Monopoly & Market Structures – Comprehensive Bullet-Point Study Notes

Marginal Revenue vs. Marginal Cost

• Core rule for all market structures (perfect competition, monopoly, monopolistic competition, oligopoly):
  • Produce the output level where MR = MC.
  • If MR > MC (marginal profit > 0): increase output until equality is restored.
  • If MR < MC (marginal profit < 0): reduce output.
• Rationale: At equality, profit cannot be raised by altering Q; any change would lower total profit.
• Micro‐foundations: profit \pi(Q) = TR(Q) - TC(Q). Maximization requires \frac{d\pi}{dQ} = 0 \Rightarrow \frac{dTR}{dQ} = \frac{dTC}{dQ} \Rightarrow MR = MC.
• Applies even when firms behave strategically (e.g., oligopoly) or face a perfectly elastic demand (perfect competition, where P = MR).

Excess Capacity vs. Efficient Scale

• Efficient Scale: Quantity where Average Total Cost is minimized ⇒ \min_{Q} ATC(Q).
• Excess Capacity: Operating at a Q lower than efficient scale ⇒ under‐utilised plant/resources.
• Common in monopolistic competition because the downward‐sloping firm demand curve meets ATC before its minimum.
  • Firms differentiate their products; each has some market power, allowing a price markup and smaller Q.
• Implication: Society forgoes lowest‐possible cost; product variety is obtained at the expense of productive efficiency.

Natural Monopoly & Economies of Scale

• Economies of scale: ATC falls as Q rises due to spreading fixed costs or increasing returns.
• Natural monopoly exists when one firm can supply the market at a lower cost than any multi‐firm configuration (ATC declining over the entire relevant demand range).
  • Graph: downward‐sloping ATC intersects demand only once ⇒ single firm optimal.
  • Examples: water, electricity, gas distribution, rail track.
• Regulatory implications: price regulation, public ownership, or franchise bidding to curb monopoly power while exploiting scale economies.

Price Discrimination & Elasticity

• Definition: Selling the same or similar product at different prices to different buyers not justified by cost differences.
• Feasibility conditions:
  1. Market power (downward‐sloping demand).
  2. Ability to segment markets (identify WTP‐differences).
  3. Prevention of resale or arbitrage.
• Profit‐maximising strategy: charge higher price in less elastic segments, lower price in more elastic segments.
  • Elasticity rule: \frac{PH - MC}{PH} = \frac{1}{|\varepsilonH|} vs \frac{PL - MC}{PL} = \frac{1}{|\varepsilonL|} where |\varepsilonH| < |\varepsilonL|.
• Welfare: can raise output and sometimes reduce deadweight loss (DWL) but redistributes surplus from consumers to producer.

Monopoly Pricing & Deadweight Loss

• Monopoly chooses QM where MR = MC, charges PM on demand curve.
• Results vs. perfect competition (where PC = MC at QC):
  • PM > MC, QM < Q_C.
  • DWL: triangle bounded by demand curve, MC, and vertical line at Q_M.
  • Consumer surplus ↓, producer surplus ↑ (relative to competition) but total surplus ↓.
• Mathematical expression for DWL (linear demand & constant MC): DWL = \tfrac{1}{2}(PM - MC)(QC - Q_M).

Oligopoly & Marginal Analysis

• Few firms, each large enough to influence price; strategic interdependence paramount.
• Decision principle (still):
  • If MB > MC → expand.
  • If MC > MB → contract.
• Game theory tools (Cournot, Bertrand, Stackelberg, prisoner's dilemma) model rival reactions.
• Possibility of collusion (cartel) vs. competition; collusion is illegal but tempting because mimics monopoly outcome.

Cooperation & Welfare in Oligopoly

• Cooperation (explicit or tacit) pushes price ↑ toward monopoly level:
  • Raises total (firm) surplus; lowers consumer surplus.
  • May improve productive efficiency but hurts allocative efficiency.
• Game‐theoretic insight: each firm has incentive to undercut price slightly (cheat); hence collusive agreements unstable without enforcement.
• Policy: antitrust laws to deter collusion, leniency programs, and merger review.

MR = MC (Universal Profit Maximisation Rule)

• Reiterated principle (#8): regardless of structure/time horizon, the intersection of MR and MC supplies the optimal Q.
• Provides a test question staple: "If MR > MC at current output, what should the firm do?" → increase output.

Monopolistic Competition – Long Run

• Free entry/exit drives economic profit to zero.
• Long‐run equilibrium: demand curve tangent to ATC at Q_{LR} (not at its minimum).
  • Price P_{MC} > MC (allocative inefficiency).
  • Q{LR} < Q{efficient\ scale} (excess capacity, productive inefficiency).
• Consumers gain variety; firms operate like mini‐monopolies over differentiated niches.

Market Structure Comparison (Key Attributes)

• Perfect Competition: many sellers, identical product, no barriers, price = MC, zero LR profit.
• Monopoly: one seller, unique product, high barriers, price maker, possible LR profit, DWL.
• Monopolistic Competition: many sellers, differentiated, low barriers, some price setting, zero LR profit, excess capacity.
• Oligopoly: few sellers, product may differ, high barriers, mutual interdependence, LR profit depends on rivalry.

Monopoly Graph – Reading Profits

• Steps:
  1. MR = MC → Q_M.
  2. Up to demand curve → P_M.
  3. Up to ATC curve → ATC_M.
  4. Profit per unit: \piu = PM - ATC_M.
  5. Total profit: \Pi = \piu \times QM (area of rectangle between P and ATC at Q).

Perfect Competition vs. Monopoly – Efficiency Contrast

• Perfect Competition: P = MC, maximises total surplus, no DWL.
• Monopoly: P > MC, generates DWL & redistributes surplus to producer.
• Policy tools: price caps, output regulation, or promote competition.

Long‐Run Monopolistic Competition – Graphical Highlights

• Demand tangency point = break‐even.
• Still positive markup: P - MC = \text{Markup} > 0.
• Not efficient (same arguments as earlier). Variety considered a countervailing benefit.

Losses & Shutdown Decision

• Short run: fixed costs sunk.
  • Continue producing if P \ge AVC (covers variable costs); loss < fixed cost.
  • Shutdown if P < AVC (minimise loss to fixed cost).
• Long run: all costs variable → exit if P < ATC and no expectation of improvement.
• Graphical: supply curve for competitive firm is MC curve above AVC.

Elasticity & Monopoly Pricing Strategy

• Monopoly will never operate where demand is inelastic (|ε| < 1): there MR < 0; reducing Q ↑ TR & ↓ TC.
• Operates only on elastic portion (|ε| > 1) where MR > 0.
• Total revenue test: lowering price in elastic range → TR rises.

Deadweight Loss – Visualising Welfare Loss

• Efficient output: intersection of demand (MB) and MC (social MC).
• Monopoly output lower; DWL triangle bounded by demand curve, MC curve, and vertical lines at QM & QE.
• Represents lost mutually beneficial trades.

Types of Price Discrimination

• First‐degree (perfect): each consumer pays their exact WTP; CS ≈ 0, output efficient, monopoly captures all surplus.
• Second‐degree: self‐selection by quantity/quality (block pricing, two‐part tariffs, bundling). Larger buyers get lower per‐unit price.
• Third‐degree: segmentation by observable characteristic (age, location, time). Each segment faces its own elasticities.
• Welfare effects:
  • May expand output compared to single‐price monopoly → DWL ↓.
  • Consumer surplus redistributed; some groups may pay less, others more.
  • Regulatory scrutiny when considered unfair or anti‐competitive.

Cross‐Connections & Broader Context

• MR = MC anchors every topic: from shutdown rule to price discrimination formulas.
• Excess capacity in monopolistic competition parallels underproduction in monopoly → both stem from downward‐sloping demand.
• Game‐theoretic problems of oligopoly (cheating in cartels) echo inability to sustain first‐degree price discrimination without perfect info.
• Regulatory interventions differ:
  • Antitrust (Sherman Act) targets collusion/mergers (oligopoly).
  • Price caps or marginal‐cost pricing for natural monopolies.
  • Consumer protection laws for discriminatory pricing.
• Real‐world examples: airline dynamic pricing (2nd & 3rd degree), Amazon web services natural monopoly debate, OPEC cartel as oligopoly.

Key Equations & Reminders

• Profit: \pi = TR - TC.
• Marginal values: MR = \frac{dTR}{dQ},\; MC = \frac{dTC}{dQ}.
• Elasticity relation (monopoly): MR = P \left(1 - \frac{1}{|\varepsilon|}\right).
• Shutdown: produce if P \ge AVC (short run).
• DWL (linear): \text{Area} = \frac{1}{2}(PM - MC)(QE - Q_M).

Use these notes to replicate diagrams, solve numerical questions, and explain policy debates on market power and efficiency.