LECTURE 4 Monopoly and Monopolistic Competition

Lecture 4.
1: Chapter 8
Monopoly Markets
Learning Objectives
1. Define monopoly.
2. Explain three reasons why monopolies arise.
3. Explain how a monopoly determines price and
output.
4. Use a graph to illustrate how a monopoly affects
economic efficiency.
5. Discuss government policies towards monopolies.
6. Monopoly and Price discrimination
2
Is any firm ever really a monopoly?
Narrow definition of monopoly: A firm is the only

seller of a good or service which does not have a close
substitute. This implies that a monopoly can ignore the
actions of all other firms.
For example, the government water authority can ignore the
price of bottled water.
Broad definition of monopoly: This means that

other firms in the market are not close enough
substitutes to compete away economic profits in the
long run.
For example, the only pizza shop may have a monopoly,
although burgers may be a substitute.
3
Where do monopolies come from?

Monopolies emerge due to a lack of competition
created by barriers to entry.
Three reasons for high barriers to entry are:
1. Government blocks the entry of more than one firm into
a market.
2. One firm has control of a key raw material necessary to
produce a good.
3. Economies of scale are so large that one firm has a
natural monopoly.

1. Government blocks entry in three main ways:
i.
By
License
Association);
(e.g.
Taxis;
Australian
Medical
ii. By granting a patent or copyright to an individual

or firm, which gives the exclusive right to produce a
product or service for a period of time.
iii. By granting a firm a public franchise, which makes
it the exclusive legal provider of a good or service.
Example, Australia Post
5

2. Another way for a firm to become a monopoly is by
controlling a key resource.
Example
During the last century, De Beers owner 90 percent

of the worlds diamonds.
China owns 95 per cent of the worlds rare earth

metals which it has nationalised.
Firms use rare earth metals to produce 17 chemicals that
are used in the production of many goods including
mobile phones and laptops.
How does a monopoly choose price

and output?
Like every other firm, a monopoly maximises profit at
the output when marginal revenue equals marginal
cost (MR = MC).
However, the difference is that a monopolys demand
curve is the same as the demand curve for the product
(downward sloping).
How does a monopoly choose price

and output?
Monopoly is a price maker. It does not face a
horizontal demand curve.
In fact, both its demand curve and marginal
revenue curve are downward-sloping; and
Its marginal revenue curve is positioned below its
demand curve.
(dollars per subscription)
Price & marginal revenue
Demand and Marginal

Revenue
60
To sell more, the price

must be lowered. The
marginal revenue curve
will be below the demand
curve.
Total revenue
loss $4
c
50
48
Total revenue gain $48

Marginal revenue $ 44
44
MR
Quantity (subscriptions)
9
Profit-maximising quantity and price for a monopoly: Figure 8.3a

Price and cost
MC
$60
Profitmaximising
price
42
27
A
Demand
Profit-maximising quantity
10
MR
Quantity
Copyright 2013 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442558069/Hubbard and O'Brien/Essentials of Economics/2e
Profits for a monopoly: Figure 8.3b

Price and cost
MC
$60
Profit
ATC
Profitmaximising
price
42
30
A
Demand
Profit-maximising quantity
11
MR
Quantity
Does monopoly reduce economic

efficiency?
We know that equilibrium in a perfectly competitive
market results in the greatest amount of economic
surplus, or total benefit to society, from the
production of a good or service.
However, a monopoly will produce less and
charge a higher price than would a perfectly
competitive industry producing the same good.
12
What happens if a perfectly competitive industry

becomes a monopoly?: Figure 8.4
Price and
cost per
unit
If the industry is perfectly competitive, the

intersection of the demand and supply
curves determines equilibrium price and
quantity.
Price and
cost per
unit
Supply
3. and
charges a
higher price.
PC
1. If the industry
becomes a monopoly,
the supply curve
becomes the
monopolists marginal
cost curve.
2. The
monopolist
reduces
output to the
level where
MR = MC,
PM
PC
MR
Demand
0
QC
Quantity
(a) Perfect competition

13
MC
QM
QC
(b) Monopoly
Demand
Quantity
Does monopoly reduce economic

efficiency?
The effects of monopoly can be summarised as
follows:
1. Monopoly causes a reduction in consumer surplus.
2. Monopoly causes an increase in producer surplus.
3. Monopoly causes a deadweight loss, which
represents a reduction in economic efficiency;
allocative inefficiency occurs.
14
The inefficiency of a monopoly: Figure 8.5

Price and cost
Transfer of
consumer surplus to
monopoly
PM
PC
MC
Deadweight loss from a

monopoly (B + C)
B
C
MCM
Marginal cost of
the last unit
produced by the
monopoly
15
Demand
MR
0
QM
QC
Quantity
Gains from Monopoly

Market power and technological change
16
Market power: The ability of a firm to charge a

price greater than marginal cost.
The introduction of new products requires firms

to spend funds on research and development.
Because firms with market power are more likely

to earn economic profits, they are also more
likely to introduce new products.
Government Policy
Toward
Monopoly
17
Government policy toward monopoly

Collusion: An agreement among firms to charge
the same price, or to otherwise not compete.
In Australia, trade practices laws are used to deal
with monopolies, collusion and other forms of anticompetitive behaviour.
The laws usually make it illegal for large firms with
market power to collude, and firms wishing to
merge or take over another firm must apply for
permission to do so.
18

In Australia, competitive behaviour is monitored by
the Australian Competition and Consumer
Commission (ACCC).
The major regulatory law regarding trade practices
is the Competition and Consumer Act 2010. It
covers the following seven key areas:
Anti-competitive agreements, such as price fixing.
Exclusive dealing, such as: (i) market sharing
arrangements; and (ii) third line forcing.
19
20
Misuse of market power, such as predatory pricing.
Boycotts, such as an agreement between some

suppliers and purchasers not to supply to, or
purchase from, a particular firm or competitor.
Resale price maintenance.
Unconscionable and misleading conduct, such as

deceiving people into signing contracts that they do
not understand.
Product safety and reliability.
Monopoly
&
Price Discrimination
21
Monopoly & Price Discrimination

Price
discrimination:
Charging
different
customers different prices for the same product
when the price differences are not due to
differences in production costs.
22
Price discrimination
There are three requirements for successful
price discrimination:
1.A firm must possess market power.
2.The firm must know what different consumers are
willing to pay.
3.The firm must be able to divide (segment) the
market for the product, and prevent resale between
these segments.
23
Price discrimination by a cinema: Figure 8A.1
24
Airlines: The kings of price discrimination
Business travellersmore price inelastic
Holiday travellersmore price elastic
Day and time
Season
Price
Discrimination
Economy,
business and first class
25
Yield management: Continually adjusting prices to

take into account fluctuations in demand.
Perfect price discrimination: This occurs when

each consumer has to pay a price equal to the
consumers maximum willingness to pay (no
consumer surplus).
Price Discrimination
Two key outcomes of price discrimination are:
26
Firm profits increase
Consumer surplus decreases
Perfect price discrimination: Figure 8A.2
27
Lecture 4.2: Chapter

9
Monopolistic
Competition
PowerPoint to accompany:
Learning Objectives
1. Explain why a monopolistically competitive firm has
downward-sloping demand and marginal revenue
curves.
2. Explain how a monopolistically competitive firm
maximises profit in the short run.
3. Analyse the situation of a monopolistically
competitive firm in the long run.
4. Compare the efficiency of monopolistic competition
and perfect competition.
29
Monopolistic competition: A market structure in

which barriers to entry are low, and many firms
compete by selling similar, but not identical,
products.
Differentiated products
Positive economic profit in the short run
30
Starbucks: Growth through product

differentiationdecline through
competition
Starbucks has been competing
in a highly contested market for
over three decades, but was
able to maintain profits and
expand its operation across the
globe thanks to successful
differentiation strategy. It is
only recently that Starbucks ran
into trouble, with its strategy no
longer successful in all markets.
31
Demand and revenue at a Starbucks coffee house: Table 9.1
32
The demand and marginal revenue curves for a

monopolistically competitive firm: Figure 9.3
Price
Demand
0
33
MR
Quantity
Demand and marginal revenue for a

firm in a monopolistically competitive
market
Marginal revenue for a firm with a downwardsloping demand curve
Every firm that has the ability to affect the price of
the good or service it sells will have a marginal
revenue curve that is below its demand curve.
34
How a monopolistically competitive firm

maximises profits in the short run
Another way to calculate profit is using the following
formula:
Profit = (P - ATC) x Q
where P is price, ATC is average total cost and Q is
quantity traded.
Note: P - ATC provides profit per unit.
Remember: Profit is maximised or loss is minimised
when MR = MC.
35
How a monopolistically competitive firm

maximises profits in the short run
To maximise profit, the Starbucks coffee house wants to

sell caffe lattes up to the point where the marginal
revenue from selling the last caffe latte is just equal to
the marginal cost.
As the information in the table in the textbook shows,

this happens with the fifth caffe latte A which adds
$1.50 to the firms costs and $1.50 to its revenues. The
firm then uses the demand curve to find the price that
will lead consumers to buy this quantity of caffe lattes
(point B).
36
Maximising profit in a monopolistically competitive market:

Price (dollars per
cup)
$6.00
Starbucks Short-run
profit equals $1 5 =
$5.00. (i.e. (P-ATC) x
Q)
MC
ATC
3.50
Profit
2.50
A
Demand
0
37
MR
Quantity (cups per week)
What happens to profits in the long

run?
How does entry of new firms affect the profits of
existing firms?
Entry of new firms will shift the existing firms
demand curve to the left.
The firm will sell fewer products at every price.
The demand curve will also become more price
elastic.
38
A monopolistic competitor may earn a short-run

profit: Figure 9.5a
Price (dollars
per cup)
MC
Short-run profit
P(Short run)
0
39
ATC
MR(Short run)
Q (Short run)
Demand(Short run)
A monopolistic competitors profits are

eliminated in the long run: Figure 9.5b
Price (dollars
per cup)
MC
ATC
A
P(Short run)
P(Long run)
0
40
B
MR(Short run)
MR(Long run)
Q(Long run) Q(Short run)
Demand(Short run)
Demand(Long run)
What happens to profits in the long

run?
Is zero economic profit inevitable in the long run?
Relatively easy entry into the market causes the
disappearance of economic profits in the long run.
Exception: If a firm finds new ways of differentiating
its product or finds new ways of lowering the cost of
producing its product, it can maintain economic profits,
even in the long run.
41
Comparing perfect competition and

monopolistic competition
There are two important differences between long-run
equilibrium in the two markets.
1. Monopolistically competitive firms charge a price
greater than marginal cost.
2. Monopolistically competitive firms do not
produce at minimum average total cost.
42

Excess capacity under monopolistic competition
As a monopolistically competitive firm produces at P
> minimum ATC, the firm has excess capacity; if it
increased its output it could produce at a lower
average cost.
43
Comparing long-run equilibrium under perfect competition

and monopolistic competition: Figure 9.6
Price
and cost
MC
ATC
P = MC
D=MR
Quantity
QPC
(Productively efficient)

44
Comparing long-run equilibrium under perfect competition

and monopolistic competition: Figure 9.6
Price
and cost
Price
and cost
MC
MC
ATC
ATC
P
P = MC
D=MR
MC
D
MR
0
Quantity
QPC
(Productively efficient)

45
QMC
QPC
Quantity
Excess capacity
(b) Monopolistic competition

Is monopolistic competition inefficient?
Monopolistic competition is inefficient in terms of

allocative and productive efficiency.
However, it is likely to be more efficient in terms of
dynamic efficiency.
How consumers benefit from monopolistic competition.
From being able to purchase a product that is

differentiated and more closely suited to their tastes.
That is, consumers enjoy product variety.
46

LECTURE 4 Monopoly and Monopolistic Competition

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Lecture 4.

Is any firm ever really a monopoly?

Narrow definition of monopoly: A firm is the only

Broad definition of monopoly: This means that

Where do monopolies come from?

Where do monopolies come from?

ii. By granting a patent or copyright to an individual

Where do monopolies come from?

During the last century, De Beers owner 90 percent

China owns 95 per cent of the worlds rare earth

How does a monopoly choose price

How does a monopoly choose price

(dollars per subscription)

Price & marginal revenue

Demand and Marginal

To sell more, the price

Total revenue gain $48

Profit-maximising quantity and price for a monopoly: Figure 8.3a

Profits for a monopoly: Figure 8.3b

Does monopoly reduce economic

What happens if a perfectly competitive industry

If the industry is perfectly competitive, the

(a) Perfect competition

Does monopoly reduce economic

The inefficiency of a monopoly: Figure 8.5

Deadweight loss from a

Gains from Monopoly

Market power: The ability of a firm to charge a

The introduction of new products requires firms

Because firms with market power are more likely

Government policy toward monopoly

Government policy toward monopoly

Government policy toward monopoly

Misuse of market power, such as predatory pricing.

Boycotts, such as an agreement between some

Resale price maintenance.

Unconscionable and misleading conduct, such as

Product safety and reliability.

Monopoly & Price Discrimination

Price discrimination by a cinema: Figure 8A.1

Airlines: The kings of price discrimination

Business travellersmore price inelastic

Holiday travellersmore price elastic

Day and time

Yield management: Continually adjusting prices to

Perfect price discrimination: This occurs when

Two key outcomes of price discrimination are:

Firm profits increase

Consumer surplus decreases

Perfect price discrimination: Figure 8A.2

Lecture 4.2: Chapter

Monopolistic competition: A market structure in

Starbucks: Growth through product

Demand and revenue at a Starbucks coffee house: Table 9.1

The demand and marginal revenue curves for a

Demand and marginal revenue for a

How a monopolistically competitive firm

How a monopolistically competitive firm

To maximise profit, the Starbucks coffee house wants to

As the information in the table in the textbook shows,

Maximising profit in a monopolistically competitive market:

Quantity (cups per week)

What happens to profits in the long

A monopolistic competitor may earn a short-run