Monopoly
Extra Reading
• Product Differentiation Download
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
• 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.
P
MR  P 
MR  P 
P
Q
P P  P(1 
Q
Q
QP
1
)  P(1  1 )
eD
Demand Elasticity
Theoretical Note:
Monopolies and Inelastic Demand
• Monopolist will not operate where demand
elasticity is between 0 and -1. Why?
• Raising prices/cutting production will
increase revenues. MR < 0
• When facing an inelastic demand,
monopolist raises prices until demand
becomes inelastic.
Example
Demand,
Revenue,
Marginal
Revenue
Output
Price
Revenue
Marginal Revenue
10,000.00
33.0 330,000.0
13.7
20,000.00
23.3 466,690.5
10.5
30,000.00
19.1 571,576.8
8.8
40,000.00
16.5 660,000.0
7.8
50,000.00
14.8 737,902.4
7.0
60,000.00
13.5 808,331.6
6.5
70,000.00
12.5 873,097.9
6.0
80,000.00
11.7 933,381.0
5.7
90,000.00
11.0 990,000.0
5.4
100,000.00
10.4 1,043,551.6
P 35.0
Example
Demand
30.0
25.0
20.0
15.0
MR
10.0
5.0
0.0
10
20
30
40
Price
50
60
70
80
Marginal Revenue
90
Q
Monopolist
• Maximize Profits 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
Price
P*
MC = ATC
D
MR
QMono
QPC
Output
Monopolist: Revenue
Price
P*
MC = ATC
Revenues
D
MR
Q*
Output
Monopolist: Profits
Price
P*
Profit
MC = ATC
D
ATC
Q*
MR
Output
Price
10,000
Revenue
33.0
330000
Marginal
Revenue
Cost
80000
13.66905
20,000
23.3 466690.5
160000
19.1 571576.8
16.5
240000
660000
320000
14.8 737902.4
400000
13.5 808331.6
480000
12.5 873097.9
11.7
560000
933381
11.0
990000
313097.9
8
640000
5.661905
90,000
328331.6
8
6.028302
80,000
337902.4
8
6.476632
70,000
340000
8
7.042918
60,000
331576.8
8
7.790243
50,000
306690.5
8
8.842323
40,000
Profit
250000
8
10.48863
30,000
Marginal
Cost
293381
8
720000
270000
Monopolist: General Case
MC
Price
ATC
P*
D
MR
Q*
Output
Monopolist: Revenue
MC
Price
ATC
P*
D
Revenues
MR
Q*
Output
Monopolist: Costs
MC
Price
ATC
P*
D
MR
Costs
Q*
Output
Monopolist: Profits
MC
Price
ATC
P*
Profits
D
MR
Q*
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
P
MC
Rule of thumb for a monopolist,
MC  MR  P (1  1
P
)

eD
MC
1
(1  1
eD
– If markups are below this level, raise prices.
– If markups are above this level, lower prices.
)
Monopolist’s Schedule
• The less 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)
Monopolistic Competition and
Product Differentiation
Monopolistic Competition
• Most firms produce a good that is (to a
certain extent) unique. No other good has
the exact same properties.
– Coke, Pepsi, President’s Choice
• To the extent that you are a unique
producer, you will have some market power.
• Products may vary by type, scale, or
location.
Characteristics of Monopolistically
Competitive Markets
•
•
•
•
Differentiated Products
Free Entry into very similar markets.
Fixed costs of setting up production
Individual firms face downward sloping
demand curve and a falling average total
cost curve.
– They would sell more if they could at the
going rate but lowering their prices to sell
more would lead to losses.
No Barriers to Entry
• What happens if new firms can enter?
• If there are profits to be had,
entrepreneurs will enter markets to provide
close substitutes for profit making goods.
• New goods splitting the market and better
substitutes means lower, flatter demand
curve.
Profitable Monopolistic Competition:
Short-term
Price
MC
ATC
P*
D
MR
Q*
Output
Unprofitable Monopolistic Competition:
Short-term
Price
MC
ATC
P*
D
MR
Q*
Output
Monopolistic Competition:
Entry of Competitors
MC
Price
ATC
D
D′
MR′
Q*
MR
Output
Monopolistic Competition:
Long-term
Price
MC
ATC
P*
MR
Q*
D
Output
Monopolistic Competition vs.
Perfect Competition
• Similar: Both have many firms, both have
zero profits and P = ATC.
• Different:
– P > MC : On the margin, monopolistically
competitive firms want more customers.
Greater variety generated by this market may
compensate for loss of efficiency.
– MC < ATC: Firm is operating at a level that
does not minimize total costs.
Variety and Monopolistic
Competition
• Given that most markets have the “feel” of
monopolistic competition, do we have too
many firms or is variety it’s own reward?
• Does advertising create phony
differentiation or provide information?
Monopolistic Competition and
Entrepreneurship
• New markets are frequently developed.
• For many goods, the only barriers to entry
is imagination.
• Entrepreneurs develop new ideas for new
goods. The pay-off for entrepreneurship
are short-run monopoly profits. (Ted
Turner and CNN). Only in rare cases will
firms be able to make long-term
monopolistic profits.
Learning Outcomes
• Define marginal revenue.
• Characterize the relationship between price,
marginal revenue, marginal cost, average total
cost, and profits in a monopolistic market.
• Use the rule of thumb to calculate optimal
markups.
• Describe 4 barriers to entry that may enable
monopoly power.
• Characterize the relationship between price,
marginal revenue, marginal cost, average total
cost, and profits in a monopolistically competiive
market.
Closed Book Final
•
•
•
•
•
Date: Sunday, October 28th
Time: 2:00-5:00
Place: Room 3007, 3008
Coverage: Material in Notes to date
Bring Calculator, Writing Instruments
–Good Luck!