Eco 101

Lecture Notes
Pure Monopoly
A single firm producing a unique product for the whole market. A monopoly faces the market demand curve.

Reasons Behind Monopoly
Exclusive patent rights
Legal restrictions
Large start-up unrecoverable (sunk) costs
Control of a rare essential resource (input)
Artificial barriers to entry
Technological superiority
Extensive economies of scale

Monopoly versus Competition

Equilibrium under Monopoly
  Profit maximization rule:
                              MR = MC
                                P   > MR
                     =>      P   >  MC
      P=MU    =>    MU >  MC
                     =>    Inefficient allocation

    ATC        MC =>  ATC is not at its minimum
                           =>    Inefficiency in production

Monopolistic Profit
A monopoly can sustain its profit in the long run
A monopoly can increase its profit by increasing demand: advertisement
A monopoly can increase its profit by lowering its costs
A monopoly could benefit from economies of scale

The Case of Natural Monopoly
When the economies of scale are extensive, as a result of competition, one firm could gradually expand and price other competitors out of the market and eventually end up being a monopoly.
That is a case where the downward sloping segment of the long-run average total cost extends to or beyond the market demand (curve).
Natural Monopoly


Efficiency and Natural Monopoly


Price Discrimination under Monopoly

Price discrimination occurs when:
A monopolist faces two or more markets with different demand curves (due to different preferences, different incomes, etc.)
The markets are separable and inter-market trades are not allowed (or possible)
A price discriminating monopoly could maximize its profit by charging a different price in each market

Monopolistic Competition

Monopolistic competition
Many firms
Many buyers
Free entry and exit
Differentiated (heterogeneous) but similar products
Substitutability among differentiated products
The firm faces a downward sloping demand curve

A monopolistically competitive firm starts out as a monopoly.


Monopolistic Competition: Long-Run Equilibrium

Long-Run Equilibrium in a Monopolically Competitive Industry
Many firms
Excess capacity:  ATC >  MC
Zero economic profit:  P  = ATC
P > MC;   MU > MC
Neither efficiency in production nor efficiency in allocation is present.
Product variety

An industry dominated by a few large firms each capable of influencing the market
Oligopolies may produce homogeneous or differentiated products
Each oligopoly is watchful of the actions (or reactions) of the others in the industry: intra-industry interdependence
Competition among oligopolies (especially non-price competition) tends to be intense

Some Oligopoly Models
Ignoring interdependence; maximizing revenue
Price leadership
The kinked demand curve
The game theory; the prisoners’ dilemma model: The Nash equilibrium
Cournot oligopolies

Price Leadership
Taking into account the total supply of the followers, acting like a monopoly, the leader sets its marginal cost equal to its MR and determine the price according to the residual market demand, DL

The followers take the price determined by the leader as given and act like competitive firms.

The sum of the outputs produced by the leader and the followers would be the equilibrium quantity at the price set by the leader.

The Kinked Demand Curve Model


A Game Theory Example
Two auto dealerships (a duopoly)
No exchange of information between the two firms allowed
Symmetry in the two firms market positions
Two possible pricing strategies for each firm: charging a high price or charging a low price

A Game Theory Example