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Topic 6 Imperfect Market Structure: Monopoly, Monopolistic & Oligopoly Topic Outline - Monopoly
Topic 6 Imperfect Market Structure: Monopoly, Monopolistic & Oligopoly Topic Outline - Monopoly
Topic 6
6.1 Characteristics
IMPERFECT MARKET 6.2 Short-run Decision: Profit Maximization
STRUCTURE: MONOPOLY, 6.3 Short-run Decision: Minimizing Loss
MONOPOLISTIC 6.4 Long-run Profit Maximization & Misconception
& 6.5 Social Cost of Monopoly
OLIGOPOLY 6.6 Price Discrimination
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Characteristics:
Monopoly: l One seller and large number of buyers:
l Firm supply is equal to the whole market/industry supply.
l The monopolist is a firm as well as an industry in itself.
l Definition:
l Product has no close substitute :
l Unique product with no competition.
l Existence of a single seller in the market who
produces goods that have no substitutes. l Price maker :
l Monopoly can influence either the market price or quantity
l An industry with a single firm in which the entry of
supplied.
new firms is blocked. l Constraint by demand behavior of consumers.
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(iii) Cost of establishing an efficient plant:
l This is the case of natural monopoly.
l A natural monopoly exists when one firm can (iv) Government franchises:
meet the entire market demand at a lower price
as compared to two or more firms. • The government will give an exclusive rights to a
l Example; Tenaga Nasional Berhad (TNB)
firm to sell certain goods and services in certain
area.
Ø 5 small firms in the industry: Ø One large firm in the industry:
• Example; the government has given the right to
install the satellite television system to ASTRO in
Each firm can produce 100,000 produce 500,000 at lower cost
Ø
units, but produce at higher costs
Ø
($1) due to economies of scale.
Malaysia.
($5).
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Demand Curve and Elasticity of Demand: Short-run Decision: Profit Maximization
l MR = MC
The monopolist will fix a higher price if demand is inelastic
and a lower price if demand is elastic. l Profit maximizing output
l No incentive to change the output.
l When demand is elastic (Ed >1):
l a decrease in price increases total revenue l MR < MC
l the firm to decrease output as the cost would be
l When demand is unitary/ unit elastic higher than revenue
(Ed = 1):
l Total revenue is maximum
l MR > MC
l it would be better off for the firm to increase output
l When demand is inelastic (Ed < 1):
l an increase in price increases total revenue
The monopolist is a price maker because can select the price that
maximizes profit.
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l Supernormal profit:
ATC
l Profit that earned by a firm when its (TR > TC) or (P >
ATC). • TR > TC
P • P > ATC
l Normal profit: ATC
l Profit that earned by firm when its (TR = TC) or (P = ATC)
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ATC
ATC
• TR = TC P
P = ATC • P = ATC • TR < TC
• P < ATC
DD=AR DD=P=AR
MR MR
Quantity of Quantity of
0 output 0 output
Q Q
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Short-run Decision: Minimizing Loss Subnormal Profit – Continue:
Price / cost
MC
l Firm suffer losses: ATC
ATC • TR < TC
l The monopolist will continue to produce rather than shut
AVC • P < ATC
down in the short run if price exceeds average variable P
• P > AVC
cost (P>AVC).
l The monopolist will shut down in the short run if price AVC
exceeds average variable cost (P>AVC).
DD=P=AR
MR
Quantity of
0 output
Q
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Price / cost
Subnormal Profit – Shut down: ATC Long Run Profit Maximization
MC
ATC AVC l Long-run is the time period in which the firm can
adjust its input used in the production.
l A monopolist firm in the long-run is also in
• TR < TC
AVC
equilibrium at a point where MR = MC.
P • P < ATC
• P < AVC
l A monopolist that earns economic profit in the
short-run may find that profit can be increased in
the long run by adjusting the scale of the firm.
DD=P=AR
l A monopoly that suffers a loss in the short run
MR
may be able to eliminate that loss in the long run
0
Quantity of
output
by adjusting to a more efficient size.
Q
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Deadweight Loss: Try this!!
D
E Producer
Surplus
Total
Surplus
Deadweight Loss????
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Definition: Conditions:
l Monopoly Power:
l Charging different prices to ü The sellers must be a monopolist or at least must
posses some ability to control output and price (price
different buyers for the same maker).
good or different prices for the l No resale:
üAbility to prevent those who pay the lower price
same good on different units from reselling the product to those who pay the
sold. higher price.
l Market Segregation:
ü Identify and separate different buyers based on
different elasticity of demand.
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Question
Topic Outline –
The following graph shows LR equilibrium for ARWIN BHD. Monopolistic Competition
6.7 Characteristics
6.8 Short-run Decision: Profit Maximization
6.9 Short-run Decision: Minimizing Loss
6.10 Long-run Equilibrium
6.11 Monopolistic versus Perfect Competition
a) Identify the profit maximizing price and output.
b) Calculate the profit earned by the firm and
identify the type of profit.
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Characteristic (Cont.)
Characteristic (Cont.)
l Many seller
§ There are many firms competing for the same
l Price maker
group of customers. ¡ Control over price ‘Price makers’
§ Product examples include computer games, ¡ Downward sloping demand curve
restaurants, cookies, furniture, etc.
l Product differentiation
l Free entry and exit
¡ The firms produce goods which are differentiated.
§ Firms can enter or exit the market without
restriction.
¡ Each seller will use various methods to
differentiate their products from other sellers. § The number of firms in the market adjusts
until economic profits are zero.
¡ Differentiation of the product may be through the
packaging, design, labeling, advertising and § In the long run, firms earn zero economic
brand names. profit or normal profit.
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ATC ATC
• TR > TC • TR = TC
• P > ATC P = ATC • P = ATC
P
ATC
DD=AR DD=AR
MR MR
Quantity of Quantity of
0 Q output 0 Q output
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Economic Loss / Subnormal
Profit
SHORT-RUN DECISION: MINIMIZING
Price / cost LOSS
MC
ATC ATC
DD=AR DD=AR
MR MR
Quantity of Quantity of
0 Q output 0 Q output
LONG-RUN EQUILIBRIUM
LONG-RUN EQUILIBRIUM
Free entry:
l If the firms are making economic profit /
supernormal profit in the short-run, they will
attract more firms to enter the market.
l Decrease the demand for existing firms, so
the demand curve will shift leftward.
l The process will continue until all profits are
eliminated and (P = ATC).
l In the long-run, a monopolistic firm will earn
normal profit.
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LONG-RUN EQUILIBRIUM
LONG-RUN EQUILIBRIUM
Free exit:
l If the firms are making economic loss /
subnormal profit in the short-run, the existing
firms will exit from the market.
l Increase the demand for existing firms, so
the demand curve will shift rightward.
l The process will continue until all losses are
eliminated and (P = ATC).
l In the long-run, a monopolistic firm will earn
normal profit.
RESOURCE ALLOCATION
1. Excess Capacity:
The two key differences between • A firm’s efficient scale is the quantity at which ATC is a
minimum.
Monopolistic Competition and • Perfect competitive firm produces at P = min ATC
Perfect Competition are that in (efficient scale).
• A monopolistic competitive firm has excess capacity
Monopolistic Competition, there is because the quantity (QMC) it produces is less than
quantity at which ATC is a minimum (QPC). P ≠ min
excess capacity & a markup of ATC
price. 2. Markup
§ A monopolistic competitive firm’s markup is the amount
by which P > MC.
§ In perfect competition, the firm produces at P = MC.
MR
D
MR
Qmc Qc Quantity
QMC Quantity QPC Quantity
(efficient scale)
Excess Capacity
(when firm in monopolistic produces output
less than efficient point)
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Characteristic of Oligopoly
Topic Outline - Oligopoly l Few in number but large in size
l The market share of each firm is large enough
to dominate the market and its controlled by a
6.12 Characteristic few firms.
l Interdependent
6.13 Oligopoly Model l The behavior of oligopoly firms depend on the
(a) The Collusion Model behavior of other firms in the industry before
making the decision.
(b) The Kinked Demand Curve Model
l Homogeneous or differentiated product
(c) The Price-Leadership Model
l The products sold may be homogeneous or
differentiated.
l Example: Petroleum (homogenous) and
automobiles (differentiated). 50
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l Barriers to entry
(a) Collusion Model
l Scale economies (reduce LRATC as Q l Agreement among firms to
increases)
l Divide the market
l Patents l Fix the price
l Technology
l Name recognition l Cartel
l Group of firms that agree to collude
l Incentive to collude (join together)
l Act as monopoly
l Colluding firms usually reduce output,
l Increase economic profit
increase price, and block the entry of new
l Example: Organization of Petroleum Exporting
firms to achieve the monopoly power.
Countries (OPEC).
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Kinked Demand Curve Model and Price Rigidity
Oligopoly Model (cont.)
§ The kinked demand (c) The Price-Leadership Model
curve creates a gap in
the MR curve, illustrates
the price rigidity of a • The dominant firm (leader) set a
firm in an oligopoly. price level .
§ Equilibrium price and • Then, the smaller firms (followers)
quantity occur at P* and
Q*, when MR = MC. follow its pricing policy due to
§ As long as MR intersect assumption that products are
with MC c urve in t he identical.
gap, price and output
will remain constant.
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