Ln11 Micro v2

Microeconomics: Theory and Applications
with Calculus
Fifth Edition
Chapter 11
Monopoly and Monopsony
Monopoly: one parrot.
Slides in this presentation contain

hyperlinks. JAWS users should be
able to get a list of links by using
INSERT+F7
Copyright © 2020, 2017, 2014 Pearson Education, Inc. All Rights Reserved
Chapter 11 Outline
Challenge: Brand-Name and Generic Drugs
11.1 Monopoly Profit Maximization
11.2 Market Power and Welfare
11.3 Taxes and Monopoly
11.4 Causes of Monopolies
11.5 Government Actions that Reduce Market Power
11.6 Internet Monopolies: Network Effects, Behavioral Economics, and
Economies of Scale
11.7 Monopsony
Challenge Solution
11.2 Sources of Market Power
• Elasticity of the market demand curve depends on consumers’
tastes and options.
• Demand becomes more elastic (which implies less market
power for the firm):
– as better substitutes for the firm’s product are introduced
– as more firms enter the market selling a similar product

– as firms that provide the same service locate closer to the
firm
• As a profit-maximizing monopoly faces more elastic demand, it
has to lower its price.
• Example: Apple’s iPad
11.2 Effects of Market Power on
Welfare (1 of 2)
• Recall from Chapter 9 that competition maximizes welfare,
which is the sum of consumer surplus and producer
surplus, because price equals marginal cost.
• By contrast, a monopoly
– sets price above marginal cost (and above the
competitive price)
– causes consumers to buy less than the competitive

level of output
– generates deadweight loss
11.2 Effects of Market Power on
Welfare (2 of 2)
• The competitive
equilibrium, ec, has
no DWL, while the
monopoly
equilibrium, em, has
DWL = C+E.
11.3 Taxes and Monopoly (1 of 3)
• Taxes (ad valorem and specific) affect monopoly differently
than a competitive industry:
1. Tax incidence on consumers (the change in the
consumers’ price divided by the change in the tax) can
exceed 100% in a monopoly market but not a
competitive market.
2. If tax rates α and τ are set so that the after-tax output
is the same with either type of tax, the government
raises the same amount of tax revenue in a
competitive market using either type of tax, but raises
more revenue using an ad valorem tax than a specific
tax under monopoly.
• Comparative Statics (of specific tax, τ)
– Before-tax cost function is
– After-tax cost function is
– Necessary condition for maximizing after-tax profit:
– Derivative (with respect to τ) of the sufficient condition for

maximizing after-tax profit:
• As the specific tax rises, the monopoly reduces its output.

• Downward sloping means the monopoly raises its price.
• Tax Incidence on Consumers
– Consumer price may rise by an amount greater than the tax.
– Assume constant marginal cost, m, and inverse demand
function with constant elasticity, ε,
▪ Maximize profit by equating after-tax marginal cost and marginal
revenue:
▪ Substituting for Q in inverse demand yields the price set by monopoly:
• Differential with respect to τ is greater than one because monopoly operates

on elastic portion of demand curve.
11.3 Specific Taxes and Monopoly
• With a specific tax:
• MC shifts up by t
• Output decreases
from Q1 to Q2
• Price increases from
p1 to p2
• Consumer surplus
decreases from A+B+C
to A
• Producer surplus changes from D+E+D to B+D
• Deadweight loss increases from F to C+E+F
11.4 Causes of Monopolies
• Why are some markets monopolized?
• Two key reasons:

– Cost advantage over other firms
– Government created monopoly
11.4 Cost Advantages of Monopoly (1 of 3)
• Sources of cost advantages:
1. Control of an essential facility, a scarce resource that a rival firm

needs to use to survive
▪ Example: owning the only quarry in a region generates a cost
advantage in the production of gravel
2. Use of superior technology or a better way of organizing
production
▪ Example: Henry Ford’s assembly lines and standardization
3. Protection from imitation through patents or informational
secrets
▪ Secrets are more common in new and improved processes;
patents more common with new products
4. A market has a natural monopoly if one firm can
produce the total output of the market at lower cost
than several firms could.
– where
• Examples: public utilities such as water, gas, electric, and

mail delivery
• Natural monopolies may have high fixed costs, but low and
fairly constant marginal costs.
• A natural monopoly has economies of scale at all levels of
output, so average costs fall as output increases.
11.5 Government Actions That Create
Monopolies
• Governments typically create monopolies:
1. By granting or auctioning licenses to operate
▪ Example: U.S. cities require new hospitals to secure
a certificate of need to demonstrate the need for a
new facility
2. By granting monopoly rights to a public utilities
3. By granting patents:
▪ An exclusive right for an investor to sell a new and
useful product process, substance, or design for a
fixed time
11.5 Government Actions That Reduce
Market Power (1 of 6)
• Governments limit monopolies’ market power in various
ways:
1. Optimal Price Regulation: government regulates the
monopoly by imposing a price ceiling that is equal to
the competitive price, which eliminates DWL.
2. Nonoptimal Price Regulation: government-imposed
price ceiling is not set at the competitive level, which
reduces but does not eliminate DWL.
3. Increasing Competition: allowing/encouraging market
entry by new domestic firms and ending import bans that
kept out international firms.
• Shifting from the $400
monopoly price of
Botox to p=MC=25:
• Increases consumer
surplus from A to
A+B+C
• Eliminates the
producer surplus B
• Eliminates the
deadweight loss C
• With optimal price
regulation, the
government imposes
a price ceiling that is
equal to the
competitive price.
• The government sets
a price ceiling at p2,
which is below the
socially-optimal p1,
but above the
monopoly’s minimum
average cost. The
result:
• Welfare is lower by
B+D compared to
the optimal
regulation
• Shortage = Qd−Q2
• If a natural monopoly
is regulated (in this
case natural gas) by
setting the regulated
price equal to M
C=5.78, then the
monopolist loses
2=7.78−5.78. With the
regulation:
• DWL is eliminated
• CS increases
• Monopolist is subsidized
by amount of loss
• How does the
presence of pirated
3D toys affect the
price that Disney
charges for its own
toy?
• Disney’s marginal
cost is MC and
marginal cost of
pirated is MC+x
• Demand for Disney product is residual demand and Disney’s
MR jumps
• Pirated price is p1 and Disney’s price is MC+x
11.6 Internet Monopolies
• Two reasons why Facebook, Google, and Amazon have
such large shares of their markets that they are nearly
monopolies
– Consumers form a network: an interconnected group
of people
– These firms have a cost structure with low or zero
marginal cost and high fixed cost. They are natural
monopolies
11.6 Internet Monopolies: Network
Externalities
• A good has a network externality if one person’s demand
depends on the consumption of the good by others.
– If a good has a positive network externality, its value to
a consumer grows with the number of units sold (e.g.,
telephones)
– A consumer sometimes wants a good because
“everyone else has it.”
With a bandwagon effect, a person places greater
value on a good as more and more people possess it
• In markets with positive externalities, we frequently see
one or a few large firms surviving
Copyright
This work is protected by United States copyright laws and is

provided solely for the use of instructors in teaching their
courses and assessing student learning. Dissemination or sale of
any part of this work (including on the World Wide Web) will
destroy the integrity of the work and is not permitted. The work
and materials from it should never be made available to students
except by instructors using the accompanying text in their
classes. All recipients of this work are expected to abide by these
restrictions and to honor the intended pedagogical purposes and
the needs of other instructors who rely on these materials.

Ln11 Micro v2

Uploaded by

Copyright:

Available Formats

You might also like

Ln11 Micro v2

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ln11 Micro v2

Uploaded by

Copyright:

Available Formats

Microeconomics: Theory and Applications

Monopoly and Monopsony

Monopoly: one parrot.

Slides in this presentation contain

– as better substitutes for the firm’s product are introduced

– as more firms enter the market selling a similar product

– causes consumers to buy less than the competitive

– Derivative (with respect to τ) of the sufficient condition for

• As the specific tax rises, the monopoly reduces its output.

▪ Substituting for Q in inverse demand yields the price set by monopoly:

• Differential with respect to τ is greater than one because monopoly operates

• Two key reasons:

1. Control of an essential facility, a scarce resource that a rival firm

• Examples: public utilities such as water, gas, electric, and

This work is protected by United States copyright laws and is

You might also like