Imperfect Competition and

Monopoly
Chapter 9
Definition
Imperfect competition prevails in an industry whenever individual sellers
can affect the price of their output. The major kinds of imperfect
competition are monopoly, oligopoly, and monopolistic competition.
At one pole of the competitive spectrum is the perfect competitor, which is
one firm among a vast multitude of fi rms. At the other pole is the monopoly,
which is a single seller with complete control over an industry. (The word
comes from the Greek words mono for “one” and polist for “seller.”)
In monopolies, there is only one (dominant) seller. That company offers a
product to the market that has no substitute. Monopolies have high barriers
to entry, a single seller which is a price maker. That means the firm sets the
price at which its product will be sold regardless of supply or demand.
Finally, the firm can change the price at any time, without notice to
consumers
Oligopolies
In an oligopoly, there are many buyers but only a few sellers. Oil
companies, grocery stores, cellphone companies, and tire
manufacturers are examples of oligopolies. Because there are a few
players controlling the market, they may bar others from entering the
industry. The firms in this market structure set prices for products and
services collectively or, in the case of a cartel, they may do so if one
takes the lead
Monopolistic Competition
Monopolistic competition occurs when there are many sellers who offer
similar products that aren't necessarily substituted. Although the barriers to
entry are fairly low and the companies in this structure are price makers, the
overall business decisions of one company do not affect its competition.
Examples include fast food restaurants like McDonald's and Burger King.
Although they are in direct competition, they offer similar products that
cannot be substituted—think Big Mac vs. Whopper.
In this situation, a large number of sellers produce differentiated products.
This market structure resembles perfect competition in that there are many
sellers, none of whom has a large share of the market. It differs from perfect
competition in that the products sold by different fi rms are not identical
Monopolistic Competition: Differentiation
concept

Differentiated products are ones whose important characteristics vary.

Personal computers, for example, have differing characteristics such as
speed, memory, hard disk, modem, size, and weight. Because
computers are differentiated, they can sell at slightly different prices.

Product quality is an increasingly important part of product

differentiation today. Goods differ in their characteristics as well as
their prices.
Types of Market Structure at a Glance
Monopoly or Perfectly Competetive3 Market
Figure 9-1 shows graphically the
difference between the demand
curves faced by perfectly and
imperfectly competitive fi rms.
Figure 9-1( a ) reminds us that a
perfect competitor faces a
horizontal demand curve, indicating
that it can sell all it wants at the
going market price. An imperfect
competitor, in contrast, faces a
downward-sloping demand curve.
Figure 9-1 ( b ) shows that if an
imperfectly competitive fi rm
increases its sales, it will definitely
depress the market price of its
output as it moves down its dd
demand curve.
Price Elasticity and Monopoly Market
Another way of seeing the difference between perfect and imperfect
competition is by considering the price elasticity of demand. For a
perfect competitor, demand is perfectly elastic; for an imperfect
competitor, demand has a finite elasticity. The fact that the demand
curves of imperfect competitors slope down has an important
implication: Imperfect competitors are price-makers not price-takers.
They must decide on the price of their product, while perfect
competitors take the price as given.
SOURCES OF MARKET IMPERFECTIONS
• Most cases of imperfect competition can be traced to two principal
causes. First, industries tend to have fewer sellers when there are
significant economies of large-scale production and decreasing costs.
Under these conditions, large fi rms can simply produce more cheaply
and then undersell small fi rms, which cannot survive.

• Second, markets tend toward imperfect competition when there are

“barriers to entry” that make it difficult for new competitors to enter
an industry. In some cases, the barriers may arise from government
laws or regulations which limit the number of competitors. In other
cases, there may be economic factors that make it expensive for a
new competitor to break into a market.
Costs and Market Imperfection
The technology and cost structure of an industry help determine how
many fi rms that industry can support and how big they will be. The key
is whether there are economies of scale in an industry. If there are
economies of scale, a fi rm can decrease its average costs by expanding
its output, at least up to a point. That means bigger fi rms will have a
cost advantage over smaller firms.
Costs and Market Imperfection
Figure 9-2 ( a ) shows an
industry where the point of
minimum average cost is
reached at a level of output
that is tiny relative to the
market. As a result, this
industry can support the large
number of efficiently operating
fi rms that are needed for
perfect competition. Figure 9-2
( a ) illustrates the cost curves
in the perfectly competitive
farm industry
Costs and Market Imperfection
Figure 9-2(b), which shows an
industry where fi rms have minimum
average costs at a sizable fraction of
the market. The industry demand
curve allows only a small number of
fi rms to coexist at the point of
minimum average cost. Such a cost
structure will lead to oligopoly. Most
manufacturing industries in the
United States including steel,
automobiles, cement, and oil have a
demand and cost structure similar to
the one in Figure 9-2(b). These
industries will tend to be
oligopolistic, since they can support
only a few large producers.
Costs and Market Imperfection
A natural monopoly is a market in
which the industry’s output can be
efficiently produced only by a single
fi rm. This occurs when the
technology exhibits significant
economies of scale over the entire
range of demand. Figure 9-2 (c)
shows the cost curves of a natural
monopolist. With perpetual
increasing returns to scale, average
and marginal costs fall forever. As
output grows, the firm can charge
lower and lower prices and still
make a profit, since its average cost
is falling. Peaceful competitive
coexistence of thousands of perfect
competitors will be impossible
because one large fi rm is so much
more efficient than a collection of
small fi rms.
Barriers to entry
In economics, barriers to entry are factors that can prevent or impede
newcomers to a market or industry sector; as such, they can limit
competition. Barriers to entry can include high startup costs, regulatory
hurdles, or other obstacles that prevent new competitors from easily
entering a business sector. They benefit existing firms because they
protect their market share and ability to generate revenues and profits.

Common barriers to entry include special tax benefits to existing firms,

patent protections, strong brand identity, customer loyalty, and high
customer switching costs. Other barriers include the need for new
companies to obtain licenses or regulatory clearance before operation.
Barriers to entry
Government/ Legal Barriers to Entry

Industries heavily regulated by the government are usually the most

difficult to penetrate. Examples include commercial airlines, defense
contractors, and cable companies. The government creates formidable
barriers to entry for varying reasons. In the case of commercial airlines,
not only are regulations strict, but the government restricts new
entrants to limit air traffic and simplify monitoring.1 Cable companies
are heavily regulated and limited because their infrastructure requires
extensive public land use. Sometimes government do it either for
lobbying or sometimes to protect existing local businesses.
Barriers to entry
Natural Barriers to Entry

Barriers to entry can also form naturally as the dynamics of an industry take
shape. Brand identity and customer loyalty serve as barriers to entry for
potential entrants. Certain brands, such as Kleenex and Jell-O, have identities
so strong that their brand names are synonymous with the types of products
they manufacture.

High consumer switching costs are barriers to entry as new entrants face
difficulty enticing prospective customers to pay the additional money
required to make a switch.
Barriers to entry
Market Dominance Barriers

In some cases, the market leader position is so advanced as to be

nearly impossible to catch in the short term. For these barriers,
companies may consider using a disruptive pricing model and even
incurring a short-term loss to steal long-term customers. A company
may also set difference objectives such as "be the lowest cost
producer".
Barriers to entry
Industry Barrier

• Governments also impose entry restrictions on many industries.

Typically, utilities, such as telephone, electricity distribution, and
water, are given franchise monopolies to serve an area. In these cases,
the firm gets an exclusive right to provide a service, and in return the
fi rm agrees to limit its prices and provide universal service in its
region even when some customers might be unprofitable.
Barriers to entry
Import Restriction

Historians who study the tariff have written, “The tariff is the mother of
trusts.” This is because government-imposed import restrictions have
the effect of keeping out foreign competitors. It could very well be that
a single country’s market for a product is only big enough to support
two or three firms in an industry, while the world market is big enough
to support a large number of firms.
Barriers to entry
High Cost Of Entry
In addition to legally imposed barriers to entry, there are economic barriers
as well. In some industries the price of entry simply may be very high. Take
the commercial-aircraft industry, for example. The high cost of designing and
testing new airplanes serves to discourage potential entrants into the
market. It is likely that only two companies Boeing and Airbus—can afford
the $10 to $20 billion that the next generation of aircraft will cost to develop.
In addition, companies build up intangible forms of investment, and such
investments might be very expensive for any potential new entrant to match.
Consider the software industry. Once a spreadsheet program (like Excel) or a
word-processing program (like Microsoft Word) has achieved wide
acceptability, potential competitors find it difficult to make inroads into the
market. Users, having learned one program, are reluctant to switch to
another