FINC304

Managing Uncompetitive
Markets
SESSION 9: MONOPOLY AND
MONOPOLISTIC COMPETITION

Lecturer: Dr. Agyapomaa Gyeke-Dako, UGBS

Contact Information: agyeke-dako@ug.edu.gh

College of Education
School of Continuing and Distance Education
2014/2015 – 2016/2017
 Session Overview
• In this session, we start looking at how the manager can select
price and output that will maximize profit in an uncompetitive
market. In particular, we look at both the monopoly and
monopolistically competitive markets

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 2

 Session Outline
The key topics to be covered in the session are as follows:
• Characteristics of Monopoly
• Profit maximization under monopoly
• Characteristics of Monopolistic Competition
• Profit maximization under monopolistic competition

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 3

 Reading List
• Baye Michael and Price Jeffery: Managerial
Economics and Business Strategy, 8th Edition

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 4

 Monopoly
• A monopoly refers to a market where a single firm

serves an entire market

• In a monopoly, there are huge barriers to entry into the market

• A monopolist may but need not be a large firm

• In a monopoly market, the product produced is unique

• The fact that a firm is the only producer does not mean that
the firm has complete control over the price of the product

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 5

 • The firm may have a substantial degree of control
over the price of the product but not ultimate
control
• This means that the monopolist has a downward
sloping demand curve

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 6

 Sources of Market Power
• Economies of scale
• Barriers created by government:
• Licenses Patents & Copyrights

• Input barriers Brand loyalties

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 7

 Monopolist’s Demand Curve and MR
• As stated in the previous slide, the monopolist is
the only firm in the market. Hence, the monopolist’s
demand curve is also the market demand
• The monopolist faces a downward-sloping demand curve (price maker)
This means to sell more the monopolist has
to reduce price
• This means the Marginal Revenue will be greater
than price unlike perfect competition
• We can show that the MR revenue will be lower the price. Refer to
table on revenue and upcoming slide on algebra

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 8

 Profit Maximising Output: Example
• Recall the previous example where SRTC is
•TC = 400 + 2q + 0.5q2 where q is the number of
cocoa bags harvested per month. Assume demand
curve is
• Qd = 50 − 5P

(a)If this market is served by a monopolist what will

be the profit-maximizing level of output?

(b)What price will be charged?

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 9

 Profit-Maximising Output: Solution
• Recall the previous example where SRTC is
•TC = 400 + 2Q + 0.5Q2 where q is the number of cocoa
bags harvested per month. Assume demand curve is
• Qd = 50 − 5P

• (a) The monopolist maximizes profit by choosing output

to equate MC and MR
• MC = 2+Q
• For MR, we need to write the demand function in the inverse form ie
make price the subject, multiply by quantity to get the TR
• P = 10 − 0.2Qd = > TR = P ∗ Q = 10Q − 0.2Q2= >
• MR = 10 − 0.4Q

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 10

 Profit-Maximising Output Solution
• Recall the previous example where SRTC is
•TC = 400 + 2Q + 0.5Q2 where q is the number of
cocoa bags harvested per month. Assume demand
curve is
• Qd = 50 − 5P

• Setting MC=MR, we have: 10 − 0.4Q = 2 + Q => Q =

5.71

• What price will be charged?

• P=10-0.2(5.71)=8.86s

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 11

 Higher Prices, Higher Profits and Lower
Outputs than under Perfect
Competition

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 12

 Monopolistic Competition:
Environment and Implications
• Numerous buyers and sellers

• Differentiated products
• Implication: Since products are differentiated, each firm faces a
downward sloping demand curve.
• Consumers view differentiated products as close substitutes: there exists
some willingness to substitute.

• Free entry and exit

• Implication: Firms will earn zero profits in the long run

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 13

 Managing a Monopolistically
Competitive Firm
• Like a monopoly, monopolistically competitive firms

• have market power that permits pricing above marginal cost. level of
sales depends on the price it sets.

• But . . .

• The presence of other brands in the market makes the demand for
your brand more elastic than if you were a monopolist. Free entry and
exit impacts profitability.

• Therefore, monopolistically competitive firms have limited market

power.

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 14

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 15
 Monopolistic Competition : Profit
Maximisation
• Maximize profits like a monopolist
• Produce output where MR = MC.
• Charge the price on the demand curve that corresponds to
that quantity.

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 16

 Short-Ru n Monopolistic Competition

$
ATC

pM
ATC

Quantity of Brand X
MR
4/27/2018 Slide 17
Agyapomaa Gyeke-Dako(PhD)
 Long Run Adjustments

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 18

 Monopolistic Competition
• The Good (To Consumers)
• Product Variety

• The Bad (To Society)

• P > MC
• Excess capacity
• Unexploited economies of scale

• The Ugly (To Managers)

• P = ATC > minimum of average costs.
• Zero Profits (in the long run)!

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 19

 Maximising Profits: A Synthesizing
Example
• C (Q) = 125 + 4Q2

• Determine the profit-maximizing output and price,

and discuss its implications, if
• You are a price taker and other firms charge $40 per unit; You are a
monopolist and the inverse demand for your product is P = 100 - Q;
• You are a monopolistically competitive firm and the inverse demand
for your brand is P = 100 – Q.

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 20

 Marginal Cost

•C (Q) = 125 + 4Q2 So MC = 8Q

• This is independent of market structure

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 21

 Price Taker
• MR = P = $40
set MR = MC
40 = 8Q
Q = 5units

• Cost of producing 5 units.

C (Q) = 125 + 4Q2 = 125 + 100 = $225

• Revenues:
PQ = (40)(5) = $200.
Maximum profits of -$25.
• Implications: Expect exit in the long-run

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 22

 Monopoly/Monopolistic Competition
•MR = 100 - 2Q (since P = 100 - Q)
Set MR = MC, or 100 - 2Q = 8Q.
• Optimal output: Q = 10.
• Optimal price: P = 100 - (10) = $90. Maximal profits:
• PQ - C(Q) = (90)(10) -(125 + 4(100)) = $375.

• Implications
• Monopolist will not face entry (unless patent or other entry
barriers are eliminated).
• Monopolistically competitive firm should expect other firms to
clone, so profits will decline over time.

Agyapomaa Gyeke-Dako(PhD) 4/27/2018 Slide 23