If any of the four strict assumption
for perfect competition do not hold then imperfect competition
exists. Under imperfect competition one or more buyers or sellers
have a perceptible influence on the price/quantity outcome.
The form of imperfect competition is determined by the number of
buyers or sellers with such influence:
monopoly/monopsony (single seller/single
sellers/several large buyers)
competition (many sellers of differentiated goods & services).
We will examine monopoly, monopolistic
competition and oligopoly by changing the assumptions of perfect
competition and determine their short and long run equilibrium and
compare it with perfect competition. Beginning with monopoly:
i - Anonymity
while goods & services are homogenous there is only one seller and hence
no anonymity. Everyone knows the monopolist.
ii - No Market Power
Under Monopoly there is only one
seller facing the market demand curve and that seller has market power
to be a 'price maker', i.e., it can choose profit maximizing
output. Market power is limited only by the proximity of
substitutes. The degree of market power is reflected by the
elasticity of the market demand curve. The more inelastic the
demand curve, the more market power; the more elastic, the less market
power. The market supply curve is the marginal cost curve of the
monopolist above the shut down point.
iii -Perfect Knowledge
Under Monopoly the assumption of perfect knowledge holds.
Free Entry & Exit
Under Monopoly there are barriers to entry inhibiting competitors.
Such barriers exist for one or more of four reasons.
First, a firm can become a monopolist because the average cost
per unit reaches a minimum (minimum optimum scale) at an output sufficient to supply
the entire market at the lowest possible cost (MKM C15/322-3). This
is a natural monopoly (P&B
7th Ed Fig. 13.1;
Any competitor trying to enter the market usually does so at less than
minimum optimum scale and hence must charge a higher price. In the
short run the monopolist can lower market price below the shut down
point of the entrant. After driving the competitor out of business
the monopolist can then raise price again.
Second, one firm may control the entire supply of a basic input
(MKM C15/320-1). Thus at the
beginning of the 20th century John D. Rockefeller's Standard Oil of New
Jersey effectively controlled all oil wells and refineries in the United
States. In the middle of the 20th century ALCOA (Aluminum Company
of America) effectively owned all the bauxite mines and aluminum
smelters in the free world.
Third, a firm may acquire an intellectual property
right (IPR) - copyright, patent, registered industrial design, trademark -
granted by the State
In effect only the monopolist can use the knowledge protected by an IPR.
IPRs are granted only for a limited period of time after which the
knowledge enters the public domain where anyone can use it. While
in force, however, the State will use the judicial system to protect a
monopolist's IPRs hence blocking entry into the market.
the government becomes a monopolist when it grants itself (MKM
exclusive market franchise, e.g. electric power, roads, water supply,
In effect, a government franchise is granted when
a natural monopoly exists for a good or service considered too important
to the public interest to be left in private, profit maximizing hands.
2. Marginal Revenue Curve
The market supply
curve is the horizontal summation of the MC curves (above shut down) of
all producers in an industry. In perfect competition entry or exit
of a firm shifts the market supply curve. In Monopoly, however,
there is only one producer - the monopolist. The market supply
curve is, in fact, the monopolist's MC curve above its shut down point.
MKM Fig. 15.4
thus faces the market demand curve alone.
As in perfect competition, the market demand curve is constructed
from the horizontal summation of consumer demand curves. In perfect competition, however, a firm has no control facing,
in effect, a horizontal perfectly elastic demand
curve at market clearing price.
It can sell as much as it wants at market price and profit maximizes where
P = MR = MC (MKM
C14/Fig 14.1). The monopolist, however, can increase sales by
lowering or decrease sales by raising the price. This means a new
curve emerges called the marginal revenue (MR) curve
(P&B 4th Ed
R&L 13th Ed
C15/Fig. 15.3). Profit maximization occurs where the revenue
earned from the last unit sold
equal to the cost of the last unit produced (MC). And what is the
output at this point (in MKM
Fig. 15.4, point A)? Graphically we drop down from A to the
x-axis (quantity) and arrive at the profit maximizing quantity
Fig. 15.4, point
And what is the price consumers are willing to pay for this quantity?
Graphically we move straight up from the profit maximizing quantity to
the market demand curve that reflects the willingness to pay
Fig. 15.4, point
In the short run, following the diagram below, the monopolist produces at
Qm not Qc, the competitive output corresponding to where Demand meets
Supply at point S (the marginal cost curve of the monopolist). Thus
the first cost of monopoly is a smaller output than under perfect
The second cost is a price of Pm rather than
PC, i.e., higher price.
The third cost is allocative efficiency.
If the monopolist supplied Qc then consumer surplus would include the
triangle E (consumer surplus every thing up from price to the demand
curve). Similarly, producer surplus would include triangle K
(producer surplus everything from price down to the supply curve).
However, because the monopolist produces at Qm rather than Qc both
consumer surplus E and producer surplus K are not generated. They
are lost - triangle RST. This is called the deadweight loss of
monopoly. In other words, the monopolist does not allocate enough
capital, labour and natural resources to produce the competitive
outcome, Qc. Monopoly displays allocative inefficiency.
The fourth cost of monopoly involves the
appropriation of consumer surplus in the form of monopoly profit
(rectangle B). Why are consumers willing to pay a higher price for
a smaller quantity? The law of diminishing marginal utility.
d) Long-Run Equilibrium
barriers to entry fall, e.g.,
a patent expires, then in the long-run the monopolist will continue to
economic profit. It may, however,
still enjoy economies of scale and increase the size of its plant &
equipment. The result will be lower costs and lower prices but
continued and probably higher economic profits.
far we have consider what is called 'a single price' monopoly, i.e.,
all consumer pays the same price. However, the most profitable form of monopoly is the price
discriminating monopolist who, in effect, disaggregates the
market demand curve into individual consumer demand curves and charges
each consumer a price that extracts
consumer surplus and maximizes profit (P&B
7th Ed Fig. 13.9;
R&L 13th Ed
Fig. 10-6; MKM
Fig. 15.9b). Classic example is the town doctor who
charges the farmer a chicken or sheep for a broken leg but charges the
town banker a much higher price for the same service.