ECON 300 PPT CH - 06

Understanding Economics
6th edition
by Mark Lovewell
Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.
Understanding
Economics
6th edition
by Mark Lovewell
Chapter 6
Monopoly and Imperfect
Competition
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives
After this chapter you will be able to:
1. outline the demand conditions faced by
monopolists, monopolistic competitors, and
oligopolists
2. distinguish how monopolists, monopolistic
competitors, and oligopolists maximize profits
3. understand nonprice competition, and the
arguments over industrial concentration

Monopolists Demand
A monopolists demand curve is the same as

for the entire market
it is downward sloping

Demand Faced by a Monopolist

Figure 6.1, Page 145
Demand Curve for Megacomp
Demand Schedule
for Megacomp
($ millions per
computer)
$160
120
80
(computers
per year)
1
2
3
160
Price ($ millions
per computer)
Quantity
Demanded
Price
200
a
b
120
80
40
0
Quantity (computers per year)

Monopolistic Competitors Demand
A monopolistic competitors demand curve is

elastic because of many substitutes for the
businesss product

Demand Faced by a Monopolist

Competitor
Demand Curve for Jaded Palate
Demand Schedule for

Jaded Palate
Price
($ per meal)
$11
10
9
8
(meals per
day)
100
200
300
400
12
Price ($ per meal)
Quantity
Demanded
10
8
6
4
2
0
100
200
300
400
Quantity (meals per day)

Oligopolists Demand
Oligopolies are characterized by mutual
interdependence.
Oligopolists in a market characterized by
rivalry face a kinked demand curve.
A business raising price finds rivals keep theirs
constant, so demand is relatively flat.

A business reducing price finds rivals raise
theirs as well, so demand is relatively steep.

Actions and Reactions among Rivals in an

Oligopoly
Action of
Company A
Probable
Response of
Competitors
raise price
keep prices
constant
lower price
match price
drop
Effect on
Company As
Market Share
Company As
Quantity
Demanded
product now
high-priced, so
market share
falls
large increase
as market share
lost to
competitors
since all
companies
selling at lower
price, Company
As market share
stays constant
small increase
as lower prices
for all
companies
attract new
buyers

Demand Faced Among Rivals in an

Oligopoly
Price
Quantity
Demanded
($ thousands
per car)
(thousands
of cars per year)
$35
30
20
10
10
20
25
30
Demand Curve for Centaur Cars
Price ($ thousands per car)
Demand Schedule
For Centaur Cars
40
30
20
D
10
10
20
30
Quantity (thousands of cars per year)

Cooperative Oligopolies
There are various ways that oligopolists can

cooperate:
price leadership
collusion
cartel

Revenue Conditions for a Monopolist

A monopolists average revenue is the same
as the downward-sloping market demand
curve.
A monopolists marginal revenue is below its
demand curve because demand (average
revenue) falls as quantity increases.

Revenues for a Monopolist

Revenue Curves for Megacomp
Price
(P)
Quantity
(Q)
Total
Revenue
(TR)
(P x Q)
Marginal
Revenue
(MR)
(TR/Q)
($
($ millions
millions (computer
per
per
s per
($ millions) computer)
computer
year)
0
$ 0
)
$160
$160
1
160
80
120
2
240
0
80
3
240
-80
40
4
160
Average
Revenue
(AR)
(TR/Q)
($ millions
per
computer)
$160/1 =
160
240/2 = 120
240/3 = 80
160/4 = 40
$ Millions per Computer
Revenue Schedules for Megacomp

200
160
120
80
40
D=AR
0
-40
-80
MR
Quantity of Computers per Year
Profit-Maximization for a Monopolist

(a)
A monopolist maximizes profit at the quantity
where marginal revenue and marginal cost are
equal. At this output, the monopolist charges
the highest possible price, as found using the
demand curve.
Monopolists meet neither the minimum-cost
pricing nor the marginal-cost pricing
conditions.

Profit Maximization for a Monopolist (b)

$160
120
80
40
Quantity
(Q)
(computer
s per
year)
0
1
2
3
4
$ Millions per computer
Price
(P)
(AR)
($ millions
per
computer)
Profit Maximization Table for Megacomp

Total
Revenue
(TR)
(P x Q)
($ millions)
$ 0
160
240
240
160
Marginal
Marginal Cost Average Cost
(AC)
Revenue
(MC)
(MR)
(TR/Q)
($ millions per($ millions per
computer)
($ millions per
computer)
computer)
$160
$ 60
$140
80
40
90
0
70
83
-80
150
100
Profit Maximization Graph for Megacomp

200
MC
160
12
09
80
0
b
c
40
0
AC
Profit = $60 million
a
1
MR
2
Quantity of Computers per Year

Other Features of
Monopolies
A monopolist charges a higher price and a

lower quantity than would occur if the market
were perfectly competitive.
Regulators of monopolies usually adopt
average-cost pricing in an effort to make
regulated monopolies break even.

Monopoly versus Perfect Competition

$ per T-Shirt
S(=MC)
4
b
MR
0
18 000
22 000
Quantity of T-Shirts per Day

Revenue Conditions for a

Monopolistic Competitor
A monopolistic competitors average revenue
is the same as its downward-sloping demand
curve.
A monopolistic competitors marginal revenue
is below its demand curve because demand
(average revenue) falls as quantity increases.

Revenues for a Monopolistic

Competitor
Revenue Schedules for Jaded Palate
Price
(P)
($ meal)
Total
Revenue
(TR)
(P x Q)
$
0
1100
2000
2700
3200
Marginal
Revenue
(MR)
(TR/Q)
1100/100 = $11
900/100 = 9
700/100 = 7
500/100 = 5
Revenue Curves for Jaded Palate

12
10
$ per Meal
$-11
10
9
8
Quantity
(Q)
(meals per
day)
0
100
200
300
400
D=
AR
6
MR
4
2
0
100
200
300
400
Quantity of Meals per Year

Average
Revenue
(AR)
TR/Q)
1100/100 = $11
2000/200 = 10
2700/300 = 9
3200/400 = 8
Profit-Maximization for a Monopolistic

Competitor (a)
The profit-maximizing quantity for a
monopolistic competitor is found where
marginal revenue and marginal cost are equal.
Price is found with the aid of the businesss
demand curve.
In the short run a monopolistic competitor
may make a profit or a loss at its profitmaximizing point.

Profit-Maximization for a Monopolistic

Competitor (b)
In the long run, a monopolistic competitor

breaks even.
If profits (losses) are being made in the short

run, new businesses enter (leave) the industry,
pushing businesses demand curves leftward
(rightward) and making them more (less)
elastic.
The business meets neither the minimum-cost

pricing nor the marginal-cost pricing rules,
since too few units of output are produced.
Profit Maximization for a Monopolistic

Competitor (c)
Short-Run Profit Maximization
For Jaded Palate
Long-Run Profit Maximization

For Jaded Palate
MC
$ per Meal
8.00
AC
D0
MR
200
Quantity of Meals per Day
e
7.50
MC
AC
minimum point
of AC
D1
$ per Meal
10.00
d
MR
0
150
Quantity of Meals per Day

Revenue Conditions for an

Oligopolist
For an oligopolist in a market characterized by
rivalry, average revenue is identical with its
kinked demand curve.
This businesss marginal revenue curve has
two linear segments which are below its
kinked demand curve

Profit-Maximization for an Oligopolist

(a)
The profit-maximizing quantity for this type of
oligipolist is found where marginal revenue
and marginal cost are equal. Price is found
using the businesss kinked demand curve.
Oligopolists meet neither the minimum-cost
pricing nor the marginal-cost pricing rules.

Profit Maximization for an

Oligopolist (b)
Profit Maximization Graph for
Centaur Cars
Profit Maximization Table for Centaur Cars
Total
Price
Marginal Marginal
Average
Revenue
(P)
Revenue
Cost
Cost
(TR)
(=AR)
(MR)
(MC)
(AC)
(P x Q) (TR/Q)
($ thousands (thousands
($
($
($
of cars per
($
Per car)
thousands thousands thousands
year)
millions) per car)
per car)
per car)
-$35
30
20
10
0
10
20
25
30
0
35
0
60
0
50
0
30
0
35
25
20
40
15
10
15
25
30
20
19
20
40
$ Thousands per car
Quantity
(Q)

30
MC
Profit = $200 million
20
10
0
-10
10
20
30
-20
-30
-40
MR
Quantity (thousands of cars per year)
AC
Game Theory
Game theory is the analysis of how mutually
interdependent actors try to achieve their

goals through the use of strategy.
Originally a field in mathematics, game theory
has become a set of concepts whose use has
spread to all social sciences, especially
economics.

The Prisoners Dilemma

(a)
The prisoners dilemma is a classic example
of how players self-interested actions can be

self-defeating.
It refers to a case in which two arrested men
are in separate cells and are facing the choice

of whether or not to confess. If both confess,
each gets a jail time of 5 years. If one confesses
and the other doesnt, the confessor gets off
and the other gets 10 years. If both dont
confess, they each get one year of jail.

(b)
By following a narrowly self-interested
strategy that minimizes his own potential

harm, each prisoner has an incentive to
confess, even though the best possible result
would be if both stayed silent.


Pauls Strategies
Confess
Dont Confess
Peters Strategies
Confess
Dont Confess
Paul: 5
Peter: 5
Paul: 10
Peter: 0
Paul: 0
Peter: 10
Paul: 1
Peter: 1
Applying the Prisoners Dilemma to

Oligopoly (a)
The prisoners dilemma can be applied
to oligopoly by looking at two businesses

that have entered a collusive agreement
to charge a high price.
If both businesses live by the
agreement, they each make $20 million
in profit. If one cheats and the other
doesnt, the cheater makes $25 million
in profit and the other makes $10
million. If both cheat, they each make
$15 million.
Applying the Prisoners Dilemma to

Oligopoly (b)
If price cutting can be accomplished in an
underhanded way, each business has an

incentive to cheat, since the profit for the
cheater (when the other business is living
within the agreement) is higher than
otherwise.
But if both businesses cheat, each makes a
lower profit than they would do if both lived
within the agreement.
The Case of Oligopoly

Deltas Strategies
Dont Cheat
Cheat
D: $20 m.
G: $20 m.
D: 25 m.
G: $10 m.
D: $10 m.
Cheat
Gammas Strategies
Dont Cheat
G: $25 m.
D: 15 m.
G: $15 m.
Anti-Combines
Legislation (a)
Anti-combines legislation represents laws
aimed at preventing industrial concentration

and abuses of market power.
The Competition Act of 1986 was a major
reform of Canadas anti-combines legislation.

Anti-Combines
Legislation (b)
Criminal offences under the Competition Act
include:
conspiracy
bid-rigging
predatory pricing
abuse of dominant position

Anti-Combines
Legislation (c)
Civil matters reviewed by the Competition
Tribunal include:
abuse of dominant position
mergers
horizontal merger
vertical merger
conglomerate merger

Nonprice Competition
Nonprice competition by monopolistic

competitors and oligopolists includes:
product differentiation
advertising
Nonprice competition raises a businesss

revenue and costs.
Nonprice competition may or may not be
beneficial to businesses and consumers.

Industrial Concentration
Industrial concentration refers to market

domination by a few large businesses.
It can provide the consumer with benefits due
to increasing returns to scale.

It can impose costs on the consumer due to
market power.
It may or may not encourage technical
innovation.

Concentration Ratios
Industrial concentration is measured using
concentration ratios.
The four-firm concentration ratio shows the
percentage of total sales revenue in a market
earned by the four largest business firms.
Concentration ratios overestimate
competition in localized markets and
underestimate it in global markets.

Concentration Ratios in Selected Canadian

Industries (1988)
Tobacco products
Petroleum and coal products
Transportation
Beverages
Metal mining
Paper and allied industries
Electrical products
Printing, publishing, and allied
industries
Food
Finance
Machinery
Retail trade
Clothing industries
Construction
Share of Industry Sales

by Four Largest
Businesses

98.9
74.5
68.5
59.2
58.9
38.9
32.1
25.7
19.6
16.4
11.3
9.7
6.6
2.2
Concentration in the Canadian Economy

(1999)
Share of Assets and Share of Revenues for
Enterprises with $75 million or More in
Revenues
Asset
Revenues
s
Foreign
26.2
Canadian
18.9
30.5
57.8
56.7
76.7

The Games People Play

(a)
Thomas Schelling applied game theory
principles to military strategy, showing how

the most effective deterrence during the
nuclear arms race between the US and the
Soviet Union was not first-strike capability, but
second-strike capability.
He explained this using the example of two
gunfighters in a threatened shootout, who

would both be loath to shoot if both were
assured of living long enough to shoot back
with unimpaired aim.
The Games People Play

(b)
Schelling also showed how, in many ordinary
social situations, a divergence between what

people are motivated to do individually and
what they would like to accomplish
collectively creates conditions for breaking the
laissez faire principle.
One example is the rationing of electricity
during summer shortages. In this case, rulesbased rationing makes more sense than merely
appealing to peoples civic virtue, says
Schelling.
Pumping up Price (OLC)

The Role of OPEC
The Organization of Petroleum Exporting
Countries is an example of a cartel that has

had some success in the past in influencing
the global price of oil.
During the 1970s, OPEC members used
market-sharing agreements to significantly
raise this price.


OPEC in the 1980s
In the 1980s, the oil price fell and OPECs
influence waned. This was due to:

a reduction in quantity demanded a delayed
reaction to the high prices of the 1970s

increases in quantity supplied by non-OPEC
producers
cheating by some OPEC members, who secretly
raised output to counteract reduced prices, and
thereby made the price reductions even greater


OPEC in the 1990s and 2000s
During the 1990s and the early 2000s,
despite continuing conflicts within OPEC, oil

prices were driven much higher, due to a
variety of factors, including political
considerations:
the Iraq War and its aftermath
tensions between the West and Iran

One for Another (OLC) (a)

The medieval philosopher Thomas Aquinas
provided a comprehensive world view that

included a treatment of economic issues.
He argued that lending for interest was unfair
to borrowers.
According to this view, interest payments bring
into question the stability of the monetary

system, since they seem to presume that
money necessarily depreciates in value.

One for Another (OLC) (b)

The condemnation of what was then called
usury was virtually impossible to enforce, with

interest being hidden by lenders in other
payments made by borrowers.
Aquinas extended Aristotles theory of
exchange by refining the notion of a just price.

Whereas Aristotle believed that selling for a
price higher than one paid was unethical,

Aquinas recognized traders deserved a return
that covered more than out-of-pocket costs.

One for Another (OLC) (c)

Aquinass followers gradually extended the idea
of the just price so that it came to be seen as

the value of an item that allowed producers to
maintain their customary position in society.
The notion of the just price is still used today,
for example in markets governed by price
controls.

Understanding Economics
6th edition
by Mark Lovewell
Chapter 6
The End

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Understanding Economics

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

A monopolists demand curve is the same as

Copyright 2012 by McGraw-Hill Ryerson

Demand Faced by a Monopolist

Demand Curve for Megacomp

Quantity (computers per year)

Copyright 2012 by McGraw-Hill Ryerson

Monopolistic Competitors Demand

A monopolistic competitors demand curve is

Copyright 2012 by McGraw-Hill Ryerson

Demand Faced by a Monopolist

Demand Schedule for

Price ($ per meal)

Quantity (meals per day)

Copyright 2012 by McGraw-Hill Ryerson

A business raising price finds rivals keep theirs

constant, so demand is relatively flat.

Copyright 2012 by McGraw-Hill Ryerson

Actions and Reactions among Rivals in an

Copyright 2012 by McGraw-Hill Ryerson

Demand Faced Among Rivals in an

Demand Curve for Centaur Cars

Price ($ thousands per car)

Quantity (thousands of cars per year)

Copyright 2012 by McGraw-Hill Ryerson

There are various ways that oligopolists can

Copyright 2012 by McGraw-Hill Ryerson

Revenue Conditions for a Monopolist

Copyright 2012 by McGraw-Hill Ryerson

Revenues for a Monopolist

$ Millions per Computer

Revenue Schedules for Megacomp

Copyright 2012 by McGraw-Hill Ryerson

Profit-Maximization for a Monopolist

Copyright 2012 by McGraw-Hill Ryerson

Profit Maximization for a Monopolist (b)

$ Millions per computer

Profit Maximization Table for Megacomp

Profit Maximization Graph for Megacomp

Profit = $60 million

Quantity of Computers per Year

A monopolist charges a higher price and a

Copyright 2012 by McGraw-Hill Ryerson

Monopoly versus Perfect Competition

Quantity of T-Shirts per Day

Copyright 2012 by McGraw-Hill Ryerson

Revenue Conditions for a

Copyright 2012 by McGraw-Hill Ryerson

Revenues for a Monopolistic

Revenue Curves for Jaded Palate

Quantity of Meals per Year

Profit-Maximization for a Monopolistic

Copyright 2012 by McGraw-Hill Ryerson

Profit-Maximization for a Monopolistic

In the long run, a monopolistic competitor

If profits (losses) are being made in the short

The business meets neither the minimum-cost

Profit Maximization for a Monopolistic

Long-Run Profit Maximization

Copyright 2012 by McGraw-Hill Ryerson

Revenue Conditions for an