IEA 1201

Principles of Economics
Module 7

MONOPOLY
&
OLIGOPOLY
MONOPOLY
Definition of Monopoly

The Monopolistic Supply Decisions

Can anything good be said about monopoly

Price Discrimination under Monopoly

 A PURE MONOPOLY IS AN INDUSTRY IN WHICH THERE IS
ONLY ONE SUPPLIER OF A PRODUCT FOR WHICH THERE ARE
DEFINITION NO CLOSE SUBSTITUTES AND IN WHICH IT IS VERY DIFFICULT
OR IMPOSIBLE FOR ANOTHER FIRM TO COEXIST.

BARRIERS TO ENTRY COST ADVANTAGES

Are attributes of a
SOURCES OF market that make it
more difficult or
MONOPOLY expensive for a new firm
to open for business that
it was for the firms
already present in that
market
1
LEGAL RESTRICTIONS
01 U.S. POSTAL SERVICE HAS A MONOPOLY POSITION BARRIERS TO ENTRY
BECAUSE CONGRESS HAS GIVEN IT TO ONE.

2 5
PATENTS
02 IS A PRIVILEGE GRANTED TO AN INVENTOR,
WHETHER AN INDIVIDUAL OR A FIRM, THAT
05
PROHIBITS ANYONE ELSE FROM PRODUCING OR
USING THAT INVENTION WITHOUT THE PERMISSION
OF THE HOLDER OF THE PATENT
LARGE SUNK COSTS
ENTRY INTO AN INDUSTRY WILL, OBVIOUSLY, BE
VERY RISKY IF IT REQUIRES A LARGE INVESTMENT,
ESPECIALLY IF THAT INVESTMENT IS SUNK-
MEANING THAT IT CANNOT BE RECOUPED FOR A
CONSIDERABLE PERIOD OF TIME

3 6
CONTROL OF A SCARCE RESOURCE OR INPUT TECHNICAL SUPERIORITY
03 IF A CERTAIN COMMODITY CAN BE PRODUCED
ONLY BY USING A RARE INPUT, A COMPANY THAT
06 a firm whose technological expertise vastly
exceeds that of any potential competitor
GAINS CONTROL OF THE SOURCE OF THAT INPUT can, for a peirod of time, maintain a
CAN ESTABLISH A MONOPOLY POSITION FOR monopoly position
ITSELF.

4 7
DELIBERATELY ERECTED ENTRY BARRIERS
04 A FIRM MAY DELBERATELY ATTEMPT TO MAKE
ENTRY INTO THE INDUSTRY DIFFICULT FOR OTHERS
07
ECONOMIES OF SCALE
IF MERE SIZE GIVES A LARGE FIRM A COST
ADVANTAGE OVER A SMALLER RIVAL, IT IS
LIKELY TO BE IMPOSSIBLE FOR ANYONE TO
COMPETE WITH THE LARGEST FIRM IN THE
INDUSTRY.
 NATURAL MONOPOLY

Are attributes of a market that

Average Cost make it more difficult or
3.5
expensive for a new firm to open
for business that it was for the
firms already present in that
3 market

2.5

1.5

0.5

0
0 0.5 1 1.5 2 2.5 3

Average Cost Poly. (Average Cost)

 THE MONOPOLISTIC’S SUPPLY DECISION

Revenue Cost Total Profit

Q P
TR = P x Q MR TC MC TR - TC
0 - - 10 (10)
1 140 140 140 70 60 70
2 107 214 74 120 50 94
3 92 276 62 166 46 110
4 80 320 44 210 44 110 The market cannot impose a price
on a monopolistic as it imposes a
5 66 330 10 253 43 77 price on the price-taking perfectly
6 50 300 (30) 298 45 2 competitive firm. But the
monopolistic cannot select both
price and the quantity it sells. In
accord with the demand curve,
the higher the price it sets, the
less it can sell
 DETERMINING THE
TO STUDY THE DECISIONS OF A PROFIT
MAXIMIZING MONOPOLIST PROFIT-MAXIMIZING
OUTPUT

1
01
FIND THE OUTPUT AT WHICH MR = MC
TO SELECT THE PROFIT MAXIMIZING
OUTPUT LEVEL
Q P
Revenue
TR = P x Q MR TC
Cost
MC
Total Profit
TR - TC

2
0 - - 10 (10)
FIND THE HEIGHT OF THE DEMAND
02
1 140 140 140 70 60 70
CURVE AT THAT LEVEL OF OUTPUT TO 2 107 214 74 120 50 94
DETERMINE THE CORRESPONDING 3 92 276 62 166 46 110
PRICE 4 80 320 44 210 44 110
5 66 330 10 253 43 77
6 50 300 (30) 298 45 2

3
COMPARE THE HEIGHT OF THE

03 DEMAND CURVE WITH THE HEIGHT OF

THE AC CURVE AT THAT OUTPUT TO SEE
WHETHER THE NET RESULT IS AN
ECONOMIC PROFIT OR A LOSS.
 PROFIT-MAXIMIZING
EQUILIBRIUM FOR A MONOPOLIST
COMPARISON OF A MONOPOLY AND COMPETITIVE INDUSTRY
 COMPARING MONOPOLY & PERFECT COMPETITION

1
A MONOPOLIST’S PROFIT PERSIST
01 Are any excess of the profits earned persistently by a monopoly firm over and above those that would be
earned if the industry were competitive.

2
MONOPOLY RESTRICTS OUTPUT TO RAISE SHORT-RUN PRICE
02 Excess monopoly profit can be a problem. But economist believe that the second difference between
competition and monopoly is even more worrisome:
“Compared with the perfect competitive ideal, the monopolist restricts output and charges a higher price”

3
MONOPOLY RESTRICTS OUTPUT TO RAISE LONG-RUN PRICE
03 Under monopoly, consumers continue to maximize their own welfare by setting MU equal to P. But the
producer sets MC equal to MR. Because MR is below the Market Price,P, it is concluded that in a
monopolized industry
MU = P and MC = MR < P, so MC < MU

4
MONOPOLY LEADS TO INEFFICIENT RESOURCE ALLOCATION

04 Because it is protected from entry, a monopoly firm may earn profits in excess of the opportunity
cost of capital. At the same time, monopoly breeds inefficiency in resource allocation by
producing too little output and charging too high for a price. For these reasons, some of the
virtues of the laissez-faire evaporate if an industry becomes monopolized.
 MONOPOLY IS LIKELY TO
SHIFT DEMAND
Under perfect competition, purchasers consider the
products of all suppliers in an industry to be identical. So
no single supplier has any reason to advertise. But if a
monopoly takes over from a perfectly competitive
industry, it may very well pay to advertise.
MONOPOLY IS LIKELY TO
SHIFT COST CURVES
The advent of monopoly may also shift the average and
marginal cost curves.
• One reason for higher cost is the advertising.
• Another reason is the sheer size of the monopolist’s
organization, which may lead to bureaucratic
inefficiencies, coordination problems and the like.
MONOPOLY MAY AID
INNOVATION
A MONOPOLY HAS PARTICULARLY STRONG MOTIVATION
TO INVEST IN RESEARCH. IF THIS RESEARCH BEARS FRUIT,
THE MONOPOLIST’S COSTS WILL BE LOWER THAN THOSE
OF A COMPETITIVE INDUSTRY IN THE LONG RUN, EVEN IF
THEY ARE HIGHER IN THE SHORT RUN.
NATURAL MONOPOLY : WHERE SINGLE
FIRM PRODUCTION IS CHEAPEST
ECONOMIES OF LARGE SCALE PRODUCTION
 PRICE DISCRIMINATION
UNDER MONOPOLY

UNIFORM PRICES
Is the sale of a given product at different prices to different
customers of the firm, when there are no differences in the

DEFINITION
1 costs of supplying these customers. Prices are also
discriminatory if it costs more to supply one customer than
another, but they are charges the same price

REVENUE
MARGINAL
When a firm charges discriminatory prices, profits are normally
2 higher than when the firm charges nondiscriminatory (uniform)
prices.

The marginal revenue from a sale to a Group A must

3 be the same as that from a sale to a Group B
customer. MRa = MRb.
PRICES AND QUANTITIES UNDER PRICE DISCRIMINATION
BET WEEN COMPETITION &
MONOPOLY
Monopolistic Competition

OLIGOPOLY
 MONOPOLISTIC refers to a market in which products are heterogeneous but
which is otherwise the same as a market that is perfectly
COMPETITION competitive

MANY BUYERS AND SELLERS,

ALL OF WHOM ARE SMALL

NUMEROUS FREEDOM OF EXIT PERFECT HETETOGENEOUS

PARTICIPANTS AND ENTRY INFORMATION PRODUCTS

AS FAR AS THE BUYER IS CONCERNED, EACHS

SELLER’S PRODUCT DIFFERS ATLEAST
SOMEWHAT FROM EVERY OTHER SELLER’S
PRODUCT
 PRICE AND OUTPUT
DETERMINATION UNDER
MONOPOLISTIC
COMPETITION
 THE EXCESS CAPACITY
THEOREM AND RESOURCE
ALLOCATION

Under monopolistic competition in the long run, the firm will

tend to produce an output lower than that which minimizes
its unit costs, and hence unit costs of the monopolistic
competitor will be higher than necessary. Because the level
of output that corresponds to minimum average cost is
naturally considered to be the firm’s optimal capacity, this
result hs been called the excess capacity theorem of
monopolistic competition. Thus, monopolistic competition
tends to lead firms to have unused or wasted capacity.
Long-run equilibrium under monopolistic
competition requires that the firm’s demand
curve be tangent to its average cost curve
 IS A MARKET DOMINATED BY A FEW SELLERS, AT LEAST
SEVERAL OF WHICH ARE LARGE ENOUGH RELATIVE TO THE
OLIGOPOLY TOTAL MARKET TO BE ABLE TO INFLUENCE THE MARKET
PRICE
OLIGOPOLY MODELS
IGNORING
INTERDEPENDENCE
One simple approach to the
problem of oligopolistic
interdependence is to
assume that the oligopolist
themselves ignore it
- That they behave as if their
actions will not elicit
reactions from their rivals
STRATEGIC
INTERACTION
Because they operate in the
same market, the price and
output decisions of same
brands (Brand X and Brand
Y) really are interdependent.
CARTELS
Is a group of sellers of a
product who have joined
together to control its
production, sale, and price
in the hope of obtaining the
advantages of monopoly.
PRICE LEADERSHIP &
TATIC COLLUSION
Under price leadership, one
firm sets the price for the
industry and the others
follow.
 A FIRM’S OBJECTIVE IS SAID TO BE SALES
SALES MAXIMIZATION: MAXIMIZATION IF IT SEEKS TO ADOPT PRICES AND
AN OLIGOPOLY MODEL WITH OUTPUT QUANTITIES THAT MAKE ITS TOTAL

INTERDEPENDENCE IGNORED REVENUE(ITS “SALES”), RATHER THAT ITS PROFIS,

AS LARGE AS POSSIBLE

IF A FIRM IS MAXIMIZING SALES REVENUE, IT WILL

PRODUCE MORE OUTPUT AND CHARGE A LOWER
PRICE THAT IT WOULD IF IT WERE MAXIMIZING
PROFITS.
A KINKED DEMAND
CURVE
IS A DEMAND CURVE THAT CHANGES
ITS SLOPE ABRUPTLY AT SOME LEVEL OF
OUTPUT.
 THE GAME-THEORY
APPROACH

THE MAXIMIN STRATEGY AND THE PRISONER’S DILEMMA

REQUIRES YOU TO SELECT THE STARTEGY THAT YIELDS THE MAXIMUM
PAYOFF ON THE ASSUMPTION THAT YOUR OPPONENT WILL DO AS MUCH
DAMAGE TO YOU AS HE OR SHE CAN

OTHER STRATEGIES : THE NASH EQUILIBRIUM

results when each player adopts the strategy that gives her the highest
payoff if her rival sticks to the strategy he has chosen

REPEATED GAMES
IS ONE THAT IS PLAYED OVER AGAIN A NUMBER OF TIMES

THREATS AND CREDIBILITY

A CREDIBLE THREAT IS A THREAT THAT DOES NOT
HARM THE THREATENER IF IT IS CARRIED OUT

A MARKET IS PERFECTLY CONTESTABLE IF ENTRY

AND EXIT ARE COSTLESS AND UNIMPEDED
 ATTRIBUTES OF THE
FOUR MARKET FORMS

Number of
Long-Run
Market Form Firms in the Frequency in Reality Entry Barriers Public Interest Results Equilibrium Conditions
Profit
Market
Perfect Competition Very Many Rare (If Any) None Good Zero MC = MR = AC = AR = P
Pure Monopoly One Rare Likely to be high Misallocates resources May be high MR = MC
MR = MC
Monopolistic Competition Many Widespread Minor Inefficient Zero AR = AC
Oligopoly Few Produces large share of GDP Varies Varies Varies Varies
THANK YOU
Engr. Leo Victor B. Amores, CIE, CLSSYB,
Trained LSSGB

University of San Carlos

Industrial Engineering Department

School of Engineering