2015 by McGraw-Hill Ryerson Ltd.

Chapter 6
Monopoly and
Imperfect Competition

2015 by McGraw-Hill Ryerson Ltd.

Learning Objectives
After this chapter you will be able to:

outline the demand conditions faced by

monopolists, monopolistic competitors,
and oligopolists
explain how monopolists maximize profit
explain how monopolistic competitors
and oligopolists maximize profits
describe nonprice competition and the
arguments over industrial concentration
2015 by McGraw-Hill Ryerson Ltd.

Monopolists Demand
A monopolists demand curve
is the same as for the entire
market.

It is downward sloping.

2015 by McGraw-Hill Ryerson Ltd.

Demand Faced by a Monopolist

FIGURE 6.1

Demand Curve for Megacomp

Demand Schedule
for Megacomp

($ millions per
computer)
$160
120
80

Quantity
Demanded
(computers
per year)
1
2
3

160

Price ($ millions
per computer)

Price

200
a
b

120

80

40
0

Quantity (computers per year)

2015 by McGraw-Hill Ryerson Ltd.

Monopolist Competitors
Demand
A monopolistic competitors
demand curve is elastic because
of many substitutes for the
businesss product.

2015 by McGraw-Hill Ryerson Ltd.

Demand Faced by a Monopolistic

Competitor FIGURE 6.2
Demand Curve for Jaded Palate

Demand Schedule for

Jaded Palate

($ per meal)
$11
10
9
8

(meals per
day)
100
200
300
400

12

Price ($ per meal)

Price

Quantity
Demanded

10
8

6
4
2
0

100

200

300

400

Quantity (meals per day)

2015 by McGraw-Hill Ryerson Ltd.

Oligopolists Demand
Oligopolies are characterized by mutual
interdependence.
Oligopolists in a market characterized by
rivalry face a kinked demand curve.

A business raising price finds rivals keep

theirs constant, so demand is relatively flat.
A business reducing price finds rivals reduce
theirs as well, so demand is relatively steep.

2015 by McGraw-Hill Ryerson Ltd.

Actions and Reactions

among Rivals FIGURE 6.3
Action of
Company A

Probable
Response of
Competitors

raise price

keep prices
constant

lower price

match price
drop

Effect on
Company As
Market Share

Company As
Quantity
Demanded

product now
high-priced, so
market share
falls

large increase
as market share
lost to
competitors

since all
companies
selling at lower
price, Company
As market share
stays constant

small increase
as lower prices
for all
companies
attract new
buyers

2015 by McGraw-Hill Ryerson Ltd.

Demand Faced Among Rivals in

an Oligopoly FIGURE 6.4
Demand Curve for Centaur Cars

Price

Quantity
Demanded

($ thousands
per car)

(thousands
of cars per year)

$35
30
20
10

10
20
25
30

Price ($ thousands per car)

Demand Schedule
For Centaur Cars

40
30
20
D

10

10

20

30

Quantity (thousands of cars per year)

2015 by McGraw-Hill Ryerson Ltd.

10

Cooperative Oligopolies
There are various ways
oligopolists can cooperate:
price leadership
collusion
cartel

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11

Revenues for a Monopolist

A monopolists average revenue
is the same as the downwardsloping market demand curve.
A monopolists marginal
revenue is below its demand
curve because price (average
revenue) falls as quantity
increases.

2015 by McGraw-Hill Ryerson Ltd.

12

Revenues for a Monopolist

FIGURE 6.5
Revenue Curves for Megacomp

Price
(P)

Quantity
(Q)

Total
Revenue
(TR)
(P x Q)

Marginal
Revenue
(MR)
(TR/Q)
($
($ millions
millions (computer
per
per
s per
($ millions) computer)
computer
year)
0
$ 0
)
$160
$160
1
160
80
120
2
240
0
80
3
240
-80
40
4
160

Average
Revenue
(AR)
(TR/Q)
($ millions
per
computer)
$160/1 =
160
240/2 = 120
240/3 = 80
160/4 = 40

2015 by McGraw-Hill Ryerson Ltd.

$ Millions per Computer

Revenue Schedules for Megacomp

200
160
120
80
40

D=AR

0
-40

-80

MR
Quantity of Computers per Year

13

Profit-Maximization for a
Monopolist
A monopolist maximizes profit at the
quantity where marginal revenue and
marginal cost are equal. At this output,
the monopolist charges the highest
possible price, as found using the
demand curve.
Monopolists meet neither the
minimum-cost pricing nor the
marginal-cost pricing conditions.

2015 by McGraw-Hill Ryerson Ltd.

14

Profit-Maximization for a
Monopolist FIGURE 6.6
Profit Maximization Table for Megacomp

$160
120
80
40

Quantity
(Q)
(computer
s per
year)
0
1
2
3
4

$ Millions per computer

Price
(P)
(AR)
($ millions
per
computer)

Total
Revenue
(TR)
(P x Q)
($ millions)
$ 0
160
240
240
160

Marginal
Marginal Cost Average Cost
(AC)
Revenue
(MC)
(MR)
(TR/Q)
($ millions per($ millions per
computer)
($ millions per
computer)
computer)
$160
$ 60
$140
80
40
90
0
70
83
-80
150
100

Profit Maximization Graph for Megacomp

200

MC

160
12
09
80
0

b
c

40
0

AC

Profit = $60 million

a
1

MR
2

Quantity of Computers per Year

2015 by McGraw-Hill Ryerson Ltd.

15

Other Features of
Monopolies
A monopolist charges a higher
price and a lower quantity than
would occur if the market were
perfectly competitive.
Regulators of monopolies
usually adopt average-cost
pricing in an effort to make
regulated monopolies break
even.

2015 by McGraw-Hill Ryerson Ltd.

16

Monopoly versus Perfect

Competition FIGURE 6.7

$ per T-Shirt

S(=MC)

4
b

MR
0

18 000

22 000

Quantity of T-Shirts per Day

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17

Revenues for a
Monopolistic Competitor
A monopolistic competitors
average revenue is the same as its
downward-sloping demand curve.
A monopolistic competitors
marginal revenue is below its
demand curve because price
(average revenue) falls as quantity
increases.

2015 by McGraw-Hill Ryerson Ltd.

18

Revenues for a Monopolistic

Competitor FIGURE 6.8
Revenue Schedules for Jaded Palate

$-11
10
9
8

Quantity
(Q)
(meals per
day)
0
100
200
300
400

Total
Revenue
(TR)
(P x Q)
$
0
1100
2000
2700
3200

Marginal
Revenue
(MR)
(TR/Q)
1100/100 = $11
900/100 = 9
700/100 = 7
500/100 = 5

Average
Revenue
(AR)
TR/Q)
1100/100 = $11
2000/200 = 10
2700/300 = 9
3200/400 = 8

Revenue Curves for Jaded Palate

12
10

$ per Meal

Price
(P)
($ meal)

D=
AR

6
MR

4
2
0

100

200

300

400

Quantity of Meals per Year

2015 by McGraw-Hill Ryerson Ltd.

19

Profit-Maximization for a
Monopolistic Competitor
(a)
The profit-maximizing quantity for a

monopolistic competitor is found

where marginal revenue and marginal
cost are equal. Price is found with the
aid of the businesss demand curve.
In the short run a monopolistic
competitor may make a profit or a
loss at its profit-maximizing point.
2015 by McGraw-Hill Ryerson Ltd.

20

Profit-Maximization for a
Monopolistic Competitor
(b)
In the long run, a monopolistic

competitor breaks even.

If profits (losses) are being made in the

short run, new businesses enter (leave)
the industry, pushing businesses
demand curves leftward (rightward)
and making them more (less) elastic.

The business meets neither the

minimum-cost pricing nor the
marginal-cost pricing rules, since
2015 by McGraw-Hill Ryerson Ltd.

21

Profit Maximization for a

Monopolistic Competitor
Short-Run Profit Maximization
For Jaded Palate

FIGURE 6.9

Long-Run Profit Maximization

For Jaded Palate

MC

$ per Meal

8.00

AC
D0

e
7.50

a
MR
0

MC

$ per Meal

10.00

200
Quantity of Meals per Day

2015 by McGraw-Hill Ryerson Ltd.

minimum point
of AC
D1
d
MR

AC

150
Quantity of Meals per Day

22

Revenue Conditions for an

Oligopolist
For an oligopolist in a market
characterized by rivalry, average
revenue is identical with its kinked
demand curve.
This businesss marginal revenue
curve has two linear segments
which are below its kinked
demand curve.

2015 by McGraw-Hill Ryerson Ltd.

23

Profit-Maximization for an
Oligopolist
The profit-maximizing quantity for
this type of oligopolist is found where
marginal revenue and marginal cost
are equal. Price is found using the
businesss kinked demand curve.
Oligopolists meet neither the
minimum-cost pricing nor the
marginal-cost pricing rules.

2015 by McGraw-Hill Ryerson Ltd.

24

Profit-Maximization for an
Oligopolist FIGURE 6.10
Profit Maximization Graph for
Centaur Cars
Profit Maximization Table for Centaur Cars
Total
Price
Marginal Marginal
Average
Revenue
(P)
Revenue
Cost
Cost
(TR)
(=AR)
(MR)
(MC)
(AC)
(P x Q) (TR/Q)
($ thousands (thousands
($
($
($
of cars per
($
Per car)
thousands thousands thousands
year)
millions) per car)
per car)
per car)

-$35
30
20
10

0
10
20
25
30

0
35
0
60
0
50
0
30
0

35
25
20
40

15
10
15
25

30
20
19
20

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40

$ Thousands per car

Quantity
(Q)

30

MC

Profit = $200 million

20

10

0
10

-10

20

30

-20
-30
-40

MR

Quantity (thousands of cars per year)

25

AC

Game Theory
Game theory is the analysis of how
mutually interdependent actors try to
achieve their goals through the use of
strategy.
Originally a field in mathematics,
game theory has become a set of
concepts whose use has spread to all
social sciences, especially economics.

2015 by McGraw-Hill Ryerson Ltd.

26

The Prisoners Dilemma (a)

The prisoners dilemma is a classic example
of how players self-interested actions can
be self-defeating.

It refers to a case in which two arrested men

are in separate cells and are facing the choice
of whether or not to confess. If both confess,
each gets a jail time of 5 years. If one
confesses and the other doesnt, the confessor
gets off and the other gets 10 years. If both
dont confess, they each get one year of jail.
2015 by McGraw-Hill Ryerson Ltd.

27

The Prisoners Dilemma (b)

By following a narrowly selfinterested strategy that

minimizes his own potential
harm, each prisoner has an
incentive to confess, even
though the best possible result
would be if both stayed silent.
2015 by McGraw-Hill Ryerson Ltd.

28

The Prisoners Dilemma

FIGURE 6.11

Pauls Strategies

Confess
Dont Confess

Peters Strategies

Confess

Dont Confess
Paul: 5

Peter: 5

Paul: 10
Peter: 0

Paul: 0
Peter: 10

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Paul: 1
Peter: 1

29

The Prisoners Dilemma in

Oligopoly (a)
The prisoners dilemma can be applied to
oligopoly by looking at two businesses that
have entered a collusive agreement to
charge a high price.
If both businesses live by the agreement,
they each make $20 million in profit. If one
cheats and the other doesnt, the cheater
makes $25 million in profit and the other
makes $10 million. If both cheat, they
each make $15 million.

2015 by McGraw-Hill Ryerson Ltd.

30

The Prisoners Dilemma in

Oligopoly (b)
If price cutting can be accomplished in
an underhanded way, each business
has an incentive to cheat, since the
profit for the cheater (when the other
business is living within the
agreement) is higher than otherwise.
But if both businesses cheat, each
makes a lower profit than they would
do if both lived within the agreement.

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31

Prisoners Dilemma in
Oligopoly FIGURE 6.12
Deltas Strategies

Dont Cheat

D: $20 m.

G: $20 m.
D: $10 m.

Cheat

Gammas Strategies

Dont Cheat

G: $25 m.

2015 by McGraw-Hill Ryerson Ltd.

Cheat
D: 25 m.

G: $10 m.
D: 15 m.
G: $15 m.

32

Anti-Combines Legislation
(a)
Anti-combines legislation
represents laws aimed at
preventing industrial
concentration and abuses of
market power.
The Competition Act of 1986
was a major reform of Canadas
anti-combines legislation.

2015 by McGraw-Hill Ryerson Ltd.

33

Anti-Combines Legislation
(b)
Criminal offences under the
Competition Act include:
conspiracy
bid-rigging
predatory pricing
abuse of dominant position

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34

Anti-Combines Legislation
(c)
Civil matters reviewed by the
Competition Tribunal include:
abuse of dominant position
mergers
horizontal merger
vertical merger
conglomerate merger

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35

Nonprice Competition

Nonprice competition by monopolistic

competitors and oligopolists includes:
product differentiation
advertising

Nonprice competition raises a

businesss revenue and costs.
Nonprice competition may or may not
be beneficial to businesses and
consumers.

2015 by McGraw-Hill Ryerson Ltd.

36

Industrial Concentration
Industrial concentration refers to
market domination by a few
large businesses.
It can provide the consumer with
benefits due to increasing returns
to scale.
It can impose costs on the
consumer due to market power.
It may or may not encourage

2015 by McGraw-Hill Ryerson Ltd.

37

Concentration Ratios
Industrial concentration is measured
using concentration ratios.
The four-firm concentration ratio
shows the percentage of total sales
revenue in a market earned by the
four largest business firms.
Concentration ratios overestimate
competition in localized markets and
underestimate it in global markets.

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38

Industry Concentration Ratios

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39

Concentration in the
Economy

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40

The Games People Play

Thomas Schelling applied game theory
principles to military strategy, showing how the
most effective deterrence during the nuclear
arms race between the US and the Soviet Union
was not first-strike capability, but second-strike
capability.
He explained this using the example of two
gunfighters in a threatened shootout, who
would both be loath to shoot if both were
assured of living long enough to shoot back
with unimpaired aim.

2015 by McGraw-Hill Ryerson Ltd.

41

Game Theory in
Economics
Schelling also showed how, in many ordinary
social situations, a divergence between what
people are motivated to do individually and
what they would like to accomplish collectively
creates conditions for breaking the laissez faire
principle.
One example is the rationing of electricity
during summer shortages. In this case, rulesbased rationing makes more sense than merely
appealing to peoples civic virtue, says
Schelling.

2015 by McGraw-Hill Ryerson Ltd.

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