1 Monopoly and Antitrust Policy Chapter 13

2 IMPERFECT COMPETITION AND MARKET POWER imperfectly competitive industry An industry in which single firms have some control over the price of their output. market power An imperfectly competitive firm’s ability to raise price without losing all of the quantity demanded for its product. Imperfect competition does not mean that no competition exists in the market. In some imperfectly competitive markets competition occurs in more arenas than in perfectly competitive markets. Firms can differentiate their products, advertise, improve quality, market aggressively, cut prices, and so forth.

3 IMPERFECT COMPETITION AND MARKET POWER DEFINING INDUSTRY BOUNDARIES The ease with which consumers can substitute for a product limits the extent to which a monopolist can exercise market power. The more broadly a market is defined, the more difficult it becomes to find substitutes. pure monopoly An industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

4 IMPERFECT COMPETITION AND MARKET POWER BARRIERS TO ENTRY barrier to entry Something that prevents new firms from entering and competing in imperfectly competitive industries. Government franchise A monopoly by virtue of government directive. Patent A barrier to entry that grants exclusive use of the patented product or process to the inventor. Economies of Scale and Other Cost Advantages Ownership of a Scarce Factor of Production

5 IMPERFECT COMPETITION AND MARKET POWER PRICE: THE FOURTH DECISION VARIABLE Regardless of the source of market power, output price is not taken as given by the firm. Instead: Price is a decision variable for imperfectly competitive firms. Firms with market power must decide not only (1) how much to produce, (2) how to produce it, (3) how much to demand in each input market (4) what price to charge for their output.

6 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS To analyze monopoly behavior, we make two assumptions: (1) that entry to the market is blocked, and (2) that firms act to maximize profits.

7 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

8 By knowing the demand curve it faces, the firm must simultaneously choose both the quantity of output to supply and the price of that output. Once the firm chooses a price, the market determines how much will be sold. The monopoly chooses the point on the market demand curve where it wants to be.

9 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

10 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

11 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS A profit-maximizing monopolist will continue to produce output as long as MR exceeds MC. Because the market demand curve is the demand curve for a monopoly, a monopolistic firm faces a downward-sloping demand curve. The monopolist must lower the price it charges to raise output and sell it. Selling the additional output will raise revenue, but this increase is offset somewhat by the lower price charged for all unit sold. Therefore, the increase in revenue from increasing output by one (MR) is less than the price.

12 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

13 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS At zero units →TR=0 To begin selling, the firm must lower the product price (MR>0, TR begins to increase) To sell more, the firm must lower its price more and more Output between 0 and Q* → firm moves down on its demand curve from A to B: MR>0, TR continues to increase Q rising pushing TR (PxQ) up and P falling pushing TR down Up to point B → the effect of increasing Q dominates the effect of falling P: TR rises, MR>0 Point B toward C → lowering P to sell more Q, but above Q* : MR<0, TR starts to fall Beyond Q* → the effect of cutting P on TR is larger than the effect of increasing Q: TR falls At C → TR=0 because P=0

14 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

15 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS All firms, including monopolies, raise output as long as marginal revenue is greater than marginal cost. Any positive difference between marginal revenue and marginal cost can be thought of as marginal profit. The profit-maximizing level of output for a monopolist is the one at which marginal revenue equals marginal cost: MR = MC. The Absence of a Supply Curve in Monopoly A monopoly firm has no supply curve that is independent of the demand curve for its product. A monopolist sets both price and quantity, and the amount of output that it supplies depends on both its marginal cost curve and the demand curve that it faces.

16 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

17 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS Perfectly competitive markets: Long run and short run Short run → fixed factor of production, no entry and exit (MC increase with Q) Long run → free entry and exit, LR equilibrium where industry profits equal to zero Monopoly: Short run → limited with fixed factor of production (diminishing returns to factors of production) Long run → if monopoly earning positive profits, nothing will happen (entry blocked) Monopoly will operate at the most efficient scale of production (no change in LR)

18 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

19 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS

20 PRICE AND OUTPUT DECISIONS IN PURE MONOPOLY MARKETS COLLUSION AND MONOPOLY COMPARED collusion The act of working with other producers in an effort to limit competition and increase joint profits. The outcome would be exactly the same as the outcome of a monopoly in the industry.

21 THE SOCIAL COSTS OF MONOPOLY

22 PRICE DISCRIMINATION price discrimination Charging different prices to different buyers. perfect price discrimination Occurs when a firm charges the maximum amount that buyers are willing to pay for each unit.

23 EXAMPLES OF PRICE DISCRIMINATION