Revision: competition, monopoly, oligopoly

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Revisioncompetition, monopoly, oligopoly

• Unit 03

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Perfect competition

• A market is in perfect competition if every buyer
  and every seller is so small that he or she
  cannot influence prices
• and if goods are perfectly substitutes.
• If the price is given and invariable
• The total revenue increases as quantities
  increase
• The average revenue remains invariable
• The marginal revenue is invariable and equal to
  price.
• Goal of the firm maximising profits

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The profit is maximum when marginal revenue
marginal cost
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Profits and losses how to measure them Profit
total revenue total cost (RT CT ) or
average revenue average cost times the
quantity ( (RMe CMeT) ? Q ) P Rme ( (P
CMeT) ? Q ) Conversely Loss average cost
price times the quantity ( (CMeT P) ? Q ) The
quantity Q, respectively, maximises profit or
minimises loss.
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In the long run - entry when price is higher
than average total cost ( P gt CMeT ) - exit
when price is lower than average total cost ( P
lt CMeT )
The firm decides to enter the market only if
revenues cover all costs, including fixed ones
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- equilibrium when price average total cost
( P CMeT )
In the long run profits are equal to zero
P
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Monopoly

• Fundamental cause of monopoly entry barriers
• Entry barriers have three causes
• A key resource is possessed by a single firm
  resource monopoly
• States grant to a single firm the exclusive right
  to produce a good (patents, privatives) legal
  monopoly
• The structure of production costs makes a single
  firm more efficient than a multitude of small
  producers natural monopoly

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Natural monopoly the average total cost curve
continuously decreases instead of having the
usual U-form.

• Cases
• water distribution
• railway network

If production were divided among many firms, each
of them could produce a lesser quantity at higher
average total costs.
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A fundamental characteristic of a monopoly firm
is its capacity to influence market prices. Under
perfect competition the price is given. The
demand curve of a competitive firm corresponds to
a infinitesimal share of the market and is
perfectly elastic. That of the monopoly firm
coincides with the demand curve of the whole
market and is normally downwards sloping.
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The demand curve (reflecting buyers willingness
to pay) represents the only constraint to the
monopolists market power. If the monopolist
increases the price of his/her good, consumers
buy a lower quantity and vice versa if he or she
diminishes the price.
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Total, average and marginal revenues of a
monopolist
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Graphically
Average revenue Price Marginal revenue always
lower than average revenue
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Gola of the monopolisty firm is always profit
maximisation. The usual condition is RM CM.
NB P gt RM Under competition, on the
contrary P RM
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The monopolists profit is always RT CT or P
CMeT ? Q.
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Do monopolies diminish social welfare? Economists
answer in the affirmative monopolies entail a
deadweight loss for consumers.
The demand curve reflects willingness to pay The
monopolists marginal cost curve reflects his/her
costs. The socially efficient quantity
corresponds to the intersection between the
marginal cost curve and the demand curve
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As the monopoly firm maximises profits when RM
CM, it produces a lower quantity than the
socially efficient one.
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Observe the triangle above the price line it is
the consumer surplus when the price is unique.
The triangles A and B represent the deadweight
loss. A is the consumers loss of surplus, and B
is the producers loss of surplus (more than
compensated by the monopoly profits represented
by the rectangle C)
C
A
B
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Let us suppose that the monopolist manages to
apply different prices to different groups of
customers small purchases, normal purchases,
Large purchases price discrimination Effect 1.
The surplus of small buyers is reduced, the
monopolists Profit increases
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Let us suppose that the monopolist manages to
apply different prices to different groups of
customers small purchases, normal purchases,
Large purchases price discrimination Effect 2.
Buyers that formerly renounced to buy large
quantities Now decide to buy them. The deadweight
loss is diminished The monopolists profits
increase. Social welfare increases!
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Limit case if the monopolist manages to invent a
continuous series of classes on which to apply
price discrimination, we attain a total
elimination of the consumer surplus and of
deadwieght loss and the monopolist transforms
into profit the whole area above the Average
cost curve and below the demand curve. ?Perfect
price discrimination
NB. Social welfare is maximum!!!
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Oligopoly
An oligopoly market is a market in which there
are a few firms, each exerting, by its choices, a
considerable influence on the profits of other
firms. Oligopoly is a kind of imperfect
competition, in which a few firms sell similar
products (oil, tennis balls) It is different
from monopoly competition, in which many firms
sell similar although non identical products
(CDs, videogames).
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If oligopoly firms cooperate, they act like a
monopoly firm and share profits. Very often,
however oligopoly firms are forced to compete
among them. In this case they adopt a strategic
behaviour they make their choice according to
the choices of competitors, in order to increase
their share of the market. But this generates
negative effects for all competitors (reduction
of profits). The game theory studies the
strategic behaviour of oligopoly firms.
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Example of non cooperative game prisoners
dilemma. Let us suppose that Bonnie e Clyde are
arrested. At the moment of arrest they have on
them illegal arms. The punishment for this crime
is 1 year of imprisonment. They are interrogated
in different rooms at the same time. The
magistrate proposes to each of them the same
deal if he or she confesses and denounces her or
his accomplice, the illegal possession of
firearms will be remitted and he or she will be
liberated. The accomplice will be condemned to 20
years of imprisonment. If both confess, the
punishment will be 8 years (partial remittance
for confessing).
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The following is the matrix of payoffs
The strategy consisting in confessing is called
dominant strategy. It is advantageous for both,
ignoring the choice of the accomplice. If they
could communicate, the would cooperate and choose
not to confess..
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Another example oil producing countries
This example shows that oligopoly companies have
an interest in making secret (trusts) or
explicit (cartels) agreements, in order to
cooperate and keep high profits. An example is
OPEC.