ECON1101 Lecture Notes - Lecture 3: Market Power, Imperfect Competition, Strategic Dominance
Part III Iperfectly Copetitive Markers
7.0 Market Power: Monopoly
Key Definitions
market power: a firm has market power if it has the ability to set its own price
imperfectly competitive market: is a market where that at least one of the characteristics of
a perfectly competitive market fails to be satisfied
• firms with market power are said to be price-makers (instead of price-takers perfectly
competitive markets
o have the ability to set their own prices
o when they increase their price they wont lose all their customers
o now the demand curve is downward sloping
• there are three main forms of imperfectly competitive markets
1. Monopoly: there is only one firm in the market, hee the fir’s idiidual dead
curve replicates the market demand curve.
2. Monopolistic competition: a large number of firms, each producing a slightly
differentiated product, provides a measure of market power as no exact substitutes
3. Oligopolistic competition: there is a small number of firms that sell goods that are
close substitutes
7.1 Determinates of Market Power
• The invisible hand principle – whenever firms make profits, some new firms will be willing to
enter the market and commence production of the same good, and this will continue until
the firms in market make $0 = no power
• If ability to enter the market is hindered, market power is created
• Major barriers to entry
1. Control over scarce resources: if a firm has exclusive control over some key inputs
of production, can be impossible for firms to enter the market
2. Government-created barriers to entry: done so by issuing patents, offering
copyright protection and granting licenses
3. Increasing return to scale: (economics of scale) when the average total cost of
producing a certain good decreases with the amount of the good produced. This
allows larger firms to be more efficient and can offer a lower price making it hard for
smaller firms to compete
4. Network economics: eerge he the ustoer’s satisfaction with a given product
increases with the number of uses e.g. Facebook, power companies
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7.2 Monopoly
• The costs and production decisions for a perfectly competitive firm also applies to a
monopoly
• However!
o A perfectly competitive firm faces a horizontal demand curve (it can sell any
number of units at the market price)
o this entails that the marginal revenue is constant and equal to the market price
o the demand curve for a monopolist is unlikely to be horizontal and thus does not
have a consistent marginal revenue
o the monopolist needs to reduce the price in order to increase the quantity sold
• marginal revenue = ∆R/∆Q
• to deterie the uer of uits that aiize the oopolist’s profit: epad production
until the marginal revenue equals the marginal cost
7.3 Monopoly and the Invisible Hand
• to deterie hether the oopolist’s produtio deisio optial for soiet, look at
what happens if the monopolist hired an extra worker
o quantity then produced would be 800
o the marginal benefit =$0.25
o marginal cost =$0.05
o clearly the marginal benefit is greater than the marginal cost, so by hiring the 4th
worker it increases production from 600-800 increasing total surplus
o the consumers clearly gain from having more goods in the market, but the
monopolist is worse off as the profit is lower
• conflict exists because in order to sell extra units, the monopolist needs to reduce the price
and hence their profit is decreased
• hence there is an implicit cost in increasing the quantity sold, and this leads to an
equilibrium production level lower than the socially optimal one
• the socially optimal level of production occurs when the marginal benefit = marginal cost,
i.e. 5 workers
• THUS when the monopolist maximizes their profits the result is not socially optimal
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find more resources at oneclass.com
7.4 Government Regulation
Key Definitions
• Allocatively inefficient: a fir’s output is said to e Alloatiel Ieffiiet if the prie asked
for the goods produced exceeds their marginal cost
• Competition law: competition law denotes laws intended to foster market competition by
regulating the anti-competitive conduct of firms
• To solve these inefficiencies, stimulate competition by encouraging new firms to enter the
market governments achieving this by establishing competition laws, that intended to
foster competition by regulating anti-competitive conduct by firms
• In a natural monopoly (with increasing return to scale) the gov. intervention might create its
own inefficiencies
• Therefore gov. often regulates the price at which the monopolist is allowed to sell it
products – average cost pricing, which eliminates any positive profit accrued to the
monopolist
o Gov. sets the price and quantity at the intersection for the average total cost curve
and demand curve
o However, ACP is hard to implement because
▪ Government does not know the ATC, it can only estimate
▪ Once this policy is in place, firms have no incentive to invest in new
technology to lower their production costs
▪ Whe ipleeted the fir’s output is Alloatiely inefficient, as price
usually exceeds the marginal cost, the government could set a price celling
equal to the marginal cost – forcing the monopolist to sell its product at the
marginal cost
7.5 First Degree Price Discrimination
• First price discrimination: describes a situation in which the monopolist knows the
reservation price of each consumer and is able to charge each consumer his marginal benefit
(or reservation price)
• assume that the monopolist knows the maximum price that every consumer is willing to pay
and can charge each consumer exactly their reservation price first degree price
discrimination
o given that the monopolist can charge each market a different price, can create a
balance to receive maximum profit
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