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  1. 1. MonopolyPrice determinationunder imperfectcompetition
  2. 2. Patterns of imperfect competitionThe major kinds of imperfect competition are: Monopoly, Oligopoly, and Monopolistic competitionWe shall see that for a given technology, prices arehigher and outputs are lower under imperfectcompetition than under perfect competition.Imperfect competitions also have virtues along with vices.Large firms exploit economies of large-scale productionand are responsible for much of the innovation thatpropels long-term economic growth.
  3. 3. Patterns of imperfect competitionDefinition of Imperfect Competition:If a firm can appreciably affect the market price ofits output, the firm is classified as an “imperfectcompetitor.” Imperfect competition prevails in an industry whenever individual sellers have some measures of control over the price of their output. It does not imply that a firm has absolute control over the price of its product. For example Coca-Cola and Pepsi where if the average price in the market is Rs.75, they can sell Rs.70 or 80 and still remain a viable firm.
  4. 4. Patterns of imperfect competitionDefinition of Imperfect Competition: The firm could hardly set the price at Rs.400 or Rs.5 a bottle because at those prices it would go out of business. This tells that an imperfect competitor has some but not complete discretion over its prices. Moreover, the amount of discretion over prices will differ from industry to industry.
  5. 5. Patterns of imperfect competition Firm demand under Firm demand under P perfect competition P imperfect competitionPrice (Rupees per unit) Price (Rupees per unit) d d’ d d B d d’ q q 0 0 Firm quantity Firm quantity
  6. 6. Patterns of imperfect competitionExplanation of the graphs: The figure (a) shows that a perfectly competitive firm can sell all it wants along its horizontal dd without depressing the market price. But the imperfect competitor will find that its demand curve slopes downwards as higher price drives sales down. And unless it is sheltered monopolist, a cut in its rivals’ prices will appreciably shift its own demand curve leftwards to d’d’.We can also see the difference between perfect andimperfect competition in terms of price elasticity.For a perfect competitor; demand is perfectly elastic; for animperfect competitor; demand has a finite elasticity.
  7. 7. Patterns of imperfect competitionVarieties of imperfect competition:Economists classify imperfectly competitive marketsinto three different structures. Monopoly Oligopoly Monopolistic competition.
  8. 8. Patterns of imperfect competitionSources of market imperfections:Most cases of imperfect competition can be tracedto two principal causes. First, industries tend to have fewer sellers when there are significant economies of large-scale production and decreasing costs. Under these conditions, large firms can simply produce more cheaply and then undersell small firms, which cannot survive.
  9. 9. Patterns of imperfect competitionSources of market imperfections: Second, markets tend toward imperfect competition when there are “barriers to entry” that make it difficult for new competitors to enter an industry. In some cases, the barriers may arise from government laws or regulations which limit the number of competitors. In other cases, there may be economic factors that make it expensive for a new competitor to break into a market.
  10. 10. Patterns of imperfect competitionSources of market imperfectionsCosts and Market Imperfection: The technology and cost structure of an industry help determine how many firms that industry can support and how big they will be. If there are economies of scale, a firm can decrease its average costs by expanding its output, at least up to a point(where they produce most of the industry’s total output). That means bigger firms will have a cost advantage over smaller firms.
  11. 11. Patterns of imperfect competitionSources of market imperfectionsTo understand how costs may determine market structure, let’slook at a case which is favorable for perfect competition. P D Perfect Competition ACAC, MC, P MC Total industry demand DD is so vast relative to the efficient scale of a single seller that the market allows viable coexistence of numerous perfect competitors. D 0 Q 1 2 3 4 5 10000 12000
  12. 12. Patterns of imperfect competitionSources of market imperfections Oligopoly P D ACAC, MC, P MC Costs turn up at a higher level of output relative to total industry demand DD. D 0 Q 100 200 300 400
  13. 13. Patterns of imperfect competitionSources of market imperfections Natural Monopoly P DAC, MC, P AC When costs fall rapidly and MC indefinitely, as in the case of natural monopoly, one firm can expand to monopolize the industry. D 0 Q 100 200 300 400
  14. 14. Patterns of imperfect competitionSources of market imperfectionsBarriers to entry:Barriers to entry are factors that make it hard for new firms toenter an industry. When barriers are high, an industry may have few firms and limited pressure to compete. Economies of scale act as one of the common type of barriers to entry, there are others as well, such as: Legal Restrictions High Cost of Entry Advertising and Product Differentiation
  15. 15. Marginal Revenue and MonopolyThe concept of marginal revenueSuppose that a firm finds itself in possession of a completemonopoly in its industry. The firm might be fortunate owner of a patent for a new anticancer drug, Or it might own the operating code to a valuable computer program. If the monopolist wishes to maximize its profits, what price should it charge and what output level should it produce?
  16. 16. Marginal Revenue and MonopolyThe concept of marginal revenueTo answer these questions, we need the marginalrevenue (MR) concept.Marginal Revenue is the change in revenue that isgenerated by an additional unit of sales.MR can be either positive or negative
  17. 17. Marginal Revenue and MonopolyA Monopoly’s revenue Total Revenue P x Q = TR Average Revenue TR/Q = AR = P Marginal Revenue DTR/DQ = MR
  18. 18. Quantity Price Total revenue Marginal revenue q P=AR=TR/q TR=P*q MR 0 220 0 +200 1 200 200 +160 2 180 360 +120 3 160 480 +80 4 140 560 +40 5 120 600 0 6 100 600 -40 7 80 560 -80 8 60 480 -120 9 40 360 -160 10 20 200 -200 11 0 0
  19. 19. Price determination under monopoly220180140100 60 20 d=AR -20 0 1 2 3 4 5 6 7 8 9 10 11 12 -60-100 MR-140
  20. 20. 700600500400300200100 0 TR 0 2 4 6 8 10 12
  21. 21. Marginal Revenue and MonopolyWhen the marginal revenue is negative it does not meanthat the firm is paying people to take its goods. Negative MR means that in order to sell additional units, the firm must decrease its price on earlier units so much that its total revenues decline. For example, when the firm sells 6 units, it gets TR(6 units) = 6*$100= $600 when it sells the additional (7th)unit, it can increase sales only by lowering price. Because it is an imperfect competitor. TR(6 units) = (6*$80)+(1*80)= $560
  22. 22. Marginal Revenue and MonopolyThe necessary price reduction on the first 6 units is so largethat, even after adding in the sale of the 7th unit, totalrevenue fell. Even though MR is negative, AR, or price, is still positive MR turns negative when AR is halfway down towards zero. With demand sloping downward, P > MR
  23. 23. Marginal Revenue and Monopoly Elasticity and Marginal Revenue  Marginal revenue is positive when demand is elastic, zero when demand is unit-elastic, and negative when demand is inelastic.  Demand is elastic when a price decrease leads to a revenue increase.  In such a situation, a price decrease raises output demanded so much that revenue rise, so marginal revenue is positiveIf demand is Relation of Q and P Effect of Q on TR Value of MRElastic (ED > 1) %change Q > %change p Higher Q raises TR MR > 0Unit-elastic (ED = 1) %change Q = %change p Higher Q leaves TR MR = 0 unchangedinelastic (ED < 1) %change Q < %change p Higher Q lowers TR MR < 0
  24. 24. Marginal Revenue and MonopolyProfit maximization of monopolyIf a monopolist wishes to maximize total profit, what should itdo??We know that: TP = TR – TC = (P * q ) - TC To maximize its profits, the firm must find the equilibrium price and quantity that give the largest profit, or the largest difference between TR and TC. A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity.
  25. 25. Quant Price Total Total Total Marginal Margin ity P revenue cost profit revenue al cost q TR TC TP MR MC 0 220 0 185 -185 +200 30 1 200 200 215 15 +160 25 2 180 360 240 120 +120 20 3 160 480 260 220 +80 30 4 140 560 290 270 +40 40 5 120 600 330 270 0 50 6 100 600 380 220 -40 70 7 80 560 450 110 -80 90 8 60 480 540 -60 -120 110 9 40 360 650 -290 -160 130 10 20 200 780 -580 -200 150 11 0 0 930 -930
  26. 26. Marginal Revenue and MonopolyProfit maximization of monopoly The maximum profit price (P*) and quantity (q*) of a monopolist come where the firm’s marginal revenue equals its marginal cost. MR = MC, at the maximum profit P* and q* Thistells us that when MR exceeds MC, additional profits can be made by increasing output; when MC exceeds MR, additional profits can be made by decreasing q.
  27. 27. Monopoly Equilibrium in Graphs200160 MC120 G AC 80 F 40 E 0 MR d 0 1 2 3 4 5 6 7 8 9 10 11 12
  28. 28. 700 At maximum profit point, slopes of TC TC and TR are parallel600500 At maximum profit400 $270 point, slopes is zero and horizontal300200 $270100 TR 0 0 1 2 3 4 5 6 7 8 9 10 11 12-100-200 TP
  29. 29. Marginal Revenue and MonopolyComparing Monopoly and Competition For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. P > MR = MC