Chapter7 Slides

Part III Imperfectly Compe00ve Markets

© Playconomics, LHS 1

Imperfect vs. Perfect

Im-‐perfect = Perfect except that one or more of the following assump?ons apply: •  Consumers/suppliers are price-‐takers, or •  Goods are homogeneous, or •  There externali?es, or •  Goods are excludable and rival, or

(not full) informa?on, or free entry and exit.


Imperfect vs. Perfect

Im-‐perfect = Perfect except that: •  Consumers/suppliers are NOT price-‐takers, •  Goods are NOT homogeneous, or •  There ARE externali?es, or •  Goods are NOT excludable and rival, or •  Imperfect (not full) informa?on, or •  NO free entry and exit.


Market Power

Defini0on: A firm is said to be a Price-‐Maker (or Price-‐SeJer) if it has the ability to set its own prices. A firm has Market Power if it has the ability to set its own price.


Market Power


Types of Market Power

: Only one firm in the market (à the firm’s individual D curve = market D curve!)

: There is a large number of firms, each producing slightly differen?ated goods (almost perfect subs?tutes).

: There is a small number of firms selling goods that are close subs?tutes.


An?dote to Market Power

Free Entry / Exit!

Otherwise, : Over

Barriers to Entry


Increasing Returns to Scale (IRS)

Defini0on: We say that there are Increasing Returns to Scale (Economies of Scale) when the average cost of producing a certain good decreases with the amount of the good produced.



à Firms experiencing IRS become more profitable with size à  A single firm producing a large quan?ty of the good can do so more efficiently than a large number of firms each producing small quan??es.

Natural Monopoly!



Defini0on: A Natural Monopoly denotes a monopoly that occurs because of increasing returns to scale.


Chapter 7: Market Power Monopoly


Market Power: Monopoly

Defini0on: Monopoly is a market structure where there is only one firm opera?ng in the market.





MR=P=const

(MR=)D is downward-‐sloping



MR=ΔR/ΔQ= =(400*.65-‐200*.85)/(400-‐200)

= $0.45



MR=MC © Playconomics, LHS 16

Monopoly and the Invisible Hand

Socially op0mal monopolist op0mal



To sell the extra units of the good and adract new consumers, the monopolist needs to ê P à affects all units sold (because the monopolist needs to charge all consumers the same price) à implicit cost in é Q sold à

Q*monopoly < Q*socially




Government Regula?on

Compe00on Law: Compe00on Law denotes a law that is intended to foster market compe??on by regula?ng the an?-‐compe??ve conduct of firms.

ensures that consumers are charged the lowest possible prices



Average Cost Pricing (esp. for natural monopolies): The Average Cost Pricing denotes a policy through which the government forces the monopolist to set the price and quan?ty at the intersec?on of the ATC curve and demand curve.

eliminates any posi?ve profit accrued to the monopolist



The Average Cost Pricing is hard to implement: (it can

only es?mate them) •  once implemented,

to lower their costs •  when implemented, the

alloca0vely inefficient.



Defini0on: A firm’s output is said to be Alloca0vely Inefficient if the price asked for the goods produced exceeds their marginal cost.

Set Price Ceiling at MC à But in same cases , the industry collapses!


First Degree Price Discrimina?on What if the monopolist could set a different

price for different consumers?

Assume that the monopolist -‐  knows the maximum price (or reserva?on

price) that every consumer is willing to pay AND

-‐  can charge each consumer exactly his reserva?on price.


First Degree Price Discrimina?on

Defini0on: First Degree Price Discrimina0on describes a situa?on in which the monopolist knows the reserva?on price of each consumer and is able to charge each consumer his marginal benefit (or reserva?on price).



(selling more in Country A does not require the monopolist to ê P in other countries)



A monopolist engaging in 1st degree price discrimina?on is actually selling the socially op?mal quan?ty (that max. social surplus)!

BUT uneven :

The monopolist extracts all surplus from the consumers (i.e., it accrued all the surplus

available in the market).


Other Forms of Price Discrimina?on

•  Second degree price discrimina0on: the monopolist charges

by each consumer (bulk discount, economy/business airfare, etc).

•  Third degree price discrimina0on: the monopolist charges

such as loca?on (European vs. Australia as 2 # mkts)


Third Degree Price Discrimina?on






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