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Monopoly
KW Chap. 14
Market Power
• Market power is the ability of a firm to affect the
market price of a good to their advantage. In
declining order.
• Monopoly – A single producer without
competition
• Oligopoly Power – A small number of producers
sometimes acting in concert.
• Monopolistic Competition – Firms selling
differentiated products.
Price effects
• There is a demand curve relating the
quantity of a product that can be sold at a
given price.
• Invert the concept: For each quantity, there
is a price that the market may bare.
• Change the quantity and change that price
• Marginal revenue
Marginal Revenue
• For price taking firm, marginal revenue is
equal to price.
• For a firm with market power, marginal
revenue must include the change in the
price that results from a change in
quantity.
P
MR  P 
MR  P 
P
Q
P P  P(1 
Q
Q
QP
1
)  P(1  1
)


D
Demand Elasticity
Example
Demand,
Revenue,
Marginal
Revenue
Output
Price
Revenue
Marginal Revenue
10,000.00
33.0 330,000.0
13.7
20,000.00
23.3 466,690.5
10.5
30,000.00
19.1 571,576.8
8.8
40,000.00
16.5 660,000.0
7.8
50,000.00
14.8 737,902.4
7.0
60,000.00
13.5 808,331.6
6.5
70,000.00
12.5 873,097.9
6.0
80,000.00
11.7 933,381.0
5.7
90,000.00
11.0 990,000.0
5.4
100,000.00
10.4 1,043,551.6
P 35.0
Example
Demand
30.0
25.0
20.0
15.0
MR
10.0
5.0
0.0
10
20
30
40
Price
50
60
70
80
Marginal Revenue
90
Q
Monopolist
• Maximize Revenues by choosing an output
level such that marginal revenue equals
marginal cost.
• Price will exceed marginal cost. Monopolists
will make greater profits than a competitive
firm.
– Monopolists will charge higher prices and
produce less output than a competitive industry.
• Profits should attract new entrants to the
market.
– Monopoly can only survive if there are some
barriers to entry.
Monopolist: Constant Cost
Price
P*
MC = ATC
D
MR
ATC
QMono
QPC
Output
Monopolist: Revenue
Price
P*
MC = ATC
Revenues
D
ATC
Q*
MR
Output
Monopolist: Profits
Price
P*
Profit
MC = ATC
D
ATC
Q*
MR
Output
Price
10,000
Revenue
33.0
330000
Marginal
Revenue
Cost
80000
13.66905
20,000
23.3 466690.5
160000
19.1 571576.8
16.5
240000
660000
320000
14.8 737902.4
400000
13.5 808331.6
480000
12.5 873097.9
11.7
560000
933381
11.0
990000
313097.9
8
640000
5.661905
90,000
328331.6
8
6.028302
80,000
337902.4
8
6.476632
70,000
340000
8
7.042918
60,000
331576.8
8
7.790243
50,000
306690.5
8
8.842323
40,000
Profit
250000
8
10.48863
30,000
Marginal
Cost
293381
8
720000
270000
Monopolist: General Case
MC
Price
ATC
P*
D
MR
Q*
Output
Monopolist: Revenue
MC
Price
ATC
P*
D
Revenues
MR
Q*
Output
Monopolist: Costs
MC
Price
ATC
P*
D
MR
Costs
Q*
Output
Monopolist: Profits
MC
Price
ATC
P*
Profits
D
MR
Q*
Output
Markups
• If a market is competitive, then price will
equal marginal cost.
• Degree of market power is often measured
as markup over marginal cost
P  MC
P
Lerner Index
• Net markups are a measure of the market
power of a firm or industry. Referred to as
the Lerner index. P  MC
P
• Rule of thumb for a monopolist,
P  MC 1
1
MC  MR  P(1 
)

D
D
P
– If markups are below this level, raise prices.
– If markups are above this level, lower prices.
Monopolist’s Schedule
• The more elastic the demand curve, the
higher the market power.
• The greater the market power, the greater
the markup.
• Firm has more pricing power if good has
fewer substitutes.
Barriers to Entry
• Total Control over Vital Resource
– Alcoa in the aluminum market
– DeBeers in Diamond market
• Patents or Secret Formula:
– Xerox: Controlled photocopying
• Regulations: Jockey Club, SDTM
– Gambling is a legally restricted monopoly
• Returns to Scale:
– TownGas is an regulated monopoly supplier of a
particular type of piped natural gas (may have
competition from LNG)
Natural Monopoly
• In markets with a natural monopoly there
may be one firm.
• Economies of scale indicate that at marginal
cost pricing firms make a loss.
• Efficient production involves 1 firm. Firm will
naturally charge markup and earn profits.
Monopolist: High Fixed Costs
Price
P*
ATC
MC
D
MR
ATC
QMono
QPC
Output
Monopoly
P
600
D
500
Average
Cost
Pricing
ATC
400
MC
300
200
MR
Competition
100
0
0
50
100
150
200
250
Q
Regulation
• Government may step in, usually to put a
maximum price level. Should be minimum
amount necessary to get the firm to operate
small decisions that lead to a competitive
outcome.
• Average cost pricing
• Information Problem. A single decision maker
may not have full access to enough information.
.
Learning Outcomes
• Define marginal revenue.
• Characterize the relationship between
price, marginal revenue, marginal cost,
average total cost, and profits in a
monopolistic market.
• Measure the degree of market power with
the Lerner index.
• Describe 4 barriers to entry that may
enable monopoly power.