Imperfect Competition

Monopoly
Oligopoly
Monopolistic Competition
Prepared by: M. Consignado
Source:ECONOMICS: Principles and Applications
McGraw-Hill/Irwin 2005 Powerpoint Presentation
Imperfect Competition
 market situation where individual firms
have a measure of control over the
price of the commodity in an industry.

Note: the word “imperfect” neither reflects the business

ethics of the owner of the firms nor implies absence
of rivalry in the industry. The term “imperfect” simply
denotes a deviation from a defined “ideal” of a market
that is said to bring about efficient allocation of
resources-the perfectly competitive market.
Sources of Market
Imperfection
 Barriers to entry
 artificial barriers are legal restrictions like patents and
exclusive franchises
 Natural barrier
 demand may be too small to warrant entry of
numerous firms
 Firm’s production function exhibits increasing returns
to scale.

 Significant differences or advantages in cost

conditions.
Types of Imperfect Markets
 Monopoly – a market situation where a
single seller exists and has complete
control over an industry.
 Oligopoly- a market structure with few
sellers.
 Monopolistic Competition – occurs
when there are many sellers producing
differentiated products.
Pure Monopoly
 Refers to a market for a good that has no
good substitutes. For example, the only rail
transit company in Metro Manila may be
considered a monopolist in the sense that it is
the sole provider of light railway transport
services in Metro Manila. However, with the
presence of Metro buses plying the same
routes, it cannot be considered a pure
monopolist.
MONOPOLY REVENUES & COSTS
Elastic Inelastic
$200

150

Dollars 200

50 MR D
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

$750
Dollars

500
TR
250

Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
OUTPUT AND PRICE DETERMINATION

Cost Data
MR = MC Rule
No Monopoly Supply Curve
Monopoly Pricing
Misconceptions
• Not Highest Price
• Total, Not Unit, Profit
• Possibility of Losses
Graphically…
OUTPUT AND PRICE DETERMINATION
Profit Maximization Under Monopoly
Remember
200
the MR=MC Rule?
175 Profit
Per Unit
Price, costs, and revenue

150
MC
$122 125

$94 100
Profit ATC
75
D
50

25 MR = MC
MR
Q
0 1 2 3 4 5 6 7 8 9 10
Since monopolists are sole producers of
a unique commodity, the demand curve
faced by the monopolist is the same
demand curve faced by the whole
industry, and downward sloping. The
determination of the maximum level of
profit of a monopolist is similar to the
PCM’s profit-maximizing condition- by
working with the behavior of the total
revenue and total cost curves.
 There are several misconceptions about
monopolies that must at once be
rectified.
 First, being a monopolist does not
ensure the firm instant profit.
 It is not true that the firm can impose
any price it wants. The maximum price
the monopolist can charge is dictated by
the market demand the monopoly faces.
 Lastly, a monopolist cannot maximize
profit at the inelastic region of the
market demand curve.
 In reality it is not easy and simple to
achieve the profit-maximizing solution for the
monopolist. From a graphical analysis, it is
easy to determine the price and output levels
by simply equating marginal cost to marginal
revenue. However, the detailed information
with regards to the market demand function,
and marginal revenue function may be
difficult to obtain. Monopolists usually have a
relatively more accurate information on own
costs but this is not true with regards to
demand (Costales et.al., 2000)
Oligopoly
 Classification according to nature of
commodity being sold:
 Pure oligopolies-firms sell a practically
homogenous product, the same kind of
commodity. Ex. Cement industry
 Differentiated oligopolies-firms sell
products that vary in quality. Ex.
Automobile industry
Oligopoly
 Classification according marketing strategies employed:
 Independent action-firms do not collaborate in any way in the
market
 Collusion-firms act as one, like a monopoly, by setting a price
level that maximizes profit for the whole industry and setting
quotas in the production of each firm. Ex. OPEC
 Imperfect collusion-firms have no formal arrangements

 Perfect collusion-firms formally establish a binding

agreement on price and output in the market

 Centralized cartels
 Market-sharing cartels
CARTELS AND OTHER COLLUSION
Colluding Oligopolists Will
Split the Monopoly Profits
Economic
Profit MC
Price and costs

P0

A0 ATC
D

MR = MC
MR
Q0
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
The firm’s demand and
marginal revenue curves
Price

D1
Quantity MR1
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
The rival’s demand and
marginal revenue curves
Price

D2

MR2
D1
Quantity MR1
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
Rivals tend to
follow a price cut
Price

D2

MR2
D1
Quantity MR1
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
Rivals tend to
follow a price cut
or ignore a
price increase
Price

D2

MR2
D1
Quantity MR1
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
Effectively creating
a kinked demand curve
Price

D2

MR2
D1
Quantity MR1
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
Effectively creating
a kinked demand curve
Price

D
Quantity
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
Effectively creating
a kinked demand curve

MC1
MR2
Price

MC2

D
Quantity MR1
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
Profit maximization
MR = MC occurs
at the kink
MC1
MR2
Price

MC2

D
Quantity MR1
 KINKED DEMAND THEORY:
NONCOLLUSIVE OLIGOPOLY
This behavior can set
off a price war.
MC1
MR2
Price

MC2

D
Quantity MR1
Price war
 The process of undercutting prices to
capture consumer demand towards
one’s own market.
Monopolistic Competition
 The difference between this market type
and perfect competition is that sellers in
monopolistic competition can vary
product characteristics. Furthermore,
firms have slight control over the price
of the commodity and they advertise to
attract customers.
Major sources of
differentiation among firms
 Location
 Quality of the product
 Trademark or brand of the commodity
 PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Expect New CompetitorsMC
ATC

P1
Price and Costs

A1

Short-Run
Economic
Profits D
MR
Q1
Quantity
 PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
Expect New CompetitorsMC
ATC
New competition drives down the
price level
P – leading to economic
1
Price and Costs

losses
A in the short run.
1

Short-Run
Economic
Profits D
MR
Q1
Quantity
 PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
MC
ATC
A2
P2
Price and Costs

Short-Run
Economic
Losses
D
MR
Q2
Quantity
 PRICE AND OUTPUT IN
MONOPOLISTIC COMPETITION
MC
ATC
A2
With economic losses, firms will
P2
exit the market – stability occurs
Price and Costs

whenShort-Run
economic profits are zero.
Economic
Losses
D
MR
Q2
Quantity
PERFECT COMPETITION
Characteristics
 smallness of buyer or seller relative to the
market
 homogeneous product

 perfect mobility of goods, services and

resources
 absence of artificial restraints

 perfect information or knowledge of market

prices and participants

The Short Run
 refers to the market period wherein a
firm can vary some of its resources, and
thus, change output level, but does not
have enough time to vary the size of its
plant.
Economic Profit
 An excess of total revenue over all
costs of production including opportunity
costs of all resources used.
Total Revenue and Total Cost
 Total Revenue (TR)  Total Cost (TC)
Price of a good Sum of all costs (both
multiplied by the explicit & implicit)
quantity sold of that incurred by the firm in
good the production of a
good
Marginal Revenue and
Marginal Cost
 Marginal Revenue  Marginal Cost (MC)
(MR) Additional cost
Additional revenue incurred from
from selling an producing an
additional unit of additional unit of
output; slope of TR output; slope of TC
curve curve.
Profit maximization
FOC’s for π-max:
𝜕π/𝜕𝑄 = 0; 𝜕𝑇𝑅/𝜕𝑄 - 𝜕𝑇𝐶/𝜕𝑄 = 0

or : MR = MC (& MC is rising)

Since P=MR for a firm in perfect

competition, then P = MC
PURE MONOPOLY
Characteristics
 There is only one seller/supplier in the

market
 The firm faces the market demand and
it has relative freedom with respect to
the prices it charges
 Entry into the monopolistic market is
difficult
Conditions for π –
maximization:
 Choose the output level at which for that
Q =Q*,
MR = MC
NOTE: P > MR – since the monopolist
faces the downward sloping market
demand curve, it has to lower the price on
all units to be sold if it wants to sell an
additional unit of the output
Oligopoly
 Market situation wherein there are only
a few number of sellers such that the
activities of one affect the others’ and
the activities of any on all of the other
firms affect those of the first.
Pure Oligopoly
 Oligopolistic market situation in which
the firms sell homogeneous or identical
products.
e.g. Cement – Atlas, Fortune, Union
fuel oil – Petron Phil., Pilipinas Shell,
Caltex
Differentiated Oligopoly
 Market situation in which oligopolistic
firms sell differentiated products.
e.g. automobiles –Toyota,Mitsubishi,Ford,
Isuzu
softdrinks – Coca-cola Bottlers,Pepsi
beer – SMC, Asia Brewery
toothpaste – Procter & Gamble,PRC
MONOPOLISTIC
COMPETITION
Market structure in which there are
numerous buyers and sellers of a
differentiated product.
Examples of differentiated products:
Textile,hosieries,shoes,etc. identified by their
brand names.
Profit maximization condition: produce that
output level where: MC = MR with P > MR