Unit 4: Imperfect Competition 1

Unit 4: Imperfect Competition 4.1 Monopolies 2

Imperfect Competition FOUR MARKET STRUCTURES Perfect Competition Monopolistic Competition Monopolistic Competition Pure Monopoly Pure Monopoly Oligopoly Oligopoly Imperfect Competition Every product is sold in a market that can be considered one of the above market structures. Characteristics of Perfect Competition: Many buyers and sellers Products identical (or nearly so—substitutes) Easy entry and exit out of the market 3

Imperfect Competition FOUR MARKET STRUCTURES Perfect Competition Monopolistic Competition Monopolistic Competition Pure Monopoly Pure Monopoly Oligopoly Oligopoly Imperfect Competition Every product is sold in a market that can be considered one of the above market structures. For example: Fast Food Market The Market for Cars Market for Operating Systems (Microsoft) Strawberry Market Cereal Market 4

Monopoly 5

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Characteristics of Monopoly: Examples: Idaho Power, De Beers, One large firm (the firm is the market) Unique product (no close substitutes) High Barriers- Firms cannot enter the industry Monopolies are “Price Makers” Some advertising

What do you already know about monopolies? True or False? All monopolies make a profit. Monopolies are usually efficient. All monopolies are bad for the economy. All monopolies are illegal. The government never prevents monopolies from forming. All are False 7

Can a monopoly be good for the economy? Sure, for example: Electric Companies If there were three competing electric companies they would have higher costs Economies of scale make it impractical to have smaller firms. Natural Monopoly- It is NATURAL for only one firm to produce because they can produce at the lowest cost. 8

Graphing Monopolies 9

The good news… Only one graph because the firm IS the industry. The cost curves are the same The MR=MC rule still applies Shut down rule still applies Not a firm graph and a market graph 10

THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE! DEMAND DOES EQUAL PRICE! The Main Difference Monopolies (and ALL imperfectly competitive firms) have downward sloping demand curve. Which mean to sell more a firm must… lower its price. So does MR = Price = Demand? THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE! DEMAND DOES EQUAL PRICE! 11

Why is MR less than Demand? P Qd TR MR $11 - 12

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $10 13

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $10 $9 $9 14

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $10 $9 $9 $8 $8 $8 15

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 16

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 17

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 18

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4 19

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $9 $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4 20

Why is MR less than Demand? P Qd TR MR $11 - $10 1 10 $9 2 18 8 $8 3 24 6 $7 4 28 $6 5 30 $5 $4 7 -2 $10 $9 $9 MR IS LESS THAN DEMAND $8 $8 $8 $7 $7 $7 $7 $6 $6 $6 $6 $6 $5 $5 $5 $5 $5 $5 $4 $4 $4 $4 $4 $4 $4 21

Calculating Marginal Revenue 22

Does the Marginal Revenue equal the price? To sell more a firm must lower its price. What happens to Marginal Revenue? Price Quantity Demanded Total Revenue Marginal Revenue $6 $5 1 $4 2 $3 3 $2 4 $1 5 Does the Marginal Revenue equal the price? 23

Does the Marginal Revenue equal the price? To sell more a firm must lower its price. What happens to Marginal Revenue? Price Quantity Demanded Total Revenue Marginal Revenue $6 - $5 1 5 $4 2 8 3 $3 9 $2 4 -1 $1 -3 Does the Marginal Revenue equal the price? 24

Does the Marginal Revenue equal the price? To sell more a firm must lower its price. What happens to Marginal Revenue? Price Quantity Demanded Total Revenue Marginal Revenue $6 - $5 1 5 $4 2 8 3 $3 9 $2 4 -1 $1 -3 MR DOESN’T EQUAL PRICE Does the Marginal Revenue equal the price? 25

Moonbuck’s D and MR Curves P, MR $ 5 1.50 6 2.00 5 2.50 4 3.00 3 3.50 2 4.00 1 $4.50 MR P Q –1 $4 Demand curve (P) 4 MR 3 2 1 The numbers in the table are from the preceding exercise. Students can see either from the table or the graph that, at any Q, MR < P. -1 -2 -3 Q 1 2 3 4 5 6 7

Understanding the Monopolist’s MR Increasing Q has two effects on revenue: The output effect: Higher output raises revenue The price effect: Lower price reduces revenue To sell a larger Q, the monopolist must reduce the price on all the units it sells. Hence, MR < P MR could even be negative if the price effect exceeds the output effect (e.g., when Moonbucks increases Q from 5 to 6). Note that a competitive firm has the output effect but not the price effect: the competitive firm does not need to reduce its price in order to sell a larger quantity, so, for the competitive firm, MR = P.

Calculate and Plot the Demand, Marginal Revenue, and Total Revenue Curves $6 5 4 3 2 1 Q 1 2 3 4 5 TR $9 8 7 6 5 4 3 2 1 Q 1 2 3 4 5 28

Demand and Marginal Revenue Curves What happens to TR when MR hits zero? $15 10 5 P D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 TR MR $64 40 20 Total Revenue is at it’s peak when MR hits zero TR Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 29

Elastic vs. Inelastic Range of Demand Curve 30

Total Revenue Test to Determine Elasticity Quiz Yourself: The total revenue test says that if… Price Increase and TR Decrease it is Elastic for Demand or Price Decreases and TR Increases it’s Elastic for Demand Price Increases and TR Increases it is Inelastic for Demand Price Decreases and TR Decreases it’s Inelastic for Demand TR for inelastic good will increase. TR for elastic good will decrease.

Total Revenue Test to Determine Elasticity Relatively Inelastic Relatively Elastic MC1 MC1 MC MC D D TR for inelastic good will increase. TR for elastic good will decrease. What happens to total revenue for each when price increases?

Total Revenue Test Review Uses elasticity to show how changes in price will affect total revenue (TR). Inelastic Demand- Price increase causes TR to increase Price decrease causes TR to decrease Elastic Demand- Price increase causes TR to decrease Price decrease causes TR to increase Unit Elastic- Price changes and TR remains unchanged

Elastic and Inelastic Range P Elastic Inelastic $15 10 5 Total Revenue Test If price falls and TR increases then demand is elastic. D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 TR A monopoly will only produce in the elastic range MR $64 40 20 Total Revenue Test If price falls and TR falls then demand is inelastic. TR Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 34

Maximizing Profit 35

Profit-Maximization 1. The profit- maximizing Q is where MR = MC. Quantity Costs and Revenue 1. The profit- maximizing Q is where MR = MC. 2. Find P from the demand curve at this Q. D MR MC P Q Profit-maximizing output

The Monopolist’s Profit Quantity Costs and Revenue ATC D MR MC As with a competitive firm, the monopolist’s profit equals (P – ATC) x Q P ATC Q

A Monopoly Does Not Have an S Curve A competitive firm takes P as given has a supply curve that shows how its Q depends on P A monopoly firm is a “price-maker,” not a “price-taker” Q does not depend on P; rather, Q and P are jointly determined by MC, MR, and the demand curve. So there is no supply curve for monopoly.

Profit-Maximization MR = MC What output should this monopoly produce? How much is the TR, TC and Profit or Loss? $9 8 7 6 5 4 3 2 P MC ATC Profit =$6 D MR Q 1 2 3 4 5 6 7 8 9 10 39

Conclusion: A monopolists produces where MR=MC, buts charges the price consumer are willing to pay identified by the demand curve. $9 8 7 6 5 4 3 2 P MC ATC D MR Q 1 2 3 4 5 6 7 8 9 10 40

How much is the TR, TC, and Profit or Loss? What if cost are higher? How much is the TR, TC, and Profit or Loss? MC $10 9 8 7 6 5 4 3 P ATC AVC D TR= $90 TC= $100 Loss=$10 MR Q 6 7 8 9 10 41

Identify and Calculate: TR= TC= Profit/Loss= Profit/Loss per Unit= $50 Identify and Calculate: $25 $25 Price $5 MC $10 9 8 7 6 5 ATC D MR 5 6 7 8 9 10 11 Q 42

Identify and Calculate: TR= TC= Profit/Loss= Profit/Loss per Unit= $54 Identify and Calculate: $36 $18 $3 P $10 9 8 7 6 5 4 MC= ATC D MR Q 1 2 3 4 5 6 7 8 9 10 43

Case Study: Monopoly vs. Generic Drugs The market for a typical drug Patents on new drugs give a temporary monopoly to the seller. When the patent expires, the market becomes competitive, generics appear. Quantity Price D MR PM QM PC = MC QC Here, we assume constant marginal cost, for simplicity. PM and QM denote the monopoly price and quantity, respectively. PC and QC denote the competitive price and quantity, respectively.

Are Monopolies Efficient? 45

Monopolies are inefficient because they… Charge a higher price Don’t produce enough Produce at higher costs 46

Types of efficiency Efficient in production is when an economy is producing on the PPC Efficient in allocation means resources are used so that consumers are as well off as possible 47

Consumer Surplus, Producer Surplus and Deadweight Loss Monopolies vs. Perfect Competition Test Yourself: Draw a perfectly competitive market (not firm) showing CS, PS, and Deadweight Loss Is it allocatively efficient? Is it productively efficient? 48

Monopolies vs. Perfect Competition S = MC P In perfect competition, CS and PS are maximized, thus it is allocatively efficient It is also productively efficient CS Ppc PS D Q Qpc 49

Consumer Surplus, Producer Surplus and Deadweight Loss Monopolies vs. Perfect Competition Test Yourself: Draw a monopoly showing CS, PS, and Deadweight Loss Is it allocatively efficient? Is it productively efficient? 50

Monopolies vs. Perfect Competition S = MC P At MR=MC, A monopolist will produce less and charge a higher price Pm Ppc D MR Q Qm Qpc 51

Monopolies vs. Perfect Competition Where is CS and PS for a monopoly? S = MC P CS Total surplus falls. Now there is DEADWEIGHT LOSS Pm PS Monopolies underproduce and over charge, decreasing CS and increasing PS. D MR Q Qm 52

The Welfare Cost of Monopoly Competitive eq’m: quantity = QC P = MC total surplus is maximized Monopoly eq’m: quantity = QM P > MC deadweight loss Quantity Price Deadweight loss D MR MC P MC QM P = MC QC It’s worth mentioning the following: Most people know that monopoly changes the way the economic “pie” is divided: by charging higher prices, the monopoly gets more surplus and consumers get less surplus. The analysis on this slide shows that the monopoly also reduces the size of the economic pie – by producing less than the socially efficient quantity and causing a deadweight loss.

Are Monopolies Productively Efficient? No. They are not producing at the lowest cost (min ATC) Does Price = Min ATC? $9 8 7 6 5 4 3 2 P MC ATC D MR Q 1 2 3 4 5 6 7 8 9 10 54

Monopolies are NOT efficient! Are Monopolies Allocatively Efficiency? No. Price is greater. The monopoly is under producing. Does Price = MC? $9 8 7 6 5 4 3 2 P MC ATC Monopolies are NOT efficient! D MR Q 1 2 3 4 5 6 7 8 9 10 55

Natural Monopoly One firm can produce the socially optimal quantity at the lowest cost due to economies scale. P It is better to have only one firm because ATC is falling at socially optimal quantity MC ATC MR D Q Qsocially optimal 56