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Market Power: Monopoly

Delve into the concepts of monopoly power, perfect competition, and antitrust laws in Chapter 10. Learn about monopolistic behavior, profit maximization, pricing strategies, and the social costs associated. Gain insights into market structures and how firms wield control. Explore case studies to grasp economic implications.

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Market Power: Monopoly

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  1. Market Power: Monopoly

  2. Topics to be Discussed • Monopoly • Monopoly Power • Sources of Monopoly Power • The Social Costs of Monopoly Power Chapter 10

  3. Topics to be Discussed • Monopsony • Monopsony Power • Limiting Market Power: The Antitrust Laws Chapter 10

  4. Perfect Competition • Review of Perfect Competition • P = LMC = LRAC • Normal profits or zero economic profits in the long run • Large number of buyers and sellers • Homogenous product • Perfect information • Firm is a price taker Chapter 10

  5. D S LMC LRAC P0 P0 D = MR = P q0 Q0 Perfect Competition Market Individual Firm P P Q Q

  6. Monopoly • Monopoly 1) One seller - many buyers 2) One product (no good substitutes) 3) Barriers to entry Chapter 10

  7. Monopoly • The monopolist is the supply-side of the market and has complete control over the amount offered for sale. • Profits will be maximized at the level of output where marginal revenue equals marginal cost. Chapter 10

  8. Monopoly • Finding Marginal Revenue • As the sole producer, the monopolist works with the market demand to determine output and price. • Assume a firm with demand: • P = 6 - Q Chapter 10

  9. Total, Marginal, and Average Revenue Total Marginal Average Price Quantity Revenue Revenue Revenue P Q R MR AR $6 0 $0 --- --- 5 1 5 $5 $5 4 2 8 3 4 3 3 9 1 3 2 4 8 -1 2 1 5 5 -3 1 Chapter 10

  10. Average Revenue (Demand) Marginal Revenue Average and Marginal Revenue $ per unit of output 7 6 5 4 3 2 1 Output 0 1 2 3 4 5 6 7 Chapter 10

  11. Monopoly • Observations 1) To increase sales the price must fall 2) MR < P 3) Compared to perfect competition • No change in price to change sales • MR = P Chapter 10

  12. Monopoly • Monopolist’s Output Decision 1) Profits maximized at the output level where MR = MC 2) Cost functions are the same Chapter 10

  13. Maximizing Profit When Marginal Revenue Equals Marginal Cost The Monopolist’s Output Decision • At output levels below MR = MC the decrease in revenue is greater than the decrease in cost (MR > MC). • At output levels above MR = MC the increase in cost is greater than the decrease in revenue (MR < MC) Chapter 10

  14. MC P1 P* AC P2 Lost profit D = AR Lost profit MR Q1 Q* Q2 Maximizing Profit When Marginal Revenue Equals Marginal Cost $ per unit of output Quantity Chapter 10

  15. Monopoly The Monopolist’s Output Decision • An Example Chapter 10

  16. Monopoly The Monopolist’s Output Decision • An Example Chapter 10

  17. Monopoly The Monopolist’s Output Decision • An Example Chapter 10

  18. Monopoly The Monopolist’s Output Decision • An Example • By setting marginal revenue equal to marginal cost, it can be verified that profit is maximized at P = $30 and Q = 10. • This can be seen graphically: Chapter 10

  19. C t' R c’ t Profits c Example of Profit Maximization $ 400 300 200 150 100 50 Quantity 0 5 10 15 20 Chapter 10

  20. C $ t' R 400 300 c t 200 150 Profits 100 50 c 0 5 10 15 20 Quantity Example of Profit Maximization • Observations • Slope of rr’ = slope cc’ and they are parallel at 10 units • Profits are maximized at 10 units • P = $30, Q = 10, TR = P x Q = $300 • AC = $15, Q = 10, TC = AC x Q = 150 • Profit = TR - TC • $150 = $300 - $150 Chapter 10

  21. MC AC Profit AR MR Example of Profit Maximization $/Q 40 30 20 15 10 0 5 10 15 20 Quantity Chapter 10

  22. $/Q 40 MC 30 AC Profit 20 AR 15 MR 10 0 5 10 15 20 Quantity Example of Profit Maximization • Observations • AC = $15, Q = 10, TC = AC x Q = 150 • Profit = TR = TC = $300 - $150 = $150 or • Profit = (P - AC) x Q = ($30 - $15)(10) = $150 Chapter 10

  23. Monopoly • A Rule of Thumb for Pricing • We want to translate the condition that marginal revenue should equal marginal cost into a rule of thumb that can be more easily applied in practice. • This can be demonstrated using the following steps: Chapter 10

  24. A Rule of Thumb for Pricing Chapter 10

  25. A Rule of Thumb for Pricing Chapter 10

  26. A Rule of Thumb for Pricing Chapter 10

  27. A Rule of Thumb for Pricing = the markup over MC as a percentage of price (P-MC)/P 8. The markup should equal the inverse of the elasticity of demand. Chapter 10

  28. A Rule of Thumb for Pricing Chapter 10

  29. Monopoly • The Multiplant Firm • For many firms, production takes place in two or more different plants whose operating cost can differ. Chapter 10

  30. Monopoly • The Multiplant Firm • Choosing total output and the output for each plant: • The marginal cost in each plant should be equal. • The marginal cost should equal the marginal revenue for each plant. Chapter 10

  31. Monopoly The Multiplant Firm • Algebraically: Chapter 10

  32. Monopoly The Multiplant Firm • Algebraically: Chapter 10

  33. Monopoly The Multiplant Firm • Algebraically: Chapter 10

  34. Monopoly • Algebraically: Chapter 10

  35. MC1 MC2 MCT P* D = AR MR* MR Q1 Q2 Q3 Production with Two Plants $/Q Quantity Chapter 10

  36. Observations: 1) MCT = MC1 + MC2 2) Profit maximizing output: MCT = MR at QT and P * MR = MR* MR* = MC1 at Q1, MC* = MC2 at Q2 MC1 + MC2 = MCT, Q1 + Q2 = QT, and MR = MC1 + MC2 Production with Two Plants $/Q MC1 MC2 MCT P* D = AR MR* MR Q1 Q2 Q3 Quantity Chapter 10

  37. Monopoly Power • Monopoly is rare. • However, a market with several firms, each facing a downward sloping demand curve will produce so that price exceeds marginal cost. Chapter 10

  38. Monopoly Power • Scenario: • Four firms with equal share (5,000) of a market for 20,000 toothbrushes at a price of $1.50. Chapter 10

  39. Monopoly Power • Measuring Monopoly Power • In perfect competition: P = MR = MC • Monopoly power: P > MC Chapter 10

  40. Monopoly Power • Lerner’s Index of Monopoly Power • L = (P - MC)/P • The larger the value of L (between 0 and 1) the greater the monopoly power. • L is expressed in terms of Ed • L = (P - MC)/P = -1/Ed • Ed is elasticity of demand for a firm, not the market Chapter 10

  41. Monopoly Power • Monopoly power does not guarantee profits. • Profit depends on average cost relative to price. • Question: • Can you identify any difficulties in using the Lerner Index (L) for public policy? Chapter 10

  42. Monopoly Power • The Rule of Thumb for Pricing • Pricing for any firm with monopoly power • If Ed is large, markup is small • If Edis small, markup is large Chapter 10

  43. The more elastic is demand, the less the markup. P* MC MC P* AR P*-MC MR AR MR Q* Q* Elasticity of Demand and Price Markup $/Q $/Q Quantity Quantity

  44. Markup Pricing:Supermarkets to Designer Jeans • Supermarkets Chapter 10

  45. Markup Pricing:Supermarkets to Designer Jeans • Convenience Stores Chapter 10

  46. Markup Pricing:Supermarkets to Designer Jeans Convenience Stores • Convenience stores have more monopoly power. • Question: • Do convenience stores have higher profits than supermarkets? Chapter 10

  47. Markup Pricing:Supermarkets to Designer Jeans Designer Jeans • Designer jeans Ed = -3 to -4 • Price 33 - 50% > MC • MC = $12 - $18/pair • Wholesale price = $18 - $27 Chapter 10

  48. The Pricing ofPrerecorded Videocassettes 1985 1999 Title Retail Price($) Title Retail Price($) Purple Rain $29.98 Austin Powers $10.49 Raiders of the Lost Ark 24.95 A Bug’s Life 17.99 Jane Fonda Workout 59.95 There’s Something about Mary 13.99 The Empire Strikes Back 79.98 Tae-Bo Workout 24.47 An Officer and a Gentleman 24.95 Lethal Weapon 4 16.99 Star Trek: The Motion Picture 24.95 Men in Black 12.99 Star Wars 39.98 Armageddon 15.86

  49. The Pricing ofPrerecorded Videocassettes • What Do You Think? • Should producers lower the price of videocassettes to increase sales and revenue?

  50. Sources of Monopoly Power • Why do some firm’s have considerable monopoly power, and others have little or none? • A firm’s monopoly power is determined by the firm’s elasticity of demand. Chapter 10

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