1. Monopoly

2. Market Power Market power is the ability of a firm to affect the market price of a good to their advantage. In declining order. Monopoly – A single producer without competition Oligopoly Power – A small number of producers sometimes acting in concert. Monopolistic Competition – Firms selling differentiated products.

3. Price effects There is a demand curve relating the quantity of a product that can be sold at a given price. Invert the concept: For each quantity, there is a price that the market may bare. Change the quantity and change that price Marginal revenue

4. Marginal Revenue For price taking firm, marginal revenue is equal to price. For a firm with market power, marginal revenue must include the change in the price that results from a change in quantity.

5. Example Demand, Revenue, Marginal Revenue

6. Example Demand MR

7. Monopolist Maximize Revenues by choosing an output level such that marginal revenue equals marginal cost. Price will exceed marginal cost. Monopolists will make greater profits than a competitive firm. –Monopolists will charge higher prices and produce less output than a competitive industry. Profits should attract new entrants to the market. –Monopoly can only survive if there are some barriers to entry.

8. Monopolist: Constant Cost MC = ATC ATC MR D Q Mono P* Q PC Price Output

9. Monopolist: Revenue MC = ATC ATC MR D Q* P* Revenues Price Output

10. Monopolist: Profits MC = ATC ATC MR D Q* P* Profit Price Output

12. Monopolist: General Case MC ATC MR D Q* P* Price Output

13. Monopolist: Revenue MC ATC MR D Q* P* Revenues Price Output

14. Monopolist: Costs MC ATC MR D Q* P* Costs Price Output

15. Monopolist: Profits MC ATC MR D Q* P* Profits Price Output

16. Markups If a market is competitive, then price will equal marginal cost. Degree of market power is often measured as markup over marginal cost

17. Lerner Index Net markups are a measure of the market power of a firm or industry. Referred to as the Lerner index. Rule of thumb for a monopolist, –If markups are below this level, raise prices. –If markups are above this level, lower prices.

18. Monopolist’s Schedule The more elastic the demand curve, the higher the market power. The greater the market power, the greater the markup. Firm has more pricing power if good has fewer substitutes.

19. Barriers to Entry Total Control over Vital Resource –Alcoa in the aluminum market –DeBeers in Diamond market Patents or Secret Formula: –Xerox: Controlled photocopying Regulations: Jockey Club, SDTM –Gambling is a legally restricted monopoly Returns to Scale: –TownGas is an regulated monopoly supplier of a particular type of piped natural gas (may have competition from LNG)

20. Natural Monopoly In markets with a natural monopoly there may be one firm. Economies of scale indicate that at marginal cost pricing firms make a loss. Efficient production involves 1 firm. Firm will naturally charge markup and earn profits.

21. Monopolist: High Fixed Costs MC ATC MR D Q Mono P* Q PC ATC Price Output

22. Regulation Government may step in, usually to put a maximum price level. Should be minimum amount necessary to get the firm to operate small decisions that lead to a competitive outcome. Average cost pricing Information Problem. A single decision maker may not have full access to enough information..

23. MC ATC MR D Monopoly Competition Average Cost Pricing

24. Monopolistic Competition and Product Differentiation

25. Monopolistic Competition Most firms produce a good that is (to a certain extent) unique. No other good has the exact same properties. –Coke, Pepsi, President’s Choice To the extent that you are a unique producer, you will have some market power. Price elasticity of individual products are larger than total category. But not infinite as in the case of commodity goods.

26. Monopolistic Competition: Short-term MC ATC MR D Q* P* Price Output

27. Characteristics of Monopolistically Competitive Markets Differentiated Products DownloadDownload Free Entry into very similar markets. Fixed costs of setting up production Individual firms face downward sloping demand curve and a falling average total cost curve. –They would sell more if they could at the going rate but lowering their prices to sell more would lead to losses.

28. No Barriers to Entry What happens if new firms can enter? If there are profits to be had, entrepreneurs will enter markets to provide close substitutes for profit making goods. New goods splitting the market and better substitutes means lower, flatter demand curve.

29. Monopolistic Competition: Entry of Competitors MC ATC MR D Q* MR′ D′D′ Price Output

30. Monopolistic Competition vs. Perfect Competition On a market-by-market basis, perfect competition will offer greater efficiency both in terms of minimizing deadweight losses and encouraging an efficient production scale. Monopolistic Competition only occurs with differentiated products. –Greater variety generated by this market may compensate for loss of efficiency.

31. Monopolistic Competition: Long-term MC ATC MR D Q* P* Price Output

32. Monopolistic Competition vs. Perfect Competition Similar: Both have many firms, both have zero profits and P = ATC. Different: –P > MC : On the margin, monopolistically competitive firms want more customers. Greater variety generated by this market may compensate for loss of efficiency. –MC < ATC: Firm is operating at a level that does not minimize total costs.

33. Variety and Monopolistic Competition Given that most markets have the “feel” of monopolistic competition, do we have too many firms or is variety it’s own reward? Does advertising create phony differentiation or provide information?

34. Monopolistic Competition and Entrepreneurship New markets are frequently developed. For many goods, the only barriers to entry is imagination. Entrepreneurs develop new ideas for new goods. The pay-off for entrepreneurship are short-run monopoly profits. (Ted Turner and CNN). Only in rare cases will firms be able to make long-term monopolistic profits.

35. Unprofitable Monopolistic Competition: Short-term MC ATC MR D Q* P* Price Output

36. Consequences of Market Power One clear consequence of the existence of market power is that prices are higher than marginal cost and output is smaller than perfect competition. Additional consequences of the presence of market power may be: –Complacency by firms managers (i.e. standard corporate governance measures do not generate efficiency) –Rent-seeking: Firms may put effort into constructing artificial barriers to entry rather than producing goods.

37. Learning Outcomes Define marginal revenue. Characterize the relationship between price, marginal revenue, marginal cost, average total cost, and profits in a monopolistic market. Measure the degree of market power with the Lerner index. Describe 4 barriers to entry that may enable monopoly power.

38. Final Exam Date: Saturday, October 25 Time: 2:30pm Place: 3007 (L2) & 3008 (L1) Coverage: Lecture notes covered in class, semi-open book. Bring writing instruments, calculator, 1 A4 sized paper with written notes. Office Hours: 7-8Thur. 15 th Floor HK Club Building, 10-12Sat. 2346,