Imperfect Competition and Market Power: Core Concepts
Pure Monopoly:
An industry with a single firm.
The firm produces a product with no close substitutes.
Significant barriers to entry prevent other firms from competing for profits.
Barrier to Entry: Something that prevents new firms from entering and competing in imperfectly competitive industries.
Government Franchises: A monopoly by virtue of government directive.
Patents: A barrier to entry that grants exclusive use of the patented product or process to the inventor.
Economies of Scale and Other Cost Advantages
Ownership of a Scarce Factor of Production: Example: The DeBeers Company of South Africa controls about 80 percent of the market for uncut diamonds.
Price as a Decision Variable:
Price is a decision variable for imperfectly competitive firms.
Firms with market power must decide:
How much to produce.
How to produce it.
How much to demand in each input market.
What price to charge for their output.
Output price is not taken as given; the firm has the power to influence it.
Assumptions for Analyzing Monopoly Behavior:
Entry to the market is blocked.
Firms act to maximize profits.
Monopoly is a price-taker with respect to inputs of production.
No price discrimination.
Monopoly faces a known demand curve.
Demand in Monopoly Markets:
In a monopoly market, there is no distinction between the firm and the industry.
The firm is the industry.
The market demand curve is the demand curve facing the firm.
The total quantity supplied in the market is what the firm decides to produce.
Marginal Revenue and Market Demand:
For a monopolist, an increase in output involves not just producing more and selling it but also reducing the price of its output to sell it.
Monopoly Costs, Revenues, and Profits
Producing past where MR = MC, the incremental cost will exceed the incremental revenue.
Producing less than where MR = MC, the monopolist is not maximizing profits.
Price and Output Decisions in Pure Monopoly Markets
All firms, including monopolies, raise output as long as marginal revenue is greater than marginal cost.
Any positive difference between marginal revenue and marginal cost can be thought of as marginal profit.
The profit-maximizing level of output for a monopolist is the one at which marginal revenue equals marginal cost: MR=MC.
A monopoly firm has no supply curve that is independent of the demand curve for its product.
A monopolist sets both price and quantity, and the amount of output that it supplies depends on both its marginal cost curve and the demand curve that it faces.
Monopoly in the Long and Short Run
If a firm can reduce its losses by operating in the short run, it will do so.
Perfect Competition and Monopoly Compared
Relative to a perfectly competitive industry, a monopolist restricts output, charges higher prices, and earns positive profits.
The Demand Curve a Monopolist Faces:
Single seller
Faces entire industry demand
Must lower price to sell more
Not all units are sold for the same price (MR < P).
Perfect Competition
Many sellers
Faces perfectly elastic demand
Must produce more to sell more
All units sold for the same price (P=MR).
Elasticity and Monopoly:
The monopolist faces a downward-sloping demand curve (its average revenue curve).
It cannot charge just any price with no changes in quantity demanded.
If a monopoly raises price, quantity demanded will decrease.
Remember how consumers respond to a change in price.
A monopolist is a single seller of a well-defined good or service with no close substitute.
The demand curve slopes downward because individuals compare marginal satisfaction to cost.
Consumers have limited incomes and unlimited wants.
The market demand curve slopes downward because individuals compare the marginal satisfaction they will receive to the cost of the commodity to be purchased.
Collusion and Monopoly Compared
Collusion: The act of working with other producers to limit competition and increase joint profits.
The Social Costs of Monopoly: Inefficiency and Consumer Loss