PERFECT COMPETITION This scenario is shown in this diagram, as the price or

INTRODUCTION average revenue, denoted by P, is above the average

A perfectly competitive market cost denoted by C.
 many buyers and sellers,
 undifferentiated products, GRAPH
 no transaction costs,
 no barriers to entry and exit, and
 perfect information about the price of a good.

Firms are said to be in perfect competition when the

following conditions occur:
 Many firms produce identical products.
 Many buyers are available to buy the product,
and many sellers are available to sell the
product.
Sellers and buyers have all relevant information to
make rational decisions about the product being bought
and sold.
Firms can enter and leave the market without any
restrictions—in other words, there is free entry and exit
into and out of the market.
The total revenue for a firm in a perfectly competitive
market is the product of price and quantity (TR = P * Q).
Perfect Competition in the Long Run: In the long-run,
economic profit cannot be sustained.
The arrival of new firms in the market causes the
demand curve of each individual firm to shift
downward, bringing down the price, the average
revenue and marginal revenue curve. In the long-run,
the firm will make zero economic profit. Its horizontal
demand curve will touch its average total cost curve at
its lowest point.

The average revenue is calculated by dividing total GRAPH

revenue by quantity ( AR=TR/Q).

Marginal revenue is calculated by dividing the change in

total revenue by change in quantity (MR= CTR/ CQ).

A firm in a competitive market tries to maximize profits.

In the short-run, it is possible for a firm’s economic

profits to be positive,

Economic profits will be zero in the long-run.

Demand Curve for a Firm in a Perfectly Competitive

In the short-run, if a firm has a negative economic
Market: The demand curve for an individual firm is
profit, it should continue to operate if its price exceeds
equal to the equilibrium price of the market. The
its average variable cost.
market demand curve is downward-sloping.
It should shut down if its price is below its average
variable cost.

Perfect Competition in the Short Run: In the short run,

it is possible for an individual firm to make an economic
profit.
 LOSS GRAPH

A perfectly competitive firm is a price taker, which SHUTDOWN GRAPH

means that it must accept the equilibrium price at
which it sells goods.

PROFIT MAXIMIZATION SUMMARY

BREAK-EVEN GRAPH

MONOPOLY AND PRICE DISCRIMINATION

monopoly
 a firm that is the sole seller of a product
 no close substitutes
 many buyers
 shut down: when price or average revenue is
less than the average cost
Fundamental Cause of Monopoly:
The fundamental cause of monopoly is barriers to
entry: (have three main sources)
 Monopoly resources
 Government regulation
 The production process

Examples of Monopoly
 Microsoft
 Standard Oil

Natural Monopolies
An industry is a natural monopoly when a single firm
can supply a good or service to an entire market at a
lower cost than could two or more firms

A natural monopoly arises when there are economies of

scale over the relevant range of output.

Monopoly versus Competition

The key difference between a competitive firm and a
monopoly is the monopoly’s ability to influence the
price of its output.
By contrast, because a monopoly is the sole producer in
its market, it can alter the price of its good by adjusting
the quantity it supplies to the market.
A competitive firm is small relative to the market in
which it operates and, therefore, has no power to
influence the price of its output. It takes the price as
given by market conditions.
Economies of Scale as a Cause of Monopoly
When a firm’s average-total-cost curve continually
declines, the firm has what is called a natural monopoly.
In this case, when production is divided among more
firms, each firm produces less, and average total cost
rises. As a result, a single firm can produce any given
amount at the lowest cost.
Profit Maximization
the monopolist’s profit-maximizing quantity of output is
determined by the intersection of the marginal-revenue
curve and the marginal-cost curve.
For a competitive firm:
P= MR = MC.
For a monopoly firm:
P > MR = MC.
In following the rule for profit maximization,
competitive firms and monopolies are alike. But there is
also an important difference between these types of
firms: The marginal revenue of a competitive firm
equals its price, whereas the marginal revenue of a
monopoly is less than its price. That is, the equality of
marginal revenue and marginal cost determines the
profit maximizing quantity for both types of firm. What
differs is how the price is related to marginal revenue
and marginal cost.
A Monopoly’s Profit
To see a monopoly firm’s profit in a graph, recall that
profit equals total revenue (TR) minus total costs (TC):
Profit = TR - TC.
Figure 8
the intersection of the marginal cost curve and marginal
revenue gives the profit maximization quantity where
the monopolist can get the most profit, but since this is
monopoly the monopolist will not peg at that point and
will move it price till the demand line because that is
where people are still willing to pay.
the intersection of demand curve at that point, the
price is lower than the monopolist price and quantity is
more than the monopolist quantity. this point is called
SOCIALLY OPTIMAL EQUILIBRIUM , meaning if there are
other players in the market that point should be the
socially optimal price and socially optimal quantity.
Price Discrimination
the business practice of selling the same good at
different prices to different customers
It is a rational strategy for profit-maximizing monopolist.
It requires ability to separate customers according to
their willingness to pay or sometimes, according to their
age or income.
NOTE :
It is NOT POSSIBLE when a good is sold in a competitive
market.
The Analytics of Price Discrimination
Perfect price discrimination describes a situation in
which the monopolist knows exactly each customer’s
willingness to pay and can charge each customer a
different price.
Examples of Price Discrimination
Movie Tickets
Airline Prices
Discount Coupons
Financial Aid
Quantity Discounts
Oligopoly And Game Theory
Oligopoly:
 only a few sellers
 offer similar or identical products.
Strategic behavior in oligopoly:
A firm’s decisions about P or Q can affect other firms
and cause them to react. The firm will consider these
reactions when making decisions.
Characteristic of an Oligopoly
 Oligopolies must have 3 companies or more.
The maximum number of companies is reached
when the individual companies within the
oligopoly no longer have a dramatic impact on
the others.
 Companies in an oligopoly must have
independence from each other. This means that
each company is separate from the others.
 Each company's actions have a dramatic effect
on the other companies in the market.
 The companies are in direct competition with
each other and do not have common goals.
 Oligopolies operate in a market where it is very
difficult for a new company to enter due to
economic, regulatory, and infrastructure
barriers.
  Oligopolies have rigid prices because the small 2. Cartel Model/Collusive Oligopoly
number of companies could cause price 3. Price Leadership Model
warring.
 Companies within an oligopoly often rely 1. Rigid Prices: Kinked Demand Curve Model
heavily on advertising to keep their product in The kinked demand curve model was developed to
the consumer's mind. explain price rigidity, or oligopolist’s desire to maintain
price at the prevailing price, P∗
Some Example of Oligopoly
Google Kinked demand model asserts that a firm will have an
Aluminum asymmetric reaction to price changes. Rival firms in the
Gas industry will react differently to a price change, which
Automobile results in different elasticities for price increases and
Beer price decreases.
Film If a firm increases price, P>P∗ , other firms will not
Petroleum follow
cellphone If a firm decreases price, P<P∗ , other firms will follow
Tire immediately
Television
Airline Assumes that if one oligopolistic organization increases
the prices, then other organizations would not follow
Oligopoly Revenue Curve increase in prices
Total Revenue = Total Quantity x Price
Assumption of a Collusive Oligopoly/Cartels
 Each firm produces and sells a homogeneous
product that is a perfect substitute for each
other.
 The market demand curve for the product is
given and is known to the cartel.
 The number of buyers is large.
 The price of the product determines the policy
To understand the behavior of oligopoly, we will
of the cartel.
consider an oligopoly with just two members – a
 The cost curves of the firm’s are different but
duopoly.
are known to the cartel.
The textbook’s example (water) is simpler, because it
 The cartel aims at joint profit maximisation.
uses zero marginal cost (as well as zero fixed cost). This
is appropriate, because students will not have the
Price Leadership
instructor’s assistance when reading the textbook.
Price leadership occurs when a leading firm in a given
fixed costs are still zero.)
industry is able to exert enough influence in the sector
that it can effectively determine the price of goods or
Marginal Revenue
services for the entire market.
– the revenue earned by selling one more unit.
3 Types of Price Leadership
Average Revenue
Dominant Price Leadership
Average Revenue = Total Revenue / Quantity
It refers to a type of leadership in which only one
organization dominates the entire industry.

Barometric Price Leadership

3 Basic Theories About Oligopolistic Pricing:
1. Kinked-Demand Theory
It refers to a leadership in which one organization first Cooperative Game - A game in which participants can
announces a change in prices and believes other negotiate binding contracts that allow them to plan
organizations will accept it. joint strategies.
Non-cooperative Game- A game in which negotiation
Aggressive Price Leadership and enforcement of binding contracts are not possible
Implies a leadership in which one organization
establishes its supremacy by threatening the
organizations to follow its leadership. Different Strategies and Solutions for Games:
Equilibrium in Dominant Strategies = An outcome of a
Two Additional Models of Pricing game in which each firm is doing the best that it can
Price Signaling regardless of what its competitor is doing
A form of implicit collusion in which a firm announces a
price increase in the hope that other firms will follow 1. Dominant Strategy - is a strategy that results in the
suit. highest payoff to a player regardless of the opponent’s
action.
Price Leadership
A form of pricing where one firm, the leader, regularly A matrix which gives the possible outcome of a two-
announces price changes that other firms, the person zero-sum game when player A has possible
followers, then match. moves and player B moves. The analysis of the matrix in
order to determine optimal strategies is the aim of
Types Of Oligopoly game theory.
Pure or perfect Oligopoly
produce homogeneous products The term “payoff matrix” is fairly standard in
Example: microeconomics, so it may be worth mentioning to your
Steel industry students.
Airline company
Cellphone 2. Nash Equilibrium
A set of strategies in which each player has chosen its
Imperfect or differentiated Oligopoly best strategy given the strategy of its rivals.
produce Differentiated products
Example: 3. Maximin Strategy - a strategy that maximizes the
Mercury Drug minimum payoff for one player.
The maximin, or safety first, strategy can be found by
Collusive Oligopoly identifying the worst possible outcome for each
Example strategy. Then, choose the strategy where the lowest
Patents, licenses, requirement of large capital payoff is the highest.

Non Collusive oligopoly 4. Cooperative Strategy - a strategy that leads to the

highest joint payoff for all players.
Open Oligopoly The cooperative strategy is defined as the best joint
outcome for both players together.
Close Oligapoly
Bad for oligopoly firms:
prevents them from achieving monopoly profits
Game theory helps us understand oligopoly and other Good for society:
situations where “players” interact and behave Q is closer to the socially efficient output
strategically. P is closer to MC
CHAPTER SUMMARY make a supernormal profit.
The prisoners’ dilemma shows that self-interest can
prevent people from cooperating, even when
cooperation is in their mutual interest. The logic of the
prisoners’ dilemma applies in many situations.
Policymakers use the antitrust laws to prevent
oligopolies from engaging in anticompetitive behavior
such as price-fixing. But the application of these laws is
sometimes controversial.

Monopolistic Competition and Advertising

Monopolistic competition Long-run Curve
 type of imperfect competition average costs increase due to higher levels of
 many producers competition
 products that are differentiated from one profits fall to normalized levels.
another as goods but not perfect substitutes. Firms will still aim to profit maximize, thereby increasing
 a mixture between a monopoly and perfect production until Marginal Revenue
competition
(MR) = Marginal Cost (MC)
MONOPOLISTIC COMPETITIVE MARKETS ARE:
1. Have products that are highly differentiated,
meaning that there is a perception that the
goods are different for reasons other than price;
2. Have many firms providing the good or service;
3. Firms can freely enter and exits in the long run;
4. Firms can make decisions independently;
5. There is some degree of market power, meaning
producers have some control over price;
6. Buyers and sellers have imperfect information.

CHARACTERISTICS OF MONOPOLISTIC COMPETITION

MANY SELLERS
SLIGHTLY DIFFERENTIATED PRODUCTS Profits
MAXIMIZE PROFITS In a monopolistic market, profits can range from
LOW BARRIERS TO ENTRY AND EXIT supernormal in the short term, to ordinary in the long
NON-PRICE COMPETITION term.
NORMAL PROFITS IN THE LONG-RUN
IMPERFECT INFORMATION By contrast, perfect competition is generally locked in
equilibrium, only earning small amounts of profit.
MONOPOLISTIC COMPETITION GRAPH
Short-run Curve We then have a monopoly market, which, quite
understandably, makes supernormal profits.

ADVANTAGES OF MONOPOLISTIC COMPETITION

 Active business environment
 Customers can obtain a great variety of
products and services since they are
differentiated
  Consumers are informed about goods and
services available in the market;
 Offers higher quality of products
 Excess waste of resources

DISADVANTAGES OF MONOPOLISTIC COMPETITION

 Limited access to economies of scale because of
a considerable number of companies;
 Lack of standardized goods
 Misleading advertising
 Lack of standardized goods

ADVERTISING AND MONOPOLISTIC COMPETITION

 have incentive to advertise
 The goals of advertising are to increase demand
and make demand more inelastic.
 The increase in the cost of a monopolistically
competitive product is the cost of
"differentness"
 The goals of advertising include shifting the
demand curve to the right and making it more
inelastic.

If consumers are willing to pay for "differentness", it's a

benefit for them

ADVERTISING, PRICES, AND PROFITS

Product differentiation reduces the price elasticity of
demand, which appears as a sleeper demand curve.
Successful product differentiation enables the firm to
charge a higher price.

BRAND NAME
• A brand name is valuable to a firm; it makes the
demand less elastic and can enable the firm to earn
higher profits.

• Once a consumer has had a positive experience with a

good, the price elasticity of demand for that good
typically decreases-- the consumer becomes loyal to the
product.