Unit 2: Imperfect Market Structure

1. Monopoly

A monopoly exists when a single firm is the sole producer of a product with no close substitutes.

Core Characteristics:

• Single Seller: The firm and the industry are synonymous.
• Price Maker: The firm exercises significant control over the market price.
• Barriers to Entry: Strong barriers prevent new competitors from entering the market.

Profit Maximization: A monopolist maximizes profit by producing at the level where Marginal Revenue (MR) equals Marginal Cost (MC). Because the demand curve is downward-sloping, the price is higher than MR.

2. Price Discrimination

Price discrimination is the practice of charging different prices to different consumers for the same good, where price differences do not reflect cost differences.

Types of Price Discrimination:

• First-Degree: Charging each consumer the maximum price they are willing to pay (captures all consumer surplus).
• Second-Degree: Charging different prices based on the quantity consumed (e.g., volume discounts).
• Third-Degree: Charging different prices to different groups of consumers based on their price elasticity of demand (e.g., senior citizen discounts).

3. Monopolistic Competition: Price and Output Determination

Monopolistic competition involves many firms selling differentiated products that are close substitutes but not identical.

Equilibrium Analysis:

• Product Differentiation: Firms use branding and quality to gain a limited degree of market power.
• Short-Run: Firms can earn supernormal profits or incur losses, reaching equilibrium where MR = MC.
• Long-Run: Ease of entry and exit leads to a situation where firms earn only normal profits, though they produce at a point where Average Cost is still falling (excess capacity).

4. Oligopoly

Oligopoly is a market structure dominated by a few large firms that are strategically interdependent.

Key Features:

• Interdependence: Each firm's decisions regarding price and output significantly impact its rivals.
• Barriers to Entry: Significant obstacles make it difficult for new firms to enter.
• Non-Price Competition: Firms often compete through advertising and product improvements rather than price cuts to avoid price wars.

5. Government Intervention

Governments often intervene in imperfect markets to address inefficiencies and protect consumer interests.

• Antitrust Laws: Regulations intended to prevent monopolies and encourage competition.
• Price Ceilings: Setting a maximum price to prevent firms from overcharging consumers.
• Public Ownership: In some cases, the government may take control of an industry (e.g., utilities) to ensure fair service and pricing.