Cyberlecture

This chapter introduces you to imperfect competition, a market condition characterized by firms that face downward-sloping demand curves. You will learn that when markets are imperfectly competitive, they are usually not socially optimal.

What is imperfect competition?
The main difference between perfectly competitive firms and imperfectly competitive firms is that the imperfectly competitive firms face a downward-sloping demand curve. These firms have market power – they can set their prices anywhere on their demand curves.
      Imperfectly competitive industries are usually classified as one of three types.

• Monopoly
  • a sole supplier of a good or service
  • example: Hydro Quebec
• Oligopoly
  • only a few firms supply a good or service
  • example: Sprint, Primus and MCI
• Monopolistic Competition
  • many firms supply a slightly different good or service
  • example: gas stations

Why do monopolies exist?
The only way that monopolies can exist as single firms is if there are barriers keeping competing firms out of the market. These barriers to entry are:

• ownership of an important input without close substitutes
• economies of scale which result in falling average costs over very large amounts of output
• legal or other governmental restrictions
  • patents
  • licenses and franchises
• difficulty raising sufficient capital to start up a competing business
  • large fixed costs lead to economies of scale

Patents protect inventors from competition in the production of their invention. Canada has issued more than 1,400,000 patents over the past 75 years. Go to the Canadian Intellectual Property Office (http://strategis.ic.gc.ca/sc_mrksv/cipo/welcome/welcom-e.html) to learn more about patents, and to see many inventions that have been registered over the years.

How does a monopolist maximize profit?
The monopolist uses the same profit-maximizing rule that the perfectly competitive firm uses.
      The monopolistic firm should continue to increase its output if and only if the marginal revenue received from selling that output exceeds the marginal cost of producing the output.
      Marginal revenue (MR) is the additional revenue that is earned from the sale of one more unit of output (Q). In this case, marginal revenue is how much total revenue increases when the firm produces and sells an extra unit of output.

• the monopolist's marginal revenue curve shares the demand curve's intercept but is twice as steep

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Marginal cost (MC) is the additional cost that is incurred by the production of one more unit of output (Q). In this case, marginal cost is how much total cost increases when the firm produces an extra unit of output.
      Profit is maximized at the level of output for which marginal revenue precisely equals marginal cost. The price is taken from the demand curve.

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Practice Activity 1 Try answering some questions about monopoly profit maximization.

Why are monopolies socially inefficient?
A single-price monopoly supplies less to the market than a perfectly competitive industry because its marginal revenue is less than price. While perfectly competitive markets are efficient, monopoly markets fail.

• MR = MC < price at the profit-maximizing output
• marginal benefit to society > marginal cost to society, creating a deadweight loss
• society would benefit from the production of more output

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Monopolies redistribute economic surplus between consumers and producers.

• society in general loses economic surplus equal to the deadweight loss
• consumers also lose surplus to the monopoly

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Practice Activity 2 Try answering some questions about monopoly and social efficiency.

What is price discrimination?
Price discrimination occurs when a firm sells output to different buyers for different prices in order to increase its profit.
      Perfect price discrimination occurs when a firm can sell its output to each buyer at exactly that buyer's reservation price.

• economic surplus is maximized because the socially efficient amount of output is produced
  • the monopolist captures all of the economic surplus
  • the consumer captures zero economic surplus

Imperfect price discrimination occurs when a firm cannot sell output to each buyer at exactly that buyer's reservation price

• some buyers will pay less than their reservation prices

Where multinational companies are involved, price discrimination can be international. Visit http://archives.seattletimes.nwsource.com/cgi-bin/texis.cgi/web/vortex/display?slug=drug05m&date=20000905 to find out why prescription drugs cost more in the United States than they do in Canada.

What is the hurdle method of price discrimination?
The hurdle method of price discrimination separates buyers with low reservation prices from buyers with high reservation prices. To take advantage of a lower price for a product, the consumer must mail in a coupon or make an effort in some stipulated way to earn the rebate. The firm still makes more profit than a single-price monopolist.

• high reservation price buyers will not bother with the hurdle
• only low reservation price buyers will end up paying the lower price

Examples of discriminatory pricing using the hurdle method are temporary sale prices, mail in rebate coupons, less expensive second-run paperback editions of books, less expensive generic versions of name-brand products, and discount or economy airfares.
      Total economic surplus is greater under the hurdle method than with single-price monopoly as both consumers and producers earn more surplus.

Economic Naturalist If everyone can save money by making an offer to Priceline.com, doesn't that mean the sellers of these products are losing money? So why do they do it?

Understanding Questions Do I understand this chapter? As a check to your understanding of the material in this chapter, you should be able to answer our questions.