2. Unit 4: Imperfect Competition 1 FOUR MARKET STRUCTURES Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Imperfect Competition

3. Memorizing vs. Learning 12-35711131-71923 Try memorizing the above number How effective is memorizing it? The point: If you try to MEMORIZE all the graphs of economics you will forget them. You must LEARN them!

4. 3 FOUR MARKET STRUCTURES Perfect Competition Pure Monopoly Monopolistic Competition Oligopoly Imperfect Competition Every product is sold in a market that can be considered one of the above market structures. For example: 1.Fast Food Market 2.The Market for Cars 3.Market for Operating Systems (Microsoft) 4.Strawberry Market 5.Cereal Market

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6. 5 Characteristics of a Monopoly 1. Single Seller  One firm controls the vast majority of a market  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 (ie. supply shifts to the left). Ex: California electric companies 4. High Barriers to Entry  New firms can NOT enter market  No immediate competitors  Firm can make profit in the long-run 5. Some “Nonprice” Competition  Despite having no close competitors, monopolies still advertise their products in an effort to increase demand. 5

7. What do you already know about monopolies? True or False? 1.All monopolies make a profit. 2.Monopolies are usually efficient. 3.All monopolies are bad for the economy. 4.All monopolies are illegal. 5.Monopolies charge the highest price possible 6.The government never prevents monopolies from forming. 6 Examples of Monopolies

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9. 4 types of monopolies Geographical Technological Government Natural

10. 4 types of monopolies Geographical TechnologicalGovernmentNatural Location or control of resources limits competition and leads to one supplier. Ex: Nowhere gas stations, Cable TV, Los Angeles Lakers

11. 4 types of monopolies Technological GovernmentNatural Patents and widespread availability of certain products lead to only one major firm controlling a market. Ex: Microsoft, Intel, Frisbee, Band-Aide… Geographical Ex: Nowhere gas stations, Cable TV, Los Angeles Lakers Location or control of resources limits competition and leads to one supplier.

12. 4 types of monopolies GeographicalTechnological Government Natural Ex: Nowhere gas stations, Cable TV, Los Angeles Lakers Patents and widespread availability of certain products lead to only one major firm controlling a market. Ex: Microsoft, Intel, Frisbee, Band-Aide… Government allows monopoly for public benefits or to stimulate innovation. The government issues patents to protect inventors and forbids others from using their invention. (They last 20 years) Ex: water company, firefighters, the army, pharmaceutical drugs, rubix cubes… Location or control of resources limits competition and leads to one supplier.

13. 4 types of monopolies Geographical Technological Government Natural Ex: Nowhere gas stations, Cable TV, Los Angeles Lakers Patents & widespread availability of certain products lead to only one major firm controlling a market. Ex: Microsoft, Intel, Frisbee, Band-Aide… Government allows monopoly for public benefits or to stimulate innovation. The government issues patents to protect inventors and forbids others from using their invention. (20 yrs) Ex: water company, firefighters, the army, pharmaceutical drugs, rubix cubes… 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. Ex: Electric Companies (SDGE)  If there were three competing electric companies they would have higher costs.  Having only one electric company keeps prices low Location or control of resources limits competition and leads to one supplier.

14. Good news… 1.Only ONE graph because the firm IS the industry. 2.The cost curves are the same 3.The profit maximizing rule MR=MC still applies 4.Shut down point rule still applies 13 Drawing Monopolies

15. 14

16. PQdTRMR $1100- $10110 $92188 $83246 $74284 $65302 $56300 $4728-2 15 $4 $5 $6 $7 $8 $9 $10 MR is less than Demand?

17. PQdTRMR $1100- $10110 $92188 $83246 $74284 $65302 $56300 $4728-2 16 $4 $5 $6 $7 $8 $9 $10

18. 17  How many units can be sold for a price of $10?  What is the total revenue at price of $10? TR=____  How many units can be sold for a price of $9?  As price decreases from $10 to $9, TR=____ $10 $18 0 1 2 3 4 5 6 P($) Q 10 9 8 6 4 From 1 to 2 units, MR= $18-$10 = $8 How about MARGINAL REVENUE? TR will increase with the additional unit sold.

19. 18 10 9 8 6 4  What is the total revenue at price of $10? TR=____  As price decreases from $10 to $9, TR=____  As price decreases from $9 to $8, TR=____ $10 $18 $24 D MR As price continuously decreases, TR will increase. From 1 to 2 units, MR= $18-$10 = $8 From 2 to 3 units, MR= $24-$18 = $6 How about MARGINAL REVENUE? TR will increase with the additional unit sold. P($) Q 0 1 2 3 4 5 6

20. ATC 19 Combine the Demand of an industry with the costs of a firm. D Quantity Costs (dollars) MC MR = Price

21. 20 Calculating Marginal Revenue

22. Calculate TR and Marginal Revenue 21 QuantityPriceTRMR 0$160- 115 2142813 3 3911 412489 511557 610605 79633 88641 9763 10660-3 QuantityPriceTRMR 0$160- 115 21428 31339 41248 51155 61060 7963 8864 9763 10660 QuantityPriceTRMR 0$160- 115 214 313 412 511 610 79 88 97 6 QuantityPriceTRMR 0$160- 115 2142813 3 3911 412489 511557 610605 79633 88641 9763 10660-3

23. Q Dollars $15 10 5 $105 55 30 TR D 0 1 2 3 4 5 6 7 8 9 10 11 12 Q MR Demand & MR Curves What happens to TR when MR hits zero? When MR goes negative, TR will fall 22 Plot the Demand, MR & TR Curves 0 1 2 3 4 5 6 7 8 9 10 11 12

24. Elastic vs. Inelastic Range of Demand Curve 23

25. Q Dollars $15 10 5 $105 55 30 TR D 0 1 2 3 4 5 6 7 8 9 10 11 12 Q MR 24 0 1 2 3 4 5 6 7 8 9 10 11 12 Elastic vs. Inelastic Range ElasticInelastic Total Revenue Test If price & TR demand is… INELASTIC ELASTIC Total Revenue Test If price & TR demand is… A monopoly will only produce in the elastic range

26. What output should this monopoly produce? MR = MC Q 0 1 2 3 4 5 6 7 8 9 10 Price $9 8 7 6 5 4 3 2 How much is the TR, TC and Profit or Loss? 25 MR D MC ATC Conclusion : Monopolists produce where MR=MC, but charges the price consumer are willing to pay identified by the demand curve. Conclusion : Monopolists produce where MR=MC, but charges the price consumer are willing to pay identified by the demand curve. Profit =$6 Maximizing Profit

27. MR Loss Q 0 1 2 3 4 5 6 7 8 9 D $90 80 70 60 50 40 30 20 10 26 MC What if cost is higher? How much is the TR, TC and Profit or Loss? ATC AVC Costs  Price  Minimum AVC is shut down point

28. TR=$780 MR Q 0 1 2 3 4 5 6 7 8 9 Price, costs, and revenue D 27 MC 1.TR = 2.TC = 3.Profit/Loss = 4.Profit/Loss per Unit = ATC $175 150 125 100 75 50 $130 $110 ----------------- $780 ----------------- $600 ----------  $180 ---  $30 TC=$600 Profit=$180 Quiz Time

29. 28 Are Monopolies Efficient?

30. Q Efficiency of Perfect Competition P D S = MC PcPc QcQc An industry in perfect competition sells where supply & demand are equal CS PS 29 CS and PS of a Perfect Competition

31. PmPm QmQm Q INEFFICIENCY OF MONOPOLY P D S = MC PcPc QcQc 30 MR At MR=MC, A monopolist will produce less and charge higher price CS PS Result is DEADWEIGHT LOSS to society CS and PS of a Monopoly Monopolies underproduce & over charge, decreasing CS & increasing PS.

32. MONOPOLIES AND EFFICIENCY Productive Efficiency The production of a good in a least costly way. (minimum amount of resources are being used) Graphically it is where… Price = Minimum ATC Productive Efficiency The production of a good in a least costly way. (minimum amount of resources are being used) Graphically it is where… Price = Minimum ATC 31 Allocative Efficiency The apportionment of resources towards the production of products most wanted by society (as measured by their price). Graphically it is where… Price = MC Allocative Efficiency The apportionment of resources towards the production of products most wanted by society (as measured by their price). Graphically it is where… Price = MC

33. D MC Q 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 Price, costs, and revenue Are Monopolies Efficient? ATC 32 MR Monopolies are NOT productive efficient Monopolies are NOT allocative efficient Price = Min ATC ?Price = MC ?

34. 33 Are Monopolies Efficient? Monopolies are inefficient because… 1. They charge a higher price 2. They don’t produce enough  No allocative efficiency 3. They produce at higher costs  No productive efficiency 4. They have little incentive to innovate Why? Because there is little external pressure to be efficient Monopolies are NOT efficient!

35. 2004 AP Micro FRQ B #1 1.Due to a new technology, Brunelle Inc. enjoys monopoly power. Brunelle does not engage in price discrimination. (a)Explain why the demand curve lies above the marginal revenue curve for Brunelle. (b)Assume that Brunelle is earning short-run economic profits. Using a correctly labeled graph, show the following for Brunelle. (i) Profit-maximizing level of output, labeled as Q* (ii)Profit-maximizing price, labeled as P* (iii)Economic profits, as a shaded area (c) If Brunelle wants to maximize its total revenues instead of profits, using the graph from part (b) show the following (i)Revenue-maximizing level of output, label as Qr (ii)Revenue-maximizing price, labeled as Pr (d) Given your answer in part (b), indicate whether Brunelle is producing the allocatively efficient level of output. Explain. (e) Explain what will happen to Brunelle’s demand curve as other firms adopt the same technology.

36. Regulating Monopolies

37. How do they regulate? 1.Use Price controls: a. Price Ceiling b. Price Floor 2.Why don’t taxes work? Taxes limit supply and that’s the problem Why would the government regulate an monopoly? 1.To keep prices low 2.To make monopolies efficient 36 Regulating Monopoly

38. MR = MC Monopoly/Unregulated price Q D MR ATC Price and Costs The firm would make a loss and would require a subsidy 37 REGULATING MONOPOLY QmQm PmPm Dilemma of Regulation Which Price? QsQs PsPs QfQf PfPf P = MC Socially-Optimum Price What happens if the government sets a price ceiling to get the socially optimal quantity? MC Fair-Return Price Normal Profit TR = TC

39. Socially-Optimum Price P = MC (Allocative Efficiency) OR Fair-Return Price P = ATC (Normal Profit) Where should the government place the price ceiling? 38

40. 2007 AP Micro FRQ A #1 1.A patent gives inventors the exclusive right to produce and market a product for a period of time. GCR Company is a profit-maximizing firm. It has a patent for a unique antispyware computer program called Aspy. (a)Assume that GCR is making economic profit. Draw a correctly labeled graph and show the profit-maximizing price and quantity. (b) Assume that the government imposes a lump-sum tax on GCR. (i)What will happen to output and market price? Explain. (ii)What will happen to GCR’s profits? (c) Assume instead that the government grants a per-unit subsidy to GCR for Aspy. (i)What will happen to output and market price? Explain. (ii)What will happen to GCR’s profits?

41. Price Discrimination 40

42. Conditions Firm must have monopoly power Firm must be able to segregate the market Consumers must not be able to resell product Practice of selling specific products to different buyers at different prices. 41 PRICE DISCRIMINATION

43.  Price discrimination seeks to charge each consumer what they are willing to pay in an effort to increase profits.  Those with elastic demand are charged less than those with inelastic. Examples: Airline Tickets (vacation vs. business) College All Coupons (spenders vs. savers) WHS soda machine (students vs. teachers) 42 PRICE DISCRIMINATION

44. Q P Q1Q1 Price Monopoly NON-PRICE DISCRIMINATION 43 D MR MC ATC Costs

45. MR Q P Q1Q1 Price and Costs Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! 44 MR’ D MC ATC PRICE DISCRIMINATION

46. MR Q P Q1Q1 Price and Costs Q2Q2 A perfectly discriminating monopolist has MR=D, producing more product and more profit! 45 PRICE DISCRIMINATION MR’ D MC ATC

47. What’s the Point? Perfectly price discriminating firms: Make more profit Produce more Produce at allocative efficiency 46 A perfectly discriminating can charge each person differently so the Marginal Revenue = Demand Price Discrimination results in several prices, more profit, No CS, and a higher socially optimal quantity PRICE DISCRIMINATION

48. Can You Do The Following? 1.Draw a monopoly making a profit identify price, quantity, and profit. 2.Draw a perfectly competitive industry AND firm at long-run equilibrium 3.Draw a price discriminating monopoly at equilibrium and label price, quantity, MR, and profit 47

49. P Q P Q 5000 D S $15 48 MR=D 8 ATC Industry Firm (Price Taker) Firm (Price Taker) MC Side-by-side graph for perfectly completive industry and firm in the LONG RUN Is the firm making a profit or a loss? Why?

50. COST COMPLICATIONS Using your notes from last class, discuss why costs may differ for a monopoly  Economies of Scale  X-Inefficiency  Rent-Seeking  Incentives for Innovation 49 COSTS COSTS COMPLICATIONS

51. Average total costs Quantity X Q1Q1 Q2Q2 ATC x ATC 1 X-Inefficiency Inefficient internal operation leads to higher-than-necessary costs 50 COST COMPLICATIONS ATC x’ ATC 2 X’ ATC

52. MONOPOLY REVENUES & COSTS 51 Revenue DataCost Data # of output PriceTRMRATCTCMCProfit or Loss 0$172$0-$100-$100 1162 $162$19019090-28 MR = $162 – 0 = $162 MC = $190 – 100 = $90 MR > MC Loss Improvement from -$100 to -$28 Check next unit of output!

53. MONOPOLY REVENUES & COSTS 52 Revenue DataCost Data # of output PriceTRMRATCTCMCProfit or Loss 0$172$0-$100-$100 1162 $162$19019090-28 215230414213527080+34 3142426122113.3334070+86 413252810210040060+128 5122610829447070+140 61126726291.6755080+122 71027144291.4364090+74 8927362293.73750110-14 982738297.78880130-142 1072720-181031030150-310 Can you see profit maximization? MR ≥ MC 5 5 122 610 94 470 70 +140 83

54. Q Dollars TR D Q MR 53 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 ElasticInelastic $200 150 100 50 $750 500 250 MONOPOLY REVENUES & COSTS

55. OUTPUT AND PRICE DETERMINATION 1.Cost Data 2.MR = MC Rule 3.No Monopoly Supply Curve 4.Monopoly Pricing Misconceptions Not Highest Price Total, Not Unit, Profit Possibility of Losses Graphically… 54

56. Average Total Cost Quantity $20 15 10 0 50 100 200 LRATC Electric companies have economies of scale. The more they produce the lower the average cost.  If there are 4 firms, the ATC is $20  If there are 2 firms the ATC is $15  If there is 1 firm the ATC is $10 Assume that 200 units need to be produced 55