Unit 7. Firm behaviour and market structure: monopoly

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1 Unit 7. Firm behaviour and market structure: monopoly

2 In accordance with the APT programme objectives of the lecture are to help You to: identify and examine the sources of monopoly power; understand the relationship between a monopolist s demand curve and its total and marginal revenue curves; compare a monopolist s price, level of output and profit with those of a firm operating in a perfectly competitive market; learn how and why competitive markets achieve an efficient allocation of resources, whereas monopolists do not; and show the efficiency loss due to monopoly; understand the model of price discrimination as a dimension of monopoly behaviour.

3 Required reading Begg, D., R.Dornbusch, S.Fischer. Economics. 8th edition. McGraw Hill Chapter 8. Perfect competition and pure monopoly: 8.6. Pure monopoly: the opposite limiting case; 8.7. Profit-maximizing output for a monopolist; 8.8. Output and price under monopoly and perfect competition; 8.9. A monopoly has no supply curve; Monopoly and technical change. Chapter 9. Market structure and imperfect competition: 9.1. Why market structures differ. Chapter 17. Industrial policy and competition policy: The social cost of monopoly power; Competition policy; Mergers. Chapter 18. Natural monopoly: public or private?

4 Questions to be revised The relationships among the short-run and long-run costs: total, average and marginal; Total and marginal revenue; Elasticity and producers total revenue; The profit-maximizing rule; Profit maximization by a competitive firm in the short run and in the long run; Market supply under perfect competition; Equilibrium and efficiency of a competitive market; Dead weight loss; Per-unit tax, competitive equilibrium and efficiency.

5 Market structure determinants Legislative barriers to entry: patents and copyrights; government licenses or franchises; Technological barriers to entry: economies of scale relative to market size; network economies. The minimum efficient scale is the minimum output at which a firm s long-run average cost curve stops declining. The minimum efficient scale as related to the size of the market determines the number of firms that is appropriate for the industry. There is a natural monopoly when the minimum efficient scale is relatively large as compared to size of the market. Strategic barriers to entry: actions of monopolists (investment, price-setting, exclusive control over important inputs) that prevent entry of potential competitors to the market. 5

6 Profit-maximizing Output for a Monopolist First order condition: that is: Second order condition: that is:

7 Profit-maximizing Output for a Monopolist Recollect: for a price-taker:, so MR=P. A monopolist faces a downward-sloping demand curve, thus, MR(Q) P(Q). Marginal revenue is smaller than the price: MR(Q)<P(Q), since : monopolist can sell an additional unit only by cutting price for all units. MR>0, so, i.e. monopolist never produces on the inelastic part of the demand curve.

8 PR, TR, TC Profit maximization by a monopoly TC TR E 1 1 d 0 d p E p 0 d Ep Q 1 Q * E 1 d p PR d E p 0 Q P, MR, MC MC P * MR D 0 Q 1 Q * Q

9 Example: APT 1999

10 Example: APT 2011

11 Example: APT 2008 (Form B)

12 Profit maximization by a monopoly in the short run: positive economic profit P SMC SATC P M C A B MC=MR E 0 Q M MR D Q

13 Profit maximization by a monopoly in the short run: economic loss P, C SMC SAC loss AVC P * D MR 0 Q * Q

14 Example: APT 2006 (Form B)

15 Measuring monopoly power: Lerner index

16 Example: APT 1995 Question 3

17 A monopoly has no supply curve P, MR, MC MR 1 P 1 MC P 2 D 1 MR 2 D 2 0 Q* One and the same monopolistic output may correspond to different price levels due to changes in market demand. There is no functional correspondence between quantity supplied and market price under monopoly. Q

18 P, MR, MC A monopoly has no supply curve D 1 MC P * MR 1 MR 2 D 2 0 Q 1 Q 2 One and the same price level may correspond to different quantities supplied by a monopoly due to changes in market demand. There is no functional correspondence between market price and optimal output under monopoly. Q

19 Profit maximization by a monopoly in the long run P P E G F SMC A SAC LMC LAC B 0 C Q MR D Q

20 Monopoly and efficiency: dead weight loss P C P * M B P * C A E LMC=LAC 0 Q * M MR Q * C D Q

21 Example: APT 2000

22 Example: APT 2003 (Form B)

23 Unregulated natural monopoly TR, TC, PR TC TR P, AC, MC PR 0 Q MR Q* P * PR AC MC D 0 Q* Q Economies of scale over the entire range of output Q F Q E

24 Natural monopoly: dilemma of regulation P D P * M M F P 2 R P 1 R 0 L B A H LAC LMC MR C D Q * Q M 2 Q R 1 R Q

25 Example: APT 2008

26 Monopoly and efficiency: price ceiling P P * M P 1 P C M A SMC C SATC E B 0 Q * M Q 1 Q C MR D Q

27 Example: APT 2011 (continued)

28 Monopoly and efficiency: per-unit tax P A P t M P M N L 0 M t E t K Q t Q M M M E MR C t LMC t LMC D Q

29 Example: APT 2007

30 Example: APT 2000

31 Price discrimination Different customers are charged different prices for one and the same good produced at the same cost No resale condition Perfect (first degree) price discrimination: each customer is charged her reservation price Reservation price is the highest price a customer is ready to pay for a good

32 P Perfect price discrimination: discrete demand P 1 P 2 A 1 A 2 P 3 A 3 P 4 A 4 P 5 A MC Q

33 P A Perfect price discrimination: smooth demand MC P M B P C E C MR 0 Q M Q C D Q

34 Example: APT 2011 (continued)

Managerial Economics & Business Strategy Chapter 8. Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets

Managerial Economics & Business Strategy Chapter 8 Managing in Competitive, Monopolistic, and Monopolistically Competitive Markets I. Perfect Competition Overview Characteristics and profit outlook. Effect