ECON1010

Introductory Microeconomics

LECTURE 8
Monopoly and Imperfect Competition

Lecture 7 Review
Q1. A firm in a perfectly competitive industry is earning an economic
profit. An economist would predict that over time:

a. market supply will decrease

b. market demand will increase
c. the market price will decrease
d. firms will continue to make economic profits
e. the market price will rise

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Lecture 7 Review
Q2. If buyers and sellers are free to pursue their own selfish interests,
according to the invisible hand theory, the result would be:

a. exploitation of workers and natural resources

b. an inequitable allocation of resources
c. poor services for consumers
d. an efficient allocation of resources
e. no one being able to see what is happening in society

Lecture 8 ECON1010 3

At the midway point of the course, it might be

worth reflecting on the following:
1. Are you consistently devoting 10 hours per lecture to ECON1010?

2. Are you regularly

• attending lectures?
• making and revising lecture notes?
• studying the handouts?
• preparing for and attending tutorials?
• booking and attending consultation sessions?
3. Remember, UQ has very clear policies when it comes to
assessment and passing grades, so work toward hitting your target.

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Plan of Lecture 8
Part 1

• A focus on monopolies, monopoly power, and how economic theory

guides government responses toward monopolies

Part 2

• Monopolistic competition

Lecture 8 ECON1010 5

Demand for Perfectly and Imperfectly

Competitive Firms

Monopoly

Price The more inelastic is demand,

($/unit) Oligopoly the more pricing power the firm
has and more market power.

Monopolistic

Perfectly Competitive
Quantity
0
(units)
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Market structure
Perfectly Competitive Firm

• demand is perfectly elastic (horizontal)

• is a price taker, maximising profit by setting output quantity so that
P = MC

Imperfectly Competitive Firm

• faces a downward sloping (non-horizontal) demand curve

• is a price maker, maximising profit at a specific output quantity
(not just selling whatever it likes and charging any price!)

Lecture 8 ECON1010 7

Lecture Overview
1. Definition and features of a monopoly
2. Reasons why monopolies exist
3. How a monopoly sets price and output
4. Impacts monopolies have on economic surplus
5. Government policies for dealing with monopolies
6. The role of the ACCC
7. Monopolistic competition

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Definition and Features of a (Pure) Monopoly

Definition:

 a firm that is the only seller of a product or service

 it has no close substitutes
 the monopoly (firm) supply is the market supply

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Examples of Monopolies
a. Consider a small outback Australian town, where there is only one
lawyer

• no-one else is legally entitled to sign off legal documents

b. Power transmission lines (spatial monopoly)

• an electricity generator does not own the power lines, but needs to
transmit electricity

• if only one owner of power lines → monopoly

c. Others?

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2. Why Monopolies Exist
i. Entry into the industry is deliberately blocked (barriers to entry)
allowing only one firm to supply the market

• by governments granting a patent or copyright to a firm for the

supply of its products (e.g., manufacturing drugs)
• by governments designating only ONE company as a supplier of
services to customers
• supply of electricity, gas, water, postal services

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Why Monopolies Exist

ii. Control over key raw material resources to produce a product

• a company owning 40% of the world’s uranium deposits, as well

as large amounts of the world’s other key minerals (iron ore,
zinc)
• a quarry owner in the middle of a city supplying aggregate to
concrete suppliers for high rise construction in the CBD

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Why Monopolies Exist
iii. Network externalities

• a product’s usefulness increases as more consumers adopt it

and use it
• increasing returns to adoption

 Microsoft Windows (95% market share in personal computers and

servers),
• large take up so others adopt it by producing and supplying
complements (software, compatible hardware, etc.)
 eBay and online auction platforms
• Consumers expect many items for sale, attracts more consumers

Lecture 8 ECON1010 13

Why Monopolies Exist

iv. Economies of Scale (will reduce ATC)

• Scale refers to size, i.e., of quantity produced

(scope refers to breadth, e.g., of product offerings)

• The larger a firm’s production process becomes, the more inputs

it needs
• The firm can “buy in bulk”, use better technology and employ
more efficient processes
• If double the input results in more than double the output
→ increasing returns to scale = economies of scale

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Possible Threats to any Monopoly’s existence

a. Changes to government legislation (e.g., anti-trust legislation) to

break a monopoly’s control and power over consumers

b. The rise of potential competitors who have large amounts of cash,

with possibly new improved technologies desired by consumers
(market evolution)

c. Economic profits so high that new entrants are attracted

• Richard Branson and Virgin Galactic space tourism

Lecture 8 ECON1010 15

Book your place in space now!!

Tickets cost $200,000 and
deposits start from $20,000.

http://www.virgingalactic.com/booking

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3. How a Monopoly Maximises Profit
Recall: A competitive firm is a price taker

i.e., the market dictates the price, and the firm then supplies a
quantity up until the point where Price = MC to maximise profits.

A monopoly firm is a price maker

i.e., the firm decides what quantity it should supply in order to

maximise its profits

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How does a Monopoly Maximise Profit?

Profit  Revenue  Total Cost all are f  Q 

d ( Profit ) d ( Revenue) d (Cost )

 
dQ dQ dQ
= 0 to maximise profit

d ( Revenue) d (Cost )
 MR = MC
dQ dQ
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How does a Monopoly Maximise Profit?
Continue to produce output up until where:

Marginal Revenue = Marginal Cost

MR  MC
where:
Revenue
MR =
Quantity

This will give the profit maximising output quantity.

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MR for a Monopoly
For a monopoly, demand is downward sloping – WHY??

Assuming linear demand,

P  mQ  c (slope  –m)

Revenue  P  Q
 (– mQ  c)  Q
 – mQ 2  cQ (parabolic revenue curve)

dR
 –2mQ  c (slope of MR line is – 2m,
dQ
 MR i.e., twice the slope of the demand curve)

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MR for a Monopoly
Example:

Consider a single qualified lawyer is available to offer legal advice to

clients in a small outback country town. There are no other lawyers
within 300km of this town.

The lawyer uses the following schedule of fees to charge clients. It

varies depending on the number of clients seen per day.

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Country Lawyer’s Fee Schedule

Price Quantity Revenue MR
($/client) (clients) ($) ($/client)

200 0 0 –
180 1 180 180
160 2 320 140
140 3 420 100
120 4 480 60
100 5 500 20
80 6 480 –20

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The slope of the demand and MR curves
(refer to this approach as the ‘typical method’)

200

150
Price, MR ($/client)

40
20
100
1 1
Demand
50

0
0 2 4 6 Marginal 8
Revenue
-50
Quantity (clients)
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A Profit Maximising Monopoly

Taking the ATC curve for a monopoly as U-shaped and demand linear,
MC should cut ATC at its minimum.

The profit maximising output quantity can be found where MR and MC

intersect.

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Steps to find the Maximum Monopoly Profit

1. Plot the demand, MR, ATC, and MC curves on the one graph

2. Find where MR = MC, and determine the profit maximising output

3. Find the ATC for this output level

4. Use the demand curve to find the price to charge for this level of
output

5. Profit = P × Q – ATC × Q

Lecture 8 ECON1010 25

Monopoly Profit Maximising Condition

300
MC
Price, MR, MC, ATC ($/client)

250

200 ATC
(assumed)
150

100 Demand

50
MR
0
0 1 2 3 4 5 6 7
-50
Quantity (clients)
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 Monopoly Profit Maximising Condition
300
MR = MC
MC
Price, MR, MC, ATC ($/client)

250
ATC
200 (assumed)

150
Price = 130
100
MR = MC = 80 Demand
50
ATC = 30
MR
0
0 1 2 3 4 5 6 7
-50 Qprofit max Quantity (clients)
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= 3.5 27

Monopoly Profit Maximising Condition

300
MR = MC
MC
Maximum Profit
Price, MR, MC, ATC ($/client)

250
= (130 – 30) × 3.5 ATC
200 = $350 (assumed)

150
Price = 130
100 Demand
50 ATC = 30
MR
0
0 1 2 3 4 5 6 7
-50 Qprofit max Quantity (clients)
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= 3.5 28

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 Case where MR > MC for a given output
300 (increase output)
Profit
MC
Price, MR, MC, ATC ($/client)

250
= (160 – 50) × 2 ATC
200
= $220 (assumed)

150 Price = 160

100 Demand
50
ATC = 50
MR
0
0 1 2 3 4 5 6 7
-50
Q Quantity (clients)
Lecture 8 ECON1010 29

Case where MR < MC (for a given output)

300 (decrease output)
MC
Price, MR, MC, ATC ($/client)

250
Cut back output ATC
200
to maximise profit (assumed)

150
Price = 120
100 Profit Demand
= (120 – 50) × 4 = $280
50
ATC = 50
MR
0
0 1 2 3 4 5 6 7
-50
Quantity (clients)
Q
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 Case where MR > MC
(for a given output)
300
MC
Price, MR, MC, ATC (S/client)

Increase output
250
to maximise profit ATC
200

150 Price = 140

Profit = (140 – 25) × 3 Demand
100
= $345

50
ATC = 25 MR
0
0 1 2 3 4 5 6 7
-50
Quantity (clients)
Q
Lecture 8 ECON1010 31

What to do if MR > MC, or if MR < MC

Summary:

1. When MR > MC for a given level of output, the firm should

INCREASE output to maximise profit

2. When MR < MC for a given level of output, the firm should

DECREASE output to maximise profits

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4. Impacts of Monopoly on Economic Surplus

Only in perfectly competitive markets, will there be no loss of economic

efficiency.

In reality, few markets are perfectly competitive, and the MR curve is

downward sloping.

When MR=MC, there will always be some dead weight loss. The closer
the price is to MC, the smaller the dead weight loss and inefficiency.

The ability to exert market power (how high price can be set price
above MC for a given output quantity) dictates the extent of any dead
weight loss.

Lecture 8 ECON1010 33

Economic Surplus in a competitive Market

Total economic surplus =

total consumer surplus + total producer surplus
Price (maximised in competitive markets)
($/unit)

$$$$
Supply
Market
clearing $$$$
price

Demand
Quantity
0 (units)
Market clearing quantity
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 Impacts of Market (Pricing) Power
Definition:

• A firm that profit maximises, at an output quantity where price is

much larger that MC, is said to have Market Power

• For a single supplier, the higher the price is able to be set above MC,
the more monopoly power

Lecture 8 ECON1010 35

Dead weight loss from Monopolies

Dead weight loss from monopoly = B + C,
compared to competitive market, with A
Price, MR, MC transferred from consumers to monopoly.
($/unit)

MC = Supply
PMonopoly
A
B
PCompetitive
C

MR = MC

MR Demand

0 Quantity
Qprofit max Qcompetitive (units)

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4. Impacts of Monopoly on Economic Surplus
Output is less than would otherwise be the case in a
competitive market, where price would be higher

Monopoly transfers consumer surplus (in a competitive market)

to producer surplus

A dead weight loss results compared to the competitive

outcome

Economic inefficiency with a reduction in the efficient allocation

of resources

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Discussion:
Fact: Research and developments into new products, and
technological advances, all take money.

To what extent should society allow any firm to exercise “monopoly

power” so they can benefit from their investments?

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5. Government Policies to deal with Monopolies

• Monopolies produce economic inefficiencies. Governments aim to

improve economic efficiency using regulations

• Regulators aim to monitor prices set by monopolies to more

closely reflect a competitive outcome

• Not only through price regulation, governments can also dictate the
quantity to be supplied by monopoly, as well as the timing/amount of
any new investments

Lecture 8 ECON1010 39

Government Regulations applied to Monopolies

Over the last 20 years or so:

1. Structural Changes applied to Monopolies

• Break up of division within a firm. E.g., Telstra and proposed

breakup (wholesale and retail), early 2000 saw Microsoft being
threatened to be broken up.

2. Removal of Government owned Monopolies

• Privatisation and corporatisation. E.g., Telstra, Qantas, CBA,

Queensland Rail in proposed sale.

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6. The role of the ACCC (www.accc.gov.au)

Australian Competition and Consumer Commission (ACCC)

• a “watch dog” organisation to monitor competitive behaviour of

firms, and to focus on:
• promoting competition, openness and efficiency in the Australian
economy
• prosecuting firms who breach the Australian Consumer Act 2010
and who engage in anti-competitive and illegal behaviour (price
fixing, collusion, cartels)
• assessing mergers or takeovers for any substantial lessening of
competition

Lecture 8 ECON1010 41

Monopolistic Competition
Features:

Very similar to perfectly competitive markets:

1. A larger number of similar firms exist

2. Many close substitutes exist
3. Few barriers to entry into the industry

But an important difference:

• products/services can be slightly differentiated (i.e., not identical)

giving the firm some pricing power (downward sloping demand)
• leading to some degree of non-price competition

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Monopolistic Competition
A common market structure for consumers in an economy

Many examples:

1. Hair salons
2. Coffee shops
3. Restaurants
4. Men’s and women’s clothing
5. Furniture stores

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Monopolistic Competition – differentiation the key

• Some differentiation of product for the firm is possible, allowing the

firm some pricing power so the demand curve for the firm is slightly
downward sloping.

• The demand curve for the firm is slightly downward sloping, since a
price increase of its product causes a decrease in the quantity
demanded by customers. MR will also be downward sloping.

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 Monopolistic Competition
Example: Sushi Roll business:

1. After returning to Brisbane from holidays in Japan, you feel there

is an opportunity to sell sushi rolls in the city.
2. There are no other shops selling sushi rolls in Brisbane at that
time.
3. You open for business and set a price for the sushi rolls that
allow you to more than cover all costs, including the opportunity
cost.

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Example: Sushi business – short run outcome

Price, MR, MC, ATC ($/roll)

MC
ATC

Economic profit Demand

MR
0 1 2 3 4 5 6 7
Qprofit max Quantity (sushi rolls)
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Monopolistic Competition
Initially, in the short run:

• Few other sushi roll business owners

• A downward sloping demand curve as there are many other
substitutes (take-aways)
• Positive economic profits
• An ability to have some control over pricing with customers happy to
pay “a little extra” for the added value of your product

Lecture 8 ECON1010 47

Monopolistic Competition
Example: Sushi business (scenario continues)

• Business is great for the first couple of years, with much higher
returns on investment than expected
• After about 5 years however, there are several sushi bars operating
in the city
• You’ve tried to reinvest some of the previous profits to buy better
machines, as well as try to cut costs, yet profits have declined year
after year
• Soon, things are looking tight

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 Example: Sushi Roll business
Long run (no economic profit)

MC
Price, MR, MC, ATC ($/roll)

ATC

P = ATC

MR
0 1 2 3 4 5 6 7
Quantity (sushi rolls)
Lecture 8 ECON1010 49

In the long run (when everything can change)

• Monopolistic competition competes economic profits away

• Firms enter and exit the industry until only normal profits remain

• Constant battle to survive using innovation and differentiation to

meet customer needs

• Providing value to the consumer

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Summary
• From economist’s view, the existence of a single supplier in the
market (monopoly) results in an inefficient allocation of resources
(dead weight losses)

• From a firm’s perspective, resources satisfying opportunities to

develop market power, earn economic profits, and increase a firm’s
value

• From a government’s view, firms are encouraged to innovate to

benefit society, but government regulation is used to limit the extent of
the firm’s profits

Lecture 8 ECON1010 51

Next Lecture
Lecture 9

• Price Discrimination
• Imperfect competition – thinking strategically

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