Market and market structures

The market is defined elaborately in explanatory notes.

Economists understand the term market, not any particular marketplace in which things are
bought and sold, but the whole of any region in which buyers and sellers are in such close
contact with one another that the prices of the same goods tend to equality easily and quickly.
Thus, the market is a network of dealings between potential buyers and potential sellers. At
any point in time, a market will exist if there are:
1) Buyers and sellers
2) A product or service to be bought and sold
3) Price of the product
4) Close contact between buyers and sellers
5) Knowledge about the market
1) Very short period: Very short period is a period in which supply is fixed and the price is
determined by the demand. The period is of a few days or weeks in which the supply of
commodities cannot be increased.
2) Short period: Short period is less than one year. In this period, firms can only make
adjustments in inputs like labour
to increase the supply.
3) Long-period: long run is a period in which all factors of production and costs

How do firms establish their prices and output levels to achieve their business objective of
profit maximization?
The pricing and output decision will be answered within the framework of four basic types of
markets: perfect competition, monopoly, monopolistic competition, and oligopoly. Market
power is simply the power of a firm to establish the price of its products.
The Meaning of Competition
1. Degree/intensity of competition - the ability of firms to control the price and use it as
a competitive weapon.

2. the ability of a firm to earn an “above normal” or “economic” profit in the long run.
Market power is the ability to increase the product's price above marginal cost without losing
all customers.
Perfect Competition

1
It represents a situation where competition is at a maximum; it is therefore sometimes
referred to as pure competition or atomistic competition. There are five main conditions for
perfect competition to exist:
1 Many buyers and sellers. Each of these must buy or sell such a small proportion of the total
market output that none can have any influence over the market price.
2 Homogeneous product. Each firm must be producing an identical product, for example,
premium unleaded petrol or skimmed milk.
3 Free entry and exit from the market. This means that there are no barriers to entry or exit
that give incumbent firms an advantage over potential competitors who are considering
entering the industry. These barriers, which can represent either demand or cost advantages,
are explained in more detail in the next section.
4 Perfect knowledge. Both firms and consumers must possess all relevant market information
regarding production and prices. Both the parties to the transaction are having complete
knowledge about the product, quantity, price, market, and market conditions as well.
5 Zero transportation costs. Transportation and Advertising cost is nil.This means that it does
not cost anything for firms to bring products to the market or for consumers to go to the
market.
6 Free from government interference.
7 The price for a product is uniform across the market. It is decided by the demand and
supply forces; no firm can affect the prices, and that’s why the firms are price takers.
8 Each firm earns a normal profit.
Example: Suppose you go to a vegetable market to buy tomatoes. There are many tomato
vendors and buyers. You go to a vendor and inquire about the cost of 1 kg of tomatoes, the
vendor replies, it will cost Rs. 50. Then you go ahead and inquire about some more vendors.
The prices of all the vendors are the same for the demanded quantity. This is an example of
perfect competition.
The markets for agricultural products (e.g., corn, wheat, coffee, pork bellies), financial
instruments (e.g., stocks, bonds, foreign exchange), precious metals (e.g., gold, silver,
platinum), and the global petroleum industry provide good examples of this type of market.
In each market, the products are standardized commodities, and supply and demand are the
primary determinants of their market price. Of course, it is precisely because of this that
sellers sometimes form cartels to raise the price or to keep it from falling. OPEC and the
International Coffee Growers Association are good examples of this.
Under the above conditions, firms in the market will be price-takers; there will be one, and
only one, market price, meaning that the product will sell at the same price in all locations. It
is clear that these conditions are rarely achieved in reality; however, this does not negate the

2
usefulness of the analysis of perfect competition. Once again it is necessary to remember that
a theory should be judged not based on the realism of its assumptions but on its ability to
explain and predict. The conditions are approximately approached in some markets, for
example, agricultural products and stock markets. Furthermore, the analysis and conclusions
in terms of conduct and performance provide a useful benchmark for comparing other forms
of market structure.
Definition of Imperfect Competition
The competition, which does not satisfy one or the other condition, attached to perfect
competition is imperfect competition. Under this type of competition, the firms can easily
influence the price of a product in the market and reap surplus profits.
In the real world, it is hard to find perfect competition in any industry, but there are so many
industries like telecommunications, automobiles, soaps, cosmetics, detergents, cold drinks,
and technology, where you can find imperfect competition. By the virtue of this, imperfect
competition is also considered real-world competition.
It is important to distinguish between the individual firm and the industry as a whole.
Basis For Perfect Competition Imperfect Competition
Comparison
Meaning Perfect Competition is a type of Imperfect Competition is an
competitive market where numerous economic structure, which does
sellers are selling homogeneous products not fulfill the conditions of perfect
or services to numerous buyers. competition.
Nature of Theoretical Practical
concept
Product None Slight to Substantial
Differentiation
Players Many Few to many
Restricted entry No Yes
Firms are Price Takers Price Makers (market power)

Let us summarize the key assumptions made in analyzing the firm’s output decision in
perfect competition.
1. The firm operates in a perfectly competitive market and therefore is a price taker.
2. The firm makes the distinction between the short run and the long run.
3. The firm’s objective is to maximize its profit in the short run. If it cannot earn a profit,
then it seeks to minimize its loss.
4. The firm includes its opportunity cost of operating in a particular market as part of its

3
total cost of production.
The basic profit-maximizing model incorporates the following assumptions:
1 The firm has a single decision-maker.
2 The firm produces a single product.
3 The firm produces for a single market.
4 The firm produces and sells in a single location.
5 All current and future costs and revenues are known with certainty.
6 Price is the most important variable in the marketing mix.
7 Short-run and long-run strategy implications are the same.
The firm’s demand function
Under the conditions of PC, the firm will be a price-taker. This means that each firm faces a
perfectly elastic (horizontal) demand curve, at the level of the prevailing market price. The
economic interpretation of this is that if the firm charges above the market price it will lose
all its customers, who will then buy elsewhere, and that there is no point in charging below
the market price, because the firm can sell all it wants, or can produce, at the existing price.
The level of the prevailing market price is determined by demand and supply in the industry
as a whole, as shown in Figure The demand curve in this case represents both average
revenue (AR) and marginal revenue (MR), since both of these, is equal to the market price
(P).
The equilibrium market price, P1 is determined by the demand and supply functions in the
industry as a whole. The firms in the industry, as price-takers, then have to determine what
output they will supply at that price. This output, q 1, is where P1=MC , since this will
maximize profit.

4
Since it is assumed that opportunity costs are included in the measurement of unit costs it can
be deduced that if the market price is equal to the average total cost (ATC), the firm will just
make a normal profit. This is defined as the profit that a firm must make for it to remain in
its current business. If a firm cannot cover all its opportunity costs, meaning that P <ATC,
then it should leave the industry in the long run since the owners of the business can use the
resources more profitably elsewhere. If P < AVC then the firm should shut down in the short
run since it cannot even cover its variable costs, let alone make any contribution to fixed
costs.
However, if P>ATC, the firm is making an abnormal or supernormal profit. In Figure, this is
given by ( P1−C ) q1 . This means that the industry is more profitable than average and this will
in turn attract new firms into the industry in the long run, since it is assumed that there are no
entry or exit barriers.
Illustrative Example
The market for milk in a certain town is perfectly competitive. The market demand is given
by:
Q=16−20 P
Alternatively, this can be written as
P=0.8−0.05 Q (A)
where P is the price of milk in £/liter and Q is the quantity of milk in the market in lakhs of liters per
day. There are a hundred (100) firms in the industry and each has the following marginal cost
function:
P=0.44+ 4 q
where q is the quantity produced by each firm. Firms also have fixed costs of £80 per day.
Alternatively, this can be written as
q=−0.11+0.25 P
Therefore the industry (having 100 firms) supply curve is given by
Q=100 q=11+25 P
This can be turned around to give Supply Curve:
P=0.44+0.04 Q (B)
Solving (A) and (B)
P=0.8−0.05 Q
P=0.44+0.04 Q
Gives P=0.6 and Q=4
Thus the short-run equilibrium price in the market is £0.60/liter and the quantity
produced is 400,000 liters per day.

5
Industry Revenue = 0.6 x 400,000 = £240000
Industry Total variable Cost = 0.44 + 0.04 Q = 0.44 + 0.04 x 4 =
0.6 x 400,000 = £240000
Long-run analysis
Each firm will sell 4,000 liters per day (q=0.04), and its average cost is calculated by
substituting this value into its ATC function. This function can be obtained by considering
the firms’ TC function. The TC function is obtained by integrating the MC function, equal to
MR or the price is given by MC=P=0.44+ 4 q . This gives:
TC =a+ 0.44 q+2 q 2
Firms also have fixed costs of £80 per day and since TC is measured in lakhs of pounds (because of
the units of q and Q ), this gives:
2
TC =0.0008+0.44 q+2 q
The ATC would be
TC 0.0008
ATC= = +0.44 +2 q
q q
With q=0.04 ,
0.0008
ATC= +0.44 +2× 0.04 = 0.54
0.04
This means that each firm will make an economic profit given by (0.6 -0.54)x0.04 =0.0024
=£240
£240 per day.
In the long run, this will attract new firms into the industry and drive the price down to the minimum
level of long-run average cost. Since it has been assumed that the firm is already operating at the most
efficient scale, we have to find the minimum level of average cost for this scale and this will also be
the minimum level of long-run average cost. We, therefore, have to differentiate the ATC function
and set the derivative equal to 0:
d ( ATC ) −0.0008
ATC= = +2
dq q2
This gives q= 0.02 (2,000 liters per day) and
0.0008
ATC= +0.44 +2 q=0.04+0.44 +0.04=0.52
q
Therefore the long-run equilibrium price, equal to ATC, is £0.52 per liter, and the market output is
given by the demand function
P=0.8−0.05 Q
0.52=0.8−0.05 Q
Q=5.6∨5,60,000 liters

6
Thus, long run selling price P = £0.52 per liter and market output or supply of 5 , 60,000 liters

Calculate the profit-maximizing output and profit for the firms when market
equilibrium P ¿ 16. Calculate the market price at which profits would be zero.
Suppose the cost of each firm is given by the short-term total cost
2
TC =72+4 Q+ 2Q
Solution
∂TC
MC ¿ =4 +4 Q
∂Q
MR = P = 16
MC = MR gives Q ¿ =¿ 3
TR= Q ¿ × P=¿ 48
You should
2
TC =72+4 Q+ 2Q = 102
Profit = TR – TC = 48 -102 = -54
Zero economic profit that includes opportunity cost and normal profit
P = MC and P = AC
72
4 + 4 Q= + 4+2 Q
Q
Q = 6, P = 28
Monopoly
After an analysis of perfect competition, it is usual to consider monopoly next. Again, this is not
because this is a frequently found type of market structure, but because as an extreme form, it
provides a benchmark for comparison.
Monopoly may be the result of: (1) increasing returns to scale; (2) control over the supply of
raw materials; (3) patents; or (4) government franchise. A monopoly is the opposite of perfect
competition in every facet of its organization.
Patent laws sometimes provide companies with temporary monopolies. The pharmaceutical
industry is said to earn economic profit during the time in which its products are protected by
patents. The dominance of Microsoft in PC operating systems has led to its antitrust
problems.
Conditions
Monopoly means a single seller in an industry. However, it is preferable to define a monopoly as
being a firm that has the power to earn supernormal profit in the long run. This ability depends on two
conditions:

7
1 There must be a lack of substitutes for the product. This means that any existing products are not
very close in terms of their perceived functions and characteristics. Electricity is a good example.
2 There must be barriers to entry or exit. These are important in the long run to prevent firms from
entering the industry and competing away the supernormal profit. It is useful to distinguish between
structural and strategic barriers. Structural barriers often referred to as natural barriers, occur
because of factors outside the firm’s control, mainly when an incumbent firm has a natural cost or
marketing advantages or is aided by government regulations. Strategic barriers occur when an
incumbent firm deliberately deters entry, using various restrictive practices, some of which may be
illegal.
These practices will not be possible if the market is contestable.
The following conditions are necessary for a market to be contestable:
1 There are an unlimited number of potential firms that can produce a homogeneous
product, with identical technology.
2 Consumers respond quickly to price changes.
3 Incumbent firms cannot respond quickly to entry by reducing the price.
4 Entry into the market does not involve any sunk costs

A monopoly has these five characteristics:

 Profit maximizer: Maximizes profits.

 Price maker: Decides the price of the good or product to be sold, but does so by
determining the quantity to demand the price desired by the firm.
 High barriers to entry: Other sellers are unable to enter the market of the monopoly.
 Single seller: In a monopoly, there is one seller of the good, who produces all the
output. Therefore, the whole market is being served by a single company, and for
practical purposes, the company is the same as the industry.
 Price discrimination: A monopolist can change the price or quantity of the product. They
sell higher quantities at a lower price in a very elastic market and sell lower quantities at a
higher price in a less elastic market.
Let us now assume that the milk market is supplied by a monopoly rather than a perfectly
competitive market.
Demand: Q=16−20 P Alternatively, this can be written as P=0.8−0.05 Q
MC=0.44 +4 Q
2
TC =0.0008+0.44 Q+2 Q
Solved in following steps
1. P=0.8−0.05 Q
2. R=PQ =0.8 Q−0.05 Q2

8
 dR
3. M R= =0.8−0.1Q
dQ
4. Given MC=0.44 +4 Q, equate MC = MR
0.44+ 4 Q=0.8−0.1Q
Q=2.57143∨257,143 liters per day
5. . P=0.8−0.05 Q=0.8−0.05 × 2.57143=£ 0.67
TR = 0.67 x2.57143=¿ £172,286
TC ¿ £172,286

The price is higher and the output lower than in perfect competition. Profit can also be
calculated by computing the total costs and revenues. The total revenue is £172,286, and the
total cost is £134,244, and this gives a total profit of £37,942 per day. This compares with a
total profit in the industry of £24,000 per day under perfect competition (in the short run).

Given the demand function and cost function,

Demand function: Q=24−P
Cost function TC=¿)
Determine price and output that optimizes profit for a monopolist firm

Demand function: Q=24−P or Inverse demand function: P=24−Q

Cost function TC =¿)
Total Revenue TR = P x Q= (24−Q ) Q = 24 Q−Q2
dTR
MR= =24−2 Q
dQ
The cost functions TC=¿) has two parts :Total fixed cost (TFC) = 12 ( at Q = 0) and variable
cost TVC = Q2
dTC
MC= =2Q
dQ
Equating MR=MC → 24−2 Q=2 Q gives Q ¿ =6
Thus, the optimal production level that maximizes the profit is Q¿ =6
The optimal price is P¿ =24−Q ¿ = 18
¿ ¿
Maximum TR = P ×Q =18 ×6=¿ 108
Minimum TC = 12+ ( Q¿ )2 =12+ 62=12+36 = 48 i.e. TFC = 12 and TVC = ( Q¿ )2 = 36

9
 ¿
Optimal profit = π =TR−TC =(108−48) = 60
TFC 12
Average Fixed Cost = AFC= ¿ = =2
Q 6
TVC 36
Average Variable Cost = AVC= ¿ = =6
Q 6
TC 48
AC = Average Cost = AFC + AVC = 2 + 6 = 8 OR AC = ¿ ¿ =8
Q 6
Another method
Profit = TR – TC = ( 24 Q−Q2 )−( 12+Q2 ) = = ( 24 Q−2Q 2−12 )
dπ
Profit is maximized by setting =0 → 24 – 4Q =0
dQ
Q¿ =6
According to the standard model, in which a monopolist sets a single price for all consumers,
the monopolist will sell a lesser quantity of goods at a higher price than would companies
by perfect competition. Because the monopolist ultimately forgoes transactions with
consumers who value the product or service more than its price, monopoly pricing creates
a deadweight loss referring to potential gains that went neither to the monopolist nor to
consumers. Deadweight loss is the cost to society because the market isn't in equilibrium, it is
inefficient. Given the presence of this deadweight loss, the combined surplus (or wealth) for
the monopolist and consumers is necessarily less than the total surplus obtained by
consumers by perfect competition. Where efficiency is defined by the total gains from trade,
the monopoly setting is less efficient than perfect competition.

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Examples of monopoly exploitations
Petroleum
Standard Oil was an American oil-producing, transporting, refining, and marketing company.
Established in 1870, it became the largest oil refiner in the world. John D. Rockefeller was a
founder, chairman, and major shareholder. The company was an innovator in the
development of business trust. The Standard Oil trust streamlined production and logistics,
lowered costs, and undercut competitors. "Trust-busting" critics accused Standard Oil of
using aggressive pricing to destroy competitors and form a monopoly that threatened
consumers. Its controversial history as one of the world's first and largest multinational
corporations ended in 1911 when the United States Supreme Court ruled that Standard was an
illegal monopoly. The Standard Oil trust was dissolved into 33 smaller companies; two of its
surviving "child" companies are ExxonMobil and the Chevron Corporation.
Steel
U.S. Steel has been accused of being a monopoly. U.S. Steel made 67 percent of all the steel
produced in the United States. 
Diamonds
De Beers settled charges of price fixing in the diamond trade in the 2000s. De Beers is well
known for its monopoly practices throughout the 20th century, whereby it used its dominant
position to manipulate the international diamond market. The company used several methods
to exercise this control over the market. Firstly, it convinced independent producers to join its
single channel monopoly, it flooded the market with diamonds similar to those of producers
who refused to join the cartel, and lastly, it purchased and stockpiled diamonds produced by
other manufacturers to control prices through limiting supply.
In 2000, the De Beers business model changed due to factors such as the decision by
producers in Russia, Canada, and Australia to distribute diamonds outside the De Beers

11
channel, as well as the rising awareness of blood diamonds that forced De Beers to "avoid the
risk of bad publicity" by limiting sales to its own mined products. De Beers' market share by
value fell from as high as 90% in the 1980s to less than 40% in 2012, having resulted in a
more fragmented diamond market with more transparency and greater liquidity.
Price discrimination allows a monopolist to increase its profit by charging higher prices for
identical goods to those who are willing or able to pay more. For example, most economic
textbooks cost more in the United States than in developing countries like India. In this case,
the publisher is using its government-granted copyright monopoly to price discriminate
between the generally wealthier American economics students and the generally poorer
Indian economics students. Similarly, most patented medications cost more in the U.S. than
in other countries with a (presumed) poorer customer base. Typically, a high general price is
listed, and various market segments get varying discounts. This is an example of framing to
make the process of charging some people higher prices more socially acceptable. Perfect
price discrimination would allow the monopolist to charge each customer the exact maximum
amount they would be willing to pay. This would allow the monopolist to extract all
the consumer surplus of the market. A domestic example would be the cost of airplane flights
about their takeoff time; the closer they are to the flight, the higher the plane tickets will cost,
discriminating against the late planners and often business flyers. While such perfect price
discrimination is a theoretical construct, advances in information
technology and micromarketing  may bring it closer to the realm of possibility.

Monopolistic competition
Although economics textbooks tend to concentrate more on discussing perfect competition
and monopoly, monopolistic competition and oligopoly are more prevalent in practice. The
theory of monopolistic competition, as an intermediate form of market structure between
perfect competition and monopoly, was originally developed by Chamberlin in 1933.
There are five main conditions for monopolistic competition:
1 There are many buyers and sellers in the industry.
2 Each firm produces a slightly differentiated product.
3 There are minimal barriers to entry or exit.
4 All firms have identical cost and demand functions.
5 Firms do not take into account competitors’ behaviour in determining price and output.
Monopolistic competition refers to the market organization in which many firms are selling
closely related but not identical commodities. An example is given by the many cigarette
brands available (e.g., Marlboro, Bristol, Charminar). Another example is given by the many
different detergents on the market (e.g., Surf, Tide,Wheel). Because of this product
differentiation, sellers have some degree of control over the prices they charge and thus face a

12
negatively sloped demand curve. However, the existence of many close substitutes severely
limits the sellers' “monopoly” power and results in a highly elastic demand curve.
In monopolistic competition, many firms are selling a differentiated product or service. It is a
blend of competition and monopoly. This market is deemed to be monopolistic because
product differentiation enables firms to exercise some market power (i.e., to act as price
makers). The competitive elements result from a large number of firms and easy entry. The
monopoly element results from differentiated (i.e., similar but not identical) products or
services. Product differentiation may be real or imaginary and can be created through
advertising. However, the availability of close substitutes severely limits the “monopoly”
power of each firm.
Monopolistic competition is the most prevalent form of market organization in retailing. The
numerous grocery stores, gasoline stations, dry cleaners, etc. within the close-proximity of
each other are good examples. Examples of differentiated products include numerous brands
of headache remedies (e.g., aspirin, Bufferin, Excedrin, etc.), soaps, detergents, breakfast
cereals, and cigarettes. Even if the differences are imaginary (as in the case of various brands
of aspirin), they are economically important if the consumer is willing to pay a little more or
travel a little further for a preferred brand.
Small businesses, particularly retail and service establishments, provide the best examples of
this kind of market. Among them are boutiques, luggage stores, shoe stores, stationery shops,
restaurants, repair shops, laundries, and beauty parlours. There are many of them in any given
city or area of the city. A Chinese restaurant may attempt to differentiate itself by offering
cuisine from a relatively unknown region of China. A dry cleaner may try to distinguish itself
by keeping longer store hours or by having its service clerks greet every regular customer by
name as he or she enters. If customers perceive these kinds of differences to be important
enough, these retail establishments may be able to charge a higher price than their
competitors.

Profit Maximization
The monopolistic competitor faces a demand curve that is negatively sloped (because of
product differentiation) but highly elastic (because of the availability of close substitutes).
The monopolistic competitor’s profit-maximizing or best level of output is the output at
which MR = MC, provided P > AVC. At that output, the firm can make a profit, break even,
or minimize losses in the short run. In the long run, firms are either attracted into an industry
by short-run profits or leave it if faced with losses until the demand curve (d) facing
remaining firms is tangent to its AC curve, and the firm breaks even (P = AC).
Panel A of Figure 15-1 shows a monopolistic competitor producing 550 units of output
(where MR = MC), selling it at $10.50 (on d), and making a profit of $3.50 per unit and

13
$1925 in total. These profits attract more firms into the industry. This causes a downward
(leftward) shift in this firm’s demand curve to d_ (in Panel B), at which the firm sells 400
units at $8 and breaks even. Since P > MR where MR = MC, the MC curve above AVC does
not represent the firm’s supply curve.
In the short run, the equilibrium of the firm in monopolistic competition is very similar to that
of the monopolist. Profit is again maximized by producing the output where MC=MR.
Supernormal profit can be made, depending on the position of the AC curve, because the
number of firms in the industry is fixed. The only real difference between the two situations
is that in Figure, relating to monopolistic competition, the demand curve (and hence the MR
curve) is flatter than the demand curve in Figure relating to monopoly. This is because of the
greater availability of substitutes.

In the long run, new firms will enter the industry, attracted by the supernormal profit. This
will have the effect of shifting the demand curve downwards for existing firms. The
downward shift will continue until the demand curve becomes tangential to the AC curve
(LAC in this case), at which point all supernormal profit will have competed away.

14
Demand: P=140−4 Q
Cost: TC =120 Q−12 Q2+ 2Q3
where P is in £, TC is in £ and Q is in thousand units. In this case, the total cost function is a
cubic function, with no fixed costs (for the sake of simplicity).
2
R=P Q=( 140−4 Q ) Q=140 Q−4 Q
Marginal Revenue : MR=140−8 Q
Marginal Cost: MC=120−24 Q+6 Q2
Equating MC=MR gives Q=3.594=3594 units
P ¿ ( 140−4 Q )=¿ £125.6
TC 2 2
AC= =120−12 Q+ 2Q =120−12 ×3.594+2 × ( 3.594 ) =£ 102.7
Q
Profit ¿ ( P− AC ) ×Q=( 125.6−102.7 ) × 3594=£ 82,300
This profit will attract new entrants into the industry in the long run, causing the demand
curve for existing firms to shift downwards. We will assume that this is a parallel shift, with
no change in slope; in other words, there is no change in the marginal effect of price on sales.
We will also assume for simplicity that the long-run cost curves are identical to the short-run
curves. The new demand curve faced by firms is given by:
Demand: P=a−4 Q
Revenue: R=P Q=( a−4 Q ) ×Q=aQ−4 Q 2

dR
Marginal Revenue : MR= =a−8Q
dQ
Marginal Cost: MC=120−24 Q+6 Q2
Equating MC=MR gives
2
a=120−16 Q+6 Q (a)
TC 2
AC= =120−12 Q+ 2Q
Q
In long-run equilibrium, P = AC, as all supernormal profit has competed away. It gives
2
a−4 Q=120−12Q+2 Q
2
a=120−8Q+ 2Q (b)
Equating (a) =(b) Q = 2, and
a=120−8Q+ 6 Q 2=120−8 × 2+ 2× 22=112
The new demand curve is:

15
P=112−4 Q
P=112−4 x 2=£ 104

Comparison with perfect competition and monopoly

There are four areas where a comparison can be made:
a. Price. This tends to be higher than in perfect competition (PC), being above the minimum
level of average cost, in both the short run and the long run (similar to monopoly).
b. Output. This tends to be lower than in PC, since firms are using a less-than-optimal scale,
at less-than-optimal capacity (similar to monopoly).
c. Productive efficiency. This is lower than in PC, for the reason stated previously.
d. Allocative efficiency. There is still a net welfare loss, because of P>MC.
Comparison with oligopoly
It is the last assumption, regarding the independence of firms’ decision-making that has
attracted the most attention from economists. Many economists claim for example that
monopolistic competition is not a distinct form of market structure. This claim is based on the
observation that firms are typically faced with competition from a limited number of
neighbouring firms, with markets being segmented spatially. Segmentation may also be in
terms of product characteristics.
An example will illustrate this situation. The restaurant industry is not a single market. An
individual restaurant does not compete with all other restaurants in the country, or even in the
same town. It may compete with other restaurants within a one-mile radius; furthermore, it
may not compete strongly with some of these restaurants because they are not seen as being
close substitutes. Thus an Indian restaurant may not compete with Italian, French, Greek or
Mexican restaurants to any great degree. This degree of competition can be examined
empirically by measuring the cross-elasticity of demand. Of course, it can be argued that if
there are few competitors then the product is not slightly differentiated, as required in
monopolistic competition, but highly differentiated. However, regardless of how the
assumptions of monopolistic competition are violated, it seems that because of these factors it
is often preferable to consider firms in many situations as being involved in a system of
intersecting oligopolies, with low entry and exit barriers.
Oligopoly
Oligopoly Defined
Oligopoly is a form of market organization in which there are few sellers of a product. If the
product is homogenous, there is a pure oligopoly (e.g. crude oil) If the product is
differentiated, there is a differentiated oligopoly. Since there are only a few sellers of a

16
product, the actions of each seller affect others. That is, the firms are mutually
interdependent.
Pure oligopoly is found in the production of cement, aluminum, and many other industrial
products which are virtually standardized. Examples of differentiated oligopolies are
industries producing automobiles, mobile phones, cigarettes, PCs, and most electrical
appliances, where three or four large firms dominate the market. Because of mutual
interdependence, if one firm lowered its price, it could take most of the sales away from the
other firms. Other firms are then likely to retaliate and possibly start a price war. As a result,
there is a strong compulsion for oligopolists not to change prices but, rather, to compete
based on quality, product design, customer service, and advertising.
An oligopolistic market structure describes a situation where a few firms dominate the
industry. The product may be standardized or differentiated; examples of the first type are
steel, chemicals, and paper, while examples of the second type are cars, electronics products,
and breakfast cereals. The most important feature of such markets that distinguishes them
from all other types of market structure is that firms are interdependent. Strategic decisions
made by one firm affect other firms, who react to them in ways that affect the original firm.
Thus firms have to consider these reactions in determining their strategies. Such markets are
extremely common for both consumer and industrial products, both in individual countries
and on a global basis. However, there is a considerable amount of heterogeneity within such
markets. Some feature one dominant firm, like Intel in computer chips; some feature two
dominant firms, like Coca-Cola and Pepsi in soft drinks; some feature half a dozen or so
major firms, like airlines, mobile phones, or athletic footwear; and others feature a dozen or
more firms with no dominant firm, like car manufacturers, petroleum retailers, and
investment banks. Of course, in each case, the number of major firms depends on how the
market is defined, spatially and in terms of product characteristics.
Conditions
The main conditions for the oligopoly to exist are therefore as follows:
1 A relatively small number of firms account for the majority of the market.
2 There are significant barriers to entry and exit.
3 There is an interdependence in decision-making.
As far as the first condition is concerned many measures are used to indicate the degree of
market concentration in an industry. The easiest to interpret is the four-firm or eight-firm
concentration ratios. These indicate the proportion of the total market sales accounted for by
the largest four or eight firms in the industry. A more detailed measure, though more difficult
to interpret, is the Herfindahl index. This index is computed by taking the sum of the squares
of the market shares of all the firms in the industry. For example, if two firms account for the

17
whole market on a 50:50 basis, the Herfindahl index (H) would be0.52 +0.5 2=0.5. In general
terms, the index is given by:
H ¿ ∑ S2
where S = the proportion of the total market sales accounted for by each firm in the industry.
A value of this index above 0.2 normally indicates that the market structure is oligopolistic.
The kinked demand curve model
The Kinked Demand Curve Model
As a further development toward more realistic models, we have the kinked demand curve or
Sweezy model. This tries to explain the price rigidity often observed in oligopolistic markets.
Sweezy postulates that if an oligopolistic firm increases its price, others in the industry will
not raise theirs and so the firm would lose most of its customers. On the other hand, an
oligopolistic firm cannot increase its share of the market by lowering its price since the other
oligopolists in the industry will match the price cut. Thus, there is a strong compulsion for the
oligopolist not to change the prevailing price but rather to compete for a greater share of the
market based on quality, product design, advertisement, and service.
Monopolistic competition and oligopoly are considered “imperfect” competition because
firms in these markets have the power to set their prices within the limits. The key
characteristic that separates perfect competition from the other three markets is market
power. Firms in perfect competition are price takers, whereas firms in the other three markets
are price makers. The key characteristic that separates perfect competition and monopoly
from monopolistic competition and oligopoly is nonprice competition. Market entry and exit
are easiest in perfect competition and relatively easy in monopolistic competition. It is not
possible in a monopoly and could be difficult in an oligopoly. The presence of mutual
interdependence is the one factor that separates oligopoly from the other markets.

This model was originally developed by Sweezy and has been commonly used to explain
price rigidities in oligopolistic markets. Price rigidity refers to a situation where firms tend to
maintain their prices at the same level despite changes in demand or cost conditions. The
model assumes that if an oligopolist cuts its prices, competitors will quickly react to this by
cutting their own prices to prevent losing market share. On the other hand, if one firm raises
its price, it is assumed that competitors do not match the price rise, to gain market share at the
expense of the first firm. In this case, the demand curve facing a firm would be much more
elastic for price increases than for price reductions.

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The kink in the demand curve causes a discontinuity or break in the MR curve. The
consequence of this is that if the marginal cost function shifts from the original function MC 1
upwards or downwards within the range from MC 2 to MC 3, then the profit-maximizing
output will remain atQ0 and the price will remain at P0, since the MC curve passes through
the MR curve in the vertical break. Similarly, if the demand curve shifts from D 1 to D2, the
MR curve will shift to the right to MR 2, but the original MCcurve will still pass through the
vertical break.
This means that the profit-maximizing output will increase from Q0 toQ1, but the price will
remain the same at P0. The reason for this is that the vertical break occurs below the kink in
the demand curve, which is at the prevailing price P0.

Collusion and cartels

Collusion is the term frequently used to refer to cooperative behaviour between firms in an
oligopolistic market. Such collusion may be explicit or tacit; explicit collusion often involves
the firms forming a cartel. This is an agreement among firms, of a formal or informal nature,
to determine prices, total industry output, market shares, or the distribution of profits. Most
such agreements are illegal in developed countries, though they are still widely practiced on
an informal basis because their existence is difficult to prove. There are also producers’
associations, for example representing taxi drivers, which may have the legal right to restrict
entry into the industry, at least on a local scale. On an international basis, the best-known
cartel is OPEC, the Organization of Petroleum Exporting Countries, which has existed for
decades with a mixed record of success for its members.
Collusion
An orderly price change (i.e., one that does not start a price war) is usually accomplished by
collusion that can be overt or tacit. The most extreme form of overt collusion is the

19
centralized cartel, in which the oligopolists produce the monopoly output, charge the
monopoly price, and somehow allocate production and profits among the cartel members.
Antitrust laws make overt collusion illegal in the U.S. In tacit collusion, the oligopolists
informally follow a recognized price leader in their pricing policies or agree on how to
share/divide the market.
Until the 1980s, U.S. Steel (now called USX) was a recognized price leader. When rising
costs required it, U.S. Steel raised the price of some of its products on the tacit understanding
that other domestic steel producers would match the price within a few days. An orderly price
increase was thus achieved without exposing producers to government antitrust action or the
danger of a price war.

Pricing and Profitability

A firm’s profitability depends in general on two factors: market conditions and competitive
advantage.
Market conditions. These relate to external factors, not just for the firm, but also for the
industry as a whole. Industries vary considerably in terms of their profitability; thus
throughout the 1990s, computer software firms, biotech firms, and banks achieved higher
than average profitability, while steel firms, coal producers, and railways did badly. These
industry trends can vary from country to country, according to differences in external factors.
These external factors are sometimes discussed in terms of another of Porter’s concepts, the
five-forces analysis (internal rivalry, entry, substitutes and complements, supplier power, and
buyer power). A 1997 study by McGahan and Porter concluded that these factors explained
about 19 percent of the variation in profit between firms.
2. Competitive advantage. This relates to internal factors, specifically those that determine a
firm’s ability to create more value than its competitors. The study above concluded that these
factors explained about 32 percent of the variation in profit between firms.
Value creation
The value created by a firm can be expressed in the following way:
The value created = perceived benefit to the customer - the cost of inputs
V =B−C

20
The equilibrium price, P, at the intersection of the demand and supply curves can be seen to
divide this value into two parts, consumer surplus (CS) and producer surplus (PS). Consumer
surplus is given by B-P in general terms, representing the amount that a consumer is prepared
to pay over and above that which they have to pay. Producer surplus is given by PC, which
represents supernormal or economic profit.
CS=B−P
PS=P−C
V =CS+ PS=B−C
A particular consumer may pay £200 for a cell phone; they may be prepared to pay £250 for
that particular model, even though the marginal cost of production is only £130. In this case,
the value created by that product item is £120, of which £50 is consumer surplus and £70 is
producer surplus.
Firms can be considered as making bids for consumers by offering them more surplus than
competitors; a market will be in equilibrium when each product is offering the same surplus
as its rivals. Thus in the athletic shoe market, a particular model of Nike shoe may sell for
£10 more than a competitor’s product, but if consumers perceive the benefit to be £10
greater, they will obtain the same surplus from consuming each product and therefore be
indifferent between the two products.
If a firm (or product) has a competitive advantage, it is in a position to make more profit than
competitors. Firms can do this essentially in two different ways: pursuing a cost advantage or
pursuing a benefit advantage. These concepts are examined in more detail shortly but can be
briefly summarized here:

21
1 Cost advantage. In this case, the greater value created (B - C) depends on the firm being
able to achieve a lower level of costs than competitors, while maintaining a similar perceived
benefit.
2 Benefit advantage. In this case, the greater value created depends on the firm being able to
achieve a higher perceived benefit than competitors, while maintaining a similar level of
costs.
Price discrimination
Price discrimination is a microeconomic pricing strategy where identical or largely similar
goods or services are sold at different prices by the same provider in different markets. Price
differentiation essentially relies on the variation in the customers' willingness to pay. The
term differential pricing is also used to describe the practice of charging different prices to
different buyers for the same quality and quantity of a product, but it can also refer to a
combination of price differentiation and product differentiation. Other terms used to refer to
price discrimination include equity pricing, preferential pricing, dual pricing, and tiered
pricing.
Price discrimination has been defined in many different ways. The simplest definition relates
to a situation where a firm sells the same product at different prices to different customers.
However, the most useful definition involves a firm selling the same or similar products at
different prices in different markets, where such price differentials are not based on
differences in marginal cost. Using this definition we can consider the following common
practices as price discrimination:
 Airlines that charge different fares for the same journey at different seasons
 of the year.
 Universities that charge higher fees to overseas students than to home
 students.
 Restaurants that offer ‘early bird’ dinners.
 Professional people, like doctors, accountants and consultants, who charge
 richer clients higher fees than poorer clients for the same service.
 Exporters who charge lower prices abroad than they charge domestically.
 Prestige outlets that charge higher prices than high street or discount stores
 for the same products.
 Health clubs that sell off-peak memberships.
 Supermarkets that offer points or reward schemes to regular shoppers.
 Happy hour.
The conditions that are necessary for price discrimination to be possible are
1 There must be different market segments with different demand elasticities.
2 The market segments must be separated so that there is no possibility of

22
resale from one segment to another.
To illustrate the importance and application of these conditions let us consider the example of
a butcher. Instead of advertising his meat prices, he may wait until the customer comes into
the shop and charge prices according to an assessment of the individual customer’s ability
and willingness to pay. Such a strategy may be successful in the case of customers who are
ignorant of the prices being charged to other customers; however, once they become aware of
this situation, and assume that other butchers are following the same practice, high-paying
consumers will find ways to avoid paying higher prices by buying their meat from other
customers, in other words, arbitrage will occur. Arbitrage refers to the practice of buying at a
lower price and selling at a higher price to make a riskless profit. Thus in this instance, a
butcher cannot successfully practice price discrimination. On the other hand, a dentist is in a
position to do so; patients cannot ask other patients to have their teeth capped for them. Thus,
price discrimination is generally easier in the markets for services, especially personal and
professional services.
Degree of price discrimination
Economists tend to classify price discrimination into three main categories, according to the
extent to which consumer surplus is transferred to the producer.
First-degree price discrimination.
Exercising first-degree price discrimination requires the monopoly seller of a good or service
to know the absolute maximum price (or reservation price) that every consumer is willing to
pay. By knowing the reservation price, the seller can sell the good or service to each
consumer at the maximum price they are willing to pay, and thus transform the consumer
surplus into revenues, leading it to be the most profitable form of price discrimination. So the
profit is equal to the sum of consumer surplus and producer surplus.
This is sometimes referred to as perfect price discrimination since all the consumer surplus is
transferred to the producer. For this to be possible the producer must have complete
knowledge of its demand curve, in terms of knowing the highest price that each customer is
prepared to pay for each unit and be able to sell the product accordingly. This situation is
extremely rare, but an example is an auction market, like the Treasury Bill market. The figure
illustrates the situation. It is assumed in this case that marginal costs are constant, for
simplicity. The whole consumer surplus, GCP3, becomes revenue and profit for the producer.
2. Second-degree price discrimination.
In second-degree price discrimination, price varies according to the quantity demanded.
Larger quantities are available at a lower unit price. This is particularly widespread in sales to
industrial customers, where bulk buyers enjoy discounts.
Additionally, to second-degree price discrimination, sellers are not able to differentiate
between different types of consumers. Thus, the suppliers will provide incentives for the
23
consumers to differentiate themselves according to preference, which is done by quantity
"discounts", or non-linear pricing. This allows the supplier to set different prices to the
different groups and capture a larger portion of the total market surplus.
In this situation, a firm may charge different prices for different levels of consumption. The
firstQ1 units may be sold at the high price of P1; the next block of units, Q2−Q1 maybe sold
at the price P2, and the last block of units, Q 3−Q2 , may be sold at the price of P3. This
situation is also shown in Figure 10.2 and the size of the consumer surplus is given by the
three triangles, GAP1, ABE and BCF. This type of strategy may be used in the selling of a
product like electricity.
In other situations, a reverse type of strategy is sometimes used, where early buyers pay a
lower price and later buyers have to pay more. Examples are the selling of tickets to certain
events, like concerts, and the selling of certain types of club membership. Usually buying
early involves more inconvenience or inflexibility for the buyer, thus segmenting the market.
Second-degree price discrimination often features a two-part tariff or pricing system. There is
some lump sum charge and then a user charge. In some cases the lump sum is minimal and
the user fees relatively large; This explains the apparent anomaly that replacement blades for
many razors cost more to buy than whole disposable razors. On the other hand, with many
club memberships the lump sum charge, or entry fee, is relatively large, while user fees are
nominal.
3. Third-degree price discrimination.
Third-degree price discrimination means charging a different price to different consumer
groups. For example, rail and tube (subway) travelers can be subdivided into commuter and
casual travelers, and cinema goers can be subdivided into adults and children, with some
theatres also offering discounts to full-time students and seniors. Splitting the market into
peak and off-peak use of service is very common and occurs with gas, electricity, and
telephone supply, as well as gym membership and parking charges. Some parking lots charge
less for "early bird" customers who arrive at the parking lot before a certain time.
This is, in practice, the most common form, where a firm divides its market into segments
and charges different prices accordingly. Markets can be segmented in various ways for this
purpose, and this aspect is now discussed.
b. Segmentation for price discrimination
Firms can segment markets on different bases; the following are the most common.
1. Time. Many products that have seasonal demand have different prices at different periods;
airlines, hotels, restaurants, cinemas, power providers, and many other industries have this
feature. Demand is less elastic at peak season, so prices are higher then.

24
2. Location. In some cases, the price of a product may be higher in one location than another
because of higher transportation or other costs. This is not price discrimination. However,
when the price in one location is higher than is justified by a difference in marginal cost,
because of demand being less elastic, then this does involve discrimination. It should also be
mentioned that sometimes a kind of reverse price discrimination occurs. Instead of charging
different prices when the marginal cost is the same, some firms will charge the same price
even when marginal costs are different. This occurs, for example, when there are differences
in transportation costs between different markets, but a universal price is charged.
3. Product form. Many firms offer a product line where the top-of-the-line model is
considerably more expensive than the other products in the line. This may be true even when
there is little difference in the cost of production of the different products. In this case, there
may be some consumers who are determined to have the best (stereo, television, car,
mountain bike, tennis racquet), and therefore, again, their demand is less elastic in the normal
price range.
4. Customer.
Two-part tariff
The two-part tariff is another form of price discrimination where the producer charges an
initial fee and then a secondary fee for the use of the product. This pricing strategy yields a
result similar to second-degree price discrimination. An example of two-part tariff pricing is
in the market for shaving razors. The customer pays an initial cost for the razor and then pays
again for the replacement blades. This pricing strategy works because it shifts the demand
curve to the right: since the customer has already paid for the initial blade holder and will
continue to buy the blades which are cheaper than buying disposable razors.

Price discrimination Illustrative example

Valair is an airline flying a particular route that has seasonal demand.
The firm’s total demand is given by:
Q=600−4 P
where Q is the number of passengers per year, in thousands, and P is the fare (in £). In the
peak season the demand is given by:
Q H =320−1.5 P H
and in the off-season the demand is given by:
Q L=280−2.5 PL

assume that fixed costs are £6 million per year and that marginal costs are constant at £60 per
passenger. Thus the cost function is given by:

25
C=6000+60 Q
where C is total costs (in £’000).
a. Calculate the profit-maximizing price and output without price discrimination, and the size
of the profit.
b. Calculate the profit-maximizing price and output with price discrimination, and the size of
the profit.
c. Calculate the demand elasticities of the two segments at their profit-maximizing prices.
Without price discrimination
P= (150−0.25 Q )

R=PQ =( 150 Q−0.25 Q )

2

dR
=( 150 Q−0.25 Q )
2
MR=
dQ
TC=6000+60 Q
dTC
MC= =60
dQ
MR=MC gives
Q=¿180 = 180,000 passengers per year
P= (150−0.25 Q )=( 150−0.25 ×180 )=£ 105
TC =6000+60 Q=( 6000+ 60× 180 )=16800 ( in thousand of £)
¿16800,000
R=¿ P x Q ¿ 105 x 180,000=18900,000
Profit π=R−TC=( 18900−16800 ) ×1000=£ 2,100 , 000

b. With price discrimination

We now examine each segment in turn:
Peak segment (H)
1
P= ( 320−Q )
1.5
1
R=PQ = ( 320Q−Q2 )
1.5
dR 1
MR= = ( 320−2 Q )
dQ 1.5
TC =6000+60 Q (same as earlier)

26
 dTC
MC= =60
dQ
MR=MC gives
Q=¿115 = 115,000 passengers per year
1 1
P= ( 320−Q ) ¿ ( 320−115 )=£ 136.67
1.5 1.5

Off -Peak segment (L)

P= (112−0.4 Q )

R=PQ =( 112Q−0.4 Q )
2

dR
MR= =( 112−0.8 Q )
dQ
TC=6000+60 Q (same as earlier)
dTC
MC= =60
dQ
MR=MC gives
Q=¿65 = 65,000 passengers per year
P= (112−0.4 ×65 )=£ 86
To obtain the size of the profit it is necessary to calculate total revenue and subtract total
costs. Note that it is incorrect to compute the profits in each segment separately and then add
them together. This would double-count the fixed costs.
Total revenue ¿ R H + R H =¿ ( 136.67 ×115+65 × 86 )=21307.05=£ 21307050
Q ¿ Q H +Q L =115+65=180 (' 000)
TC=6000+60 Q=¿ 6000+60 ×180=¿ 16800 ( in thousand of £)
Profit π=R−TC=( 21307.05−16800 ) ×1000=£ 4,507,050

More profit eraned from segmentation (4507.05 - 2100) = 2407.05 or £2,407,050 ( about £2.4
million more)
The demand elasticities in each segment can also be obtained using the point elasticity
formula:
dQ P 136.67
Peak: PED = ¿ × =−1.5 × =−1.8
dP Q 115
dQ P 86
Off-peak: PED = ¿ × =−2.5 × =−3.8
dP Q 65

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 At this point several general conclusions can be drawn from comparing the situation with
price discrimination and the situation without price discrimination:
1 Total output is the same in both situations (note that this is not true if the cost function is
non-linear).
2 The prices with discrimination ‘straddle’ the price without discrimination, meaning that one
is higher and the other is lower. If there are more than two market segments one or more
prices will always be higher and one or more prices will always be lower.
3 The segment with the higher price will have less elastic demand and vice versa.
4 Profit is always higher under price discrimination. This is because some of the consumer
surpluses are transferred to producer surplus, as seen earlier.
Additional Reading material
Sources of monopoly power
Monopolies derive their market power from barriers to entry – circumstances that prevent or
greatly impede a potential competitor's ability to compete in a market. There are three major
types of barriers to entry: economic, legal, and strategic (deliberate).
Economic barriers: Economic barriers include economies of scale, capital requirements,
cost advantages and technological superiority.
 Economies of scale: Decreasing unit costs for larger volumes of production. Decreasing costs
coupled with large initial costs, If for example, the industry is large enough to support one
company of minimum efficient scale then other companies entering the industry will operate
at a size that is less than MES, and so cannot produce at an average cost that is competitive
with the dominant company. And if the long-term average cost of the dominant company is
constantly decreasing[clarification needed], then that company will continue to have the least
cost method to provide a good or service.
 Capital requirements: Production processes that require large investments of capital, perhaps
in the form of large research and development costs or substantial sunk costs, limit the
number of companies in an industry:[9] this is an example of economies of scale.
 Technological superiority: A monopoly may be better able to acquire, integrate and use the
best possible technology in producing its goods while entrants either do not have the
expertise or are unable to meet the large fixed costs (see above) needed for the most efficient
technology. Thus one large company can often produce goods cheaper than several small
companies.
 No substitute goods: A monopoly sells a good for which there is no close substitute. The
absence of substitutes makes the demand for that good relatively inelastic, enabling
monopolies to extract positive profits.

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 Control of natural resources: A prime source of monopoly power is the control of resources
(such as raw materials) that are critical to the production of a final good.
 Network externalities: The use of a product by a person can affect the value of that product to
other people. This is the network effect. There is a direct relationship between the proportion
of people using a product and the demand for that product. In other words, the more people
who are using a product, the greater the probability that another individual will start to use
the product. This reflects fads, fashion trends, social networks, etc. It also can play a crucial
role in the development or acquisition of market power. The most famous current example is
the market dominance of the Microsoft office suite and operating system in personal
computers.
 Legal barriers: Legal rights can provide the opportunity to monopolize the market in a good.
Intellectual property rights, including patents and copyrights, give a monopolist exclusive
control of the production and selling of certain goods. Property rights may give a company
exclusive control of the materials necessary to produce a good.
 Advertising: Advertising is most important to sell the product because the single user, they
have to do it on their own.
 Manipulation: A company wanting to monopolize a market may engage in various types of
deliberate action to exclude competitors or eliminate competition. Such actions include
collusion, lobbying governmental authorities, and force
Xxx
Comparing monopoly and perfect competition
While monopoly and perfect competition mark the extremes of market structures there is
some similarity. The cost functions are the same. Both monopolies and perfectly competitive
(PC) companies minimize costs and maximize profit. The shutdown decisions are the same.
Both are assumed to have perfectly competitive factor markets. There are distinctions, some
of the most important distinctions are as follows:

 Marginal revenue and price: In a perfectly competitive market, price equals marginal cost. In
a monopolistic market, however, the price is set above the marginal cost.
 Product differentiation: There is no product differentiation in a perfectly competitive market.
Every product is perfectly homogeneous and a perfect substitute for any other. With a
monopoly, there is great absolute product differentiation in the sense that there is no available
substitute for a monopolized good. The monopolist is the sole supplier of the good in
question.[16] A customer either buys from the monopolizing entity on its terms or does
without.
 The number of competitors: PC markets are populated by an infinite number of buyers and
sellers. A monopoly involves a single seller.[16]

29
 Barriers to entry: Barriers to entry are factors and circumstances that prevent entry into
market by would-be competitors and limit new companies from operating and expanding
within the market. PC markets have free entry and exit. There are no barriers to entry, or exit
competition. Monopolies have relatively high barriers to entry. The barriers must be strong
enough to prevent or discourage any potential competitor from entering the market
 Elasticity of demand: The price elasticity of demand is the percentage change of demand
caused by a one percent change of relative price. A successful monopoly would have a
relatively inelastic demand curve. A low coefficient of elasticity is indicative of effective
barriers to entry. A PC company has a perfectly elastic demand curve. The coefficient of
elasticity for a perfectly competitive demand curve is infinite.
 Excess profits: Excess or positive profits are profits more than the normal expected return on
investment. A PC company can make excess profits in the short term but excess profits attract
competitors, which can enter the market freely and decrease prices, eventually reducing
excess profits to zero.[17] A monopoly can preserve excess profits because barriers to entry
prevent competitors from entering the market.[18]
 Profit maximization: A PC company maximizes profits by producing such that price equals
marginal costs. A monopoly maximizes profits by producing where marginal revenue equals
marginal costs.[19] The rules are not equivalent. The demand curve for a PC company is
perfectly elastic – flat. The demand curve is identical to the average revenue curve and the
price line. Since the average revenue curve is constant the marginal revenue curve is also
constant and equals the demand curve, Average revenue is the same as price (AR = TR/Q = P
x Q/Q = P). Thus the price line is also identical to the demand curve. In sum, D = AR = MR =
P.
 P-Max quantity, price, and profit: If a monopolist obtains control of a formerly perfectly
competitive industry, the monopolist would increase prices, reduce production, and realize
positive economic profits.
 Supply curve: in a perfectly competitive market there is a well-defined supply function with a
one-to-one relationship between price and quantity supplied. In a monopolistic market, no
such supply relationship exists. A monopolist cannot trace a short-term supply curve because
for a given price there is not a unique quantity supplied. As Pindyck and Rubenfeld note, a
change in demand "can lead to changes in prices with no change in output, changes in output
with no change in price, or both". Monopolies produce where marginal revenue equals
marginal costs. For a specific demand curve the supply "curve" would be the price-quantity
combination at the point where marginal revenue equals marginal cost. If the demand curve
shifted the marginal revenue curve would shift as well and a new equilibrium and supply
"point" would be established. The locus of these points would not be a supply curve in any
conventional sense.

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