MACQUARIE Fe mcs ECON 632 Intermediate Microeconomics Week 7: Monopoly & Monopolistic Competition * Monopoly profit maximization ° Market power * Welfare effects of monopoly * Natural vs legal monopolyMACQUARIE Monopoly Fy ise * Amonopoly is the only supplier of a good for which there is no close substitute. * Monopolies are NOT price takers like competitive firms > Monopoly output is the market output >» Monopoly demand curve is the market demand curve >» Monopolists can set their own price given market demand >» Because demand is downward sloping, monopolists set price above marginal cost to maximize profit. * Like all firms, monopolies maximize profits by setting price or output so that marginal revenue (MR) equals marginal cost (MC).MACQUARIE Average and Marginal Revenue By iay (a) Competitive firm (b) Monopoly iN & & Pl 2eak z g Loss in Rov du bb P, Demand curve Pb Aor puce "2 Demand curve (mart, q qt Quantity, g UR? S Revenue with One Initial Revenue, More Unit, fay | RX RX Competitio A A+BElasticity of Demand and Total, Average, and Marginal Revenue p P ~9MACQUARIE Monopoly: Maximising Profit Bias Rule : MR = MC (< P) = TR-TC T= (p-Ac)Maximising Profit 2. Unite per dayMACQUARIE Monopoly Example Fi ey 2 Demand function: p= 24-Q ~) TR=pQ = (24-a) Q =240-R * Can be used to find the MR function: ¢ ATR 94-2 = = - Zz MR i 2. Q : Cost function: C(Q) = VC(Q) + F=Q?+1 ! * Can be used ° find the MC function: g Mc eGgn 28 Profit-maximizing output is obtained by producing e at” & MC=MR MR 2ZQ= 2F4-2Q 2) 4Q524 »[e"=¢)5 cub indo D: = 24-6€=418 N= TR - T= 2bx6 -(6°+ 12) = 640 P reosMarket Power BH Une Market power — the ability of a firm to charge a price above marginal cost and earn a positive profit. The Lerner Index (or price markup) is a way to examine how elasticity affects a monopoly’s price relative to its MC. [p—MC _ T 5 Move & A soll p a ~e rrerkt Pewee The Lerner Index ranges from 0 to 1 for a profit-maximizing firm. * Competitive firms: Perfectly elastic demand > « = 00 > Lerner Index =0. * The Lerner Index gets closer to 1 as a firm has more market power (and faces less elastic demand). > The more elastic the demand curve, the less market power.MACQUARIE Sources of Market Power Fy ise All else the same, the demand curve a firm faces ~ oes Tim Faces <= becomes more elastic. as: Mk warlate paar * better substitutes for the firm’s product are introduced * more firms enter the market selling the same product, or * firms that provide the same service locate closer to this firm.Deadweight Loss of Monopoly MACQUARIE Fa iucon MA = MC= 12 }o-- a= __...Competition Monopoly Change Consumer Surplus, CS A+B+C A -B-C=ACS Producer Surplus, PS D+E B+D B-E=APS Welfare, W = CS + PS A+B+C+D+E A+B+tD -C-E=aW=DWLWel fane— ank DWe 4 Menopoly— 4 cs by BtC PSU by E = TS S = MC NS PST by B (es) L Owl whe in fag. onmp > TS=CSt PS Lon moro (> mane DWL vod Oy Gy MR U Efficient cutpuct > y the inf ficterey > DWL>vOne firm can produce the total output of WEVA C: 1M lifelate) eXe)h¥am the market at lower cost than several firms could. Eg, Sydney Water. & AC, MC, $ per unit AC=10+ 60/Q 18, }---eonsseraaavesenaneanene dhnaousaoneswaaaae teehee 10 Q, Units per dayBarriers to Entry: Legal Monopoly Fy ima Governments create monopolies in one of three ways: 1. by making it difficult for new firms to obtain a license to operate, 2. by granting a firm the rights to be a monopoly, or 3. by auctioning the rights to be monopoly. Patent — an exclusive right granted to the inventor to sell a new and useful product, process, substance, or design for a fixed period of time. The length of a patent varies across countries. Patents are just one example of how intellectual property can act as barrier to entry. Others include copyright and registered designs. Question: if a firm with a patent monopoly sets a high price that results in deadweight loss then why do governments grant patent monopolies?Optimal Price Regulation BCT ae Mul ecm Meck ari mat competitive price. wc Be jal reqpelaor ha rremopodixt oh, p= sie 2 casdor pwh =C+E Now the Gw intouene’ by watered P ccf whack Mc a = $16 =) pwL %A limineckeol - nape =) Welfare _ ___ Regulation Optimal Regulation Change tao, Consumer Surplus, CS A A+B+C B+C=Acs Producer Surplus, PS BaD D4+E E-B=APS Welfare, W = CS + PS A+B+D A+B+C+D+E C+E=aW Deadweight Loss, DWL -C-E 0 C+E=ADWLKae vgs Be iacouare Monopolistic Competition Features: i. Many firms Differentiated products Firms are price makers/setters iv. No barriers to entry/exit In long run firms enter the market until no new firm can enter profitably monopolistically competitive firms face downward-sloping residual demand curves, so they charge prices above marginal cost. Two conditions hold in a monopolistically competitive LR equilibrium: * marginal revenue equals marginal cost, because firms set output to maximize profit. * Price equals average cost, because firms enter until no further profitable entry is possible.Properties of Monopoly, Oligopoly, Monopolistic, and Perfect Competition | Univesity Treg may ere 2. Ability to set price Price setter Price setter Price setter Price taker T2O 3. Market power P>MC P>MC P> MC. P=MC HeauhQ 4. Entry conditions No entry Limited entry Free entry Free entry of fee 5. Number of firms 1 Few Many Many 6. Long-run profit a) 20 0 0 erty — 7. Strategy dependent on No (has no rivals) Yes Yes No (cares about individual rival firms’ market price only) behaviour 8. Products Single product May be May be Undifferentiated differentiated differentiated 9. Example _ _Utility, Casino’ __ Car manufacturers Plumbers in a city Apple growerseben T°? Monopolistic Competition in SR — sir $ TC pron. candichar > MC 2am, p” Ma, MC PF 8 yO é innte frm fo our the rorkt =) conxumen hove mow bois MR > chmerel fon Nike vboes L ‘ Market for Nila stee& = 4 chefs Lft -) MRL =) New MC uk MR ot Lner Qarnl P > Tl fall, untl lo ant D=- ACL =URP> AC > MC=MR w MACQUARIE ~p University onopolistic Competition in L p, $ per unit v q, Units per yearMonopolistic Competition: Minimum efficient [Ry macguare scale; fixed costs and the number of firms , * Minimum efficient scale — (full capacity) the smallest quantity at which the average cost curve reaches its minimum. * The number of firms in a monopolistically competitive equilibrium depends on firms’ costs. ° The larger each firm’s fixed cost, the smaller the number of monopolistically competitive firms in the market equilibrium § Ty. Mn. Sole LRAC 4s a Total D = (0,000 =) nad Sd-4178, Met (ar. ef ceonle of Mv Ac A fam = 100 ’ 7) nsel Jin ax Min. Ef. cena.MACQUARIE University Monopolistic Competition Among Airlines (4 {wo Fe the Market eon Fn le Market 5 n= 300 2 _ 2 8 ne S 8 *~ a7 station) 8 nas & 2tt fA — & 195 147 9 64 137.5 275 0 48 121.5 243 q, Thousand passengers q, Thousand passengers per quarter per quarter