Monopoly KW Chap. 14

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.

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

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.

Example Demand, Revenue, Marginal Revenue

Example Demand MR

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.

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

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

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

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

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

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

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

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

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.

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.

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)

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.

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

MC ATC MR D Monopoly Competition Average Cost Pricing

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..

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.