Chapter-6 Lovewell

Understanding Economics
6th edition
by Mark Lovewell, Khoa Nguyen and Brennan Thompson
Chapter 6
Monopoly and Imperfect
Competition
Learning Objectives
⚪ In this chapter you will:

1. consider the demand conditions faced by
monopolists, monopolistic competitors,
and oligopolists
2. see how monopolists, monopolistic
competitors, and oligopolists maximize
profits
3. learn about nonprice competition, and the
arguments over industrial concentration
Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Monopolist’s Demand
⚪ A monopolist’s demand curve is the

same as for the entire market
• it is downward sloping

Demand Faced by a Monopolist
Figure 6.1, Page 130
Demand Curve for

Demand
Megacomp
Schedule
20
for Megacomp 0
Quantity a
Price Demanded 16
0
b
per computer)
($ millions per 12
(computers
millions
Price ($
0
computer) per year) c
8
0
$160 1 4 D
120 2 0
80 3
0 1 2 3 4
Quantity (computers per

year)

Monopolistic Competitor’s Demand
⚪ A monopolistic competitor’s demand

curve is elastic because of many
substitutes for the business’s product

Demand Faced by a Monopolist
Competitor
Demand Curve for Jaded

Demand Schedule
Palate
for
Jaded Palate 1
Quantity 2
1
Price Demanded 0
8 D
Price ($ per
($ per meal) (meals per 6
meal)
day)
4
$11 100 2
10 200
9 300 0
10 20 30 40
8 400 0 0 0 0
Quantity (meals per
day)

Oligopolist’s Demand
⚪ All oligopolies are characterized by

mutual interdependence.
⚪ Oligopolists in a market characterized
by rivalry face a kinked demand
curve.
• A business raising price finds rivals keep
theirs constant (so demand is flat).
• A business reducing price finds rivals
reduce theirs as well (so demand is
steep).

Actions and Reactions among Rivals in
an Oligopoly
Probable Effect on Company A’s

Action of Response of Company A’s Quantity
Company A Competitors Market Share Demanded
raise price keep prices product now large increase as

constant high-priced, so market share lost
market share falls to competitors
lower price match price since all companies small increase as

drop selling at lower lower prices for all
price, Company A’s companies attract
market share stays new buyers
constant

Demand Faced Among Rivals in an
Oligopoly
Demand Curve for Centaur

Demand
Cars
Schedule
For Centaur Cars 4
Quantity 0
Price ($ thousands per car)

Price Demanded 3
0
($ thousands (thousands 2
per car) of cars per year) 0
1 D
$35 10 0
30 20
20 25 0
1 2 3
10 30 0 0 0
Quantity (thousands of cars per year)

Oligopolist’s Kinked Demand

Cooperative Oligopolies
⚪ There are various ways that

oligopolists can cooperate
• Price leadership (One price followed by all)
• Collusion (As they are monopoly)
• Cartel (OPEC)

A Quick Test
⚪ Consider the following demand curves

facing a business: i) relatively
inelastic; (ii) perfect elasticity, (iii)
Kinked, and relatively elastic. Identify
which one best describes:
a) A perfect competitor
b) A monopolistic competitor
c) A monopolist
d) An oligopolist in a market where
rivalry exist
Revenue Conditions for a
Monopolist
⚪ A monopolist’s average revenue is the
same as the downward-sloping
market demand curve
⚪ A monopolist’s marginal revenue is
below its demand curve because
demand (average revenue) falls as
quantity increases

Revenues for a Monopolist
Revenue Curves for Megacomp

Revenue Schedules for
Megacomp 200
Price Quantity Total Marginal Average
$ Millions per Computer

160
(P) (Q) Revenue Revenue Revenue
(TR) (MR) (AR) 120
(P x Q) (ΔTR/ΔQ) (TR/Q)
($ millions ($ millions ($ millions 80
per (computers per per
computer) per year) ($ millions) computer) computer) 40
D =AR
0 $ 0 0
$160
$160 1 160 $160/1 = 160 1 2 3 4
80 -40
120 2 240 240/2 = 120
0
80 3 240 240/3 = 80 -80
-80 MR
40 4 160 160/4 = 40
Quantity of Computers per Year

Equilibrium of a firm with MC and
MR curves
Short Run Long Run
Normal Profit (TR=TC) Normal Profit (TR=TC)
Supernormal Profit (TR>TC)
Normal/Abnormal Loss (TR<TC)

Super Profit Curve

Normal Profit Curve

Loss Curve

Profit-Maximization for a
Monopolist (a)
⚪ A monopolist maximizes profit at the
quantity where marginal revenue and
marginal cost are equal. At this
output, they charge the highest
possible price, as found using the
demand curve.
⚪ A monopolist meets neither the
minimum-cost pricing nor the
marginal-cost pricing conditions.

Profit Maximization for a Monopolist (b)
Profit Maximization Table for Megacomp

Price Quantity Total Revenue Marginal Revenue Marginal Cost Average Cost
(P) (Q) (TR) (MR) (MC) (AC)
(AR) (P x Q) (ΔTR/ΔQ)
($ millions per (computers ($ millions per ($ millions per ($ millions per
computer) per year) ($ millions) computer) computer) computer)
0 $ 0
$160 $ 60
$160 1 160 $140
80 40
120 2 240 90
0 70
80 3 240 83
-80 150
40 4 160 100
Profit Maximization Graph for Megacomp

$ Millions per computer
200
MC
160
b
120 Profit = $60 AC
90 million
80 c
40 D
a
MR
0 1 2 3 4
Quantity of Computers per Year

Revenue Conditions for a
Monopolistic Competitor
⚪ A monopolistic competitor’s average
revenue is the same as its
downward-sloping demand curve.
⚪ A monopolistic competitor’s marginal
revenue is below its demand curve
because demand (average revenue)
falls as quantity increases.

P
Monopolistic competitors
Price and Costs
have an elastic demand curve,

but not perfectly elastic....
Q
P MC
Price and Costs
MR
Q
Q
Price & Output in Monopolistic
Competition
Complications:
⚪ persistent positive profits may persist
if:
• there is continuing & significant product
differentiation
• entry is somewhat limited by the financial
investment required to establish product
differentiation

Product Variety
⚪ Benefits
• better match to consumer tastes
• better products
• tradeoff between variety & efficiency
⚪ Further Complexity
• price, product & advertising must be
juggled to achieve maximum profit

Revenues for a Monopolistic Competitor
Revenue Schedules for Jaded

Palate
Price Quantity Total Revenue Marginal Revenue Average Revenue
(P) (Q) (TR) (MR) (AR)
($ meal) (meals per day) (P x Q) (ΔTR/ΔQ) TR/Q)
$-- 0 $ 0
1100/100 = $11
11 100 1100 1100/100 = $11
900/100 = 9
10 200 2000 2000/200 = 10
700/100 = 7
9 300 2700 2700/300 = 9
500/100 = 5
8 400 3200 3200/400 = 8
Revenue Curves for Jaded Palate
12
10
$ per Meal
8 D = AR
6
4 MR
0 100 200 300 400

Quantity of Meals per Year

Monopolistic Competitor (a)
⚪ The profit-maximizing quantity for a
monopolistic competitor is found
where marginal revenue and marginal
cost are equal. Price is found using
the business’s demand curve.
⚪ In the short run a monopolistic
competitor may make a profit or a
loss at its profit-maximizing point.

Monopolistic Competitor (b)
⚪ In the long run, a monopolistic
competitor breaks even.
• If profits (losses) are being made in the
short run, new businesses enter (leave)
the industry, pushing businesses’ demand
curves leftward (rightward) and making
them more (less) elastic.
⚪ The business meets neither the
marginal-cost pricing rules, since too
few units of output are produced.

Profit Maximization for a Monopolistic
Competitor (c)
Short-Run Profit Long-Run Profit

Maximization Maximization
For Jaded Palate For Jaded Palate
MC
b AC
10.0 MC
D AC
0
8.0 0
e
c 7.5
0 minimum point
0
$ per Meal
$ per Meal
D of AC
1
a d
MR MR
20 15
0 0
0 0
Quantity of Meals per Day Quantity of Meals per Day

Oligopoly
A market structure characterized by

competition among a small number of
large firms that have market power,
but that must take their rivals’ actions
into consideration when developing
their competitive strategies

Revenue Conditions for an
Oligopolist
⚪ An oligopolist in a market
characterized by rivalry has average
revenue identical with its kinked
demand curve
⚪ This business’s marginal revenue
curve has two linear segments which
are below its kinked demand curve

Profit-Maximization for an
Oligopolist (a)
⚪ The profit-maximizing quantity for
this type of oligipolist is found where
marginal revenue and marginal cost
are equal. Price is found using the
business’s kinked demand curve.
⚪ The oligopolist meets neither the
marginal-cost pricing rules.

Profit Maximization for an Oligopolist (b)
Profit Maximization Graph for

Centaur Cars
Profit Maximization Table for Centaur

Cars 40
Price Quantity Total Marginal Marginal Average b MC
(P) (Q) Revenue Revenue Cost Cost 30 Profit = $200
AC
(TR)
$ Thousands per car

(=AR) (MR) (MC) (AC) million
(P x Q) (ΔTR/ΔQ) 20
c
($ thousands (thousands ($ ($ ($ 10
Per car) of cars per ($ thousands thousands thousands a D
year) millions) per car) per car) per car) 0
10 20 30
-- 0 0 -10
35 15 30
$35 10 350 -20
25 10 20
30 20 600 -30
-20 15 19
20 25 500
-40 25 20 -40
10 30 300 MR
Quantity (thousands of cars per year)

Why do economists study “games”
?
⚪ In a perfectly competitive market, each firm must take the
market price as a given
• Only decision a firm can make = how much to produce
⚪ Because there are no future feedback effects from that
decision, no strategic choices exist at the firm level
⚪ But many (most) markets are not like that
⚪ When the firm’s decisions can influence the market price, the
firm knows this will affect behavior of other firms – which will
influence future markets
• Strategic choices now have to be made
⚪ i.e. firms want to make the winning choice, knowing that
their competitors will respond to that choice

Theory of Games
⚪ The payoff of many actions depends upon the actions of

others
• An imperfectly competitive firm must weigh the
responses of rivals when deciding whether or not to
cut prices
⚪ Implication: decisions of competing firms are
interdependent
⚪ Game theory
• A huge change in how economists now do economic
theory
⚪ influential in many applied areas
● economic analysis of industrial organization
● international trade
● And many other areas

Game Theory Overview
⚪ oligopolists must make plans in light

of the actions & expected reactions of
their rivals
⚪ basic concepts:
• players
• rules
• strategies
• Payoffs
⚪ Equilibrium

Strategies
⚪ Dominant strategy:
• A strategy that yields a higher payoff no
matter what the other players in a game
choose
⚪ Dominated strategy:
• Any other strategy available to a player
who has not a dominant strategy
⚪ Nash Equilibrium:
• Any combination of strategies in which
each player’s strategy is his best choice,
given the other players’ strategies
Nash Equilibrium
⚪ Strategies for which all players are

choosing their best strategy, given
actions of other players
⚪ Proves useful when there is only one
unique equilibrium in the game
⚪ There may be multiple Nash
equilibrium

Prisoner’s Dilemma
⚪ The Prisoner’s Dilemma

• A classic example of potential conflict
between the narrow self-interest of
individuals and the broader interest of
larger communities
⚪ Many practical examples from other areas of
life
⚪ Prisoner’s Dilemma:
• Each player has a dominant strategy
• The dilemma is: Payoffs are smaller than
they would be if each player had played a
dominated strategy
⚪ two prisoners cannot communicate

⚪ difficult to cooperate, even when
mutually beneficial
⚪ dominant strategy produces less
favourable outcome than if the
players cooperate.
⚪ Incentive to cheat even if they agree
to cooperate

Al’s strategies
Confess Not confess
A 4 B 12
Confess
strategies
4 1
Bruno’s
Not C 1 D 2
confess
12 2

Strategies in a Two-firm Oligopoly
Rare Air’s price strategy
High Low
A $12 B $15
Uptown’s price
High
$12 $6
strategy
Low C $6 D $8
$15 $8

co
te llu Rare Air’s price strategy
nd si
en ve If both
cie High Low
s firms
A $12 B $15 choose a
Uptown’s price
High high-price
$12 $6
strategy
strategy,
each
Low C $6 D $8 earns $12
$15 $8 million in
profit

Rare Air’s price strategy If Rare Air
Low
uses a
High
low-price
A $12 B $15 strategy
Uptown’s price
Uptown’s
High against
$12 $6
strategy
profits fall to Uptown’s

$6 million high prices,
Low C $6 D $8 profits will
$15 $8 increase to
$15 million

Uptown
High Low could also
profit by
A $12 B $15 switching to
Uptown’s price
High
lower prices,
$12 $6
strategy
as long as
C D Rare Air
Low $6 $8 charges high
$15 $8 prices

High Low
A $12 B $15 If both firms

Uptown’s price
High shift to a
$12 $6
strategy
low-price
strategy,
Low C $6 D $8 profits are
$15 $8 $8 million

High Low
A $12 B $15 Incentive to

Uptown’s price
High cheat
$12 $6
strategy
Low C $6 D $8
$15 $8

Nonprice Competition
⚪ Nonprice competition is used by

monopolistic competitors and
oligopolists
• product differentiation
• advertising
⚪ Nonprice competition raises a business’s
revenue and costs
⚪ Nonprice competition may or may not be
beneficial to businesses and consumers

Industrial Concentration
⚪ Industrial concentration refers to

market domination by a few large
businesses.
• It can provide the consumer with benefits
due to increasing returns to scale.
• It can impose costs on the consumer due
to market power.
• It may or may not encourage technical
innovation.

Understanding Economics
6th edition
by Mark Lovewell, Khoa Nguyen and Brennan Thompson
Chapter 6
The End

Chapter-6 Lovewell

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Understanding Economics

⚪ In this chapter you will:

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

⚪ A monopolist’s demand curve is the

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand Curve for

Quantity (computers per

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

⚪ A monopolistic competitor’s demand

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand Curve for Jaded

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

⚪ All oligopolies are characterized by

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Probable Effect on Company A’s

raise price keep prices product now large increase as

lower price match price since all companies small increase as

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand Curve for Centaur

Price ($ thousands per car)

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

⚪ There are various ways that

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

⚪ Consider the following demand curves

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Revenue Curves for Megacomp

$ Millions per Computer

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Short Run Long Run

Normal Profit (TR=TC) Normal Profit (TR=TC)

Supernormal Profit (TR>TC)

Normal/Abnormal Loss (TR<TC)

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

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Profit Maximization Table for Megacomp

Profit Maximization Graph for Megacomp

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have an elastic demand curve,

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Revenue Schedules for Jaded

Revenue Curves for Jaded Palate

0 100 200 300 400

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Short-Run Profit Long-Run Profit

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A market structure characterized by

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Profit Maximization Graph for

Profit Maximization Table for Centaur

$ Thousands per car

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⚪ The payoff of many actions depends upon the actions of

Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.