Download Lecture II: Demand and Supply Models

Lecture ?:
Monopoly
EEP 1
Peter Berck’s Class
Who is this guy who
thinks he’s funny?
Maximilian Auffhammer
Assistant Professor IAS/ARE
[email protected]
Let’s Deviate From Perfect
Competition
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No Market Power
Perfect Information
No Externalities
No Public Goods
– Look at Market Power first.
Monopoly
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Monopolist: Only supplier of a good with
no close substitute.
– Firm output = Market output
– Firm faces market demand curve, not a
horizontal residual demand
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Does not lose all sales if price increases
Faces downward sloping demand
Monopoly
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Firm can “set price” within some
reasonable range and will still sell goods
Monopolist is a regular profit maximizing
firm:
– MR(Q) = MC(Q)
What is Marginal Revenue
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For a perfectly competitive firm:
– Marginal Revenue = Average Revenue =
Price
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For the monopolist: Price is no longer
exogenous. Price depends on Q, which
is the monopolists output choice
Average Revenue = (P(Q)xQ)/Q = P(Q)
Average Revenue is not equal to
Marginal Revenue for the
Monopolist!!!!
Convenient Fact
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If inverse Demand is linear:
– P(Q) = a – bQ
– MR(Q) = a – 2bQ
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Same intercept as inverse demand
Twice the slope of the inverse demand
MR hits Q axis “half way”
Can we show this? Yes!!!!
If MR = p, demand is perfectly elastic
Where does the monopolist
produce?
The Monopoly Decision
Market Power
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Market Power is the ability of a firm to
charge a price above marginal cost
profitably.
Degree of market power depends on
elasticity of demand curve at the profit
maximizing quantity.
Measure of Market Power: The
Lerner Index
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MR(Q*) = MC(Q*)
Lerner Index: (p- MC)/p
If firm is profit maximizing:
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(p-MC)/p = -1/ ed
Ranges from 0 to 1
If p=MC Lerner Index = 0  Perfect Competition
The more elastic the demand curve, the
smaller the markup a monopolist is able to
charge.
$
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MC
Demand Elasticity and Monopolist's Markup
The thick solid line is the more inelastic demand curve.
The dashed solid line is the corresponding Marginal Revenue Curve
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The thin solid line is the more elastic demand curve,
The thin dashed line is the corresponding Marginal Revenue Curve.
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For both demadn curves the monopolists profit maximizing output is where
MR = MC, which is 10 units and MC at this point is 20 $.
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The monopolist would charge 30 $ if the market demand is less elastic at any
given quantity. He would charge $30 to the more inelastic demand, yet only
roughly $23 to the more elastic demand.
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Note: For both demand curves the monopolist produces in the elastic section
of the demand curve!!!
~23
20
15
P(Q)1
10
MR(Q)2
5
P(Q)
MR(Q)1
2
0
0
10
Qm
20
30
40
50
60
Output (Q)
Sources of Market Power
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Demand is inelastic if:
– Consumers are willing to pay virtually
anything for a good
– No close substitutes
– No entry
– Similar firms are far away
– Other firms products are very different.