Monopoly

KW Chap. 14

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

• Oligopoly Power – A small number of producers sometimes acting in concert.

• 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 Q PQ

1 1(1 ) (1 )D

PPMR P P P P

Q Demand ElasticityQ

Example Demand, Revenue, Marginal Revenue

Output Price Revenue Marginal Revenue

10,000.00 33.0 330,000.013.7

20,000.00 23.3 466,690.510.5

30,000.00 19.1 571,576.88.8

40,000.00 16.5 660,000.07.8

50,000.00 14.8 737,902.47.0

60,000.00 13.5 808,331.66.5

70,000.00 12.5 873,097.96.0

80,000.00 11.7 933,381.05.7

90,000.00 11.0 990,000.05.4

100,000.00 10.4 1,043,551.6

Example

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

10 20 30 40 50 60 70 80 90

Q

P

Price Marginal Revenue

Demand

MR

Monopolist• Maximize Revenues 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

MC = ATC

ATC MR

D

QMono

P*

QPC

Price

Output

Monopolist: Revenue

MC = ATC

ATC MR

D

Q*

P*

Revenues

Price

Output

Monopolist: Profits

MC = ATC

ATC MR

D

Q*

P*

Profit

Price

Output

Marginal MarginalPrice Revenue Revenue Cost Cost Profit

10,000 33.0 330000 80000 25000013.66905 8

20,000 23.3 466690.5 160000 306690.510.48863 8

30,000 19.1 571576.8 240000 331576.88.842323 8

40,000 16.5 660000 320000 3400007.790243 8

50,000 14.8 737902.4 400000 337902.47.042918 8

60,000 13.5 808331.6 480000 328331.66.476632 8

70,000 12.5 873097.9 560000 313097.96.028302 8

80,000 11.7 933381 640000 2933815.661905 8

90,000 11.0 990000 720000 270000

Monopolist: General CaseMC

ATC

MR

D

Q*

P*

Price

Output

Monopolist: RevenueMC

ATC

MR

D

Q*

P*

Revenues

Price

Output

Monopolist: CostsMC

ATC

MR

D

Q*

P*

Costs

Price

Output

Monopolist: Profits

MC

ATC

MR

D

Q*

P*

Profits

Price

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

P

Lerner Index

• Net markups are a measure of the market power of a firm or industry. Referred to as the Lerner index.

• Rule of thumb for a monopolist,

– If markups are below this level, raise prices.– If markups are above this level, lower prices.

P MC

P

1 1(1 )D D

P MCMC MR P

P

Monopolist’s Schedule

• The more 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)

Natural Monopoly• In markets with a natural monopoly there

may be one firm.

• Economies of scale indicate that at marginal cost pricing firms make a loss.

• Efficient production involves 1 firm. Firm will naturally charge markup and earn profits.

Monopolist: High Fixed Costs

MC

ATC MR

D

QMono

P*

QPC

ATC

Price

Output

0

100

200

300

400

500

600

0 50 100 150 200 250

Q

P

MC

ATC

MR

DMonopoly

Competition

Average Cost Pricing

Regulation

• Government may step in, usually to put a maximum price level. Should be minimum amount necessary to get the firm to operate small decisions that lead to a competitive outcome.

• Average cost pricing• Information Problem. A single decision maker

may not have full access to enough information.

.

Learning Outcomes

• Define marginal revenue. • Characterize the relationship between

price, marginal revenue, marginal cost, average total cost, and profits in a monopolistic market.

• Measure the degree of market power with the Lerner index.

• Describe 4 barriers to entry that may enable monopoly power.