Discussion Session 3

Outline Monopoly Monopolistic Competition Antitrust Policy and Regulation

Monopoly vs. Perfect Competition Perfect Competition Monopoly Identical productsNo close substitutes Free entry (and exit)Barriers to entry No market powerMarket power Price-takerPrice-maker

Profit-maximizing Condition Perfect Competition Monopoly P=MCMR=MC

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars. Fill in the columns. QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 a.Draw the MC, MR, and demand curves for the monopolist. Label the price charged by the monopolist and the quantity it produces. b.What would be the price if this industry were a competitive industry? What are profits? c.What is the price-cost margin of the monopolist? d.Graphically show the consumer and producer surplus if this industry were a competitive industry e.Graphically show the consumer and producer surplus for the monopolist f.Graphically show the deadweight loss from having the monopoly

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars a. Draw the MC, MR, and demand curves for the monopolist. Label the price charged by the monopolist and the quantity it produces. QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars a. Draw the MC, MR, and demand curves for the monopolist. Label the price charged by the monopolist and the quantity it produces. QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars b. What would the price be if this industry were a competitive industry? What are profits? QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars b. What would the price be if this industry were a competitive industry? What are profits? QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars c. What is the price-cost margin of the monopolist? QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost / / / /7

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars c. What is the price-cost margin of the monopolist? (Price-Marginal Cost)/Price= (8-6)/8=1/4 Note that an index of 0 indicates no market power and a higher price-cost margin indicates greater market power. QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars d. Graphically show the consumer and producer surplus if this were a competitive industry QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars e. Graphically show the consumer and producer surplus for the monopolist QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 1 A monopolist’s quantity, price and marginal (in $) cost schedule are shown below. Fixed Cost is 5 dollars f. Graphically show the deadweight loss from having the monopoly? QPMCTotal Revenue Marginal Revenue Total Cost Average Total Cost

Question 2 Compare the long-run equilibrium of a competitive firm with that of a monopolistically competitive firm with the same cost structure a.Draw diagrams showing the marginal cost, average total cost, marginal revenue and demand curve for the two types of firms in the long run. Label the price charged by the two types of firms and the quantity they each produce b.Why is the long-run price different in these two models? Which type of firm operates at minimum average total cost?

Question 2

b. Why is the long-run price different in these two models? Which type of firm operates at minimum average total cost?

Question 2 b. Why is the long-run price different in these two models? Which type of firm operates at minimum average total cost? In perfect competition: Long-run profits are zero. Note that the marginal cost curve always intersects the average total cost curve at the minimum point of the average total cost curve. The only place where P=MC and P= ATC is at the lowest point on the ATC curve.

Question 2 b. Why is the long-run price different in these two models? Which type of firm operates at minimum average total cost? For competitive equilibrium: Long-run profits are zero. Note that the marginal cost cure always intersects the average total cost curve at the minimum point of the average total cost curve. The only place where P=MC and P= ATC is at the lowest point on the ATC curve. For monopolistic competition: Firms do not produce at P=MC, but at quantity that is less than the quantity at which marginal cost intersects average total cost, which means that a monopolistically competitive firm does not operate at minimum average total cost.

Question 3 Suppose 10 monopolistically competitive restaurants operate in your town with identical costs. Calculate the short-run price and quantity produced by each of the firms: Each Firm’s DemandEach Firm’s Cost QuantityPriceAverage Total CostMarginal Cost 1$ $896 3$686 4$4912 5$21014

Question 3 Suppose 10 monopolistically competitive restaurants operate in your town with identical costs. Calculate the short-run price and quantity produced by each of the firms: Profits are maximized at output of 2 units and price of $8. QuantityPriceTRMRAverage Total Cost Marginal Cost

Question 3 a. Would the price rise or fall at the typical firm in the long run? Explain QuantityPriceTRMRAverage Total Cost Marginal Cost

Question 3 a.Would the price rise or fall at the typical firm in the long run? Explain At 2 units, the existing firms are losing money. There will be exit over the long run, shifting out the Marginal Revenue and Demand curves until profits are zero. Price will rise. QuantityPriceTRMRAverage Total Cost Marginal Cost

Question 3 b. What would be the level of production if this industry were a competitive industry? Three units, because this is where P=MC. (If each typical firm produces 3 units, the price in the market is 6) QuantityPriceTRMRAverage Total Cost Marginal Cost

Question 4 One of the main concerns of the proposed American/US Airways merger in 2013 was that the creation of the world’s largest airline would create an airline industry that is too concentrated. Between April 2013 and March 2014, the US domestic market shares of the major US airlines are approximately as follows: Calculate the HHI before and after the merger. Is it likely that the DOJ and FTC will challenge the merger? Market share United/Continental16% Delta16% Southwest16% American13% US Airways9% Other airlines (5)6% each

Question 4 Herfindahl-Hirschman Index (HHI)=sum of the squares of the market shares of the firms in the industry. Higher HHI means industry is more concentrated. Lower HHI means industry is less concentrated.

Question 4 Before the merger, HHI=3x(16^2)+13^2+9^2+5*6^2=1,198 Market share United/Continental16% Delta16% Southwest16% American13% US Airways9% Other airlines (5)6% each

Question 4 Before the merger, HHI=3x(16^2)+13^2+9^2+5*6^2=1,198 After the merger, HHI=3x(16^2)+22^2+9^2+5*6^2=1,432 Market share United/Continental16% Delta16% Southwest16% American13% US Airways9% Other airlines (5)6% each

Question 4 Before the merge, HHI=1,198 After the merger, HHI=1,432 Guidelines by the US DOJ and FTC say that when the postmerger HHI is between 1,000 and 1,800, a challenge is likely to occur if the HHI rises by 100 points or more. (See Market share United/Continental16% Delta16% Southwest16% American13% US Airways9% Other airlines (5)6% each