eco415 mkt structure
TRANSCRIPT
In general, In general, the market structure can be the market structure can be classified into 4 main types:classified into 4 main types:
PERFECT COMPETITIONPERFECT COMPETITIONMONOPOLYMONOPOLYMONOPOLISTIC COMPETITIONMONOPOLISTIC COMPETITIONOLIGOPOLYOLIGOPOLY
4 main characteristics that 4 main characteristics that differentiate the market structure of differentiate the market structure of
one firm to another :one firm to another : Number and size of sellersNumber and size of sellers Number and size of buyersNumber and size of buyers Degree of product differentiation: Degree of product differentiation:
homogeneous or heterogeneous.homogeneous or heterogeneous. Conditions of entry and exit of Conditions of entry and exit of
firms into the market.firms into the market.
Characteristics of PCFCharacteristics of PCFi.i. Many small sellers and buyersMany small sellers and buyers – they are – they are
the price-takers - cannot influence the the price-takers - cannot influence the market. Thus P is constant and DD is market. Thus P is constant and DD is perfectly elastic.perfectly elastic.
ii.ii. Products are homogeneousProducts are homogeneous & & undifferentiated. Decisions to buy are made undifferentiated. Decisions to buy are made solely on the basis of price.solely on the basis of price.
iii.iii. Free entry and exitFree entry and exit from the market. from the market.iv.iv. Perfect knowledgePerfect knowledge among buyers and among buyers and
sellers in the market sellers in the market v.v. Perfect mobility of resourcesPerfect mobility of resources among among
industries in the market.industries in the market.
DD scheduleDD scheduleof a perfect competitive of a perfect competitive
firmfirmQtyQty Price Price
(P)(P)TRTR MRMR ARAR
00 55 00 -- --1010 55 5050 55 552020 55 100100 55 553030 55 150150 55 554040 55 200200 55 55
What can you conclude from the table?What can you conclude from the table?(P = MR = AR = 5)
and are constant in value.
O
RM
(b) Firm
Q (thousands)O
(a) Industry
P
Q (millions)
S
D
Pe P=5
Qe
DD curve for a firm under perfect DD curve for a firm under perfect competitioncompetition
DD =AR=MR
• is a horizontal straight lineis a horizontal straight line: at : at the price as fixed by the market. the price as fixed by the market.
• it indicates that the firm can sell it indicates that the firm can sell as much as it can produce at the as much as it can produce at the given fixed price.given fixed price.
• DD curve DD curve is is perfectly elasticperfectly elastic: : infinite elasticity infinite elasticity (PED = (PED = ∞).∞).
The shape of DD curve for a PCFThe shape of DD curve for a PCF
P DD
Price
quantity
Profit MaximizationProfit Maximization: 2 approaches to : 2 approaches to determine maximum profit in SRdetermine maximum profit in SR
TOTAL APPROACH: TOTAL APPROACH: TR –TR – TC = TC =
MARGINAL APPROACH: MARGINAL APPROACH: at equilibrium MR = MC at equilibrium MR = MC
Note: Both approaches will Note: Both approaches will definitely give the same results. definitely give the same results.
A = AR – AC
ECONOMIC PROFITSECONOMIC PROFITSPROFIT PROFIT isis TR minus TC.TR minus TC.
What is Economic Profit?What is Economic Profit?
Economic ProfitEconomic ProfitEconomic Profit Economic Profit = TR – TC= TR – TC = TR – (Explicit + Implicit = TR – (Explicit + Implicit
Costs)Costs)
Types of PROFIT-Types of PROFIT-MAXIMISATIONMAXIMISATION
(at Equilibrium in SR) (at Equilibrium in SR)•In SR:In SR: a perfect competitive firm a perfect competitive firm can attain can attain 3 types of possible profits3 types of possible profits::
o Supernormal profitSupernormal profit / Positive Economic / Positive Economic Profit.Profit.
o Normal profitNormal profit / minimum profit / / minimum profit / Zero Economic Zero Economic Profit.Profit.o Subnormal profitSubnormal profit / Negative Economic / Negative Economic Profit/ Profit/ Loss.Loss.
DD scheduleDD scheduleof a perfect competitive of a perfect competitive
firmfirmQtyQty PricPric
eeTRTR TCTC Profit (Profit ( ) )
00 55 00 2020 -20-201010 55 5050 5050 0 0 Break-evenBreak-even
2020 55 100100 7070 30303030 55 150150 150150 0 0 Break-even Break-even
4040 55 200200 220220 -20-20
Total Revenue for a PCFTotal Revenue for a PCFTRRM
Q
- is a constant straight line.
Total ApproachTotal ApproachTCTC
TRTRRMRM
TRTR--TC ApproachTC Approach
MaximumMaximumProfit Profit
Q1
Break-even point
Break-even point
Total ApproachTotal ApproachTC
TRRM
Q
TR-TC Approach
MaximumProfit
= RM30
Break-even point
Break-even point
30
MCMCPP
QtyQty
PPeeee22 DD=DD=MRMR=AR=AR
00
Q2Q2
At maximising At maximising profit equilibrium, profit equilibrium, MR=MCMR=MC
Using the Marginal Approach
e1
Q1
e2 is chosen as the maximising profit equilibrium.
Supernormal Profit /Supernormal Profit /Positive ProfitPositive Profit
ACACMCMC
PP
QtyQty
PPee
ACAC
ee
DDDD=DD=MRMR=AR=AR
00 QQee
At maximising At maximising profit profit equilibrium, e;equilibrium, e; MR=MCMR=MCAR > AC,AR > AC, TR>TCTR>TC
Using the Marginal Approach
Supernormal Profit /Supernormal Profit /Positive ProfitPositive Profit
ACACMCMC
PP
QtyQty
44 22
ee
DDDD=DD=MRMR=AR=AR
00 8080
Example; = TR – TC = (P x Q) – (AC x Q) = (4 x 80) – (2 x 80) = 320 – 160 = 140 (supernormal profit)
Normal ProfitNormal Profit / /Zero ProfitZero Profit
ACACMCMCPP
QtyQty
PPee=AC=ACminminee
DD=DD=MRMR=AR=AR
00QQee
At least a At least a Normal Normal profitprofit is is required in required in order for a order for a firm to stay firm to stay in the in the market. market.
when the when the firm’s price firm’s price line is line is equivalent to equivalent to minimum ACminimum AC
At eqm.At eqm. MC=MR;MC=MR; AR=AC; and AR=AC; and TR=TCTR=TC, , == 00..
P=AR=MR=MC=AC
Subnormal profit Subnormal profit //Loss / Negative ProfitLoss / Negative Profit
ACACMCMCPP
QtyQty
PPee ee DD=DD=MRMR=AR=AR
00 QQee
FFACAC
At eqm. e, At eqm. e, MR=MCMR=MC=Price=Price;;AC > AR, AC > AR, TC>TR, LossTC>TR, Loss
whether the whether the firm firm will will have to have to leaveleave the the market market or or notnot will will depend on depend on its ability its ability to to cover its cover its total total variable variable cost.cost.
Example;Example;
ACACMCMCPP
QtyQty
11 ee DD=DD=MRMR=AR=AR
004040
FF 22
Subnormal profit Subnormal profit //Loss / Negative ProfitLoss / Negative Profit
= TR – TC = (P x Q) – (AC x Q) = (1 x 40) – (2 x 40) = 40 – 80 = – 40 (subnormal profit)
LOSSES AND SHUTDOWN LOSSES AND SHUTDOWN DECISIONDECISION
The The best output levelbest output level of a firm in SR is of a firm in SR is achieved when achieved when MR = MCMR = MC. . This is the point where the firm is said This is the point where the firm is said to either to either maximizes profitmaximizes profit or or minimizes loss.minimizes loss.
It will be better if a firm were to enjoy It will be better if a firm were to enjoy a a supernormal profit,supernormal profit,
however what action will be however what action will be taken taken if a firm have to earn a if a firm have to earn a
subnormal profit or loss?subnormal profit or loss?
Will the firm immediately Will the firm immediately close or shut-down its close or shut-down its operation in SR? and in operation in SR? and in LR?LR?
Shutdown Point Shutdown Point
In SR,In SR, a firm will a firm will still continues its operationits operation although under the although under the loss.loss.
-- hoping for something hoping for something miraclesmiracles to happen, to happen,
especially towards a price change; especially towards a price change; - - with the hope that it will with the hope that it will recoverrecover and get a and get a positive profit again in the future.positive profit again in the future.
Shutdown Point Shutdown Point In SRIn SR, whether to leave or not, , whether to leave or not, will depend on its abilitywill depend on its ability to cover all itsto cover all its total variable cost;total variable cost; this is to consider whether –this is to consider whether – the price (AR) is the price (AR) is equalequal; ; greater greater or than AVC.or than AVC. lower lower
P = AVCP > AVC orP < AVC
A Shutdown PointA Shutdown Point
AVCAVCACACMCMC
D = P = MR =AR
QtyQty
PricePrice
e
When When minimum minimum AVCAVC is equal or is equal or tangent to the tangent to the price line (AR)price line (AR) , , this is known as this is known as the the shutdown shutdown point point (at point (at point e).e). P
P = min AVC
Q
At shut down point; TR = TVC = 0PeQ
0
loss
= loss in SR
Shutdown decision Shutdown decision criterioncriterion
AVCAVCACACMCMC
D = P = MR = AR
QtyQty
PricePrice
e P
i) If P > AVC; that is AR > AC,i) If P > AVC; that is AR > AC, it pays for the firm to it pays for the firm to continue productioncontinue production
because because revenue generated will be revenue generated will be sufficient to sufficient to cover at cover at least all the variable cost and part of the least all the variable cost and part of the fixed cost.fixed cost.
AVC = loss in SRVC
FC
When P > AVCQ
Shutdown decision Shutdown decision criterioncriterion
AVCAVCACACMCMC
D = P = MR =AR
QtyQty
PricePrice
e P
ii) If P < AVC;ii) If P < AVC; the firm minimises loss by the firm minimises loss by shutting downshutting down, as it will , as it will only be able to cover part of variable cost only be able to cover part of variable cost without without manage to cover the fixed cost.manage to cover the fixed cost.
AVC=loss in SR
VC
FC
When P < AVC Q
Shutdown decision Shutdown decision criterioncriterion
AVCAVCACACMCMC
D = P = MR =AR
QtyQty
PricePrice
e P = AVC
iii) If P = AVC;iii) If P = AVC; the shutdown decision the shutdown decision signalisessignalises the shut down the shut down pointpoint. . However, this However, this is not the sole qualification for the firm’s shut is not the sole qualification for the firm’s shut down decision…. down decision….
Cont...Cont...
=loss in SR
VC
FC
Q
So, what are So, what are other other
circumstances circumstances in which a in which a
perfect competitive firm perfect competitive firm
may may stop production in stop production in
the the short-runshort-run??
Other shutdown decision Other shutdown decision criterions:criterions:
other factorsother factors need to be considered in the need to be considered in the decision to shut down such as:decision to shut down such as:
company’s goodwill, company’s goodwill, loosing of customers to competitors,loosing of customers to competitors, maybe its just a temporary measure maybe its just a temporary measure where DD falls due to a temporary where DD falls due to a temporary
economic economic down-turn. down-turn. The possibility of incurring higher The possibility of incurring higher
reopening reopening cost if shutdown decision is made.cost if shutdown decision is made.
c) Based on (a), will the company continue its operation? Why?
AVC = 29.6 and P = MR = 42AVC = 29.6 and P = MR = 42Since P > AVC; therefore, continue Since P > AVC; therefore, continue
production.production.
Perfect competitionPerfect competition
Long-run equilibriumLong-run equilibrium
Long-run decision:Long-run decision:Firms who are under the Firms who are under the lossloss in in
LR would have to LR would have to shut down shut down and cannot continue to and cannot continue to
produce.produce.
Under Perfect Competition;Under Perfect Competition; only firms who manage to only firms who manage to produce with produce with normal profitnormal profit were able to continue to were able to continue to
produce in LR.produce in LR.
RM
Q O
MC
LRAC
D = AR = MR
P = LRAC = MC = MR = AR
Equilibrium in LR Equilibrium in LR with with normal profit.normal profit.
P
Break-even pointBreak-even point This is a point where the quantity at which This is a point where the quantity at which
the firm the firm neither earns profits or suffers neither earns profits or suffers losses, losses,
TR = TC : TR = TC : earns zero economic profit.earns zero economic profit.
TCTCTRTR
Break-even Break-even point, TR=TC, point, TR=TC,
Profit=0.Profit=0.
e
Q
RM
LR equilibrium (profit-maximizing) LR equilibrium (profit-maximizing)
of a perfect competitive firmof a perfect competitive firm As firms can As firms can easily enter and exiteasily enter and exit an industry as well as an industry as well as can also changes the size of production in LR, the firm can also changes the size of production in LR, the firm will be earning just a will be earning just a normal profitnormal profit and not a positive and not a positive economic profit economic profit in LRin LR..
2 reasons contributing towards that:2 reasons contributing towards that:a) if in SR, a firm enjoys supernormal profit –a) if in SR, a firm enjoys supernormal profit –
will encourage them to expand production as will encourage them to expand production as well as attracts new firms to join the market. well as attracts new firms to join the market.
Economic profit is forced to go down to normal Economic profit is forced to go down to normal profit in LR.profit in LR.
b) if in SR, a firm enjoys subnormal profit –b) if in SR, a firm enjoys subnormal profit – this will force them to reduce production as well this will force them to reduce production as well
as forcing some badly hit firms to leave the as forcing some badly hit firms to leave the market. market.
The loss of the firms will be covered and the The loss of the firms will be covered and the firms will enjoy normal profit in LR. firms will enjoy normal profit in LR.
How the industryHow the industrysupply curve is derived ?supply curve is derived ?
O O
(a) Industry/market
P RM
P1
Q (millions)
S
D1
(b) Firm
D1 = MR1
MC
P2D2 = MR2
D2
P3
D3 = MR3
D3
Q (thousands)
Deriving the short-run supply Deriving the short-run supply curve for a firm.curve for a firm.
ab
c
= SS
In the case where firms enjoy In the case where firms enjoy supernormal profit in SR, will supernormal profit in SR, will only enjoy normal profit in only enjoy normal profit in
LR.LR.
AR= MRAR= MR
ARAR11= MR= MR11
PPPP11
QQ00 QQ11 QQ
SSSS00
SSSS11
DDDD00
ACAC
MCMC11
QQ11
A FirmA Market
From supernormal From supernormal to normal profit in LR.to normal profit in LR.
Many new firms were attracted to the Many new firms were attracted to the supernormal profit earns by the supernormal profit earns by the industry.industry.
After more firms enter the market, After more firms enter the market, SS SS will increase and price falls.will increase and price falls.
Thus, as the firm in Perfect Thus, as the firm in Perfect Competition is a price taker; with the Competition is a price taker; with the lower price in the market, its lower price in the market, its supernormal profit is eliminated and supernormal profit is eliminated and will reach normal profit only in LR.will reach normal profit only in LR.
In the case where firms enjoy In the case where firms enjoy subnormal profit in SR, will subnormal profit in SR, will enjoy normal profit in LR.enjoy normal profit in LR.
ARAR00= MR= MR00
PP11
PP00
QQ11 QQ00 QQ11
SSSS11
SSSS00
DDDD00 ACAC11MCMC11
ARAR11= MR= MR11 P
Q
From subnormal From subnormal to normal profit in LR.to normal profit in LR.
After more firms leave the market, After more firms leave the market, SS falls and price increases.SS falls and price increases. Thus, as Thus, as the firm is a price taker, with the the firm is a price taker, with the higher price, its subnormal profit is higher price, its subnormal profit is eliminated and will reach normal eliminated and will reach normal profit in LR.profit in LR.
PCF will always enjoy PCF will always enjoy normal profit normal profit in LR.in LR.
ACACLRLR
MCMCLRLR
AR= MRAR= MR P
Q
MR = AR = MC =AC = P
Characteristics of a Characteristics of a MonopolyMonopoly
Only one seller and many buyers – Only one seller and many buyers – Seller has influence on the market Seller has influence on the market price (price-maker)price (price-maker)
Unique products - consumers Unique products - consumers perceived the product is not perceived the product is not having any close substitute or having any close substitute or competitors.competitors.
Barriers to entry and exit Barriers to entry and exit Imperfect dissemination of Imperfect dissemination of
knowledge or informationknowledge or information Perfect mobility of resources Perfect mobility of resources
among industriesamong industries
Important Note To Important Note To Remember:Remember:
An important An important assumption assumption is that is that the monopolist the monopolist can only control can only control price or quantityprice or quantity but but not bothnot both, i.e. , i.e. price may increase or decrease price may increase or decrease but quantity is constant. This is but quantity is constant. This is an important theoretical an important theoretical assumption.assumption.
Type of Barriers To Entry & ExitType of Barriers To Entry & Exit Cut throat competitionCut throat competition - the monopolist will - the monopolist will
undercut price so that the rival firm will not be undercut price so that the rival firm will not be able to compete at all.able to compete at all.
Legal restrictionsLegal restrictions such as existence of patent such as existence of patent and copyright.and copyright.
Product differentiationProduct differentiation – In the minds of – In the minds of consumers, the product of a monopoly is very consumers, the product of a monopoly is very much different and cannot be substitute by much different and cannot be substitute by other products.other products.
Control of resourcesControl of resources – potential entrants faced – potential entrants faced difficulties in obtaining the required resources difficulties in obtaining the required resources to produce.to produce.
Economies of scaleEconomies of scale – a monopolist enjoys – a monopolist enjoys economies of scale and able to produce output economies of scale and able to produce output at lower cost.at lower cost.
The high initial costThe high initial cost - made more difficult for - made more difficult for new entrants.new entrants.
The DD curve of a The DD curve of a monopolist firmmonopolist firm
Let us observe the following DD scheduleLet us observe the following DD schedule QtyQty PricePrice TRTR MRMR ARAR11 1010 1010 1010 101022 99 1818 88 9933 88 2424 66 8844 77 2828 44 7755 66 3030 22 66
What can you conclude from the table?What can you conclude from the table?
Downward sloping DD curveDownward sloping DD curve A monopoly has a A monopoly has a downward sloping downward sloping
DDDD curve. Price must decrease in curve. Price must decrease in order to increase sales or outputs order to increase sales or outputs and vise-versa.and vise-versa.
The effect of output changes on TR The effect of output changes on TR depends on the MR curve:depends on the MR curve:a)a) When MR is +ve , an increase in When MR is +ve , an increase in output will increase TRoutput will increase TRb)b) When MR is –ve , an increase in When MR is –ve , an increase in output will reduce TR.output will reduce TR.
• Is shown as a downward sloping Is shown as a downward sloping curve from left to right.curve from left to right.
• Here DD = P = AR but is not the Here DD = P = AR but is not the same same with MR . with MR .
• In other words , DD = P = AR = In other words , DD = P = AR = MRMR
The shape of Firm’s DD curveThe shape of Firm’s DD curve
AR and MR curves of a AR and MR curves of a monopolistmonopolist
P = AR =DDP = AR =DDMR MR
PP
Note: AR and MR curves have the same intercept Note: AR and MR curves have the same intercept but the slope of MR is 2 times greater than the but the slope of MR is 2 times greater than the slope of the AR curve.slope of the AR curve.
PROFIT-MAXIMIZING PROFIT-MAXIMIZING (EQUILIBRIUM)IN THE SR(EQUILIBRIUM)IN THE SR
•Profit is maximized in SR when MR = Profit is maximized in SR when MR = MC (the same standard profit MC (the same standard profit maximizing criterion used as in the case maximizing criterion used as in the case of Perfect Competition)of Perfect Competition)•In SR, a monopoly firm can also attain 3 In SR, a monopoly firm can also attain 3 possible profits:possible profits:
o Supernormal profit / Economic Supernormal profit / Economic ProfitProfito Normal profit / minimum profit Normal profit / minimum profit /zero economic profit/zero economic profit o Subnormal profit / negative Subnormal profit / negative economic economic profitprofit
Supernormal profitSupernormal profit
ARAR
MRMR
ACAC
MCMC
PP
00
PePeCC
DD
BB
QeQe
Profit maximization Profit maximization occurs when MR = occurs when MR = MC.MC.
Supernormal profit Supernormal profit area = TR – TC area = TR – TC and is shown by and is shown by CBDPe.CBDPe.
Normal profitNormal profit
ARAR
MRMR
ACACMCMC
PP
00
Pe = CPe = C DD
QeQe
AR=AC orAR=AC orTR = TC ; TR = TC ; normal normal profit (zero profit (zero profit) is profit) is attainedattained
Profit maximization Profit maximization conditions is when conditions is when
MR = MC. MR = MC.
Subnormal profitSubnormal profit
ARAR
MRMR
ACACMCMC
PP
00
Pe Pe DD
QeQe
C C F F
Profit maximization Profit maximization conditions is when MR = MC.conditions is when MR = MC.
TC > TR ; a TC > TR ; a subnormal profit subnormal profit (negative profit) is (negative profit) is attained, attained, represented by the represented by the area DFCPearea DFCPe
A monopolist’s Equilibrium in LRA monopolist’s Equilibrium in LR The monopolist will be earning only The monopolist will be earning only
supernormal profitsupernormal profit in LRin LR because: because: there is there is no competitionno competition that the firm has to that the firm has to
face. face. So, it has the So, it has the power to control pricepower to control price (as a (as a
price maker).price maker). Produces Produces unique productsunique products and might have and might have
pattern right.pattern right.
Equilibrium in LREquilibrium in LR
ARAR
MRMR
LRACLRAC
MCMC
PP
00
PePeCC
DD
BB
QeQe
A monopolist will enjoys a supernormal profit
Comparing the LR equilibrium bet. Comparing the LR equilibrium bet. Perfect Competition and MonopolyPerfect Competition and Monopoly
ARmARm
MRmMRmQQ
LRACLRAC
MCMCPP
00
PmPm CC
DD
BB
QmQm
1. In LR, a monopolist may enjoys supernormal profit but PCF only enjoys normal profit.
2. A monopolist price is higher than PCF : Pm > Pc(price maker vs.
price taker)
Pc
Qc
3. A monopolist produces less output than PCF:
Qm < Qc (Qm is produced at
AC which is still falling or less than full capacity, but Qc is at optimum, i.e. AC minimum)
ARc
Optimum OutputOptimum Output Always remember that the Always remember that the optimum point optimum point
(minimum of Average Cost)(minimum of Average Cost) is not the same is not the same as the as the equilibrium point (MC = MR)equilibrium point (MC = MR). .
A A monopoly firm monopoly firm is producing at a point of is producing at a point of excess capacity i.e. less than optimum level. excess capacity i.e. less than optimum level.
This means that the firm is not utilizing its This means that the firm is not utilizing its resources to capacity. resources to capacity.
This is different from a This is different from a perfect competition perfect competition firm firm where the optimum output is equals to where the optimum output is equals to the equilibrium output.the equilibrium output.
PRICE DISCRIMINATIONPRICE DISCRIMINATION Can be defined as:Can be defined as:
the practice where the seller the practice where the seller charges different pricescharges different prices to to different customersdifferent customers in different marketsin different markets for similar for similar goods and services. goods and services.
Examples of price discrimination exists such as:Examples of price discrimination exists such as: electricity and water consumption rate charge electricity and water consumption rate charge
differentlydifferently telephone servicestelephone services some professional services such as doctors and some professional services such as doctors and
lawyerslawyers
3 types of Price Discrimination3 types of Price Discrimination First degree Price discriminationFirst degree Price discrimination- - practice of charging each unit sold at a different price. practice of charging each unit sold at a different price. Second degree Price discriminationSecond degree Price discrimination- occurs when the same consumer pays a certain price for occurs when the same consumer pays a certain price for
some units of a commodity and a different price for some units of a commodity and a different price for further units of the same commodity.further units of the same commodity.
- Here, different price charged for different blocks.Here, different price charged for different blocks. Third degree Price discriminationThird degree Price discrimination- The same product is sold to different consumers at The same product is sold to different consumers at
different prices. different prices. - This is probably the most common form of price This is probably the most common form of price
discrimination. Customers are separated based on the discrimination. Customers are separated based on the different in their price elasticity of demand. different in their price elasticity of demand.
- High price charged for inelastic market and vice-versa.High price charged for inelastic market and vice-versa.
3 Conditions/ Assumptions3 Conditions/ Assumptions for 3rd degree Price Discriminations for 3rd degree Price Discriminations
The firm must haveThe firm must have control of price control of price (a monopolist)(a monopolist)..Market can beMarket can be separated separated/segmented /segmented and resale is impossible.and resale is impossible.
Different degree of elasticity of Different degree of elasticity of demand (PED)demand (PED) in different markets. in different markets.
33rdrd Degree Price Degree Price DiscriminationDiscrimination
Market A Market B Combined Market (Market C) MC PA PC AC PB MC=MR ARC ARA ARB MRC QA MRA Q QB MRB Q QC Q Equilibrium is achieved when MR = MC
33rdrd Degree Price Degree Price DiscriminationDiscrimination
Market A Market B Combined Market (Market C) MC 10 6 AC 5 MC=MR= 4 ARC ARA ARB MRC 30 MRA Q 50 MRB Q 80 Q Equilibrium is achieved when MR = MC
( assume that AC=MC here)
TR =10x30
=300TR=50x5
=250
TR=80x6
=480
Characteristics of Characteristics of A Monopolistic Firm:A Monopolistic Firm:
There are There are a large number of sellersa large number of sellers Consumers perceived the Consumers perceived the product produced by each product produced by each
firm are differentfirm are different i.e. i.e. differentiated productdifferentiated product, can be in , can be in the form of packaging, labeling, after-sales services, the form of packaging, labeling, after-sales services, etc.etc.
Firms have the Firms have the freedom of entry and exit.freedom of entry and exit. All buyer and sellers have All buyer and sellers have perfect dissemination of perfect dissemination of
knowledge and information,knowledge and information, in terms of its cost, in terms of its cost, price, quality, taste, etc. price, quality, taste, etc.
Important notes to remember:Important notes to remember: There is a large number of firms, There is a large number of firms, but not as many as in but not as many as in
perfect competition perfect competition Because the consumers Because the consumers have many close substituteshave many close substitutes that that
they can choose from, the firm in monopolistic competition they can choose from, the firm in monopolistic competition must ensure that the must ensure that the price offered is competitiveprice offered is competitive i.e. not too i.e. not too high or not too lowhigh or not too low which will results in a loss. which will results in a loss.
Each firm has a relatively Each firm has a relatively small market sharesmall market share of the total of the total market. Thus, it has only a very market. Thus, it has only a very small amount of control small amount of control over the market-clearing price.over the market-clearing price.
It is It is very difficultvery difficult for all of them to get together for all of them to get together to collude,to collude, that is to set a pure monopoly price (and output).that is to set a pure monopoly price (and output).
Each firm Each firm acts independentlyacts independently of the others. Rivals’ reactions of the others. Rivals’ reactions to output and price changes are largely ignored. to output and price changes are largely ignored.
• The same as in the case of monopolist.The same as in the case of monopolist.• Is shown as a Is shown as a downward sloping downward sloping
curvecurve from left to right. from left to right. • The only difference that The only difference that distinguish a distinguish a
monopolist and a monopolisticmonopolist and a monopolistic competition firm competition firm is the DD curveis the DD curve of the of the later firm is later firm is more elasticmore elastic as compared as compared to the monopolist. to the monopolist.
• Here DD = P = AR but is not the same Here DD = P = AR but is not the same with MR . with MR .
The shape of The shape of Firm’s DD Firm’s DD
curvecurve
AR and MR curves for a AR and MR curves for a monopolistic firmmonopolistic firm
P = AR =DDP = AR =DD
MRMR
PP
Note:Note: AR and MR curves for a monopolistic competition AR and MR curves for a monopolistic competition firm is firm is more elasticmore elastic as compared to a monopolist as compared to a monopolist
PROFIT-MAXIMIZING PROFIT-MAXIMIZING (EQUILIBRIUM) IN THE SR(EQUILIBRIUM) IN THE SR
•Profit is maximized in SR:Profit is maximized in SR: when MR = MC (the same when MR = MC (the same
standard standard profit maximizing profit maximizing criterion used as in criterion used as in the case the case of of Monopoly and Perfect Monopoly and Perfect Competition)Competition)•In SR, a monopolistic competition firm In SR, a monopolistic competition firm can also attain 3 possible profits:can also attain 3 possible profits:
o Supernormal profit / Positive Supernormal profit / Positive Economic Economic Profit.Profit.o Normal profit / minimum profit Normal profit / minimum profit /zero economic profit./zero economic profit. o Subnormal profit / negative Subnormal profit / negative economic economic profitprofit
Supernormal profitSupernormal profit
ARAR
MRMRQQ
ACAC
MCMC
PP
00
PePeCC
DD
BB
QeQe
Profit maximization Profit maximization occurs when MR = occurs when MR = MC. MC.
Supernormal profit Supernormal profit = TR – TC = TR – TC and is shown by theand is shown by thearea CBDPe.area CBDPe.
Normal profitNormal profit
ARAR
MRMRQQ
ACACMCMC
PP
00
Pe = CPe = C dd
QeQe
Profit maximization Profit maximization conditions is when conditions is when MR = MC. MR = MC.
Here, total area of Here, total area of TR = total area of TR = total area of TC. TC.
Thus, earn normal Thus, earn normal profit (zero profit).profit (zero profit).
Subnormal profitSubnormal profit
ARAR
MRMR
ACACMCMCPP
00
Pe Pe DD
QeQe
C C F F
At profit At profit maximization maximization conditions conditions MR = MC, MR = MC, TC > TR ; a TC > TR ; a subnormal profit subnormal profit (negative profit) (negative profit) is attained as is attained as shown by area shown by area DFCPe.DFCPe.
A monopolist’s Equilibrium in LRA monopolist’s Equilibrium in LR In the long runIn the long run, since there are so many firms , since there are so many firms
competing and substituting the firm’s product, any competing and substituting the firm’s product, any economic profits will be competed away alas, get economic profits will be competed away alas, get normal profit only in LR. normal profit only in LR.
They will be competed away either through entry by They will be competed away either through entry by new firms seeing a chance to make a higher rate of new firms seeing a chance to make a higher rate of return than elsewhere, or by changes in product return than elsewhere, or by changes in product quality and advertising outlays by existing firms in the quality and advertising outlays by existing firms in the industry.industry.
As for economic loses in the SR, they will disappear in As for economic loses in the SR, they will disappear in the LR because those firms that suffer the losses will the LR because those firms that suffer the losses will leave the industry. They will go into another business leave the industry. They will go into another business where the expected rate of return is at least normal to where the expected rate of return is at least normal to them. them.
Equilibrium in LREquilibrium in LR
ARAR
MRMRQQ
LRACLRACMCMC
PP
00
Pe = CPe = Cdd
QeQe
A monopolistic competition will enjoys a normal profit in LR
Comparing the LR equilibrium bet. Comparing the LR equilibrium bet. Perfect Competition and Perfect Competition and
MonopolisticMonopolistic
ARmARm
MRmMRmQQ
LRACLRAC
MCMCPP
00
Pm=CPm=C
DD
QmQm
1. In LR, both monopolistic firm and PCF enjoys normal profit.
2. A monopolistic price is higher than PCF : Pm > Pc
(price maker vs. price taker)
Pc
Qc
3. A monopolistic firm produces less output than PCF:
Qm < Qc (Qm is produced at
AC which is still falling or less than full capacity, but Qc is at optimum, i.e. AC minimum)
ARc
OligopolyOligopoly
Oligopoly market structureOligopoly market structure
market is dominated by market is dominated by only few sellers only few sellers that are that are interdependent among interdependent among them.them.
CharacteristiCharacteristics of an cs of an
Oligopoly:Oligopoly:
Only Only few few
firms firms
Mutual Mutual interdependencinterdependenc
ee
Products are Products are homogeneouhomogeneou
s or s or differentiatedifferentiate
ddLarge
Barrier to Entry
Characteristics of an Oligopoly:Characteristics of an Oligopoly:
1.1. Only Only few firmsfew firms dominating the market. These dominating the market. These several big firms in the market are several big firms in the market are able to set able to set the price.the price.
Only Only few few
firms firms
Characteristics of an Oligopoly:Characteristics of an Oligopoly:
2. 2. Their behaviour is said to beTheir behaviour is said to be mutual mutual interdependenceinterdependence – – each firm will react to what each firm will react to what the other firms is doingthe other firms is doing, ,
could be in terms of could be in terms of output and priceoutput and price, , as well as to changes in as well as to changes in qualityquality and and product differentiationproduct differentiation..
Mutual Mutual interdependeninterdependen
cece
Characteristics of an Oligopoly:Characteristics of an Oligopoly:
3.3. There’s 2 types of OligopolyThere’s 2 types of Oligopoly: - where the product is : : - where the product is : - - `̀homogeneoushomogeneous’ example: egg and chicken ’ example: egg and chicken
producers are identical.producers are identical. - - `̀differentiated productsdifferentiated products’ example: cars (Proton ’ example: cars (Proton
and Perodua), and Perodua), telecommunication telecommunication services services (Celcom, Digi, Hotlink), (Celcom, Digi, Hotlink), air flight air flight (MAS and Air Asia). (MAS and Air Asia).
Products are Products are homogeneous homogeneous
or or differentiateddifferentiated
Characteristics of an Oligopoly:Characteristics of an Oligopoly:
4.4.Large barrier to entryLarge barrier to entry : : had reached had reached Economies of Scale (Lower cost)Economies of Scale (Lower cost)
e.g. those big firm who manage to reduce cost e.g. those big firm who manage to reduce cost and be competitive in price, such as and be competitive in price, such as
electronic electronic companies, garment and textiles companies, garment and textiles companies.companies.
with with High Initial Fixed CostHigh Initial Fixed Cost to set-up firm. to set-up firm. e.g. transportation companies such as express e.g. transportation companies such as express
bus, shipping co., cargo transportation bus, shipping co., cargo transportation etc. etc.
Large Barrier to
Entry
Models of OligopolyModels of Oligopoly There are many models: There are many models:
because oligopolists are because oligopolists are interdependent, interdependent,
no one general theory of no one general theory of oligopoly explains their oligopoly explains their behaviourbehaviour, so , so many theories many theories have been developedhave been developed..
1. Oligopoly by Merger1. Oligopoly by Merger It can happen when merging between two or more It can happen when merging between two or more
firms occurred under a single ownership or control firms occurred under a single ownership or control There are There are three types of merger:three types of merger:
Horizontal MergersHorizontal Mergers - Involves firms selling a - Involves firms selling a similar product, e.g. two shoes manufacturing firms similar product, e.g. two shoes manufacturing firms merged.merged.
Vertical MergersVertical Mergers - Occurs when one firm merges - Occurs when one firm merges with either a firm from which it purchases an input with either a firm from which it purchases an input or a firm to which it sells its output or a firm to which it sells its output
Conglomerate MergersConglomerate Mergers - Involve the joining - Involve the joining together of two firms which have unrelated together of two firms which have unrelated activities activities
Collusion and Cartels:Collusion and Cartels: CollusionCollusion is is an agreementan agreement among among
firms to divide the market or firms to divide the market or to fix to fix the market price.the market price.
A A cartelcartel is a group of firms that agree is a group of firms that agree to coordinate production and pricing to coordinate production and pricing decisions thus decisions thus behaving like a behaving like a monopolist. monopolist.
More about CartelMore about Cartel Cartels Cartels are very are very formal arrangements either formal arrangements either
openly or secretly conspire to coorporate openly or secretly conspire to coorporate and behave like a monopolist. and behave like a monopolist. Thus, Thus, members of the cartel members of the cartel agreeagree in in output quotasoutput quotas to maintain to maintain agreed pricesagreed prices for their products. for their products.
The The motive motive for cartel formation is for cartel formation is to reduce to reduce the uncertainty in oligopolisticthe uncertainty in oligopolistic marketsmarkets by by reducing the unpredictability of rivals’ reducing the unpredictability of rivals’ reactions to changes in price;reactions to changes in price;
it thus increases the profits of the group as it thus increases the profits of the group as a whole.a whole.
Controlling price and Controlling price and output through Carteloutput through Cartel
The best example of a The best example of a well-known cartelwell-known cartel is by the world members of crude oil is by the world members of crude oil producers, producers, OPECOPEC (Organisation of (Organisation of Petroleum Exporting Countries).Petroleum Exporting Countries).Its objective is Its objective is to set oil production to set oil production quotasquotas for its members and tend for its members and tend to to influence world price.influence world price.
RM
Q O
Industry DD AR
Profit-maximising by CartelProfit-maximising by Cartel
RM
Q O
Industry D AR
Industry MC
Industry MR
Q1
P1
Profit-maximising by CartelProfit-maximising by Cartel
But then,But then,a cartel member might has an a cartel member might has an
incentive incentive to cheat.to cheat.
A firm now act as a price taker and was limited by A firm now act as a price taker and was limited by the agreed qouta.the agreed qouta.
P1
$
MR1
LRACMC
MR2P2(Cartel price)
Q2(Cartel quota)
Higher profit earn after cartelMore profit after cheatingQ3(supply at MC to cheat)Q1
OligopolyOligopoly2. Price leadership2. Price leadership
(assumption of fixed market (assumption of fixed market share)share)
More about Price leadershipMore about Price leadership Price leadership occurs when Price leadership occurs when a large dominant a large dominant
firm sets a pricefirm sets a price which is then which is then accepted as the accepted as the market pricemarket price by other firms. by other firms.
No formal agreement is needed to do this, it is No formal agreement is needed to do this, it is sufficient for other firms to sufficient for other firms to believesbelieves that this is that this is the best way of protecting or increasing their the best way of protecting or increasing their profits. Its just a pricing strategy to follow the profits. Its just a pricing strategy to follow the leader’s price and increase their price at the same leader’s price and increase their price at the same amount.amount.
In general, price leadership in oligopoly market In general, price leadership in oligopoly market can be divided into can be divided into two typestwo types::a)a) Price leadership by low-cost firmPrice leadership by low-cost firmb)b) Price leadership by big firm Price leadership by big firm
RM
Q O
MR leader
AR D leader
AR D market
Price leader aiming to maximise profits Price leader aiming to maximise profits for a given market sharefor a given market share
Assume constantmarket share
for leader
£
Q O
AR D market
MC
MR leader
PL
QT
AR D leader
QL
l t
Price leader aiming to maximise profits Price leader aiming to maximise profits for a given market sharefor a given market share
OligopolyOligopoly3. Kinked demand curve 3. Kinked demand curve theory (Sweezy’s Model)theory (Sweezy’s Model)
More about Kinked DD curve More about Kinked DD curve ModelModel
Paul M. SweezyPaul M. Sweezy originally proposed this originally proposed this model in 1939. model in 1939.
This model has since become perhaps the This model has since become perhaps the most famous of all theories of oligopoly. most famous of all theories of oligopoly.
This theory explains:…This theory explains:…
based on two (2) assumptions :based on two (2) assumptions :
i)i) If an oligopolist If an oligopolist cuts its pricecuts its price, its rivals will , its rivals will
feel feel forced to follow suitforced to follow suit and cut theirs to and cut theirs to
prevent losing customers to the first firm. prevent losing customers to the first firm.
The individual firm therefore perceives The individual firm therefore perceives
demand for its product to be relatively demand for its product to be relatively
inelastic if it lowers price.inelastic if it lowers price.
RM
QO
P1
Q1
D2 (inelastic)
D 1 (elastic)
Kinked demand for a firm under oligopolyKinked demand for a firm under oligopolyIf he tries to make a price falls, DD of his product increases only few.He perceive as he is facing an inelastic demand curve (D2).Since his rival will follow suit.
ii)ii) If an oligopolist If an oligopolist raises its priceraises its price, however, , however, its rivals will not follow suit,its rivals will not follow suit, since by since by keeping their prices the same, they will keeping their prices the same, they will thereby gain customers from the first firm.thereby gain customers from the first firm.
Because of this, the individual Because of this, the individual firm perceives demand for its product is to firm perceives demand for its product is to be relatively be relatively elastic if it raises price. elastic if it raises price.
RM
QO
P1
Q1
D2 (inelastic)
D 1 (elastic)
Kinked demand for a firm under Kinked demand for a firm under oligopolyoligopoly
If he tries to make a price rise, DD of his product falls largely.He perceive as he is facing an elastic demand curve (D1). Since his rival does not follow suit.
RM
QO
P1
Q1
D
D
Kinked demand for a firm under Kinked demand for a firm under oligopolyoligopoly
Rival does not follow suit
Rival does follow suit
Kinked demand for a firm under Kinked demand for a firm under oligopolyoligopoly
RM
QO
P1
Q1
Current priceand quantity
give one pointon the demand
curvee
RM
QO
P1
Q1
MC2
MC1
MR
a
b D AR
Stable price under conditions of a Stable price under conditions of a kinked demand curvekinked demand curve
e
Argument here is that:Argument here is that:changes might not occur after changes might not occur after
knowing the rivals reaction towards knowing the rivals reaction towards the price change.the price change.
thus, forced them to sell at thus, forced them to sell at one one stable pricestable price, at the kink ( point , at the kink ( point ee).).
The weaknesses of the The weaknesses of the Sweezy’s modelSweezy’s model
It cannot explain how price (P) was It cannot explain how price (P) was originally determinedoriginally determined
There is little empirical evidence to There is little empirical evidence to support the assumption that there support the assumption that there is a price cut, but not a price rise, is a price cut, but not a price rise, that will matched by competitors. that will matched by competitors.
Comparison of Oligopoly Comparison of Oligopoly and Perfect Competitionand Perfect Competition
There is no single model of the There is no single model of the oligopoly. oligopoly.
Price is usually higher under Oligopoly: Price is usually higher under Oligopoly: Price is higher but output lower.Price is higher but output lower.
Higher profits under Oligopoly: Profit Higher profits under Oligopoly: Profit in the long run should be higher under in the long run should be higher under oligopolies than under perfect oligopolies than under perfect competition because with few firms in competition because with few firms in the market they have more control the market they have more control over price.over price.