1

Market Structure
Monopoly, Monopolistic
competition, oligopoly
Chapter 11
INSTRUCTIONS FOR USE

▪ Define imperfect competition and compare

it to perfect competition
▪ Monopolistic competition
▪ Monopoly
▪ Oligopoly

3
ImperfectCompetition

The holder of a patent is an example of a

n
imperfectly competitive firm, or
price setter
➢ A firm with some liberty to set its own price

4
Imperfect Competition
✓ Imperfectly competitive firms have some control
of price
➢ Long-run economic profits possible /Reduce
economic surplus
✓ Three types
1. Monopoly has only one seller, no close substitutes
▪ Farthest from perfectly competitive markets
2. Monopolistic competition has many firms with
differentiated products
▪ These products are all close substitutes
▪ No significant barriers preventing firms from entering or
leaving the market

5
Imperfect Competition

◼ T h r e e types
3. Oligopoly is a small number of firms producing
close substitutes
▪ Oligopoly is typically a consequence of cost advantages
that prevent small firms from being able to compete
effectively

6
Monopoly

Perfect
Monopoly
Competition
Number of
One firm Many firms
Firms
Price Price setter Price taker
Entry and Exit Not free Free
Product Unique Standardized
Economic
Possible Zero in long run
Profits
P, Q, product
Decisions Q only
differentiation
Monopolistic Competition

Monopolistic Perfect
Competition Competition
Number of
Many firms Many firms
Firms
Price Limited flexibility Price taker
Entry and Exit Free Free
Product Differentiated Standardized
Economic
Zero in long run Zero in long run
Profits
P, Q, product
Decisions Q only
differentiation
Oligopoly
Oligopoly Perfect
Competition
Number of Few firms,
Firms each large Many firms
Price Some flexibility Price taker
Entry and Free
Large size firm
Exit
Differentiated or Standardized
Product
standardized Zero in long
Economic run
Possible
Profits
P, Q, differentiation, Q only
Decisions
advertising
Structure No. of producers Examples Firm’s degree
and degree of of control
product over Price
differentiation
Perfect Many producers, Financial None
competiti identical goods markets and
on agriculture
producers

Imperfect competition
1. Many producers real Retail trade Some
Monopolistic or perceived (pizza, burgers,
competition differences in steel, chemical)
product

2.Oligopoly Few producers little or Cars, word Some

no difference in processing
product software

3.Monopoly Single producer, Franchise Considerable

product without close monopolies
substitutes (electricity,
water)
10
©2012 The McGraw-Hill Companies, All R ights Reserved
The Essential Difference

➢ Whereas the perfectly competitive firm faces a perfectly

elastic demand curve for its product, the imperfectly
competitivefirmfacesa downward-sloping demandcurve
▪ Why is the demand curve different?
• Market Power

Imperfectly Perfectly
Competitive Firm Competitive Firm 11
Price

Price
D

D
Quantity Quantity
▪ Advantages of Perfect Competition:
▪ High degree of competition helps allocate
resources to most efficient use
▪ Price = marginal costs
▪ Normal profit made in the long run
▪ Firms operate at maximum efficiency
Consumers benefit
12
▪
Market Structure

▪ Imperfect or Monopolistic Competition

▫ Many buyers and sellers

▫ Products differentiated
▫ Relatively free entry and exit
▫ Each firm may have a tiny ‘monopoly’ because of the
differentiation of their product
▫ Firm has some control over price
▫ Examples – restaurants, professions – solicitors, etc.,
building firms – plasterers, plumbers, etc.
Market Structure

▪ Monopoly:
▫ High barriers to entry
▫ Firm controls price OR output/supply
▫ Abnormal profits in long run
▫ Possibility of price discrimination
▫ Consumer choice limited
▫ Prices in excess of MC
Market Structure

▪ Oligopoly – Competition amongst the few

▫ Industry dominated by small number of large firms

▫ Many firms may make up the industry
▫ High barriers to entry
▫ Products could be highly differentiated – branding or homogenous
▫ Non–price competition
▫ Price stability within the market - kinked demand curve?
▫ Potential for collusion?
▫ Abnormal profits
▫ High degree of interdependence between firms
Market Structure

▪ Examples of oligopolistic structures:

▫ Supermarkets
▫ Banking industry
▫ Chemicals
▫ Oil
▫ Medicinal drugs
▫ Broadcasting
Monopolist's Marginal Revenue

Price & marginal revenue ($/unit)

8

3
D
1

-1 2 3 4 5 8
MR
Quantity (units/week)

Price Quantity Total Revenue Marginal

$6 2 $12 Revenue
$5 3 $15 3
$4 4 $16 1
$3 5 $15 -1
Monopoly Demand and Marginal Revenue

a
◼ In general, the
Price
monopolist's marginal
revenue curve
a/2 ➢ Has the same
intercept as demand
➢ Has twice the slope
D
MR

of demand
Q0
Q0/2
Quantity
➢ Lies below demand
DecidingQuantity
▪ A monopolist knows his
demand and marginal revenue
curves
6
▪ Marginal cost is also known

Price ($/unit of output)

▪ If he operates at P = $3 and Q MC
= 12, MC > MR 4
▪ Decrease output 3
➢ If the firm operates at Q = 8,
then MC = MR = 2 2 D
19
▪ The demand curve sets the
price, P = $8 MR
➢ At any output below 8, 8 12
MC < MR Quantity (units/week)
Monopoly Losses and Profits

Economic loss Economic profit

= $400,000/day = $400,000/day
0.1
Price ($/minute)

ATC

Price ($/minute)
2
0.1 0.1
0 0
0.0
8 ATC

0.0 MC MC
0.05
5
D
MR D
MR
2 24
20 24
0
Minutes (millions/day)
Minutes (millions/day)
Does being a Monopolist Guarantee Profits?

▪ Being a monopolist does not guarantee positive

profits
▫ The question comes down to:
▫ At MR = MC, is the P larger or smaller than
ATC?
▫ If P > ATC → positive profits
▫ If P < ATC → negative profits (losses)
The Invisible Hand Fails

The monopolist's optimal

amount occurs where
6 Marginal Cost
MC = MR, Q = 8 units
and P = $4

Price ($/unit of output) 4

Deadweight loss from
Themonopoly
socially optimal
= $4
3 amount occurs where
MC = MB, Q = 12 units
2 and P = $3
MR

8 12 24
Quantity (units/week)
©
2
0
1
2
Monopoly andPerfect Competition
T
h
e
C Monopoly Perfect Competition
o
m
p
a MC = MR MC = MR
n
i P >MR P = MR
e
23
s P > MC P = MC
,
A Deadweight No Deadweight
l Loss Loss
l
R
i
g
Market Structure

▪ Advantages and disadvantages of monopoly:

▪ Advantages:
▫ May be appropriate if natural monopoly
▫ Encourages R&D
▫ Encourages innovation
▫ Development of some products not likely without some
guarantee of monopoly in production
▫ Economies of scale can be gained – consumer may benefit
Market Structure

▪ Disadvantages:
▫ Exploitation of consumer – higher prices
▫ Potential for supply to be limited - less
choice