Market Power 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

Monopoly Model with Positive Economic Profit Q $ ATCM QM PM Figure 6.1a D MR MC A ATC B

Monopoly Model with Negative Economic Profit Q $ ATCM QM PM Figure 6.1b MR D MC B ATC A

Monopoly Model Monopolist maximizes profits by producing where MR = MC and earns positive economic profit due to barriers to entry The monopolist could suffer losses if ATC is greater than price at the profit-maximizing level of output (previous slide)

Comparing Monopoly and Perfect Competition Figure 6.2 MC ATC D=P=MR $ QPC Q QM MC Q1 ATC MR $ P1 P2

Comparing Monopoly and Perfect Competition Monopolistic firm must seek out optimal price, which depends on demand and cost conditions Firms with market power might pursue other profit goals Price is higher and output lower under monopoly than under perfect competition

Barriers to Entry Economies of scale and mergers Barriers created by government Input barriers Brand loyalties Consumer lock-in and switching costs

Economies of Scale and Mergers Exist when a firm’s LRAC slopes downward or when lower production costs are associated with larger scale of operation Can act as a barrier to entry in different industries Mergers are particularly important in technology, media, and telecommunications

Barriers Created by Government Licenses Patents and copyrights

Input Barriers Control over raw materials Barriers in financial capital markets Larger firms can get lower interest rates Smaller firms need more collateral for loans Smaller firms are perceived as riskier

Consumer Lock-In and Switching Costs When consumers become locked into certain types or brands and would incur substantial switching costs if they changed Although lock-in types are dominant, they represent managerial strategies that can be used elsewhere to gain market power

Measures of Market Power Managers can use measures to better understand the markets Lerner Index: measure of market power that focuses on the difference between a firm’s product price and marginal cost of production L = (P – MC) P

Antitrust Issues Federal legislation that limits market power of firms and regulates how firms use their market power to compete Major components of antitrust law: Sherman Act of 1890 Clayton Act of 1914 Federal Trade Commission Act of 1914

Managerial Rule of Thumb: Understanding Antitrust Laws Managers must work within antitrust constraints Because of generalities and ambiguities, managers may not know whether their actions are illegal unless the government initiates litigation

Assumptions of Monopolistic Competition Product differentiation exists among firms Large number of firms exist No interdependence exists among these firms Entry by new firms is relatively easy

Monopolistic Competition, Long Run and Short run Figure 6.3 $ Q1 Q P1 $ Q2 Q P2 D MR MC D MR MC ATC ATC

Managerial Rule of Thumb: Monopolistic Competition Market Power in Monopolistic Competition Managers must develop a variety of strategies to maintain market power when faced with intense competition They can exploit geographic advantages, offer improved customer service, become part of a cooperative to lower cost, and develop specialized niches