Week 7 - Monopoly Flashcards
What is are 3 assumptions of imperfect competition?
- in most situations, firms can differentiate their products from their competitors
- many firms are price setters (have at least some latitude to set their own prices)
- they have market power (ability to raise the price of a good without losing all of its sales)
What is the difference between perfect competition and imperfect competition in terms of graphs?
The perfectly competitive firm faces a perfectly elastic demand curve for its product. (D=AR=MR)
The imperfect competitive firm faces a downward sloping demand curve. (D=AR)
What are the three different forms of imperfect competition?
- Pure monopoly
- Oligopoly
- Monopolistic competition
What is a pure monopoly?
a market in which a single firm (monopolist) is the only seller of a unique product.
(opposite to perfect competition)
What is an oligopoly?
a market structure which only a few firms (oligopolists) sell a given product
What is monopolistic competition?
consists of a relatively large number of firms that sell the same product with slight differentiations
What are the 5 assumptions of a monopoly?
- Many buyers (not one of which is large relative to the overall market)
- One seller
- No close substitutes
- Buyers are well informed about the offerings of competing suppliers
- Either technological or legal barriers completely block entry
What is the average revenue when the Quantity is 0? AR = 8 - q
It is not 8, it will be zero
What is the average revenue formula?
AR = a -bq
suppose if the firms faces a downward sloping demand curve so is given by this formula
What is the total revenue formula?
is given by AR x Quantity sold
TR = aq - bq^2
Why does total revenue drop after a certain level of output?
TR put on a graph is a maximum curve, increases up to certain point
What is the marginal revenue formula?
MR = dTR / dq
given by the rate of change of total revenue with respect to quantity sold
What is the similarity of AR and MR on a graph?
MR has the same y intercept as AR, but MR is twice as steep
When the MR = 0 what does this mean for TR?
TR is maximised when MR = 0
What is the shape of total costs determined by?
by the law of diminishing marginal product (in the short run) and, by economics and diseconomies of scale (in the long run). Typically costs are an inverse S shape.
(looks like a sort of inflection point curve)
What is the formula of TC?
aq^3 - bq^2 + cq + d
What happens to TC the more you produce?
the higher the TC
Why does the gradient reduce in the middle of the TC graph?
MC is the slope of the TC, is slows down in the middle suggesting MC reduces at a certain point, then continuing marginal cost increases
(through specialisation up to a certain point)
How do we calculate AC?
AC = TC / q
= aq^2 - bq + c + d/q
What is the formula of MC?
MC = dTC / dq
= 3aq^2 - 2bq + c
When is profit maximised?
When MR = MC
Where TR > TC (vertical distance between TR and TC is greatest)
slope of TR is MR
slope of TC is MC
What curves and lines are on a monopoly graph?
MC, MR, AC, D=AR
How to find the price on a monopoly graph?
Draw a vertical line through where MR=MC up to D=AR and then across
How to find total revenue on the graph?
still P x Q
How to find total cost?
vertical from q through MC=MR up to where it hits the AC curve
How to find profit on the monopoly graph?
The rectangle of TR minus TC (where vertical q line goes through MR=MC up to AC)
Algrbraic example:
Suppose that TR is given by pq and TC given by cq^2. Suppose that the inverse demand function is given by p=p_0 - aq
So profit represented as
= (p_0 - aq)q - cq^2
=p_0q - aq^2 - cq^2
What point is profit maximised (slope profit function is 0 because stationary point)
in this, MR = p_0 - 2aq
MC = 2cq
so…
d Profit/ dq
= p_0 - 2aq - 2cq
= p_0 - 2q(a+c)
0 = p_0 - 2q(a+c)
p_0 = 2q(a+c)
where a=0, similar to perfectly competitive case
if a>0 (ie firm has monopoly power) output will be lower than under perfect competition
second way: make MR=MC
Why is a monopoly inefficient?
producer surplus is the profit made (mini rectangle)
consumer surplus is the triangle above the profit
it is inefficient because it has less consumer surplus than perfect competition
Does perfect competition have producer surplus?
no only consumer surplus, triangle above where P=AC, no supernormal profit, has a greater consumer surplus than monopoly
What is price discrimination?
where customers are charged different prices for the same good
What are the 3 conditions necessary for profitable price discrimination?
- The firm must be a price maker
- The firm must be able to identify which consumer is which
- Consumers must not be able to arbitrage (process where customers, who firms charge low prices, make purchases that they then resell to customers who would otherwise have to pay high prices)
What are the 3 different types of price discrimination?
- First degree price discrimination (perfect price discrimination)
- Second degree price discrimination
- Third degree price discrimination
What is first degree discrimination (perfect price discrimination)?
The monopolist knows exactly the willingness to pay of each consumer in the market. It then sells each unit of output at a price just equal to the buyer’s maximal willingness to pay for that unit.
(theoretical doesnt exist in the real world)
What is the second degree price discrimination?
The monopolist knows that its customers have different willingness to pay but it cannot tell who is who. The same price schedule is offered to all buyers but they sort themselves through self selection.
What is third degree price discrimination?
The monopolist doesnt know each consumer’s willingness to pay. Instead, the monopolist sees an observable characteristic (such as age, gender, race, and so on) of its consumers that is related to their willingness to pay. The monopoly then charge different prices based on these.
