Chapter 15 &16

Monopoly and Oligopoly and Monopolistic Competition

Introduction
• A monopoly is a firm that is the sole seller of
a product without close substitutes.
• Characteristics :
• One seller
• Many buyers
• No close substitutes available
• A monopoly firm has market power,
• The ability to influence the market price of
the product it sells.
Why Monopolies Arise
The main cause of monopolies is barriers
to entry – other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The govt gives a single firm the exclusive right
to produce the good.
E.g., patents, copyright laws
Why Monopolies Arise
• Natural monopoly: a single firm can
produce the entire market Q at lower ATC
than could several firms.
Why Monopolies Arise

ATC is lower if
one firm services
all 200 homes
than if two firms
each service
100 homes.
Monopoly vs. Competition: Demand Curves

In a competitive market, the market demand curve slopes

downward.
but the demand curve P
for any individual firm’s product
D
is horizontal
at the market price.
The firm can increase Q
without lowering P,
Q
so MR = P for the competitive firm.
Monopoly vs. Competition: Demand
Curves
A monopolist is the only seller,
so it faces the P
market demand curve. A monopolist’s
Demand curve
To sell a larger Q,
the firm must reduce P.
Thus, MR ≠ P.
D
Q
A monopoly’s revenue
Moonbucks is
the only seller of cappuccinos in town.
The table shows the market demand for cappuccinos.
Fill in the missing spaces of the table.
What is the relation-
Between P and AR?
Between P and MR?
A monopoly’s revenue
Q P TR AR MR
0 4.50 n/a -----
1 4.00
2 3.50
3 3.00
4 2.50
5 2.00
6 1.50
Understanding the Monopolist’s MR
• Increasing Q has two effects on revenue:
• The output effect:
More output is sold, which raises revenue
• The price effect:
The price falls, which lowers revenue
• To sell a larger Q, the monopolist must reduce the price
on all the units it sells.
• Hence, MR < P
• MR could even be negative if the price effect exceeds
the output effect
(e.g., when Moonbucks increases Q from 5 to 6).
Understanding the Monopolist’s MR:output
effect
P Q PQ
2 1 2
2 3 6
2 6 12
2 10 20
Understanding the Monopolist’s MR: price effect

P Q PQ
4 8 32
3 7 21
2 6 12
1 5 5
Profit maximization
• Like a competitive firm, a monopolist maximizes profit by
producing the quantity where MR = MC.
• Once the monopolist identifies this quantity,
it sets the highest price consumers are willing to pay for that
quantity.
• It finds this price from the D curve.
Imperfect Competition
• Oligopoly: only a few sellers offer similar or
identical products.
• Characteristics :
(1) an industry dominated by a small number of
large firms
(2) firms sell either identical or differentiated
products
(3) the industry has significant barriers to entry.
Monopolistic competition
Monopolistic competition: many firms sell similar but not identical
products

Characteristics:
• Many sellers
• Product differentiation
• Free entry and exit

Examples:
• apartments
• books
• bottled water
• clothing
• fast food
Monopolistic competition
• Short run: Under monopolistic competition,
firm behavior is very similar to monopoly.
• Long run: In monopolistic competition,
entry and exit drive economic profit to zero.
• If profits in the short run:
New firms enter market,
taking some demand away from existing firms,
prices and profits fall.
Monopolistic competition
• If losses in the short run:
Some firms exit the market,
remaining firms enjoy higher demand and prices
• Entry and exit occurs until
P = ATC and profit = zero
 • Why Monopolistic Competition Is
Less Efficient than Perfect Competition
Excess capacity
• The monopolistic competitor operates on the
downward-sloping part of its ATC curve,
produces less than the cost-minimizing
output.
• Under perfect competition, firms produce the
quantity that minimizes ATC.
Monopolistic Competition and Welfare

• Monopolistically competitive markets do not

have all the desirable welfare properties of
perfectly competitive markets.
• Because P > MC, the market quantity is below
the socially efficient quantity.
Comparison among perfect competition
,monopoly and monopolistic competition
Features Perfect Monopolistic Monopoly
competition
Goal of firms Maximize profit Maximize profit Maximize profit

Rule for maximizing MR=MC MR=MC MR=MC

Can earn economic Yes Yes Yes
profit in SR
Price taker Yes No No
Price P=MC P>MC P>MC
Produces welfare- Yes No No
maximizing level of
output
No. of firms Many Many One
Entry in the LR Yes Yes No
Economic profit I the LR No No Yes