3. Imperfect Competition

 Imperfect competition exists when one or more buyers or sellers have a perceptible influence on price/quantity.  The type of imperfect competition is defined by the number of buyers or sellers with such influence:

• monopoly/monopsony

• duopoloy/duopsony

• oligopoly/oligopsony

• monopolistic competition where there are a large number of firms but product differentiation permits them to exercise some degree of control over price.

          In perfect competition the demand curve faced by a firm is horizontal.  In imperfect competition the demand curve is not horizontal.  At the extreme, in monopoly, the demand curve faced by the seller is the market demand curve.  Unfettered by competition the monopolist knows impact of any pricing decision has a negligible effect on competitors because there are none.  The monopolist can pursue pure economic profit maximization subject only to the constraint of substitutes.  The closer the substitute the more elastic the monopolists demand curve and the less market power at its disposal.  

4. Monopoly

a)     Conditions
    Monopoly satisfies the following conditions:

• no distinction between the firm and the industry, i.e. there is only one producer;

• one producer faces many buyers, i.e. the producer has market power; and,

• there is a negatively sloped demand curve.

Monopoly is mitigated only by competition from substitutes.  The firm is able to choose the price-quantity combination to maximize its profits.  The monopolist equates marginal revenue and marginal cost rather than price equal to marginal cost.  This is because a monopolist, unlike a perfect competitor, can only sell more of a good if the price drops, i.e., the monopolist faces a downward sloping demand curve, the perfect competitor, a horizontal one..  Where MR = MC is the 'sweet spot'.  In theory the monopolist is considered inefficient because the quantity supplied is less and the price higher than under perfect competition.  The inverse of a monopoly or monopsony can also exist, i.e. market power exercised by a single buyer facing many producers.
          Monopoly exist for one, or more, of four reasons.  First, one firm may control the entire supply of a basic input.  Second, a firm may become a monopolist because the average cost of producing the product reaches a minimum at an output sufficient to supply the entire market - a natural monopoly (MBB 10th Ed Fig. 9.1; MBB 11th Ed Fig. 8.1;P&B 4th Ed Fig. 13.1; 5th Ed. Fig. 12.1).  Is Microsoft a “natural monopoly’?  Third, a firm may acquire control over product through an intellectual property right - copyright, patents, registered industrial designs, trademarks - granted by the State.  Fourth, a firm may become a monopolist because government awards an exclusive market franchise, e.g. electric power, water supply, etc.
          While a monopoly may exist in a given market, a monopolist is seldom entire insulated from the economy as a whole.  All commodities are rivals for the consumer’s limited income.  The more ‘near substitutes’ the greater the moderating influence on a monopolist.  The threat of entry by outsiders interested in gaining some of the monopolist’s excess profits can serve to moderate pricing behavior, e.g. the threat that cable companies could offer telephone service will limit the pricing of a telephone monopolist.  

b) Monopoly Demand Curve
         The monopolist faces the same demand curve as the industry.  As in perfect competition, the market demand curve is constructed from the horizontal summation of individual consumer demand curves and is usually negatively sloped, i.e. if price goes up, demand goes down.  In perfect competition, however, if the market price (over which the perfect competitor has no control facing a horizontal demand curve) goes up the quantity supplied by firms will increase.  In monopoly, however, an increase in price will cause a decrease in the quantity supplied by the monopolist.  Thus unlike the perfect competitor, a monopolist can choose which price to charge and thereby what quantity will be demanded.  The monopolist can thereby charge a price that supplies a quantity that maximizes profits but cannot adjust both independently.  This can be seen by reference to marginal revenue in perfect competition and monopoly: if

• R = pq

• MR = dR/dq

• in perfect competition, the firm is a price taker at a given market price facing a horizontal demand curve and therefore MR = p

• in monopoly facing a negatively sloping demand curve, the firm is a price setter and MR does not = p because an additional unit of q can only be sold at a lower price (MBB 10th Ed Fig. 9.3; MBB 11th Ed. 8.3; P&B 4th Ed Fig. 13.2; 5th Ed Fig. 12.2)

c) Short-Run Equilibrium
          If free from outside interference a monopolist will choose the price/quantity relationship where the difference between total revenue and total cost is at a maximum, i.e. maximum profits.  In perfect competition, the maximizing firm will equate price to marginal cost to maximize profit and the supply curve is derived from these points.  Under monopoly, maximum profit is obtained when output is at the point where marginal revenue equals marginal cost.  Thus at any output where marginal revenue exceeds marginal cost, total or accumulated profits can be increased by more output.  When marginal cost exceeds marginal revenue, accumulated profits decline and can only be increased by reducing output (MBB 10th Ed Fig. 9.4; MBB 11th Ed. Fig. 8.4; P&B 4th Ed. Fig. 13.4; 5th Ed Fig. 12.4).
          In perfect competition a unique relationship exists between the price and the output supplied.  In monopoly there is not a unique relationship.  This is because variation in marginal revenue of the monopolist caused by a shift in demand can result in a different output level but at the same price.  

d) Long-Run Equilibrium
          In perfect competition there can be no long-run economic profits or losses because firms will enter or leave the market.  In monopoly, there are no long-run competitors unless the industry ceases to be a monopoly - by definition.  Thus long-run equilibrium in a monopoly will be characterized by economic profits.  If, on the other hand, a monopoly experiences short-run losses it will adjust the scale and characteristic of its plant to eliminate such losses in the long-run.  If this is not possible the monopolist will leave the industry.
          Assuming short-run profits, in the long-run the monopolist will adjust its plant to achieve even larger profits.  Output will be provided at the level at which long-run marginal cost equals long-run marginal revenue.  

e) Perfect Competition vs. Monopoly
          First, under perfect competition, each firm operates at the point where long-run and short-run average cost are at a minimum.  Under monopoly, however, the firm will operate at minimum average cost but not at its long-run minimum.
          Second, under perfect competition output tends to larger and price lower (P = MC) than under monopoly (MR = MC).  This results in a ‘dead weight loss’ of monopoly which reflects the fact that the consumer surplus is reduced but the gain to the monopolist is less than the loss to consumers (MBB 10th Ed Fig. 9.6 &  9.10; MBB 11th Ed Figs 8.6 & 8.10; 4th Ed. Fig.'s 13.5 & 13.6; 5th Ed. Fig.'s 12.5 & 12.6).  

f) Monopoly & ‘Big” in Economic Thought

Dangers of monopoly were a concern to Marx whose solution was public ownership of the means of production.  The extremity of this solution fuelled Alfred Lord Marshall efforts to set out a model of perfect competition and demonstrate the comparative costs of monopoly.  According to Marshall, the monopolist was like a tree in the forest; it would grow but eventually fall.  Reasons included the idea that inheritors to the monopolist’s power would be less able than the founder until eventually the firm died – Eatons? 

Following a series of Harvard Law Review articles written by Adolf A. Berle, Jr. and E. Merrick Dodd, Jr., in 1932 Berle and Gardiner Means’ published their influential book, The Modern Corporation and Private Property.  This text established the concept of separation of ownership and control of the ‘modern’ corporation and laid the foundation for John Kenneth Galbraith’s concept of the ‘technostructure’, i.e large firms can become self-perpetuating or ‘immortal’ through the self-genesis of management.

On the other hand, Joseph Schumpeter argued that the forces of 'creative destruction' or technological change was the dominant force in economic growth and such change required the surplus expropriated by monopoly to fund the necessary research & development.