
If markets are perfectly completive:

All firms would be efficient.

P would just be the Average Cost of production and firms will not be able to make profit for a long time.

It is very hard to find Perfectly
Competitive markets.

Firms would want to make profit, and it is practically difficult to do so in perfectly competitive markets.


In the real world, however, many firms make Economic Profit


Markets are NOT Perfectly Competitive!
Imperfect Competition




How and why such markets (real world) arise?
How do firms in imperfect market maximize profit
How imperfect is imperfect competition?



Monopoly Markets (Chap-9)
Oligopoly Markets (Chap-10)
Monopolistically Competitive
Markets (11)

1.
Which of the following two products are more IMPORTANT?
2.
A)
Water B) Diamond
Which of the above two products have
inelastic price elasticity of demand?
3.

What does Price Inelasticity of the demand for water imply about Profit making and the Price of water?
Producers can increase the Price of water to maximize Profit!

4. Which of the two products are made from a relatively more SCARCE Resources?
5.
Which of the two products ( Water or
Diamond) are more Expensive
(Command Higher Price)?
6. Why?

7. What does Price of a product reflect (tell us)?
A) The importance of the product
B) The scarcity of the resource from which the product is made?
C) The structure of the market?

Chapter 9

9.1. Monopoly, Sources and Its Market Power
9.2. Profit Max Under Monopoly
9.3. Is Monopoly bad for the Society?


Definition…

Monopoly is a sole producer/supplier of a good with no substitute.

Monopoly is a firm that produces the entire market supply of a particular good or service.


A monopolist has a market Power

Market power is the ability to alter the market price of a good or service.
That is monopoly is a Price Maker , not a Price Taker…Why?

 because unlike competitive firms that face a horizontal demand curve,…

Monopoly (a firm with market power) confront downward-sloping demand curves.

The competitive firm The industry
Demand facing competitive firm
$13
0
Quantity (bushels per day)
$13
Market demand
0
Quantity
(thousands of bushels per day)


The fundamental cause of monopoly is:


1.
Barriers to entry could arise from
three sources:
Ownership of a key resource (s).
2.
Exclusive right to produce some good
(s), given by the government.
3. Efficiency resulting from Economies of
Scale.
•
Barriers to Entry

How Monopolies Arise


Exclusive ownership of a key resource provides a firm a monopoly power.
E.g. DeBeers:
(Controls about 80% Diamond
Production)
In practice, however, monopolies rarely arise from this reason.
•
Barriers to Entry

A Government may create monopoly:
 by giving a single firm the exclusive right to sell a particular good in certain market (s).

Through:
(1)
Franchise Agreement
(2)
Patent and Copyright Laws
•
Barriers to Entry


Government may create Monopolies for several reasons:

To Generate More Income

To Serve Public Interest

Promote research, innovation, and investment.


Avoid wastage of public resources (One may be better than many)
Efficiency argument
•
Barriers to Entry


How Monopolies Arise
Could arise for natural reasons

When a single firm can supply a good or service to an entire market at a
smaller cost than could two or more firms.


Natural Monopoly.
it arises because of economies of scale
•
Barriers to Entry


Merger and Acquisition of firms:

When all else fails, purchase of or merger with a potential competitor.

Economies of scale:

The ability to produce at an extremely low average cost than any other firm wanting to enter the market.

Cost
When market demand is met before a firm achieves its minimum ATC, it becomes a natural monopoly
Average Total Cost
(ATC)
0
Quantity of Output
Copyright © 2004 South-Western


In general the preservation of monopoly power depends on…
 keeping potential competitors out of the market.

Maintain strong barriers to entry

15.3.1. A Monopoly’s
Revenue

Just as in perfectly competitive markets, in a monopoly market:



Total Revenue
P  Q = TR
Average Revenue
TR/Q = AR = P
Marginal Revenue
D TR/ D Q = MR

A Monopoly’s Total (TR), Average
(AR), and Marginal Revenue (MR)
Quantity of Water
Q
4
5
6
7
8
2
3
0
1
Price
P
7
6
5
4
3
9
8
11
10
Total
Revenue
TR
Average
Revenue
AR
Marginal
Revenue
MR

A Monopoly’s Total (TR), Average
(AR), and Marginal Revenue (MR)
Quantity of Water
Q
4
5
6
7
8
2
3
0
1
Price
P
7
6
5
4
3
9
8
11
10
Total
Revenue
TR
28
30
30
28
24
0
10
18
24
Average
Revenue
AR
Marginal
Revenue
MR

A Monopoly’s Total (TR), Average
(AR), and Marginal Revenue (MR)
Quantity of Water
Q
4
5
6
7
8
2
3
0
1
Price
P
7
6
5
4
3
9
8
11
10
Total
Revenue
TR
28
30
30
28
24
0
10
18
24
7
6
5
4
3
10
9
8
Average
Revenue
AR
Marginal
Revenue
MR

15.3.1. A Monopoly’s
Revenue




A Monopoly’s Total (TR), Average
(AR), and Marginal Revenue (MR)
Quantity of Water
Q
4
5
6
7
8
2
3
0
1
Price
P
7
6
5
4
3
9
8
11
10
Total
Revenue
TR
28
30
30
28
24
0
10
18
24
7
6
5
4
3
10
9
8
Average
Revenue
AR
4
2
0
-2
-4
10
8
6
Marginal
Revenue
MR

15.3.1. A Monopoly’s
Revenue

A monopolist’s marginal revenue is always less than the price of its good. Why?


The demand curve is downward sloping.
To sell one more unit the monopoly should drop the price, and thus declining MR.

15.3.1. A Monopoly’s
Revenue

When a monopoly increases the amount it produces, it has two effects

The output effect—more output is sold, so Q is higher.

The price effect—price falls, so P is lower.

Demand and Marginal-Revenue Curves for a Monopoly
Price
$11
10
9
6
5
4
8
7
1
0
–1
–2
–3
–4
3
2 Marginal revenue
1 2 3 4 5 6 7 8
Demand
(average revenue)
Quantity
Copyright © 2004 South-Western

Profit Maximization Under
Monopoly

Recall that:

The demand curve facing the monopoly firm is identical to the market demand curve for the product.

…because monopoly is a firm that produces the entire market supply of a particular good or service.

Profit Maximization Under
Monopoly

Thus a monopoly faces a different profit maximizing situation than competitive firms.

Recall Profit-maximization rule for
Competitive firms is to Produce at that rate of output where P= MR = MC .

Unlike competitive firms, marginal revenue (MR) for a monopolist is not equal to price (P)

Profit Maximization Under
Monopoly

Recall:

Marginal revenue is the change in total revenue that results from a oneunit increase in the quantity sold.
Marginal revenue
=
Change in total revenue
Change in quantity sold
D q

Profit Maximization Under
Monopoly

So long as the demand curve is downward-sloping, MR will always be less than price.

Implication…


In order to sell larger quantities the monopolist has to reduce prices
By producing and selling smaller quantities, the monopolist can raise the price of its product.

Profit Maximization Under
Monopoly
$14
12
10
8
6
4
2
0
A
1
B b
C
D
E c F d
G
Demand
(= price) e f
Marginal revenue g
2 3 4 5 6 7
Quantity (bushels per hour)
8 9 10


The profit Maximization Rule for any firm in any Market is MR=MC

Thus the monopolist needs to find the intersection of its marginal cost and marginal revenue.

This will give the monopolist its profitmaximizing rate of output.

Only one price is compatible with the profitmaximizing rate of output.


The intersection of the marginal revenue and marginal cost curves establishes the profit-maximization rate of output .

The monopoly price is set automatically.

The demand curve tells the monopolist how much consumers are willing to pay for that output.

Monopolist's equilibrium
A
MC
$1100
$1000
R
Monopoly profit
T
U
0
ATC
V q
M q
C
Marginal Revenue
Market demand
Quantity


Total profit equals average profit per unit times the number of units produced.
Profit per unit = price – average total cost
Profit per unit = p – ATC
Total profits = profit per unit X quantity
Total profits = (p – ATC) X q


A monopolist with several plants…

A monopolist can foresee the impact of increased production/supply on market price.
• Thus it prevents production increase by coordinating the production decisions of its plants.

Comparing Outcomes of Monopoly and Competitive Markets

Substantial difference under
Competitive Markets and Monopoly conditions exist

Comparing Outcomes of Monopoly and Competitive Markets

Both in the short and long run, Total
Quantity of Output Produced Under
Monopoly is less than Total Quantity
Produced Under Perfect competition

Price is higher under monopoly than perfect competition

A monopoly receives larger profits than a comparable competitive industry.

Monopolist's equilibrium
$1100
$1000
T
R
Monopoly profit
A
MC
U
X
Competitive short-run equilibrium
ATC
Competitive long-run equilibrium
V
0 q
M q
C
MR
Market demand
Quantity (computers per month)

Comparing Outcomes of Monopoly and Competitive Markets

Because monopoly markets do not tend towards marginal cost pricing, consumers do not get the mix of output that delivers the most utility from available resources.
– Marginal cost pricing – the offer (supply) of goods at prices equal to their marginal cost.


High prices and profits signal consumers’ demand for more output.


The high profits attract new suppliers.
Production and supplies expand.

Prices slide down the market demand curve.


A new equilibrium is established.

Price equals marginal cost at all times.

Throughout the process, there is great pressure to reduce costs or improve product quality.


High prices and profits signal consumers’ demand for more output.

Barriers to entry are erected to exclude potential competition.

Production and supplies are constrained.

Prices don’t move down the market demand curve.


No new equilibrium is established.

Price exceeds marginal cost at all times.

There is no squeeze on profits and thus no pressure to reduce costs or improve product quality.


A firm with considerable market power likely to have significant political power as well.


Monopolists only have absolute control of the quantity of output supplied to the market.

Monopolists must still contend with the market demand curve.


The greater the price elasticity of demand, the more a monopolist will be frustrated in its attempts to establish both high prices and high volume.
– Price elasticity of demand – The percentage change in quantity demanded divided by the percentage change in price.


A monopolist may be able to extract greater profits by practicing price discrimination.

Price discrimination is the sale of an identical good at different prices to different consumers by a single seller.


It is conceivable that monopolies could benefit the society.


Because of their greater profits, monopolists have a greater advantage in pursuing research and development.

They do not have a clear incentive to do so.


Market power can be an incentive for entrepreneurial activity.

An innovator can make substantial profits in a competitive market before the competition catches up.


If economies of scale exist, the monopolist may attain much greater efficiency than a large number of competitive firms.

However, there is no guarantee that such economies of scale will exist in a given industry.


A natural monopoly is an industry in which one firm can achieve economies of scale over the entire range of market supply.

Economies of scale act as a “natural” barrier to entry.


As a results Monopoly markets in the long run become contestable.

A contestable market is an imperfectly competitive market subject to potential entry if prices or profits increase.
• When potential profits reach a certain level competitors are enticed to enter the market.


The structure of monopoly is, in itself, not a problem.

If potential rivals force a monopolist to behave like a competitive firm, then a monopoly imposes no cost on consumers or on society at large.

Real World Examples:
The Case of Microsoft


Concerning Microsoft, critics argue that Microsoft:

Charges too much for its systems software.


Suppresses substitute technologies.
Bullies potential competitors.


The legal foundations for antitrust intervention are contained in three landmark antitrust laws.

Sherman Act (1890) – prohibits
“conspiracies in restraint of trade.


Clayton Act (1914) – principally aimed at preventing the development of monopolies by prohibiting price discrimination, exclusive dealing agreements, certain types of mergers, and interlocking boards of directors among competing firms.


The Federal Trade Commission
Act (1914) – created the FTC to study industry structures and behavior so as to identify anticompetitive practices.


The federal government dismantled
AT&T in 1984.

Prior to the break-up, AT&T supplied
96 percent of all long-distance service and over 80 percent of local telephone service.


Microsoft was accused of:

Thwarting competitors in operating systems by erecting entry barriers.


Using its monopoly position in operating systems to gain an unfair advantage in the applications market.
It bought out its competitors.


In its defense, Microsoft asserted that:

It dominates the computer industry because it produces the best products at attractive prices.

The computer industry is highly contestable if not perfectly competitive.


A federal court concluded that
Microsoft abused its monopoly position in operating systems.

By limiting consumer choices and stifling competition, Microsoft had denied consumers better and cheaper information technology.


The trial judge suggested a
structural remedy, that Microsoft might have to be broken into two companies to ensure competition.

The U.S. Department of Justice decided to seek a behavioral remedy instead.