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Chapter 10 Monopoly Monopoly = market with just one seller but many buyers market power when choosing -max level of output, faces market demand curve (which.

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Presentation on theme: "Chapter 10 Monopoly Monopoly = market with just one seller but many buyers market power when choosing -max level of output, faces market demand curve (which."— Presentation transcript:

1 Chapter 10 Monopoly Monopoly = market with just one seller but many buyers market power when choosing -max level of output, faces market demand curve (which slopes downward), rather than facing perfectly elastic horizontal demand curve. Implies that q* decision affects P. For monopolist: mkt D curve is NOT same as MR and P MR. Result: Higher P and lower Q than in perfect competition.

2 More on Monopoly When say monopolist faces the market down-sloped D curve: means this firm must consider the market inverse relationship between P and Q; I.e., when Q, must P. Has implications for AR, MR, and -max q* (which equals Q*). AR: price per unit sold: this is market demand curve. MR P since when sell extra Q and P, this P affects ALL Q sold, not just last Q sold.

3 Monopolists -max Decision AR is market demand curve. MR lies below AR curve (See Figure 10.1 and Table 10.1.) Monopolists production decisions: 1) Pick q* where MR = MC. (This is same rule as in PC except in PC, MR=P.) 2) Then get P off of D curve. (At q*, how much are buyers willing to pay?) Note that 0. See Figure 10.2.

4 PC vs Monopolist PC has lower price and higher quantity, has zero profits in LR, and is more efficient (efficiency due to P=MC). Monopolist has higher price and lower quantity, can have positive profits in LR (due to restricted firm entry), and is less efficient; I.e., imposes a deadweight loss (because P MC). –See Figure 10.3

5 Pricing for a Monopolist Eqn. (10.2): P = MC/[1+(1/E d )] Comes from equation (10.1) showing price mark-up over MC as a % of price. Recall for PC: P = MC. For monopolist: P MC. So HOW much is P greater than MC? Difference depends inversely on E d. If demand very elastic little mark- up, so little benefit to operating as a monopolist. See Figure KEY: Monopolist operates only on elastic portion of demand curve.

6 Price vs MR Remember two points: –Monopolist operates only on elastic portion of demand curve; –MR P. MR = P[1+1/E D ]. So if E D -1 then MR 0. In other words: if D is inelastic, then MR is negative. At point that D becomes inelastic, MR curve drops below horizontal axis. So monopolist will not operate on inelastic portion of demand curve.

7 Examples 1. Demand not very elastic; So, demand not very responsive to P: E d = -1.1: P = MC/[1+(1/E d )] P = MC/[1+(1/-1.1)] P = 10 * MC. 2. Demand very elastic: E d =-5. P = 1.25 * MC. Rule: Monopolist gains most when operating on least elastic range (of the elastic portion of D curve).

8 Other Industry Structures Some industries dont have zero market power like PC and not lots of mkt power like monopoly; they lie somewhere in between. # firms: not huge but not 1. Product differentiation. Result: firms dont face perfectly elastic D curve like in PC but dont face full market D curve like in monopoly. See Figure 10.7.

9 Measuring Market Power By how much will P exceed MC? Lerner Index of Monopoly Power: excess of price over MC as fraction of price (from eq.1). L = (P-MC)/P; 0 L 1. L = 0 for PC (when P=MC). Remember: L = -1/E D but now this E D is for a specific firm. Examples of two groups of buyers: supermarket vs convenience store. See Figure 10.8.

10 Sources of Monopoly Power Factors that affect degree to which a single firm can exert some control over price? 1) E D power. 2) # firms power. -Depends on ease of entry for new firms. 3) how firms interact: more aggressive competition leads to less market power.

11 PC vs Monopoly I. Compare P and Q: PC has lower price and higher Q. II. Compare PS and CS: Monopoly involves deadweight loss (related to loss in efficiency from non-MC pricing). This deadweight loss is the social cost of monopoly. See Figure

12 Natural Monopoly NM occurs in industry in which cost structure differs: now cost advantage to monopoly. KEY: strong economies of scale so that AC slopes down at all levels of Q. So MC AC at all Q. With this cost structure: MORE efficient to operate as NM than PC. See Figure

13 Exercise Given that MC = constant = $10 and the following P and Q information,: Calculate firms MR, -max P and Q.

14 Info for Exercise Price Quantity


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