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Monopoly and Other Forms of Imperfect Competition. Price Taker v. Price Setter. Perfectly Competitive Firm A firm that must take the price in the market A price taker Imperfectly Competitive Firm A firm with at least some latitude to set its own price A price setter.
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Price Taker v. Price Setter • Perfectly Competitive Firm • A firm that must take the price in the market • A price taker • Imperfectly Competitive Firm • A firm with at least some latitude to set its own price • A price setter
Forms of Imperfect Competition • Pure monopolist • A firm that’s the only supplier of a unique product with no close substitutes • Oligopolist • A firm that produces a product for which only a few rival firms produce close substitutes • Monopolistically competitive firm • One of a large number of firms that produce slightly differentiated products that are reasonably close substitutes for one another
Essential Difference • A perfectly competitive firm faces a perfectly elastic demand curve for its product • Firms take the price in the market, where supply and demand curves intersect • Charging a higher price or a lower price does not help increase profits • An imperfectly competitive firm faces a downward-sloping demand curve • Charging a price different from competitors may be advantageous
Fig. 9.1The Demand Curves Facing Perfectly and Imperfectly Competitive Firms
Market Power • Market Power • A firm’s ability to raise the price of a good without losing all its sales • It does not mean that a firm can sell any quantity at any price it wishes. [If firms raise price, quantity demanded falls.] • i.e. they must remember the law of demand
Sources of Market Power • Market power arises from factors that limit competition = “barriers to entry” • Exclusive control over inputs • Economies of scale (lower average costs) • Patents • Grant exclusive rights for a specified time period • Promote monopoly but encourage innovation • Government licenses or franchises
Returns to Scale • Constant returns to scale • When all inputs are changed by a given proportion and output changes by the same proportion • Increasing returns to scale • When all inputs are changed by a given proportion and output changes by a higher proportion • Also know as Economies of Scale
Economies of Scale • With Economies of Scale • Average cost of production falls as output increases • There are high start-up costs • There are low marginal costs
Fig. 9.2 Total and Average Costs for a Production Process with Economies of Scale
“Natural Monopoly” • In some markets, it makes more sense (is more efficient) to only have a single provider of the good. • Economies of scale are so great that the good or service can be provided at the lowest cost if only one firm provides it. • E.g. Utilities • How many sets of phone lines, water pipes, cable wires, electric lines … do we need? • Since monopoly power is dangerous (to consumers) what must we do with natural monopolies?
Profit Maximization • Goal of all firms: Maximize profits • Rule • Expand output when MR > MC • Decrease output when MC > MR • Sell the quantity of output where marginal revenue equals marginal cost, MR = MC
Fig. 9.3The Profit-Maximizing Output Level for a Perfectly Competitive Watermelon Farmer
Monopolist’s Marginal Revenue • Marginal Revenue • The change in a firm’s total revenue that results from a one-unit change in output • For a monopolist • marginal benefit of selling an additional unit is less than the market price • Note that a monopolist can only sell an add-itional unit if it cuts prices on all units it sells
Fig. 9.4The Monopolist’s Benefit from Selling an Additional Unit
Fig. 9.6The Marginal Revenue Curve for a Monopolist with a Straight-Line Demand Curve
Profit-Maximizing Rule • Profit is maximized at the level of output for which MR = MC • A monopolist sets the price off of the demand curve at its profit-maximizing output
Monopoly and Efficiency • Recall, the socially efficient level of output is where MB = MC • The monopolist produces less than socially efficient level of output • Monopolists are not efficient • Inefficiency is measured by deadweight loss • Monopoly may be socially inefficient, but the alternatives, like legislation, are not perfect either
Price Discrimination • Price Discrimination • The practice of charging different buyers different prices for essentially the same good or service • Discounts to senior citizens, children • Super-saver discounts on air travel • Rebate coupons on retail merchandise • Effective when the good or service cannot be resold
Types of Price Discrimination • Perfect price discrimination • A firm that charges each buyer exactly his or her reservation price • Hurdle method of price discrimination • The practice by which a seller offers a discount to all buyers who overcome some obstacle • A rebate that takes time and effort to mail in • Time spent waiting
Benefits of Price Discrimination • The number of trades increase • Brings output closer to the socially efficient level • Reduces deadweight loss and increases total economic surplus