Imperfect competition Monopoly, monopolistic competition and oligopoly

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Imperfect competition Monopoly, monopolistic competition and oligopoly
Microeconomics: Unit 3 Imperfect competition Monopoly, monopolistic competition and oligopoly

Topic 1: Monopoly 2

Characteristics of Monopolies
3

2. Unique good with no close substitutes 3. “Price Maker”
Single Seller The Firm IS the Industry 2. Unique good with no close substitutes 3. “Price Maker” The firm can manipulate the price by changing the quantity it produces 4. High barriers to entry 4

Monopoly: barriers to entry
Geography barriers -Location or control of resources limits competition and leads to one supplier 5

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) 6

Monopoly pricing strategies
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 1 10 2 9 3 8 4 7

quantity price Total Revenue Marginal 1 10 2 9 18 8 3 24 6 4 7 28
Plot Q and P and Q and MR on graph Plot above points on graph

MR<D=P \$10 . \$9 . \$8 . \$7 . D=P \$6 \$5 \$4 MR

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 curve and 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 --- 9 1 8 2 7 3 6 4 5 Complete MC and MR Remember: Marginal means additional!

What Q should this firm produce. Why
What Q should this firm produce? Why??? What is the profit at this Quantity? Price Q TC TR MR MC 10 1 --- 9 1.5 .5 8 2 2.5 16 7 3 5.5 21 5 6 4 10.5 24 17.5 25 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 P>ATC
Firm can sell an item at a higher price than it cost to make item P>ATC

Monopoly making a profit (ATC below P )
TR =\$200 TC = \$140 Profit = \$60 =AR=P

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)
TR = \$200 TC=\$240 Loss = -\$40 =AR=P

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 shrinks and creates DEADWEIGHT LOSS Consumer surplus maximized In PC (area above P and under D) CS Producer surplus

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 monopoly WHY??? 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??
LOSS: encourages exit from market Prices go up as a result PROFIT: encourages entry into market Prices go down 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)

Markup Monopolistic firms charge a higher price than a firm in PC
IN PC, price = MC In 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 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
Firm A RAISE PRICE LOWER PRICE \$15, \$15 \$10, \$20 \$20, \$10 \$12, \$12 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
Firm A RAISE PRICE LOWER PRICE \$15, \$15 \$10, *\$20 *\$20, \$10 *\$12, * \$12 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 Central Maintain Lower price * \$140, * \$150 \$120, \$110 Lower Price \$130, * \$120 * \$150, \$100 North What is Central’s Dominate Strategy??? What is North’s Dominate Strategy???