Microeconomics Set 7 - Imperfect Competition and Monopoly

Review Imperfect Competition Monopoly Summary
Economics 1
Set 7: Imperfect Competition and Monopoly
Nordhaus and Samuelson, Economics 19e, Chapter 9
Dr. Christoph Bierbrauer

Professorship for Economics
Cologne Business School
Summer Term 2016
Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Economics 1
Review of Central Concepts
Characterize the following concepts:

Perfect competition
On a perfectly competitive market:
Profit maximization
Short- and long-run shutdown conditions
Zero economic profit condition
Economic surplus
Producer surplus
Consumer surplus

Economics 1
Imperfect Competition
Few firms are price-takers, we live in a world of imperfect

competition
Imperfect competition implies

that compared to perfect competition, prices are higher and
outputs are lower
economies of scale can be exploited
incentives for innovation in order to preserve imperfect
competition which propels economic growth

Economics 1
Imperfect Competition, cont.

Economics 1
Imperfect Competition and Elasticities
Under imperfect competition, sellers are price-makers, not

price-takers
An individual producer has some discretion over its price if the

demand faced by him is not perfectly elastic
Perfect competition implies perfect price elasticity of demand
Imperfect competition implies a finite elasticity of demand

Economics 1
Definition of Imperfect Competition
Imperfect competition prevails if an individual seller can affect

the price of his output
Major kinds of imperfect competition are:

Monopoly
Oligopoly
Monopolistic competition

Economics 1
Forms of Imperfect Competition

Monopolistic competition; a large number of producers supply
differentiated goods
monopolistic competition depends on the ability of the suppliers to offer
slightly different goods, we observe that on several occasions, e.g. the
markets for chocolate, cellphones or mineral water
Oligopoly; a small number of sellers of which each has the power to

affect the market price
sources of oligopolies include the existence of economies of large scale
production, e.g. automobile production, steel industry
Monopoly; a single supplier with complete control of the market, i.e. no

other firm produces a close substitute
sources of monopolies are government regulation and/or barriers to entry
- a monopoly is difficult to obtain and to maintain, e.g. letter post,
microsoft windows a few years ago
Economics 1
Market Structures

Economics 1
Marginal Costs and Market Structures

Economics 1
Sources Imperfect Competition

Monopolistic competition; minimum average costs are reached
at a level tiny as compared to the market size
Oligopoly; economies of scale, a producer needs a market share

large, relative to the market size, i.e. only a small number of firms
can coexist on the market and reach the minimum average cost,
e.g. production of semiconductors or pharmaceuticals
Monopoly; a natural monopoly occurs in markets in which output

can only produced efficiently by a single supplier
perpetual increasing returns to scale
barriers to market entry
e.g. network industries such as railway services or water supply
Economics 1
Barriers to Market Entry
Legal barriers to entry:

Patents
Government franchise monopolies
Trade restrictions such as quotas or tariffs
Economic barriers to entry:

Economies of scale
Huge investments in advertising and/or infrastructure

Economics 1
Summary
There are two principal sources of imperfect competition:

(i) Economies of scale
(ii) Barriers to entry
Economics 1
Monopoly Behavior
Concept of Marginal Revenue
The profit maximization of a monopolist is based on total and

marginal revenue, as always, the marginal revenue refers to the
change in revenue related to selling one unit more
Total revenue
TR = PQ (1)

Economics 1
Monopoly Behavior
Concept of Marginal Revenue, cont.
Total revenue depends on the

quantity sold q
chosen price p
elasticity of demand, if demand is
elastic it responds to price changes by more than 1:1
unit-elastic it responds 1:1 to price changes
in-elastic it responds to price changes by less than 1:1

Economics 1
Monopoly Behavior
Revenue Maximization and Marginal Revenue

Economics 1
Monopoly Behavior
Revenue Maximization

Economics 1
Monopoly Behavior
Revenue Maximization and Marginal Revenue, cont.
Marginal revenue (MR) is the revenue change that is generated

by an additional unit sold
If the demand for the products of a monopolist is

elastic, a price decrease in order to increase sales implies rising
total revenues, MR > 0
unit-elastic, we observe a one-to-one decrease of demand in
response to an increase in the price, MR = 0
in-elastic, a decrease in total revenues in response to a rising
price, MR < 0
The price per unit is called the average revenue AR, total
revenue is maximized if demand is unit-elastic
Economics 1
Monopoly Behavior
Summary: Elasticity and Marginal Revenue
We observe a dome-shaped marginal revenue curve
i. Marginal revenue is the change in revenue generated by an

additional unit sold
ii. Price = average revenue
iii. Given a downward-sloping demand curve a price decrease reduces
the revenue from all units sold
iv. The response demand implied by a price increase depends on the
elasticity of demand
Economics 1
Profit-maximizing Conditions
Total Profits
Total profits (TP) are defined as

TP = TR − TC (2)
max. profits are realized if output is increased up to

MR = MC (3)
as it is always beneficial to increase production if MR < MC and

costly to do so is MR < MC

Economics 1
A monopolist chooses P in order to max. profits

Economics 1
Maxim-profit of a Monopolist
The maximum-profit price P ∗ and quantity Q ∗ of a monopolist

come where the firm’s marginal revenue equals its marginal cost
MR = MC (4)
at the maximum-profit P ∗ and Q ∗
Clearly, profits can only increase if the marginal revenue exceed the
marginal costs

Economics 1
Monopoly Equilibrium

Economics 1
Monopoly Equilibrium: Summary
Maximum-profit point E : MC = MR, Q ∗ , P ∗ where AR > AC

The total revenue curve is dome-shaped
Total costs are always increasing
Intuitively, a monopolist maximizes its profits by rationing the

supply of its goods and pushing the price up

Economics 1
Marginal Changes and the Slope
Obviously, the slope of a function is calculated utilizing the first

derivative of that function, the
slope of the total revenue curve equals the marginal revenue
slope of the total cost curve is the marginal cost
in the maximum-profit point, MR = MC , P > MC and the slope
of the total revenue curve is zero, which defines a local maximum
of a function

Economics 1
Imperfect Competition
Finite elasticity of demand, firms are price-makers to varying

degrees
Monopolistic competition
Oligopoly
Monopoly
Major Sources of monopolistic competition are

economies of scale
barriers to market entry

Economics 1
Monopoly
Monopolies lead to inefficiently high prices as well as low outputs

when compared to the perfectly competitive equilibrium, thus a
monopoly reduces consumer welfare
MR < P because of the effect of a change in P on all units

sold
A monopolist faces a downward-sloping demand curve which
implies
P = AR > MR = P − lost revenue on all previous sales (5)
Review the relationships between demand elasticity, P, Q, TR

and MR
The profit maximizing behavior of a monopolist implies MR = MC
Economics 1

Microeconomics Set 7 - Imperfect Competition and Monopoly

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Review Imperfect Competition Monopoly Summary

Dr. Christoph Bierbrauer

Cologne Business School

Summer Term 2016

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Review of Central Concepts

Characterize the following concepts:

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Few firms are price-takers, we live in a world of imperfect

Imperfect competition implies

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Imperfect Competition, cont.

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Imperfect Competition and Elasticities

Under imperfect competition, sellers are price-makers, not

An individual producer has some discretion over its price if the

Perfect competition implies perfect price elasticity of demand

Imperfect competition implies a finite elasticity of demand

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Definition of Imperfect Competition

Imperfect competition prevails if an individual seller can affect

Major kinds of imperfect competition are:

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Forms of Imperfect Competition

Oligopoly; a small number of sellers of which each has the power to

Monopoly; a single supplier with complete control of the market, i.e. no

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Marginal Costs and Market Structures

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Sources Imperfect Competition

Oligopoly; economies of scale, a producer needs a market share

Monopoly; a natural monopoly occurs in markets in which output

Barriers to Market Entry

Legal barriers to entry:

Economic barriers to entry:

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

There are two principal sources of imperfect competition:

Concept of Marginal Revenue

The profit maximization of a monopolist is based on total and

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Concept of Marginal Revenue, cont.

Total revenue depends on the

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Revenue Maximization and Marginal Revenue

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Revenue Maximization and Marginal Revenue, cont.

Marginal revenue (MR) is the revenue change that is generated

If the demand for the products of a monopolist is

Summary: Elasticity and Marginal Revenue

We observe a dome-shaped marginal revenue curve

i. Marginal revenue is the change in revenue generated by an

Total profits (TP) are defined as

max. profits are realized if output is increased up to

as it is always beneficial to increase production if MR < MC and

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

A monopolist chooses P in order to max. profits

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

The maximum-profit price P ∗ and quantity Q ∗ of a monopolist

at the maximum-profit P ∗ and Q ∗

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School

Dr. Christoph Bierbrauer Professorship for Economics Cologne Business School