Monopoly What is it What leads to monopoly –minimum size –natural resources –patent/copyright Competition& Min. Size –decreasing costs Economics of Monopoly –MR/Q/Profit –Deadweight loss Why Competitors are Price Takers Why firms like quota regulation Utility regulation

Monopoly A monopolist is a single seller. A competitor is one of very many sellers An oligopolist is one of a few sellers

Decreasing Costs Means that average cost is decreasing Increasing cost Constant cost A U shaped cost curve has a decreasing and then an increasing portion. If the bottom were flattened out, it would have a constant portion

Returns to Scale F(x 1 …x n ) a production function. For b > 1 –F(bx 1,…,bx n ) =bF(x 1,…,x n ) then constant returns to scale –F(bx 1,…,bx n ) < bF(x 1,…,x n ) then decreasing returns to scale –F(bx 1,…,bx n ) > bF(x 1,…,x n ) then increasing returns to scale

RTS and Costs If doubling inputs more than doubles output, then –cost of inputs doubles/ output more than double –AC is less when making twice as much could use b times as much to be more general Increasing Returns to Scale goes with Decreasing Costs –need this terminology bit. sorry.

Reasons for Imperfect Competition Patent Copyright Scarce Resource –Cobalt in Zaire –Nickel, INCO –Oil and OPEC –De Beers Diamonds Room in the Market for only a few firms. –Decreasing Costs –i.e. Power distribution –often regulated

LRCE Long Run Competitive Equilibrium: N firms produce at P* = MC(q*) (firm’s supply curve) S(P*) = N MC -1 (P*) = D(P*) (industry supply = demand) Profit = P*q* - C(q*) = 0 (no entry or exit)

N Firms in LRCE D N MC -1 (q*) P* q* MC AC

1 Firms in LRCE D MC -1 (q*) P* q* AC Minimum Point of AC takes up all of demand. Suppose another firm tries to enter?

Why not raise price? No new firms will enter –not room for two in market Will it make more $$$$?

Marginal Revenue demand P(Q+1) Monopolist sells one more unit. Price decreases from P(Q) to P(Q+1). Slope of demand is calculated between the two red dots on the demand curve. Q Q+1 P(Q) The slope of demand Is [P(Q) – P(Q+1) ]/ 1 Price falls by the slope of demand.

Marginal Revenue P(Q+1) By adding 1 unit a monopolist gains The area is 1 wide by P high = P Q Q+1 P(Q) The monopolist looses This area is the decrease in price, which is the slope of demand times Q. So MR is the sum of the two areas MR= P + Q (slope demand)

MR with linear Demand MR(Q) = Q (slope of P(Q)) + P(Q) P(Q) = a - b Q; slope = -b MR(Q) = - Q b + (a -bQ) = a- 2bQ MR has twice as negative a slope as demand and the same intercept. –special property of linear demand

MR = MC MR is amount revenue goes up for a unit more output MC is additional cost So if MR > MC make more MR < MC make less MR = MC determines Q; output P(Q) demand, determines price

AC Monopoly profit QmQm MR MC D PmPm

Deadweight loss DMR MC QmQm PmPm

MR and Competition Q Q+1 P(Q) q Let Q = nq. Competitor loses just q times slope and gains P whilst monopolist looses Q times slope (n times as much) and gains P. So when n is big, MR = Q/n slope+ P is approx P.

Text Book Baumol and Blinder, Chapt 10 provides the straight dope. Chapter 11 includes monopolistic competition and introduces the field of industrial organization.

MR and Elasticity Let P = D(Q) Slope = (1/  ) P / Q MR = Q slope + P = P (1/  ) + P

MR and Elasticity MR() = P (1/  ) + P= P(1+ 1/  ) – Remember it is P(Q) and MC(Q) MR is negative when elasticity of demand is between 0 and -1 MR is positive when elasticity is less than -1

Quotas and Profits Assume LRCE. Now assume that quota on air holds number of firms constant and demand increases because people get richer over time. Firm’s now earn positive profits. And there is no entry. Quotas move market toward monopoly

Regulation Cost curve of power distribution: –AC = FC/Q + b where b > 0 –Draw MC and AC –Now draw demand and MR –Find monopoly solution –Can a regulator set P = MC? Can regulator force firm to make losses? –How great a Q can the regulator set?

Deadweight Loss Call Q r the regulated output What is the deadweight loss at Q r ? At Q m the monopoly output?

Regulation Diagram b = MC AC D MR Q $/unit QrQr Decreasing Cost Industry also called Increasing Returns to Scale Triangle is DWL PrPr

Any Way to Get DWL? Two part pricing scheme: –First sell Q r at P r –Then sell the rest at MC. –The trick is to separate the market so that the cost of the next unit of power is MC. sell to big guys at MC make the peons pay more