the price at Rs.400 or
Rs.5 a bottle because at those prices it would go out of business.
This tells that an imperfect competitor has some but not complete discretion over its prices.
Moreover, the amount of discretion over prices will differ from industry to industry.
Patterns of imperfect competition
Firm quantity
Pri
ce (
Rup
ees
per
un
it)
Firm quantity
Pri
ce (
Rup
ees
per
un
it)
Firm demand under perfect competition
Firm demand under imperfect competition
P P
q q00
d d
d
d
d’
d’
B
Patterns of imperfect competition
Explanation of the graphs: The figure (a) shows that a perfectly competitive firm
can sell all it wants along its horizontal dd without depressing the market price.
But the imperfect competitor will find that its demand curve slopes downwards as higher price drives sales down. And unless it is sheltered monopolist, a cut in its rivals’ prices will appreciably shift its own demand curve leftwards to d’d’.
We can also see the difference between perfect and imperfect competition in terms of price elasticity.For a perfect competitor; demand is perfectly elastic; for an imperfect competitor; demand has a finite elasticity.
Patterns of imperfect competition
Varieties of imperfect competition:Economists classify imperfectly competitive markets into three different structures.
Monopoly
Oligopoly
Monopolistic competition.
Patterns of imperfect competition
Sources of market imperfections:Most cases of imperfect competition can be traced to two principal causes.
First, industries tend to have fewer sellers when
there are significant economies of large-scale
production and decreasing costs.
Under these conditions, large firms can simply
produce more cheaply and then undersell small
firms, which cannot survive.
Patterns of imperfect competition
Sources of market imperfections:
Second, markets tend toward imperfect competition
when there are “barriers to entry” that make it difficult
for new competitors to enter an industry.
In some cases, the barriers may arise from government
laws or regulations which limit the number of
competitors.
In other cases, there may be economic factors that make
it expensive for a new competitor to break into a market.
Patterns of imperfect competition
Sources of market imperfectionsCosts and Market Imperfection:
The technology and cost structure of an industry help
determine how many firms that industry can support and how
big they will be.
If there are economies of scale, a firm can decrease its
average costs by expanding its output, at least up to a
point(where they produce most of the industry’s total output).
That means bigger firms will have a cost advantage over
smaller firms.
Patterns of imperfect competition
Sources of market imperfectionsTo understand how costs may determine market structure, let’s look at a case which is favorable for perfect competition.P
Q0
MC
ACD
D
2 3 4 5 10000 12000
Total industry demand DD is so vast relative to the efficient scale of a single seller that the market allows viable coexistence of numerous perfect competitors.
1
Perfect Competition
AC
, M
C,
P
Patterns of imperfect competition
Sources of market imperfections
P
Q0
MC
ACD
D
200 300 400
Costs turn up at a higher level of output relative to total industry demand DD.
100
Oligopoly
AC
, M
C,
P
Patterns of imperfect competition
Sources of market imperfections
P
Q0
MC
AC
D
D
200 300 400
When costs fall rapidly and indefinitely, as in the case of natural monopoly, one firm can expand to monopolize the industry.
100
Natural Monopoly
AC
, M
C,
P
Patterns of imperfect competition
Sources of market imperfectionsBarriers to entry:
Barriers to entry are factors that make it hard for new firms to
enter an industry.
When barriers are high, an industry may have few firms and
limited pressure to compete.
Economies of scale act as one of the common type of barriers to
entry, there are others as well, such as:
Legal Restrictions
High Cost of Entry
Advertising and Product Differentiation
Marginal Revenue and Monopoly
The concept of marginal revenue
Suppose that a firm finds itself in possession of a complete
monopoly in its industry.
The firm might be fortunate owner of a patent for a new
anticancer drug,
Or it might own the operating code to a valuable computer
program.
If the monopolist wishes to maximize its profits, what price
should it charge and what output level should it produce?
Marginal Revenue and Monopoly
The concept of marginal revenue
To answer these questions, we need the marginal
revenue (MR) concept.
Marginal Revenue is the change in revenue that is
generated by an additional unit of sales.
MR can be either positive or negative
Marginal Revenue and Monopoly
A Monopoly’s revenue Total Revenue
P x Q = TR Average Revenue
TR/Q = AR = P Marginal Revenue
DTR/DQ = MR
Quantity q
PriceP=AR=TR/
q
Total revenueTR=P*q
Marginal revenueMR
0 220 0
1 200 200
2 180 360
3 160 480
4 140 560
5 120 600
6 100 600
7 80 560
8 60 480
9 40 360
10 20 200
11 0 0
+200
+160
+120
+80
+40
0
-40
-80
-120
-160
-200
Price determination under monopoly
0 1 2 3 4 5 6 7 8 9 10 11 12
-140
-100
-60
-20
20
60
100
140
180
220
d=AR
MR
0 2 4 6 8 10 120
100
200
300
400
500
600
700
TR
Marginal Revenue and Monopoly
When the marginal revenue is negative it does not mean that the firm is paying people to take its goods. Negative MR means that in order to sell additional
units, the firm must decrease its price on earlier units so much that its total revenues decline.
For example, when the firm sells 6 units, it gets
TR(6 units) = 6*$100= $600 when it sells the additional (7th)unit, it can increase
sales only by lowering price. Because it is an imperfect competitor.
TR(6 units) = (6*$80)+(1*80)= $560
Marginal Revenue and Monopoly
The necessary price reduction on the first 6 units is so large that, even after adding in the sale of the 7th unit, total revenue fell. Even though MR is negative, AR, or price, is still
positive MR turns negative when AR is halfway down towards
zero. With demand sloping downward,
P > MR
Marginal Revenue and Monopoly
Elasticity and Marginal Revenue Marginal revenue is positive when demand is elastic, zero
when demand is unit-elastic, and negative when demand is inelastic.
Demand is elastic when a price decrease leads to a revenue increase.
In such a situation, a price decrease raises output demanded so much that revenue rise, so marginal revenue is positive
If demand is Relation of Q and P Effect of Q on TR Value of MR
Elastic (ED > 1) %change Q > %change p
Higher Q raises TR MR > 0
Unit-elastic (ED = 1) %change Q = %change p
Higher Q leaves TR unchanged
MR = 0
inelastic (ED < 1) %change Q < %change p
Higher Q lowers TR MR < 0
Marginal Revenue and Monopoly
Profit maximization of monopolyIf a monopolist wishes to maximize total profit, what should it do??
We know that: TP = TR – TC = (P * q ) - TC
To maximize its profits, the firm must find the equilibrium price and quantity that give the largest profit, or the largest difference between TR and TC.
A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost.
It then uses the demand curve to find the price that will induce consumers to buy that quantity.
Quantity
q
PriceP
Total revenu
eTR
Total costTC
Total profit
TP
Marginal revenue
MR
Marginal cost
MC
0 220 0 185 -185 +200
+160
+120
+80
+400
-40
-80
-120
-160
-200
30
25
20
30
4050
70
90
110
130
150
1 200 200 215 15
2 180 360 240 120
3 160 480 260 220
4 140 560 290 270
5 120 600 330 270
6 100 600 380 220
7 80 560 450 110
8 60 480 540 -60
9 40 360 650 -290
10 20 200 780 -580
11 0 0 930 -930
Marginal Revenue and Monopoly
Profit maximization of monopoly The maximum profit price (P*) and quantity (q*)
of a monopolist come where the firm’s marginal revenue equals its marginal cost.
MR = MC, at the maximum profit P* and q*
This tells us that when MR exceeds MC, additional profits can be made by increasing output;
when MC exceeds MR, additional profits can be made by decreasing q.
0 1 2 3 4 5 6 7 8 9 10 11 120
40
80
120
160
200
MC
AC
dMR
E
F
G
Monopoly Equilibrium in Graphs
0 1 2 3 4 5 6 7 8 9 10 11 12
-200
-100
0
100
200
300
400
500
600
700 TC
TR
TP
At maximum profit point, slopes of TC and TR are parallel
At maximum profit point, slopes is zero and horizontal
$270
$270
Marginal Revenue and Monopoly
Comparing Monopoly and Competition For a competitive firm, price equals marginal
cost.
P = MR = MC
For a monopoly firm, price exceeds marginal cost.
P > MR = MC