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

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Presentation on theme: "Microeconomics: Unit 3 Imperfect competition Monopoly, monopolistic competition and oligopoly."— Presentation transcript:

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

2 Topic 1: Monopoly 2

3 Characteristics of Monopolies 3

4 1.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

5 Monopoly: barriers to entry 1.Geography barriers -Location or control of resources limits competition and leads to one supplier 5

6 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

7 Monopoly pricing strategies 1.Single Price Monopoly Sells every unit for the SAME price

8 2. Price Discriminating Monopoly – Able to sell units for different prices to different groups of people

9 Topic 2: Focus on Single price Monopoly

10 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) QPriceTotal Revenue Marginal Revenue 110 29 38 47

11 quantitypriceTotal Revenue Marginal Revenue 110 29188 38246 47284 Plot above points on graph Plot Q and P and Q and MR on graph

12 MR { "@context": "", "@type": "ImageObject", "contentUrl": "", "name": "MR

13 A Single Price Monopoly MR is NOT = to DARP MR and DARP are separated MR < DARP =AR=P

14 Elasticity of Demand Review Demand can be elastic or inelastic – Elastic demand inelastic demand PTR P TR P and TR move in opposite directions P and TR move in same direction

15 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

16 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

17 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

18 Monopolies have control over PRICE & QUANTITY How does a monopoly determine the price and quantity that will maximize its profit??? MRMC= produce MR=MC = produce and stop (profit max. point)

19 PriceQ TC TR MRMC 100 --- 911.5 9 822.5 16 735.5 21 6410.5 24 5517.5 25 Complete MC and MR Remember: Marginal means additional!

20 What Q should this firm produce? Why??? What is the profit at this Quantity? PriceQTCTR MR MC 10010 --- 911.59 9.5 822.516 7 1 735.521 5 3 6410.524 3 5 5517.525 1 7 Q of 3; Profit of 15.5

21 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

22 Monopolies in the short run Can earn a profit, loss or break even

23 Review of PROFIT Firm can sell an item at a higher price than it cost to make item P>ATC

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

25 Review of LOSS Firm sells the item at a price lower than the cost of making it P { "@context": "", "@type": "ImageObject", "contentUrl": "", "name": "Review of LOSS Firm sells the item at a price lower than the cost of making it P

26 Monopoly experiencing a Loss (ATC above P) =AR=P TR = $200 TC=$240 Loss = -$40

27 Monopoly breaking even Price = ATC

28 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)

29 Topic 3: Monopoly and Perfect Competition compared Perfect competition = efficient productively and allocatively efficient Monopoly = Inefficient – Monopoly under-produces and overcharges

30 If perfect competiton, P & Q would be set by S (MC) and D Pc and Qc considered SOCIALLY OPTIMAL

31 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

32 Monopoly creates a deadweight loss and redistributes the consumer surplus Consumer surplus maximized In PC (area above P and under D) Consumer surplus shrinks and creates DEADWEIGHT LOSS Producer surplus CS

33 Deadweight Loss Loss of economic efficiency (CS is not at a maximum as it is in Perfectly competitive industries)

34 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?

35 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

36 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

37 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

38 Topic 5: Monopolistic Competition

39 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

40 2. produce differentiated product

41 3. Non-price competition – Competition on quality, services and packaging

42 4. Easy entry and exit 5. Price maker

43 Monopolistic firms have control over price and quantity How do monopolistic firms determine price and quantity to produce? MRMC = produce MR=MC= produce (profit max. point)

44 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

45 Monopolistic Competition

46 Monopolistic competitive firms in the LONG RUN Different from monopoly Monopolistic competitive firms earn a NORMAL PROFIT in long run

47 Why do monopolistic competitive firms earn a normal profit in the long run?? PROFIT: encourages entry into market Prices go down as a result LOSS: encourages exit from market Prices go up as a result

48 Monopolistic & PC compared major difference between monopolistic competition and perfect competition is PRODUCT DIFFERENTIATION!! This allows them to have slight control over price

49 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)

50 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)

51 Markup Monopolistic firms charge a higher price than a firm in PC IN PC, price = MC In monopolistic competition, P > MC

52 Topic 6: Oligopoly A. Small number of firms Mutual interdependence; one firm’s actions impact the decisions of the other firm

53 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

54 c. Products may be identical or differentiated

55 Identical products in oligopoly

56 Differentiated products in oligopoly

57 2 types of Oligopolies 1.Colluding oligopolies = Cartel A cartel is a group of producers that create an agreement to fix prices high. Together they act as a monopoly

58 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

59 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 )

60 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

61 Example of Oligopoly pricing

62 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

63 Prisoner’s dilemma What is the BEST outcome for both??? IF A and B don’t trust each other, what will be the outcome???

64 Game theory example

65 Pay-off Matrix: The payoff matrix below shows profits for A and B RAISE PRICELOWER PRICE RAISE PRICE$15, $15$10, $20 LOWER PRICE$20, $10$12, $12 Firm A Firm B

66 Nash Equilibrium Situation in which each player is doing as well as it can given what the other player is doing

67 Pay-off Matrix: The payoff matrix below shows profits for A and B RAISE PRICELOWER PRICE RAISE PRICE$15, $15$10, *$20 LOWER PRICE*$20, $10*$12, * $12 Firm A 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?

68 Dominate Strategy The Dominant Strategy is the best move to make regardless of what your opponent does MaintainLower price Maintain * $140, * $150 $120, $110 Lower Price $130, * $120* $150, $100 Central North What is Central’s Dominate Strategy??? What is North’s Dominate Strategy???



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