Monopoly

P&R Chapter 10

Topics to be Discussed
Monopoly and Monopoly Power Sources of Monopoly Power Social Costs of Monopoly Power Monopsony Antitrust Laws

Monopoly
Monopoly
1. 2. 3. 4.

One seller - many buyers One product (no good substitutes) Barriers to entry Price maker

Monopolist controls supply-side of market

Controls price, but must consider consumer demand Profits maximized at output level where marginal revenue equals marginal cost

Total, Marginal, and Average Revenue

Average revenue (AR), price received per unit sold, is market demand curve Marginal revenue (MR), change in revenue from unit change in output P = -aQ + b MR = -2aQ + b When demand is downward sloping, AR is greater than MR
To increase sales price must fall

As before, profits maximized at output level where MR = MC

4

Average and Marginal Revenue

$ per unit of output

7 6 5 4 3 2 1 0
Marginal Revenue

Average Revenue (Demand)

7 Output
5

Monopolists Output Decision

$ per unit of output

MC P1 P* AC P2
Lost profit

D = AR MR Q1 Q* Q2
Lost profit

Quantity
6

Example of Profit Maximization

$/Q

40

MC

Profit = (P - AC) x Q = ($30 - $15)(10) = $150

P=30
Profit

AC AR

20 AC=15 10 MR 0 5 10 15 20
Quantity
7

Monopoly pricing

Monopoly: P > MC P=

MC 1 + (1 Ed )

Price is larger than MC by amount that depends inversely on elasticity of demand

Monopoly
Monopoly pricing compared to perfect competition pricing:
Perfect Competition P = MC Demand is perfectly elastic, so P=MC

P=

MC 1 + (1 Ed )

If demand is very elastic, little benefit to being monopolist

Shifts in Demand
In perfect competition, market supply curve determined by marginal cost For monopoly, output determined by marginal cost and shape of demand curve
No supply curve for monopolistic market

Shifts in demand lead to

Changes in price with no change in output Changes in output with no change in price Changes in both price and quantity

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Effect of Tax
In competitive market, per-unit tax causes price to rise by less than tax
Burden shared by producers and consumers

Under monopoly, price can rise by more than tax amount To determine impact of tax:
t = specific tax MC = MC + t

Amount price increases with tax depends on elasticity of demand Profits for monopolist fall with tax

11

Multi-plant Firm
Firm must determine how to distribute production between plants with different costs
1. 2.

Production should be split so MC in plants is same Output chosen where MR=MC. Profit maximized when MR=MC at each plant. Q1 and C1 is output and cost of production for Plant 1 Q2 and C2 is output and cost of production for Plant 2 QT = Q1 + Q2 is total output Profit is = PQT C1(Q1) C2(Q2)
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Algebraically:

Multi-plant Firm
Firm should increase output from each plant until additional profit from last unit produced at Plant 1 equals 0 ( PQT ) C1 = =0 Q1 Q1 Q1

MR MC1 = 0 MR = MC1
For Plant 2 MR = MC1 = MC2
13

Production with Two Plants

$/Q

MC1

MC2 MCT

P*

MR*

D = AR

MR Q1 Q2 QT
Quantity
14

Monopoly Power
Pure monopoly rare Less rare:
Market with several firms, each facing downward sloping demand curve, producing so P>MC

Firms often produce similar goods with some differences that differentiate themselves

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Market power
-

Found in 1934 by Abba Lerner

P MC 1 = P ED (0 L 1) L=
-

In perfect competition: P = MC L = 0 The higher value of L is, the stronger market power a firm can gain Ed is elasticity of demand for a firm, not market

Monopoly Power
Monopoly power does not guarantee profit
Firm may have more monopoly power but lower profits due to high average costs

Pricing for any firm with monopoly power:

If Ed large, markup is small If Ed small, markup is large

Firms demand elasticity determined by:

Elasticity of market demand Number of firms in market (with one firm, demand curve is market demand curve) Interaction among firms

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Elasticity of Demand and Price Markup

$/Q
More elastic demand, less markup. MC

$/Q

P*

MC

P*
P*-MC
D

P*-MC

MR D MR

Q*

Quantity

Q*

Quantity

Social Costs of Monopoly Power

Monopoly power results in higher prices and lower quantities Perfectly competitive firm produce where MC = D PC and QC Monopoly produces where MR = MC, with price from demand curve Loss in consumer surplus (deadweight loss) when going from perfect competition to monopoly

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Deadweight Loss from Monopoly Power

$/Q
Lost Consumer Surplus Because of higher price, consumers lose A+B and producer gains A-C.

Deadweight Loss

MC

Pm A PC B C AR=D

MR Qm QC
Quantity
20

Social Costs of Monopoly Power

Natural Monopoly: Firm that can produce entire output of an industry at cost lower than if there were several firms
Arises when large economies of scale Splitting market into two firms results in higher AC for each firm than when only one firm was producing

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Regulating Price of a Natural Monopoly

$/Q
Unregulated, monopolist would produce Qm and charge Pm. If price were regulated to be Pc, firm would lose money and go out of business. Cant cover average costs Setting price at Pr , profits as large as possible without going out of business

Pm

Pr PC MR
Qm Qr

AC MC AR

QC

Quantity
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Monopsony
Monopsony: market with single buyer Oligopsony: market with few buyers Monopsony power: ability of buyer to affect price of good and pay less than competitive market price

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Monopsony
Typically choose to buy until benefit from last unit equals units cost Marginal value: additional benefit derived from purchasing one more unit Marginal expenditure: additional cost of buying one more unit Depends on buying power Competitive Buyer Price taker P = Marginal expenditure = Average expenditure D = Marginal value
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Competitive Buyer Compared to Competitive Seller

$/Q

Buyer

$/Q

Seller

MC

ME = AE

AR = MR

P*

P*
MR = MC P* = MR P* = MC D = MV

ME = MV at Q* ME = P* P* = MV

Q*

Quantity

Q*

Quantity

Monopsonist Buyer
Buyer buys until value from last unit equals expenditure on that unit Market supply curve Shows how much pay per unit as function of total units purchased Supply curve is average expenditure curve Upward sloping supply implies marginal expenditure curve must lie above it Decision to buy extra unit raises price paid for all units
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Monopsonist Buyer
$/Q

ME

Monopsony ME above S Quantity where ME = MV: Qm Price from supply curve: Pm

S = AE PC P*m D = MV
Competitive P = PC Q = QC

Q*m

QC

Quantity
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Monopsony Power
Degree of monopsony power depends on: Number of buyers Fewer number of buyers, less elastic supply and greater monopsony power 2. Interaction among buyers Less buyers compete, greater monopsony power 3. Elasticity of market supply Extent to which price is marked down below MV depends on elasticity of supply If supply is very elastic, markdown small More inelastic supply, more monopsony power
1.
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Monopsony Power: Elastic Versus Inelastic Supply

$/Q MV - P*

Elastic

$/Q

Inelastic ME
MV - P* S = AE

ME P*
S = AE

MV

P* MV

Q*

Quantity

Q*

Quantity

Social Costs of Monopsony Power

Since monopsony power gives lower prices and lower quantities purchased, would expect sellers worse off and buyers better off
For sole monopsonist, quantity is where ME = MV and price is from demand For competitive market, quantity and price where S = D

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Deadweight Loss from Monopsony Power

$/Q

ME
Deadweight Loss Consumers gain A-B B

S = AE
C

PC P*

Lost Producer Surplus

MV

Q*

QC

Quantity
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Monopsony Power
Bilateral Monopoly
Market with only one buyer and one seller Bilateral monopoly rare Markets with small number of sellers with monopoly power selling to market with few buyers with monopsony power more common Monopsony and monopoly power counteract each other

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Limiting Market Power: U.S. Antitrust Laws

Market power harms some players, reduces output, leads to deadweight loss, raises problems of equity and fairness To limit market power? Tax monopoly profits and redistribute to consumers Difficult to measure, find those who lost Direct price regulation of natural monopolies U.S. antitrust laws Prohibiting actions that restrain or are likely to restrain competition Restricting forms of allowable market structures
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Exercise
A monopolist with 2 plants faces demand curve P=12-0,1Q. Cost function for each plant: ATC1=4+0,1Q1 and ATC2=2+0,1Q2
a. b. c.

Calculate P* and Q* for this monopolist Calculate Q* for each plant Calculate profit for each plant.