TYPES OF MARKET STRUCTURE

In order to develop models and make predictions

about how producers will behave, we have
developed four principal models of market
structure:

 perfect competition
 monopoly
 oligopoly
 monopolistic competition

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
TYPES OF MARKET STRUCTURE
Are products differentiated?

No Yes

Not applicable
One Monopoly

How many
producers are Few Oligopoly
there?

Perfect Monopolistic
Many competition competition

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
THE MEANING OF MONOPOLY

Monopolist: a firm that is the only producer of a good with

no close substitutes.
(An industry controlled by a monopolist is known as a monopoly)
Market power: the ability of a firm to raise prices.
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
WHAT A MONOPOLIST DOES
A monopolist reduces the quantity supplied to QM and moves up
the demand curve from C to M, raising the price to PM.

Price

S
PM M
2. … and raises
price. C
PC

QM QC Quantity

1. Compared to perfect competition, a

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
WHY DO MONOPOLIES EXIST?
How do they get away with this and protect their
profit from new firms?

Profits will not persist in the long run unless

there is a barrier to entry.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
BARRIERS TO ENTRY
Barriers generate profit for the monopolist in the
short run and long run.
Barriers can take the form of:
 control of natural resources or inputs.
 increasing returns to scale.
 technological superiority.
 government-made barriers, including patents and
copyrights.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
1. CONTROL OF A SCARCE RESOURCE OR
INPUT
If De Beers owned nearly all of the diamond
mines in the world, it would have a monopoly in
diamond production.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
ECONOMICS IN ACTION
NEWLY EMERGING MARKETS: A DIAMOND
MONOPOLIST’S BEST FRIEND
DeBeers (the original diamond monopoly) has, since 1990
 Lost control of many mines
 Agreed to stop monopolizing and fixing prices in the US
diamond market (2013)
 Been faced with high-quality synthetic diamond alternatives
BUT… demand is growing in China and India… and mines
are being depleted

C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
2. INCREASING RETURNS TO SCALE

A natural monopoly exists

when increasing returns to
scale (economies of scale)
provide a cost advantage to
a single firm.

Hoover Dam, a natural

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
2. INCREASING RETURNS TO SCALE
A given quantity of output is produced more cheaply by one large firm
than by two or more smaller firms.

Price,
cost

Natural monopoly. ATC is

falling over the relevant
output range

Natural monopolist’s ATC

break-even price

D
Quantity
Relevant output range
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
3. TECHNOLOGICAL SUPERIORITY

A firm that maintains a consistent technological

advantage over potential competitors can
establish itself as a monopolist.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
4. NETWORK EXTERNALITY
Network externality: the value of a good or service
to an individual increasing as more others use the
same good or service.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
5. GOVERNMENT-CREATED BARRIER
A patent gives an inventor a
temporary monopoly in the
use or sale of an invention.

A copyright gives the

creator of a literary or
artistic work sole rights to
profit from that work.
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
HOW A MONOPOLIST MAXIMIZES PROFIT
Competitive firms cannot choose price. Monopolists can.

(a) Demand curve of an individual (b) Demand curve of a monopolist

perfectly competitive producer
Price Price

Market DC
price

DM

Quantity Quantity

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
HOW A MONOPOLIST MAXIMIZES PROFIT

MR is below the demand curve…

An increase in production by a monopolist has two
opposing effects on revenue:
A quantity effect: One more unit is sold,
increasing total revenue by the price at which
the unit is sold.
A price effect: To sell the last unit, the
monopolist must cut the market price on all
units sold.
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
DEMAND, TOTAL REVENUE, AND
MARGINAL REVENUE

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
LEARN BY DOING: PRACTICE QUESTION

Suppose that a monopolist can sell 5 units of

output at a price of $5 or 6 units of output
at a price of $4.
What is the MR of the sixth unit?
a) $24
b) $49
c) –$1
d) $10

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
A MONOPOLIST’S DEMAND, TOTAL REVENUE,
AND MARGINAL REVENUE CURVES
(a) Demand and marginal revenue
Price, cost, marginal
revenue of demand
$1,000

A Quantity effect =
550 B +$500
500
Price effect = –
$450
50 C D
0 9 10 20
–200 Marginal revenue =
–400 $50 MR
Quantity of diamonds
(b) Total Revenue

Total Quantity effect dominates Price effect dominates

Revenue price effect. quantity effect.

$5,000
4,000
3,000
2,000
1,000
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C O P Y R I G H T 2 0 1 5 W O R T Quantity
H P Uof B
diamonds
L I S H E R S
PROFIT MAXIMIZATION FOR A MONOPOLY

Profit maximization consists of two steps:

1.Choosing a quantity
Choose Q where MR = MC.
2.Choosing a price
Choose the highest price you can get away with,
which is the highest price consumers will pay for that
quantity.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
THE MONOPOLIST’S PROFIT-
MAXIMIZING OUTPUT AND PRICE
Price, cost,
marginal revenue
of demand
$1,000 Monopolist’s
optimal point

B
PM 600
Perfectly competitive
Monopoly industry’s optimal point
profit
PC 200 MC = ATC
A C
D
0
8 10 16 20
Quantity of diamonds
–200 QM QC
MR
–400

The price De Beers can charge per diamond is found by going to the point on the
demand curve directly above point A, (point B here)—$600 per diamond. It makes a
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
THE MONOPOLIST’S PROFIT
As long as the monopoly has strong barriers to entry,
profit will stay.

Price, cost,
marginal
revenue
MC
ATC
B
PM

Monopoly
profit
A
D
ATCM
C

MR

QM Quantity Back to Ta
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
LEARN BY DOING: PRACTICE QUESTION

What are the monopolist's profit-maximizing price and output

level here?
a) P = $3.00; Q = 40
b) P = $16.50; Q = 40
c) P = $6.00; Q = 40
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
IS THERE A MONOPOLY SUPPLY
CURVE?
Monopolists don’t have supply curves since
they control prices there is no set relationship
between Price and Quantity supplied.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
MONOPOLY CAUSES INEFFICIENCY

(a) Total surplus with perfect competition (b) Total surplus with monopoly
Price, Price, cost,
cost Consumer surplus with marginal Consumer surplus with
perfect competition revenue monopoly

PM Profit

Deadweight loss

PC MC = ATC MC = ATC
D D
MR
QC Quantity QM Quantity

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
MONOPOLY AND PUBLIC POLICY
When a monopoly raises prices and lowers Q,
consumer surplus falls and deadweight loss is
created.

To avoid deadweight loss, government policy

attempts to prevent monopoly behavior.
Antitrust policy: The government policies used to
prevent or eliminate monopolies.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
DEALING WITH NATURAL MONOPOLY
Natural monopolies are a different story: They
bring lower costs…

…but there’s no guarantee the firm will

voluntarily pass along its cost savings to
consumers.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
DEALING WITH NATURAL MONOPOLY
What can public policy do about this?
Public (government) ownership:
But publicly owned companies are often poorly
run.
Price regulation:
A price ceiling imposed on a monopolist does not
create shortages if it is not set too low.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
UNREGULATED AND REGULATED
NATURAL MONOPOLY
(a) Total surplus with an unregulated (b) Total surplus with a regulated
natural monopolist natural monopolist

Price, cost, Price, cost,

marginal Consumer marginal Consumer
revenue surplus revenue surplus

Profit
PM

ATC PR* ATC

MC MC
D D
MR MR
QM QR Quantity QR* Quantity

If the monopoly’s price is regulated at PR, consumer surplus

rises (and profits fall).
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
PRICE DISCRIMINATION
So far we’ve been assuming our firms is a single-
price monopolist:
It offers its product to all consumers at the same
price.

Some firms practice price discrimination:

They charge different prices to different consumers
for the same good.

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
PRICE DISCRIMINATION AND PROFIT
MAXIMIZATION
Recall the profit-maximizing rule for firms with
monopoly power:
 Produce the Q at which MR = MC.
 Based on that Q, charge as much as the market will
bear.
But what if you sell to more than one market, each
with its own demand curve?
E.g., senior citizens and young people, business
travelers and leisure travelers.
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
PRICE DISCRIMINATION

55+ Students
DISCOUNT Get
10% Off!
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
TWO TYPES OF AIRLINE CUSTOMERS
Price, cost of
ticket Profit from sales to business If your consumers have
travelers
low price elasticity,
$550 charge them more!

B Profit from sales to student

travelers

150
125 MC
S
D
0 2,000 4,000
Quantity of tickets
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
LEARN BY DOING: PRACTICE QUESTION
Who probably has more elastic demand for a Hertz rental
car? Person A reserves a car online weeks before a trip;
person B walks up to a Hertz counter after he walks off an
airplane after a four-hour flight? Who probably gets
charged more?
a) Person B a more elastic demand and will be charged
less.
b) Person B has a more elastic demand and will be charged
more.
c) Person A has a more elastic demand and will be charged
more.
d) Person A has a more elastic demand and will be charged
less.
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
PRICE DISCRIMINATION INCREASES SALES
AND PROFITS
(a) Discrimination with two prices (b) Discrimination with three prices
Price, Price,
cost cost
Profit with
two prices Profit with
Phigh
three prices
Phigh
Pmedium
Plow
Plow

MC MC

D D

Quantity Quantity
Sales to Sales to Sales to Sales to Sales to
consumers consumers consumers consumers consumers
with a high with a low with a high with a with a low
willingness to willingness willingness to medium willingness to
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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
PRICE DISCRIMINATION
There is no deadweight loss, because all mutually beneficial
transactions are exploited.
There is zero consumer surplus: The entire surplus is captured by
the monopolist in the form of profit.
Price, cost (c) Perfect price discrimination

Profit with perfect price

discrimination

MC

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
PRICE DISCRIMINATION
Common techniques for price discrimination:
Advance purchase restrictions
Volume discounts
Two-part tariffs

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C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
ECONOMICS IN ACTION

Sales, Factory Outlets, and Ghost Cities: Evidence of Price

Discrimination?
Necessities: (sheets, towels) go on sale rarely
Outlets: lower prices but further away
Airline tickets: often cheaper to fly longer distances to major
cities than short distances to small cities
Can you explain the pricing in light of differences in price
elasticity of demand?

C O P Y R I G H T 2 0 1 5 W O R T H P U B L I S H E R S
LEARN BY DOING: BUSINESS CASE
Amazon and Hachette Go to War
May 2014: in a dispute over the increase in
Amazon’s fees to Hachette publishers (30% to
50%) Amazon slowed delivery of Hachette books,
removed ordering options and suggested
alternatives to customers.

QUESTIONS FOR THOUGHT

1. What is the source of surplus in this industry? Who
generates it? How is it divided among the various agents
(author, publisher, and retailer)?
2. What are the various sources of market power here?
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