Chapter 6 Non-Competitive Markets

Simple Monopoly In The Commodity Market

This chapter explores market structures where the conditions of perfect competition are not fully met. This includes situations where there are a limited number of sellers, or the products are not perfectly homogeneous, or entry/exit is restricted.

A Monopoly is a market structure where there is a single seller and many buyers.

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Defining features of a monopoly market structure:

• Exactly one seller of a specific commodity.
• No other commodity serves as a close substitute for the product.
• Significant restrictions or barriers prevent other firms from entering the market.

To isolate the effects of monopoly, it is assumed that all other markets (for inputs, for related goods) remain perfectly competitive, and consumers are price takers.

Unlike firms in perfect competition, a monopolist has the power to influence the market price by changing the quantity it supplies. The monopolist faces the downward-sloping market demand curve.

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Market Demand Curve Is The Average Revenue Curve

For a monopoly firm, the market demand curve is the relationship between the quantity the monopolist sells and the price it can charge. A larger quantity can only be sold at a lower price, and a smaller quantity can be sold at a higher price.

Since the monopoly is the only seller, it faces the entire market demand curve. The price at which the monopolist sells a given quantity is determined by what consumers are willing to pay, as shown by the demand curve.

Average Revenue (AR) for any firm is Total Revenue (TR) divided by quantity (q): $AR = TR/q$. Since $TR = p \times q$, $AR = (p \times q) / q = p$.

Therefore, the market demand curve is also the Average Revenue (AR) curve for a monopoly firm. This curve is downward sloping.

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Total, Average And Marginal Revenues

The total revenue (TR) of a monopoly firm is $TR = p \times q$. Since the price (p) is not constant but depends on the quantity (q) (as per the demand curve), the TR curve is not a straight line like in perfect competition.

For a typical downward-sloping linear demand curve, the TR curve is an inverted vertical parabola. TR initially increases as quantity increases, reaches a maximum, and then declines.

q	p	TR	AR	MR
0	10	0	–	–
1	9.5	9.5	9.5	9.5
... (intermediate values) ...
10	5	50	5	0.5
11	4.5	49.5	4.5	-0.5
... (remaining values) ...
13	3.5	45.5	3.5	-2.5

Average Revenue (AR) is $\frac{TR}{q}$. As shown earlier, $AR=p$. So the AR curve is identical to the demand curve and is downward sloping.

Marginal Revenue (MR) is the change in TR from selling one additional unit ($\Delta TR / \Delta q$). For a monopolist, MR is less than AR (and price) because to sell an additional unit, the monopolist must lower the price not just for that unit, but for all previous units as well. The MR curve is also downward sloping and lies below the AR curve.

Relationship between TR and MR: When TR is increasing, MR is positive. When TR reaches its maximum, MR is zero. When TR is decreasing, MR is negative.

Relationship between AR and MR: The MR curve lies below the AR curve for a downward sloping demand curve. The steeper the demand curve (AR curve), the further below the MR curve lies.

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Marginal Revenue And Price Elasticity Of Demand

There is a relationship between MR and the price elasticity of demand ($e_D$) for the demand curve the monopolist faces.

• When demand is elastic ($|e_D| > 1$), MR is positive. Increasing quantity sold (lowering price) increases TR.
• When demand is inelastic ($|e_D| < 1$), MR is negative. Increasing quantity sold (lowering price) decreases TR.
• When demand is unitary elastic ($|e_D| = 1$), MR is zero. Increasing quantity sold (lowering price) does not change TR.

This relationship means the elastic portion of the demand curve corresponds to positive MR, the unitary elastic point corresponds to zero MR, and the inelastic portion corresponds to negative MR.

q	p	MR	Elasticity
0	10	-	-
...	...	...	...
9	5.5	1.5	1.22
10	5	0.5	1
11	4.5	-0.5	0.82
...	...	...	...

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Short Run Equilibrium Of The Monopoly Firm

Like firms in perfect competition, a monopoly firm aims to maximise profit ($\pi = TR - TC$). The firm determines the quantity to produce and the price to charge to achieve this goal.

Profit is maximum at the output level where the vertical distance between the TR curve and the TC curve is largest, and TR is above TC.

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The Simple Case Of Zero Cost

If the monopolist has zero production costs (TC=0), profit equals TR. Profit is maximised when TR is maximum. As discussed, this occurs when MR = 0.

The output level where MR=0 determines the profit-maximising quantity. The price is then determined by the demand curve (AR curve) at that quantity. Profit is the maximum TR.

Comparing this to a perfectly competitive market with zero costs, price would be driven down to zero (MC=0) and quantity would be higher (where demand intersects the quantity axis, i.e., demand = 20 units in this example). Monopoly restricts output and charges a higher price compared to perfect competition.

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Introducing Positive Costs

With positive production costs (TC > 0), the monopolist maximizes profit where $TR - TC$ is maximum. This occurs at the output level where the slopes of the TR and TC curves are equal, meaning Marginal Revenue equals Marginal Cost ($MR = MC$).

For profits to be maximum at a positive output level, the MC curve must also be non-decreasing at the intersection point with MR.

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Using Average And Marginal Curves

Graphically, the profit-maximising output level (q0) occurs where the MR curve intersects the MC curve from below (MC is rising at this point). The price (p0) is then found on the demand curve (AR curve) corresponding to this quantity q0.

At the profit-maximising output q0:

• Price is $p_0 = aq_0$ (from the Demand/AR curve).
• Average Cost is $dq_0$ (from the AC curve).
• Total Revenue = $p_0 \times q_0$ = Area of rectangle Oq0ab.
• Total Cost = $AC \times q_0$ = Area of rectangle Oq0dc.
• Profit = Total Revenue - Total Cost = Area of rectangle cdab.

This profit is typically a supernormal profit in the short run due to barriers to entry.

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Comparison With Perfect Competition Again

Comparing the monopoly outcome to perfect competition under similar cost conditions reveals significant differences:

• Equilibrium Condition: Monopoly: $MR = MC$. Perfect Competition: $p = MC$. Since MR < p for a monopolist, a monopolist sets $MC = MR < p$.
• Output: The monopoly produces a lower quantity (q0) compared to perfect competition (qc, where MC intersects Demand).
• Price: The monopoly charges a higher price (p0) compared to perfect competition (pc, where MC intersects Demand).
• Profit: The monopolist typically earns supernormal profit (area cdab), while perfectly competitive firms earn zero supernormal profit in the long run.

Monopoly is often seen as leading to higher prices and lower output compared to perfect competition.

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In The Long Run

Unlike perfectly competitive markets where free entry and exit eliminate supernormal profits in the long run, in a monopoly, barriers to entry prevent new firms from entering. Thus, if a monopolist earns supernormal profit in the short run, it can continue to do so in the long run.

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Some Critical Views

Monopolies are often criticised for exploiting consumers through high prices and restricted output. However, there are counterarguments:

• Pure monopolies may not exist in reality, as all goods are substitutes to some degree, and firms compete for consumer income.
• Even pure monopolies face competition in the long run from new products and technologies that serve as substitutes. The threat of future competition can influence their short-run behaviour.
• Monopolies earning large profits may invest in research and development, potentially leading to better quality goods or lower production costs, which could ultimately benefit consumers (though the extent of this benefit is debated).

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Other Non-Perfectly Competitive Markets

Besides monopoly, other market structures deviate from perfect competition.

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Monopolistic Competition

This market structure combines features of both monopoly and perfect competition:

• Large number of firms.
• Free entry and exit of firms.
• Products are differentiated (heterogeneous) but are close substitutes (e.g., branded biscuits, different restaurants). Firms have some control over price due to product differentiation.

Each firm faces a downward-sloping demand curve (which is also its AR curve), but it is more elastic than a monopolist's demand curve because of the availability of close substitutes. MR is less than AR and downward sloping.

Like other firms, a monopolistically competitive firm maximizes profit by producing where MR = MC.

In the short run, the outcome can be similar to a monopoly, with the firm potentially earning supernormal profit (price > AC).

In the long run, however, free entry and exit play a role. Supernormal profits attract new firms, shifting the demand curves of existing firms leftward (fewer customers for each). This continues until supernormal profits are eliminated, and firms earn only normal profit (price = AC).

The long-run equilibrium in monopolistic competition is characterised by zero supernormal profit, but unlike perfect competition, firms still produce at an output level less than the minimum average cost (due to downward sloping demand), leading to excess capacity and prices higher than marginal cost.

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How Do Firms Behave In Oligopoly?

An Oligopoly is a market structure where there are a few large firms selling a homogeneous or differentiated product. A Duopoly is a specific case with exactly two sellers.

Due to the small number of firms, each firm's decision significantly impacts the market and other firms. This interdependence leads to complex strategic interactions.

Oligopoly behavior can range between two extremes:

• Collusion (Cartel): Firms cooperate to maximize collective profits, acting like a single monopolist (e.g., forming a cartel to restrict output and raise prices). Often difficult to sustain in practice due to incentives for individual firms to cheat on the agreement.
• Competition: Firms compete aggressively, often by undercutting prices to gain market share. This can drive prices down towards the level of marginal cost, similar to the outcome in perfect competition.

In reality, oligopoly outcomes often lie somewhere between these extremes. Firms recognise the harm of fierce competition but may find collusion difficult. The actual outcome depends on the specific strategies and interactions between the limited number of firms.

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Key Concepts

Monopoly

Monopolistic Competition

Oligopoly.

Summary

• Monopoly: Single seller, no substitutes, restricted entry. Faces downward-sloping market demand (AR curve). MR is below AR.

• TR curve is inverted parabola for linear demand. MR is positive when demand is elastic, zero when unitary elastic, negative when inelastic.

• Monopoly profit maximisation: Short run and long run equilibrium where MR = MC, and MC is rising. Price is on the demand curve above MC/MR intersection.

• Monopoly output is less, and price is higher than under perfect competition. Monopolies can earn supernormal profits in the long run due to entry barriers.

• Monopolistic Competition: Large firms, free entry/exit, differentiated products. Firms face downward-sloping (elastic) demand curves (AR). MR < AR. Short-run profit maximisation at MR = MC. Long-run equilibrium has zero supernormal profit (price = AC), but output is less than minimum AC.

• Oligopoly: Few firms, producing homogeneous or differentiated products. Each firm's action impacts others, leading to strategic interaction. Behavior ranges from collusion (acting as monopoly) to fierce competition (driving price towards MC).

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