Models of Competition Part II: Agenda: Sources of Market Power A. Different types of products B. Few sellers and/or buyers C. Barriers to entry 2. Optimization for Monopolists A. A monopolists marginal revenue B. Short run and long run monopoly production 3. Garden Gnomes revisited… Mathematical treatment – math as a took to keep complex relationships straight and make useful predictions and comparisons.

What were those assumptions again??? Microsoft Office – network externalities (everyone else was using it…) NJTransit – quasi-public utilities – tough to have multiple rail lines (but sometimes we manage…) Unions – monopoly on supply of labor (closed shop, non right-to-work states) Patents

Sources of Market Power What if products are not standardized? What if there are few sellers or buyers? What if there are high barriers to entry or exit?

What if Products are NOT Standardized? Experience Goods: Consumers do not know the utility until AFTER consumption. Credence Goods: Consumers do not know the utility EVER – even after consumption.

Natural Monopolies What if there are BIG economies of scale? Large economies of scale are in effect high barriers to entry – tough to enter as a small competitor Natural Monopolies

Monopsony What if there are FEW customers? Not going to deal a lot with monposony

What if there are BARRIERS to ENTRY or EXIT? Location (retail – if you have key locations, that creates a barrier to competitors) Patents Talent! Work place environment – best places to work Network externalities Regulation

Standardized Product, Low Barriers → Perfect Competition Standardized Product, High Barriers → Monopoly, Oligopoly Diversified Product, Low Barriers → Monopolistic Competition Diversified Product, High Barriers → Monopoly, Oligopoly

The ultimate victory in business is being sued by the FTC for anti-trust violation!

Sometimes monopoly is the best structure to promote change! Monopolists can NOT set whatever price they want! They are still constrained by DEMAND from CONSUMERS! Sometimes monopoly is the best structure to promote change!

Profit Maximization for Monopolists Perfect Competition Monopoly Marginal Revenue = Marginal Cost Short run MR = price for perfect competition, but not for monopolies Profit max is NOT euqal to max revenue Use ruler trick for monopolists MR Are these short run or long run graphs? What is the marginal revenue for perfect competition? For monopolists, is the maximum profit equal to the maximum total revenue? Sketch the monopolists marginal revenue curve

For a price decline: If A<B then MR>0 MR = 0 at an elasticity of 1 See Goolsbee Figure 9.1 and derivation p. 364 with a somewhat different but algebraically equivalent derivation What curve is this? A demand curve – optimal monopolist price is constrained by the elasticity of demand! WHEN IS MR = 0?? Note: p;. 383 – MR curve always intersects the X axis at the half-way point because that corresponds to the mid-point on a (linear) demand curve where elasticity is 1. A monopolist will never produce on the inelastic part of the demand curve

How much more should the monopolist charge? Substitute expression for MR as a function of elasticity Is MR greater than, less than, or equal to the price? LERNER INDEX: The profit maximizing mark-up is the inverse of the elasticity of demand Answers: Mark up = 5 MC = 5 Surplus = 10*10 – 10*5 = 50 (assuming a constant MC over the 10 units). What is the mark-up if demand is perfectly elastic? If price = 10 and elasticity = 2 what is: The mark up The marginal cost The producer surplus at 10 units sold (assuming constant MC)?

Linear demand and marginal revenue General linear demand function: What is the demand function for this graph? What is the marginal revenue function for this graph? What is the general linear marginal revenue function?

What quantity should a monopolist produce? What is this triangle? What is this rectangle? What is the difference between short-run average total cost and long-run average cost? Note: I’m not reviewing all the information in the text about price discrimination, welfare effects, and regulatory responses to monopoly – all from Econ 5 Long run assumes optimal inputs! Do Monopolists earn a producer surplus in the long-run?

Example: Garden Gnomes Revisited! Congratulations, you’ve developed an incredible new technology that makes Garden Gnomes absorb CO2 and combat global warming. You have a patent, so everyone wants to buy your garden gnomes. Better yet, the new technology has not changed your cost structure. Market demand: QD = 6500 -100P FIRM total cost: C(q) = 722 + q2/200 FRIM marginal cost: MC(q) = 2q/200 = q/100 1. What is your Marginal Revenue? 2. What is the equilibrium price and quantity? 3. What is the profit (loss) for the FIRM? 4. What is the CONSUMER surplus in this market? (hint: draw a graph!) Test yourself: go back and compute the consumer surplus in the perfectly competitive garden gnome market!

Summary 1. Monopolist can NOT set whatever price they want! MR=MC=f(demand) 2. Monopolist will produce where the elasticity of demand = 1 3. Monopolist DO earn a producer surplus in the long run. Why? P > LAC 4. Unless the Monopolist is perfectly price discriminating, then consumers will still have a surplus in a monopoly market.