Chapters 10

1
Chapters 10 11 Monopoly, Monopolistic
Competition, Game Theory
2
The Theory of Monopoly

• Examples
• AT T before 1980s
• Standard Oil Company in early 20th century
• Local telephone, cable and other public services
  before 1990s.
• Airlines that control a large number of flights
  from a hub?

• What does it take?
• One seller
• No close substitutes for the product
• Extremely high barriers to entry

3
To Understand Monopoly

• Monopolists set quantity and price
• Perfectly competitive firms can only set their
  own quantity.
• Market Demand curve reflects consumer decisions
  and willingness to pay.
• Monopolist can only react to it, and set its
  price and quantity to be on the demand curve.
• Perfectly competitive firms see only market P.
• Marginal Revenue ?TR/?Q ?(PQ)/?Q
• For Monopolist, marginal revenue is function of
  price and quantity (because a change in Q changes
  P)
• For perfectly competitive firm, marginal revenue
  is only price (because a change in Q cannot
  change P)

4
For a Monopolist Price Changes affect Quantity
5
For a MonopolistMR lies below the Demand Curve
6
For a MonopolistMaximizing profits means
producing the quantity of output at which MR
MC and charging the highest price per unit at
which this quantity of output can be sold.
7
Exhibit 6 Monopoly, Perfect Competition, and
Consumers Surplus
8
Monopoly and Price Discrimination

• Price Discrimination seller charges different
  prices for the product it sells, and the price
  differences do not reflect cost differences.
• Perfect Price Discrimination seller charges the
  highest price each consumer would be willing to
  pay for the product rather than go without it.
• Single Price Monopolist
• Does not discriminate prices, sells to everyone
  at the same (high) price.

9
Exhibit 9 Comparison of a Perfectly Competitive
Firm, Single-Price Monopolist, and Perfectly
Price-Discriminating Monopolist
10
Arguments Against Monopoly

• Deadweight Loss of Monopoly
• The net value of the difference between the
  monopoly quantity of output and the competitive
  quantity of output.
• The loss of not producing the competitive
  quantity of output.

11
Arguments Against Monopoly

• Rent Seeking Actions of individuals and groups
  who spend resources to influence public policy in
  the hope of redistributing income to themselves
  from others.
• X-Inefficiency the increase in costs and
  organizational slack in a monopoly resulting from
  the lack of competitive pressure to push costs
  down to the lowest possible level.

12
Monopolistic Competition

• Many sellers and buyers
• A slightly differentiated product
• Easy entry and exit.
• Examples Retail clothing, computer software,
  restaurants, etc.

13
The Nature of Monopolistic Competition

• Substitutes exist, but not perfect substitutes.
• PgtMC like a monopoly, unlike perfect competition
  where PMC.
• Demand curve is downward sloping, unlike perfect
  competition where it is horizontal.

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Exhibit 2 Monopolistic Competition in the Long
Run

• If economic profits are being earned, new firms
  will enter the industry.
• If economic losses are being incurred, firms will
  leave the industry.
• Economic profits will equal zero in the long run.

15
Oligopoly

• Few sellers and many buyers
• Products can be homogeneous or differentiated.
• Significant barriers to entry.
• Types
• Cartel
• Kinked Demand
• Price Leadership

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Cartel Theory

• Cartel Theory oligopolistic firms act as if
  there were only one firm in the industry.
• Cartel an organization of firms that reduces
  output and increases price in an effort to
  increase joint profits.
• Free Rider Each member has an incentive to be a
  free rider, to stand by and take a free ride from
  the actions of others.

17
OPEC

• Formed in Baghdad in 1960
• Embargoed US and Netherlands in 1973.
• Started to set production quotas in 1982
• Current members
• Algeria, Indonesia, Iran, Iraq, Kuwait, Libya,
  Nigeria, Qatar, Saudi Arabia, the United Arab
  Emirates, and Venezuela.
• Currently supply around 40 of world oil, have
  50 of world oil exports, and have around 67 of
  proven reserves.

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How Successful has OPEC been?

• Stated Goal is to maintain prices in the 22 -
  28 per barrel range
• Current price 54 per barrel
• Historically
• Oil Embargo in 1973 against US and Netherlands
• Not very successful because these countries could
  purchase oil at world prices elsewhere
• Gas lines caused by Nixon price ceilings
• Oil prices have declined in real terms

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Crude oil prices since 1861
BP Statistical Review of World Energy
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Problems with Enforcement (Generic for all
Cartels)

• Members have incentives to cheat
• Over-produce and sell illegally
• Shave prices
• New Entrants
• Higher prices in 1970s spurred investments in
  other places Gulf of Mexico, Alaska, North Sea
• Recent higher prices have spurred investments in
  Russia
• Higher prices also spur Technological Change
• Higher prices spur Substitution and Conservation

21
Price Leadership

• The dominant firm establishes price in accordance
  with its profit maximizing objectives.
• Other firms take this prices as given, and will
  equate price with their respective marginal
  costs.
• Other firms are price takers.