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Monopoly, Oligopoly, and Monopolistic Competition Monopoly, Oligopoly, and Monopolistic Competition

Monopoly, Oligopoly, and Monopolistic Competition - PowerPoint Presentation

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Monopoly, Oligopoly, and Monopolistic Competition - PPT Presentation

Chapter 8 McGrawHillIrwin Copyright 2015 by McGrawHill Education Asia All rights reserved Learning Objectives Distinguish among three types of imperfectly competitive industries and describe how imperfect competition differs from perfect competition ID: 647487

price cost revenue marginal cost price marginal revenue total monopoly 000s output profit carla economic competition atc fixed scale economies 200 000

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Slide1

Monopoly, Oligopoly, and Monopolistic Competition

Chapter 8

McGraw-Hill/Irwin

Copyright ©

2015

by

McGraw-Hill Education (Asia).

All rights reserved.Slide2

Learning Objectives

Distinguish among three types of imperfectly competitive industries and describe how imperfect competition differs from perfect competitionIdentify the five sources of monopoly power and describe why economies of scale are the most enduring of the various sources of market powerApply the concepts of marginal cost and marginal revenue to find the output and price that maximizes a monopolist's profitsExplain why the profit-maximizing output level for a monopolist is too small from society's perspectiveDiscuss why firms offer discounts to buyers who are willing to jump a hurdleDiscuss public policies that are often applied to natural monopoliesSlide3

Imperfect Competition

Imperfectly competitive firms have some ability to set their own price: they are price settersLong-run economic profits possibleReduce economic surplusThree types: Monopoly has only one seller, no close substitutesMonopolistic competition has many firms producing slightly differentiated products that are reasonably close substitutesOligopoly has a small number of large firms producing products that are close substitutesSlide4

Monopolistic Competition

Monopolistic Competition

Number of Firms

Many firms

Price

Limited flexibility

Entry and Exit

Free

Product

Differentiated

Economic Profits

Zero in long run

Decisions

P, Q, product differentiation

Perfect CompetitionMany firmsPrice takerFreeStandardizedZero in long runQ onlySlide5

Oligopoly

Oligopoly

Number of Firms

Few firms,

each large

Price

Some flexibility

Entry and Exit

Difficult

Product

Differentiated or standardized

Economic Profits

Possible

DecisionsP, Q, differentiation, advertising

Perfect CompetitionMany firmsPrice takerFreeStandardizedZero in long runQ onlySlide6

Imperfect Competition

Examples of monopolyElectricity and Magic CardsExamples of monopolistic competitionRetail gas stationsConvenience storesExamples of oligopolyWireless phone serviceCementAutomobiles and tobaccoSlide7

The Essential Difference

Market power is the firm's ability to raise its price without losing all its salesAny firm facing a downward sloping demand curveFirm picks P and Q on the demand curveMarket power comes from factors that limit competition

Quantity

Price

Imperfectly

Competitive Firm

D

Quantity

Price

Perfectly

Competitive Firm

DSlide8

Five Sources of Market Power

Exclusive control over inputsPatents and copyrightsGovernment licenses or franchisesEconomies of scale (natural monopolies)Network economiesSlide9

Market Power: Economies of Scale

Returns to scale refers to the percentage change in output from a given percentage change in ALL inputsLong-run ideaConstant returns to scale: doubling all inputs doubles outputIncreasing returns to scale: output increases by a greater percentage than the increase in inputsAverage costs decrease as output increasesNatural monopoly: a monopoly that results from economies of scaleSlide10

Market Power: Network Economies

Network economies occur when the value of the product increases as the number of users increasesVHS format for video tapes, Blu-ray for DVDsTelephonesWindows operating systemeBayFacebook and WhatsappSlide11

Economies of Scale and Start-Up Costs

New products can have a large fixed development costVariable cost: sum of payments made to the variable factors, such as laborFixed cost: sum of payments made to the fixed factors, such as capitalStart-up costs can be thought of as a fixed costAverage total cost (ATC): total cost divided by outputA good whose production has a large start-up cost and low variable cost is subject to economies of scaleATC declines sharply as output increasesSlide12

Economies of Scale and Start-Up Costs

Consider an example:Assume marginal cost (M) is constantVariable cost is M*QTotal cost is fixed cost (F) plus variable costTC = F + M*QTotal cost increases as output increasesAverage total cost is ATC = F / Q + MAverage total cost decreases as output increasesAverage fixed cost = F/QSlide13

Economies of Scale

QuantityTotal cost ($/year)

F

TC = F + M Q

Average cost ($/unit)

Quantity

ATC = F/Q + M

MSlide14

Example: Video Game Producers – Different Volumes

Nintendo

Playstation

Annual Production (000s)

1,000

1,200

Fixed Cost ($000s)

$200

$200

Variable Cost ($000s)

$800

$960

Total Cost ($000s)

$1,000$1,160

ATC per game$1.00$0.97Slide15

Example: Video Game Producers – Lower Marginal Costs

Nintendo

Playstation

Annual Production (000s)

1,000

1,200

Fixed Cost ($000s)

$200

$200

Variable Cost ($000s)

$200

$240

Total Cost ($000s)

$400

$440ATC per game$0.40$0.37Slide16

Example: Video Game Producers – Higher Fixed Cost

Nintendo

Playstation

Annual Production (000s)

1,000

1,200

Fixed Cost ($000s)

$10,000

$10,000

Variable Cost ($000s)

$200

$240

Total Cost ($000s)

$10,200$10,240

ATC per game$10.20$8.53Slide17

Example: Video Game Producers – Different Production Levels

Nintendo

Playstation

Annual Production (000s)

500

1,700

Fixed Cost ($000s)

$10,000

$10,000

Variable Cost ($000s)

$100

$340

Total Cost ($000s)

$10,100$10,240

ATC per game$20.20$6.08Slide18

Intel's Advantage

Development cost of a new chip $2 billionMarginal cost of making a chip PenniesDominating the market PricelessIntel supplies more than 80% of the processors for PCsSlide19

Profit Maximization for the Monopolist

Like all other firms, a monopolist:Maximizes profitsApplies the Cost-Benefit Principle:Increase output if marginal benefit > marginal costDecrease output is marginal benefit < marginal costMarginal benefit is called marginal revenue:Change in total revenue from a one-unit change in outputEqual to price for the perfectly competitive firmLess than price for the monopolistSlide20

Price ($/unit)

Quantity (units/week)

Profit Maximization for the Monopolist

To sell another unit the monopolist must lower price

Total revenue from 2 units = $12Total revenue from 3 units = $15

Marginal revenue = $3

D

2

6

3

5Slide21

Monopolist's Marginal Revenue

Total Revenue$12

$15

$16

$15

Price

Quantity

$6

2

$5

3

$4

4

$3

5Price & marginal revenue ($/unit)88DQuantity (units/week)MR

3

2

3

1

4

-1

5

Marginal Revenue

3

1

-1Slide22

Monopoly Demand and Marginal Revenue

The monopolist's marginal revenue curve:Has the same intercept as the straight-line demand curveHas twice the slope of the demand curveLies below the demand curve

Price

Quantity

a

D

Q

0

Q

0

/2

a/2

MRSlide23

Deciding Quantity

Profit is maximized at the level of output where marginal cost equals marginal revenueAt P = $3 and Q = 12, MC > MRDecrease outputAt Q = 8, MC = MR = 2The demand curve sets the price at P = $4At any output below 8, MC < MR

Price ($/unit of output)

Quantity (units/week)

3

MC

2

6

D

12

MR

4

8Slide24

Monopoly Profit

Profit = Total revenue – total costTotal cost = ATC x QProfit = P x Q – ATC x QProfit = (P-ATC) x QIf P > ATC then the firm earns a profitIf P < ATC then the firm suffers a lossThis can be graphically illustratedSlide25

Monopoly Losses and Profits

Price ($/minute)Minutes (millions/day)

20

0.12

0.10

ATC

Economic loss

= $400,000/day

D

0.05

MC

MR

24

Price ($/minute)Minutes (millions/day)2420

0.080.10ATCD0.05MCMREconomic profit= $400,000/daySlide26

The Invisible Hand Fails

Price ($/unit of output)Quantity (units/week)

The socially optimal

amount occurs where

MC = MB, Q = 12 units

and P = $3

The monopolist's optimal

amount occurs where

MC = MR, Q = 8 units

and P = $4

2

MR

8

424D3126Marginal CostDeadweight loss from monopoly = $4Slide27

Monopoly and Perfect CompetitionSlide28

Managing Monopoly: The Breakdown of the Invisible Hand

Monopolies exist for economic reasonsPatents, copyrights, and innovationEconomies of scaleNetwork economiesAnti-trust laws attempt to limit deadweight lossLimiting monopoly has costsPatents encourage innovationEconomies of scale minimize ATCNetwork economies increase benefitsSlide29

Price Discrimination

Price discrimination means charging different buyers different prices for essentially the same good or serviceSeparate the groupsNo side trades among buyersMany forms of price discriminationHurdle method: discounts for identifiable groups (e. g., students, AARP)Perfect discrimination: negotiate separate deals with each customerSlide30

Carla the Editor: Social Optimum

Opportunity cost of Carla's time is $29What is the social optimum?What if Carla is a profit maximizer? What is Carla's total revenue?Student

Reservation Price

A

$40

B

38

C

36

D

34

E

32

F

30G 28Total Revenue $40 $76 $108

$136

$160

$180

$196

6 papers with an economic profit of $6Slide31

Carla the Editor: Marginal Revenue

Opportunity cost of Carla's time is $29What is Carla's marginal revenue?Student

Reservation Price

A

$40

B

38

C

36

D

34

E

32

F

30G 28MR$40 $36 $32

$28

$24

$20

$16

Total Revenue

$40

$76

$108

$136

$160

$180

$196

3 papers with an

economic profit of $21Slide32

Carla the Editor: Price Discriminator

Opportunity cost of Carla's time is $29What if Carla is a perfect price discriminator?What is Carla's total revenue?Student

Reservation Price

A

$40

B

38

C

36

D

34

E

32

F

30G 28Total Revenue $40 $78 $114

$148

$180

$210

$238

6 papers with

an economic

profit of $36Slide33

Hurdle Method of Price Discrimination

The hurdle method of price discrimination is the practice of offering a discount to all buyers who overcome some obstacle.Temporary salesHard cover and paperback booksMultiple car models from one manufacturerCommercial air carriers, e.g. CX, JAL, SQMovie producers, 2D and 3D versionsDiscount coupons with min spending requirementsSlide34

Carla Offers a Rebate

If reservation price < $36, student will mail in rebateStudentReservation Price

Total Revenue

A

$40

$40

B

38

76

C

36

108

Discounted Price Submarket

D

$34$34E3264F3090

MR

$40

36

32

$34

30

26

5 papers, price $36, rebate $4, economic profit $27Slide35

Carla's Choices

Program Social Optimum

Papers Edited

6

Price

$30

Total Revenue

$180

Carla's Time 

 $174

Economic Profit

$6

Total Surplus

$26

Hurdle 5 = (3 + 2) $36, $4 rebate$172$145 

$27

$35

Perfect Discriminator

6

Reservation

$210

$174 

$36

$36

Single Price

3

$36

$108

$87

$21

$27Slide36

Monopoly and Public Policy

Challenge: create the greatest increase in total surplusPolicy optionsGovernment ownership and operationRegulationCompetitive bids for natural monopoly servicesBreak upSlide37

State-Owned Natural Monopoly

Marginal cost is always less than average costMarginal cost pricing produces lossesOptionsFund losses from tax revenuesFixed monthly fee plus usage fee Fixed fee covers lossesLimited incentives to innovate and cut costsCommonly used for water, Post Office, and some electricitySlide38

Regulated Monopolies

Cost-plus regulation sets price at per unit explicit costs plus a mark-up for implicit costsUsed for electricity, telephone, and cablePolicies vary by stateDisadvantagesHigh administrative costReduced incentive for cost-saving innovationPrice is greater than marginal costSlide39

Exclusive Contracting for Natural Monopolies

Government awards contract to low bidder for natural monopoly servicesGarbage collection, fire protection, road construction, Department of DefenseCould achieve marginal cost pricing IF government pays the resulting lossesAsset transfer for large fixed investment is complexSlide40

Enforcement of Anti-Trust Laws

Two landmark laws in the United StatesSherman Act of 1890Declared conspiracy to create a monopoly illegalClayton Act of 1914Outlawed transactions that would "substantially lessen competition"Applies to mergers and acquisitions todayIBM avoided break-up; AT&T did notMicrosoft survivedSlide41

Another Policy Option: Ignore Monopoly

Two objections to monopoliesRestrict output, decrease total surplusRaise price, earn economic profitsAnalysisDiscount offers allow some customers to pay less than average cost, though more than marginal costEconomic profits generated by customers who pay list price – their choiceAbout two-thirds of economic profits are taxed awayRemainder accrues to shareholdersSlide42

Imperfect Competition

Imperfect CompetitionMonopolistic Competition

and Oligopoly

Sources of Market Power

Monopoly

Public PolicySlide43

Chapter 8 Appendix

The Algebra of Monopoly MaximizationSlide44

From Demand to Marginal Revenue

Given a demand curve such as P = 15 – 2 QWe can write the marginal revenue curve as MR = 15 – 4 Q Suppose marginal cost is a line with zero intercept and a slope of 1MC = QThe remaining step is to set marginal revenue equal to marginal costSlide45

MR = MC

Let Q* be the profit maximizing level of outputMC = MRQ* = 15 – 4 Q*5 Q* = 15Q* = 3To find P, substitute Q = 3 into the demand equationP = 15 – 4 Q*P = 15 – 4 (3)P = 3