1. Llad Phillips1 Introduction to Economics Microeconomics The US Economy

2. Llad Phillips2 Market Power and Monopoly Is monopoly a good thing or not? Is monopoly a good thing or not? How about Microsoft, is this firm good or bad for consumers? How about Microsoft, is this firm good or bad for consumers?

3. Llad Phillips3 Market Power & Market Structure No market power: competition No market power: competition  many producers  firms are price takers  no excess profit  price to consumer = long run average cost Market power: monopoly Market power: monopoly  one producer  monopolist is price setter  monopolist makes profits at expense of the consumer

4. Llad Phillips4 The Brief for Competition.... and against monopoly.... and against monopoly

5. Llad Phillips5 Outline: Lecture Thirteen Competitive Industries Competitive Industries  agriculture  construction Market Supply in the Short Run Market Supply in the Short Run The Optimal Plant Size The Optimal Plant Size Market Supply in the Long Run Market Supply in the Long Run

6. Llad Phillips6 Competitive Markets In the long run, resources will flow to a competitive market if firms are making excess profits In the long run, resources will flow to a competitive market if firms are making excess profits  new firms will enter the industry  if returns to scale are constant, then price will be driven down to long run average total cost  if returns to scale first increase and then decrease, price will be driven down to minimum long run average cost Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product Excess Profits are driven to Zero Excess Profits are driven to Zero

7. Llad Phillips7 Competitive Industries: Agriculture source: Census of Agriculture, 1987

8. Llad Phillips8 Competitive Industries sources: Census of Manufactures, 1987 Census of Construction Industries, 1987

9. Llad Phillips9 Short Run Plant Size of a firm is fixed Plant Size of a firm is fixed

10. Llad Phillips10 AVC I MC I AVC II MC II QIQI Q II Q I + Q II Market Supply Quantity MC, AVC Short Run Market Supply: Two Firm Industry

11. Llad Phillips11 Market Supply and Demand in the Short Run Demand Supply MC, Market Price Quantity pMpM QMQM

12. Llad Phillips12 AVC I MC I AVC II MC II QIQI Q II Q I + Q II Market Supply Quantity MC, AVC, ATC Short Run Market Supply: Two Firm Industry PMPM Market Demand In the short run, both firms are making excess profits. This may motivate them to find the lowest cost size for plant and equipment. ATC I ATC II

13. Llad Phillips13 Short Run* World Supply: Copper * Existing Mines Fixed Source: Minerals Yearbook, 1985

14. Llad Phillips14 Zaire Zambia Chile US Peru Canada

15. Llad Phillips15 Long Run What is the optimal plant size? What is the optimal plant size?  constant returns to scale  increasing, then decreasing returns  increasing returns to scale

16. Llad Phillips16 SMC I SMC II Quantity MC,, ATC Optimal Size of the Firm: Constant Returns to Scale If market price is above long run marginal cost, the firm will make the same excess profit per unit of output in a large plant as in a small plant. The firm may prefer larger to smaller. As long as firms are making excess profits, other firms will enter the industry, increasing supply, and driving price down to LMC. SATC I SATC II LATC, LMC pMpM

17. Llad Phillips17 Demand Long Run Equilibrium Supply with the Free Entry of Firms: Constant Returns to Scale PMPM Market Price Short Run Supply P M = LMC = LATC Supply after Entry of Profit Seeking Firms Quantity Long Run Supply

18. Llad Phillips18 SMC I SMC II Quantity MC,, ATC Optimal Size of the Firm: Constant Returns to Scale If market price is above long run marginal cost, the firm will make the same excess profit per unit of output in a large plant as in a small plant. The firm may prefer larger to smaller. As long as firms are making excess profits, other firms will enter the industry, increasing supply, and driving price down to LMC. SATC I SATC II LATC, LMC pMpM

19. Llad Phillips19 LATC Optimal Size of Plant with Variable Returns to Scale SATC I SATC III SATC IV SATC II SMC IV LMC If market price is above long run average cost, then firms with efficient scale of plant, SATC III,will make an excess profit. In the long run other firms in the industry will move to this efficient size plant. As long as there are excess profits to be made, new firms will enter the industry, driving market price down to minimum long run average total cost, LATC. Market Price Quantity pMpM LATC SMC III

20. Llad Phillips20 Demand Long Run Equilibrium Supply with the Free Entry of Firms: Variable Returns to Scale, Deceasing and then Increasing PMPM Market Price Short Run Supply P M = LMC = Minimum LATC Supply after Entry of Profit Seeking Firms Quantity Long Run Supply

21. Llad Phillips21 LATC Optimal Size of Plant with Variable Returns to Scale SATC I SATC III SATC IV SATC II SMC IV LMC If market price is above long run average cost, then firms with efficient scale of plant, SATC III,will make an excess profit. In the long run other firms in the industry will move to this efficient size plant. As long as there are excess profits to be made, new firms will enter the industry, driving market price down to minimum long run average total cost, LATC. Market Price Quantity pMpM LATC SMC III

22. Llad Phillips22 Competitive Markets In the long run, resources will flow to a competitive market if firms are making excess profits In the long run, resources will flow to a competitive market if firms are making excess profits  new firms will enter the industry  if returns to scale are constant, then price will be driven down to long run average total cost  if returns to scale first increase and then decrease, price will be driven down to minimum long run average cost Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product Consumers benefit from the efficient, lowest cost use of resources and the lowest price for the product Excess Profits are driven to Zero Excess Profits are driven to Zero

23. Llad Phillips23 Natural Monopoly Increasing Returns to Scale Increasing Returns to Scale  optimal size of the firm  larger is better Constant Returns to Scale Constant Returns to Scale  optimal size of the firm: indeterminate  LAC = LMC = same at all outputs Increasing then Decreasing Returns to Scale Increasing then Decreasing Returns to Scale  optimal size of the firm: minimum LAC  minimum LAC where LAC = LMC

24. Llad Phillips24 Optimal Size of Plant with Increasing Returns to Scale: Bigger is Better SATC I SATC II Price Quantity LATC LMC

25. Llad Phillips25 Market Power: Size in 1994 source: World Bank & Fortune 500

26. Llad Phillips26 Market Power: Market Share

27. Llad Phillips27 How does a monopolist use power to maximize profits? marginal principle: increase output until marginal revenue = marginal cost marginal principle: increase output until marginal revenue = marginal cost

28. Llad Phillips28 Monopoly Sales Price Market Demand Quantity 0 0 Revenue $25,000 $10 0 A B A B

29. Llad Phillips29 Long Run Total Costs Increasing Returns to Scale and Long Run Total Costs $ Quantity

30. Llad Phillips30 LTC $ LTC R Quantity Revenue Maximum Monopoly Profits: Marginal Revenue = Marginal Cost $ Excess Profit 0 Quantity

31. Llad Phillips31 Monopoly Profits with Increasing Returns to Scale Price Quantity Market Demand MR

32. Llad Phillips32 Monopoly Profits with Increasing Returns to Scale Price Quantity LATC LMC Market Demand MR QQ PMPM

33. Llad Phillips33 LTC $ LTC R Quantity Revenue Maximum Monopoly Profits: Marginal Revenue = Marginal Cost $ Excess Profit 0 Quantity

34. Llad Phillips34 The Social Cost of Monopoly: Example, Constant Returns to Scale LATC = LMC Market Demand Competition Monopoly Market Demand LATC = LMC PMPM Consumer Surplus MR Q COMP Q MONOP PMPM Under monopoly, consumers pay a higher price and consume less

35. Llad Phillips35 The Social Cost of Monopoly: Example, Constant Returns to Scale LATC = LMC Market Demand Competition Monopoly Market Demand LATC = LMC PMPM Consumer Surplus MR Q COMP Q MONOP PMPM Under monopoly, some consumer surplus is redistributed to the monopolist as profit, and some is lost to society Profit Dead Weight Loss

36. Llad Phillips36 Social Policy If returns to scale are constant If returns to scale are constant  regulate  make the monopolist charge a price equal to marginal cost obtain the competitive solutionobtain the competitive solution If returns to scale are increasing If returns to scale are increasing  regulation is not so easy  can not set monopolist’s price equal to marginal cost: monopolist will suffer losses because marginal cost is less than average costbecause marginal cost is less than average cost  could socialize the industry and the government could subsidize the losses  could live with monopoly

37. Llad Phillips37 MONOPOLY POWER Society How can we control it? Regulation, Franchises, Patents Higher Prices Less Goods Excess Profits Entrepreneurs How do we get it? Political Influence Strategic Planning

38. Llad Phillips38 Strategic Planning: Brand Names source: USA Today, 1992

39. Llad Phillips39 Advertising Cost of a Car source: Fortune

40. Llad Phillips40 Strategic Action: Advertising source: Advertising Age

41. Llad Phillips41 Classification of US Industry source: Survey of Current Business

42. Llad Phillips42 Summary-Vocabulary-Concepts competitive industries competitive industries short run short run short run marginal cost short run marginal cost optimal plant size optimal plant size long run long run long run marginal cost long run marginal cost constant returns to scale constant returns to scale free entry free entry long run equilibrium long run equilibrium variable returns to scale variable returns to scale excess profits excess profits increasing returns to scale increasing returns to scale natural monopoly natural monopoly market share market share marginal revenue marginal revenue monopoly profit monopoly profit social cost of monopoly social cost of monopoly consumer surplus consumer surplus dead weight loss dead weight loss regulation of monopoly regulation of monopoly brand names brand names strategic planning strategic planning