ECONOMICS 103
Topic 8: Imperfect Competition
• Single price monopoly.• Monopolistic competition.
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Principles of Microeconomics
• Thus far, all firms have been price takers.- Markets are characterized by many, many sellers.- Any individual seller is too small to influence the market price.- Price determined by S and D; firm chooses whether or not and
how much to produce, given that price.• All implies that MR = P for competitive firms.
- Same thing as saying that the demand for any individual firm’s output is perfectly elastic at the market price.
• We want to contrast this with the opposite extreme: monopoly.
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Principles of Microeconomics
COMPETITIVE MARKETS V MONOPOLY
• In our final Topic 103, we will look at simplest case of monopoly behaviour: - Single price monopolist; seller charges same P to all
customers.• We want to understand two things:
- MR < P for single-price monopolist.‣ Means there will be a DWL due to monopoly power.
- Barriers to entry mean that Π > 0 can prevail in LR monopoly.• Only thing we need to understand that is new here is that the D
curve for a monopolist’s output is the market demand curve, which is downward sloping.- This is what results in MR < P, which drives everything else.
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Principles of Microeconomics
MONOPOLY
• Recall that MR = P for a perfectly competitive firm.
• Can sell as much as it wants at market price P.
• Selling one extra unit of q yields P in extra revenue.
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MR FOR A COMPETITIVE FIRMPrinciples of Microeconomics
• Means that the demand curve for a single competitive firm’s output is perfectly elastic at the prevailing market price.
• True because any given firm is only a small, small part of the market.• This is not true for the monopolist: the monopolist is the market,
on the selling side, at least.
q
MR = P
q1 q1 + 1
• The demand curve for the monopolist’s output is the market demand curve.
• This means that, to sell one more unit, it must ↓ P to all buyers.
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MR FOR A MONOPOLISTPrinciples of Microeconomics
• Selling one extra unit has a gain and a loss.- Gain = P2: extra unit sold at new lower price
‣ Gain = area A.- Loss = ∆P × Q1: units that used to sell at P1 now sell at P2.
‣ Loss = area B.• MR = A - B = P2 - (∆P × Q1) < P1.
Q
D
P1
Q1 Q1 + 1
P2
A
B
• Note: MR could be > 0 or < 0, depending on region of D.
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MONOPOLY MRPrinciples of Microeconomics
• Selling one extra unit has a gain and a loss.- Gain = P2: extra unit sold at new lower price
‣ Gain = area A.- Loss = ∆P × Q1: units that used to sell at P1 now sell at P2.
‣ Loss = area B.• MR = A - B = P2 - (∆P × Q1) < P1.
Q
P1
Q1 Q1 + 1
P2
A
B• High up the D curve, A > B ⇒ MR > 0.
• Note: MR could be > 0 or < 0, depending on region of D.
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MONOPOLY MRPrinciples of Microeconomics
• We know linear D has ePD > 1 along “top half.”- Tells us that ↓P ⇒ ↑TR ⇒ MR > 0.
• We know linear D has ePD < 1 along “bottom half.”- Tells us that ↓P ⇒ ↓TR ⇒ MR < 0.
• And, linear D has ePD = 1 halfway ⇒ MR = 0 halfway down D.
Q
D
P1
Q1 Q1 + 1
P2A
B
• Low down the D curve, A < B ⇒ MR < 0.• High up the D curve, A > B ⇒ MR > 0.
• All depends on ePD.
• Along top half of D, ePD > 1, so ↑Q ⇒ ↑TR.• ⇒ MR > 0.
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MONOPOLY MR Principles of Microeconomics
Q
D
$
Q
$
PMAX
QMAX
QMAX(QMAX)/2
(QMAX)/2
(PMAX)/2
TR (Q)
• Halfway down D, MR = 0.
↑Q ⇒↑TR ⇒MR >0
↑Q ⇒↓TR ⇒MR <0
• Along bottom half of D, ePD < 1, so ↑Q ⇒ ↓TR.
• ⇒ MR < 0.
P(Q)1
Q1
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MONOPOLY MRPrinciples of Microeconomics
Q
MR
• We want to draw MR curve, which shows MR for all possible levels of Q.
• Tells us that MR curve must lie below D curve.
MR(Q)1
• Recall: we read P off the D curve.
$
• And we deduced that, at any Q, MR < P.
D
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MONOPOLY MRPrinciples of Microeconomics
Q
Pmax
Qmax2
Qmax
Marginal Revenue
ePD = 1
ePD > 1
MR = 0
MR > 0 ePD > 1
MR < 0
• So MR curve lies below D since MR < P.
• Once you understand that MR < P for monopolist, rest is easy.- Profit max ⇒ monopolist chooses Q s.t. MR = MC.
‣ Same as for a competitive firm.- But for monopolist, MR < P ⇒ MC < P.
‣ P > MC so monopolist does not max mkt surplus.
• For linear D:- MR > 0 over top half; and- MR < 0 over bottom half.
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MONOPOLY Principles of Microeconomics
Q
MR
D
• Π max ⇒ choose Q s.t. MR = MC- Q = QM.
• Recall that consumers’ MB = P, and P > MR = MC.- So at monopoly equilibrium we have MB > MC.- Market surplus is not maximized!
• What P will monopolist charge?- The highest it can, given D curve.
- P = PM.QM
PM
MC
MB > MC
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MONOPOLY Principles of Microeconomics
Q
MR
D
• Note: comp mkt would produce where MB = MC. i.e., comp mkt would produce QC units.
• Why not? Because in order to sell those units, monopolist would have to lower P to all consumers, and doing so would ↓ Π.
• In comp mkts, Π max behaviour ⇒ mkt surplus is maximized.• With single price monopoly, ∏ max behaviour ⇒ mkt surplus is
not maximized.
• TB of those units > TC of those units.
QM
PM
MC
• For each Q from QM to QC, MB > MC.
• Those units could generate mkt surplus > 0, but they don’t get produced and sold.QC
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MONOPOLY Principles of Microeconomics
Q
MR
D
• Note: comp mkt would produce QC units, monopolist produces QM.
• Then area A = DWL due to the monopoly.• Area A = extent to which SS falls short of what it could be.
- DWL always = unrealized SS.• Competitive markets would take us to QC, so A = measure of
loss to society from having monopoly relative to competition.
• Assume mkt surplus = SS.
QM
PM
MC
- That is, assume no externalities.
QC
A
• Note carefully the source of the DWL: it arises because monopolist must lower its price to sell more output.- We have constrained the monopolist to charge all customers
same price for its output.- That’s what a single price monopolist is.
• What if monopolist could charge different customers different prices for the same product?- We observe this often, in many markets.‣ Movie tickets, plane tickets, software, etc.
• This is known as price discrimination.- Covered in later micro classes like 203 and 313.
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Principles of MicroeconomicsMONOPOLY
• Back to the problem of the single P monopolist.- P > MC ⇒ DWL.
• If we cannot somehow “make” the market competitive (more on this shortly), what govt policies can help correct mkt failure?
• Recall the problem is that QM is too low, so we don’t want to use any policy instrument that reduces Q.- Taxes, quotas, etc are all inappropriate.
• How might we get Q to increase in monopoly markets?- Subsidize monopolists output (distributionally “interesting”....).- Regulate prices: specifically, mandate that P = MC.
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Principles of Microeconomics
CORRECTING MKT FAILURE.
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PRICE REGULATION Principles of Microeconomics
Q
MR
D
• Set price ceiling = PC.• Now for any Q < QC, MR = PC.
• We want to see that price ceiling can now increase Q .
• Opposite effect to price ceiling in competitive market.
PC
• It does so by changing the relationship between MR and P.
QC
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PRICE REGULATION Principles of Microeconomics
Q
MR<P
D
• D and MR are now as shown above.
PC
QC
D: MR=P
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PRICE REGULATION Principles of Microeconomics
Q
MR<P
D
• MR = MC now at QC.• As long as PC > ATC at QC, monopolist will maximize profits by
producing QC and charging P = PC.
PC
QC
MR=P
QC
MCATC
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PRICE REGULATION Principles of Microeconomics
Q
MR
D
• Without actual competition - potential for entry and exit - we don’t get the same outcome in the LR as under perf comp.- We don’t get to ATC min.- Even with P regulation, monopoly markets are “too small.”
‣ We want to be at min of ATC, with more firms in industry.
• Set price ceiling at PC.• As long as PC > ATC, we get to QC.
QM
PM
MCATC
PC
QC
• Looks like we might have replicated outcome of competitive mkt, but....
• So far, we have just assumed the existence of monopolist.• Need to ask why monopoly would survive in a mkt economy.• Monopoly profits should attract entry, just as in comp mkts.• So there must be barriers to entry, if we see monopoly persist.• Different types of barriers to entry:
- Collusive barriers (these are illegal, btw)- Legal barriers, such as patents.- Technological barriers.
• Text book talks about some of these. Read if you are interested, but won’t be on the final exam.
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Principles of Microeconomics
WHY MONOPOLY?
• So far we have looked at two extremes: - Perfectly competitive mkts.- Monopoly markets.
• Real world markets are often in between.• Lots and lots of econ models looking at in-between cases:
- Take more econ courses!• We will look briefly at just one approach to the in-betweens.
- A discussion of the model of monopolistic competition.- As the name suggests, this model assumes some aspects of
monopoly and some of perfect competition.
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Principles of Microeconomics
MARKET STRUCTURE
• In competitive markets we assume identical products.- Many products are not really identical.
• Monopolistic comp assumes that each firm produces goods that are in many ways similar, but not identical:- Substitutes, but not perfectly so; differentiated products.
• Example: smartphones:- Samsung phone not identical to an iPhone, but both are phones.- My decision to buy one over the other depends on price of each,
as well as each phone’s own unique attributes.- If something happens to make one cheaper relative to the other,
some - but not all - consumers will switch.• Means that there is a unique D curve for each product, but there is
an interdependence among those D curves.22
Principles of Microeconomics
MONOPOLISTIC COMPETITION
• Understanding interdependence among demand curves is key.• First, realize that differentiated products means that each monop.
comp. firm faces a downward sloping D curve for its output.• Suppose 2 sellers of differentiated products in a monopolistically
competitive market.- If firm 2 lowers its price, D for firm 1’s output will
decrease.- If firm 2 increases its price, D for firm 1’s output will
increase.- If a third firm enters the market, D for both firm 1 and firm
2’s output will decrease.• Understand the above, add it to the basic monopoly model, assume
free entry, and you’ve got monopolistic competition.23
Principles of Microeconomics
MONOPOLISTIC COMPETITION
• Monop. comp. is more or less like monop., but with free entry of sellers whose output is similar, but not identical to, existing firms.
• Entry/exit occurs for the same reasons as in perf. comp. mkts.- If Π > 0 in industry (broadly defined) then new firms enter.- Entry ⇒ ↓D for existing firms ⇒ P↓, eroding Π.- Entry will drive Π = 0, just as in perf comp.
• This means that P = ATC in the LR in monop. comp. mkts.• Difference is that MR < P for monop comp firms, because each
firm faces ↓ sloping D.• Importantly, this means that P > MC and P > ATC min:
• P > MC ⇒ DWL.• P > ATCMIN ⇒ Don’t get least cost production in the LR.
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Principles of Microeconomics
MONOPOLISTIC COMPETITION
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MONOPOLISTIC COMPETITION Principles of Microeconomics
QMR
D
• But P1, Q1 is NOT a LR equil for monopolistically comp firm.• Π > 0 ⇒ entry of firms who produce an imperfect substitute for
this firm’s output.• This firm will lose some - but not all - customers after entry.• The D curve for this firm’s output will shift in.• If D shifts in, then MR also shifts.
Q1
P1
MC
• P1, Q1 is SR equil for monop comp firm.
ATC • MR = MC ⇒ Π max.
• P > MC ⇒ there is a DWL.ATC1
• P > ATC ⇒ Π > 0.
P
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MONOPOLISTIC COMPETITION Principles of Microeconomics
QMRD
• More entry results in further decrease in D and P.• Entry continues until P driven down so that P = ATC; Π > 0.• In LR in monop competitive industries we will have P = ATC.• D curve must shift until we have MR = MC at Q where P = ATC.
- If D curve doesn’t shift in exactly this way, can’t a LR equ.
Q2
P2
MC • D shift means this firm will have to charge lower P and sell less Q.ATC
ATC2
P
• If new lower P > ATC, still true that Π > 0, so there is still incentive for entry.
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MONOPOLISTIC COMPETITION Principles of Microeconomics
QMR
D
• In LR, we still have DWL and don’t reach minimum cost Q.• That’s the price we pay for variety.
QLR
PLR
MC• LR equil, diagrammatically.
ATC• P = ATC.
• MR = MC.• P > MR.
• P > MC.
• Comparison of three types of market structure.
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Principles of MicroeconomicsROUND-UP
Market type Description MR v
PP v MC LR Π LR
ATC DWL
Perf. Comp.
Many sellers, identical goods, free entry in LR
MR = P P = MC Π = 0ATCLR = ATCMIN
No
Monopoly Single seller, barriers to entry
MR < P P > MC Π > 0ATCLR > ATCMIN
Yes
Monop. Comp.
Many sellers, differentiated products, free entry in LR
MR < P P > MC Π = 0ATCLR > ATCMIN
Yes