JD

Perfect Competition and Monopoly

Outline of Lecture

  • Perfect Competition

    • Perfect Competition as a Price taker

    • Profit maximising output

    • Short-run equilibrium

    • Long-run equilibrium

  • Monopoly

    • How monopoly arises

    • Single price monopolist output and price decision

    • Monopoly compared with Perfect Competition

    • Price discrimination

Perfect Competition

True or False Questions

  • A firm should close down if it is making losses. (False)

  • A firm maximises profit if it is producing at its minimum ATC. (False)

Market Structures

  • Four types:

    • Perfect competition

    • Monopoly

    • Monopolistic competition

    • Oligopoly

  • Perfect competition → Monopolistic competition → Oligopoly → Monopoly (Continuum from more to less competition and less to more concentration)

  • Perfect Competition:

    • Many sellers

    • Homogeneous product

    • No barriers to entry

    • Examples: None

  • Monopolistic Competition:

    • Many sellers

    • Differentiated product

    • No barriers to entry

    • Examples: Most retails & restaurants

  • Oligopoly:

    • Few sellers

    • Homogeneous or Differentiated product

    • May be considerable barriers to entry

    • Examples: Most manufacturing sectors

  • Monopoly:

    • One seller

    • No close substitutes

    • Yes, barriers to entry

    • Examples: Some public utilities

Perfect Competition (PC)

  • Price taker

    • The PC firm is a price taker and cannot influence the price of the good or service that it produces.

    • In Perfect Competition, marginal revenue = price (MR = P)

Perfect Competition (PC) - Determining Profit-Maximising Output

  • Two methods to determine Profit-maximising output

    • Total revenue minus Total cost (TR – TC)

    • Marginal analysis (MR = MC) (Focus on this)

Perfect Competition (PC) - Marginal Analysis Cases

  • What is the firm’s profit maximising output if the market price is:

    • Case 1: $8?

    • Case 2: $4?

    • Case 3: $2?

  • Profit maximising condition: MR = MC

  • Case 1: If P = $8

    • If MR > MC ? Increase output

    • If MR < MC? Reduce output

    • profit maximising output is 10.

Perfect Competition (PC) - If MR > MC

  • At Q=9, MR=8 is greater than MC=4.

  • The firm should increase output.

Perfect Competition (PC) - If MR < MC

  • At Q=11, MR=8 is less than MC=9.

  • The firm should reduce output.

Perfect Competition (PC) - Economic Profit in Diagram

  • Need ATC

  • ATC = {TC}{Q}

  • TR = $80

  • TC = $51

  • Profit = $80 – $51 = $29

Perfect Competition (PC) - Case 2: P = $4

  • P < ATC and firm is making losses.

  • If P = $4 (MR = MC = 4), Q = 9

Perfect Competition (PC) - Numerical Justification

  • If firm shuts down, it faces a loss equivalent to TFC =$15 per day.

  • If it continues to produce at P=$4 and Q=9, then:

    • TR = 4
      eq 9 = 36

    • TC = 4.9
      eq 9 = 44

    • It faces a loss of 36 - 44 = $8 per day.

Perfect Competition (PC) - Note

  • So, TR=36 can cover its TVC=29, and part of TFC=15.

  • Loss = 36 – 44 = $8 per day.

  • But the firm should continue to operate as long as it can cover the variable costs and recover part of its fixed costs.

Perfect Competition (PC) - AVC

  • We verify this by looking at AVC.

  • As long as P > AVC, the firm can continue to minimise losses.

Perfect Competition (PC) - Shutdown case: P = $2

  • Case 3: If P = $2 (MR = MC = 2)

    • Q = 7

    • P < min AVC

    • The firm should shutdown as the firm cannot cover the variable costs and recover its fixed costs.

    • If firm produces,

      • TR = 2
        eq 7=$14

      • TC = $36

      • Loss = $22

    • If firm shuts down, it will face TFC=$15

Perfect Competition (PC) - Firm's Supply Curve

  • Firm’s supply curve is the same as the MC curve at prices above the minimum point of AVC.

Perfect Competition (PC) - Short Run Market Equilibrium

  • Economic profits

Perfect Competition (PC) - Long Run Market Equilibrium

  • Normal or Zero-economic profits

Perfect Competition (PC) - Short Run Market Equilibrium

  • Economic loss

Perfect Competition (PC) - Long Run Market Equilibrium

  • Normal or Zero-economic profits

  • But why do some firms leave and others don’t?

Perfect Competition (PC) - Efficiency

  • Why Perfect Competition is the Perfect market and efficient.

Testing Your Understanding

  • Consider a coffee producer currently producing 6 tons of coffee per month. The ATC is $10 and rising; the selling price is constant at $12. If the MC of coffee is (a) $11 (b) $13 should you increase/decrease output?

Testing Your Understanding - Solution

  • Current output = 6, P = $12 and ATC is $10 and rising

  • (a) If MC = $11 < MR = $12: increase output

  • (b) If MC = $13 > MR = $12: decrease output

Monopoly

Market Structures

  • Four types:

    • Perfect competition

    • Monopoly

    • Monopolistic competition

    • Oligopoly

  • Perfect competition → Monopolistic competition → Oligopoly → Monopoly (Continuum from more to less competition and less to more concentration)

    • Perfect Competition:

      • Many sellers

      • Homogeneous product

      • No barriers to entry

      • Examples: None

    • Monopolistic Competition:

      • Many sellers

      • Differentiated product

      • No barriers to entry

      • Examples: Most retails & restaurants

    • Oligopoly:

      • Few sellers

      • Homogeneous or Differentiated product

      • May be considerable barriers to entry

      • Examples: Most manufacturing sectors

    • Monopoly:

      • One seller

      • No close substitutes

      • Yes, barriers to entry

      • Examples: Some public utilities

Monopoly - How Monopoly Arises

  • No close substitutes

  • Barriers to entry

    • Natural

      • Economies of Scale (i.e., natural monopoly)

    • Ownership

      • Control of a scarce input (e.g., Previously, DeBeers diamond syndicate controlled supply of highest quality diamonds in the world).

    • Legal

      • Govt franchises/licenses (Utilities; Casinos)

      • Patents

Single Price Monopolist Output and Price Decision

  • Suppose you own the only tree nursery in town.

  • Given the D for and MC of operating the nursery, what are your profit maximisation output & price?

Single Price Monopolist Output and Price Decision - Profit Maximization Condition

  • Profit maximization condition? MR=MC

  • As we have MC, we now need to calculate MR

Single Price Monopolist Output and Price Decision - Demand and MR

  • Illustrating demand and MR in a diagram

Single Price Monopolist Output and Price Decision - MR = MC

  • Where MR=MC,

  • profit maximizing price and output are

Single Price Monopolist Output and Price Decision - Economic Profit

  • If we include a hypothetical ATC, we can illustrate the economic profit as shown in the shaded green area.

Monopoly and Perfect Competition

  • Suppose in the long run, firms under PC sell at price Pc.

  • Consumer surplus and producer surplus are maximised.

Monopoly and Perfect Competition - Merged Firms

  • Suppose now all firms decide to merge and monopolised by one producer.

  • Underproduction creates a deadweight loss.

  • Consumer surplus shrinks while producer surplus expands.

Price Discrimination

Monopoly - Economic Profit

  • Suppose a single-price monopolist makes an economic profit of $4.8 million.

Monopoly - Increasing Profit

  • After taking EFB231, the owner of an airline ponders … How can I increase my profit? Maybe I can capture the consumer surplus using Price Discrimination.

Monopoly - Discriminating Among Groups

  • Discriminating among groups of buyers

  • This type of price discrimination works when each group has a different average willingness to pay for the good or service.

Monopoly - Key Idea Behind Price Discrimination

  • The key idea behind price discrimination is to convert consumer surplus into economic profit.

    • Discriminating among groups of buyers

      • The firm offers different prices to different types of buyers, based on things like age, employment status or some other easily distinguished characteristic.

      • Example: Airfares, cinema tickets, public transport

    • Discriminating among/between units of a Good

      • The firm charges the same prices to all its customers but offers a lower price per unit for a larger number of units bought.

      • Example: Toilet rolls, fresh milk (1L, 2L)

Between-Group Price Discrimination Study

  • A study on between-group price discrimination

  • Puller, S.L., Taylor, L.M., 2012. Price discrimination by day-of-week of purchase: Evidence from the U.S. airline industry. Journal of Economic Behavior & Organization. 84:801-812.

    • Setting:

      • Compared tickets on the same airline and route that are purchased on different days of the week.

    • Considerations: day of week of travel, the ticket restrictions, the demand characteristics of the flights and the number of days in advance that the ticket is purchased.

    • Findings:

      • That fares are 5% lower when purchased on the weekend.

      • That weekend purchasers are more likely to be price-elastic leisure travelers.

Discrimination Between Two Types of Travelers

  • Consider two groups: Business travelers and leisure travelers

  • No price discrimination

Discrimination Between Two Types of Travelers - With Price Discrimination

  • With price discrimination

Discrimination Between Two Types of Travelers - Profit Increase

  • By equalising MR (for each group) to MC, profit can be increased.

    • With price discrimination:

      1. Business travellers:

        • TR = P
          eq Q = 180
          eq 100 = $18,000

        • TC = ATC
          eq Q = 70
          eq 100 = $7,000

        • Profit = TR - TC = $11,000

      2. Leisure travellers:

        • TR = P
          eq Q = 140
          eq 100 = $14,000

        • TC = ATC
          eq Q = 70
          eq 100 = $7,000

        • Profit = TR - TC = $7,000

      3. Total profit = $11,000 + $7,000 = $18,000

    • Without price discrimination: (150
      eq 200) - (70
      eq 200) = $16,000

Review of Today’s Lecture

  • Perfect Competition

    • Perfect Competition as a Price taker

    • Profit maximising output

    • Short-run equilibrium

    • Long-run equilibrium

  • Monopoly

    • How monopoly arises

    • Single price monopolist output and price decision

    • Monopoly compared with Perfect Competition

    • Price discrimination