Lecture5_MonopolyandMonopolistic_Competition

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Lecture5_MonopolyandMonopolistic_Competition

Monopoly definition- The only supplier of a good for which there is no close substitute

If there is only one buyer then the situation is called Monopsony

SOURCES OF MONOPOLY:

How could a firm totally supply the market;

- Exclusive control over important inputs

-Economies of scale

-Patents

-Network Economies

-Government Licenses or Franchises

MARGINAL REVENUE:

All firms,including competitive firms and monopolies,maximise their profits by setting marginal revenue equal to marginal cost.

A firms marginal revenue depends on its demand curve.

A firms demand curve shows the price( P), it recieves for selloing a given quantity(Q).The price is the average revenue the firm recieves,so a firms revenue is R=pq

A firms marginal revenue(MR) is the change in revenue from selling one more unit

The marginal revenue of a monopoly differs from that pf a competitive firm bevcause the monopoly faces a downward sloping demad curveunlike the competitive firm.

With monopolists,being the sole supplier of the product can determine the qauntity to be sold, but they cannot force a buyer to purchase.The monopolist must reduce the price to esnure the sale of the additoinal unit.

A competitive firm will have a horizontal demand curve,meaning they can sell another unit of output without dropping its price,therefore the marignal revenue it recieves from selling the last unit of output is the market price.

A monopoly faces a downward sloping market demand curve,so if you were to sell one more unit the price would be lower than before.

Marginal revenue curve:

The monoploys marginal revenue curve lies below the demand curve at every positive quantity.

CHOOSING PRICE OR QUANTITY:

Any firm maximises its profit by operating where its marginal revenue equals its marginal cost.

- Unlike a competitive firm, a monopoly can adjust its price,so it has the choice of setting its price OR its quantity to maximise its profit.(A competitive firm sets its quantity to maximise profit because it cannot affect market price)

-The monopoly is contrainted by the market demand curve.Because the demand curve slopes downward, the monopoly faces a trade off between a higher price and lower quantity or a lower price and a higher quantity.

-The monopoly chooses the point on the demand curve that maximises its profit.

-If the monopoly sets its price,the demand curve determines how much output it sells.If the monopoly picks an output level,the demand curve determines the price.

MARGINAL REVENUE AND PRICE ELASTICITY OF DEMAND:

- The marginal revenue at any given quantity depends on the demand curve's height(price) and shape.

-The shape of the demand curve at any particular quantity is described by the price elasticity of demand.

-Formula= %change in Quantity demanded/%change in price

-Marginal revnue is closer to the price as demand becomes more elastic.Where the demand curve hits the price axis(Q=0),the demand curve is perfectly elastic,so MR=P

Where the demand curve is unitary(=-1),MR=0

MR is negative where the demand curve is inelastic(i.e.-1<ED<0)

RESTIRCTED OUTPUT OF A MONOPOLIST:

Marginal revnue becomes negative where the elasticity of demand is equal to 1.Even if the production price is 0, monopolist will not produce more

-It is implied that the output of a monopolist is always restricted no matter what is the cost of production.

-Government intervention is therefore required to regulate monopolies

MONOPOLY AND PRICE DISCRIMINATION:

-The downward sloping demand curve has been drawn assuming that the monopolist must charge all the buyers the same price

Q: What if the monopolist can charge different prices to different buyers?

a: Price discrimination- A practice where the monopolists charge different prices to different buyers.

3 TYPES OF PRICE DISCRIMINATION:

1st degree(perfect)price discrimination-

Price varies by customers willingness or abilty to pay

-If successful,the firm can extract the entire consumer surplus that lies underneath the demand curve and turn it into extra revenue or producer surplus

-If the monopolist can perfectly segment the market,then the average revenue curve becomes the marginal revenue curve.

-A monopolist will continue to sell as long as the extra revenue exceeds the marginal cost of production

2ND degree price discrimination:

Price varies according to quantities sold.Larger quantities are available at a lower unit price.Normally done in industry,where bulk buyers enjoy higher discounts.No discrimination of consumer type.

-Hotel industry where spare rooms are sold on a last minute standby basis.

3RD Degree price discrimination:

-Charging different prices to buyers in completely seperate markets

Main conditions needed for price discrimination to work?

Differneces in price elasticity of demand- There must be a difference in price elasticity for each type of consumer.The firm is then able to charge a higher price to the more inelastic group,allowing them to cinrease total revenue and profits(higher level of producer surplus).

To maximise,the firm will want each market segment to have MR=MC

MONOPOLISTIC COMPETITON:

ASSUMPTIONS-

- There are many porducers and many consumers,the industry conentration ratio is low

-There is product differentation- competition is strong,with plenty of consumer switching taking place

-Producers have some control over price- they are "price maker" not " price takers",but the elasticity of demand is higher than it would be under a situation of monopoly.

Monopolistically competitive markets do not have barriers to entry.

-Firms enter the market until no new firm can enter profitably

-Monopolistically competitive firms face downward sloping demand curves,so they charge prices above marginal cost.

-Monopolistic competition is competiton with increasing returns to scale.

- Unlike monopoly,there are no barriers to entry.This means that the short run supernormal profit attracts new producers into the market,and so normal profits only are made in the long run equilibrium

-As more firms enter the market,demand curve for existing customers moves to the left,deman curve keeps oving to the left until it is tangential to the AC curve. at this oint the monopolistically competitive firm is at its profit maximising level of output(MR=MC) but is mking normal profit(AR=AC)

MONOPOLSTICALLY COMPETITIVE EQUILIBRIUM:

Two conditions hold in a monopolistically competitive equilibrium in the long run

1. Marginal revenue=Marginal cost

- Because firms set output to maximise profit

2.Price=Average cost

-Because firms enter until no further profitable entry is possible

Perfect competition VS Monopolistic competition:

PC= Perfect competition

MoC=Monopolistic Competition

-Number of producers: PC= Many Moc= Many

-Types of goods and services available for consumers: PC= Homogenous Moc= Differentiated

- Does the firm have control over their prices?;PC= no(price takers) Moc= Yes(some pricing power)

-type of entry barriers?; PC= Zero Moc=Low

Does this lead to allocative efficieny in the Long run?: PC= Yes(Price=MC) MoC= Not quite(P>MC)

Does this market structure lead to productive efficiency in the long run?: PC= Yes(min LRAC) MoC= No( higher LRAC)