Monopoly and Oligopoly

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Themes of Today’s Lecture Monopoly Oligopoly

Monopoly - Structure single firm no close substitutes barriers to entry full and symmetric information

Sources of Monopoly Entry Barriers Natural monopoly: the most efficient scale of production is so large, relative to market demand, that a single firm dominates the market. Patents, copyrights, licenses, franchises: government protection of a firm’s right to produce a unique product. Economic and/or legal restrictions, strategies or situations that make entry more difficult for new competitors than for the existing monopoly firm.

“Other” Monopolies - Good? Bad? Input Ownership DeBeer’s and diamonds Industry Secret or Know-how IBM and mainframes? Strategic Behavior buy ‘em up blow’ em up let’s make a deal Microsoft and operating systems?

Caveats monopoly does not => big big does not => monopoly monopoly does not => absolute and unlimited control over price monopoly does not => must have economic profit short run profit does not => monopoly power monopoly does not => badly behaved firm

Classic Simple Monopoly Polar extreme from perfect competition. Monopolist is a “price maker.” Cost curves are pretty much the same (except in the case of natural monopoly). 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. A monopolist faces the declining market demand curve for its product and simultaneously chooses price and quantity. Now P>MR (before 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.”

The Simple Monopolist: Rules for Profit Maximization Suppose we are in the short run. Rules for profit maximization are the same as before. If Q SM maximizes profit, then MR(Q SM ) = MC(Q SM ) very important note: for a simple monopolist P>MR at all positive levels of Q. Q SM is a max and not a min. at Q SM it’s worth operating.

Simple Monopoly Economic profits equal total revenue minus total costs. Marginal revenue is the rate of change of total revenue (just like marginal cost is the rate of change of total cost) as quantity increases. Economic profits are maximized when marginal revenue equals marginal costs

Graphical Display of Monopolist’s Solution The monopolist sets marginal revenue equal to marginal cost at MR=MC and considers producing Q=90. The monopolist then gets the price off the demand curve. This implies a market price of $55/unit. The monopoly profits (light blue in the graph) are the difference between price ($55) and average total cost ($44.44) times the number of units sold. Notice that our monopolist is a “natural monopoly” since the average total costs decline over the entire relevant range of production. Notice that if our monopolist operated at the competitive equilibrium (Price=MC=$30, Quantity=140), the firm would make a loss (ATC>Price).

Implications of the Monopolist’s Profit Maximum Price will exceed the competitive price. Quantity will be less than the competitive quantity. The monopolist sells the output at a price greater than marginal costs but the monopoly price can be above or below average total costs. Thus, the monopolist need not always make a profit. In the long run, of course, unprofitable monopolists will either stop production or raise the price further above marginal cost until it covers average total costs. The monopolist will always try to operate on the elastic portion of the demand curve because when the elasticity of demand is greater than -1 (inelastic, between 0 and 1 in absolute value), marginal revenue is negative and, necessarily, less than marginal cost. Since there is no entry to consider monopolists can have persistent long run economic profit.

Simple Monopoly- Performance Efficiency: Is the monopoly equilibrium Pareto Efficient? That is, at Q SM is net social surplus maximized? Does $MB=$MC at Q SM ? Is the monopolist productively efficient? Does the monopolist operate at minimum efficient scale? Equity: Is the outcome of monopoly fair? Equitable? Just?

Simple Monopoly- Performance Answers The simple monopoly equilibrium is not Pareto Efficient. The simple monopolist creates “dead-weight-loss.” At Q SM, $MB>$MC. Recall: $MR=$MC at Q SM while $P SM >$MR at all Q. So $P SM >$MC. Since $P=$MB, then $MB>$MC. The simple monopolist may or may not be productively efficient. Compared to the competitive equilibrium, there is a transfer of surplus from consumers to producers.