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R. Larry Reynolds 1997
Market Power
· In pure competition sellers are “price
takers.”
· No seller [or buyer] has the ability to
influence the market price.
· In most markets, at least one or more of
the conditions required for pure
competition are violated. This gives sellers
or buyers the ability to influence the
market price and allocation of resources
Fall ‘ 97
Principles of Microeconomics
Slide -- 2
Market Power
· Market power is the ability of an agent to
influence the price of a good they sell or buy and
to alter the allocation of resources.
· Sources of market power:
· monopoly, oligopoly, monopolistic competition
· monopsony, oligopsony
· Institutional structure {laws, regulations
customs, mores, . . .}
Fall ‘ 97
Principles of Microeconomics
Slide -- 3
Market Power Among Sellers
· Monopoly - a single seller of a good with no close
substitutes and barriers of entry.
· Oligopoly - a market characterized by significant
barriers to entry and “a few “ sellers who
recognize their interdependence in the market;
products may be homogeneous or differentiated.
·
Monopolistic competition - a market with a
large number of sellers and relatively free entry;
each firm “differentiates” its product.
Fall ‘ 97
Principles of Microeconomics
Slide -- 4
Other Forms of Market Power
· Monopsony - a single buyer of a resource
or good.
· Oligopsony - a market characterized by “a
few” buyers” of a resource or good.
· Bilateral monopoly - a market where a
monopolist sells to a monopsonist.
· Cartel - an organization of sellers who
engage in collusion to control output and
price.
Fall ‘ 97
Principles of Microeconomics
Slide -- 5
Barriers To Entry [BTE]
· Social or political institutions or
economic conditions that prevent
firms from entry into a market.
· laws, regulations, patents, copyrights,
trademarks, . . .
· location, natural ability, information,
economics of scale (natural monopolies)
Fall ‘ 97
Principles of Microeconomics
Slide -- 6
Monopoly
· A monopoly
· single seller
· the good produced and sold has no close
substitutes
· Barriers to entry prevent others from
competing
· in the short, run the firm can alter the price
and output; the firm is a “price maker” {or “price
setter”}
Fall ‘ 97
Principles of Microeconomics
Slide -- 7
REVENUE FUNCTIONS FOR MONOPOLIST
Since there is only one seller, the market demand is the demand
faced by the firm.
market demand & demand
$
The monopolist can set
faced by monopolist
their price which determines
AR = D
the amount they can sell.
At the mid-point of demand,
the price elasticity of
demand, ep = - 1. At this
quantity the maximum TR
ocurrs. At the max. of
TR its slope is 0. Therefore,
MR = 0.
.
ep = - 1, TR = max,
MR=0
D = AR
MR
The MR “bisects” the area under AR,
its slope is 2X the slope of AR.
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Principles of Microeconomics
X/2
X
Q/ut
Slide -- 8
A linear, negatively sloped demand
function; P = a - mQ
TR = PQ =(a - mQ) Q
TR = aQ - m Q2
TR
TR = aQ - m Q2 is a
nonlinear function.
MR =
TR
Q
= a - 2mQ
MR = a - 2mQ
P
a
The slope of MR is twice
the slope of AR or demand.
At the maximum of TR,
its slope is 0; MR = 0
Fall ‘ 97
TR
D = AR
MR
Principles of Microeconomics
Q
Slide -- 9
SHORT RUN PROFIT MAXIMIZATION
The market demand determines the revenue functions of the
monopolist.
The MC and ATC are
determined by the
production function and
prices of the inputs.
$
Monopoly Firm
PM > MC
To maximize p, the
firm will produce where
MC=MR.
The monopolist will
produce QM, which can
be sold at a price PM.
CMin
The AC at output QM is CM.
AC
PM
CM
.
QM
MR
QC
The output with the minimum cost per unit is at QC , the
equilibrium output level in pure competition.
Fall ‘ 97
MC
Principles of Microeconomics
D = AR
Q/ut
Slide -- 10
MONOPOLY PROFITS
Given the revenue and cost functions faced by the monopolist,
the firm maximizes p where MC = MR.
Output is QM at price PM.
Total revenue is calculated:
TR = PM QM
AC is CM
Total cost is;
PM
TCM = QM CM
Remember that “normal p”
is included in costs.
Monopoly Firm
$
CM
“Economic p” = TR - TC
PM > MC
.
AC
TR = PM QM
p
TCM= QM CM
In a monopoly there are BTE so,
there is no entry to capture
the above normal p; the firm continues to
earn above normal or “monoply p.”
Fall ‘ 97
MC
QM
Principles of Microeconomics
MR
D = AR
Q/ut
Slide -- 11
WELFARE LOSSES IN MONOPOLY
Monopoly profits are:
(PM - CM ) QM = pMonopoly
Monopoly Firm
$
The MC of all units up to
Q* is less than what
buyers are willing and able to
pay. Buyers “value” all units
up to Q* more than the MC
PM
of producing those units.
MB > MC.
CM
m
The monopolist restricted output and
raised price above MC.
Fall ‘ 97
AC
p
The welfare loss to society
is the area above the MC and
and below the demand
function. [Area fhm.]
MC
h
f
D = AR
MR
QM
Principles of Microeconomics
Q*
Q/ut
Slide -- 12
Market Power
· When a firm faces a negatively sloped demand
function for their product, they can raise the
price above MC and reduce output
· Buyers are willing to purchase a good so long as
marginal benefits are equal to or greater than the
price, they buy until MB =P
· MB = P > MC; The benefits of the last unit sold
exceed the costs of producing that unit.
Fall ‘ 97
Principles of Microeconomics
Slide -- 13
Demand and Marginal Revenue
·
·
·
·
·
The demand and AR are the same thing.
MR is the change in TR associated with a change in quantity
sold.
Remember that when a marginal value is less than the
average, the average is decreasing. On a graph, when the AR
is decreasing, MR must be below the AR.
When a demand function is negatively sloped it is the same
as AR decreasing.
Therefore, in the absence of price discrimination, MR will lie
below the Demand function.
Fall ‘ 97
Principles of Microeconomics
Slide -- 14
Monopolistic Competition
· Large number of sellers
· relative ease of exit / entry
· products are differentiated
· actual differentiation
· perceived differentiation
· Only difference from pure comp is that the
demand faced by the firm is not perfectly elastic;
MR will lie below the Demand function [AR]
Fall ‘ 97
Principles of Microeconomics
Slide -- 15
Monopolistically competitive firms have differentiated products but
must compete with other sellers of goods that are close subsitutes.
The result is that each firm faces a negatively sloped demand function
that is “relatively elastic.”
If there are “below normal p “
some firms will exit and the
demand for remaining firms
will shift out.
$
Above normal pwill encourage
entry and each firm’s demand
function will shift in and may
become more relatively more
“elastic.”
D
D’
D*
Q /ut
As firms enter there are more close substitutes so each firms’
demand shifts in and is relatively more elastic.
Fall ‘ 97
Principles of Microeconomics
Slide -- 16
$
ATC!
ATC2
ATC3
ATC*
ATC5
ATC6
LRAC
D
D*
Q/ut
Given the production function and the prices of inputs, the average cost
functions for the monopolistically competitive firm are determined.
A firm who faces a demand function D will be able to earn above normal p.
Firms will enter, shifting the demand to the left and reducting its slope.
Once D* is tangent to LRAC [LRAC= AR= D] there is no reason for others
to enter or exit. Long run equilibrium.
Fall ‘ 97
Principles of Microeconomics
Slide -- 17
$
ATC!
MC
ATC2
ATC3
ATC*
ATC5
LRAC
P= C*
MR
Q*
ATC6
D*
Q/ut
At this point the firm will elect to build plant ATC3 and produce Q* output.
At Q* output the firm has an average cost of C* which is also the Price and
average revenue. The firm earns a normal profit.
The firm builds a plant that is “too small” and operates it at less than an
efficient level of output. The “excess capacity theorem.”
Fall ‘ 97
Principles of Microeconomics
Slide -- 18
Oligopoly
· Characteristics:
· A “few sellers” who recognize their
interdependence
· Products may be homogeneous or
differentiated
· Significant barriers to entry exist
· Explanations of oligopoly behavior require
knowledge of competititors’ behavior
Fall ‘ 97
Principles of Microeconomics
Slide -- 19
Kinked Demand Model
· An oligopolist whose price and output
choice is dependent on competitors’
behavior.
· Firms tend to have capacity to
increase output
· Consumers see goods as subsitutes
· Two service stations at an off-ramp
Fall ‘ 97
Principles of Microeconomics
Slide -- 20
Station A
$
gas /ut
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Principles of Microeconomics
Slide -- 21
P= Cmin
Q*
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Principles of Microeconomics
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Principles of Microeconomics
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1
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3
4
5
6
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Principles of Microeconomics
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Utility X
Q
1
2
3
4
5
6
7
8
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TU
30
55
75
90
100
105
105
100
Principles of Microeconomics
Slide -- 26