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
200
Quantity a
Price Demanded 160
Price ($ millions
b
per computer)
120
($ millions per (computers
computer) per year) 80
c
$160 1 40 D
120 2
80 3
0 1 2 3 4
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
12
Quantity
10
Price Demanded
Price ($ per meal)

8 D
($ per meal) (meals per 6
day)
4
$11 100 2
10 200
9 300 0 100 200 300 400
8 400
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
Probable Effect on Company As

Action of Response of Company As Quantity
Company A Competitors Market Share Demanded
raise price keep prices product now large increase

constant high-priced, so as market share
market share lost to
falls competitors
lower price match price
drop since all small increase
companies as lower prices
selling at lower for all
price, Company companies
As market share attract new
stays constant buyers

Demand Faced Among Rivals in an
Oligopoly
Demand Curve for Centaur Cars

Demand Schedule
For Centaur Cars
40
Price ($ thousands per car)

Quantity
Price Demanded 30
($ thousands (thousands 20
per car) of cars per year)
10 D
$35 10
30 20
20 25 0 10 30
20
10 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
Revenue Schedules for Megacomp
200
$ Millions per Computer

Price Quantity Total Marginal Average 160
(P) (Q) Revenue Revenue Revenue
(TR) (MR) (AR) 120
(P x Q) (TR/Q) (TR/Q)
($ ($ millions ($ millions 80
millions (computer per per
per s per ($ millions) computer) computer) 40
computer year) D=AR
0 $ 0 0
) $160
$160 1 160 $160/1 = 1 2 3 4
80 -40
120 2 240 160
0
80 3 240 240/2 = 120 -80
-80 MR
40 4 160 240/3 = 80
160/4 = 40 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)
Figure 6.6, Page 150 Profit Maximization Table for Megacomp

Price Quantity Total Marginal Marginal Cost Average Cost
(P) (Q) Revenue Revenue (MC) (AC)
(AR) (TR) (MR)
($ millions (computer (P x Q) (TR/Q) ($ millions per($ millions per
per s per ($ millions per computer) computer)
computer) year) ($ millions) computer)
0 $ 0
$160 $ 60
$160 1 160 $140
80 40
120 2 240 90
0 70
80 3 240 83
-80 150
40 4 160 100
Profit Maximization Graph for Megacomp

$ Millions per computer
200
MC
160
b
12
Profit = $60 million AC
09
80 c
0
40 D
a
MR
0 1 2 3 4
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
S(=MC)
c
7
$ per T-Shirt
4 a
b
MR D
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 Quantity Total Marginal Average
(P) (Q) Revenue Revenue Revenue
($ meal) (meals per (TR) (MR) (AR)
day) (P x Q) (TR/Q) TR/Q)
$-- 0 $ 0
1100/100 = $11
11 100 1100 1100/100 = $11
900/100 = 9
10 200 2000 2000/200 = 10
700/100 = 7
9 300 2700 2700/300 = 9
500/100 = 5
8 400 3200 3200/400 = 8
Revenue Curves for Jaded Palate
12
10
$ per Meal
8 D=
AR
6
4 MR
0 100 200 300 400

Quantity of Meals per Year

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 profit-

maximizing 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 Long-Run Profit Maximization

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

40
Price Quantity Total Marginal Marginal Average b MC
(P) (Q) Revenue Revenue Cost Cost 30 AC
$ Thousands per car

(=AR) (TR) (MR) (MC) (AC) Profit = $200 million
(P x Q) (TR/Q) 20
c
($ thousands (thousands ($ ($ ($ 10
Per car) of cars per ($ thousands thousands thousands a D
year) millions) per car) per car) per car) 0
10 20 30
-- 0 0 -10
35 15 30
$35 10 35 -20
25 10 20
30 20 0 -30
- 15 19
20 25 60
20 25 20 -40
10 30 0 MR
-
50
40 Quantity (thousands of cars per year)
0
30
0

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
Paul: 5 Paul: 10
Peters Strategies
Confess
Peter: 5 Peter: 0
Dont Confess
Paul: 0 Paul: 1
Peter: 10 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 Dont Cheat Cheat

Gammas Strategies
D: $20 m. D: 25 m.
G: $20 m. G: $10 m.
D: $10 m. D: 15 m.
Cheat
G: $25 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)
Share of Industry Sales
by Four Largest
Businesses
Tobacco products
Petroleum and coal products 98.9
Transportation 74.5
Beverages 68.5
Metal mining 59.2
Paper and allied industries 58.9
Electrical products 38.9
Printing, publishing, and allied 32.1
industries 25.7
Food 19.6
Finance 16.4
Machinery 11.3
Retail trade 9.7
Clothing industries 6.6
Construction 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, rules-
based 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

ECON 300 PPT CH - 06

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Understanding Economics

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Demand Curve for Megacomp

Quantity (computers per year)

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Demand Curve for Jaded Palate

Price ($ per meal)

Copyright 2012 by McGraw-Hill Ryerson

rivalry face a kinked demand curve.

Copyright 2012 by McGraw-Hill Ryerson

Probable Effect on Company As

raise price keep prices product now large increase

Copyright 2012 by McGraw-Hill Ryerson

Demand Curve for Centaur Cars

Price ($ thousands per car)

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

demand curve because demand (average

Copyright 2012 by McGraw-Hill Ryerson

$ Millions per Computer

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pricing nor the marginal-cost pricing

Copyright 2012 by McGraw-Hill Ryerson

Figure 6.6, Page 150 Profit Maximization Table for Megacomp

Profit Maximization Graph for Megacomp

Copyright 2012 by McGraw-Hill Ryerson

average-cost pricing in an effort to make

Copyright 2012 by McGraw-Hill Ryerson

Quantity of T-Shirts per Day

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is below its demand curve because demand

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Revenue Curves for Jaded Palate

0 100 200 300 400

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may make a profit or a loss at its profit-

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Copyright 2012 by McGraw-Hill Ryerson

Short-Run Profit Maximization Long-Run Profit Maximization

Quantity of Meals per Day Quantity of Meals per Day

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two linear segments which are below its

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pricing nor the marginal-cost pricing rules.

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Profit Maximization Table for Centaur Cars

$ Thousands per car

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Copyright 2012 by McGraw-Hill Ryerson

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Confess Dont Confess

Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

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Dont Cheat Dont Cheat Cheat

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Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson