Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

ECONOMICS NOTES

DYNAMICS OF IMPERFECT
MARKETS

GRADE: 12

YEAR: 2023

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

TOPIC 6: IMPERFECT MARKETS

Imperfect market is any market which does not meet the requirements of a perfect
market. Three imperfect market structures are: monopoly, oligopoly and monopolistic
competition.

MONOPOLY: (Possible essay: discuss monopoly in details with/ without the aid of
graphs- concept, characteristics short run economic profit & economic loss & long run
economic profit)

Monopoly is when a single firm and its product offering dominate a market. An
example in South Africa is ESKOM.

CHARACTERISTICS/MARKET STRUCTURE

 Number of businesses
 Monopoly market has only one seller of a product. Therefore, the firm faces no
competition.
 The seller is also responsible for the industry output.
 Nature of the product
 Monopolist product is unique with no close substitutes, therefore there is no
competition.
 The consumer can only buy the monopolist’ product or go without it.
 Market entry
 Barriers prevent other businesses from entering the market.
 Natural barriers such as exclusive ownership of scarce natural resource provide a
barrier. For example, De Beers had sole ownership of diamond for years
 A natural monopoly is created due to the large amount of initial capital needed to
develop such businesses. For example, to provide electricity needs power stations
that are expensive to build. Government is usually the only entity with large amount of
capital, therefore natural monopolies are often owned by governments.
 When barriers to entry are not economic in nature, an artificial monopoly is created.
Example of such barriers are patents which give the patent holder the right to be the
exclusive manufacturer of a particular product. Licensing is another way in which
artificial monopoly is applied, e.g. TV and radio licenses. licenses protect operators
against entry of other competitor.
 Control over price
 A monopoly firm has a considerable control over price as such it is known as a price
maker.
 However, monopoly does not have control over demand, so demand will influence the
monopolists ‘price.
 The monopolist can only decide at which part of the demand curve they want to
produce.

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

 Demand curve
 The monopolist demand curve slope downwards from left to right.
 This indicates that the quantity demanded will increase as price decrease.
 Because the monopolist is the only supplier of the product in the market, its demand
curve represents the market demand curve.
 Although the monopolist is the only supplier of a product, the product is still influenced
by market forces in the economy e.g. consumers have limited budgets and therefore
monopolies cannot demand excessive prices for their products.
 Market information
 There is incomplete information about market conditions to consumers.
 The monopolist withholds information or provide insufficient information to consumers
and this prevent them to make informed decisions.
 Profit
 The monopolist can make economic profit both in the short run and the long run.
 This is because the market entry is blocked, other firms cannot enter the market due
to the short term profit.

THE DOWNWARD SLOPPING SHAPE OF THE DEMAND CURVE

Price

D /AR

Quantity

 The monopoly’s demand curve slopes downward from left to right.

 Since the monopolist is the only supplier in the market, its demand curve represents
the market demand curve.
 The shape of the demand curve indicates that less will be bought a higher price
while more will be bought at lower price.
 This means the monopolist cannot charge excessively high prices for its products,
since consumers’ resources (money) are limited.
 If the monopolist wants to increase revenue it would have to decrease price, and this
means the law of demand also apply to a monopolist.

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Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

THE RELATIONSHIPS BETWEEN THE REVENUE CURVES OF THE MONOPOLIST

Quantity Price Total revenue Average revenue Marginal revenue

(Q) (P) (AR) (TR= P x Q) (AR =TR ÷ Q) (MR = ∆TR ÷ ∆Q)
0 R11 0 0 -
10 R10 100 10 10 (100 ÷ 10)
20 R9 180 9 8 (80 ÷ 10)
30 R8 240 8 6
40 R7 280 7 4
50 R6 300 6 2
60 R5 300 5 0
70 R4 280 4 -2
80 R3 240 3 -4
90 R2 180 2 -6
100 R1 100 1 -8

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10
9
8

R5
AR& MR

R3
AR/D

MR
10 20 30 40 50 60 80 Quantity
TOTAL REVENUE (TR)

R300
280
240
180
100

10 20 30 40 50 60
Quantity

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

 The relationship between the price per unit of a product (AR) and marginal revenue
(MR)is that with the exception of the first unit, MR is always lower than the AR.
 This means for every product sold (after the first unit), the additional revenue earned
is lower than the price (AR) for the product (see the table in page 4).
 The relationship between AR and TR is that the price paid (AR) for every unit bought
contribute towards total revenue.
 The monopolist earns highest total revenue (maximises revenue) where MR = 0
which at the price R5.
 At this point, the Price / AR is at the centre of the demand curve, this means to earn
maximum TR price should not be too high or too low, but should be moderate.

SHORT- RUN PROFIT AND LOSSES IN MONOPOLY (POSSIBLE ESSAY)

1. Economic profit

MONOPOLY ECONOMIC PROFIT

MC

AC
PRICE/COSTS/REVENUE

100 Economic profit

80 p

MR AR /D

50 QUANTITY

 Economic profit is the extra profit that the firm makes over and above the
normal profit.
 The firm makes maximum profit where MR = MC.
 The firm makes economic profit when TR > TC or when AR > AC

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

Calculation of economic profit

TR > TC AR > AC
PROFIT = TR - TC (AR - AC) x Q
= (p x q) - (ac x q) (100 - 80) x 50
= (100 x 50) - (80 x 50) = 20 x 50
= 5000 - 4000 = 1000
= 1000

2. Economic loss

MC
AC

120
Economic loss
PRICE/ COSTS/REVENUE

100 o

MR AR/P

50
QUANTITY

 Though a monopolist is the only seller of the product, it can still make a loss if
demand is lower and production costs are higher.
 At MC= MR the firm makes minimum loss, therefore it is a loss minimizing point.
 The monopolist makes a loss when TR < TC or AR < AC.
TR - TR AR < AC
LOSS = TR - TC LOSS = (AR - AC) x Q
= (p x q) - (ac x q) = (100 - 120) x 50
= (100 x 50) - (120 x 50) = - 20 x 50
= 5000 - 6000 - 1000
= - 100)

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

LONG TERM EQUILIBRIUM (LONG RUN ECONOMIC PROFIT

 Due to the barriers to entry, monopolist is protected therefore it continue to make

profit even in the long run.
 If the monopolist makes losses in the short term, it has the opportunity to improve
the situation since it would still be the only firm in the market even in the long term.
 When the monopolist makes profit in the short term, they will try to expand their plant
size to make even more profits.

LMC

LAC
Price/Revenue/Costs

P / R20

Economic profit
C/ R15
AR/P

MR

(Q) 100 Quantity

 The firm maximises profit where Marginal cost is equal to marginal revenue (MC =MR).
 The profit maximising quantity is 100 and the Price is R20.
 The firm ‘s average cost is R15, therefore resulting in an economic profit of R5 per unit
sold.
 The total profit made will be = TR - TC
 (P x Q) - (AC x Q)
(20 X 100) - (15 x 100)
2000 - 1500

= R50

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

PRICES AND PRODUCTION LEVELS IN MONOPOLY

 A monopolist often produces lower output in order to influence the price of its products.
 It charges higher prices as a result of producing relatively lower quantities.
 The effect of charging higher prices is that some consumers are excluded from the
market because they cannot afford paying those prices. This represents allocative
inefficiency because the resources are used in a way that quantity produced is much
less than it could be.
 A monopolist also is inefficient productively, because it produces its product at a higher
cost than it can possibly be,

OLIGOPOLY MARKET (possible essay: examine oligopoly in details- concept,

characteristics & the kinked demand curve)

 Oligopoly represents a state of limited competition in which a market is shared by few

sellers.
 Examples are banks, cell – phone service companies, car manufacturers, media
companies such as TV.
 In situations where there are only two dominant firms, the market is called duopoly.

CHARACTERISTICS /MARKET STUCTURE

 Number of sellers
- The market is dominated by a few number of large firms.
- If a market is dominated by two firms, the type of oligopoly is known as duopoly.
 Nature of product
 The product manufactured may either be homogenous or heterogeneous.
 When the product is the homogeneous, the market is called pure oligopoly and when
the product is differentiated, the market is called differentiated oligopoly.
 Example of homogeneous product is petrol and heterogeneous product is motor car.
 Entry and exit
- The entry in to the market is difficult due to various barriers such the large amount of
capital outlay often needed.
- The existing firms may often be enjoying economies of scale and this may be a further
barrier.
 Demand curve
- oligopolies face a kinked demand curve that slopes downwards from left to right.
- the upper segment of the demand curve is elastic and the lower segment is inelastic.
- an individual firm gains little from reducing price and stands to lose for increasing price.
 Control over price
 Oligopolies have some influence on the price of their products, though not as much as
the monopolist.
 While the firms are price makers the extent to which they can increase their price is
limited by the fact that they have competition.
 Price wars as often a feature when existing firms want to limit entrance in to the market.

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023


 Market information
 Buyers and sellers have incomplete market information.
 Even though oligopolies monitor one another’s actions they do not always know how
the competitor will react to their actions.
 Collusion
 There is collusion which is an agreement between firms to fix prices and limit output.
 Price leadership/ informal/ tacit/ hidden agreement between firms is one form of
collusion. The biggest and dominant firm acts as a price leader and other firms follow.
 Explicit collusion /formal collusion is where firm agree to fix prices, limit output and
competition among themselves.
 Mutual dependence
 Oligopolistic firms are often influenced by the action of one another.
 The decision that one firm make about prices, advertising and quantities depends on
how it thinks other firms will react.
 Therefore, the policy decisions of an oligopolistic firm are more complex than in other
market structure.

THE OLIGOPOLIST’ KINKED DEMAND CURVE

 Rationale
- Due to mutual interdependence among firms, the demand curve of an individual firm
tends to be kinked (when there is no collusion among firms).
- Firms in an oligopoly attempt to protect and maintain their market share/customers
- If a firm changes its price, the result of such decision depends on how the competitors
will react to the change in price.

 The graph

Price D elastic

R105

R100

Inelastic
R50

70 100 120 Quantity

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

- The demand curve has two segments which are elastic and inelastic. Where these two
segments meet, a kink (bend) is formed.
- An oligopoly firm sets its market price at the kink. A firm ‘s price decision making
include whether to increase or decrease the price or to leave it at the kink.
 Price increase
- If the firm increases its price, it operates on the elastic part of the demand curve.
- Elastic demand means a small increase in price will result in a bigger decrease in
quantity demanded.
- The other firms often will not follow the firm in increasing their prices.
- If price increases from R100 to R105, quantity may decrease from 100 to 70. This
represents a 30% decrease in market share.
- This means a 5% increase in price has resulted in a 30% decrease in customers
(market share)
 Price decrease
- If the firm decrease prices, it will operate on the inelastic part of the demand curve.
- Inelastic demand means a larger percentage decrease in prices will result in a small
increase in quantity demanded.
- If the price decrease of R50 quantity demanded may increase to 120. This means a
50% decrease in price (100 -50) resulted in a 20% increase in market share.
- This is because when the firm reduce its price the other firms will follow it and reduce
their prices as well.
- Some firms may lower their prices much more than the firm, therefore a price wars
may happen.

 Leaving the price unchanged

- The best position for the firm’s price is at the kink as this can give it the highest possible
revenue.
- The quantities at this price allows the firm to maximise profit as well.

NON – PRICE COMPETITION

 The oligopolistic firms use non- price competition; this is to avoid risks such as price
wars.
 Non – price competition can be applied in the following forms:
 Advertising
 Oligopolistic firms make use of advertising very extensively in order to attract as many
customers as possible.
 They aim to provide information about the product and the firm.
 Firms want to encourage the customer to buy their product.
 They also aim to remind the customer that the firm ‘s product is beneficial to them.
 Branding
 Branding is when a firm or its product is appealing or seen in positive way by
consumers.

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

 For example, there are certain cars are viewed to be for wealthy and luxurious, while
others are viewed to be for working class.
 Branding is used to appeal to a certain kind of a consumer.
 Product differentiation
 It is when a firm markets its products as different from the competitors’ products even
though they may not be different.
 The difference is created in through communicating that the product is of superior
qualities.
 Sometimes the differences may be imagined by the consumers.
 Packaging is another way of making a firm’s product look different to the competitors’
products.
 Product proliferation
 This is when firms produce wide variety of products to cater for different customers
within its market. Example, car manufacturers often produce variety of cars such as
sedans, SUV, hatch backs, 4 x 4.

 Other forms of non-price competition are:

 Door to door delivery
 Extended warranties for consumers.
 Longer trading hours e.g. closing late in the evening on weekends.
 Offering after sale service to consumers.
 Doing business over the internet.

COLLUSION
 Collusion is when firms cooperate with one another in order to fix prices and achieve
high profits.
 Collusion happen in oligopoly as a result of intense pressure of competing and
mutual dependence in decision making. Firms end up being tempted to cooperate
with one another instead of competing in order to have certainty about the market
conditions.
Forms of collusion
 Cartels/ Overt collusion/ explicit collusion
 It is when firms openly and formally agree to control the market by agreeing to fix
prices and output.
 An example is OPEC, which often meet to decide on the quantity they can supply in
order to obtain high profit.
 The colluding firms operate as a collective monopoly.
 This form of collusion is illegal in South Africa
 Price leadership/ tacit collusion/ implicit collusion
 This is an informal agreement between firms to control the market.
 A dominant firm often take the lead by changing its prices.
 Other firms then follow it by also changing their prices to match that of the biggest
firm.

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

 Without any meetings or communication of any kind, the firms will always watch the
actions of the price leader and act accordingly.
 The biggest firm is known as the price leader.
 Price leadership is allowed by law in South Africa.

PRICES AND PRODUCTION LEVELS IN OLIGOPOLY

 Oligopolistic firms often produce lower output in order to influence the price of their
products.
 They charge higher prices as a result of producing relatively lower quantities.
 The effect of higher prices is that some consumers are excluded from the market
because they cannot afford paying such prices. This is allocative inefficiency because
the resources are used in a way that quantity produced is much less than it could be.
 An oligopolistic firm also is inefficient productively, because it produces its product at
a higher cost than it can possibly be.

MONOPOLISTIC COMPETITION

 It is a market structure that in which many sellers produce similar but slightly
differentiated products. Example petrol stations, restaurant, fast-food outlets, clothing
shops.
 Monopolistic competition is a hybrid structure, because it combines some
characteristics of monopoly and perfect competition.
 It consists of many sellers (like perfect market) and each seller make its product
unique (like monopoly) by differentiating it from that of its competitors.
 There is non-price competition among seller (see non-price competition on page 10)

CHARACTERISTICS

 Number of businesses
 There are many sellers and buyers in the market.
 The sellers are mostly small in size, however as a market their combined turnover is
large.
 Nature of the product
 Product sold by each firm are slightly differentiated.
 Products are similar but are not the same (identical).
 The product differentiation is often influenced by factors such as packaging and
advertising.
 The differences are often imaginary rather than real.
 Control over price
 Firms have little control over the prices of their products
 Each seller is a price maker as they set their own prices
 Brand loyalty play an important role in influencing each firm ‘s price level.

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 Economics/Grade 12 Topic Imperfect markets Nkangala District/2023

 Market entry
 Entry into the market is easy as there are no barriers such as patents and large capital
outlay.
 It is also easy to exit the market, so firms which wish to leave the market can do so.
 Demand curve
 The demand curve is downward sloping with relative elasticity.
 This relative price elasticity is an indication that each seller has many competitors.

 Market information
 Market information is incomplete for both buyers and sellers.
 Participants do not have full information such as prices and product quality.
 Profit
 The firm can make economic profit in the short run.
 In the long run, a monopolistic competitor can make only normal profit.
 This is because the short run profit will attract new firms to enter the market, therefore
increasing supply and decreasing prices.

PRICES AND PRODUCTION LEVELS OF A MONOPOLISTIC COMPETITIOR

 Monopolistic competitors often produce lower output in order to influence the price of
its products (even though they have limited control over their prices)
 They charge higher prices as a result of producing relatively lower quantities.
 The effect of this is that some consumers are excluded from the market because they
cannot afford paying higher prices. This is allocative inefficiency because the
resources are used in a way that quantity produced is much less than it could be.
 A monopolistic competitor also is inefficient productively, because it produces its
product at a higher cost than it can possibly be

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Economics/Grade 12 Topic / Imperfect markets Nkangala District/2021

Characteristic Perfect competition Monopoly Oligopoly Monopolistic

competition
Number of businesses Many sellers that no single ONE Seller whose output Few firms dominate the Large number of small
business can influence the represents industry output market firms
market price

Nature of the product Products are Unique products with Products are Products are
homogenous, i.e. no close substitutes homogeneous or differentiated
identical in respect of differentiated
size, shape etc.
Market entry Completely free entry in Entry is completely - The entry in to the  Entry into the market is
to the market blocked by barriers market is difficult due to easy as there are no
such as patents and various barriers such barriers such as patents
ownership of scarce
the amount of capital and large capital outlay.
resources
outlay often needed.

Control over price Firms have no control Have considerable Some control over Firms have little control
over price, they are control over prices, the price, but not as much over their prices
price takers firm is a price maker. as the monopoly
Limited by demand and
the goal of wanting to
maximize profit
Demand curve Perfectly elastic Demand curve slopes The demand curve is Downward sloping
(horizontal) demand downward. It also kinked, indicating that demand curve
curve serves as the industry firms often prefers non-
demand curve price competition

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Economics/Grade 12 Topic / Imperfect markets Nkangala District/2021

Characteristics Perfect Competition Monopoly Oligopoly Monopolistic

competition

Profit Economic profit in the Monopolist can make The firms can make Economic profit in the
short run. The profit economic profit both in economic profit both in short run, then new
attracts new entrants in the short run and long the short run and the firms will be attracted to
to the market. The firm run. Because the firm long run enter the market as the
Makes only normal is protected by barriers entry is free. The firm
profit in the long run. to entry, no firms can makes only normal
be attracted by the profit in the long run
short run profit and
manage to enter the
market.
Collusion Impossible, participants Irrelevant, there is only Collusion is possible Collusion is impossible,
have perfect knowledge one seller in the market and often happens. as there are many
of market conditions Firms get tired of sellers
competing and collude
to achieve higher profits
Productive efficiency Efficient : goods are Inefficient: Average Inefficient: Average Inefficient: average
produced at lowest cost cost of production are costs of production are cost of production are
possible high high high
Allocative efficiency Efficient: quantities Inefficient: Produces Inefficient: Produces Inefficient: firms
required by consumers lower quantities than lower quantities than produce lower
are available what the consumers what the consumers quantities
wish for wishes for
Decision making Each firm make Independent decision Due to mutual Competitors actions
independent decisions making interdependence , firms have influence on a
influence one another ‘s firm’s decision making
decision making

Possible essay: compare and contrast any of the two market structure in details.

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