Intermediate Microeconomics
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Transcript Intermediate Microeconomics
Intermediate Microeconomics
Monopoly
1
Pure Monopoly
A Monopolized market has only a single seller.
Examples?
XM radio?
Microsoft?
Walmart in a small town?
2
Monopolies
So what causes monopolies?
Legal Constraints:
e.g patents for new drugs
Ownership of a fixed resource
e.g. toll highway, land in a given area.
Collusion
e.g. several producers act as one (OPEC)
Large economies of scale (natural monopolies)
e.g. land line phone service, utilities, Google? Microsoft?
3
Monopolies
Why are we concerned about Monopolies?
4
Implications of Monopoly
Key to Monopoly: Seller is not a price taker!
Specifically, since monopolist chooses market supply, it essentially
picks a point on the market demand curve to operate on.
This means that for a monopolist, equilibrium price is a function of the
quantity they supply, so they effectively get to choose both
i.e. choose where to operate on p(q) (“Inverse Demand Curve”)
$
QD(p) or p(q)
Q
5
Monopolist’s Problem
In perfect competition, a firm wanted to choose a quantity to maximize
profits, given it is a “price taker”.
max π(q) = R(q) – C(q)
= pq – C(q)
To find profit maximizing q, we take derivative of π(q) and set it equal to zero,
This gives
p - MC(q*) = 0
“First Order Condition” (FOC)
or equivalently, keep producing until MC(q*) = p
Like any firm, a monopolist wants to choose quantity to maximize profits,
but by doing so effectively chooses price as well.
max π(q) = R(q) – C(q)
= p(q)q – C(q)
So what will be profit maximization condition for the monopolist?
6
Monopolist’s Problem
$
c(Q)
R(Q) = p(Q)Q
q
π(Q)
7
Marginal Revenue for Monopolist
Profit max condition is always MR(q*) = MC(q*) (from FOC)
For firm in perfect competition, firm is a price taker so MR(q) = p for all q.
For monopolist: MR(q*) = [p’(q*)q* + p(q*)]
Since p(q) is the inverse of the market demand curve, we know p’(q) < 0.
Therefore, [p’(q)q + p(q)] < p(q), implying MR(q) < p(q) (i.e. marginal
revenue from producing and selling another unit is less than price)
What is intuition?
Ex: Consider a Market Demand Curve: QD(p) = 400 – 5p
What is Equation for the Inverse Demand curve?
What is Equation for Marginal Revenue curve?
Graphically?
8
Monopolist Behavior
Consider a monopolist:
Cost function given by C(q) = q2 + 8q + 20
Market Demand Curve of QD(p) = 400 – 5p.
What will be equilibrium price and quantity?
Graphically?
9
Profit Maximization and Demand Elasticity
Recall that R(q) = p(q)q
So MR(q) = p’(q) q + p(q)
= p(q)[p’(q) q/p(q) + 1]
Recall ε(p) = Q’(p) p/Q(p)
= slope of demand curve times price divided by quantity
So 1/ε = slope of inverse demand curve times quantity divided by price
= p’(q) q/p(q)
So MR(q) = p(q)[1/ε + 1]
Recalling ε < 0, what does this tell us about output under a monopoly
and demand elasticity, recognizing that Monopolist will choose q to
equate MR(q) to MC(q)?
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Profit Maximization and Demand Elasticity
We can actually learn even more from elasticity.
In competitive markets, firms produced until
p = MC(q*)
Alternatively, monopolist supplies until MR(q*) = MC(q*), or until:
p(q*)[1/ε + 1] = MC(q*)
Re-writing we get:
p(q*) = MC(q*)ε /[ε +1]
So how does monopoly “mark-up” depend on elasticity of demand?
11
Monopoly and Efficiency
The key implication of a Pareto Efficient
outcome is that all possible gains from trade are
exhausted.
Will this be true in a monopolized market?
Consider first what it means for all gains from
trade to be exhausted.
Output is produced as long as marginal cost of
last unit is less than what a consumer is
willing to pay for that unit.
How do we know this won’t be true under a profit
maximizing monopolist? How would we see this
graphically?
12
Taxing a Monopolist
What if government imposes a tax on monopolist equal to $t/unit
sold. Will this somehow increase efficiency?
Consider again monopolist with MC(q) = 2Q + 8 that faces a demand
curve such that MR(Q) = 80 – 2Q/5
We know that without tax, Q = 30 and p = 74
What will change with tax of t = $12?
Graphically?
13
Entry
If a monopolist is making all these economic profits, can this
monopoly be maintained?
Entry constrained by law (patents, patronage/political favors)
Natural Monopoly - firm’s technology has economies-of-scale large
enough for it to supply the whole market at a lower average cost than is
possible with more than one firm in the market.
Essentially very high fixed costs of entry.
Examples?
14
Monopoly Policy
Under natural monopoly it is best for one firm to supply whole
market.
To prevent inefficiencies of monopoly, there are a couple of strategies.
Have government run/regulate industry.
e.g. Utilities, postal service?
Break-up monopolist
Especially relevant when declining marginal cost structure due to
high entry costs (e.g. software, drugs)
Block mergers that could allow monopolies to form in the first place.
Problems?
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