Imperfect Competition and Monopolies

Unit 4: Imperfect Competition

• Focus on monopolies as a primary example of imperfect competition.
• Characteristics include a single firm dominating the market.
• Key metrics include the following:
  • Market share: 60%
  • Firms: 1

Drawing Monopolies

• Monopolies can be illustrated with a single graph representing the firm as the industry.
• Important points:
  • Firm's cost curves are identical to those in perfect competition.
  • Marginal revenue (MR) equals marginal cost (MC) for profit maximization.
  • The shut down rule also applies, meaning firms will cease production when the cost exceeds revenue.

Key Differences in Monopolies

• Monopolies operate under a downward sloping demand curve.
• To increase sales, firms lower prices, which affects marginal revenue.
• Result: MR does not equal price (
  MR \neq P ).

Calculating Marginal Revenue

• For example, the relationship between price, quantity demanded, total revenue, and marginal revenue is illustrated as follows:
  • Price: $6, Quantity Demanded: 0, Total Revenue: 0, Marginal Revenue: -
  • Price: $5, Quantity: 1, Total Revenue: 5, Marginal Revenue: 5
  • Price drop results in a decrease of MR as price goes down; thus, MR \neq P holds.

Demand and Revenue Curves

• Total Revenue (TR) reaches a peak when MR hits zero.
• To maximize profit, firms must understand elasticity:
  • Elastic demand: Price falls, TR increases.
  • Inelastic demand: Price falls, TR decreases.
  • Monopolies operate where demand is elastic, maximizing revenue.

Maximizing Profit

• Monopolists operate where MR equals MC to determine the optimal output. Example given shows profit calculation:
  • At the optimal output point, the profit is calculated as total revenue minus total cost ($6 profit for the given example).

Efficiency of Monopolies

• Monopolies are considered inefficient because they:
  1. Charge higher prices to consumers.
  2. Produce less output than what would be socially optimal.
  3. Result in higher production costs compared to perfect competition.
  4. Lack incentives to innovate due to reduced competitive pressure.

Comparison: Monopolies vs. Perfect Competition

• In perfect competition, consumer surplus (CS) and producer surplus (PS) are maximized.
• Monopolists produce at a quantity less than the social optimum, leading to deadweight loss and reduced overall surplus.

Regulation of Monopolies

• Government can intervene with price ceilings to achieve social optimal price (P = MC) or fair-return pricing (P = ATC).

Price Discrimination

• Monopolies may practice price discrimination to charge different prices based on willingness to pay.
• Requires: monopoly power, market segmentation, and prevention of resale.
• In a price discriminating monopoly, MR = D , indicating different prices can lead to higher profits.

Characteristics of Monopolistic Competition

• Many sellers with differentiated products.
• Some price control with easy market entry and exit.
• Firms must compete on other factors, like advertising, leading to non-price competition.

Overview of Oligopoly

• Comprised of a few large firms, with high barriers to entry.
• Firms are price makers and often engage in strategic interactions (Kinked Demand Curve).
• Collusion among firms can result in behavior similar to monopolies.
• Non-colluding firms may react to price changes, impacting demand curves accordingly.

Elements of Strategic Behavior in Oligopoly

• Dominant strategy: best response irrespective of others' actions.
• Payoff matrices illustrate the interdependence of firm actions in an oligopolistic market.