Monopoly
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This document discusses imperfect competition and monopoly. It defines monopoly as a situation where a firm has complete control over the price of its product. Under monopoly, prices are higher and output is lower than under perfect competition. The profit-maximizing monopoly will produce the quantity where marginal revenue equals marginal cost, and charge the price corresponding to that quantity on the demand curve. This leads to prices above marginal cost and lower output compared to perfect competition.
Monopoly
- 2. Patterns of imperfect competition The major kinds of imperfect competition are: Monopoly, Oligopoly, and Monopolistic competition We shall see that for a given technology, prices are higher and outputs are lower under imperfect competition than under perfect competition. Imperfect competitions also have virtues along with vices. Large firms exploit economies of large-scale production and are responsible for much of the innovation that propels long-term economic growth.
- 3. Patterns of imperfect competition Definition of Imperfect Competition: If a firm can appreciably affect the market price of its output, the firm is classified as an “imperfect competitor.” Imperfect competition prevails in an industry whenever individual sellers have some measures of control over the price of their output. It does not imply that a firm has absolute control over the price of its product. For example Coca-Cola and Pepsi where if the average price in the market is Rs.75, they can sell Rs.70 or 80 and still remain a viable firm.
- 4. Patterns of imperfect competition Definition of Imperfect Competition: The firm could hardly set the price at Rs.400 or Rs.5 a bottle because at those prices it would go out of business. This tells that an imperfect competitor has some but not complete discretion over its prices. Moreover, the amount of discretion over prices will differ from industry to industry.
- 5. Patterns of imperfect competition Firm demand under Firm demand under P perfect competition P imperfect competition Price (Rupees per unit) Price (Rupees per unit) d d’ d d B d d’ q q 0 0 Firm quantity Firm quantity
- 6. Patterns of imperfect competition Explanation of the graphs: The figure (a) shows that a perfectly competitive firm can sell all it wants along its horizontal dd without depressing the market price. But the imperfect competitor will find that its demand curve slopes downwards as higher price drives sales down. And unless it is sheltered monopolist, a cut in its rivals’ prices will appreciably shift its own demand curve leftwards to d’d’. We can also see the difference between perfect and imperfect competition in terms of price elasticity. For a perfect competitor; demand is perfectly elastic; for an imperfect competitor; demand has a finite elasticity.
- 7. Patterns of imperfect competition Varieties of imperfect competition: Economists classify imperfectly competitive markets into three different structures. Monopoly Oligopoly Monopolistic competition.
- 8. Patterns of imperfect competition Sources of market imperfections: Most cases of imperfect competition can be traced to two principal causes. First, industries tend to have fewer sellers when there are significant economies of large-scale production and decreasing costs. Under these conditions, large firms can simply produce more cheaply and then undersell small firms, which cannot survive.
- 9. Patterns of imperfect competition Sources of market imperfections: Second, markets tend toward imperfect competition when there are “barriers to entry” that make it difficult for new competitors to enter an industry. In some cases, the barriers may arise from government laws or regulations which limit the number of competitors. In other cases, there may be economic factors that make it expensive for a new competitor to break into a market.
- 10. Patterns of imperfect competition Sources of market imperfections Costs and Market Imperfection: The technology and cost structure of an industry help determine how many firms that industry can support and how big they will be. If there are economies of scale, a firm can decrease its average costs by expanding its output, at least up to a point(where they produce most of the industry’s total output). That means bigger firms will have a cost advantage over smaller firms.
- 11. Patterns of imperfect competition Sources of market imperfections To understand how costs may determine market structure, let’s look at a case which is favorable for perfect competition. P D Perfect Competition AC AC, MC, P MC Total industry demand DD is so vast relative to the efficient scale of a single seller that the market allows viable coexistence of numerous perfect competitors. D 0 Q 1 2 3 4 5 10000 12000
- 12. Patterns of imperfect competition Sources of market imperfections Oligopoly P D AC AC, MC, P MC Costs turn up at a higher level of output relative to total industry demand DD. D 0 Q 100 200 300 400
- 13. Patterns of imperfect competition Sources of market imperfections Natural Monopoly P D AC, MC, P AC When costs fall rapidly and MC indefinitely, as in the case of natural monopoly, one firm can expand to monopolize the industry. D 0 Q 100 200 300 400
- 14. Patterns of imperfect competition Sources of market imperfections Barriers to entry: Barriers to entry are factors that make it hard for new firms to enter an industry. When barriers are high, an industry may have few firms and limited pressure to compete. Economies of scale act as one of the common type of barriers to entry, there are others as well, such as: Legal Restrictions High Cost of Entry Advertising and Product Differentiation
- 15. Marginal Revenue and Monopoly The concept of marginal revenue Suppose that a firm finds itself in possession of a complete monopoly in its industry. The firm might be fortunate owner of a patent for a new anticancer drug, Or it might own the operating code to a valuable computer program. If the monopolist wishes to maximize its profits, what price should it charge and what output level should it produce?
- 16. Marginal Revenue and Monopoly The concept of marginal revenue To answer these questions, we need the marginal revenue (MR) concept. Marginal Revenue is the change in revenue that is generated by an additional unit of sales. MR can be either positive or negative
- 17. Marginal Revenue and Monopoly A Monopoly’s revenue Total Revenue P x Q = TR Average Revenue TR/Q = AR = P Marginal Revenue DTR/DQ = MR
- 18. Quantity Price Total revenue Marginal revenue q P=AR=TR/q TR=P*q MR 0 220 0 +200 1 200 200 +160 2 180 360 +120 3 160 480 +80 4 140 560 +40 5 120 600 0 6 100 600 -40 7 80 560 -80 8 60 480 -120 9 40 360 -160 10 20 200 -200 11 0 0
- 19. Price determination under monopoly 220 180 140 100 60 20 d=AR -20 0 1 2 3 4 5 6 7 8 9 10 11 12 -60 -100 MR -140
- 20. 700 600 500 400 300 200 100 0 TR 0 2 4 6 8 10 12
- 21. Marginal Revenue and Monopoly When the marginal revenue is negative it does not mean that the firm is paying people to take its goods. Negative MR means that in order to sell additional units, the firm must decrease its price on earlier units so much that its total revenues decline. For example, when the firm sells 6 units, it gets TR(6 units) = 6*$100= $600 when it sells the additional (7th)unit, it can increase sales only by lowering price. Because it is an imperfect competitor. TR(6 units) = (6*$80)+(1*80)= $560
- 22. Marginal Revenue and Monopoly The necessary price reduction on the first 6 units is so large that, even after adding in the sale of the 7th unit, total revenue fell. Even though MR is negative, AR, or price, is still positive MR turns negative when AR is halfway down towards zero. With demand sloping downward, P > MR
- 23. Marginal Revenue and Monopoly Elasticity and Marginal Revenue Marginal revenue is positive when demand is elastic, zero when demand is unit-elastic, and negative when demand is inelastic. Demand is elastic when a price decrease leads to a revenue increase. In such a situation, a price decrease raises output demanded so much that revenue rise, so marginal revenue is positive If demand is Relation of Q and P Effect of Q on TR Value of MR Elastic (ED > 1) %change Q > %change p Higher Q raises TR MR > 0 Unit-elastic (ED = 1) %change Q = %change p Higher Q leaves TR MR = 0 unchanged inelastic (ED < 1) %change Q < %change p Higher Q lowers TR MR < 0
- 24. Marginal Revenue and Monopoly Profit maximization of monopoly If a monopolist wishes to maximize total profit, what should it do?? We know that: TP = TR – TC = (P * q ) - TC To maximize its profits, the firm must find the equilibrium price and quantity that give the largest profit, or the largest difference between TR and TC. A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity.
- 25. Quant Price Total Total Total Marginal Margin ity P revenue cost profit revenue al cost q TR TC TP MR MC 0 220 0 185 -185 +200 30 1 200 200 215 15 +160 25 2 180 360 240 120 +120 20 3 160 480 260 220 +80 30 4 140 560 290 270 +40 40 5 120 600 330 270 0 50 6 100 600 380 220 -40 70 7 80 560 450 110 -80 90 8 60 480 540 -60 -120 110 9 40 360 650 -290 -160 130 10 20 200 780 -580 -200 150 11 0 0 930 -930
- 26. Marginal Revenue and Monopoly Profit maximization of monopoly The maximum profit price (P*) and quantity (q*) of a monopolist come where the firm’s marginal revenue equals its marginal cost. MR = MC, at the maximum profit P* and q* Thistells us that when MR exceeds MC, additional profits can be made by increasing output; when MC exceeds MR, additional profits can be made by decreasing q.
- 27. Monopoly Equilibrium in Graphs 200 160 MC 120 G AC 80 F 40 E 0 MR d 0 1 2 3 4 5 6 7 8 9 10 11 12
- 28. 700 At maximum profit point, slopes of TC TC and TR are parallel 600 500 At maximum profit 400 $270 point, slopes is zero and horizontal 300 200 $270 100 TR 0 0 1 2 3 4 5 6 7 8 9 10 11 12 -100 -200 TP
- 29. Marginal Revenue and Monopoly Comparing Monopoly and Competition For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. P > MR = MC