Imperfect Competition

• Competition is limited
o No competition: monopoly
o Some competition: oligopoly, strategic interaction
o Some more competition: some more firms than oligopoly but less than
perfect competition : monopolistic competition.
• In perfect competition, p=MR
• But in imperfect competition, they face a downward sloping
demand curve and to sell more, they need to reduce price or
make their demand curve shift by more advertising or other
appropriate strategies

1
Monopoly
 Market Structure
• Many buyers, ONE seller
o Sellers are price makers
o Sellers do not behave strategically
• Blocked entry to the market

3
 The Profit-maximising Monopolist
• Monopolist faces the industry demand curve

• Profit max. conditions imply that MR = MC and MR cuts MC

in its rising part (the other one will not be stable)

• How do we get this MR curve of the monopolist?

From the TR function! How?
• TR =PQ
• Put the demand curve: P= 24 – 3Q
• TR function: TR=PQ= (24 – 3Q)*Q = 24Q – 3Q2
• Differentiating wrt Q, get MR = 24 – 6Q.

4
 Marginal Revenue
MR = 40 – 10Q
100
Q TR MR P
0 0 40 40
50 1 35 30 35
2 60 20 30
0
0 2 4 6 8 10
Demand 12 3 75 10 25
4 80 0 20
-50
5 75 -10 15
MR
-100 6 60 -20 10
TR
7 35 -30 5
-150
8 0 -40 0
9 -45 -50 -5
• Marginal revenue falls as output sold increases
10 -100 -60 -10
• Marginal revenue is less than price (refer demand curve)

• After TR is max, MR becomes negative

• MR lies below the Demand curve

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 How Monopolies Make Production
& Pricing Decisions
• Profit maximization
o If MR > MC – increase production
o If MC > MR – produce less
o Maximize profit
• Produce quantity where MR=MC
• Intersection of the marginal-revenue curve and the marginal-cost curve
• The monopolist chooses q and also decides p.

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 Monopoly Equilibrium
In perfect competition, p=MR = MC
Rs In monopoly, p> MR and since MR=MC, p>MC

MC
P
AC

Monopoly
Profit
D
Q Qty
MR 7
A Monopolist Breaking
Even
Price MC
ATC

PM

MR D
0 QM Quantity
A Monopolist Making a Loss
Price MC ATC

CM B
Loss A
PM

MR D
0 QM Quantity
 When will the monopolist shut down?

• In the short run, the monopolist can earn profit, make losses or
just break even
• It will continue to operate (i.e. min. losses) as long as p
exceeds AVC at the optimum level of output, i.e. p* = AVC is
the shutdown point

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 When will the monopolist shut down?
• In the short run, the monopolist can earn profit, make losses or
just break even
• It will continue to operate (i.e. min. losses) as long as p
exceeds AVC at the optimum level of output, i.e. p* < AVC

P, R, C MC
AC

AVC

P*

AR

Q
Q*
MR
 Long Run
• In the long run the firm is on its long run cost curves

• No entry of new firms takes place, so economic profit can

exist in the long run

• Hence in long run also, the monopolist chooses output as in

short run, i.e. at MR = LMC and sets the price from the cor.
demand curve

• But the monopolist stops producing if he incurs losses in the

long run

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 Monopoly Price and Output
• In order to earn economic profit, monopolists tend to cut
production and charge higher prices compared to perfectly
competitive firms

• That is why we have regulations that promote competition and

prevent unwarranted monopolies

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 Measurement of Monopoly Power
• Price Elasticity of demand: the degree of market power is
inversely related to e. Fewer the substitutes, less is e, greater the
firm’s market power
MR = P (1-1/|e|) Always: MR < P

• Lerner Index: LI = (P – MC) / P where P is the price the

monopolist sets
o Under perfect competition, P = MC, hence LI = 0
o Under monopoly P > MC (as P> MR = MC), LI >0
o Higher LI, higher is market power
o LI is inversely related to price elasticity of demand

• Cross price elasticity: A high positive cross p-elasticity implies

existence of close substitutes, hence lower market power

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 Measurement of Market Power
• Measure of Concentration
o If a relatively small no of firms have a large share of total
sales, then the market is concentrated
o Herfindahl-Hirschman Index (sum of squares of market
shares of each firm)
o 1 firm with 100% market share: HHI = 1
o 2 firms with 50% market share each: HHI = 0.52 + 0.52 =
0.5
o 4 firms with 30%, 30%, 20%, 20% market share: HHI =
0.26
o 10 firms each with market shares 10%: HHI = 0.1

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 Assessing the Degree of Competition
• Elasticity
• 4-firm concentration ratio
• Product differentiation leads to imperfect substitutes, so
market power increases

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 Problems on Monopoly
1. Chalchitra Cinema is the only movie theater in Sunderbans. The nearest
rival movie theater the Chhayachitra, is 35 miles away. Thus Chalchitra
Cinema possesses a degree of market power. Despite having market power,
it is currently suffering losses. In a conversation with the owner of the
Chalchitra Cinema, manager of the movie theater made the following
suggestions: “Since Chalchitra is a local monopoly, we should just increase
ticket prices until we make enough profit.”
Is it a correct strategy? Comment.

2. The Total Cost function for a monopolist is given by the equation TC = 900 +
50Q^2. The demand function for the good produced by the monopolist is given
by 2Q = 48 – 0.08P. Find out the profit maximizing output and price for the
monopolist.

3. The demand function of a monopolist is estimated to be Q = 100 – 10P. If the

Marginal Revenue is Rs. 4, and output sold is 30 units, what is the price
elasticity of demand for the good?
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The Welfare Cost of Monopolies
o Produce quantity where
• MC = MR
o Produces less than the socially efficient quantity of output
o Charge P>MC (while perfectly competitive firm produces at P=MC)
o Deadweight loss
• This occurs because of misallocation of resources
o Higher profit
o Bigger producer surplus and smaller consumer surplus
 DEADWEIGHT LOSS FROM MONOPOLY POWER

The shaded rectangle and

triangles show changes in
consumer and producer surplus
when moving from competitive
price and quantity, Pc and Qc,
to a monopolist’s price and
quantity, Pm and Qm.
Because of the higher price,
consumers lose A + B
and producer gains A − C. The
deadweight loss is B + C.
 The inefficiency of monopoly
Under
Costs Monopoly,
and CS = ABC
Revenue A PS = BCDE
Deadweight Marginal cost
loss
Monopoly B C Under Perfect
price Competition,
Competitive G CS=AFG
price F PS=EFG
D
Demand
Hence, under
monopoly,
E Deadweight loss
Marginal revenue = CDG

0 Monopoly Efficient Quantity

quantity quantity
Because a monopoly charges a price above marginal cost, not all consumers who value the good at more
than its cost buy it. Thus, the quantity produced and sold by a monopoly is below the socially efficient level.
The deadweight loss is represented by the area of the triangle between the demand curve (which reflects the
value of the good to consumers) and the marginal-cost curve (which reflects the costs of the monopoly
 Problem Set 2
1. You are a manager of a monopoly and your demand and cost
functions are given by P=300-3Q and C(Q)=1500+2Q^2.
a. What price-quantity combination maximizes your firm’s profits?
Calculate the maximum profit.
b. Calculate the consumer surplus, producer surplus and the dead weight loss
under monopoly

2. Consider a monopolist. TC=1500+4Q. If the price elasticity of

demand is -1.5, what is the price charged by the monopolist?

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 PYQs
1. A monopolist faces the following demand function: Q = 200 – 2P. The total cost
function is given as: TC = 2Q^2. (3+1+1=5)
• What is the profit maximizing level of output and price charged by the monopolist?
How much profit is the monopolist earning?
• At the equilibrium, calculate the monopoly power.
• “More the demand curve is elastic, more is the monopoly power”. Is this statement
true? Give reasons in one sentence.

2.a. Monopoly is said to be economically inefficient. Explain and show how it causes
deadweight loss?
• b).A monopolist faces a demand curve P=100- 4Q. If MC is constant and is equal to
20,what is the amount ofprofit made by the monopolist.
• What is the dead weight loss on account of monopoly?(2+3)

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 Problems on Monopoly

4. A monopolist faces a demand curve P = 11 – Q, Q measured in thousands.

The average and marginal cost both are Rs. 5. [DO IT YOURSELF]
o What are the monopolist’s profit-maximising price and quantity?
o Find out deadweight loss

ANS:
MR=11-2Q.
MR=MC implies
11-2Q=5, or Q =3.
Hence P = 11-3 = 8

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 Ref
Pindyck and Rubinfeld, Chapter 10

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