PURE MONOPOLY

The purpose of this chapter is to examine the

pure monopoly model in the product market.
Because monopolies are price givers, there
are significant differences between
monopolies and competitive firms, these
differences will be examined in details in this
chapter
 The Assumptions of Monopoly

(1) there is a single seller.

(2) the single seller offers a singular product,

(3) entry and generally exit are blocked,

(4) there is non-price competition, and

(5) the monopolist dictates price in the market.

MONOPOLY

How Monopoly Arises

A monopoly has two key features:
▪ No close substitutes
▪ Barriers to entry
Legal or natural constraints that protect a firm from
potential competitors are called barriers to entry.
MONOPOLY

There are two types of barriers to entry: legal and natural.

Legal barriers to entry create a legal monopoly, a market
in which competition and entry are restricted by the
granting of a:
▪ Public franchise (like the U.S. Postal Service public
franchise to deliver first-class mail).
▪ Government license (like a license to practice law or
medicine)
▪ Patent and copyright
MONOPOLY

Natural barriers to entry

create a natural
monopoly, which is an
industry in which one
firm can supply the
entire market at a lower
price than two or more
firms can.
Figure 12.1 illustrates a
natural monopoly.
MONOPOLY

One firm can produce 4

units of output at 5 cents
per unit.
Two firms can produce 4
units—2 units each—at
10 cents per unit.
Four firms can produce 4
units—1 unit each—at 15
cents per unit.
MONOPOLY

Because the firm is the industry it therefore faces a

downward sloping demand curve, which is also the
average revenue curve for the firm (hence the
industry).If the firm wants to sell more it must lower its
price therefore marginal revenue is also downward
sloping. Remember when you lower price the average
revenue falls, but not as fast as the marginal,
Unlike the purely competitive model here is no supply curve in
an industry which is a monopoly. The monopolist decides how
much to produce using the profit maximizing rule; or where
MC = MR. In this sense, the monopolist is a price dictator,
in that it is the cost structure, together with the change in total
revenue with respect to change in quantity sold that directs
the monopolist’s pricing behavior, rather than the interaction
of the monopolist’s supply schedule, with the demand
schedule of consumers (demand curve).
 MC

Economic C
ATC
Profit

MR
Price

The above diagram shows the economic profits that can be maintained
in the long run because of the barriers to entry into this industry. The
monopolist produces where MC= MR

On the other hand, there is nothing in the analysis that requires any given
monopolist will be profitable. In fact, a monopolist can operate at an
economic loss, the same as a competitive firm can but only in the short run,
as in the long run he will gain economic profit.
MONOPOLY

Monopoly Price-Setting Strategies

For a monopoly firm to determine the quantity it sells, it
must choose the appropriate price.
There are two types of monopoly price-setting strategies:
Price discrimination is the practice of selling different
units of a good or service for different prices. Many firms
price discriminate, but not all of them are monopoly firms.
A single-price monopoly is a firm that must sell each unit
of its output for the same price to all its customers.
 MONOPOLISTIC
COMPETITION

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Monopolistic Competition

– Monopolistic competition is a market with the

following characteristics:
▪ Many firms.
▪ Each firm produces a differentiated product.
▪ Firms compete on product quality, price, and
marketing.
▪ Firms are free to enter and exit the industry.

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Monopolistic Competition

Many Firms

– The presence of many firms in the market implies:

▪ Each firm has only a small market share and
therefore has limited market power to influence the
price of its product.
▪ Each firm is sensitive to the average market price,
but no firm pays attention to the actions of the other,
and no one firm’s actions directly affect the actions of
other firms.
▪ Collusion, or conspiring to fix prices, is impossible.

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 Monopolistic Competition
Product Differentiation
– Firms in monopolistic competition practice product
differentiation, which means that each firm makes a
product that is slightly different from the products of
competing firms.

Competing on Quality, Price, and Marketing

Product differentiation enables firms to compete in three areas:
quality, price, and marketing.
Quality includes design, reliability, and service.
Because firms produce differentiated products, each firm has a
downward-sloping demand curve for its own product.But there
is a tradeoff between price and quality.
Differentiated products must be marketed using advertising and
packaging.
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 Monopolistic competition in the short run

At profit maximization, MC = MR, and output is Q and price P. Given that price
(AR) is above ATC at Q, supernormal profits are possible (area PABC).

As new firms enter the market, demand for the existing firm’s products becomes
more elastic and the demand curve shifts to the left, driving down price. Eventually, all
super-normal profits are eroded away.

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 Monopolistic competition in the long run

Super-normal profits attract in new entrants, which shifts the demand curve
for existing firm to the left. New entrants continue until only normal profit is
available. At this point, firms have reached their long run equilibrium.

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 OLIGOPOLY

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What is Oligopoly?

– An oligopoly is a market structure in which a few firms

dominate. When a market is shared between a few
firms, it is said to be highly concentrated. Although
only a few firms dominate, it is possible that many
small firms may also operate in the market.
– Considering the market for air travel, major airlines
like British Airways (BA) and Air France often operate
their routes with only a few close competitors, but
there are also many small airlines catering for the
holidaymaker or offering specialist services

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 What is Oligopoly?

Key characteristics
The main characteristics of firms operating in a market with few close
rivals include:
Interdependence
Firms operating under conditions of oligopoly are said to be
interdependent , which means they cannot act independently of each other.
A firm operating in a market with just a few competitors must take the
potential reaction of its closest rivals into account when making its own
decisions

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Barriers to entry
Oligopolies and monopolies frequently maintain their position of dominance in a
market might because it is too costly or difficult for potential rivals to enter the
market
Collusive oligopolies
Another key feature of oligopolistic markets is that firms may attempt to collude,
rather than compete. If colluding, participants act like a monopoly and can enjoy
the benefits of higher profits over the long term.
Types of collusion Overt: occurs when there is no attempt to hide agreements,
Covert : occurs when firms try to hide the results of their collusion, usually to
avoid detection by regulators, such as when fixing prices.
Tacit: arises when firms act together, called ‘acting in concert’ but where
there is no formal or even informal agreement

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Criticism of Pure Competition as a Mode of Analysis for the Real World.

The distribution of income may lack equity or even technical

efficiency. In a purely competitive world, workers will be paid
the value of what they contribute to the total output of the
firm. If the product they produce is not highly valued then
some workers could be paid very low wages, even though the
human capital and effort requirements are substantial.
If all industries are purely competitive there be
consumer dissatisfaction because each firm offers a
standardized product

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 1) Which of the following is ALWAYS true for a single-price monopolist in equilibrium?
A) P = MC B) P = MR C) MC = ATC D) MR = MC

1) The figure above shows the demand and cost curves for a single-price monopolist. What level
of output maximizes the firm's economic profit?
A) 0 units B) 50 units C) 20 units D) 30 units

1) . What price will the firm charge?

A) $50 per unit B) $10 per unit C) $20 per unit D) $30 per unit

1) What economic profit does this firm earn?

A) $400 B) zero C) $600 D) $200

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 Price (dollars Quantity Total cost
per unit) (units per day) (dollars)

30 0 10
25 1 20
20 2 25
15 3 40
10 4 60
5 5 85

1) The table above shows the demand and costs for a single-price monopolist. The firm will
A) maximize profits by producing 2 units.
B) operate on the elastic portion of its demand curve.
C) operate on the unit elastic portion of its demand curve.
D) maximize profits by producing 3 units.

1) The firm will earn an economic profit of

A) $15. B) $45. C) $40. D) $25.

1) Why can a monopoly earn an economic profit in the long run?

A) because there is only a single firm in the market
B) because there are close substitutes for the firm's product
C) because the firm is protected by barriers to entry
D) ALL of the above are reasons why a monopoly can earn an economic profit in the long run.

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