The University of Kansas

ECON 630 Fall 2015

GTA: Jssica Dutra, dutra@ku.edu
Office Hours: Snow 229 MW: 2:00-3:00pm, T: 2:30-3:30pm

The market demand is given by = () = 200

The supply for the competitive fringe is = () = 40
Marginal cost for the dominant firm is = 40

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Derive the residual demand for the dominant firm.

Derive the marginal revenue for the dominant firm.
How much will the dominant firm decide to produce?
What is the price imposed in the market by the dominant firm?
How much will the competitive fringe supply?
How is the consumer surplus different in this market vs. if it were a monopoly?
How did producer surplus differ from that of monopoly?
What would be your arguments advising the FTC on the pros and cons of this market structure?

Residual demand () = (() ()) = 240 2 120

Notice that inverse demand is = 200 and inverse supply is = 40 + . Inverse residual demand
is = 120 0.5. As usual, marginal revenue for linear demand functions, same intercept, double the
slope = 120 . As a maximizing profit firm, choose quantity where MR=MC.

120 = 40
= 80

At this quantity, choosing the price that maximizes profit for the dominant firm.
= 120 0.5(80) = 80
= ( ) = (80 40) 80 = 3200$
As price-takers, the competitive fringe observe the price chosen by the dominant firm and supply

accordingly: = 40
= 40, making total market quantity supplied 120.
If it were a monopoly, the firm would face a marginal revenue correspondent to market demand, and not
corresponding to residual demand (another way to think of this is that the residual demand is in fact all
market demand in the absence of other firms).
= 200 2

Setting it equal to MC 200 2 = 40

= 80

= 200
= 120

= (120 40) 80 = 6400$

Consumer Surplus under DFCF (Dominant Firm Competitive Fringe):

=

(200 80) 120

= 7200
2

Consumer Surplus under Monopoly

=

(200 120) 80
= 3200
2

Because the marginal revenue curve has two sections, there are two possible types of equilibria:

The dominant firm charges a high price, so that it makes economic profits and the fringe firms
also make profits or break even.
The dominant firm sets a price so low that the fringe firms shut down to avoid making losses and
the dominant firm becomes a monopoly.

A low-cost dominant firm has market power even though it competes with other firms.

A profit-maximizing dominant firm does not attempt to drive out fringe firms at all costs.

Its behavior depends on how great its cost advantage over fringe firms is and on how easily other
firms can enter.

If a large number of price-taking firms can enter the market whenever a profit opportunity occurs,
the dominant firm is unable to charge prices substantially above the competitive price.

Even if fringe firms do not enter a market, the threat of their entry may cause a monopoly to set a
lower price than it would in the absence of the fringe.