Micro CHAPTER 4.1:

CHAPTER SUMMARY

Up until now, we have focused on perfectly competitive markets, where all firms sell the exact same product. In this unit, we will investigate the unique features of different types of imperfectly competitive markets - ones where there are differences between producers, and the rules of economics get more complicated! There are several types of imperfectly competitive markets:

• Monopolistic Competition - a monopolistically competitive market has many sellers and low barriers to entry, but sellers are able to differentiate their products from one another. One example is the restaurant industry.

• Oligopoly - An oligopolistic market has just a few firms (more than 1, but less than 10) that dominate the market due to high barriers to entry. One example is the airline industry.

• Monopoly - A monopolistic market is one where there is only 1 firm that dominates the market, with little or no competition. One example is the utilities (water, power, etc.) industry. A monopoly can occur because there are extremely high barriers to entry, or because a market is controlled by the government.

Under imperfect competition, firms are price-makers, meaning they can choose what price to sell their products for, unless the government requires them to sell them for a specific price (this sometimes happens with monopolies). Firms can also engage in non-price competition (superior quality, advertising, unique product features, etc.), and can earn long-run profits.

When a firm is a price-maker, it no longer has a perfectly elastic demand curve. It instead has a downward-sloping demand curve, which has a major impact: the MR=D=AR=P curve no longer exist. It is still true that D=AR=P, but the MR becomes a separate curve, as seen below.

How is this possible? Remember that marginal revenue is the additional revenue earned by selling one more unit. For an imperfectly competitive firm, in order to sell more units, they have to lower the price. For example, let's say a firm is currently selling 10 units at a price of $50 each. In order to increase sales to 11 units, they cannot just sell another one for $50, because there is no one left who wants to buy it at that price. So, they lower their price to $48 in order to sell 11 units instead of 10.

You might think, okay, so marginal revenue is $48. However, unless a firm is able to price discriminate (we will learn what that means later), they will have to lower the price to $48 for all customers, not just the 11th customer. That means they are now selling 11 units at $48 each. So here is a before & after:

Before: 10 units * $50 = $500 total revenue

After: 11 units * $48 = $528 total revenue

So, by selling one additional unit for $48, the total revenue actually only increased by $28! This means the marginal revenue of the 11th unit is only $28. As a rule, the MR curve will start at the same point as the demand curve (because the MR of the first unit is equal to the highest price that one customer is willing to pay), but will go down more steeply than the demand curve.

A few other notes about the imperfect competition graph:

• The point where MR crosses 0 is the revenue maximization quantity. Beyond that, lowering the price to sell more quantity results in less revenue overall because MR is negative, meaning TR is going down.

• Everything to the left of the revenue maximizing quantity on the demand curve represents price elastic demand, because lowering the price increases revenue. Everything to the right of it represents price inelastic demand, because lowering the price decreases revenue.

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