Monopoly Monopoly and perfect competition. Profit maximization by a monopolist. Inefficiency of a monopoly. Why do monopolies occur? Natural Monopolies.

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Presentation transcript:

Monopoly Monopoly and perfect competition. Profit maximization by a monopolist. Inefficiency of a monopoly. Why do monopolies occur? Natural Monopolies.

Monopoly and Perfect Competition Perfect competition: each firm takes market price as given and decides how much to produce. Monopoly: does not take market price as given when deciding quantity. Figures that higher production will lead to different price.

Monopoly and Perfect Competition: Demand Curves

Profit Maximization Monopolist maximizes profits:

Profit Maximization: Revenue Competitive firm: Monopolist:

Profit Maximization Solve: Optimality condition:

Profit Maximization Optimality condition: Marginal revenue:

Profit Maximization Competitive firm: Monopolist:

Profit Maximization: Example Inverse market demand: Marginal revenue:

Profit Maximization: Example

Profit Maximization: Markup Pricing Price exceeds marginal cost: Rearrange:

Profit Maximization: Markup Pricing Markup pricing: Price/marginal cost = markup:

Inefficiency of a Monopoly

Inefficiency of a Monopoly: Deadweight Loss

Inefficiency of a Monopoly: What about Inventions? Patents in the US grant monopoly to a company over an innovative product or process for 17 years. Company will sell the product for 17 years at monopoly prices: deadweight loss.

Inefficiency of a Monopoly: What about Inventions? No patent protection little incentive to innovate. Too strong patent protection 1) Deadweight loss for longer time 2) Low incentives to innovate Optimal patent life balances these conflicting effects.

Why Do Monopolies Occur? 1. Cartels. 2. Patents. 3. Incumbent’s strategy of threatening potential entrants in industry to engage in a price war. 4. Relationship between the Minimum Efficient Scale and the Demand Curve.

Minimum Efficient Scale and Demand

Antitrust Laws Sherman Act of 1890: Section 1: prohibits contracts and conspiracies, explicit or implicit, to restraint trade by fixing prices or restrict output. Section 2: illegal to monopolize or attempt to monopolize a market.

Antitrust Laws Clayton Act of 1914: Illegal for a firm with a large market share to require a buyer not to buy from a competitor. Prohibits mergers and acquisitions if they substantially lessen competition. Illegal to sell a product at different prices to different buyers, if this injures competition.

Regulation: Natural Monopoly Some monopolies can be regulated: government sets price equal to marginal cost. Problems with this policy: 1) incentives to invest in research and innovation decrease. 2) At that price monopoly could be making negative profits!

Regulation: Natural Monopoly

Regulating Natural Monopolies Examples: phone companies, gas companies, public utilities in general. Regulations: 1. Let monopolist charge price equal to average cost. What is a firm’s cost function? 2. Government operates service: price equal marginal cost and subsidy to the firm to cover losses.