Download Monopoly, Dominant Firm, Monopsony (in PDF)

ECMC41 – Week Three
Topics:
a. Monopoly:
Structure, Conduct, Basic Conditions,
Performance
b.
Dominant Firm, Competitive Fringe
Or, what happens when competitive firms
enter a monopoly industry? Structure,
Conduct, Performance
c.
Monopsony:
Structure, Conduct, Performance
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The Monopoly Model
(a) Single seller
(b) Entry to market is blocked.
Therefore, firm has entire industry demand and no
competitors or potential competitors to worry
about.
Could be:
(a) cost advantage – economies of scale which
are large relative to the size of the market
(known as “natural monopoly”
(b) government licence or restriction
(patent)
(c) ownership of scarce but essential
resource
(d) some other barrier to entry (e.g., huge
advertising costs)
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Single seller faces entire market demand
curve (price maker, not price taker)
Graphically:
Price
per unit
quantity
MC
AC
Demand
MR
0
3
Quantity
produced
per unit of
time
Why is MR < P?
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Algebraic example
Market Demand: P = 100 - .02Q
So, total revenue = TR = PxQ = 100Q - .02Q2
Marginal Revenue = dTR/dQ = 100 - .04Q
(the rate at which total revenue is changing
as output increases)
Total cost function of monopoly firm:
TC = .01q2 + 10q + 432 or .01Q2 + 10Q + 432
So, MC = .02Q + 10
(the rate at which total cost is changing as
output increases)
AC = .01Q + 10 + 432Q-1
We can solve by forming the profit function
and maximizing with respect to Q
TR – TC = 100Q - .02Q2 - .01Q2 + 10Q + 432
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Or we can set MC = MR and solve for Q
(Conduct)
Substitute into the demand curve to find
P*(Conduct)
How much is the profit of the monopolist?
(Performance)
Where is the monopolist’s supply curve?
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What about the long run?
Is the monopolist efficient? (Performance)
Several perspectives:
Does the monopolist minimize costs?
Is marginal benefit equal to marginal cost at
the monopolist’s equilibrium output?
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Does the monopolist’s output maximize the
sum of producer and consumer surpluses?
Classic view is that monopoly distorts
resource allocation and causes deadweight
efficiency loss. Monopolist produces too
little output (uses too few resources). In
practice, there are other considerations.
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A distributional concern (not allocative
efficiency):
Does the monopolist transfer potential CS
into PS?
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What is the role of elasticity? (Basic
Conditions)
Derive an expression for the market power of
the monopolist (any firm, really)
First part: Take expression for MR and
analyze it (in abstract form):
MR = dTR/dQ = d(P x Q)/dQ
By the product rule of calculus…
d(P x Q)/dQ = (dP/dQ x Q) + (dQ/dQ x P) =
(dP/dQ x Q) + P
Then divide by P = (dP/dQ x Q/P) + P/P
And multiply by P = P[(dP/dQ x Q/P) + 1]
But (dP/dQ x Q/P) = 1/ED
So, we have: MR = P(1 + 1/ED)
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Second part: Since, at profit max, MC = MR,
then at profit max quantity:
MC = P(1 + 1/ED)
So, MC/P =(1 + 1/ED)
Or MC/P – P/P = 1/ED
Or (MC – P)/P = 1/ED
Or, multiplying both sides by –1…
Or (P - MC)/P = -1/ED
Which can be interpreted as proportional
markup depends on elasticity of demand (for
the output of the firm, not the industry).
Interpret (P - MC)/P as an index of market
power and call it the Lerner Index
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How does elasticity affect DWL, and profit?
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What about natural monopoly?
What about dynamic efficiency?
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Dominant Firm, Competitive Fringe
Assumptions (structure):
(a) One firm dominant – lower production
costs
(b) Fringe of other small firms. No market
power. Price takers. Competitive Fringe
(c) No additional entry
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Graph (gives conduct):
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Algebraic example:
Industry demand: P = 1000 - .005Q
100 firms in competitive fringe
TCCF = 600q + q2
TCDF = 500q
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Monopsony:
What is it?
Structure, Conduct, Performance
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