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Imperfect Competition and Monopoly

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  1. Study Guide (Course-wide Content)

A. Patterns of Imperfect Competition
  1. Most market structures today fall somewhere on a spectrum between perfect competition and pure monopoly. Under imperfect competition, a firm has some control over its price, a fact seen as a downward-sloping demand curve for the firm's output.

  2. Important kinds of market structures are (a) monopoly, where a single firm produces all the output in a given industry; (b) oligopoly, where a few sellers of a similar or differentiated product supply the industry; (c) monopolistic competition, where a large number of small firms supply related but somewhat differentiated products; and (d) perfect competition, where a large number of small firms supply an identical product. In the first three cases, firms in the industry face downward-sloping demand curves.

  3. Economies of scale, or decreasing average costs, are the major source of imperfect competition. When firms can lower costs by expanding their output, perfect competition is destroyed because a few companies can produce the industry's output most efficiently. When the minimum efficient size of plants is large relative to the national or regional market, cost conditions produce imperfect competition.

  4. In addition to declining costs, other forces leading to imperfect competition are barriers to entry in the form of legal restrictions (such as patents or government regulation), high entry costs, advertising, and product differentiation.

B. Monopoly Behavior
  1. We can easily derive a firm's total revenue curve from its demand curve. From the schedule or curve of total revenue, we can then derive marginal revenue, which denotes the change in revenue resulting from an additional unit of sales. For the imperfect competitor, marginal revenue is less than price because of the lost revenue on all previous units of output that will result when the firm is forced to drop its price in order to sell an extra unit of output. That is, with demand sloping downward, P = AR > MR = P − lost revenue on all previous q

  2. Recall Table 9-4's rules relating demand elasticity, price and quantity, total revenue, and marginal revenue.

  3. A monopolist will find its maximum-profit position where MR = MC, that is, where the last unit it sells brings in extra revenue just equal to its extra cost. This same MR = MC result can be shown graphically by the intersection of the MR and MC curves or by the equality of the slopes of the total revenue and total cost curves. In any case, marginal revenue = marginal cost must always hold at the equilibrium position of maximum profit.

  4. For perfect competitors, marginal revenue equals price. Therefore, the profit-maximizing output for a perfect competitor comes where MC = P.

  5. Economic reasoning leads to the important marginal principle. In making decisions, count marginal future advantages and disadvantages, and disregard sunk costs that have already been paid. Be wary of loss aversion.

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