1. Industrial Organization
Avner Shaked
ISET March-April 2016

2. PowerPoint 2007 presentations:

3. Bibliography Wolfstetter,E., Topics in Microeconomics: Industrial
Organization, Auctions, and Incentives
Tirole,J., The Theory of Industrial Organization
Shy, O., Industrial Organization: Theory and Applications
Belleflamme, P., M. Peitz, Industrial Organization, Markets & Strategies

4. Perfect Competition
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5. Agents (consumers & producers) are price takers
Producers maximize their profits
Markets clear: quantity supplied equals quantity demanded
A Competitive Equilibrium exists when firms exhibit decreasing or constant returns to scale. Firms produce where p =MC.
When firms exhibit increasing returns to scale, there exists NO Competitive Equilibrium.
Perfect Competition
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6. Equilibrium: price Supply (MC) Demand quantity 15:23
Perfect Competition
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7. When firms exhibit increasing returns to scale, there exists no Competitive Equilibrium.
Doubling the input →
more than doubling output
quantity
produced
input 1 2
Perfect Competition
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8. When firms exhibit increasing returns to scale, there exists no Competitive Equilibrium.
TC(Q) = Pinput x Input(Q) the inverse function
quantity
produced
TC = Total Cost Q
input
quantity
Input(Q)
Perfect Competition
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9. When firms exhibit increasing returns to scale, there exists no Competitive Equilibrium.
AC > MC
AC =C/Q, MC=C’
TC = Total Cost AC C MC
quantity Q
quantity
Perfect Competition
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10. If p is sufficiently large, the firm wants to produce
When firms exhibit increasing returns to scale, there exists no Competitive Equilibrium.
If p is sufficiently large, the firm wants to produce
an infinite quantity
AC > MC AC p
profit
Revenue = p*q MC
Cost= q*AC q
quantity
Perfect Competition
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11. If p is small, the firm prefers not to produce
When firms exhibit increasing returns to scale, there exists no Competitive Equilibrium.
If p is small, the firm prefers not to produce
AC > MC AC
Total
cost
The firm makes a loss p MC
Revenue
quantity
Perfect Competition
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12. p Efficiency of competitive equilibrium
Any additional unit will be offered at a price > p
and any consumer without the good is willing to pay p < for it.
price
Supply p
All possible deals are made.
Demand
quantity
Perfect Competition
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13. Monopoly
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14. A monopolist maximizes
Concave
Monopoly
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15. The monopolist maximizes
Monopoly
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16. The monopolist maximizes
Monopoly
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17. By how much is the monopolist’s price higher than the marginal cost ??
Monopoly
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18. By how much is the monopolist’s price higher than the marginal cost ??
The price elasticity of demand, ε
Monopoly
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19. By how much is the monopolist’s price higher than the marginal cost ??
At the Cournot point:
Monopoly
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20. By how much is the monopolist’s price higher than the marginal cost ??
> 0
Difficult to estimate,
for C’(x) is usually unknown
Monopoly
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21. Monopoly Deadweight Loss
Compared to perfect competition, a monopolist causes a loss of welfare
The monopolist keeps the quantity low and the price high.
More customers would buy the product if it were available
(at a price higher than production cost)
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22. At the monopolist’s point:
Consumers’ Surplus
Monopolist’s Revenue
Monopolist’s Cost
Monopolist’s Surplus
(= Profit = Producer’s Surplus)
Total Welfare
Monopoly: Deadweight Loss
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23. In Perfect Competition:
Consumers’ Surplus
Monopolist’s Surplus
Total Welfare (competition)
Total Welfare (monopoly)
The difference
Deadweight Loss
All the consumers here are willing to pay less than pM,
but more than it costs to produce the goods.
The monopolist refuses to sell (no price discrimination)
Monopoly: Deadweight Loss
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24. The government sets s so as to make the monopolist choose
Correcting the loss in efficiency
The government gives the
monopolist a subsidy s for
each unit sold. It also levies
a lump-sum tax T.
The government sets s so as to make the monopolist choose
x = xC where P = C’.
Monopoly: Deadweight Loss
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25. Correcting the loss in efficiency
The government gives the monopolist a subsidy s per unit sold, and it levies a lump sum-tax T to pay for the subsidy.
Monopoly: Deadweight Loss
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26. Correcting the loss in efficiency
The government gives the monopolist a subsidy s for each unit sold. It also levies a lump sum-tax T.
The government sets:
Monopoly: Deadweight Loss
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27. Welfare Loss: Rent Seeking
Firms compete to become a monopoly. In the process they spend resources which are a welfare loss.
If n firms compete for the future monopoly gains, each is willing to spend as much as its expected profit.
If they have equal probabilities of becoming the monopolist, each will spend as much as
All together spend up to:
Monopoly: Rent Seeking
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28. Monopoly and Innovation
Incentives to innovate:
Patents
In a competitive industry with p0 = C’0 , one firm develops a new technology reducing the MC to C’1 < C’0 .
The firm is a monopolist for all prices < p0 .
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29. p0 C’0 The new monopoly price p1M The new (lower) marginal cost C’1
P(x)
R’(x)
If the competitive price is above the monopoly price
The firm produces at p1M and its profit is
Monopoly: & Innovation
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30. p0 The new monopoly price p1M C’0 The new (lower) marginal cost C’1
P(x)
R’(x)
If the competitive price is below the monopoly price
The firm produces at just below p0 and its profit is
Monopoly: & Innovation
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31. The incentive of a monopolist to innovate is:
Incentives to Innovate A
A + B C
C’0 D
The new (lower) marginal cost
C’1
P(x)
A firm produces at C’0 .
What is its incentive to reduce its MC to C’1 ???
R’(x)
If, to begin with, the firm was a monopolist
The incentive of a monopolist to innovate is:
(B+C+D)-(A+B) = C+D-A
The profit at C’0 : A +B
The profit at C’1 : B+C+D
Monopoly: & Innovation
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32. A+B ≥ B+C Incentives to Innovate Note that A ≥ C.
For at C’0 the optimal quantity is x0M
and NOT x1M
A+B ≥ B+C D
The new (lower) marginal cost
C’1
P(x)
A firm produces at C’0 .
What is its incentive to reduce its MC to C’1 ???
x0M
x1M
R’(x)
If, to begin with, the firm was a monopolist
The incentive of a monopolist to innovate is:
B+C+D-(A+B) = C+D-A
The profit at C’0 : A +B
The profit at C’1 : B+C+D
< D
Monopoly: & Innovation
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33. The incentive of a competitive firm to innovate is:
Incentives to Innovate
Now the firm is a monopolist and would like to produce at p1M
But, p1M > pC so it produces at just under pC as in slide 30.
p1M pC
C’0 D E
The new (lower) marginal cost
C’1
P(x)
A firm produces at C’0 .
What is its incentive to reduce its MC to C’1 ???
R’(x)
If the firm was competitive to begin with
The incentive of a competitive firm to innovate is:
D+ E
The profit at C’0 (competition): 0
The profit at C’1 (p1M > pC) : D+E
Monopoly: & Innovation
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34. C+D-A < D < D+E Incentives to Innovate Since
The incentive of a monopolist to innovate is lower than that of a competitive firm
p1M pC
C’0 D E
The new (lower) marginal cost
C’1
P(x)
A firm produces at C’0 .
What is its incentive to reduce its MC to C’1 ???
The incentive of a monopolist to innovate is:
B+C+D-(A+B) = C+D-A
R’(x)
If the firm was competitive to begin with
The incentive of a competitive firm to innovate is:
D+ E
The profit at C’0 (competition): 0
The profit at C’1 (p1M > pC) : D+E
Monopoly: & Innovation
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35. Monopoly and Quality
Does a monopolist produce the ‘optimal’ quality ??
Monopoly & Quality
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36. Monopoly & Quality
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37. Willingness to pay for an increase in qualityx p
q fixed
P’q
P’’qx < 0
Willingness to pay for an increase in quality
Monopoly & Quality
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38. Willingness to pay for an increase in qualityx p
q fixed
P’q
P’’qx < 0
Willingness to pay for an increase in quality
Monopoly & Quality
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39. But this may not be a global maximum. p
Similarly, when P’’qx > 0 Welfare has a local maximum at the monopolist’s optimum.
But this may not be a global maximum.
The global maximum of welfare may be at a point where x is high and q low.
q fixed
P’q
P’’qx < 0
Willingness to pay for an increase in quality
Monopoly & Quality
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40. Regulation
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41. Exercises
Wolfstetter, p. 32, example 1.5