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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 QP 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.