1ECON1010
Introductory Microeconomics
LECTURE 8
Monopoly and Imperfect Competition
2Q1. A firm in a perfectly competitive industry is earning an
economic profit. An economist would predict that over
time:
a. Market supply will decrease
2
b. Market demand will increase
c. The market price will decrease
d. Firms will continue to make economic profits
e. The market price will rise
Last lecture feedback
3Q2. If buyers and sellers are free to pursue their own
selfish interests, according to the invisible hand theory, the
result would be:
a. exploitation of workers and natural resources
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b. an inequitable allocation of resources
c. poor services for consumers
d. an efficient allocation of resources
e. no one being able to see what is happening in society
Last lecture feedback
4At the midway point of the course, it might be
worth reflecting on the following.
1. Are you consistently devoting 10 hours per
week to ECON1010?
2. Are you regularly reading the textbook,
attending tutorial, PASS, consultation sessions?
3. Remember, UQ has very clear policies when it
comes to assessment and passing grades, so
work toward hitting your target.
4
5Plan of Lecture 8.
Part 1
A focus on monopolies, monopoly power, and
how economic theory guides government
responses toward monopolies.
Lecture 8 ECON1010 5
Part 2
Monopolistic competition.
6Demand for Perfectly and Imperfectly
Competitive Firms
0
Quantity
(units)
Price
($/unit)
Perfectly Competitive
Monopolistic
Monopoly
Oligopoly
The more inelastic is demand,
the more pricing power the firm
has and more market power.
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Perfectly Competitive Firm.
▪ demand is perfectly elastic (horizontal).
▪ is a price taker, maximising profit where
quantity exists so that P = MC.
Imperfectly Competitive Firm.
▪ faces a downward sloping demand curve.
▪ is a price maker, maximising profit at a
specific output quantity (not just selling
whatever it likes and charging any price!)
8Lecture 8 ECON1010 8
Lecture Overview:
1. Definition and features of a monopoly.
2. Reasons why monopolies exist.
3. How a monopoly sets price and output.
4. Impacts a monopoly has on economic surplus.
5. Government policies to deal with monopolies.
6. The role of the ACCC.
7. Monopolistic competition.
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1. Definition and Features of a (Pure) Monopoly.
Defintion:
▪ a firm that is the only seller of a product or
service.
▪ it has no close substitutes.
▪ the monopoly (firm) supply is the market
supply.
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10
Examples of a Monopoly.
a. Consider a small outback Australian town,
where there is only one lawyer.
- there is no one else qualified to sign off legal
documents.
b. Power transmission lines (spatial monopoly)
- an electricity generator does not own the
power lines, but needs to transmit electricity.
If only one owner of power lines = monopoly.
c. Others?
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2. Why Monopolies Exist.
i). Entry into the industry is deliberately
blocked (barriers to entry) allowing only one
firm to supply the market.
▪ by governments granting a patent or copyright
to a firm for the supply of its products (eg:
manufacturing drugs).
▪ by governments designating only ONE company
as a supplier of services to customers (eg: supply
of electricity, gas, or water, Australia Post).
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Why Monopolies Exist.
ii). Control over key raw material resources
to produce a product.
▪ A company owning 40% of the world’s
uranium deposits, as well as large amounts of
the world’s other key minerals (iron ore, zinc)
▪ A quarry owner in the middle of a city
supplying aggregate to concrete suppliers for
high rise construction in the CBD.
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Why Monopolies Exist.
iii) Network externalities
= a product’s usefulness increases as
more consumers adopt it and use it.
▪ Microsoft Windows (95% market share in
personal computers), large take up so others
adopt it in writing software.
▪ eBay and online auctions. Consumers expect
many items for sale, attracts more consumers.
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Why Monopolies Exist.
iv) Economies of Scale (will reduce ATC)
▪ Scale is referring to how large, how big.
▪ The larger a firm’s production process
becomes, the more inputs it needs. The
firm can “buy in bulk”, use better.
technology and more efficient processes.
▪ Double the input results is more than
double the output increasing returns
to scale = economies of scale.
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Possible Threats to any Monopoly’s Existence.
a. Changes to government legislation (law) to
break a monopolies control and power over
consumers.
b. The rise of potential competitors who have
large amounts of cash, with possibly new
improved technologies desired by consumers
(evolution of markets).
c. Economic profits just so high that new
entrants are attracted. eg: Richard Branson
and space tourists.
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Book your place in space now!!
Tickets cost $200,000 and
deposits start from $20,000.
http://www.virgingalactic.com/booking/
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3. How a Monopoly Maximises Profit.
Recall: A competitive firm is a price taker.
ie: the market dictates the price, and the firm
then supplies a quantity up until the point
where Price = MC to maximise profits.
A monopoly firm is a price maker.
ie: the firm decides what quantity it should
supply in order to maximise the firm’s profits.
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Profit = Revenue – Total Cost [all are f(Q)]
= –
= 0 to maximise profit
=
MR = MC
How does a Monopoly Maximises Profit?
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Continue to produce output up until where:
How does a Monopoly Maximises Profit?
Marginal Revenue = Marginal Cost
MR = MC
where
MR =
This will give the profit maximising output quantity.
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For a monopoly, demand is downward sloping.
WHY??
MR for a Monopoly.
Revenue ($) = P*Q
= (-mQ + c) * Q
= -mQ2 + cQ (parabolic revenue curve)
= -2mQ + c (slope of MR line is -2m,
= MR ie: twice the slope of the
demand curve)
Assuming linear demand,
P = -mQ + c (slope = -m)
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Lecture 8 ECON1010 21
Example:
Consider a single qualified lawyer is available to
offer legal advice to clients in a small outback
country town. There are no other lawyers within
300km of this town.
The lawyer uses the following schedule of fees to
charge clients. It varies depending on the number
of clients seen per day.
MR for a Monopoly.
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Price
($/client)
Quantity
(clients)
Revenue
($)
MR
($/client)
200 0 0 -
180 1 180 180
160 2 320 140
140 3 420 100
120 4 480 60
100 5 500 20
80 6 480 -20
Country Lawyer’s Fee Schedule.
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The slope of the demand and MR curves
(refer to this approach as the ‘typical method’)
-50
0
50
100
150
200
0 1 2 3 4 5 6 7P
ri
ce
,
M
R

($
/
cl
ie
n
t)
Quantity (clients)
11
2040
Demand
Marginal
Revenue
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Lecture 8 ECON1010 24
A Profit Maximising Monopoly.
▪ Taking the ATC curve for a monopoly as U-
shaped and demand linear, MC should cut
ATC at its minimum.
▪ The profit maximising output quantity can be
found where MR and MC intersect.
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Steps to find the Maximum Monopoly Profit
1. Plot the demand, MR, ATC, and MC curves
on the one graph.
2. Find where MR = MC, and determine the
profit maximising output.
3. Find the ATC for this output level.
4. Use the demand curve to find the price to
charge for this level of output.
5. Profit = P*Q – ATC *Q
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-50
0
50
100
150
200
250
300
0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/c
li
en
t)
Quantity (clients)
Monopoly Profit Maximising Condition
ATC
(assumed)
MR
Demand
MC
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-50
0
50
100
150
200
250
300
0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/c
li
en
t)
Quantity (clients)
Monopoly Profit Maximising Condition
ATC
(assumed)
MR
Demand
MC
Price = 130
MC = MR = 80
ATC = 30
Qprofit max
= 3.5
MR = MC
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-50
0
50
100
150
200
250
300
0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/c
li
en
t)
Quantity (clients)
Monopoly Profit Maximising Condition
ATC
(assumed)
MR
Demand
MC
Price = 130
ATC = 30
Qprofit max
= 3.5
MR = MC
Maximum Profit
= (130-30)*3.5
= $350
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-50
0
50
100
150
200
250
300
0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/c
li
en
t)
Quantity (clients)
Case where MR > MC for a given output
ATC
(assumed)
MR
Demand
MC
Price = 160
ATC = 50
Q
(increase output)
Profit
= (160-50)*2
= $220
30
-50
0
50
100
150
200
250
300
0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/c
li
en
t)
Quantity (clients)
Case where MR < MC (for a given output)
ATC
(assumed)
MR
Demand
MC
Price = 120
ATC = 50
Q
Cut back output
to maximise profit
Profit
= (120-50)*4 = $280
(decrease output)
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-50
0
50
100
150
200
250
300
0 1 2 3 4 5 6 7P
ri
ce
,
M
R
,
M
C
, A
T
C
(
S
/c
li
en
t)
Quantity (clients)
Case where MR > MC
(for a given output)
ATC
MR
Demand
MC
Price = 140
ATC = 25
Q
Increase output
to maximise profit
Profit = (140-25)*3
= $345
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-50
0
50
100
150
200
250
300
0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/c
li
en
t)
Quantity (clients)
Monopoly Profit Maximising Condition
ATC
(assumed)
MR
Demand
MC
Price = 130
ATC = 30
Qprofit max
= 3.5
MR = MC
Maximum Profit
= (130-30)*3.5
= $350
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Lecture 8 ECON1010 33
What to do if MR > MC or MR < MC.
Summary:
1. When MR > MC for a given level of
output, the firm should INCREASE output
to maximise profit.
2. When MR < MC for a given level of
output, the firm should DECREASE output
to maximise profits.
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4. Impacts of Monopoly on Economic Surplus.
▪ The abilility to exert market power (how high price
can be set price above MC for a given output
quantity) dictates the extent of any dead weight loss.
▪ Only in perfectly competitive markets, will there be
no loss of economic efficiency.
▪ In reality, few markets are perfectly competitive, and
the MR curve is downward sloping.
▪ When MR=MC, there will always be some dead
weight loss. The closer the price is to MC, the
smaller the dead weight loss and inefficiency.
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$$$$
Economic Surplus in a competitive Market
Quantity
(units)
Price
($/unit)
Market
clearing
price
Supply
Demand
Total economic surplus =
total consumer surplus + total producer surplus
(maximised in competitive markets)
0
$$$$
Market clearing quantity
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Lecture 8 ECON1010 36
Impacts of Market (Pricing) Power.
Definition:
A firm that profit maximises, at an output
quantity where price is much larger that MC,
is said to have Market Power.
For a single supplier, the higher the price is
able to be set above MC, the more monopoly
power.
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Dead weight loss from Monopolies
Quantity
(units)
MC = Supply
Demand
Dead weight loss from monopoly = B + C,
compared to competitive market, with A
transferred from consumers to monopoly.
0
Price, MR, MC
($/unit)
MR
B
MR = MC
Qprofit max
C
Qcompetitive
A
PMonopoly
PCompetitive
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4. Impacts of Monopoly on Economic Surplus.
Output is less than would otherwise be the case
in a competitive market, with price higher.
Monopoly transfers consumer surplus (in a
competitive market) to producer surplus.
A dead weight loss results compared to the
competitive outcome.
Economic inefficiency with a reduction in the
efficient allocation of resources.
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Lecture 8 ECON1010 39
Discussion:
Fact: Research and developments into
new products, and technological advances,
all take money.
To what extent should society allow a
firm to exercise “monopoly power” so
they can benefit from their investments?
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Lecture 8 ECON1010 40
5. Government Policies to deal with Monopolies.
▪ Monopolies produce economic inefficiencies.
Governments aim to improve economic efficiency
using regulations.
▪ Regulators aim to monitor prices set by
monopolies to more closely reflect a competitive
outcome.
▪ Not only through price regulation, governments can
also dictate the quantity to be supplied by
monopoly, as well as the timing/amount of any new
investments.
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Lecture 8 ECON1010 41
Government Regulations applied to Monopolies.
1. Structural Changes applied to Monopolies
Over the last 20 years or so:
▪ Break up of division within a firm. eg: Telstra and
proposed breakup (wholesale and retail), early 2000
saw Microsoft being threatened to be broken up.
2. Removal of Government owned Monopolies
▪ Privatisation and corporatisation eg: Telstra,
Qantas, CBA, Queensland Rail in proposed sale.
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Australian and Consumer Competition Commission
(ACCC) = a “watch dog” type organisation to monitor
competitive behaviour of firms, and to focus on:
i) promoting competition, openness and efficiency in the
Australian economy.
ii) prosecuting firms who breach the Australian Consumer
Law 2011 and who engage in anti-competitive and
illegal behaviour (price fixing, collusion, cartels).
iii) assessing mergers or takeovers for any substantial
lessening of competition.
6. The role of the ACCC. www.accc.gov.au
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Monopolistic Competition
Features:
Very similar to perfectly competitive markets:
1. A larger number of similar firms exist.
2. Many close substitutes exist.
3. Few barriers to entry into the industry.
But an important difference = products/services
can be slightly differentiated (ie: not identical)
giving the firm some pricing power (downward
sloping demand).
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Lecture 8 ECON1010 44
Monopolistic Competition – a common
market structure for consumers in an economy.
Many examples
1. Hair salons
2. Coffee shops
3. Restaurants
4. Men’s and women’s clothing
5. Furniture stores
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Monopolistic Competition - Differentiation the key
▪ some differentiation of product for the firm is
possible, allowing the firm some pricing
power so the demand curve for the firm is
slightly downward sloping.
▪ the demand curve for the firm is slightly
downward sloping, since a price increase of
its product causes a decrease in the quantity
demanded by customers. MR will also be
downward sloping.
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Lecture 9 ECON1010 46
Monopolistic Competition
Example: Sushi Roll business
The scenario:
1. After returning to Brisbane from holidays in
Japan, you feel there is an opportunity to sell
Sushi rolls in the city.
2. There a no other shops selling sushi rolls in
Brisbane at that time.
3. You open for business and set a price for the
sushi rolls that allow you to more than cover all
costs, including the opportunity cost.
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Example: Sushi Roll business
Short run outcome
0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/r
o
ll
)
Quantity (sushi rolls)
MC
ATC
Demand
MR
Qprofit max
Economic profit
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Lecture 9 ECON1010 48
Initially, in the short run:
▪ a downward sloping demand curve as there
are many other substitutes (take-aways)
▪ few other “sushi roll” business owners
▪ positive economic profits
▪ An ability to have some control over pricing
with customers happy to pay “a little extra”
for the added value of your product.
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Business is great for the first couple of years,
with much higher returns on investment than
expected. After about 5 years however, there
are several sushi bars operating in the city.
You’ve tried to reinvest some of the previous
profits to buy better machines, as well as try to
cut costs, yet profits have declined year after
year. Soon, things are looking tight.
Monopolistic Competition
Example: Sushi Roll business (scenario continues)
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0 1 2 3 4 5 6 7
P
ri
ce
,
M
R
,
M
C
, A
T
C
(
$
/r
o
ll
)
Quantity (sushi rolls)
MC
ATC
MR
P = ATC
Example: Sushi Roll business
Long run (no economic profit)
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Lecture 9 ECON1010 51
In the long run, (when everything can change)
▪ Firms enter and exit the industry until only
normal profits remain.
▪ Monopolisitc competition competes
economic profits away.
▪ a constant battle to survive using innovation
and differentiation to meet customer needs.
▪ providing value to the consumer
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Conclusions.
▪ From economist’s view, the existence of a single
supplier in the market (monopoly) results in an
inefficient allocation of resources (dead weight losses).
▪ From a firm’s perspective, resources satisfying
opportunities to develop market power, earn
economic profits, and increase a firm’s value.
▪ From a government’s view, firms are encouraged to
innovate to benefit society, but government regulation
is used to limit the extent of the firm’s profits.
52Lecture 8 ECON1010
53
Next Lecture
▪ Lecture 9.
Price Discrimination
Imperfect competition – thinking strategically.
Lecture 8 ECON1010 53