Oligopoly and Monopoly Market Structures

Characteristics of a Monopoly

• A single firm controls the vast majority of the market.
• The firm is the whole industry.
• The product is unique with no close substitutes.
• The firm can manipulate the price by changing the quantity it produces.
• Example: Oregon electric companies

High Barriers to Entry in Monopolies

• New firms are unable to enter the market.
• There are no immediate competitors.
• Firms can make a profit in the long run.

Non-Price Competition

• Monopolies still advertise their products to increase demand despite having no immediate competitors.

Origins of Monopolies

• Geography can be a barrier to entry, examples include: Nowheres gas stations, De Beers Diamonds, Cable TV, and Rose Garden Hot Dogs.
• Location or control of resources limits competition and can lead to a single supplier.
• The government is a barrier to entry. Examples include: Water companies, firefighters, the Army, and pharmaceutical drugs with a patent.
• The government allows monopolies for public benefit or to stimulate innovation.
• The government issues patents to protect inventors and forbids others from using their inventions.
• Patents typically last for 20 years.
• Technology or common use is a barrier to entry.
• Examples include: Microsoft, Intel, Frisbee, and Band-Aide.
• Patents and widespread availability of certain products limit market control to one major firm.
• Mass production and low costs are barriers to entry, such as Bonneville Dam Hydro Power.
• Multiple competing electric companies would have higher costs.
• Having only one electric company keeps prices low.
• Economies of scale make it impractical to have smaller firms.
• Natural Monopoly: It is more efficient for only one firm to produce because they can produce at the lowest cost.

Drawing Monopolies Key Points

• There is only one graph because the firm is the industry.
• The cost curves are the same.
• The MR=MC rule still applies.
• The shut-down rule still applies.
• Monopolies (and all imperfectly competitive firms) have downward sloping demand curves.
• To sell more, a firm must lower its price.
• Marginal revenue does not equal the price.

Calculating Marginal Revenue

• To sell more, a firm must lower its price.
• Marginal Revenue(MR) is less than price.
• Total Revenue (TR) is at its peak when MR hits zero.

Elastic vs Inelastic Range of Demand Curve

• If price falls and TR increases, demand is elastic.
• If price falls and TR falls, demand is inelastic.
• A monopoly will only produce in the elastic range.

Maximizing Profit for Monopolies

• A monopolist produces where MR=MC, but charges the price that consumers are willing to pay based on the demand curve.
• If costs are higher, Total Revenue (TR) will be $90, Total Cost (TC) will be $100, and the firm will incur a loss of $10.

Monopoly Efficiency:

• Monopolies underproduce and overcharge, decreasing Consumer Surplus (CS) and increasing Producer Surplus (PS).
• Monopolies are not productively efficient because Price ≠ Minimum ATC.
• Monopolies are not allocatively efficient because Price > MC.
• Monopolies are inefficient because they charge a higher price, don't produce enough, produce at higher costs, and have little incentive to innovate.

Natural Monopoly

• Natural monopolies: One firm can produce the socially optimal quantity at the lowest cost due to economies of scale.
• It is better to have only one firm in a natural monopoly because Average Total Costs (ATC) is falling at the socially optimal quantity.

Regulating Monopolies

• Regulation aims to keep prices low and make monopolies efficient via price controls such as price ceilings.

Government Price Ceiling Placement

• Socially Optimal Price: Where Price = MC for allocative efficiency.
• Fair-Return Price: Where Price = ATC for normal profit.
• An unregulated firm produces where Marginal Revenue (MR) = Marginal Cost (MC).
• Socially Optimal price is where MC interests demand, which is efficient.
• Fair Return means no economic profit.
• Regulating a natural monopoly to get the socially optimal quantity would cause the firm to make a loss and require a subsidy.

Price Discrimination

• Price discrimination is selling the same products to different buyers at different prices.
• Examples include: Airline tickets (vacation vs business), movie theaters (child vs adult), coupons (spenders vs savers), and AHS football games (students vs parents).
• Price discrimination seeks to charge each the consumer what they are willing to pay to increase profits.
• Those with inelastic demand are charged more than those with elastic demand.

Conditions for Price Discrimination

• Must have monopoly power.
• Must be able to segregate the market.
• Consumers must not be able to resell the product.
• Marginal Revenue (MR) = Demand (D)
• Perfectly discriminating monopolies can change each person differently.

Results of Price Discrimination

• Regular Monopoly: Price Discrimination results in several prices, more profit, no CS, and a higher socially optimal quantity.

Monopolistic Competition

• Monopolistic competition falls between perfect competition and oligopoly.
• Characteristics include: A relatively large number of sellers, differentiated products, some control over price, easy entry and exit with low barriers, and much non-price competition like advertising.

Monopolistic Qualities vs Perfect Competition Qualities

• Control over price of own good due because of the differentiated product.
• Demand (D) is greater than Market Revenue (MR).
• A lot of advertising.
• Not efficient. Perfect Competition Qualities:
• Large number of smaller firms.
• Relatively easy entry and exit.
• Zero economic profit in the long-run since firms can enter.

Differentiated Products

• The goods are not identical.
• Firms seek to capture a piece of the market by making unique goods.
• Firms use non-price competition because there are substitutes.
• Examples: Brand names and packaging, product attributes, service, location, and advertising.
• Advertising aims to increase demand and to make demand more inelastic.

Drawing Monopolistic Competition

• In the short-run, is the same graph as a monopoly making profit.
• In the long-run, new firms will enter, which drives down the demand for firms already in the market.

Economic Profit

• Firms enter and cause demand to fall until there is no economic profit.
• Price and quantity fall, and TR = TC meaning there is a normal profit.
• Long-run Equilibrium: Quantity where Market Revenue (MR) = Market Cost (MC) up to Price = Average Total Cost (ATC).

Demand Shift Factors

• Demand shifts when short-run profits are made.
• New firms enter.
• New firms mean more close substitutes and less market shares for each existing firm.
• Demand for each firm falls.
• Demand shifts when short-run losses are made.
• Firms exit.
• Result is fewer substitutes and more market shares for remaining firms.
• Demand for each firm rises.
• When there is a loss occurs, firms will eventually exit.
• Price and quantity increase and Total Revune (TR)=Total Cost (TC)

Monopolistically Competitive Efficiency

• Not allocatively efficient as Price ≠ MC.
• Not productively efficient because not producing at minimum ATC.
• The firm also has excess capacity.
• The firm can produce at a lower cost but it holds back production to maximize profit.
• Advantages: Large number of firms and product variation meets societies' needs.
• Nonprice Competition or product differentiation and advertising may result in sustained profits for some firms.

Oligopolies

• Characteristics: A few large producers (less than 10), identical or differentiated products, high barriers to entry, control over price (price maker), mutual interdependence, and firms' use of strategic pricing.
• Examples: OPEC, Cereal Companies, Car Producers. Oligopolies occur: When only a few large firms start to control an industry, high barriers to entry keep others from entering.
• Economies of Scale: Example, the car industry is difficult to enter because only large firms can make cars at the lowest cost.
• High Start-up Costs
• Ownership of Raw Materials

Game Theory

• Game theory is the study of how people behave in strategic situations.
• An understanding of game theory helps firms in an oligopoly to maximize profit.
• Game theory predicts human behavior.
• Oligopolies are interdependent since they compete with only a few other firms.
• Their pricing and output decisions must be strategic to avoid economic losses.
• Game theory helps analyze their strategies.
• Dominant Strategy: The best move to make regardless of what your opponent does.
• Oligopolies must use strategic pricing.
• Oligopolies have a tendency to collude to gain profit.
• Collusion is the act of cooperating with rivals to "rig" a situation. Collusion results in the incentive
• Firms make decisions based on dominant strategies.

Oligopoly Graphs

• There are three types of oligopolies due to interdependence:
  • Price Leadership (no graph)
  • Colluding Oligopoly
  • Non-Colluding Oligopoly

Price Leadership Model

• Collusion is illegal.
• Firms cannot outright set prices.
• Price leadership is used by firms to coordinate prices without outright collusion.
• General Process:
  • "Dominant firm" initiates a price change
  • Other firms follow the leader.
• Temporary Price Wars: May occur if other firms don't follow price increases of a dominant firm, causing each firm to undercut each other.

Colluding Oligopolies

• A cartel is a group of producers that creates an agreement to fix prices high. Cartels:
  • Set price and output at an agreed-upon level
  • Require identical or highly similar demand and costs
  • Must have a way to punish cheaters
  • Together, they act as a monopoly Firms in a colluding oligopoly act as a monopoly and share the profit.

Non-Colluding Oligopolies

• The kinked demand curve model shows how noncollusive firms are interdependent. The result will be firms that react to competitor's pricing in two ways:

  • Match price: If one firm is cuts its prices, then the firms cuts it’s suit causing a inelastic demand

  • Changes when being ignored: when having one who raises prices, maintaining an elastic demand

  • In the graph, the Q won't change, but the MC can move. Meaning being that the price is sticky.

Explore oligopoly and monopoly market structures, focusing on collusion, price stickiness, and the kinked demand curve. Understand price discrimination and government regulation. Compare output levels across different market types.