Transcript Theme 6-English

Monopoly and
market power
2
Introduction

Definition of a monopoly

Profit maximization

Substitutes, elasticities and market power

Suboptimal allocation of ressources

Discussions
3
Definition of a monopoly
What do you know concerning:

the number of firms? 1 firm

the selling price? Picked by the firm

consumer welfare? lower
4
Profit maximization
Like any profit-maximizing firm:
MC = MR ( = ∆R/∆q)
Moreover, market output = Q = q (= firm output
because only one firm)
Therefore, how is the demand curve facing a
monopoly different from that facing a competitive
firm? The monopolist faces the market demand
curve rather than a perfectly elastic demad curve.
Comparing with competition
p
Competitive firm
Dfirm
p*
A
B
p
p1
p2
Monopoly
H
F
q q+1
Competition
Monopoly
Dfirm
G
q q+1
R(q)
R(q+1)
∆R
A
A+B
B
H+F
F+G
G-H=p2<p1
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Marginal revenue
Therefore, the MR curve lies below D.
Tradeoff between selling more and selling at a high price
Ex: If D: p = 24 – Qd
then
R = Q x (24-Q)
p
24
and MR = ∆R/∆q = 24-2Q
D
Draw MR.
12
24
Q
7
MR and Ep
One can show (exercise!) that:


1

MR  p1 
 E 
p 

8
MR and Ep
1.MR=P(1
+ 1/E)
2.MR=P
+ P/E
3.MR=P
+ P x 1/ (ΔQ/Q/ ΔP/P)
4.MR
= P + P x (ΔP/P) / (ΔQ/Q)
5.MR
= P + ΔP/ΔQ x Q
Item 5 is the equation for MR that one obtains by
differentiating revenue with respect to the quantity.
Profit maximization (graph.)
1) Choose Q* such that MC = MR
2) Read p* on D
Ex : p = 24 – Qd ,
C(Q) = Q² + 12  MC = 2Q
AC = Q + 12/Q
p
MC
24
AC
PM
Draw MR, MC and AC.
Determine Q*, p* and π*
graphically. Q*=6, P*=18$
π*=(18$-AC(6))x6
(18$-8)x6=60$
D
QM
12
24
MR
Q
10
Profit max. (algebraically)
Same example.
Determine Q*, p* et π* algebraically.
See previous page for details
Recall: π = R – C
= p x q – AC x q
= (p – AC ) x q
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Market power
Definition: The ability to charge a price greater than
the marginal cost without losing all its customers.
A measure of market power:
Lerner index: L = (p-MC)/p = -1/ED
Takes values between 1 and 0. Higher values imply
greater market power in the industry, lower values
imply that the firms in the industry behave more like
perfectly competing firms.
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Sources of market power
= sources of demand inelasticity:

Lack of substitute products: examples? Unique
good, think of the invention of the first personal
computer, IPhone, etc.

Barriers to entry: examples? Natural monopolies,
electricity, huge cost of setting up electrical wires,
etc.

Transaction costs: examples?

Legislation: examples? Pharmaceutical Patents
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The social cost of monopolies
p
24
Compet.
Monop.
∆
CS
A+B+C
A
-(B+C)
PS
E+F+G
B+E+G
F-B
W=
CS+PS
A+B+C+ A+B+E+
E+F+G
G
S
A
pm
pc
B
C
E
F
G
MR
Qm
Qc
Compute.
D
24
Q
-(C+F)
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Discussions (1)
When can we talk about a monopoly?
Q1:
Does the firm « St-Hubert » have market power?
Yes and no, geographically it might the only one in the region, also, some might
think that St-Hubert is so delicious that it has no substitute, others might disagree.
Q2:
Is « St-Hubert » the only firm on the market for rotisserie chicken?
It’s not, although, the closness of substitutes might depend on peoples’ specific
preferences for rotisserie chicken.
How can you explain this « contradiction » ?
Market power depends on how the « market » is defined, which in turn, depends
on how the good is defined, how unique and interchangeable it is. The definition of
a good could include dimensions as abstract as its location in time and space.
We call this situation monopolistic competition. When numerous firms have
« local market power » because the goods are somewhat different. They can price
as monopolists but nonetheless have little or no economic profits.
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Discussions (2)
Should a show always sell out ?
The Bell Centre can hold up to
p
20,000 people. The demand for
the Beastie Boys’ concert is given
300
by:
p = 300 – 0.01 Q
Assuming zero marginal cost,
what ticket price maximizes the
Bell Centre’s profits?
How many tickets will be sold?
D
20 000 30 000
Q
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Discussions (2)
Should a show always sell out ?
If MC=0, the BB will try to
p
maximize their revenues.
Max P*Q=(300-0.01Q)*Q
300
=300Q -0.01*Q2
Rev’=300-0.02*Q (set to 0 to max)
QM =300/0.02=15,000
D
Observe that MC=RM=0 at 15,000
20 000 30 000
Q
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Conclusions

Monopoly behavior:


Impact on society


Lowers total surplus, welfare
Market power (it’s everywhere!)


Price setter, MR=MC
Because no good has a truly homogenous
substitute
Next: Pricing strategies