Monopoly, Monopolistic Competition and Oligopoly

Presented By:Aasim Mushtaq

Monopoly

Monopoly

1) One seller - many buyers

2) One product (no good substitutes)

3) Barriers to entry

Monopoly

The monopolist is the supply-side of the market and has complete control over the amount offered for sale.

Profits will be maximized at the level of output where marginal revenue equals marginal cost.

Characteristics of a Monopoly

Characteristics of monopolies are: Single seller but a large number of buyers Unique Product, i.e., there are no close substitutes Ability to Set Prices (monopolist is a price maker;

discriminating monopolists charge different prices to different classes of consumers)

Barriers to Entry (a monopoly generally has an economic, legal or technical barrier to entry to other firms)

Monopoly

A Rule of Thumb for PricingWe want to translate the condition that

marginal revenue should equal marginal cost into a rule of thumb that can be more easily applied in practice.

Sources of Monopoly Power

Why do some firm’s have considerable monopoly power, and others have little or none?

A firm’s monopoly power is determined by the firm’s elasticity of demand.

Sources of Monopoly Power

The firm’s elasticity of demand is determined by:1) Elasticity of market demand2) Number of firms3) The interaction among firms

The Monopolist’s TR, AR, and MR Curves

Since the monopolist is the only firm producing a product, the monopolist’s demand curve is precisely the same as the market demand curve. So, AR is the monopolist’s

demand curve And it is negatively sloped

Since AR is negatively sloped, AR & MR are not the same. MR is also negatively

sloped, and is twice as steep as the AR.

The Total Revenue curve is concave downward because the monopolist’s demand curve is downward sloping.

Q

P

MR AR

TR

The Monopolist’s Cost Curves

If the monopolist in the product market faces a perfectly competitive input market, then it can not affect input prices.

In that case, the concept of cost curves do not change.

The TC, TVC, TFC, ATC, AVC, AFC, and MC curves, therefore, are as discussed before for perfect competition.

Costs

Output

TOTAL COSTS

TC

TVC

TFC

ATC

AVCCost

s/unit

Output

AFC

MC

Profit Maximizing Output Decisionunder Monopoly in the Short-run

The Total Curves Approach

Profit maximization output decision rule for a monopolist depends on two considerations.

One, whether there is any output level at which TR exceeds the TVC. If not, the profit maximizing strategy is to shut down.

If there are output levels at which TR > TVC, the monopolist will produce where the vertical distance between TR and TC is at its maximum.

$TR

TC

TVC

Q

Profit Maximizing Output Decisionunder Monopoly in the Short-run

The Total Curves Approach

In this case, the vertical distance between TR and TC is at maximum at the Q* level of output.

Note that at Q* units of output, TR and TC curves have the same slope, i.e., MR = MC. (This is called the Necessary Condition of profit maximization)

Further, the slope of MC exceeds that of the MR (MC has a positive slope and MR has a negative slope). (This is called the Sufficient Condition of profit maximization)

$TR

TC

TVC

QQ*

Profit Maximizing Output Decisionunder Monopoly in the Short-run

The Average & Marginal Curves Approach

Again, the same decision rules should be considered.

Does the AR lie above the AVC in some output range? If not, the best strategy in the short-run is to shut down.If yes, the profit maximizing output is where MR=MC and the slope of the MC is greater than the slope of the MR.This is the Q* level of output.

$/unit

Q

MR

AR

Q*

MC

AC

AVC

Price Determination under Monopoly

After deciding that Q* is the profit maximizing level of output, the monopolist must decide the price at which the output is to be sold.

The monopolist will sell the output at the maximum price at which he can sell the output.That maximum price is the price that the consumers are willing to pay (derived from the demand/AR Curve) – that is P*

At that price of P*, note that profit per unit is BA dollars and the total economic profit received by the monopolist is P*ABC.

$/unit

Q

MR

AR

Q*

MC

AC

AVCP*

A

BC

A Mathematical Example

Suppose that the Monopolist’s TR and TC curves are given by:

TR = 50 Q – 4 Q2

TC = 10 Q What is the Profit Maximizing level of output?

Note that at the profit max level of output, MR must equal to MC (the Necessary Condition of profit maximization)MR = ∂TR/∂Q = 50 – 8QMC = ∂TC/∂Q = 10At MR = MC, 50 – 8Q = 108Q = 40 or Q = 5

Also note that at the profit max level of output, the slope of MC must exceed the slope of the MR (the Sufficient Condition of profit maximization)Slope of MR = ∂MR/∂Q = – 8Slope of MC = ∂MC/∂Q = 0Thus the Slope of MC > the slope of MR

A Mathematical Example

The Monopolist’s TR and TC curves are given by:

TR = 50 Q – 4 Q2

TC = 10 Q What is Equilibrium Price?

Note that TR = P*Q = 50Q - 4Q2

So, P = 50 – 4Q

Since Q = 5, then P = 50 – 20 = $30

What is the Profit? Note that Profit = TR – TC

TR = 50 (5) – 4 (5)2 = $150

TC = 10 (5) = $50

So, Profit = $150 - $50 = $100

Monopolistic Competition:Monopolistic competition is a market with the following characteristics: A large number of firms. Each firm produces a differentiated product. Firms compete on product quality, price, and marketing. Firms are free to enter and exit the industry.

Monopolistic Competition:

Large Number of FirmsThe presence of a large number of firms in the market implies: Each firm has only a small market share and therefore has limited market power to influence the price of its product. Each firm is sensitive to the average market price, but no firm pays attention to the actions of the other, and no one firm’s actions directly affect the actions of other firms.

Collusion, or conspiring to fix prices, is impossible.

Monopolistic Competition:

Product DifferentiationFirms in monopolistic competition practice product differentiation, which means that each firm makes a product that is slightly different from the products of competing firms.

Entry and ExitThere are no barriers to entry in monopolistic competition, so firms cannot earn an economic profit in the long run.

Oligopoly: few sellers either homogeneous or a

differential product difficult market entry