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Topic 9

Monopoly and Imperfect Competition




The monopoly market structure

Monopoly is characterised by:
a single seller in the market
a unique product
high barriers to entry that make it difficult or
impossible for other firms to enter the market.

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Barriers to entry
Barriers to entry arise because a firm has:
ownership of a vital resource
licences and patents that create legal barriers
to other entrants
economies of scale.

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A natural monopoly
An industry where the LRAC declines along the
entire range of output.
A single firm can supply the entire market
demand at a lower cost than two or more smaller
firms.
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Price and output decisions for a monopolist
The major difference between monopoly and
perfect competition is the shape of the demand
curve faced by the firm.
Monopolists are price makers they face a
downward-sloping demand curve for their
products.
This means they can choose between price and
output combinations.
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The monopolists demand curve
The monopolists
demand curve
and the industry
demand curve are
one and the
same.

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Demand and marginal revenue curves
If demand is downward sloping, then the
monopolist must lower price in order to sell an
extra unit.
This price-cut applies to all units, not just the
last unit. This means marginal revenue is
always less than price.
The marginal revenue for a monopolist
intersects the quantity axis halfway between
the origin and the demand curve.
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Profit maximisation
Economists assume that all firms try to maximise
profits (or minimise losses).
Like the perfectly competitive firm, the monopolist
also maximises profit by producing that level of
output for which MR = MC.

Monopoly in the short run
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Monopoly in the long run
If the factors determining the positions of a
monopolists demand and cost curves mean it
earns an economic profit, and if nothing
disturbs these factors, economic profit will
continue in the long run.

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Price discrimination
Price discrimination is a pricing technique that a
monopolist can use to maintain an economic
profit.
Price discrimination is the practice of a seller
charging different customers different prices for
the same product not justified by cost differences.

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Conditions for
price discrimination
A firm can engage in price discrimination if the
seller:
is a price maker
can separate consumers into market
segments (perhaps on the basis of price
elasticity of demand)
can prevent arbitrage (buying then reselling
for a higher price).
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Price discrimination
in practice
Many firms with a downward-sloping demand
curve (not just monopolists) can practise price
discrimination:
different fares based on age or status
different seat prices at sporting events
restaurant discounts to senior citizens
discounts for volume purchases.
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Is price discrimination unfair?
Price discrimination allows sellers to charge what
buyers are willing to pay.
Many buyers benefit from the discrimination by
not being excluded from purchasing a product
they could not otherwise afford.

Comparing monopoly and perfect
competition
Compared to perfect competition, the monopolist:
allocates resources inefficiently
produces less output
charge a higher price.
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Chapter

9 Imperfect
Competition

Monopolistic competition and oligopoly
The monopolistic competition market
structure
Monopolistic competition features:
many small sellers
differentiated product
non-price competition
easy entry and exit.
It is the market structure in which we find more
firms than any other structure.

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Many small sellers
Each firm is so small, relative to the total market,
that each firms pricing decisions have a
negligible effect on the market price.
However, monopolistically competitive firms are
price makers; that is, they have some control over
their price.

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Product differentiation
Product differentiation is the key feature of
monopolistically competitive markets.
Product differentiation is the process of creating
real or apparent differences between goods and
services.
Such differences give firms the capacity to
increase their prices.

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Non-price competition
In monopolistically competitive markets, firms
compete using non-price techniques:
advertising
packaging
product development
better service.
This avoids having to compete by lowering prices.

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Entry and exit
Monopolistic competition features low barriers to
entry.
Thus entry for new firms is fairly easy, especially
if they can differentiate themselves from
competitors.
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The monopolistic competitors demand
curve
The demand curve for a monopolistically
competitive firm is downward sloping.
It is less elastic than the demand curve for the
perfectly competitive firm.
It is more elastic than a monopolists demand
curve.
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Advertising
Advertising is one of the types of non-price
competition used in monopolistic competition.
Its purpose is to help differentiate the product
from its competitors.
Advertising is probably more effective in the short
run than in the long run.
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Monopolistic competition in the long run
In the long run, each firm in a monopolistically
competitive market will earn normal profit.
This is because there is relatively easy entry and
exit.
For example, if a restaurant earns a short-run
economic profit, new firms have an incentive to
enter the market.
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Benefits of
monopolistic competition
Although monopolistic competition fails the
efficiency test, the product variety that occurs
because of product differentiation may
outweigh efficiency loss.
Differentiated products allow consumer choice
(not available in perfect competition).
The oligopoly market structure
Oligopolistic markets tend to be dominated by a
few large firms.
Oligopolistic markets feature:
few sellers
homogeneous/differentiated product
difficult market entry.
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Mutual interdependence
Mutual interdependence is the distinguishing
feature of oligopoly.
This means a decision by one firm is likely to
cause some reaction from other firms in the same
market, e.g. banks and the fees they charge.
Interdependence means decisions in oligopoly
are more complex than in other market forms.
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Price and output
decisions for an oligopolist
Mutual interdependence makes the oligopoly
marketplace more difficult to analyse than perfect
competition, monopolistic competition or
monopoly.
So the priceoutput decision also takes into
account the possible reactions of other firms.
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Kinked demand curve
This is one explanation of oligopolistic behaviour.
The firm assumes rivals will ignore a price
increase and match a price cut.
The demand curves therefore have two
segments, above and below a price point.
This model suggests prices will be sticky.
Kinked demand curve
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