ECON1101: Microeconomics 1

Chapter 10: Imperfect

competition
Perfectly competitive market
A perfectly competitive market is a market in which firms cannot influence
the price.

Price taker
A price taker is a firm that cannot influence the price.

Imperfectly competitive market

An imperfectly competitive market is a market in which firms have at least
some ability to set their own price.

Price setter
A price setter is a firm that has the ability to raise the price of a good
without losing all its sales.

Market power
Market power is a firms ability to raise the price of a good without losing
all its sales.

Forms of imperfect competition

1. A pure monopoly is a market in which a single firm is the only supplier of
a product for which there are no close substitutes (e.g. Australia Post is a
monopolist in the market for the delivery of standard letters).
2. An oligopoly is a market in which only a few rival firms dominate sales of
a product, which may be identical or different (e.g. banks, groceries).
3. Monopolistic competition is a market in which a large number of firms
produce slightly different products that are reasonably close substitutes
for one another (e.g. petrol stations sell the petrol but have different
locations and services).

Demand curves
Perfectly competitive firms have a perfectly elastic demand curve at the market
price.
Imperfectly competitive firms have a downward-sloping demand curve. A
monopolists demand curve will be the same as the market demand curve.

Barriers to entry
A barrier to entry is any force that prevents firms from entering a new market.
The most enduring barriers to entry are economies of scale and network
economies.
1. Exclusive control over important inputs (e.g. Chinese control over
global rare-earth metals gives it an advantage in high-tech manufacturing)
2. Government-created monopolies (e.g. patents, copyrights, gambling
licenses)
3. Economies of scale

A production process has constant returns to scale if, when all

inputs are changed by a given proportion, output changes by the
same proportion.

A production process has increasing returns to scale (or economies

of scale) if, when all inputs are changed by a given proportion,
output changes by more than that proportion.

A natural monopoly is a monopoly that results from economies of

scale because a single firm can serve the entire market at a lower
cost than can more firms.

4. Network economies occur when a products quality increases as the

number of users increases (e.g. Facebook users)

Economies of scale and fixed costs

Economies of scale occur when fixed costs are relatively larger than marginal
costs because increasing output decreases average total costs (e.g. in research,
design, engineering).

TC ( total cost ) =F ( cost ) + MQ ( marginal cost quantity )

ATC=

F
+M
Q

Marginal revenue
Marginal revenue (MR) is the change in a firms total revenue that results
from a one-unit change in output.

MR is below the market price

For a price setter who must sell all output at a single price, MR is always
below the demand curve (the market price) because output can only rise if
the price falls for all buyers (both existing and marginal buyers).

MR maximisation
The MR curve cuts the x-axis at the middle of the demand curve because
revenue is maximised when demand is unit price-elastic (at the midpoint).

Monopoly
Profit maximisation
A monopolist maximises profit when marginal revenue equals marginal
cost. This is not socially-optimal and there is deadweight loss because
marginal cost does not equal societys total marginal benefit (the demand
curve).

Calculating profit

Revenue=P Q

Total cost ( TC ) =ATC Q

Profit=[ ( P Q )( ATC Q ) ]=[ Q ( P ATC ) ]

Short-run shutdown rule

A monopolist should shutdown in the short-run and produce nothing if the
price is always below the AVC curve.

P< AVC (for all real Q)

Long-run shutdown rule

A monopolist should leave a market in the long-run if there are economic
losses.

Economic profit can persist

Whereas perfectly competitive firms tend to earn zero economic profit, a
monopolists economic profit can persist because firms will not enter the
market and drive the price down.

Monopolistic competition
Monopolistic competition has price setters but there are no barriers to entry.

How is monopolistic competition similar to a monopoly?

They both have a downward-sloping demand curves because they are

price setters.
Their MC curves are below their demand curve because they must charge
one price for all buyers.

How is monopolistic competition similar to perfect

competition?

They tend to earn zero economic profit because firms can freely enter and
exit the market, and shift the demand and MR curves.

How is monopolistic competition different from perfect

competition?

Monopolistic competition has excess capacity because output is less than

when ATC is minimised.
Monopolistic competition sets a price above MC because it is a price
setter.
Monopolistic competition produces slightly different products. Thus,
markets may put up with the inefficiency for the variety of products.
While perfectly competitive firms only choose the quantity supplied,
monopolistically competitive firms try to differentiate their products and
develop an advantage over others.

Oligopoly
Oligopolies have highly interdependent firms which use modern game theory
when making economic decisions.

Price discrimination
Price discrimination occurs when price setters charge different buyers
different prices for the same good or service, where differences do not reflect
differences in costs of supplying different buyers (e.g. concession discounts,
rebates, volume-based discounts).

Perfectly discriminating firm

A perfectly discriminating firm is a firm that charges each buyer their
reservation price. It makes the MR and demand curves the same; it
maximises total economic surplus (although all economic surplus is
producer surplus); and is socially optimal.

Imperfect price discrimination

Imperfect price discrimination is price discrimination in which at least
some buyers are charged less than their reservation prices. In reality,
price discrimination is imperfect because it is difficult to know each
buyers reservation price and charge each buyer that price.

Forms of price discrimination

1. Group pricing is a form of price discrimination where different discounts
are offered in different sub-markets, while members of a particular submarket all receive the same discount (e.g. concession discounts).
2. The hurdle method of price discrimination (or versioning) is the
practice by which a seller offers a discount to all buyers who overcome a
particular obstacle (e.g. rebates, bundled purchases, basic vs. deluxe
editions, sales discounts).

A perfect hurdle is a hurdle that completely segregates buyers

whose reservation prices lie above it from others whose reservation
prices lie below it, imposing no cost on those who jump the hurdle.

Is price discrimination desirable?

Price discrimination increases total economic surplus but must avoid
appearing unfair or inequitable (e.g. Amazon.com upset customers when
they found out that they were charged different prices for the same DVD).

Is price discrimination legal?

The Competition and Consumer Act 2010 (Cth) pt IV may prohibit price
discrimination that damages competition or prevents entry into markets
(socially desirable price discrimination e.g. lower prices, improved quality
may be acceptable).

Anti-discrimination law prohibits price discrimination based on certain

characteristics (e.g. gender, race, religion).

Regulating competition
The Competition and Consumer Act (CCA) 2010 s 50 allows the Australian
Competition and Consumer Commission (ACCC) to prevent mergers that increase
market power, although this is rarely exercised.
Government-regulated monopolies still exist in order to achieve economies of
scale, protect consumers and ensure adequate output (e.g. telecommunications,
transport, water and gas).

Regulating prices
1. A price equals marginal cost rule produces an economic loss such that
fixed costs will never be recovered. It could be compensated by (1) a
government subsidy to ensure a normal profit, or (2) a two-part tariff: a
fixed charge for access, and a per unit charge for consumption (e.g. water,
electricity, telecommunications).
2. A price equals average total cost rule has the difficulty to determining
which costs should be recovered, and it may limit the incentive to reduce
costs.
3. A price cap is a price ceiling automatically adjusted for inflation. It
encourages increased productivity.