1. Foundation of Economic Analysis 3250:600
Instructor: Richard W. Stratton
Meets: Thursday 5:20 – 7:50 pm
CAS 134

2. The University of Akron
Administration
This Week’s Assignments
Farnham Chapter 8 (Monopoly)
Farnham Chapter 9 (Oligopoly)
Essay 1
Next Week’s Assignments
Test 2
2/27/2019
The University of Akron
Decision Tree

3. Monopoly Monopolistic competition Oligopoly
Decision Tree
Monopoly
Monopolistic competition
Oligopoly

4. Market Structure - summary
Common behavior
Firms estimate marginal costs and marginal revenues and then try to sell all units of output for which expected MR > expected MC
Price takers
The price out of control of firm: P = MR
Thus they only need to determine the level of output for which MC = P = MR
Price seekers (makers)
Firms have some market power and choice in the price they charge.
Thus they try to set prices that enable them to sell all units of output for which expected MR > expected MC
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5. Decision Tree Description Monopoly model
Comparison to perfect competition
Market power

6. Description – Market Structure
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Decision Tree

7. Description - Monopoly
Market power: ability of a firm to influence the prices of its products and develop strategies to earn profits over longer periods of time
Monopoly: single firm producing product with no close substitutes
Price-searchers: firms in imperfect competition
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Decision Tree

8. Description - Monopoly
One firm
Firm is the market supplier
Selling unique product
No or very poor substitutes
Barriers to entry
Potential competitors face substantial barriers (costs) of entry
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Decision Tree

9. Description - Monopoly
Monopoly Firm Behavior
Continue to assume profit maximization
Profit = Total Revenue – Total Cost
P = TR – TC
Same profit maximization rule
MR = MC
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Decision Tree

10. Description - Monopoly
Remember that perfectly competitive firms face a perfectly elastic demand curve, at the market equilibrium price
What demand curve does the monopoly firm face?
The market demand!
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11. Description - Monopoly
If firm faces the market demand,
What impact on the firm’s revenue function?
To sell more output, the firm must lower its price
Thus the firm’s revenue function is NOT a straight line
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Decision Tree

12. The University of Akron
Monopoly Model
Q = P
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Decision Tree

13. The University of Akron
Monopoly Model AR MR
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14. The University of Akron
Monopoly Model
Can you identify the elasticity of this market demand?
Elastic
Inelastic AR MR
Unit Elastic
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15. The University of Akron
Monopoly Model
At what output level is TR maximized?
What is MR at this level of output? AR MR TR
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16. Monopoly Model, SR profit
Firm Behavior
Firms maximize profits
Profit = Total Revenue – Total Cost
P = TR – TC
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Decision Tree

17. Monopoly Model, SR profitTC
Profit = TR - TC
At what level of output is profit max?
So let’s use MC=MR! $ ? TR Q* Q
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Decision Tree

18. Monopoly Model, SR profit
Profit = TR - TC
At what level of output is profit max?
Price? MC AR MR
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19. Monopoly Model, SR profit
Profit maximizing output level? Price?
Figure 8.1a $ D MR MC A PM B QM Q
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20. Monopoly Model, SR profit
Is this firm making a profit or loss?
Figure 8.1a $ D MR MC A PM
ATC B
ATCM QM Q
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21. Monopoly Model, long run
What market adjustments will be made in the long run?
Since there are barriers to entry, the firm can continue to operate at a profit
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22. Monopoly Model, SR profit
Is this firm making a profit or loss?
Figure 8.1a $ D MR MC
ATC B
ATCM PM A QM Q
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23. Monopoly Model, long run
What market adjustments will be made in the long run?
This firm is making a loss
It will operate in SR if P>AVC
It will shut down in the LR, unless demand increases
2/27/2019
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Decision Tree

24. Comparison Monopoly & PC
Perfect Competition
Monopoly
MR = MC
P = MR
P > MR; P > MC
Supply =>MC
Supply is a single P,Q combination
LR: P = ATC; P = 0
LR: P > ATC; P > 0
LR: ATC minimized
Firms may have other objectives
LR: P = min. ATC
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25. Comparison Monopoly & PC
Perfect Competition
Monopoly
Lots of small firms may have high minimum ATC
Economies of scale may allow monopolist to offer good at lower cost than competitive market
P = 0 implies no funds for research and development
P > 0 may be source of research and innovation
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26. The University of Akron
Market Power
Sources
Limits
Measures
Antitrust
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27. The University of Akron
Market Power - sources
Barriers to entry
Economies of scale
Input barriers
Government created
Brand loyalties
Consumer lock-in
Network externalities
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The University of Akron

28. The University of Akron
Market Power - sources
Economies of scale
Firms which find MES have cost advantage
Mergers can eliminate rivals
Input barriers
Ownership of key input
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29. The University of Akron
Market Power - sources
Government created
Licenses, copyrights, patents
Franchises – utilities, cable TV, etc.
Brand loyalties
Consumers perceived differences
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The University of Akron

30. The University of Akron
Market Power - sources
Consumer lock-in
Contractual commitments - Cell phones
Durable goods - Computer management systems; database
Specific training
Network externalities
Industry standards – usefulness depends on extent of users
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31. The University of Akron
Market Power - limits
Consumer demand
Own price elasticity of demand
Limits the price monopolies can charge
Potential competition
Cost of overcoming barriers
Fear of regulation
If consumers protest to government
Dynamic nature of market power
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32. Market Power - measures
Price-cost margin (Lerner Index)
L = (P – MC) / P
Concentration ratio
Four-firm (8-firm) ratio (Sale4/TotalSale)
Cross-price elasticity
Can be used to determine the extent of the relevant market
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33. Market Power - measures
Herfindahl-Hirschman Index
S = market share
0 < HHI < 10,000
Justice department threshold
Increase index by 200 points
and beyond 1000
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34. Market Power – and antitrust
Government (FTC) approval needed for some mergers
Government enforcement of rules against monopoly practices
Regulation of monopolies
How to set price, but we have no time
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35. Market Power – other issues
Regulation of monopolies
How to set price
Price discrimination
Can firm sell output at different prices to different customers?
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36. Monopoly Monopolistic competition Oligopoly
Decision Tree
Monopoly
Monopolistic competition
Oligopoly

37. Description – Market Structure
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Decision Tree

38. Monopolist competition
Key feature is product differentiation
Perceived (may not be real)
Many close substitutes
Thus the firm’s demand function is highly elastic, but NOT perfectly elastic
Examples of differentiation
Design (clothes)
Services
Brand
Location
Qualtity
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39. Monopolist competition
Firm’s demand is downward sloping
Lower price relative to competitors
Own customers buy more
Increase market share
Higher price relative to competitors
Own customers buy less
Decrease market share
However, low barriers to entry constrains profits
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40. Monopolist competition, SR profit
Is this firm making a profit or loss?
Figure 8.4 $ D MR MC
ATC P
ATC
Qmc Q
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41. Monopolist competition
Short run profits entice firms to enter the market
Each firm’s market share decreases
Deducing demand, but increasing elasticity
Reducing profits
When will firms stop entering the market?
2/27/2019
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42. Monopolist competition, LR profit
As firms enter the market
Figure 8.4 $ MC D MR
ATC
P = ATC
Qmc Q
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43. Monopolistic Competition & PC
Perfect Competition
Monopolistic Competition
P = MR = MC
P > MR = MC
LR: P = ATC; P = 0
LR: P = ATC; P = 0, marginal firm
LR: ATC minimized
LR: P = min. ATC
LR: P = ATC above minimum; Excess capacity
Market output less than PC
Product variety
Advertising costs > 0
2/27/2019
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44. Monopoly Monopolistic competition Oligopoly
Decision Tree
Monopoly
Monopolistic competition
Oligopoly

45. Description – Market Structure
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Decision Tree

46. Description - Oligopoly
Oligopoly can be caused by the same market power factors as monopoly
Economies of scale
Input barriers
Mergers
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47. Description - Oligopoly
Key features
Few firms
Barriers to entry
Firm interdependence
The actions of one firm impacts the actions of other firms
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48. Description - Oligopoly
Firm interdependence
The actions of one firm impacts the actions of other firms
This causes modeling problems
This is the only market structure which requires manager to anticipate rivals’ responses to their decisions
2/27/2019
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49. Description - Oligopoly
Since there are many possible responses, there is no one model to fit all circumstances
Different models may be appropriate in different situations
Each has different behavioral assumptions
Non-cooperative models
Rivals compete
Cooperative models
Rivals try to act as monopoly
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50. The University of Akron
Oligopoly models
Non-cooperative models
Kinked demand
Maintain market share
Game theory
Strategic behavior
Strategic entry deterrence
Keeping competitors out
Predatory Pricing
Drive competitors out of market
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51. The University of Akron
Oligopoly models
Cooperative models
Cartel
Joint profit maximization (monopoly)
Tacit collusion
Price leadership
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The University of Akron

52. The University of Akron
Oligopoly & PC
Perfect Competition
Oligopoly
MR = MC
P = MR
P > MR; P > MC
LR: P = ATC; P = 0
LR: P > ATC; P > 0
LR: ATC minimized
LR: P = ATC above minimum; Excess capacity
LR: P = min. ATC
Firms may have other objectives
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53. The University of Akron
Oligopoly & PC
Perfect Competition
Oligopoly
Market output less than PC
Advertising costs > 0
Product variety possible
Concentrated economic and political power may not be desirable
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The University of Akron

54. The University of Akron
Oligopoly models - LR
Contestable markets
If barriers of entry can be reduced, potential entrants can keep profits low
Improve efficiency
Notice role of international trade in this process
2/27/2019
The University of Akron

55. Market Structure - summary
Common behavior
Firms estimate marginal costs and marginal revenues and then try to sell all units of output for which expected MR > expected MC
Price takers
The price out of control of firm: P = MR
Thus they only need to determine the level of output for which MC = P = MR
Price seekers (makers)
Firms have some market power and choice in the price they charge.
Thus they try to set prices that enable them to sell all units of output for which expected MR > expected MC
2/27/2019
The University of Akron

56. Monopoly Monopolistic competition Oligopoly
Decision Tree
Monopoly
Monopolistic competition
Oligopoly