principles of microeconomics economics 103 - …ehutchin/resources/103/slides/econ103topic8.pdf ·...

ECONOMICS 103

Topic 8: Imperfect Competition

• Single price monopoly.• Monopolistic competition.

1

Principles of Microeconomics

• Thus far, all firms have been price takers.- Markets are characterized by many, many sellers.- Any individual seller is too small to influence the market price.- Price determined by S and D; firm chooses whether or not and

how much to produce, given that price.• All implies that MR = P for competitive firms.

- Same thing as saying that the demand for any individual firm’s output is perfectly elastic at the market price.

• We want to contrast this with the opposite extreme: monopoly.

2


COMPETITIVE MARKETS V MONOPOLY

• In our final Topic 103, we will look at simplest case of monopoly behaviour: - Single price monopolist; seller charges same P to all

customers.• We want to understand two things:

- MR 0 can prevail in LR monopoly.• Only thing we need to understand that is new here is that the D

curve for a monopolist’s output is the market demand curve, which is downward sloping.- This is what results in MR < P, which drives everything else.

3


MONOPOLY

• Recall that MR = P for a perfectly competitive firm.

• Can sell as much as it wants at market price P.

• Selling one extra unit of q yields P in extra revenue.

4

MR FOR A COMPETITIVE FIRMPrinciples of Microeconomics

• Means that the demand curve for a single competitive firm’s output is perfectly elastic at the prevailing market price.

• True because any given firm is only a small, small part of the market.• This is not true for the monopolist: the monopolist is the market,

on the selling side, at least.

q

MR = P

q1 q1 + 1

• The demand curve for the monopolist’s output is the market demand curve.

• This means that, to sell one more unit, it must ↓ P to all buyers.

5

MR FOR A MONOPOLISTPrinciples of Microeconomics

• Selling one extra unit has a gain and a loss.- Gain = P2: extra unit sold at new lower price

‣ Gain = area A.- Loss = ∆P × Q1: units that used to sell at P1 now sell at P2.

‣ Loss = area B.• MR = A - B = P2 - (∆P × Q1) < P1.

Q

D

P1

Q1 Q1 + 1

P2

A

B

• Note: MR could be > 0 or < 0, depending on region of D.

6

MONOPOLY MRPrinciples of Microeconomics

• Selling one extra unit has a gain and a loss.- Gain = P2: extra unit sold at new lower price

‣ Gain = area A.- Loss = ∆P × Q1: units that used to sell at P1 now sell at P2.

‣ Loss = area B.• MR = A - B = P2 - (∆P × Q1) < P1.

Q

P1

Q1 Q1 + 1

P2

A

B• High up the D curve, A > B ⇒ MR > 0.

• Note: MR could be > 0 or < 0, depending on region of D.

7


• We know linear D has ePD > 1 along “top half.”- Tells us that ↓P ⇒ ↑TR ⇒ MR > 0.

• We know linear D has ePD < 1 along “bottom half.”- Tells us that ↓P ⇒ ↓TR ⇒ MR < 0.

• And, linear D has ePD = 1 halfway ⇒ MR = 0 halfway down D.

Q

D

P1

Q1 Q1 + 1

P2A

B

• Low down the D curve, A B ⇒ MR > 0.

• All depends on ePD.

• Along top half of D, ePD > 1, so ↑Q ⇒ ↑TR.• ⇒ MR > 0.

8

MONOPOLY MR Principles of Microeconomics

Q

D

$

Q

$

PMAX

QMAX

QMAX(QMAX)/2

(QMAX)/2

(PMAX)/2

TR (Q)

• Halfway down D, MR = 0.

↑Q ⇒↑TR ⇒MR >0

↑Q ⇒↓TR ⇒MR <0

• Along bottom half of D, ePD < 1, so ↑Q ⇒ ↓TR.

• ⇒ MR < 0.

P(Q)1

Q1

9


Q

MR

• We want to draw MR curve, which shows MR for all possible levels of Q.

• Tells us that MR curve must lie below D curve.

MR(Q)1

• Recall: we read P off the D curve.

$

• And we deduced that, at any Q, MR < P.

D

10


Q

Pmax

Qmax2

Qmax

Marginal Revenue

ePD = 1

ePD > 1

MR = 0

MR > 0 ePD > 1

MR < 0

• So MR curve lies below D since MR < P.

• Once you understand that MR MC so monopolist does not max mkt surplus.

• For linear D:- MR > 0 over top half; and- MR < 0 over bottom half.

11

MONOPOLY Principles of Microeconomics

Q

MR

D

• Π max ⇒ choose Q s.t. MR = MC- Q = QM.

• Recall that consumers’ MB = P, and P > MR = MC.- So at monopoly equilibrium we have MB > MC.- Market surplus is not maximized!

• What P will monopolist charge?- The highest it can, given D curve.

- P = PM.QM

PM

MC

MB > MC

12


Q

MR

D

• Note: comp mkt would produce where MB = MC. i.e., comp mkt would produce QC units.

• Why not? Because in order to sell those units, monopolist would have to lower P to all consumers, and doing so would ↓ Π.

• In comp mkts, Π max behaviour ⇒ mkt surplus is maximized.• With single price monopoly, ∏ max behaviour ⇒ mkt surplus is

not maximized.

• TB of those units > TC of those units.

QM

PM

MC

• For each Q from QM to QC, MB > MC.

• Those units could generate mkt surplus > 0, but they don’t get produced and sold.QC

13


Q

MR

D

• Note: comp mkt would produce QC units, monopolist produces QM.

• Then area A = DWL due to the monopoly.• Area A = extent to which SS falls short of what it could be.

- DWL always = unrealized SS.• Competitive markets would take us to QC, so A = measure of

loss to society from having monopoly relative to competition.

• Assume mkt surplus = SS.

QM

PM

MC

- That is, assume no externalities.

QC

A

• Note carefully the source of the DWL: it arises because monopolist must lower its price to sell more output.- We have constrained the monopolist to charge all customers

same price for its output.- That’s what a single price monopolist is.

• What if monopolist could charge different customers different prices for the same product?- We observe this often, in many markets.‣ Movie tickets, plane tickets, software, etc.

• This is known as price discrimination.- Covered in later micro classes like 203 and 313.

14

Principles of MicroeconomicsMONOPOLY

• Back to the problem of the single P monopolist.- P > MC ⇒ DWL.

• If we cannot somehow “make” the market competitive (more on this shortly), what govt policies can help correct mkt failure?

• Recall the problem is that QM is too low, so we don’t want to use any policy instrument that reduces Q.- Taxes, quotas, etc are all inappropriate.

• How might we get Q to increase in monopoly markets?- Subsidize monopolists output (distributionally “interesting”....).- Regulate prices: specifically, mandate that P = MC.

15


CORRECTING MKT FAILURE.

16

PRICE REGULATION Principles of Microeconomics

Q

MR

D

• Set price ceiling = PC.• Now for any Q < QC, MR = PC.

• We want to see that price ceiling can now increase Q .

• Opposite effect to price ceiling in competitive market.

PC

• It does so by changing the relationship between MR and P.

QC

17


Q

MR<P

D

• D and MR are now as shown above.

PC

QC

D: MR=P

18


Q

MR ATC at QC, monopolist will maximize profits by

producing QC and charging P = PC.

PC

QC

MR=P

QC

MCATC

19


Q

MR

D

• Without actual competition - potential for entry and exit - we don’t get the same outcome in the LR as under perf comp.- We don’t get to ATC min.- Even with P regulation, monopoly markets are “too small.”

‣ We want to be at min of ATC, with more firms in industry.

• Set price ceiling at PC.• As long as PC > ATC, we get to QC.

QM

PM

MCATC

PC

QC

• Looks like we might have replicated outcome of competitive mkt, but....

• So far, we have just assumed the existence of monopolist.• Need to ask why monopoly would survive in a mkt economy.• Monopoly profits should attract entry, just as in comp mkts.• So there must be barriers to entry, if we see monopoly persist.• Different types of barriers to entry:

- Collusive barriers (these are illegal, btw)- Legal barriers, such as patents.- Technological barriers.

• Text book talks about some of these. Read if you are interested, but won’t be on the final exam.

20


WHY MONOPOLY?

• So far we have looked at two extremes: - Perfectly competitive mkts.- Monopoly markets.

• Real world markets are often in between.• Lots and lots of econ models looking at in-between cases:

- Take more econ courses!• We will look briefly at just one approach to the in-betweens.

- A discussion of the model of monopolistic competition.- As the name suggests, this model assumes some aspects of

monopoly and some of perfect competition.

21


MARKET STRUCTURE

• In competitive markets we assume identical products.- Many products are not really identical.

• Monopolistic comp assumes that each firm produces goods that are in many ways similar, but not identical:- Substitutes, but not perfectly so; differentiated products.

• Example: smartphones:- Samsung phone not identical to an iPhone, but both are phones.- My decision to buy one over the other depends on price of each,

as well as each phone’s own unique attributes.- If something happens to make one cheaper relative to the other,

some - but not all - consumers will switch.• Means that there is a unique D curve for each product, but there is

an interdependence among those D curves.22


MONOPOLISTIC COMPETITION

• Understanding interdependence among demand curves is key.• First, realize that differentiated products means that each monop.

comp. firm faces a downward sloping D curve for its output.• Suppose 2 sellers of differentiated products in a monopolistically

competitive market.- If firm 2 lowers its price, D for firm 1’s output will

decrease.- If firm 2 increases its price, D for firm 1’s output will

increase.- If a third firm enters the market, D for both firm 1 and firm

2’s output will decrease.• Understand the above, add it to the basic monopoly model, assume

free entry, and you’ve got monopolistic competition.23



• Monop. comp. is more or less like monop., but with free entry of sellers whose output is similar, but not identical to, existing firms.

• Entry/exit occurs for the same reasons as in perf. comp. mkts.- If Π > 0 in industry (broadly defined) then new firms enter.- Entry ⇒ ↓D for existing firms ⇒ P↓, eroding Π.- Entry will drive Π = 0, just as in perf comp.

• This means that P = ATC in the LR in monop. comp. mkts.• Difference is that MR MC and P > ATC min:

• P > MC ⇒ DWL.• P > ATCMIN ⇒ Don’t get least cost production in the LR.

24

25

MONOPOLISTIC COMPETITION Principles of Microeconomics

QMR

D

• But P1, Q1 is NOT a LR equil for monopolistically comp firm.• Π > 0 ⇒ entry of firms who produce an imperfect substitute for

this firm’s output.• This firm will lose some - but not all - customers after entry.• The D curve for this firm’s output will shift in.• If D shifts in, then MR also shifts.

Q1

P1

MC

• P1, Q1 is SR equil for monop comp firm.

ATC • MR = MC ⇒ Π max.

• P > MC ⇒ there is a DWL.ATC1

• P > ATC ⇒ Π > 0.

P

26


QMRD

• More entry results in further decrease in D and P.• Entry continues until P driven down so that P = ATC; Π > 0.• In LR in monop competitive industries we will have P = ATC.• D curve must shift until we have MR = MC at Q where P = ATC.

- If D curve doesn’t shift in exactly this way, can’t a LR equ.

Q2

P2

MC • D shift means this firm will have to charge lower P and sell less Q.ATC

ATC2

P

• If new lower P > ATC, still true that Π > 0, so there is still incentive for entry.

27


QMR

D

Q1

P1

MC

ATC

ATC1

P

28


QMR

D

MC

ATC

P

Q2

P2

ATC2

29


QMR

D

QLR

PLR

MC

ATC

30


QMR

D

• In LR, we still have DWL and don’t reach minimum cost Q.• That’s the price we pay for variety.

QLR

PLR

MC• LR equil, diagrammatically.

ATC• P = ATC.

• MR = MC.• P > MR.

• P > MC.

• Comparison of three types of market structure.

31

Principles of MicroeconomicsROUND-UP

Market type Description MR v

PP v MC LR Π LR

ATC DWL

Perf. Comp.

Many sellers, identical goods, free entry in LR

MR = P P = MC Π = 0ATCLR = ATCMIN

No

Monopoly Single seller, barriers to entry

MR MC Π > 0ATCLR > ATCMIN

Yes

Monop. Comp.

Many sellers, differentiated products, free entry in LR

MR MC Π = 0ATCLR > ATCMIN

Yes

principles of microeconomics economics 103 - …ehutchin/resources/103/slides/econ103topic8.pdf ·...

Documents