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Market Structure

Eksa Pamungkas
eksa.pamungkas@fe.unpad.ac.id

Market Structure

Market Structure those characteristics of the


market that significantly affect the behavior and
interaction of buyers and sellers

MARKET STRUCTURE

number and size of sellers and buyers


type of the product
conditions of entry and exit
transparency of information

MARKET STRUCTURE
Type of market structure influences how a
firm behaves:
Pricing
Supply
Barriers to Entry
Efficiency
Competition

Perfect Competition - structure


Many and small sellers, so that no one can
affect the market
Homogeneous product
Free entry to and exit from the industry
Transparent and free information

Perfect Competition
Consider market for a single good.
The perfectly competitive firm is a price taker: it cannot
influence the price that is paid for its product.
This arises due to consumers indifference between the
products of competing firms = for example, buy from
store with lowest price.

Consumers indifference arises from:


Product homogeneity
Consumers have perfect information
No transactions cost
Many firms

PC firm faces horizontal demand curve at market price p


7

PC firms profit maximization problem

General Equilibrium
and the Efficiency
of Perfect Competition

Firm and Household Decisions


Input and output
markets cannot
be considered
separately or as
if they operated
independently.

10

General Equilibrium and the


Efficiency of Perfect Competition
Partial equilibrium analysis is the
process of examining the equilibrium
conditions in individual markets and
for households and firms separately.
General equilibrium is the condition
that exists when all markets in an
economy are in simultaneous
equilibrium.

11

General Equilibrium and the


Efficiency of Perfect Competition
In judging the performance of an
economic system, two criteria used
are efficiency and equity (fairness).
Efficiency is the condition in which
the economy is producing what
people want at the least possible
cost.

12

General Equilibrium Analysis


To examine the move from partial
to general equilibrium analysis we
will consider the impact of:
a major technological advance, and
a shift in consumer preferences.

13

A Technological Advance:
The Electronic Calculator

Technology improvements made it possible to produce


at lower costs in the calculator industry.
14

A Technological Advance:
The Electronic Calculator

As new firms entered the industry and existing firms


expanded, output rose and market prices dropped.
15

A Technological Advance:
The Electronic Calculator
A significant technological change
in a single industry affects many
markets:
Households face a different structure
of prices and must adjust their
consumption of many products.
Labor reacts to new skill
requirements and is reallocated
across markets.
Capital is also reallocated.
16

A Shift in Consumer Preferences:


The Wine Industry in the 1970s
To examine the effects of a change in one market on
other markets, we will consider the wine industry in the
1970s.
Production and Consumption of Wine in the United States, 19651980

YEAR

U.S.
PRODUCTION
(MILLIONS OF
GALLONS)

IMPORTS
(MILLIONS OF
GALLONS)

TOTAL
(MILLIONS OF
GALLONS)

1965

565

10

575

1.32

1970

713

22

735

1.52

1975

782

40

822

1.96

1980

983

91

1073

2.02

Percent change,
19651980

+ 74.0

+ 86.6

+ 53.0

+ 810.0

CONSUMPTION
PER CAPITA
(GALLONS)

Source: U.S. Department of Commerce, Bureau of the Census, Statistical Abstract of the United States, 1985, Table 1364, p. 765.

17

Adjustment in an Economy
with Two Sectors
This graph shows the
initial equilibrium in an
economy with two
sectorswine (X) and
other goods (Y)prior
to a change in
consumer preferences.

18

Adjustment in an Economy
with Two Sectors
A change in consumer
preferences causes an
increase in the
demand for wine, and,
consequently, a
decrease in the
demand for other
goods.

19

Adjustment in an Economy
with Two Sectors
A higher price creates
a profit opportunity in
sector X.

Simultaneously,
lower prices result in
losses in industry Y.

20

Adjustment in an Economy
with Two Sectors
As new firms enter
industry X and existing
firms expand, output
rises and market
prices drop. Excess
profits are eliminated.

21

Adjustment in an Economy
with Two Sectors
As new firms exit
industry Y, market
price rises and losses
are eliminated.

22

A Shift in Consumer Preferences:


The Wine Industry in the 1970s
Land in Grape Production in the United States and in
California Alone, 1974 and 1982
NUMBER OF
VINEYARDS

NUMBER
OF ACRES

United States

1974

14,208

712,804

1982

24,982

874,996

Percent change

+ 75.8

+ 22.8

California
1974

8,333

607,011

1982

10,481

756,720

Percent change

+ 25.8

+ 24.7

Source: U.S. Department of Commerce, Bureau of the Census, Census of Agriculture (1974 and 1982), 1, part 51.

23

Formal Proof of a
General Competitive Equilibrium
This section explains why perfect
competition is efficient in dividing
scarce resources among alternative
uses.
If the assumptions of a perfectly
competitive economic system hold,
the economy will produce an
efficient allocation of resources.
24

Pareto Efficiency
Pareto efficiency, or Pareto
optimality, is a condition in which no
change is possible that will make
some members of society better off
without making some other members
of society worse off.
This very precise concept of efficiency
is known as allocative efficiency.
25

The Efficiency of Perfect Competition


The three basic questions in a
competitive economy are:
1. What will be produced? What
determines the final mix of output?
2. How will it be produced? How do
capital, labor, and land get divided
up among firms?
3. Who will get what is produced?
What is the distribution of output
among consuming households?

26

The Efficiency of Perfect Competition


As we will see, in a perfectly
competitive economic system:
1. resources are allocated among firms
efficiently,
2. final products are distributed among
households efficiently, and
3. the system produces the things that
people want.
27

The Efficiency of Perfect Competition


Efficient Allocation of Resources:
Perfectly competitive firms have incentives to

use the best available technology.


With a full knowledge of existing technologies,

firms will choose the technology that produces


the output they want at the least cost.
Each firm uses inputs such that MRPL = PL. The

marginal value of each input to each firm is just


equal to its market price.
28

The Efficiency of Perfect Competition


Efficient Distribution of Outputs
Among Households:
Within the constraints imposed by income and

wealth, households are free to choose among


all the goods and services available in output
markets. Utility value is revealed in market
behavior.
As long as everyone shops freely in the same
markets, no redistribution of final outputs
among people will make them better off.
29

The Efficiency of Perfect Competition


Producing What People
Wantthe Efficient Mix
of Output:
Society will produce the
efficient mix of output if
all firms equate price and
marginal cost.

30

The Key Efficiency Condition:


Price Equals Marginal Cost
If PX > MCX, society gains value by producing more

X
If PX < MCX, society gains value by producing less

31

Efficiency in Perfect Competition


Efficiency in perfect competition follows from a
weighing of values by both households and
firms.

32

The Sources of Market Failure


Market failure occurs when resources are
misallocated, or allocated inefficiently. The
result is waste or lost value. Evidence of
market failure is revealed by the existence of:

Imperfect market structure


Public goods
External costs and benefits
Imperfect information

33

Advantages of Perfect Competition:


High degree of competition helps allocate
resources to most efficient use
Price = marginal costs
Normal profit made in the long run
Firms operate at maximum efficiency
Consumers benefit

34

The Necessary Conditions for Perfect


Competition
Both buyers and sellers are price takers.
A price taker is a firm or individual who takes the
market price as given.
In most markets, households are price takers
they accept the price offered in stores.

35

The Necessary Conditions for Perfect


Competition
Both buyers and sellers are price takers.

The retailer is not perfectly competitive.


A store is not a price taker but a price maker.

36

The Necessary Conditions for Perfect


Competition
The number of firms is large.
Large means that what one firm does has no
bearing on what other firms do.
Any one firm's output is minuscule when
compared with the total market.

37

The Necessary Conditions for Perfect


Competition
There are no barriers to entry.
Barriers to entry are social, political, or
economic impediments that prevent other
firms from entering the market.
Barriers sometimes take the form of patents
granted to produce a certain good.

38

The Necessary Conditions for Perfect


Competition
There are no barriers to entry.
Technology may prevent some firms from
entering the market.
Social forces such as bankers only lending to
certain people may create barriers.

39

The Necessary Conditions for Perfect


Competition
The firms' products are identical.
This requirement means that each firm's
output is indistinguishable from any
competitor's product.

40

The Necessary Conditions for Perfect


Competition
There is complete information.
Firms and consumers know all there is to know
about the market prices, products, and
available technology.
Any technological advancement would be
instantly known to all in the market.

41

The Necessary Conditions for Perfect


Competition
Firms are profit maximizers.
The goal of all firms in a perfectly competitive
market is profit and only profit.
Firm owners receive only profit as
compensation, not salaries.

42

The Definition of Supply and Perfect


Competition
If all the necessary conditions for perfect
competition exist, we can talk formally about
the supply of a produced good.
This follows from the definition of supply.

43

The Definition of Supply and Perfect


Competition
Supply is a schedule of quantities of goods
that will be offered to the market at various
prices.

44

The Definition of Supply and Perfect


Competition
This definition requires the supplier to be a
price taker (the first condition for perfect
competition).
Since most suppliers are price makers, any
analysis must be modified accordingly.

45

The Definition of Supply and Perfect


Competition
Because of the definition of supply, if any of
the conditions are not met, the formal
definition of supply disappears.

46

The Definition of Supply and Perfect


Competition
That the number of suppliers be large (the
second condition), means that they do not
have the ability to collude.

47

The Definition of Supply and Perfect


Competition
Conditions 3 through 5 make it impossible for
any firm to forget about the hundreds of other
firms just itching to replace their supply.

Condition 6 specifies a firm's goal profit.

48

The Definition of Supply and Perfect


Competition
Even if we cannot technically specify a supply
function, supply forces are still strong and
many of the insights of the competitive model
can be applied to firm behavior in other
market structures.

49

Demand Curves for the Firm and the


Industry
The demand curves facing the firm is different
from the industry demand curve.
A perfectly competitive firms demand
schedule is perfectly elastic even though the
demand curve for the market is downward
sloping.

50

Demand Curves for the Firm and the


Industry
This means that firms will increase their
output in response to an increase in demand
even though that will cause the price to fall
thus making all firms collectively worse off.

51

Market Demand Versus Individual Firm


Demand Curve
Market

Firm

Market supply

Price
$10

Price
$10

Market
demand

2
0

1,000

3,000 Quantity

Individual firm
demand

4
2
0

10

20

30

Quantity
52

Profit-Maximizing Level of Output


The goal of the firm is to maximize profits.
When it decides what quantity to produce it
continually asks how changes in quantity
affect profit.

53

Profit-Maximizing Level of Output


Since profit is the difference between total
revenue and total cost, what happens to profit
in response to a change in output is
determined by marginal revenue (MR) and
marginal cost (MC).

A firm maximizes profit when MC = MR.

54

Profit-Maximizing Level of Output


Marginal revenue (MR) the change in total
revenue associated with a change in quantity.

Marginal cost (MC) -- the change in total


cost associated with a change in quantity.

55

Marginal Revenue
Since a perfect competitor accepts the market
price as given, for a competitive firm, marginal
revenue is price (MR = P).

56

Marginal Cost
Initially, marginal cost falls and then begins to
rise.
Marginal concepts are best defined between
the numbers.

57

How to Maximize Profit


To maximize profits, a firm should produce
where marginal cost equals marginal revenue.

58

How to Maximize Profit


If marginal revenue does not equal marginal
cost, a firm can increase profit by changing
output.
The supplier will continue to produce as
long as marginal cost is less than marginal
revenue.

59

How to Maximize Profit


The supplier will cut back on production if
marginal cost is greater than marginal
revenue.
Thus, the profit-maximizing condition of a
competitive firm is MC = MR = P.

60

Marginal Cost, Marginal Revenue, and


Price
Price = MR Quantity
Produced

$35.00
35.00
35.00
35.00
35.00
35.00
35.00
35.00
35.00
35.00
35.00

0
1
2
3
4
5
6
7
8
9
10

MC

Marginal Costs
Cost

$28.00
20.00
16.00
14.00
12.00
17.00
22.00
30.00
40.00
54.00
68.00

60
50
40
30

A
A

C
B

P = D = MR

20
10

1 2 3 4 5 6 7 8 9 10 Quantity
61

The Marginal Cost Curve Is the Supply


Curve
The marginal cost curve is the firm's supply
curve above the point where price exceeds
average variable cost.

62

The Marginal Cost Curve Is the Supply


Curve
The MC curve tells the competitive firm how
much it should produce at a given price.

The firm can do no better than producing


the quantity at which marginal cost equals
price which in turn equals marginal
revenue.
63

The Marginal Cost Curve Is the Firms


Supply Curve
Marginal cost

$70

Cost, Price

60
50
40

30
B

20
10
0

9 10 Quantity
64

Firms Maximize Total Profit


When we speak of maximizing profit, we refer
to maximizing total profit, not profit per unit.
Firms do not care about profit per unit; as long
as an increase in output will increase total
profits, a profit-maximizing firm should
increase output.

65

Profit Maximization Using Total


Revenue and Total Cost
Profit is maximized where the vertical distance
between total revenue and total cost is
greatest.
At that output, MR (the slope of the total
revenue curve) and MC (the slope of the total
cost curve) are equal.

66

Profit Determination Using Total Cost


and Revenue Curves
Total cost, revenue

TC
$385
350
315 Maximum profit =$81
280
245
210
$130
175
140
105
70
Loss
35
0

TR

Loss

1 2 3 4 5 6 7 8 9

Profit

Quantity
67

Total Profit at the Profit-Maximizing


Level of Output
While the P = MR = MC condition tells us how
much output a competitive firm should
produce to maximize profit, it does not tell us
the profit the firm makes.

68

Determining Profit and Loss From a


Table of Costs
Profit can be calculated from a table of costs
and revenues.
Profit is determined by total revenue minus
total cost.

69

Determining Profit and Loss From a


Table of Costs
The profit-maximizing position is not
necessarily a position that minimizes either
average variable cost or average total cost.

It is only the position that maximizes total


profit.

70

Costs Relevant to a Firm


Profit Maximization for a Competitive Firm
Total
P = MR Output Total Cost Marginal Average
Cost
Total Cost Revenue

Profit
TR-TC

35.00
35.00
35.00
35.00
35.00
35.00

40.00
33.00
18.00
1.00
22.00
45.00
63.00

0
1
2
3
4
5
6

40.00
68.00
88.00
104.00
118.00
130.00
147.00

28.00
20.00
16.00
14.00
12.00
17.00

68.00
44.00
34.67
29.50
26.00
24.50

0
35.00
70.00
105.00
140.00
175.00
210.00

71

Costs Relevant to a Firm


Profit Maximization for a Competitive Firm
Total
P = MR Output Total Cost Marginal Average
Cost
Total Cost Revenue

35.00
35.00
35.00
35.00
35.00
35.00
35.00

4
5
6
7
8
9
10

118.00
130.00
147.00
169.00
199.00
239.00
293.00

14.00
12.00
17.00
22.00
30.00
40.00
54.00

29.50
26.00
24.50
24.14
24.88
26.56
29.30

140.00
175.00
210.00
245.00
280.00
315.00
350.00

Profit
TR-TC

22.00
45.00
63.00
76.00
81.00
76.00
57.00
72

Determining Profit and Loss From a


Graph
Find output where MC = MR.
The intersection of MC = MR (P) determines
the quantity the firm will produce if it wishes
to maximize profits.

73

Determining Profit and Loss From a


Graph
Find profit per unit where MC = MR.
To determine maximum profit, you must
first determine what output the firm will
choose to produce.
See where MC equals MR, and then drop a
line down to the ATC curve.
This is the profit per unit.
74

Determining Profits Graphically


MC
MC
MC
Price
Price
Price
65
65
65
60
60
60
55
55
55
ATC
50
50
50
ATC
45
45
45
40
40 D
A
P = MR 40
P = MR
Loss
35
35
35
P = MR
Profit
30
30
30
B ATC
AVC
25
25 C
25
AVC
AVC
E
20
20
20
15
15
15
10
10
10
5
5
5
0
0
0
1 2 3 4 5 6 7 8 9 10 12
1 2 3 4 5 6 7 8 9 10 12
1 2 3 4 5 6 7 8 9 10 12
Quantity
Quantity
Quantity
(b) Zero profit case
(a) Profit case
(c) Loss case
Irwin/McGraw-Hill

75
The McGraw-Hill Companies, Inc., 2000

Zero Profit or Loss Where MC=MR


Firms can also earn zero profit or even a loss
where MC = MR.
Even though economic profit is zero, all
resources, including entrepreneurs, are being
paid their opportunity costs.

76

Zero Profit or Loss Where MC=MR


In all three cases (profit, loss, zero profit),
determining the profit-maximizing output
level does not depend on fixed cost or average
total cost, by only where marginal cost equals
price.

77

The Shutdown Point


The firm will shut down if it cannot cover
average variable costs.
A firm should continue to produce as long as price
is greater than average variable cost.
Once price falls below that point it makes sense to
shut down temporarily and save the variable
costs.

78

The Shutdown Point


The shutdown point is the point at which the
firm will gain more by shutting down than it
will by staying in business.

79

The Shutdown Point


As long as total revenue is more than total
variable cost, temporarily producing at a loss
is the firms best strategy since it is taking less
of a loss than it would by shutting down.

80

The Shutdown Decision


MC
Price
60

ATC

50
40

Loss
P = MR

30

AVC
20
$17.80

A
10
0

8 Quantity
81

Short-Run Market Supply and Demand


While the firm's demand curve is perfectly
elastic, the industry's is downward sloping.
For the industry's supply curve we use a market
supply curve.

82

Short-Run Market Supply and Demand


In the short run when the number of firms in
the market is fixed, the market supply curve is
just the horizontal sum of all the firms'
marginal cost curves, taking account of any
changes in input prices that might occur.

83

Short-Run Market Supply and Demand


Since all firms have identical marginal cost
curves, a quick way of summing the quantities
is to multiply the quantities from the marginal
cost curve of a representative firm by the
number of firms in the market.

84

Long-Run Competitive Equilibrium


Profits and losses are inconsistent with longrun equilibrium.
Profits create incentives for new firms to
enter, output will increase, and the price will
fall until zero profits are made.
Only zero profit will stop entry.

85

Long-Run Competitive Equilibrium


The existence of losses will cause firms to
leave the industry.
Zero profit condition is the requirement
that in the long run zero profits exist.
The zero profit condition defines the longrun equilibrium of a competitive industry.

86

Long-Run Competitive Equilibrium


Zero profit does not mean that the
entrepreneur does not get anything for his
efforts.

87

Long-Run Competitive Equilibrium


In order to stay in business the entrepreneur
must receive his opportunity cost or normal
profits the owners of business would have
received in the nest-best alternative.

88

Long-Run Competitive Equilibrium


Normal profits are included as a cost and are
not included in economic profit. Economic
profits are profits above normal profits.

89

Long-Run Competitive Equilibrium


Even if some firm has super-efficient workers
or machines that produce rent, it will not take
long for competitors to match these
efficiencies and drive down the price.

Rent is an income received by a specialized


factor of production.
90

Long-Run Competitive Equilibrium


The zero profit condition is enormously
powerful.
It makes the analysis of competitive markets
far more applicable to the real world than can
a strict application of the assumption of
perfect competition.

91

Long-Run Competitive Equilibrium


MC

Price
60

50

SRATC

LRATC

40
P = MR

30
20
10
0

Quantity
92

Adjustment from the Long Run to the


Short Run
Industry supply and demand curves come
together to lead to long-run equilibrium.

93

Profits, Losses, and Perfectly


Competitive Firm Decisions in the Long
and Short Run

94

An Increase in Demand
An increase in demand leads to higher prices
and higher profits.
Existing firms increase output and new firms
will enter the market, increasing output still
more, price will fall until all profit is competed
away.

95

An Increase in Demand
If the the market is a constant-cost industry,
the new equilibrium will be at the original
price but with a higher output.

A market is a constant-cost industry if the


long-run industry supply curve is perfectly
elastic.
96

An Increase in Demand
The original firms return to their original
output but since there are more firms in the
market, the total market output increases.

97

An Increase in Demand
In the short run, the price does more of the
adjusting.
In the long run, more of the adjustment is
done by quantity.

98

Market Response to an Increase in


Demand
Market

Price

Price

Firm

S0SR
$9
7

AC

S1SR

B
C
A

SLR

MC

$9
Profit
7

B
A

D1
D0
0

700

840 1,200 Quantity

10 12 Quantity
99

Long-Run Market Supply


Two other possibilities exist:
Increasing-cost industry factor prices rise as
new firms enter the market and existing firms
expand capacity.
Decreasing-cost industry factor prices fall as
industry output expands.

100

An Increasing-Cost Industry
If inputs are specialized, factor prices are likely
to rise when the increase in the industry-wide
demand for inputs to production increases.

101

An Increasing-Cost Industry
This rise in factor costs would force costs up
for each firm in the industry and increases the
price at which firms earn zero profit.

102

An Increasing-Cost Industry
Therefore, in increasing-cost industries, the
long-run supply curve is upward sloping.

103

A Decreasing-Cost Industry
If input prices decline when industry output
expands, individual firms' marginal cost curves
shift down and the long-run supply curve is
downward sloping.

104

A Decreasing-Cost Industry
Input prices may decline to the zero-profit
condition when output rises and when new
entrants make it more cost-effective for other
firms to provide services to all firms in the
market.

105

A Real World Example


Owners of the Ames chain of department
stores decide to close over 100 stores after
experiencing two years of losses (a shutdown
decision).

106

A Real World Example


Initially, Ames thought the losses were
temporary.
Since price exceeded average variable cost,
it continued to produce even though it was
losing money.

107

A Real World Example


After two years of losses, its prospective
changed.
The company moved from the short run to
the long run.

108

A Real World Example


They began to think that demand was not
temporarily low, but permanently low.

At that point they shut down those stores


for which P < AVC.

109

A Real World Example:


A Shutdown Decision
Price

MC

ATC
Loss

AVC
P = MR

Quantity
110

Profit, Loss and Shutdown

111

Pure Monopoly- market structure


Only one producer in the industry
The product does not have close substitutes
Blocked entry

112

Monopoly
Assumptions

One seller and many buyers


Implication: The seller is a price maker and the buyers are
price takers.

Barriers to Entry
Ownership of a unique resource (Diamonds)
Government granted rights for exclusive production (e.g.
patents, copyrights, licenses, concessions)
Economies of scale and declining long-run average costs
Implication: Monopolist faces the entire market demand
curve and profits can persist in the short and long-run.

113

Limits to Monopoly
Size of the market (Pavarotti versus Joe,
uncongested bridge)
Definition of market and close substitutes
(ornamental versus industrial diamonds,
bottled water).
Potential competition

114

Production Decisions
Monopolist versus competitive firm.
CF is a price taker who faces a perfectly elastic demand
curve MR=P
M is a price maker who faces the entire market demand
curve MR<P
Intuitive proof to sell another unit the monopolist must lower
the price. This means lowering the price not only on the extra unit
sold, but also all the other units the monopolist was selling. So
MR = Price of the additional unit the sum of the decreases in all
the units previously sold ( e.g. selling 4 units @$100, to sell the 5
unit the price must be lowered to $90, so the monopolists MR =
$90 4X$10=$50)
Tabular proof see next table and handout
Graphical proof

115

A Monopolys Revenue
Total Revenue
P Q = TR
Average Revenue
TR/Q = AR = P
Marginal Revenue
DTR/DQ = MR

116

Table 1 A Monopolys Total, Average,


and Marginal Revenue

117
Copyright2004 South-Western

Figure 2 Demand Curves for Competitive and Monopoly Firms

(a) A Competitive Firms Demand Curve


Price

(b) A Monopolists Demand Curve


Price

Demand

Demand

Quantity of Output

Quantity of Output

118
Copyright 2004 South-Western

Figure 3 Demand and Marginal-Revenue Curves for a


Monopoly
Price
$11
10
9
8
7
6
5
4
3
2
1
0
1
2
3
4

Demand
(average
revenue)

Marginal
revenue
1

Quantity of Water

119
Copyright 2004 South-Western

Profit Maximization
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.

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Profit Maximization
Set MR = MC to find Q that maximizes profits.
Use the market demand curve to find the P that the Q
brings
Find ATC and AVC cost to determine profits, losses, or
shutdown.

Difference between the monopolist decision and the


competitive firms decision
The monopolist does not have a supply curve like the CF,
rather they pick a single price and quantity
Monopolists produce where P>MR and P>MCversus CFs
who produce where P=MR and P=MC.

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Figure 4 Profit Maximization for a Monopoly


Costs and
Revenue

2. . . . and then the demand


curve shows the price
consistent with this quantity.
B

Monopoly
price

1. The intersection of the


marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity . . .

Average total cost


A

Demand

Marginal
cost

Marginal revenue
0

QMAX

Quantity
Copyright 2004 South-Western

122

Figure 5 The Monopolists Profit


Costs and
Revenue
Marginal cost
Monopoly E
price

Monopoly
profit
Average
total D
cost

Average total cost

Demand

Marginal revenue
0

QMAX

Quantity
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Figure 6 The Market for Drugs


Costs and
Revenue

Price
during
patent life
Price after
patent
expires

Marginal
cost

Marginal
revenue
0

Monopoly
quantity

Competitive
quantity

Demand

Quantity
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Copyright 2004 South-Western

Welfare Costs of Monopoly


In competitive markets, firms produce where

P=MC
And since
P=MB=willingness to bud
And
MC=willingness to sell

P=MC MB=MC or
Maximum total surplus
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In monopoly,
P>MR so

P>MC
Or
MB>MC
Output falls short of the efficient amount
Deadweight Welfare Loss
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Figure 7 The Efficient Level of Output


Price
Marginal cost

Value
to
buyers

Cost
to
monopolist

Value
to
buyers

Cost
to
monopolist

Demand
(value to buyers)

Quantity

0
Value to buyers
is greater than
cost to seller.

Value to buyers
is less than
cost to seller.

Efficient
quantity

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Copyright 2004 South-Western

Figure 8 The Inefficiency of Monopoly


Price
Deadweight
loss

Marginal cost

Monopoly
price

Marginal
revenue

Monopoly Efficient
quantity quantity

Demand

Quantity
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Copyright 2004 South-Western

Monopoly profit is not usually a social cost but


a transfer of surplus from consumer to
producer.
Profit can be a social cost if extra costs are
incurred to maintain it, such as political
lobbying, or if the lack of competition leads to
costs not being minimized (X-inefficiency
again!)
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Public Policy and Monopolies


Working towards P=MC
Attempts to increase competition through anti-trust
legislation
Sherman Antitrust Act of 1890
Examples: Breakup of Standard Oil and turning MA Bell
into Baby Bells

Regulation Natural Monopolies


P=MC doesnt work with extensive economies of scale
Regulated forms have little incentive to minimize costs

Public Ownership
Public utilities and the Postal Service

Hands-off Approach
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Price-Discriminating Monopolist
Price discrimination occurs when different prices are
charged to different consumer that do no reflect
differences in the cost of providing th good
Perfect Price Discrimination charging each customer
their maximum willingness to pay.
Imperfect Price Discrimination segmenting the
market into different consumer groups.
Parable Hardcopy versus paperback copy
Allows firms to increase profits
Requires separating customers into different groups and
minimize arbitrage
Results in greater economic welfare than single-pricing
monopolists.

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Basis for Price Descrimination


Different consumers have different willingness to pay
different price elasticities of demand
Rule: segment the market according to price elasticity of
demand and charge the consumers will less elastic demand
more than those with more elastic demand
Examples: (remember the smaller the % of income or the
greater the number of close substitutes the less price elastic
the demand,)

Movie Tickets
Airline Tickets
Discount Coupons
Financial Aid
Quantity Discounts

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Oligopoly market structure


A) Tight oligopoly a few big firms in the industry
with comparable market shares/ B) Dominant firm
oligopoly one of the big firms in the industry is
recognized as the price leader
Homogeneous / Heterogeneous oligopoly
Significant barriers to entry to and exit from the
industry
Significant barriers to information

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What Do These Models Tell Us About the


Impact of Structure?
Entry Conditions are Important: They affect whether high
profits can be maintained in the long run.
The Number of Competitors and their Behaviour is Important.
A few co-operating competitors can lead to monopoly-type
profits
Product Differentiation is Important. Without it all firms must
charge the same price in a competitive market

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