Competition and Monopoly

2012

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
1
Slides prepared by Muni Perumal, University of Canberra, Australia.
 What is Perfect Competition?
• Perfect competition is an industry in
which:
– Many firms sell identical products to many buyers.
– There are no restrictions to entry into the industry.
– Existing firms have no advantages over new ones.
– Sellers and buyers are well informed about prices.
– A competitive seller is a price taker, not a price maker
– Sellers face a perfectly elastic demand curve
– P = AR = MR = Demand curve
Revenue Concepts
• Average revenue (AR): Total revenue per
unit of a product sold
• Total revenue (TR): Total number of dollars
received by a firm or firms from the sale of
a product
• Marginal revenue (MR): Additional revenue
received resulting from the sale of an extra
unit of output
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
3
Slides prepared by Muni Perumal, University of Canberra, Australia.
Product
Price Quantity
(Average Demanded Total Marginal
Revenue) (Sold) Revenue Revenue

$131 0 $ 0
] $131
131 1 131
] 131
131 2 262
] 131
131 3 393
] 131
131 4 524
] 131
131 5 655
] 131
131 6 786
131
131 7 917 ]
131
131 8 1048 ] 131
131 9 1179 ] 131
131 10 1310 ]
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
4
Slides prepared by Muni Perumal, University of Canberra, Australia.
 P

Price, average and marginal revenue,

TR
total revenue (dollars)
917

786

655

524

393

262
P = AR = MR = D
131

0
1 2 3 4 5 6 7 8 9 10
Quantity demanded (sold)

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
5
Slides prepared by Muni Perumal, University of Canberra, Australia.
Profit Maximisation:
MR–MC Approach
• MR = MC Rule
– A firm will maximise profit or minimise losses by
producing at that point where marginal revenue
equals marginal cost
• Three characteristics of the MC = MR
rule
– Firms would rather produce than shut down
– MR = MC is profit maximisation in all markets
– Competitive markets maximise at P = MC

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
6
Slides prepared by Muni Perumal, University of Canberra, Australia.
 Profit Maximisation: MR–MC
Approach
Average Average Average Price = Total
Total Fixed Variable Total Marginal Marginal Economic
Product Cost Cost Cost Cost Revenue Prof./Loss

0 ] – $100
90 $ 131
1 100.00 90.00 190.00 ] – 59
80 131
2 50.00 85.00 135.00 ] –8
70 131
3 33.33 80.00 113.33 ] + 53
60 131
4 25.00 75.00 100.00 ] + 124
70 131
5 20.00 74.00 94.00 ] + 185
80 131
6 16.67 75.00 91.67 ] + 236
90 131
7 14.29 77.14 91.43 ] + 277
110 131
8 12.50 81.25 93.75 ] + 298
130 131
9 11.11 86.67 94.78 + 299
] 150 131
10 10.00 93.00 103.00 + 280

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
7
Slides prepared by Muni Perumal, University of Canberra, Australia.
Profit Maximisation: MR–MC Approach
P
200
MR, MC and Unit Costs (dollars) Economic Profit MC
150
131 MR
ATC
100
97.78
AVC
50

0
1 2 3 4 5 6 7 8 9 10 Q
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
8
Slides prepared by Muni Perumal, University of Canberra, Australia.
 Loss-Minimising Case: MR–MC Approach
200
MC
Economic Loss:
Total revenue and total costs (dollars)
Loss Minimisation
150

ATC
100 AVC
81 MR
50

0 Q
1 2 3 4 5 6 7 8 9 10
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
9
Slides prepared by Muni Perumal, University of Canberra, Australia.
Close-Down Case: MR–MC Approach
200
Economic Loss: MC
Total revenue and total costs (dollars) Close down
150 in the short run

ATC
100 AVC

71 MR
50

0 Q
1 2 3 4 5 6 7 8 9 10
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
10
Slides prepared by Muni Perumal, University of Canberra, Australia.
Short-Run Supply Curve
• For the individual firm: MC above AVC
• For the entire industry: horizontal sum
of firms’ MC curves above AVC

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
11
Slides prepared by Muni Perumal, University of Canberra, Australia.
P = MC: Short-Run Supply Curve
P MC2
If costs increase...
the supply curve MC1
effectively shifts
to the left
AVC2

AVC1

Q
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
12
Slides prepared by Muni Perumal, University of Canberra, Australia.
P = MC: Short-Run Supply Curve
P
MC1
If costs decrease...
the supply curve MC2
effectively shifts
to the right
AVC1

AVC2

Q
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
13
Slides prepared by Muni Perumal, University of Canberra, Australia.
Profit Maximisation in the
Long Run
Assumptions:
• Entry and exit
• Identical costs
• Constant-cost industry
Goals:
• Price = Minimum ATC
• Zero economic profit model

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
14
Slides prepared by Muni Perumal, University of Canberra, Australia.
Profit Maximisation in the Long Run (cont.)
Zero Economic Profit (Break-Even) Equilibrium
S1
P Zero Economic P
Profits
MC
ATC

$60 $60
50 50
40 MR 40

D1

100 Q 100 000 Q

Firm (price taker) Industry
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
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Slides prepared by Muni Perumal, University of Canberra, Australia.
Profit Maximisation in the Long Run
Entry of firms eliminates economic profits
S1
P Zero Economic P S2
Profits
MC
ATC

$60 $60
50 50
40 MR 40
D1

100 Q 100 000 Q

(a) Single firm (b) Industry
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
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Slides prepared by Muni Perumal, University of Canberra, Australia.
 Profit Maximisation in the Long Run
Exit of firms eliminates economic losses
P Zero Economic P S2
S1
Profits MC
ATC

$60 $60
$50 $50
$40 MR $40

D1
$100 Q $90 000 $100 000
Firm Industry Q
(price taker)
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
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Slides prepared by Muni Perumal, University of Canberra, Australia.
Long-Run Competitive
P Equilibrium
MC
Price ATC

MR

Price = MC = Minimum ATC

(normal profit)

Quantity Q
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
18
Slides prepared by Muni Perumal, University of Canberra, Australia.
 Efficiency Defined
Allocative efficiency:
• Resources are allocated among firms and
industries to obtain a mix of products most
desired by consumers
Productive efficiency:
• Goods are produced using the least cost
production methods
Dynamic efficiency:
• Firms do not innovate
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
19
Slides prepared by Muni Perumal, University of Canberra, Australia.
Efficiency and Competition
• Allocative efficiency: P = MC
– under-allocation: P > MC
– over-allocation: P < MC
• Productive efficiency:
– P = min ATC
• The ‘invisible hand’ simultaneously:
– maximises profits
– maximises satisfaction

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
20
Slides prepared by Muni Perumal, University of Canberra, Australia.
 The monopoly firm
• A firm is considered a monopoly if ...
– it is the sole seller of its product.
– its product does not have close substitutes.
– The firm has market power, the firm is a ”price
maker” and not a “price taker”
– If there are significant barriers to entry and exit
Barriers to Entry
• Ownership of essential raw materials, e.g.
De Beers(diamonds) or Alcoa (bauxite).
• Legal barriers: patents, copyrights,
registered designs and licences etc
• Natural monopoly, very high fixed costs
very low (i.e. zero) marginal costs

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
22
Slides prepared by Muni Perumal, University of Canberra, Australia.
Monopoly Demand
• Monopolist’s demand curve is the
industry demand curve and therefore
is down-sloping
• Price (P ) exceeds marginal revenue
(MR)
• Monopolist is a ‘price maker’ since it
can influence total supply

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
23
Slides prepared by Muni Perumal, University of Canberra, Australia.
Monopoly Price-Setting Strategies
• There are two types of monopoly price-
setting strategies:
– A single-price monopoly is a firm that must sell
each unit of its output for the same price to all its
customers.
– Price discrimination is the practice of selling
different units of the same good or service for different
prices to different people. Many firms price
discriminate, but not all of them are monopoly firms.
Demand, MR, TR: Imperfectly Competitive
Firm 200
Elastic
Unit Elasticity
150

Dollars
Inelastic
200

50 MR D
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q
750

500
Dollars

250
TR
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Q

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
25
Slides prepared by Muni Perumal, University of Canberra, Australia.
Price and Output
Determination
• Profit-seeking monopolist employs
same rationale as in a competitive
industry:
– MC = MR Rule
• No supply curve. Why?
– At any given demand and cost conditions, there
is only one profit-maximising price–output
combination

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
26
Slides prepared by Muni Perumal, University of Canberra, Australia.
 The monopoly’s profit
Costs and
revenue

Marginal cost

Monopoly E B
price

Monopoly Average total cost

profit

Average
total D C
cost
Demand

Marginal revenue

0 QMAX Quantity

Copyright © 2004 South-Western

The inefficiency of monopoly
Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity

Copyright © 2004 South-Western

 Natural monopoly Figure 15.2

30

25
Price & Cost (dollars per household

P
20
per month)

15 Consumer
surplus ATC

10 MC

0 2 4 6 8 10
Quantity (millions of households)
Economic Effects of Monopoly
• Productive inefficiency:
– Minimum ATC is not necessarily chosen
• Allocative inefficiency:
– P price does not necessary equal MC
• Dynamic efficiency:
– Because these firms make profits they can
afford the R&D costs to develop new products
and processes
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
30
Slides prepared by Muni Perumal, University of Canberra, Australia.
Price Discrimination
Three required Conditions
• Monopoly power
• Market segmentation, different willingness
and ability to pay, different PED.
• No resale
Consequences
• More profits
• More production

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
31
Slides prepared by Muni Perumal, University of Canberra, Australia.
 A Single Price of Air Travel
Figure 11.8
Consumer MC
Price (dollars per trip)

2100 surplus

1800 Economic ATC

profit
1500

1200

900 $48
million
600

300 MR D
0 5 8 10 15 20
Passengers (thousands per year)
 Price Discrimination

• Profiting by Price Discriminating

– By price discriminating, the firm can increase its profit.
– In doing so, it converts consumer surplus into
economic profit.
– First degree (or order) or perfect PD
– Second degree (or order) PD
– Third degree (or order) PD
Third order Price
Discrimination
Increased economic Figure 11.9
MC
2100 profit from price
discrimination
Price and cost (dollars per trip)

1800 ATC
1600
1400
1200

900

600

300
D
0 2 4 6 8 10 15 20
Passengers (thousands per year)
The Yacht diagram
• Assume just two market segments.
• One has a high willingness to pay and
a low PED.
• The other has a low willingness to pay
and a high PED.

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
35
Slides prepared by Muni Perumal, University of Canberra, Australia.
 Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
36
Slides prepared by Muni Perumal, University of Canberra, Australia.
The Yacht diagram

D1

P1

P2
D2

MR2 37
MR1
 The Yacht diagram

D1

P1

P2
D2

MR2 38
MR1
 Perfect Price
Discrimination
• When a firm practices perfect price
discrimination it extracts the entire
consumer surplus.
• Firm needs to be able to segment the
market into very many segments e.g.
auctions.
Perfect Price Discrimination
Increase in economic
MC Figure 11.10
profit from perfect
Price (dollars per trip)

2100 price discrimination

1800 ATC
1600
1400
1200
900

600

300 Increase
in output D
0 2 4 6 8 11 15 20
Passengers (thousands per year)
Second order price
discrimination
• Price varies according to quantity sold, larger quantities
are available at a lower unit price. Widespread in sales to
industrial customers, where bulk buyers enjoy higher
discounts.
• Sellers are usually not able to differentiate between
different types of consumers. So suppliers provide
incentives for consumers to differentiate themselves
according to preference. Quantity discounts is a method
suppliers use to distinguish classes of consumers.
Suppliers set different prices to the different groups and
capture a larger portion of the total market surplus.
 Two part Tariffs
• The price of a product is composed of two
parts - a lump-sum fee and a per-unit
charge. Two-part tariffs may also exist in
PC when consumers are uncertain about
their ultimate demand.
• The product must be identical to all
consumers, price may vary, but not due to
different costs borne by the firm, this would
infer a differentiated product.
Copyright  2004 McGraw-Hill Australia Pty Ltd
PPTs t/a Microeconomics 7/e by Jackson and McIver
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Slides prepared by Muni Perumal, University of Canberra, Australia.
Bundling
• A quick review.
• Firms can of course combine PD, two
part tariffs and bundling to maximise
profits.

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
43
Slides prepared by Muni Perumal, University of Canberra, Australia.
 CONSUMER SURPLUS
• Why do people pay cover charges?
• http://www.youtube.com/watch?v=IZnQKXs3NVA

Copyright  2004 McGraw-Hill Australia Pty Ltd

PPTs t/a Microeconomics 7/e by Jackson and McIver
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Slides prepared by Muni Perumal, University of Canberra, Australia.
Regulating Natural Monopoly
• Natural Monopoly Regulation
– Natural monopoly occurs when one firm can
supply the entire market at a lower price than
two or more firms.
– A natural monopoly experiences economies of
scale no matter how high an output it achieves
– Examples: telephone, electricity and water
 Natural Monopoly Regulation
• Regulating Monopoly in the Social
Interest
– Regulation in the social interest sets the price equal
the marginal cost, referred to as marginal cost
pricing rule
– The sum of consumer surplus and producer
surplus—total surplus is maximised.

• If the Firm Incurs a Loss

– Price discrimination
– Two-part tariff
 Marginal Cost Pricing Figure 15.2

30

25
Price & Cost (dollars per household

20
per month)

Loss per
household
15 Consumer
surplus ATC

10 MC

0 2 4 6 8 10
Quantity (millions of households)
Natural Monopoly Regulation
• Regulating Monopoly in the Social Interest
• Average Cost Pricing Rule
– Sets price equal to average total cost
– Consumer surplus is less than under marginal cost
pricing
Natural Monopoly:
Average Cost Pricing
30

25
Price & Cost (dollars per household

20 Consumer
per month)

surplus
P = AR
15
Producer ATC
surplus
10 MC
Deadweight
loss D

0 2 4 6 8 10
Quantity (millions of households)
 Marginal cost pricing
30 Profit maximising
Price & Cost (dollars per household

outcome
25
per month)

20 Average cost pricing

15 P = AR

ATC
10 P = MC (S = D)
Average cost pricing
D PC outcome

0 2 4 6 MR 8 10
Quantity (millions of households)
 Monopsony
– A monopsony is a market with a single buyer.
– Rather than setting MB = MC or MR = MC to
determine quanatity and then letting the demand
curve set the price, as in monopoly,
– The monoponist sets MR = MC to determine quantity
but then uses the supply curve to set prices, both the
quantity and the price is less than the perfectly
competitive outcome
 A Monopsony Market Figure A14-2

MCL
S
Wage rate (dollars per hour)

10.00

7.50 Competitive
equilibrium

5.00

MRP = D
Monopsony
equilibrium
0 50 100
Labour (hours per day)
 Bilateral Monopoly

MCF
Union wage S
Blue is Union
Red is employer
Employer N1 is the optimum Q
wage
W is indeterminant

VMP = D
MRP

N2 N1
 A Dominant Firm Monopoly
A competitive fringe and market Dominant firm’s output decision
demand
S10
Price (dollars per litre)

MC
1.50 1.50

A B A B
1.00 1.00

D
0.50 0.50
ED

MR

0 10 Qcf 20 Qd 0 10Qdf 20
Quantity (thous. of litres/week) Quantity (thous. of litres/week)