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Monopoly and market power

Monopoly and market power. Introduction. Definition of a monopoly Profit maximization Substitutes, elasticities and market power Suboptimal allocation of ressources Discussions. Definition of a monopoly. What do you know concerning: the number of firms? 1 firm

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Monopoly and market power

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  1. 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.

  5. Comparing with competition p p Competitive firm Monopoly p1 Dfirm H p* p2 Dfirm A B F G q q+1 q q+1

  6. Marginal revenue Therefore, the MR curve lies below D. Tradeoff between selling more and selling at a high price p Ex: If D: p = 24 – Qd then R = Q x (24-Q) and MR = ∆R/∆q = 24-2Q Draw MR. 24 D 12 Q 24

  7. MR and Ep One can show (exercise!) that:

  8. MR and Ep • MR=P(1 + 1/E) • MR=P + P/E • MR=P + P x 1/ (ΔQ/Q/ ΔP/P) • MR = P + P x (ΔP/P) / (ΔQ/Q) • MR = P + ΔP/ΔQ x Q Item 5 is the equation for MR that one obtains by differentiating revenue with respect to the quantity.

  9. 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 Draw MR, MC and AC. Determine Q*, p* and π* graphically. Q*=6, P*=18$ π*=(18$-AC(6))x6 (18$-8)x6=60$ p MC 24 AC PM D QM Q 12 24 MR

  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

  11. 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.

  12. 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

  13. The social cost of monopolies p 24 S A pm B C pc E F G MR Compute. D Q Qm Qc 24

  14. 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.

  15. Discussions (2) Should a show always sell out ? The Bell Centre can hold up to 20,000 people. The demand for the Beastie Boys’ concert is given 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? p 300 D Q 20 000 30 000

  16. Discussions (2) Should a show always sell out ? If MC=0, the BB will try to maximize their revenues. Max P*Q=(300-0.01Q)*Q =300Q -0.01*Q2 Rev’=300-0.02*Q (set to 0 to max) QM =300/0.02=15,000 Observe that MC=RM=0 at 15,000 p 300 D Q 20 000 30 000

  17. Conclusions • Monopoly behavior: • Price setter, MR=MC • Impact on society • Lowers total surplus, welfare • Market power (it’s everywhere!) • Because no good has a truly homogenous substitute • Next: Pricing strategies

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