Monopoly

1. Setting the stage Review of Perfect Competition – P = LMC = LRAC ; i.e. normal profits or zero economic profits in the long run – Large number of buyers and sellers – Homogenous product – Perfect information – Firm is a price taker

2. Monopoly Key features 1) One seller 2)One product (no good substitutes) 3)Barriers to entry

3. Question for class What are some examples of industries dominated by a single seller?

4. Strategies for wannabe monopolists “You might be a monopolist if” – You control scarce inputs – You have huge economies of scale – You have the right patents – You have friends in government

5. Output decision Goal: maximize  = P(Q)Q – C(Q) This happens when d  /dQ = P(Q) + (dP/dQ)Q – dC/dQ = 0 P(Q) + (dP/dQ)Q = dC/dQ MR = MC

6. Pricing decision Rewrite P(Q) + (dP/dQ)Q – dC/dQ = 0 as P + (dP/dQ)Q = MC Multiply/divide second term on LHS by P P + P(dP/dQ)(Q/P) = MC

7. Pricing decision Recall E d = (dQ/dP)/(P/Q) P+ P(1/ E d ) = MC P(1 + (1/ E d )) = MC P = MC/(1 + (1/ E d ))

8. Key results on pricing P = MC/(1 + (1/ E d )) P > MC always Output always in elastic segment of demand Markup of P over MC smallest for goods with most elastic demand

9. Elasticity of Demand and Price Markup $/ Q Quantity D MR D MC Q* P* P*-MC The more elastic is demand, the less the markup.

10. Example using linear demand Demand: P = a – bQ Total revenue: TR = Q(a-bQ) = aQ – bQ 2 Marginal revenue: MR = dTR/dQ = a –2bQ MR has same vertical intercept as demand Slope of MR twice as steep as demand

11. Demand and Marginal Revenue Output $ per unit of output a= 6 7 Demand Marginal Revenue

12. Simple example Demand: P = Q; TR = 80Q - 2Q 2 Cost: TC = Q 2 Set MR = MC where Q = 4Q; Q =10 P = Q = 60  = 600 – 300 = 300

13. Profit Maximized When Marginal Revenue = MC Quantity $ per unit of output D MR MC P* Q* AC

14. Profit Maximized When Marginal Revenue = MC At output levels below MR = MC the decrease in revenue is greater than the decrease in cost (MR > MC). At output levels above MR = MC the increase in cost is greater than the decrease in revenue (MR < MC)

15. Profit Maximized When Marginal Revenue = MC Quantity $ per unit of output D MR MC P* Q* P1P1 Q1Q1 Lost profit Lost profit P2P2 Q2Q2 AC

16. Profit Maximization Observations – Set Q where MR=MC – Set P off demand curve (P=30 here) – Profit = (P - AC) x Q = ($30 - $15)(10) = $150 Quantity $/Q MC D MR AC Profit

17. Monopoly vs. perfect competition Monopoly P > MC Q inefficient (too low)  > 0 Perfect competition P = MC Q efficient  = 0

18. The Social Costs of Monopoly Power Monopoly power results in higher prices and lower quantities. However, does monopoly power make consumers and producers in the aggregate better or worse off?

B A 19. Deadweight Loss from Monopoly Power Quantity D MR MC PmPm QCQC PCPC QmQm C Lost Consumer Surplus Deadweight Loss Because of the higher price, consumers lose A+B and producer gains A-C. $/Q

20. Getting beyond static analysis Resources spent on rent seeking Incentives for cost-saving innovation: Monopolist can raise profits by lowering costs; Consumers gain higher output and lower prices Competition from new products

21. Regulating monopoly Antitrust Price regulation Nationalization

22. Limiting Market Power: The Antitrust Laws Antitrust Laws: – Attempt to prevent firms from acquiring excessive market power and therefore reduce the deadweight loss. – Promote a competitive economy

23. Limiting Market Power: The Antitrust Laws Sherman Act (1890) – Section 1 Prohibits contracts, combinations, or conspiracies in restraint of trade – Explicit agreement – Implicit collusion through parallel conduct

24. Limiting Market Power: The Antitrust Laws Sherman Act (1890) – Section 2 Makes it illegal to monopolize or attempt to monopolize a market and prohibits conspiracies that result in monopolization.

25. Limiting Market Power: The Antitrust Laws Clayton Act (1914) 1)Makes it unlawful to require a buyer or lessor not to buy from a competitor 2)Prohibits predatory pricing 3)Prohibits mergers and acquisitions if they “substantially lessen competition”or “tend to create a monopoly” 4)Bans price discrimination

26. Limiting Market Power: The Antitrust Laws Federal Trade Commission Act (1914, amended 1938, 1973, 1975) 1)Created the Federal Trade Commission (FTC) 2)Prohibitions against deceptive advertising, labeling, agreements with retailer to exclude competing brands

27. Limiting Market Power: The Antitrust Laws Antitrust laws are enforced three ways: 1)Antitrust Division of the Department of Justice A part of the executive branch--the administration can influence enforcement Fines levied on businesses; fines and imprisonment levied on individuals

28. Limiting Market Power: The Antitrust Laws Antitrust laws are enforced three ways: 2)Federal Trade Commission Enforces through voluntary understanding or formal commission order 3)Private Proceedings Lawsuits for damages Plaintiff can receive treble damages

29. Evaluating antitrust Gains to consumers from greater competition VERSUS Costs of litigation, enforcement Possible loss of economies of scale, scope Obsolete with global competition

30. Price Regulation $/Q D MC Quantity MR PmPm QmQm If left alone, a monopolist produces Q m and charges P m. AC

31. Price Regulation $/Q D MC Quantity MR PmPm QmQm P1P1 Q1Q1 Marginal revenue curve when price is regulated to be no higher that P 1. For output levels above Q 1, the original average and marginal revenue curves apply. AC

32. Price Regulation $/Q D MC Quantity MR PmPm QmQm P1P1 Q1Q1 If price is lowered to P C output increases to its maximum Q C and there is no deadweight loss. AC P 2 = P C QcQc

33. Price Regulation $/Q D MC Quantity MR PmPm QmQm P1P1 Q1Q1 If price is lowered to P 3 output decreases and a shortage exists. AC P 2 = P C QcQc P3P3 Q3Q3 Q’ 3

34. Price Regulation $/Q D MC Quantity MR PmPm QmQm P1P1 Q1Q1 Any price below P 4 results in the firm incurring a loss. AC P 2 = P C QcQc P3P3 Q3Q3 Q’ 3 P4P4

35. Regulating the Price of a Natural Monopoly D MR PmPm $/Q MC QmQm Unregulated, the monopolist would produce Q m and charge P m. AC Quantity

36. Regulating the Price of a Natural Monopoly D MR PmPm $/Q MC QmQm If the price were regulate to P C, the firm would lose money and go out of business. AC Quantity PCPC QCQC

37. One option: AC pricing D MR PmPm $/Q MC QmQm Setting the price at P r yields the largest possible output;excess profit is zero. AC Quantity PCPC QCQC QrQr PrPr

38. Another option: MC pricing with cover charge (2 part tariff) D MR PmPm $/Q MC QmQm If the price were regulate to P C, the firm would lose money and go out of business. AC Quantity PCPC QCQC AC c

39. Nationalization Widely practiced throughout the world; rare in US but not unheard of (education, postal service) Issue: what do nationalized firms maximize?

40. Domination by a few firms Pure, classic monopoly is rare. However, a market with several firms, each facing a downward sloping demand curve will produce so that price exceeds marginal cost.

41. Domination by a few firms Quantity 10, QAQA $/ Q ,00030,0003,0005,0007, DADA MR A Market Demand Yahoo sees a much more elastic demand curve due to competition--E d = -.6. Still Yahoo has some monopoly power and charges a price which exceeds MC. MC A

42. Sources of Monopoly Power Why do some firm’s have considerable monopoly power, and others have little or none? Monopoly power is determined by the firm’s elasticity of demand.

43. Sources of Monopoly Power The firm’s elasticity of demand is determined by: 1)Elasticity of market demand 2)Number of firms Firms have the incentive to create barriers to entry Natural barriers may exist – These include patents, economies of scale, copyrights, licenses

44. Sources of Monopoly Power The firm’s elasticity of demand is determined by: 3)The interaction among firms