1. Market Power and Welfare Monopoly and Monopsony

2. Monopoly Profit Maximization A monopoly is the only supplier of a good for which there is no close substitute. Monopolies are not price takers like competitive firms Monopoly output is the market output Monopoly demand curve is the market demand curve Monopolists can set their own price given market demand Because demand is downward sloping, monopolists set price above marginal cost to maximize profit. Like all firms, monopolies maximize profits by setting price or output so that marginal revenue (MR) equals marginal cost (MC).

3. Monopoly Profit Maximization A monopoly firm’s MR curve depends on the demand curve it faces. MR is also downward sloping and lies below the demand curve If p(Q) is the inverse demand function, which shows the price received for selling Q, then the marginal revenue function is: Given a positive value of Q, MR lies below inverse demand. Selling one more unit requires the monopolist to lower the price Price is lowered on the marginal unit and all other units sold

4. Monopoly Profit Maximization We can rewrite MR function so that it is stated in terms of elasticity: This makes the relationship between MR, D, and elasticity quite clear. Where demand hits the vertical axis, MR=P and demand is perfectly elastic. Everywhere that MR > 0, demand is elastic. The quantity at which MR = 0 corresponds to the unitary elastic portion of the demand curve. Everywhere that MR < 0, demand is inelastic.

5. Monopoly Profit Maximization

7. The monopolist’s profit maximizing choice of output is found where MR=MC. At the profit- maximizing output, set p according to inverse demand.

8. The Effect of Monopoly Market Power on Welfare

9. Perfect competition maximizes welfare because price equals marginal cost. By contrast, a monopoly sets price above marginal cost (and above the competitive price) causes consumers to buy less than the competitive level of output generates deadweight loss

10. Causes of Monopolies Why are some markets monopolized? Two key reasons: Cost advantage over other firms Government created monopoly Sources of cost advantages: 1. Control of an essential facility, a scarce resource that a rival firm needs to use to survive 2. Use of superior technology or a better way of organizing production 3. Protection from imitation through patents or informational secrets Governments typically create monopolies in 1 of 3 ways: 1.By making it difficult for new firms to obtain a license to operate 2.By granting a firm the rights to be a monopoly 3.By auctioning the rights to be a monopoly

11. Government Actions That Reduce Monopoly Market Power Governments limit monopolies’ market power in various ways: 1.Optimal Price Regulation: government regulates the monopoly by imposing a price ceiling that is equal to the competitive price, which eliminates DWL. 2.Non-optimal Price Regulation: government-imposed price ceiling is not set at the competitive level, which reduces but does not eliminate DWL. 3.Increasing Competition: allowing/encouraging market entry by new domestic firms and ending import bans that kept out international firms.

12. Optimal Price Regulation for Monopolies With optimal price regulation, the government imposes a price ceiling that is equal to the competitive price.

13. Monopsony A monopsony is a single buyer in a market, much like a monopoly is a single seller in a market. A monopsony exercises its market power by buying at a price below the price that competitive buyers would pay. Examples: professional baseball teams, university in a college town, mining in a “company town” Suppose that a firm is the sole employer in town and uses only one factor, L, to produce a final good. The monopsony’s total expenditure is E = w(L)L, where w(L) is the wage given by the market labor supply curve. The firm’s marginal expenditure is then: ME is upward sloping and greater than w(L), the labor supply curve.

14. Monopsony Equilibrium The firm hires labor until the marginal value of the last worker hired equals the firm’s marginal expenditure. Assume the firm is a price taker in the output market, and maximize profit by choosing L given its production function, Q(L): FOC: The firm hires labor until the value of the output produced by the last worker equals the marginal expenditure on the last worker. The markup of ME over the wage is inversely proportional to the elasticity of supply, :

15. Monopsony Equilibrium Equilibrium is determined by the intersection of marginal expenditure and demand.

16. Monopsony: Example

17. Welfare Effects of Monopsony Monopsony results in welfare loss of C+E relative to competition.

18. The Effect of Monopsony Market Power on Welfare

20. Government Actions That Reduce Monopsony Market Power Governments limit monopsony’s market power in various ways: 1.Optimal Wage Regulation: government imposes a minimum wage that is equal to the competitive wage, which eliminates DWL. 2.Non-optimal Wage Regulation: government-imposed minimum wage is not set at the competitive level, which reduces but does not eliminate DWL. 3.Increasing Competition in the Labor Market: allowing/encouraging market entry by new firms.