Download Chapter 14

Firms with Market Power
 Essentially firms with market
power(aka.monopoly power) include all firms that
are not price-takers or are not confronted with a
perfectly elastic demand curve.
 Thus, market power means that the firm has some
control over price. It can raise price without
losing all of its sales.
 Thus, this chapter includes firms with significant
price control and firms with some but little price
control.
14.1
(Pure) Monopoly
 The characteristics of the monopoly model
are:
– A single firm in the market.
– That firm produces a unique product with no
close substitutes.
– Barriers to entry into the industry.
– Firm has significant price control.
14.2
Monopolistic Competition
 A different market structure that still reflects
market power is monoplistic competition.
 As its name implies it includes competitive
as well as monopoly elements.
14.3
Monopolistic Competition
 The characteristics of the monopolistic
competition are:
– A large number of firms in the market.
– That each firm produces and sells a
differentiated product with other firm’s
products being close substitutes.
– Low barriers to entry into the industry.
– Firm has some price control but it is limited by
the number of available substitutes.
14.4
Measurement of Market Power
 Economists have developed several
quantitative measures of the degree of
monopoly power. These are frequently used
in antitrust cases and the evaluation of
mergers and acquisitions. They are:
–
–
–
–
Elasticity
Lerner Index
Cross-Price Elasticity
Herfindahl Index – not discussed
14.5
Defining the Market
 Before discussing market power we must
delineate the concept of a market.
 To define a specific market one must
identify the producers and products that
(directly) compete for consumers in a
specific area. These competing products
must be perceived as “close” substitutes for
one another.
14.6
Defining the Market for CocaCola
 Is Pepsi in the same market?
 Is Gatorade in the same market?
 Is Budweiser in the same market?
 Is Orange Juice in the same market?
14.7
Measuring Market Power:
Elasticity of Demand
 A price-taker had a perfectly elastic demand curve.
 As elasticity increases, the ability to raise price
and not lose substantial sales is diminished.
 Thus, the elasticity coefficient gives an indication
of market power.
– The higher elasticity the lower the degree of market
power and vice versa
 Note we will show later that a firm will never
operate in the inelastic portion of its demand
curve.
14.8
The Lerner Index
 The Lerner Index measures the extent that
Price deviates from the price that would
exist under perfect competition.
P  MC
LI 
P
14.9
Lerner Index and Elasticity
 Assuming profit maximization MR=MC.
 Also we demonstrated that MR = P(1+1/E)
in Chapter 3. Thus, Lerner Index is
1 )
P

P
(
1

P  MR
E


P
P
1  (1  1 )   1
E
E
14.10
Lerner Index
 Under Perfect Competition the Lerner Index
is zero.
 The Lerner Index increases with the degree
of market power.
 The Lerner Index varies inversely with the
elasticity of demand.
14.11
Cross Price Elasticity
 The cross price elasticity serves as an
indicator of market power – although not a
direct measure of market power.
 It measures the degree of substitutability
between two products – the extent to which
consumers view the products as substitutes.
 The higher the cross price elasticity(positive
assumed) coefficient – the less market
power and vice versa.
14.12
Determinants of Market Power
 Strong barriers to entry increase market
power. Sources of these are
– Economies of scale
– Government created
• Licenses
• Franchises
• Patents
– Control of input supply
– Brand loyalty
14.13
Profit Maximization under
Monopoly
Demand and Marginal Revenue in Monopoly
P& MR($s)
D
MR
Q
14.14
Profit Maximization under
Monopoly
Not the shutdown case.
MC
P& MR($s)
P*
D
Q*
MR
Q
14.15
Short Run Equilibrium
 Need to visualize possible short run cases.
– No shutdown, produce where MR=MC as long
as P>AVC for some level of output.
• Profit Max if P>ATC
• Loss Min if AVC<P<ATC
– Shutdown, produce Q=0 and Loss= TFC
– All but shutdown are shown in Figures 14.3 &
14.4
14.16
Long Run Profit Max
 To max profits in the LR, the monopolist
produces where MR=LMC unless P<LAC
in which case exiting from the industry is
the optimal decision.
 The monopolist will general earn an
economic profit in the long run since entry
is restricted.
 See Fig 14.5
14.17
Optimal Input Usage for the
Monopolist
 Same rule applies as before MRP = MC of
the input(or wage rate if input is labor).
 The only thing to be careful with is that
MRP = MR*MP and in perfect competition
since MR and P were the same we generall
multiplied MP times the output price to get
MRP.
 In the case of monopoly we need to be sure
MRP is the product of MR and MP.
14.18
Monopolistic Competition
 Short run equilibrium(profit max) looks just
like monopoly model SR equilibrium. The
only difference is that the monopolistically
competitive firm’s demand curve is more
elastic(flatter?).
 However, that difference is not discernible
in our graphics.
14.19
Long Run Equilibrium in
Monopolistic Competition
 Given the ease of entry and exit, and the
closeness of substitutes, in monopolistic
competition firms will earn normal profits.
 Thus, P = LAC.
 However, P > LMC since LMC=MR and
MR<P due to negative slope to demand
curve.
 See Fig 14.9 for graphic view.
14.20