Monopoly and Other Forms of
Imperfect Competition
Introductory Microeconomics
1
The Perfectly Competitive Firm Is a Price Taker
(Recap)
 The perfectly competitive firm has no influence over the
market price. It can sell as many units as it wishes at
that price.
 Typically, a “perfectly” competitive industry is one that
consists of a large number of sellers, each of which
makes a highly standardized product.
2
Profit-maximization for the perfectly competitive
firm

Profit = Total revenue - total cost
Q. How much output should a perfectly competitive firm produce if its
goal is to earn as much profit as possible?
A. It should keep expanding output as long as the marginal benefit
of doing so exceeds the marginal cost.
 The marginal benefit of expanding output by one unit is the
market price.
 The marginal cost of expanding production by one unit is the
firm's marginal cost at its current production level.
3
Example 10.1.
 If this grower can sell as many bushels of corn as he
chooses to at a price of $5 per bushel, how many
bushels should he sell in order to maximize profit?
$/bushel
The profit-maximizing quantity for the
perfectly competitive firm is the one for which
price = MC.
Marginal cost of
producing corn
6
5
4
Price
6
9
12
Thousands of
bushels/year
4
Imperfect Competition
Monopoly = "single seller"
Oligopoly = "few sellers"
Monopolistic competition:
Many sellers, each with a
differentiated product
5
Monopoly = “single seller”
Towngas (The Hong Kong and China Gas
Company Limited) supplies cooking fuel to
households in Hong Kong
An electronic payment system using a contactless
smartcard.
The sole supplier of electricity in Kowloon and
New Territories.
The sole supplier of electricity on Hong Kong Island.
6
Oligopoly = “few sellers”
Six mobile service
providers in Hong
Kong
7
Monopolistic competition: Convenience stores
8
Five Sources of Monopoly
1. Exclusive control over important inputs
Perrier’s mineral spring
9
Five Sources of Monopoly
2. Economies of Scale (Natural monopoly)
The average cost of production declines as the number
of unit s produced increases.
Example: domestic cooking fuel
10
Five Sources of Monopoly
3. Patents
Example: Prescription drugs
11
Five Sources of Monopoly
4. Government licenses or franchises
Example: Postal services
12
Five Sources of Monopoly
5. Network Economies
Example: Microsoft Windows
13
Five Sources of Monopoly
5. Network Economies
Sony Playstation library: Over 1000 games that will not
play on other formats
14
Five Sources of Monopoly
5. Network Economies
Network economies may be thought of as a kind of
economy of scale.
Most enduring source of monopoly is economies of
scale.
With growth of research and development expenses,
economies of scale are becoming more important.
15
The Old Economy
 Two widget producers, Acme and Ajax
 Each has fixed costs of $200,000, and variable costs
of $0.80 per widget.
Acme
Annual production
Ajax
$1,000,000 $1,200,000
Fixed costs
$200,000
$200,000
Variable cost
$800,000
$960,000
Total cost
Cost per widget
$1,000,000 $1,160,000
$1.00
$0.97
Ajax, the high
volume producer,
has only a small
cost advantage.
Widget: 1. A small mechanical device or control.
2. An unnamed or hypothetical manufactured article.
16
The New Economy
 In the new economy, fixed costs are $800,000,
reflecting the growing importance of the information and
ideas in the product.
Variable costs are only $0.20/widget.
Acme
Annual production
Ajax
$1,000,000 $1,200,000
Fixed costs
$800,000
$800,000
Variable cost
$200,000
$240,000
Total cost
Cost per widget
$1,000,000 $1,040,000
$1.00
$0.87
Ajax, the high
volume producer,
has a much larger
cost advantage.
Note: Capital can substitute for labor in production. Thus, higher fixed
cost is likely associated with lower variable cost.
17
The New Economy
 This cost advantage becomes self reinforcing, as more
and more of the market goes to Ajax:
Acme
Ajax
Annual production
$500,000
$1,700,000
Fixed costs
$800,000
$800,000
Variable cost
$100,000
$340,000
Total cost
$900,000 $1,140,000
Cost per widget
$1.80
$0.67
18
Demand curves facing Monopoly, oligopoly,
and monopolistically competitive firms
 Monopoly, oligopoly, and monopolistically competitive
firms have in common the fact that the demand curves
for their goods are downward sloping.
Price
D
Quantity
For convenience, we will refer to any of these three
types of imperfectly competitive firms as monopolists.
19
Demand curves facing perfectly a
competitive firm
 The demand curve facing a perfectly competitive firm is
a straight line at the market price.
$/unit of output
Market
Price
D
Quantity
20
Marginal Revenue
 The marginal benefit to
a competitive firm of
selling an additional unit
of output is the market
price.
 By contrast, the marginal
benefit to a monopolist
of selling an additional
unit of output is less than
the market price.
The reason MR < P for the monopolist is that it must cut
its price in order to sell an extra unit of output.
This means that is will earn less on the output it was
selling thus far.
21
Example 10.2.
 If this monopolist is currently selling 3 units of output at
a price of $7 per unit, what is its marginal benefit from
selling an additional unit?
Price
TR from the sale of 3 units = $7x3 = $21
10
TR from the sale of 4 units = $6x4 = $24
So MR from the fourth unit
= $24 - $21 = $3,
which is less than both the original price and
the new price.
7
6
3 4
10
Quantity
22
Example 10.3.
 If this monopolist is currently selling 4 units of output at
a price of $6 per unit, what is its marginal benefit from
selling an additional unit?
Price
TR from the sale of 4 units = $6x4 = $24
10
TR from the sale of 5 units = $5x5 = $25
So MR from the fifth unit
= $25 - $24 = $1,
which is less than both the original price and
the new price.
6
5
4 5
10
Quantity
23
Example 10.4.
 If this monopolist is currently selling 5 units of output at
a price of $5 per unit, what is its marginal benefit from
selling an additional unit?
Price
TR from the sale of 5 units = $5x5 = $25
10
TR from the sale of 6 units = $4x6 = $24
So MR from the sixth unit
= $24 - $25 = - $1,
5
4
5 6
10
Quantity
24
Marginal Revenue Curve
 The Marginal Revenue Curve for the monopolist in
the preceding examples:
Price
10
5
D
5
MR
10
Quantity
25
Marginal Revenue Curve
 More generally, MR for any monopolist with a straightline demand curve:
Price
For a straight-line demand curve:
P = a - bQ
a
The corresponding MR curve:
MR = a - 2bQ
a/2
D
Q0/2
MR
Q0
Quantity
26
Marginal Revenue Curve
 More generally, MR for any monopolist with a straightline demand curve:
Price
For calculus-trained students:
Demand: P = a - bQ
MR = dTR/dQ
TR = PQ = aQ-bQ2
so
MR = a - 2bQ
a
a/2
D
Q0/2
MR
Q0
Quantity
27
Example 10.5
 Find this monopolist’s marginal revenue curve.
Price
For calculus-trained students:
8
MR = dTR/dQ
TR = PQ = 8Q-0.5Q2
so
4
MR = 8 - Q
Demand: P=8-0.5Q
8
MR
16
Quantity
28
Profit-maximization for the monopolist
 Profit = total revenue - total cost
Q. How much output should a monopolist produce if its goal is to earn
as much profit as possible?
It should keep expanding output as long as the marginal benefit of
doing so exceeds the marginal cost.
The marginal benefit of expanding output by one unit is the marginal
revenue at the current output level.
The marginal cost of expanding production by one unit is the firm's
marginal cost at the current output level.
So the monopolist should expand output until MR = MC.
29
Example 10.6.
 True or False: The profit-maximizing level of output for
this monopolist is 9 units.
Price
MC
12
At Q=9, MC=6 > MR=0. There
is net gain from producing one
less unit at the proposed
output.
So the monopolist cannot be
maximizing profit at Q=9.
6
Demand: P=12-0.67Q = 12 – (2/3)Q
9
MR
18
Quantity
30
Example 10.6.
 True or False: The profit-maximizing level of output for
this monopolist is 9 units.
The profit-maximizing quantity
for the monopolist is the one for
MC which MR = MC, in this case 6
units of output. At that level of
output the monopolist will
charge a price of $8/unit.
Price
12
8
MR = 12 – (4/3)Q and MC = (2/3)Q
Hence Q = 6, P=8.
6
4
Demand: P=12-0.67Q = 12 – (2/3)Q
Quantity
18
6 9
MR
31
Example 10.7.
Price
 Consider the profit-maximizing monopolist in Example 10.6. At
Q=6, what is the benefit to society of an additional unit of output?
 What is the cost to society of an additional unit?
 Is this situation efficient from society's point of view?
MC
12
8
6
4
D
6 9
MR
18
At Q=6, the marginal benefit to society
of an additional unit of output is $8.
The MC of an additional unit is only $4.
That is, the society would gain a net
benefit of $4 per unit of output if output
were expanded by 1 unit from the
profit-maximizing level.
Quantity
32
Social efficiency:
 For social efficiency, production should expand as long
as the marginal benefit to society exceeds the marginal
cost.
 Marginal social benefit of an extra unit of output
= the amount people are willing to pay for it
= the amount given by the demand curve.
 Thus, social efficiency occurs where the demand curve
intersects the marginal cost curve.
33
Social efficiency of monopoly
 Under monopoly: MC = MR < P, so output produced by
monopoly is too low for social efficiency.
Price
MC
P*
Social efficient point
MC, MR
D
Q*
Quantity
MR
34
Social efficiency of perfect competition
 Under perfect competition: MC = P, so output
produced by perfectly competitive industry is socially
efficient.
MC i
Price
Price
ATC i
D
S
P
P
Q
Market Quantity
Q i*
Firm i’s Quantity
35
Social efficiency of monopoly
 Note that the monopolist would gladly expand output if
it could do so without having to sell the current output
at a lower price.
Price
MC
P*
MC, MR
D
Q*
Quantity
MR
36
Example 10.8
 If this monopolist maximizes profit, by how much will
total economic surplus be smaller than the maximum
possible economic surplus?
Price
MC
12
8
6
4
D
6 9
MR
18
Quantity
37
Example 10.8
 The maximum possible economic surplus = CS + PS
Price
12
Consumer surplus
MC
6
D
Producer surplus
9
18
Quantity
38
Example 10.8
 Loss in economic surplus from Monopoly
Price
Consumer surplus
12
8
MC
Loss in surplus
=0.5*(9-6)*(8-4)=6
6
4
D
Producer surplus
6 9
MR
18
Quantity
39
Example (loss in economic surplus)
 Rebecca is a single-price, profit-maximizing monopolist in the sale
of singing lessons. If her demand and marginal cost curves are as
shown, by how much does total economic surplus fall short of the
maximum achievable surplus in this market if Rebecca charges the
profit-maximizing price?
$/lesson
24
a. $8 per week.
b. $16 per week.
c. $32 per week
d. $56 per week.
e. None of the above.
MC
18
16
12
8
6
D
6 8
12
MR
Lessons per week
24
40
Should we outlaw monopoly?
 Does the fact that perfect competition is socially
efficient and monopoly is not mean that we should
outlaw monopoly?
 Suppose the monopoly in question is the result of a
patent that prevents all but one firm from
manufacturing a highly valued product.
 Would we be better off without patents?
41
Should we outlaw monopoly?
 Suppose the monopolist is a natural monopolist.
 For the natural monopolist, MC < AC
Price
($/minute)
AC
MC
Minutes
(millions/day)
42
Should we outlaw monopoly?
 Efficiency requires P=MC
 But if MC<AC, setting P=MC means losing money
Price
($/minute)
Economic loss
= -$400,000/day
AC = 0.06
P = 0.05
MR
40
AC
MC
D
Minutes
(millions/day)
43
Should we outlaw monopoly?
 What do you prefer?
1. A natural monopolist to maximize profit and stay in business
2. Force the monopolist to charge MC and go out of business.
Price
($/minute)
0.15
Consumer surplus
= $500,000/day
Economic profit
= $400,000/day
0.10
0.08
AC
MC
0.05
D
20
MR
Minutes
(millions/day)
44
Source of efficiency loss from a monopoly
 The efficiency loss from single-price natural monopoly stems from
the fact that the profit-maximizing price is above marginal cost,
thereby excluding many buyers who "should" be in the market
(because they are willing to pay a price greater than or equal to
marginal cost).
Price
($/minute)
Output shortfall
0.10
AC
MC
0.05
D
20
40
MR
Minutes
(millions/day)
45
Should we outlaw monopoly?
 Recall that the monopolist would gladly expand output
if it could do so without having to sell the current
output at a lower price.
Price
MC
P*
MC, MR
D
Q*
Quantity
MR
46
Price discrimination
 Can the monopolist find ways of lowering prices to
some buyers while keeping price high for others?
 Price discrimination: charging different buyers
different prices for the same good or service.
47
Example 10.9.
 Ram is a monopolist in the market for carved sisalwood
bowls in his village, a minor tourist stop in Northern
India.
48
Example 10.9.
 Each day 8 tourists visit his shop, and each has a different
reservation price for Ram's standard bowl. If these reservation
prices are as listed in the table below, draw the demand curve Ram
faces each day.
Visitor
Reservation price
A
$16
B
$14
C
$12
D
$10
E
$8
F
$6
G
$4
H
$2
49
Example 10.9.
$/bowl
Visitor
Res. price
A
$16
B
$14
C
$12
D
$10
10
E
$8
8
F
$6
6
G
$4
H
$2
4
2
16
14
12
0 1
D
2
3
4
5
6
7
8
Quantity
50
Example 10.10
 Ram has to charge
the same price to all
buyers.
 He can produce as
many bowls as he
chooses at a cost of
$3 each (and bowls
can be sold only in
integer amounts).
 How many bowls
should he sell each
day if his goal is to
maximize profit?
Expand if MR > MC = 3
MR from 1st bowl = 16;
$/bowl
MR from 2nd bowl = 12;
T R=28 MR from 3rd bowl = 8;
16
14
T R=36
MR from 4th bowl = 4;
T R=40 MR from 5th bowl = 0;
T R=40
12
10
So keep expanding
until Q = 4.
8
6
4
2
0 1
D
2
3
4
5
6
7
8
Quantity
51
Example 10.11.
 In the preceding example, how much profit does Ram
make?
Total revenue = 10x4 = $40/day
Total cost = 3x4 = $12/day
Profit = $40 - $12 = $28/day
52
Example 10.12.
 In the preceding example, is 4 bowls per day a socially
efficient level of output?
 No, because buyers are willing to pay more for
additional bowls than their $3 marginal cost.
53
Example 10.12.
Visitor
Reservation price
A
$16
B
$14
C
$12
D
$10
E
$8
F
$6
G
$4
H
$2
Visitors A-G are willing to pay
more for a bowl than the cost
of producing one, and thus it
is efficient that they each
should have one.
Visitor H is not willing to pay
the cost of producing a bowl
and so should not have one.
Thus the socially efficient
number is 7 bowls/day.
54
Example 10.13.
 Now suppose that Ram is a shrewd judge of human
nature. After a moment's conversation with a visitor, he
is able to discover the visitor's reservation price for a
bowl. If Ram then charges each visitor his respective
reservation price, how many bowls will he sell and how
much profit will he make?
55
Example 10.13.
Visitor
Reservation price
A
$16
B
$14
C
$12
D
$10
E
$8
F
$6
G
$4
H
$2
Ram will sell bowls to visitors
A-G and each will pay his
reservation price. He will not
sell to visitor H.
Total rev = 16+14+12+10+8+6+4 = $70/day
Total cost = 7x3 = $21/day
Profit = 70-21 = $49/day
56
Efficiency of a perfectly discriminating
monopolist
 A monopolist who is able to charge each buyer his or
her reservation price is called a perfectly
discriminating monopolist.
 For a perfectly discriminating monopolist, there is no
efficiency loss.
 All buyers are served who are willing to pay a price
high enough to cover marginal cost.
 In practice, however, there are virtually no sellers who
know each buyer's reservation price.
 Price discrimination does occur, but it is imperfect
price discrimination.
57
The Hurdle Method of Discrimination
58
The Hurdle Method of Discrimination
Pay discount price
Start
Pay list price
59
Example 10.14.
 Ram's 8 visitors again have the same reservation prices
for carved wooden bowls as before. Ram does not know
each buyer's reservation price. But he knows that all
buyers with a reservation price above $9/bowl never
use discount coupons. Those with reservation prices
below $9 use them whenever they are available.
 If Ram makes coupons available in the government
tourist magazine, those buyers who clip and present
them get to pay a discount price for bowls. Others pay
the regular list price for bowls.
 To maximize profit, at what levels should Ram set the
list price of a bowl? The discount price?
60
Example 10.14.
 In each submarket, the monopolist should expand
output as long as MR>MC.
List price submarket
Visitor
Res. price
A
$16
B
C
D
$14
$12
$10
Discount price
submarket
Visitor
E
Res. price
$8
F
G
H
$6
$4
$2
61
Example 10.14.
 For the list price submarket, MR from sale of fourth
bowl is 4 > MC =3.
 To sell 4 bowls in the list price submarket, Ram will
choose a list price of $10. At that price, all non-coupon
clippers buy a bowl.
Visitor
A
B
C
D
Res. price
$16
$14
$12
$10
MR
$16
$12
$6
$4
62
Example 10.14.
 For the discount price submarket, the MR from the sale
of the 2nd bowl is 4; the MR from the 3rd bowl is 0.
 So Ram should choose a discount price of $6/bowl and
sell 2 bowls in the discount market.
Visitor
E
F
G
H
Res. price
$8
$6
$4
$2
MR
$8
$4
$0
-$4
63
Example 10.14.
$/bowl
16
14
12
10
8
6
T R=28
T R=36
T R=40
T R=8
T R=12
T R=12
T R=8
4
2
0 1
D
8
6 7
5
3 4
2
Discount price
List price
buyers
buyers
Quantity
64
Example 10.15.
 At a list price of $10/bowl and a discount price of $6/bowl in the
preceding example, how many bowls does Ram sell and how much
profit does he make? Is this outcome socially efficient?
Total revenue = 10x4 + 6x2 = $52/day
Total cost = 6x3 = $18/day
Profit = 52-18 = $34/day
 The outcome is not socially efficient because visitor G is excluded
even though he is willing to pay more than marginal cost.
 But it is more efficient than the single-price case.
65
Examples of the hurdle method of price
discrimination:
 Rebate coupons:
hurdle = having to mail the coupon to the manufacturer
66
Examples of the hurdle method of price
discrimination:
 Temporary sales:
hurdle = having to find out when & where the sale occurs
67
Examples of the hurdle method of price
discrimination:
 Hardback books and paperbacks:
hurdle = having to wait for the paperback
It is the ongoing behavior
of our peers which
ultimately determines
how much we spend and
how we spend it.
Hardback: $25.00
Paperback: $16.47
68
Examples of the hurdle method of price
discrimination:
 BMW 330i and BMW 325i:
Hurdle = less powerful engine and fewer standard features
330i: MSRP = $39,900
325i: MSRP= $29,900
MSRP: Manufacturer's suggested retail price
69
Examples of the hurdle method of price
discrimination:
 Coach fares and Super-Saver fares:
hurdle = having to stay over a Saturday night
Los Angeles-Honolulu round trip:
NW Flight 91
Depart Thu Jun 16
Return Thu Jun 23
$570
NW Flight 91
Depart Wed Mar 30
Return Fri Apr 1
$1467
70
The hurdle method of price discrimination:
 In general, the more finely the monopolist can partition
his market using hurdle methods, the smaller the
efficiency loss will be.
 It is common in most firms to see not one but a whole
menu of different discount prices, each with a different
set of restrictions (the deeper the discount, the more
stringent the restriction).
71
The fairness problem:
The monopolist may earn an economic profit.
Price
($/minute)
Economic profit = $400,000/day
0.10
0.08
AC
MC
0.05
D
20
MR
Minutes
(millions/day)
72
Aside: The monopolist may not earn any
economic profit.
Price
($/minute)
Economic loss = $400,000/day
0.12
0.10
AC
0.05
MC
D
Minutes
(millions/day)
20
MR
73
The fairness problem:
The monopolist may earn an economic profit.
 If the monopolist does earn economic profits, their
source is the list price buyer, who could have bought at
a discount had he been willing to jump a minor hurdle.
 How is each dollar of the monopolist's excess profits
distributed?
Corporate income tax
15 cents
Dividend or capital gains to shareholders
85 cents
74
Two Concerns about Natural Monopoly with
price discrimination:
1. Inefficient (output is restricted because MR<P)
2. Unfair (monopoly profit > 0 => P>AC)
75
Two Concerns about Natural Monopoly with
price discrimination :
1. Inefficient (output is restricted because MR<P)
 The hurdle method of pricing enables monopolists
to expand their markets beyond point at which
MR=MC for single-price monopolist.
 This mitigates efficiency losses associated with
natural monopoly.
76
Hurdle method of pricing mitigates efficiency
losses
Price
Qs* = profit-maximizing quantity
for single-price monopolist
P s*
Price
QL* = profit maximizing
quantity at list price
PL*
QD* = profit maximizing
quantity at discount price
PD*
MC
MC
MC
D
D
Q s*
Q
MR
QL*
Q
MR
QL*+QD*
77
Not too unfair….
 On the fairness side, the source of excess profits is the
list-price buyer.
 These profits are distributed to shareholders, many of
whom are wealthy.
 And 15% of each dollar of excess profits goes to
finance various government services, many of which are
targeted at low-income families.
 So the fairness argument against natural monopoly may
also be less compelling that it might first appear.
78
End
79