Monopoly Structure and Conduct Dr. Jennifer P. Wissink ©2011 John M. Abowd and Jennifer P. Wissink, all rights reserved.

Market Structures: Briefly Perfectly Competitive: many firms identical products free entry and exit full and symmetric information Monopoly: single firm only imperfect substitutes in related markets barriers to entry and possibly exit full and symmetric information, or possibly not Monopolistic competition: several firms similar products but with some degree of differentiation Oligopoly: A few firms similar products, degree of product differentiation varies depending upon the market there often are barriers to entry of some kind

Question What is the market structure for each of these products or firms: competitive, monopoly, oligopoly, monopolistic competition? The Campus Store (for textbooks) The Campus Store (for Cornell memorabilia) Gnomon copy service Whole wheat bread Mac computer Windows computer AmeriCom (long distance phone service)

Answers And Discussion The Campus Store (textbooks): competitive thanks to Internet book sellers. The Campus Store (Big Red stuff): monopoly, these are licensed products. Gnomon Copy Service: local monopolistic competition due to differentiated service among suppliers (possibly oligopoly, no clear boundary). Whole wheat bread: competitive Mac computer: hardware and operating system monopoly. Windows computer: hardware competitive; operating system monopoly; complete systems monopolistic competition (differentiated features). AmeriCom: competitive, now hundreds of suppliers of long distance service.

Classic Monopoly Structure Single firm  firm is the market. No close substitutes, only imperfect substitutes in related markets. Barriers to entry and possibly exit. Full and symmetric information, or possibly not.

Sources Of Monopoly Entry Barriers Technical: Natural monopoly (1) Vital input ownership (2) Technical secrets (the better mousetrap) (3) Legal: Patents (4) Franchises (5) Licenses (6) Strategic: Buy ‘em up (7) Blow ‘em up (8) Let’s make a deal (9)

(2) (9) (5) (4) (6) (3) (7) (8) (1)

Monopoly Caveats Monopoly does not imply you’re big. Big does not imply you’re a monopoly. Monopoly does not imply you have absolute and unlimited control over price. Monopoly does not imply you must have positive economic profit. Short run profit does not imply monopoly power. Monopoly does not imply a badly behaved firm.

The Classic Monopoly Polar extreme from perfect competition. Monopolist is a “price maker” rather than a price taker. Market demand = firm demand D=δ Cost curves are pretty much the same (except in the case of natural monopoly – which we ignore). The big change from before is in the demand side of the profit function.

The Simple Monopolist - Conduct The simple monopolist abides by the “law of one price.” Everyone pays the same market price for all units purchased, there is no price discrimination. The monopolist faces a declining market demand curve for its product and chooses price which implies the quantity (or chooses quantity which implies the price). Now P > mr (before, under perfect competition, P=mr) because the simple monopolist must lower the price on all preceding units to sell an additional unit. A monopolist has no “supply curve.”

Relationship Between Price And Marginal Revenue For The Simple Monopolist For all quantities greater than zero, the simple monopolist’s price will be larger than the corresponding marginal revenue. Why? To sell an additional unit, the simple monopolist must lower the price on ALL units sold. Example: Suppose the monopolist is selling 3 units at a price $12 per unit. Total revenue is $36. Suppose to sell 4 units the monopolist must lower his price to $10 per unit. Total revenue is now $40. He picked up $4 in revenue. Notice that his price at 4 units = $10/unit while his marginal revenue on the 4th unit is only $4. Why? Selling the 4th unit gave him $10 in additional revenue… … but he had to lower the price by $2/unit on the 3 units he used to sell for $12/unit, so he loses $6 in revenue on these units. In the end he picks up $10-$6=$4 in revenue by selling 4 units at $10/unit.

Rules For SR Profit Maximization Suppose we are in the short run. Rules for profit maximization are the same as before. If QSM maximizes profit, then mr(at QSM) = srmc(at QSM) very important note: for a simple monopolist P>mr at all positive levels of Q. QSM is a at a max and not a min. at QSM it’s worth operating, rather than shutting down.

Simple Monopoly Marginal Revenue With Linear Demand $ Suppose demand curve is: PD = 20 – 2Q Total revenue = PD∙Q Total revenue = (20 – 2Q)∙Q = [20∙Q - 2∙Q2 ] Marginal revenue = mr = ∆Total revenue/∆Quantity mr = 20 - 4Q Now compare this with PD With a linear demand, marginal revenue will have the same vertical intercept and be twice as steep! $20 Demand Marginal Revenue 5 10 Q

Graphical Display Of Simple Monopolist’s Short Run Profit Maximizing Solution (1) The monopolist sets marginal revenue equal to marginal cost. Then goes up to the demand curve to get the price. (2) Then makes sure he is at a max (and not a min). (3) Then makes sure it is worth operating in the short run. $ srmc Psm Demand Marginal Revenue Qsm Q

Implications Of Simple Monopoly Short Run Profit Maximization In the short run, the simple monopolist can have +, 0, or – economic profit. The simple monopolist will never operate on the inelastic portion of his demand curve. Suppose the monopolist is operating on the inelastic portion of his demand curve. Suggest he sell one fewer unit, but now at a higher price (for all the units). If demand is price inelastic at the current price, his total revenue will increase, if he takes your suggestion. Since he’s making fewer units his costs will decrease. So his revenues have increased and his costs have decreased, so his PROFIT must have increased. Why does this “suggestion” eventually not work? There is no short run supply curve to get.

Simple Monopoly With A Table: New Demand & Cost Information

Long Run Profit Maximization With Simple Monopoly Pretty much the same story as in the short run, but, use correctly calculated long run cost information. Positive economic profit invites entry, but since there are barriers to entry positive economic profit can persist. Negative economic profit encourages exit, and if the monopolist can get out he will. Monopolist might make long run adjustments to changes in the economic environment.