Imperfect Competition

Criteria to classify the market 1. Cross elasticities of demand 2. Bains Cocept on the condition of entry 3. The Herfindahls Index 4. Concentration Ratio

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Sources of market imperfection

Cost and market imperfections Barriers to entry Legal Restrictions High cost industry Advertising and product differentiation

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10.1
SOURCES OF MONOPOLY
When one firm supplies the entire market, the market structure is called a monopoly. A monopoly is characterized by a single firm selling an output for which there are no close substitutes. Monopoly is caused by very high barriers to entry, which exist when investors or entrepreneurs find obstacles to joining a profitable industry.

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Sources of Monopoly
Ownership of strategic raw material Exclusive knowledge of production technique Patent Right Licencing or foreign trade barrier The size of market may not allow to support more than one plant to be optimal. In this case it is natural monopoly.
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Barriers to Entry
Monopoly by law (legal monopoly) when one firm is protected by law from competition, and there are no close substitutes for the good. Monopoly by possession when one firm is the only owner of a resource needed to produce a good, and there are no close substitutes for the resource or for the good. Natural monopoly when it is cheaper for one firm to produce the entire industrys output than it would be for two or more firms to produce the same output.
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Barriers to Entry
Barriers to entry bring about market power. This market power reveals itself in the slope of the firms demand curve. The steeper the demand curve, the more market power the firm has and the greater its ability to determine price. Monopoly represents the most market power, in which case the firms demand is identical to market demand.
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Natural Monopoly
Natural monopoly occurs when one firm can supply the entire market at a lower price than two or more separate firms. This means that natural monopoly will occur any time the minimum point on long-run average cost near or to the right of market demand. Natural monopoly occurs when there are substantial economies of scale.
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The monopolist faces the market demand curve for industry

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Hypothetical Demand,Total Revenue,Marginal Revenue faced by a Monopolosit

P 9 8 7 6 5 4 3 2 1 0

Q 0 1 2 3 4 5 6 7 8 2004 Prentice Hall Publishing 9

TR 0 8 14 18 20 20 18 14 8 0

MR 8 6 4 2 0 -2 -4 -6 -8 Ayers/Collinge, 1/e

10.2
THE PROFIT-MAXIMIZING MONOPOLY
o Total revenue is maximized when the elasticity of demand equals one.
o With a straight line demand curve this happens at the midpoint.

o Even if production cost were zero, the monopoly would not produce any more than the revenue-maximizing output, since to do so would lower its total revenue, and thus profit. o The monopoly firm always chooses to produce in the elastic range of demand.
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Short run equilibrium Price and Output(Total Approach)

Q 0 1 2 P 9 8 7 TR 0 8 14 STC 6 10 12 Total Profits -6 -2 2

*3
4

6
5

18
20

13.50
19

4.50
1

5 6
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4 3

20 18

30 48

-10 -30
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Marginal approach
Q P ATC Profits per Total unit profits MR MC Relationshipof MRandMC

1 8 2 7 3 6 4 5 5 4

10 6 4.5 4.75 6

-2 2 3 1 -1

-2 2 4.5 1 10

7 5 3 1 -1

3 1.5 3 8 15

MR>MC MR>MC MR=MC MR<MC MR<MC

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The Profit-Maximizing Monopoly

o The rule of profit maximization is the same for a monopoly as for all other firms: o Produce at the point where marginal revenue equals marginal cost. o MR=MC rule

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The Profit-Maximizing Monopoly

o The rule of profit maximization is the same for a monopoly as for all other firms: o Produce at the point where marginal revenue equals marginal cost. o MR=MC rule

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The Profit-Maximizing Monopoly

A downward sloping demand curve is associated with a marginal revenue curve that slopes down even more steeply. The result is that the marginal revenue from an additional unit of output would equal the price of that unit minus the price reduction on every other unit sold. The monopolist has no unique supply curve.
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Profit, Breakeven, or Loss

The profit-maximizing quantity graphically, for a monopolist occurs at the point where marginal revenue equals marginal cost. The profit maximizing price is set at the corresponding point on the demand curve. The average profit per unit sold is multiplied by the number of units sold. The average profit per unit is the difference between price and average cost at the profitmaximizing quantity.
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Efficiency and Price Discrimination

Monopoly is allocatively inefficient because the quantity that equates marginal cost and marginal revenue falls short of the quantity that equates marginal cost and demand. The profit-maximizing quantity is less than the efficient quantity. The area of deadweight loss shows the benefits that consumers would have received from the additional output minus the cost the firm would have incurred to produce it.
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Limit Pricing
In order to avoid the threat of potential competition, a monopolist might practice limit pricing.
This is where the monopolist charges the highest price customers will pay, subject to the limit that the price not be so high that it attracts potential competitors. The limit price will be lower than the short-run profit-maximizing price.
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Price Discrimination
Price discrimination is selling a good or service at different prices to various buyers, when such differences are not justified by cost differences.
Price discrimination is feasible when different prices can be charged to different market segments. Matching prices exactly to the demand curve is the extreme of perfect price discrimination
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Price Discrimination
The arrows are prices, which differ from customer to customer Marginal cost

$19 $18 $17 $16 $15 $14 $13 $12

$11

$10

Demand = Marginal benefit = Marginal revenue 1 2 3 4 5 6 7 8 9 10

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Efficient and profitmaximizing output

Quantity
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Price Discrimination
o Another example of price discrimination is multipart pricing. o Multi-part pricing depends on the amount consumed. o The monopolist sets sets the price high for the first units consumed, since those are the hardest to do without. The price for additional units could be lower. o Multi-part pricing causes marginal revenue to fall somewhere between the extremes of the monopolist with a single price, and one able to practice perfect price discrimination.
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10.3 ANTITRUST POLICY

Antitrust law is a body of public policies designed to limit the abuse of market power, and is enforced by the justice department. The antitrust laws neither make monopoly illegal nor apply only to monopoly. Antitrust laws are intended to curb abuses of market power, of which monopolist have the most.

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Examples of Antitrust Legislation

Sherman Act (1890) Federal Trade Commission Act (1914)

Clayton Act (1914)

Robinson-Patman Act (1936)

Celler-Kefauver Antimerger Act (1950)

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Antitrust Policy
GLOSSARY OF TERMS
Exclusive dealing: Exclusive territories: Predatory pricing: A firm prohibits its distributors from selling competitors products. A firm assigns a geographic area to a distributor and prohibits other distributors from operating in that territory. A firm prices a product below the marginal cost of producing it to drive rivals out of business.

Price A firm charges different customers different discrimination: prices for the same product.
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Antitrust Policy
GLOSSARY OF TERMS
Refusals to deal:
Resale price maintenance: A firm prohibits rivals from purchasing/using scarce resources (called essential facilities) that are needed to stay in business. A manufacturer sets a minimum retail price for its product.

Tie-in sales:

A firm conditions the purchase of one product upon the purchase of another.

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Alternatives to Regulation
If a monopoly is a natural monopoly the government will typically either own it or regulate it with rate-of-return regulation that restrict the monopolist from charging more than average cost. Rate-of-return pricing is also known as average cost pricing. To avoid the inefficiencies of regulation, economist recommend alternatives like franchise monopoly, which is a right to be the exclusive provider of a service.
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Alternatives to Regulation
o The government has allowed deregulation in some industries. o Deregulation is the scaling back of government regulation of industry. o The reduction of government ownership of industries is referred to as privatization.

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10.4 EXPLORE & APPLY

The U.S. Postal Service A Monopoly in the Public Interest
The U.S. Post Office is the oldest monopoly in the U.S.
It is intended to be self supporting. In 2001, it had 776,000 employees, and earned $65.9 billion in revenues. It expenses however were $67.6 billion, and as a result lost $1.68 billion dollars.

To try to make up for the losses it hired FedEx to handle its overnight deliveries, and increased the basic rate for mailing a letter to 37 cents.
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The U.S. Postal Service A Monopoly in the Public Interest

Other cost cutting measure include:
Possibly eliminating Saturday deliveries. Installing new automated equipment. Privatization

Additional challenges include:

The growing popularity of email. The cost of protecting employees and customers from the threat of anthrax.
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Terms Along the Way

o o o o monopoly barriers to entry monopoly by law monopoly by possession o natural monopoly o price maker o limit pricing
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o price discrimination o perfect price discrimination o Multi-part pricing o antitrust law o rate of return regulation o average price pricing
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Terms Along the Way (continued)

o franchising monopoly o deregulation o privatization

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Test Yourself
1. a. b. c. Barriers to entry increase the number of firms in an industry. decrease the number of firms in an industry. have no effect on the number of firms in an industry. d. have unpredictable effects on the number of firms in an industry.

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Test Yourself
2. a. b. c. d. Market power is indicated by a(n) horizontal demand curve. shortage of barriers to entry. ability to pick your selling price. j shape to the marginal cost curve.

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Test Yourself
3. Which statement is true about monopoly? a. A monopoly is a price taker. b. A monopoly will have many good substitutes for its output. c. The monopoly demand curve is also the market demand curve. d. An unregulated monopoly is always profitable.
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Test Yourself
4. A natural monopoly occurs when a. government grants a patent to a firm. b. government prohibits the entry of new competitor firms. c. one firm can produce at lower average cost than any combination of two or more firms. d. the product that is monopolized pertains to natural resources.
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Test Yourself
5. A marginal revenue curve for a monopoly will a. be shaped like the letter J. b. lie below the demand curve. c. lie above the demand curve. d. be identical to the demand curve.

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Test Yourself
6. The best example of a natural monopoly is a. a local electric utility. b. the U.S. Postal Service. c. an airline. d. a public school.

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Test Yourself
7. If a monopolist is able to practice

perfect price discrimination, the result will be

a. b. c. d. inefficient, but consumers will be better off. inefficient, and consumers will be worse off. efficient, and consumers will be better off. efficient, but consumers will be worse off.

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The End! Next Chapter 11 Oligopoly and Monopolistic Competition"

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