Imperfect Competition

and Monopoly
Patterns of Imperfect
Competition
 Definition of Imperfect
Competition
• Imperfect competition prevails in an industry
whenever individual sellers have some measure
of control over price of their output.
• However, imperfect competitor has some but not
complete discretion over its price.
• The amount of discretion over price will differ
from industry to industry.
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Graphical Depiction

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Firm Demand under Perfect
Competition
• The first figure reminds us
that a perfect competitor
faces a horizontal demand
curve, indication that it
can sell all it wants at the
going market price.

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Firm Demand under Imperfect
Competition
• An imperfect competitor, in
contrast, faces a downward-
sloping demand curve.
• If the firm increases its sales, it
will definitely depress the market
price of its output as it moves
down its dd demand curve.

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• We can also see the difference between perfect
and imperfect competition in terms of price
elasticity.
• Perfect Competitor → Demand is perfectly elastic
• Imperfect Competitor → Demand has a finite elasticity.

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 Varieties of Imperfect
Competition
• Economist classify imperfectly competitive
markets into three different market structures.
–Monopoly
–Oligopoly
–Monopolistic Competition

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 Monopoly
• The most extreme case is Monopoly: a single
seller with complete control over an industry.
– Greek word: mono for “one” and polist for “seller”
• It is the only firm producing in its industry
and there is no industry producing a close
substitute.

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• True monopolist are rare today.
• Most monopolist persist because of some form
of government regulation or protection.
• Example:
–Drug Patent
–Franchised local utility

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• In such cases there is truly a single seller
of a service with no close substitutes.
• One of the few examples of a monopoly
without government license is
Microsoft Windows, which has
succeeded in maintaining its
monopoly through network economies along
with rough (and sometimes illegal)
tactics against its competitors.

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• BUT, even monopolist must always be looking
over their shoulders for potential competitors.

• In the long run, no monopoly is completely

secure form attack by competitors.

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 Oligopoly
• The term oligopoly means “few sellers”.
• Few, in this context, can be a number as small
as 2 or as large as 10-15 firms.

• The important feature of oligopoly is that each

individual firm can affect the market price.

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• Example:
In the airline industry, decision of a single
airline to lower fares can set off a price
war which brings down the fares charged by
all its competitors.

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 Monopolistic Competition
• This occurs when a large number of sellers produce
differentiated products.
• This resembles perfect competition in that there are
many sellers, none of whom have a large share of
the market.
• It differs from the perfect competition in that the
products sold by different firms are not identical.
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 Sources of Market
Imperfections
• Most cases of imperfect competition can bc traced
to two principal causes:
1. Industries tend to have fewer sellers when there
are significant economies of large-scale
production and decreasing costs.
2. Markets tend toward imperfect competition when
there are “barriers to entry” that make it
difficult for new competitors to enter an
industry.
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 Fewer Sellers
• Under these conditions, large firms can simply
produce more cheaply and then undersell small
firms which cannot survive.

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 Barriers to Entry
• In some cases, barriers may arise from
government laws or regulations which limit the
number of competitors.
• In other cases, there maybe economic factors
that make it expensive for new competitor to
break into a market.

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Cost & Market Imperfections
• The technology and cost structure of an
industry help determine how many firms that
industry can support and how big they will be.

• The key is whether there are economies of scale

in an industry.

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• If there are economies of scale, a firm can
decrease its AVC by expanding output atleast
up to a point. (Bigger firms will have a cost
advantage over smaller firms).

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Cost in Perfect Competition
• This shows an industry where the
point of minimum AC is reached
at a relatively low level of
output.
• Any firm which tries to expand
its output beyond this point will
find its costs rapidly rising.
• As a result, this industry can
support the large number of
efficiently operating firms needed
for perfect competition.

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Cost in Oligopoly
• This shows an industry where firms
enjoy increasing returns to scale up
to a point, above which the scale
economies are exhausted and AC
begin to increase.
• AC curve is relatively flat and does
not turn up soon enough to avoid
breakdown of perfect competition;
that is, the limited demand curve of
the industry only allows a small
number of firms to coexist at the
point of minimum AC.
• Such a cost structure will tend to
lead to an Oligopoly.
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 Barriers to Entry
• Although cost differences are the most important factor
behind market structures, barriers to entry can also prevent
effective competition.
• 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 common type of barrier to
entry, but there are others, including legal restrictions, high
cost of entry, advertising, and product differentation.

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 Barriers to Entry
• Legal Restriction
– Patents, entry restrictions (franchise monopolies), foreign-
trade tariffs and quotas.
• High Cost of Entry
– Commercial-aircraft industry, intangible forms of investment
(wide acceptability)
• Advertising and Product Differentiation
– Advertising can create product awareness and loyalty to well-
known brands.
– Product Differentiation can impose a barrier to entry and
increase the market power of producers
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END

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