Unit 4 Imperfect Competition
Contents
1. Monopoly
2. Monopolistic competition
3. Oligopoly
Monopoly
4.1.1 Characteristics
4.1.2 Profit Maximization
4.1.3 Efficiency of Monopoly
4.1.4 Price Discrimination
4.1 Monopoly
4.1.1 Characteristics
Characteristics Monopoly
Market Structure Seller Numbers Product Type Seller Entry Barriers
Monopoly One Unique Yes
Oligopoly Few Depends Yes
Monopolistic
Many Differentiated No
Competition
Perfect Competition Many Homogeneous No
Characteristics of Monopoly
1. One Firm (Single Seller)
• One Firm controls the vast majority of a market
• The Firm is the Industry
2. Unique good with no close substitutes
3. High barriers to entry
• New firms cannot enter market
• Firms can earn profit in long-run
4. Price Maker
• The firm can manipulate price, but it has to obey law of demand
Source of Monopoly
• Monopoly Resources: The simplest way for a monopoly to arise is for a
single firm to own a key resource.
• Government-Created Monopolies: In many cases, monopolies arise
because the government has given one person or firm the exclusive
right to sell some good or service. E.g. patent, copy right.
•Natural Monopolies: E.g. Electric utilities, Natural gas, Railroads, Water
services, Telecommunications
4.1 Monopoly
4.1.2 Profit Maximization
Demand and Marginal revenue of Monopoly
• Monopolies (and all Imperfectly competitive firms) have downward
sloping demand curve. Which means, to sell more a firm must lower its
price.
• The marginal revenue doesn‘t equal the price -- MR and Demand
curve are two different curves -- P > MR, which means Demand curve
is above marginal revenue.
Why?
Demand and Marginal cost of Monopoly
Price Quantity Demanded Total Revenue Marginal Revenue
$6 0
$5 1
$4 2
$3 3
$2 4
$1 5
Demand and Marginal cost of Monopoly
Price Quantity Demanded Total Revenue Marginal Revenue
$6 0 0
$5 1 $5 $5
$4 2 $8 $3
$3 3 $9 $1
$2 4 $8 $-1
$1 5 $5 $-3
Demand and Marginal cost of Monopoly
Marginal
Quantity Total Average
Revenue
of Price Revenue Revenue
(MR=△TR
Water(Q) (P) (TR=P×Q) (AR=TR/Q)
/△Q)
0gallons $11 $0 -
1 10 10 $10 $10
2 9 18 9 8
3 8 24 8 6
4 7 28 7 4
5 6 30 6 2
6 5 30 5 0
7 4 28 4 -2
8 3 24 3 -4
Profit maximization
A monopoly maximizes profit by producing the
quantity at which marginal revenue equals
marginal cost.
MR = MC
• It then uses the demand curve to find the
price that will induce consumers to buy that
quantity.
• For a competitive firm: P=MR=MC
• For a monopoly firm: P> MR and P>MC
Profit of Monopoly
Profit equals total revenue minus total
costs.
Profit = TR-TC
= (TR/Q-TC/Q)×Q
= (P-ATC)×Q
• If P>ATC, there will be a profit.
• If P<ATC, there will be a loss
instead of profit.
2005_Intl_MCQ_53
53.A single-price monopolist's marginal revenue is
(A) equal to its price
(B) less than its price
(C) greater than its price
(D) negative when it maximizes revenues
(E) zero when it maximizes profit
2015_Intl_MCQ_25
25.A monopoly is different from a perfectly competitive firm in that a
monopoly
(A) does not have a U-shaped average total cost curve
(B) has an average fixed cost curve that is perfectly horizontal
(C) has a marginal revenue curve that lies below its demand curve
(D) always earns economic profits
(E) operates in the inelastic segment of its demand curve
PED and Monopoly
• If price falls and TR increases, then
demand is elastic.
• If price falls and TR falls then
demand is inelastic.
PED and Monopoly
Monopolist operates in the elastic range of demand where MR>0
4.1 Monopoly
4.1.3 Efficiency of Monopoly
Efficiency of Monopoly
• Because a monopoly charges a price
above marginal cost, not all consumers
who value the good at price more than
its cost buy it.
•Thus, the quantity produced and sold
by a monopoly is below the socially
efficient level.
Monopoly vs. Perfect competition in terms of efficiency
• Allocative efficiency: Price = MC
•Price is greater than MC. The
monopoly is under producing. So
Monopoly is not allocatively efficient.
Monopoly vs. Perfect competition in terms of efficiency
• Productive efficiency: P = minATC;
firms produce at efficient scale
•In Monopoly, price is not equal to
min ATC and monopoly is not
necessarily producing at efficient
scale (minATC). So a monopoly is
not productive efficient.
Regulations on Monopoly
• Socially Optimal (social efficient):
Allocative Efficiency, producing at
the quantity where MC = P
(demand curve)
•Fair Return: No economic profit,
producing at the quantity where
ATC = P (demand curve)
2005_Intl_MCQ_ 12
12. Generally, monopolies are considered inefficient because they
(A) produce at a point where marginal cost is less than marginal revenue
(B) produce at a point where marginal cost exceeds price
(C) produce more output than does a competitive industry with similar
cost conditions
(D) lead to an overallocation of resources in the affected market
(E) lead to an underallocation of resources in the affected market
Regulations on natural monopoly
• Natural monopoly: a monopoly that
arises because a single firm can supply
a good or service to an entire market at
a smaller cost than could two or more
firms.
• Natural monopoly has a declining ATC,
and ATC is above MC.
Regulations on natural monopoly: social optimal
• If regulators require a natural
monopoly to charge a price equal
to marginal cost, price will be
below average total cost, and the
monopoly will lose money.
•In this case, the government
usually subsidizes natural monopoly.
Regulations on natural monopoly: fair return
2021_DE_D52902_MCQ_ 18
18. The graph shows a firm’s demand, marginal
revenue (MR), marginal cost (MC), and average total
cost (ATC) curves. If the government were to regulate
the firm to produce the socially optimal quantity, then
the firm would earn
A. positive economic profit since P> MR
B. positive economic profit since ATC<MC
C. negative economic profit since P < ATC
D. negative economic profit since P>MR
E. zero economic profit since P=MC
1995_Intl_MCQ_49
49. The graph above shows the cost and
revenue curves for a natural monopoly.
Consider the following two policies for
regulating this natural monopoly.
Policy I: Require the monopoly to set
quantity and price where demand equals
marginal cost.
Policy II: Require the monopoly to set
quantity and price where demand equals
average total cost.
Which of the following is true of these
policies?
1995_Intl_MCQ_49
(A) Both would result in the same level of output and price.
(B) Both would result in an inefficient allocation of resources relative to
the unregulated result.
(C) Policy I would result in a lower level of output than would Policy II.
(D) Policy I would result in a higher price than would Policy II.
(E) Policy I might require the payment of a subsidy to the firm.
4.1 Monopoly
4.1.4 Price Discrimination
Price discrimination
• Price discrimination: the business practice of selling the same good at
different prices to different customers (Mankiw, Principles of Economics,
2015, p314)
•Examples: movie tickets, airline prices, discount coupons, hard cover
books
•Perfect price discrimination seeks to charge each consumer what they are
willing to pay in an effort to increase profits.
•Assumption: a monopoly can separate cutomers into different groups. E.g.
by their price elasticities
Price discrimination
Price/WTP Quantity Demanded Total Revenue Marginal Revenue
$6 0
$5 1
$4 2
$3 3
$2 4
$1 5
Perfect price discrimination: MR = P= D
Price discrimination
Price/WTP Quantity Demanded Total Revenue Marginal Revenue
$6 0 0
$5 1 $5 $5
$4 2 $9 $4
$3 3 $12 $3
$2 4 $14 $2
$1 5 $15 $1
Perfect price discrimination: MR = （P）= D
Efficiency of price discrimination
Consequences of perfect price discrimination:
•Quantity increases
•Allocative efficiency, no deadweight loss;
•Total surplus become profit (producer surplus)
Efficiency of price discrimination
Consequences of perfect price discrimination:
• Quantity increases
• Allocative efficiency, no deadweight loss;
• Total surplus become profit (producer surplus)
2018_Intl_MCQ_ 13
13. Which of the following is a necessary condition for price discrimination?
(A) Resale of the product or service is possible.
(B) Buyers have identical elasticities of demand.
(C) The seller can separate consumers according to their elasticities of
demand.
(D) The seller is a perfectly competitive firm.
(E) Buyers are aware of prices charged to other buyers.
Monopolistic Competition
Monopolistic Competition
4.2.1 Characteristics
4.2.2 Profit Maximization and Long Run Equilibrium
4.2 Monopolistic Competition
4.2.1 Characteristics
Characteristics of monopolistic competition
Seller Entry
Market Structure Seller Numbers Product Type
Barriers
Monopoly One Unique Yes
Oligopoly Few Depends Yes
Monopolistic
Many Differentiated No
Competition
Perfect Competition Many Homogeneous No
Characteristics
1. Many sellers
2. Free entry and exit -- firms can enter or exit the market until economic profits are zero.
3. Product differentiation -- each firm produces a product that is at least slightly different
from those of other firms.
• a lot of non-price competition – advertisement – decrease PED
4. Each firm faces a downward-sloping demand curve.
1995_Intl_MCQ_57
57. Which of the following is NOT a characteristic of monopolistically
competitive markets?
(A) Relatively easy market entry
(B) Differentiated products
(C) Substantial product advertising
(D) A large number of both buyers and sellers
(E) Long-run economic profits
4.2 Monopolistic Competition
4.2.2 Profit Maximization and Long-Run Equilibrium
Short-run equilibrium
• At any Q, MR< P. Thus MR curve is under Demand curve
• Profit maximization quantity is at MR = MC
• Firm use demand curve to find price
• Profit can be positive or negative
• In short run, firm will shut down if P<AVC; In long run, firm will exit if P<ATC
Long-run equilibrium
• If firms are making profits, some of the firms in the market enter and
the demand curves of the remaining firms shift to the left.
• Similarly, if firms are making losses, some of the firms in the market exit
and the demand curves of the remaining firms shift to the right.
Long-run equilibrium
Economic profits encourage new firms to enter the market. This
• Increases the number of products offered.
• Reduces demand faced by firms already in the market.
• Existing firms’demand curves shift to the left. So does MR.
• At new quantity of profit maximization, ATC is tangent to new demand curve
• Their profits decline to 0
Long-run equilibrium
• Because of these shifts in demand,
monopolistically competitive firms
faces price equals ATC and each
firm earns zero profit In this long-run
equilibrium.
• ATC curve is tangent to demand
curve
Efficiency of monopolistic competition
Comparing with perfect
competition:
• Markup price:
• P>MC
• Excess capacity:
• Q<efficiency scale
That means monopolistic competition is not allocative
efficient nor productively efficient
1995_Intl_MCQ_43
43. In the long run, a monopolistically competitive firm is allocatively
inefficient because the firm will
(A) produce only when marginal cost is greater than marginal revenue
(B) produce only when marginal revenue is greater than marginal cost
(C) charge a price greater than the marginal cost
(D) earn positive economic profits
(E) experience economic losses
1995_Intl_MCQ_54
54. The graph above depicts cost and
revenue curves for a typical firm in a
monopolistically competitive industry.
Suppose that the firm is producing OM
units of output. To maximize profits, it
should do which of the following to
output and price?
Output Price
(A) Increase Decrease
(B) Increase Increase
(C) Decrease Increase
(D) Not change Increase
(E) Not change Not change
Oligopoly
Oligopoly
4.3.1 Characteristics of Oligopoly
4.3.2 Dominant Strategy and Nash Equilibrium
4.3.3 Collusion, Cartel and Antitrust Law
4.3 Oligopoly
4.3.1 Characteristics
Characteristics of Oligopoly
Market Seller Seller Entry
Product Type
Structure Numbers Barriers
Monopoly One Unique Yes
Oligopoly Few Depends Yes
Monopolistic
Many Differentiated No
Competition
Perfect
Many Homogeneous No
Competition
Characteristics of Oligopoly
1. A few large firms
2. Identical or differentiated Products
3. High barriers to Entry
4. Control over price
5. Mutual Interdependence
4.3 Oligopoly
4.3.2 Dominant Strategy and Nash Equilibrium
Game theory and payoff matrix
• Oligopolies are interdependent since they compete with only a few
other firms.
• Their pricing and output decisions must be strategic in order to avoid
economic losses.
• Game theory helps us analyze their strategies.
Payoff matrix
•The reward/punishment received by a player in a game, is that player’s
payoff.
•A payoff matrix shows how the payoff to each of the participants in a two
player game depends on the actions of both.
Dominant strategy
• The Dominant Strategy is a strategy that is best for a player in a game
regardless of the strategies chosen by the other players (Mankiw,
Principles of Economics, 2015, p354)
“I’m doing the best I can
no matter what you do.
You’re doing the best you
can no matter what I do”
Dominant strategy
FirmA: No dominant strategy
Firm B: Advertise
Nash equilibrium
Nash equilibrium: a situation in which economic actors interacting with
one another each choose their best strategy given the strategies that all
the other actors have chosen. (Mankiw, Principles of Economics, 2015,
p351)
“I am doing the best I can given what you are doing.
You are doing the best you can given what I am doing.”
Find Nash Equilibrium
Exercise 1:Prisoner’s Dilemma
Two guys are charged with a crime, each prisoner has one of two
choices: Deny or Confess.
Exercise 2
Dominant Strategy vs. Nash Equilibrium
• Dominant strategy is an action from each player; while Nash Equilibrium
is a combination of actions from both players associated with an
outcome (pair of payoffs).
•Two dominant strategy from both players must form a Nash Equilibrium,
but the action in Nash Equilibrium is not necessarily a dominant strategy.
•There could be more than one Nash Equilibrium; each player has at
most one dominant strategy.
Conclusion of games
• Often people (firms) fail to cooperate with one another even when
cooperation would make them better off. Because firms have incentives to
break the agreement.
2012_Intl_MCQ_40
The payoff matrix below shows the
per-unit profits associated with the
production strategies of two utility
companies, UA and UB. Each firm has
two choices: to reduce production by
10 percent or by 20 percent. The first
entry in each cell indicates the profits
to UA, and the second, the profits to
UB.
2012_Intl_MCQ_40
Based on the information, and assuming
no cooperation, which of the following
statements is true?
(A) Neither company has a dominant
strategy.
(B) Both companies have an incentive to
reduce production by 10%.
(C) Both companies have an incentive to
reduce production by 20%.
(D) Only UA has an incentive to reduce
production by 20%.
(E) Only UB has an incentive to reduce
production by 20%.
2021_DE_D52903_MCQ_25
25. Sweetdoughnuts and Sprinkledoughnuts are the only two doughnut
shops in a town, and they both are considering the strategies of “offer
bagels” or “do not offer bagels”. The two players independently and
simultaneously choose their strategy, and each is fully aware of the
expected profits for both under each combination of strategies. If
Sweetdoughnuts chooses “do not offer bagels” because that is its
dominant strategy, which of the following statements is necessarily true?
2021_DE_D52903_MCQ_25
A. Sprinkledoughnuts will choose “offer bagels” because if one firm has a dominant
strategy, the other firm is always better off engaging in the opposite strategy.
B. Sprinkledoughnuts will choose “do not offer bagels” because if one firm has a dominant
strategy, the other firm is always better off engaging in the same strategy.
C. Sprinkledoughnuts will choose “offer bagels” because only one firm in a market can
increase its profits by offering bagels.
D. Sprinkledoughnuts will choose “do not offer bagels” if that is its dominant strategy.
E. The Nash equilibrium will be for both firms to “offer bagels” because offering more
products leads to increased profits.
4.3 Oligopoly
4.3.3 Collusion, Cartel and Antitrust Policy
Collusion and Cartel
Collusion: an agreement among firms in a market about quantities to
produce or prices to charge (Mankiw, Principles of Economics, 2015,
p349)
Cartel: a group of firms acting in unison
•Cartels set price and output at an agreed upon level
•Firms require identical or highly similar demand and costs
•Cartel must have a way to punish cheaters
•Together they act as a monopoly
A duopoly example:
Demand Schedule for Lysine
Quantity of lysine
Price of Total
demanded(millions
lysine(perpound) revenue(millions)
of pounds)
$12 0 $0 What will be the quantity and price
11 10 110 if two firms want to
10 20 200 maximize their collective revenue?
9 30 270
8 40 320
7 50 350
What if one of the firms decides to
6 60 360
cheat …
5 70 350
4 80 320
3 90 270
2 100 200
1 110 110
0 120 0
Price war and price leadership
•A Price War occurs when tacit collusion breaks down and aggressive
price competition causes prices to collapse.
•Oligopolists often reach a tacit understanding not to compete on price.
In Price Leadership, one firm sets its price first, and other firms then
follow.
Outcome of oligopoly in general
• Oligopolists have difficulty achieving the monopoly outcome for reasons
similar to those that prevent players from achieving a cooperative
outcome;
• Nevertheless, prices are generally higher and quantities are lower with
oligopoly than with perfect competition, which lead to market
inefficiency.
Antitrust policy
•In a trust, shareholders of all the major companies in an industry placed
their shares in the hands of a board of trustees who controlled the
companies. This, in effect, merged the companies into a single firm that
could then engage in monopoly pricing.
•Antitrust policy involves efforts by the government to prevent
oligopolistic industries from becoming or behaving like monopolies.
2005_Intl_MCQ_23
23. If the only two firms in an industry successfully collude to maximize
their joint profit, the price for the product will be
(A) equal to the marginal cost of production
(B) equal to the average total cost of production
(C) above the marginal cost of production
(D) above the monopoly price
(E) below the average variable cost of production
perfect
competiton
Perfect Monopolistic Oligopoly Monopoly
Competition Competition
imperfect competition
Section Question Answer
4.1.2 2005_Intl_MCQ_53 B
4.1.2 2015_Intl_MCQ_25 C
4.1.3 2005_Intl_MCQ_12 E
4.1.3 2021_DE_D52902_MCQ_18 C
4.1.3 1995_Intl_MCQ_49 E
4.1.4 2018_Intl_MCQ_13 C
4.2.1 1995_Intl_MCQ_57 E
4.2.2 1995_Intl_MCQ_43 C
4.2.2 1995_Intl_MCQ_54 C
4.3.2 2012_Intl_MCQ_40 B
4.3.2 2021_DE_D52903_MCQ_25 D
4.3.3 2005_Intl_MCQ_23 C