Industrial Organization

1. Revision of some principles in

Microeconomics

2021/22, 1st Semester

Margarida Catalão Lopes

 Basic microeconomic principles
• Demand and supply
• Elasticity
• Costs
• Equilibrium
• Surplus
• Competition
• Monopoly

2
 Basic microeconomic principles
• What Economics is about: how to efficiently
allocate resources to produce value
• Resources are scarce as compared with needs,
so agents face trade-offs and an opportunity
cost when they use the resources

3
 Basic microeconomic principles
• How do agents take decisions?
– Multiple objectives; constraints
• Tradeoffs:
– “There is no such thing as a free lunch”
– Taking a given decision implies that you must forego something
• Ex: to the beach or to the cinema?
• The cost of something is given by the value of the best
thing that you must give up to obtain it:
– Opportunity cost = value of the best alternative allocation

4
 Basic microeconomic principles
• Trade can benefit everyone:
– It allows each one to specialize in what he does best

• Markets are usually a good way of organizing production

• Main economic agents: firms, consumers, Government

• Economic agents respond to incentives

5
 Basic microeconomic principles
• Firms operate in one or more markets and
choose their strategies (marketing and others)
aiming at maximizing profits

• Any markets is characterized by those who, in

the same geographic space, intend to buy a
given good or service (D- demand ) and by
those who intend to sell (S – supply)

6
 Demand
• From the combination of tastes (represented
by indifference curves) and budget
possibilities, we obtain the optimal basket for
consumers (where the highest indifference
curve is tangent to the budget line).
• A demand function is obtained that relates
the quantity demanded of a given product as
a function of its price and other variables.

7
 Demand driving factors
• Factors that affect the quantity demanded of a
given good:
– Tastes: Preferences/Fashion/Culture
– Its price
– The price of related goods:
• substitutes
• complements
– Income
– Expectations
– Population structure

8
 Demand determinants: Price
• Usually demanded quantity falls as price
increases (exceptions like some luxury goods)

• Law of demand: demanded quantity increases as

price falls. Two reasons:
– consumers who already acquire the good can buy more
quantity with the same level of available income (income
effect)
– and those who were buying other goods (substitutes) can
now start consuming this (substitution effect)

9
 Demand determinants: Price

• How demanded quantity varies with price

depends on consumers’ sensitivity to price
changes

– Demand price elasticity

10
 The demand curve
P

Q
P D→D1: demand contracts
D→D2: demand expands
D2
D
D1
Q

Movements along the curve: price and quantity change

Curve shifts: other determinants change
11
Demand determinants: substitutes
and complements
• Substitutes – when the price of good 1
increases, demand for good 2 increases
– Coca-cola vs Pepsi; (bottled water and tap water)

• Complements – when the price of good 1

increases, demand for good 2 decreases
– Computer and printer; car and gasoline

12
Demand determinants: substitutes

Market 1 Market 2

P1
P1’

D2
D1 D2’
Q1 Q1’

Price in market 1 falls, demand in market 2 contracts.

(there was a change in quantity demanded in market 1 – movement along the curve; there was a change
in demand in market 2 – curve shift)

13
Demand determinants: complements

Market 1 Market 2

P1
P1’

D2’
D1 D2
Q1 Q1’

Price falls in market 1, demand expands in market 2.

14
 Demand determinants: income
• As income increases
– demand increases – normal goods
• holiday trips; cars
– demand decreases – inferior goods
• software, music and movies’ piracy; fast food; own
brands; public transportation

15
 Demand determinants:
Preferences/Fashion/Culture
• Consumers are not all equal
– Some prefer red to blue
– Zara, Massimo Dutti, Bershka, Stradivarius,
Pull&Bear
– Some prefer ecological/bio products

– Fashion increases demand

16
Demand determinants: Expectations
• The decision to buy today is influenced by the
expectations concerning future prices
– Promotions
– Announcement of a gasoline price increase
– Computers’ price, mobile phones’ price, …

D2
D1 D

Q
17
 Demand price elasticity
• Firms pay particular attention to their
consumers’ sensitivity to price changes, in
order to set their pricing policies

• How does demanded quantity vary when

price changes?

• Demand price elasticity is a measure of such

sensitivity
18
 Demand price elasticity
• Ratio between two proportional variations
• Elasticity (e ) = (∆% demanded Quantity) / (∆%
Price) for small changes in price

– Note: ε=
𝑑𝑄 𝑃
𝑑𝑃 𝑄

• Also: ε=
𝑑𝑙𝑜𝑔𝑄
𝑑𝑙𝑜𝑔𝑃
(because d(log x)=dx/x
19
On which factors does demand
price elasticity depend
– Preferences
– Type of the good / necessity degree
• Highly necessary
• Superfluous
– Weight in terms of budget
– Existence of substitutes
– Opportunity cost of the time needed to search for
alternatives
– Switching cost to a substitute
– Being a complement of other(s)
– Timing horizon
– In general, on the determinants of the demand for the
good under analysis

20
21
 Demand price elasticity
• Demand
– Rigid or Inelastic
• Elasticity < 1
– “of unitary elasticity”
• Elasticity = 1
– Elastic
• Elasticity > 1

22
 Elasticity and firms’ revenue
• When Elasticity < 1, if the firm increases price revenues
increase
• When Elasticity = 1, if the firm increases price revenues do
not change
• When Elasticity > 1, if the firm increases price revenues
decrease

Note: profit=revenues-costs

23
 Elasticity and firms’ revenue
• Demand curves where quantity responds differently to the
same price change:

P0
P1
DA
DB
Q0 Q1 Q0 Q1
More elastic More rigid

• Quantity’s response depends on the curve’s slope and on the departing

point.

24
25
Demand price elasticity
Selected estimated demand price elasticities (USA)

Good/service Price elasticity

Peas 2.80
Lottery 1.90
Taxis 1.24
Furniture 1.00
Shoes 0.70
Legal advice 0.61
Health insurance 0.31
Bus travel 0.20
Home electricity 0.13

Samuelson 18e
© 2005 McGraw-Hill Interamericana de España.
Todos os direitos reservados

26
 Cross-price elasticity
• Positive: goods are substitutes
• Negative: goods are complements
𝑑𝑄1 𝑃2
ε12 =
𝑑𝑃2 𝑄1

• Example: cross price elasticities between

different car models

27
 Income elasticity
• Negative: inferior goods
• Positive: normal goods
– Lower than 1: necessities
– Greater than 1: luxury goods
𝑑𝑄 𝑌
η=
𝑑𝑌 𝑄

28
 Puzzles
• It may happen that price decreases and so
does consumption. This does not necessarily
mean an upward sloping demand curve,
because other factors (income, for instance –
recall income effect and substitution effect)
may have changed as well.
• See gasoline demand application (LC, pg 25-
26)

29
 Demand curve estimation
• Several approaches
– Collect data from who has bought what and at what
price (example: customer card records)
Some difficulties
• separate price effect from the effects of other determinants
• identification problem: market data results from the
combination of demand and supply forces
– Surveys
– Experiments
– Use general ideas on elasticity related with the good
nature (exs: specific or not; luxury or necessity; long
or short term; …)

30
 Consumers’ rationality
• If consumers’ rationality fails, there is room to complement
standard economic theory with behavioural economics.
• For the (small) percentage of consumers that behaves
irrationally, use behavioural economics.
• Behavioural economics (and the associated neuroeconomics)
is the result of the integration of concepts from psychology
and economics and uses experiments to describe the players'
choices. It is primarily positive theory, whereas classical game
theory is mainly normative, pinpointing the decisions players
should take under the assumptions made.
• Example: according to experiments, consumers are more
sensitive to losses than to gains.

31
 Consumers’ rationality
• Other example: additive consumption is a form of irrational
behaviour. A smoker who wants to kick his habit is described as two
people in conflict, one who wants a long life and another one who
loves tobacco. Instead of a single self taking decisions, dual-self
models propose an explanation for time inconsistency and
hyperbolic discounting, that is, the fact that players prefer a smaller
amount today than a higher amount tomorrow, but when faced with
the same prospective choice to happen in a year from now they
prefer the higher amount. This explanation is based on the idea that
there is a short-term self who wants to drink, smoke, etc., and, at the
same time, a long-term self who wants to be healthy.

• In contrast, other authors argue that economics tools can be

appropriately applied to addictive behaviours. The formation of
wants is the field of the psychologist, the economist investigates the
consequences of any given set of wants.

32
 Supply determinants
• Which factors drive supply?
– Cost of production factors - negatively
• wages, raw-materials’ prices, interest rate, rents
– Technological progress - positively
– Expectations of future price changes
– Competition

33
 The supply curve
P S

Q S→S1: supply contracts

S1 S→S2: supply expands
P S
S2

Q
Movements along the curve: price and quantity change
Curve shifts: determinants change

34
 Some costs
• Fixed costs: costs in which the firms incurs,
independently of the quantity produced (ex: set up
costs; office rent)

• Variable costs: increasing in quantity (ex: raw

material)

• Total costs = FC+VC

35
 Some costs
• Marginal cost: the change in total cost
when quantity produced increases by one
unit
Total
Cost TC

FC
Q
Marginal
Cost MC

Q* Q

36
 A parenthesis…
• Economic analysis is marginal: marginal cost
versus marginal benefit
• In order to decide, compare the increase in
cost and the increase in revenue
• A profit optimizing firm chooses the quantity
for which marginal cost and marginal revenue
are equal

37
 Some costs
• Average (or unitary) cost: how much it costs,
on average, to produce each unit.
• AC=TC/Q
• Average cost=average fixed cost + average variable cost. The average
fixed cost is always decreasing in Q; the average variable cost may be
increasing or decreasing.
AC
MC
MC
AC

Q
38
 Marginal versus average costs
• Marginal costs serve to decide the level of
production
• Average costs serve to compute the profit
level and decide whether to produce or not

39
 Production function
• How inputs are transformed into outputs
• Mathematical relationship that can be graphically
represented by isoquants (different combinations
of inputs that yield the same level of output)
• Two extreme cases:
– linear isoquants = perfect substitutability between
inputs
– Isoquants forming a 90o angle = perfect
complementarity between inputs

40
 Production function
• Example of intermediate case: Cobb-Douglas
function with convex isoquants
• Law of diminishing marginal returns

41
 Production: Costs and Technology
• The quantity employed of some production factors
may be adapted more quickly and easier than the
quantity of others
Number of workers versus plant dimension

• Short run: not all production factors can be adjusted

according to the firm’s needs
– Ex: training of specialized employees

• Long run: sufficiently long, so that all production

factors can be adjusted according to the firms’ needs
42
 Scale economies
• In the long run, costs may grow:
– proportionally to quantity (constant returns to
scale)
– more than proportionally (decreasing returns to
scale or scale deseconomies)
– less than proportionally (increasing returns to
scale or economies of scale), a case in which
average cost is decreasing

43
 Scale economies
Average Cost economies deseconomies
of scale of scale

AC

As long as demand is large enough, it is not necessarily a bad choice to operate

under scale deseconomies.
Minimum efficient scale: minimum quantity for which scale economies are
exausted

44
 Scope economies
• The joint production cost of two or more products is
lower than the sum of the separate production costs

Examples
– Soap, shampoo, conditioner, shower gel
– Electricity for domestic use and for industrial purposes
– Train routes
– Banks
– Hospitals

Reasons: marketing economies, R&D, provisioning,

suppliers’ discounts, …

45
 Experience economies
• Experience economies are learning
economies. Average cost decreases in
accumulated past production

• Come out of accumulating experience and

know-how

• Give the incumbent firm an advantage and

may be a barrier to entry
46
47
 Profit maximization?
• Usually managers’ objectives are different
from those of shareholders
• Agency problems
• However, market correction mechanisms
(such as manager’s reputation, market
competition, capital markets and takeovers)
tend to ensure that firms don’t depart much
from profit maximization

48
49
The market equilibrium occurs in the intersection
of the demand and supply curves

Excess supply = demand

shortage

Excess demand = supply

shortage

Samuelson 18e
© 2005 McGraw-Hill Interamericana de España.
Todos os direitos reservados

50
 Market equilibrium
• S expands  S→S’Q and P New market equilibrium
• S contracts  S→S’’Q  and P  New market equilibrium

• D expands  D→D’  Q and P  New market equilibrium

• D contracts  D→D’’  Q  and P  New market equilibrium

S’’
S S

S’
D’

D D’’ D

51
 Gains from trade
• Consumer surplus: area below the demand curve and above the
equilibrium price. Represents the gain consumers derive from the
transaction (difference between the maximum price they were
willing to pay and the market price)
• Producer surplus: area above the supply curve and below the
equilibrium price. Represents the gain that producers derive from
the transaction (difference between the market price and the
minimum price at which they were wiling to sell). It is an
approximate measure of profit

P S

CS
Pe

PS

Qe Q 52
 Competitive markets
• Usual firm’s objective: profit maximization
• Profit level depends on the market structure

• Competitive market / monopolisitic competition /

oligopoly / dominant firm / monopoly

53
54
 Competitive markets
• In a perfectly competitive market no firm is able to
influence the market’s equilibrium (P or Q):
– many small firms
– product homogeneity
– no entry or exit barriers (production factors perfect long-
term mobility)
– perfect information (all agents know the same and this is
everything)

Consumers acquire from the firm which sells at the lowest price.
Each firm is so small as compared with the entire market that its
quantity choice does not influence the market price. So, each
firms takes price as a given (it is “price-taker”) and then chooses
the quantity to produce: this is its unique decision.
55
 Competitive markets
• Market demand is negatively sloped, but
demand faced by each firm has zero slope.
P P

Demand faced by a single firm

Market demand

Q Q

56
 Competitive markets
• How does a firm in a competitive market chooses its
optimal quantity:
first derive the firm’s supply curve from its MC
curve, then for given P (resulting from the market
equilibrium of aggregate demand and aggregate
supply) quantity is determined.

• For any firm in a competitive market we have that

MR=P (because P is a given, that is, it does not change
with the firm’s quantity, so d(PQ)/dQ=P and hence profit
maximization occurs at P=MC).

57
 Competitive markets
• Each firm’s supply curve corresponds to the upward part of its MC
curve. Why? Because for any given P dictated by the market, the
firm’s optimal decision is to produce Q such that MC(Q)=P. If the firm
would produce more than that, its MC would be higher than the price
obtained; in turn, if the firm would produce less it would still have the
opportunity to profitably produce more.

MC The MC curve gives us, for

MC(Q2)>P1 each P, the optimal production
of the firm: this is an optimality
relation between P and Q, that
P1
is, a supply curve.
MC(Q3)<P1

Q3 Q1 Q2 Q
58
 Competitive markets
• The declining zone of the MC curve is irrelevant for the
supply curve, because the firm may profitably increase its
production (MC<P).

MC

Q4 Q* Q

59
 Competitive markets
• Market supply correponds to the horizontal aggregation of
individual supply curves.
• For 10 firms:

MC i = Si Market supply

Qi 10 Qi = QT Q

60
 Competitive markets
• The market price comes from the equilibrium between
aggregate demand and aggregate supply. At that price
each firm produces Qi and total quantity is QT. If P>MCi
then each firm profits:
profit=[P-AC(Qi)]Qi>0
S MC i
ACi
P* P*

AC (Qi)
D

QT Q Qi

Market Firm
61
 Competitive markets
• So new firms will enter (ex: banks after the legislation change that allowed
privates to operate). This is the long-term movement.
• Aggregate S moves outwards, P decreases and so do profits. QT rises, but Qi
decreases because P falls (hence the increase in QT comes from the higher
number of firms in the market). Equilibrium is reached when economic
profits become null, that is, when P=MCi=min ACi.

S MC i
ACi
S’
P* P*

QT Q Qi

Market Firm
62
 Competitive markets
• These cost curves include the opportunity cost of
all production factors. Hence, economic profit=0
means that the firm’s capital is being remunerated
at the very same level it would obtain in the best
alternative, so does not move to another sector
and the market is stable.
• Zero economic profit does not mean zero
accounting profit.
• If there is excess entry firms will bear losses, so
some of them will decide to exit. Market supply
contracts and P rises until a new equilibrium is
reached.

63
 Competitive markets
• In case of demand contraction, P falls, firms present negative profits, so
some of them leave. Then aggregate supply contracts, P rises and the
market reaches a new equilibrium, with a lower QT, Qi is the same but
there are less firms.

S’ ACi
MC i
S
S’

D loss
D’

Q
Market level Firm level

• To determine price, use the MC curve; for profit or loss, use the AC curve.

64
 Competitive markets
• In an industry where the good is homogeneous,
there are no barriers to entry and information is
perfect, so firms can not sustain positive economic
profits for long. So they will try to differentiate, set
up entry barriers and/or“create” imperfect
information (ex: financial markets).

• But then what is the aim of addressing this market

structure?

65
 Competitive markets
• Look at it as a benchmark
• Perfectly competitive markets are efficient because:
– they are statically efficient
• the quantity produced is such that the production cost of
the last unit exactly matches its valuation by consumers
(allocative efficiency) P=MC
• production occurs at the minimum cost (technical or
productive efficiency) P=minimum AC
– they are dynamically efficient, because they promote
improvement of products and production techniques

66
 Competitive markets
• Fundamental theorem: in a competitive market
the equilibrium output and price maximize total
surplus
• Role of the Government: take measures to
increase competition

67
 Competitive markets
• Sunk costs: irreversible, no matter what the company does
• What changes in factor mobility when we distinguish sunk
from non sunk costs? Firms do not leave the market as soon
as they face negative profits

• They exit when revenues are inferior to nonsunk costs, that

is, when price falls below the minimum of the nonsunk
average cost.
• Sunk costs are irrelevant for firm’s decisions.

68
 Competitive markets
• When some of the costs are sunk, the price level above
which new firms enter is not the same as the price level
below which playing firms exit. There is a price interval
inside which no entry or exit movements occur.
AC
MC

Nonsunk AC
P1

P2

69
 Competitive markets
• Usually firms in the market are differently efficient
(heterogeneous). For a given price, they produce different
quantities. The most efficient, having special management
skills that cannot be imitated or any other comparative
advantage, will have a positive economic profit, even in
the long-run and survive (competitive selection).
AC 1
MC 2
MC 1 AC 2

P
p2

Q1 Q2
70
 Monopoly
• Firms use to possess some capacity to influence the
market price (this capacity is called market power).
This means that they face a non horizontal demand
curve. Possible reasons for this: few firms, no close
substitutes, imperfect information, barriers to free
allocation of production factors, network
economies.

• Firms try to differentiate the good they are selling

(physical characteristics, points of sale, image,
bonuses, ...), in order to enjoy some market power.

71
 Monopoly
P1P2loses A but wins B, Revenue
P3P4loses C, wins D, Revenue 
P1
A
P2
B
P3
P4 C B/C C
B D

Q*=quantity that maximizes Revenue

Q* Q
72
 Monopoly
• A monopolist firm will never sell above Q*,
because costs rise and revenue declines. So it will
choose Q<=Q*, depending on costs.

• Marginal revenue: MR=DR/DQ

In continuous terms, it is the change in revenue as
quantity sold increases marginally.

73
 Monopoly
• As Q rises, MR>0 but declining; is zero at the Revenues maximum
(point above which the firm does not want to increase production)
and becomes negative.
R

Q*
MR

Q*
74
 Monopoly
• MR=dR/dQ=d(aQ-bQ2)/dQ=a-2bQ
When D is linear, MR presents the same intercept with the vertical axis as
D and double slope.

a
P = a - bQ
D
MR
a/2b a/b

• MR is related with e (demand elastiticy):

𝑑𝑅 𝑑(𝑃𝑄) 𝑑𝑃 𝑑𝑄 𝑑𝑃 𝑄 1
𝑀𝑅 = = = 𝑄+𝑃 = 𝑃+𝑃 =𝑃 1−
𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑑𝑄 𝑃 𝜀

75
 Monopoly
𝑀𝑅 > 0 ⇔ 𝜀 > 1
𝑀𝑅 < 0 ⇔ 𝜀 < 1
𝑀𝑅 = 0 ⇔ 𝜀 = 1

e >1
e=1

e <1
MR D
Firms enjoying some market power will not operate in the
inelastic part of demand, because for that set of values they
can increase profits if they reduce Q (revenue increases and
costs decrease).

76
 Monopoly
• p>0 iff R>TC, which is equivalent to P>AC
TC

MC

AC
P1
p D p
AC1
MR
Q1 77
 Monopoly
• The firm must take into account the effect of
a change in Q over P: if Q is increased, P must
fall and it may not be worth.
• It is worth if MR>MC, so the firm will increase
Q up to the point where MR=MC (maximum
distance between TC and R, parallel tangents
to the two curves). In this way one
determines Q1.

• p=(P1-AC1)Q1, where P1 is taken from the

demand curve and P1-AC1 is the profit margin
per unit sold.
78
 Monopoly
• However, from a social point of view, the
efficient decision is to produce Q such that
P=MC (production cost of the last unit=valuation
of the last unit). When firms enjoy some market
power, MR is different from P and the optimal
firm’s choice (MR=MC) yields Q below the
socially efficent level. Price is higher.

79
 Monopoly
• In the interval [Q1 , Q*] there are consumers
willing to pay for this good more than it costs
producing it, however they do not have access to
it due to the firm’s market power.
MC
(Q*, P*) is the social
optimum
P1 AC
P*
D
AC1
MR
Q1 Q*

80
 Monopoly
• FC do not influence the firm’s choice of Q and P (VC do, because MC depends
on them). FC just influence the profit level (because they enter AC) and hence
the firm’s choice on whether to produce (Q>0) or not.
TC

AC
MC
AC

P1 p<0
D

MR
81
Q1
 Monopoly
1
• Recall that 𝑀𝑅 = 𝑃 1 −
𝜀

1
• MR=MC, so 𝑃 1 − = 𝑀𝐶
𝜀

𝜀
and hence 𝑃 = 𝑀𝐶
𝜀−1

The higher the demand elasticity, the less the firm is able to
profit from market power, since it is compelled to set a lower P
(recall that e >1, because firms will not choose to operate in the
inelastic area of D).

82
 Monopoly
• P-MC=mark-up is larger the less elastic is
D.

𝑃 − 𝑀𝐶 1
• Price-cost margin = 𝑃
=
𝜀
in a
monopoly

It is a measure of the degree of market

power.

83
 Monopoly
• Objectives:
– for the firm, maximize profit
– for the managers, maximize own welfare,
which is also a function of wages and fringe
benefits, as well as status. If managers are
stockholders their own objectives become
more aligned with the firm’s (agency
problems).

84
 Monopoly
• Managers who want to maximize sales (for prestige
motives or because they receive some comission on
sales) produce more than would be optimal for the firm.
To sell this higher quantity, price must fall
TC

Q that maximizes Q that maximizes

profit sales
• Firms with market power produce less and charge a
higher price than competitive firms
85
 Monopoly
• Objections to market power:
a) generates a welfare loss
b) genetares X inneficiency
c) generates expenses related with acquiring
and maintaining market power (noninformative
advertising, lobbies, capture, …)

86
 Monopoly
a) generates a welfare loss:
• Welfare is measured by producer and consumer
surplus
• Social welfare is the sum of both
• Market power implies a social welfare loss, because
only part of the consumer welfare loss is transfered to
producers (as profit).
• This social welfare loss is the main reason for
competition policy and for the existence of regulatory
bodies that intend to restrict market power.

87
 Monopoly
• Under perfect competition the equilibrium would be (Q2,P2).
Under market power it is (Q1,P1).

CS - Consumer surplus kept

CS p - Consumer surplus transferred to

P1
the producer
P2
p SWL SWL – Social welfare loss (because in
MC
[Q1 , Q2 ] the marginal valuation of each
unit is larger than the cost of producing it,
D
MR but these units are not produced). Also
called Harberger triangle (only a tringle
Q1 Q2 when D and MC are linear) or excess
burden.

88
 Monopoly
• The SWL represents allocative inefficiency
• But monopoly power also implies a transfer from
consumers to firms

89
 Monopoly
b) generates X inneficiency:
• Market power reduces competitive pressure and
allows unnecessary expenses - X inneficiency.
The firm operates above the minimum cost
curve, so Q is lower and P is higher than in the
absence of X inefficiency.
• This is productive inefficiency.

90
 Monopoly
Lost surplus

Profit obtained Lost profit

PX
from consumer P
surplus MC X
MC

Dispersed profit
D
MR

QX Q

The difference between MCX and MC is the amount that managers and
employees misappropraite, per unit sold. A poorly managed firm (usually
quoted below its potential) is a good target for acquisition.

91
 Monopoly
c) generates expenses related with acquiring
and maintaining market power (lobbies, …)
• To enjoy a market power position, firms are willing to
spend (in lobbies, public opinion campaigns, studies and
reports, ...) up to the amount that they will earn with the
position. This is known as the capture problem. This
expense does not imply a social welfare loss, it is just a
transfer from some agents (the firm) to others.
• Some legal barriers grant incumbents market power (ex:
licenses). Firms are willing to spend resources to sustain
this position. This is called rent seeking.

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 Monopoly
• Out of the three objections to market power
presented, a) is the most serious because b)
can be corrected by the market (the firm is
acquired by another one) and c)
corresponds to a transfer from some agents
to others.

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 Monopoly
• Many utilities (electricity, telephone, …)
have been privatized or open to
competition, so are no longer good
examples of monopolies. But there are
others.
• Whether a given market can be considered a
monopoly depends on the definition of that
market itself, and this is related with the
existence of substitutes and demand
elasticity.
94
Application I

95
Application II

96
Application II (cont.)

97
 Application III
PHARMACIES WILL RECEIVE PREMIUM FOR SELLING GENERICS

It will be 15 cents for every euro of white-label drugs sold. The goal is to
increase market share.

Pharmacies will receive 15 cents for every euro of generic drugs they sell. The
financial incentive given by the Ministry of Health aims to increase the share
of white-label medicines. The measure that has been under discussion with
the National Pharmacy Association since last year will advance next Monday.

According to Health Minister, Paulo Macedo, in a first stage the goal is to

transform the almost 47% of the market share of generics in Portugal into
50%. “What we want is to reach 50% now and then move to 60%”, said Paulo
Macedo.

Published 2015-02-03

98
 Application IV
EASYJET STARTS NEW ROUTE BETWEEN PONTA DELGADA AND LISBON ON
MARCH 29

The company will offer three weekly flights and tickets from € 32.49.

“EasyJet will start flying on March 29 on an A320 aircraft, initially three days
per week, Tuesday, Thursday and Sunday, with a fourth frequency after June”,
stated Javier Gandara at the presentation of the airline's operation in Ponta
Delgada, Azores.

EasyJet's Iberian director said tickets will go on sale on the airline's website
starting Wednesday, with a price of 32.49 euros per trip.

On October 31, the National Civil Aviation Institute informed all air carriers
that the Government decided to liberalize air transport between Terceira
Island and the mainland, as well as between Ponta Delgada (Airport João Paulo
II) and the continental territory, i.e. the routes Lisbon/Ponta Delgada/Lisbon,
Lisbon/Terceira/Lisbon, Oporto/Ponta Delgada/ Oporto and
Oporto/Terceira/Oporto.

Another low-cost airline, Ryanair, also announced last Friday that it will start
flying to the Azores from April 1st, offering trips between Ponta Delgada,
Lisbon, Oporto and London for a total of 20 weekly flights.

99
 Application IV (cont.)
EASYJET STARTS NEW ROUTE BETWEEN PONTA DELGADA AND LISBON ON MARCH 29

For the Azorean Secretary of Tourism and Transport, Vítor Fraga, the entry of new operators
does not diminish the challenges faced, instead increases the responsibility of all, in order
to respond with quality, innovation, creativity and responsibility to this growth potential.

The Secretary of State for Infrastructure, Transport and Communications, Sérgio Monteiro,
stated that before the liberalization of the two routes in the Azores (S. Miguel and Terceira)
there was in the archipelago “a kind of invisible barrier which, for reasons of social and
even political nature, was impossible to transpose until now”.

For Sérgio Monteiro, more than that “it has been worth the effort started in 2012 and
continued until now.”

Published 2014-12-09

100
 Application IV (cont.)
IT IS NOT JUST EASYJET. RYANAIR WILL ALSO FLY TO THE
AZORES

Route liberalization will streamline the destination.

The Government has decided to assign trade routes to the Azores to two low-
cost airlines. After EasyJet announced yesterday that it would make the
connection between the mainland and the island, today is Ryanair's turn to
confirm that it will also be presented in the Azores archipelago.

Published 2014-12-09

101