UNIT III: MONOPOLY & OLIGOPOLY Monopoly Oligopoly Strategic Competition 7/12.
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Transcript of UNIT III: MONOPOLY & OLIGOPOLY Monopoly Oligopoly Strategic Competition 7/12.
UNIT III: MONOPOLY & OLIGOPOLY
• Monopoly
• Oligopoly
• Strategic Competition
7/12
Monopoly
• Market Structure• Monopoly• Multiplant Monopoly: 1 Firm – 2 Plants• Price Discrimination: 1 Firm – 2 Markets• Next Time: Review
Market Structure
So far, we have looked at how consumers and firms make optimal decisions (maximize utility and profits) under constraint. Then we looked at how those individual decisions are coordinated via the market.
Under Perfect Competition, we assume an infinite number of infinitely small price-takers, and we know that the competitive market equilibrium is Pareto-efficiency.
Now want to consider other market structures (e.g., monopoly; duopoly) and characterize the corresponding equilibria; what are the welfare consequences of these market structures?
Market Structure
Market structure is related to market concentration and competitiveness. Perfect Competition is a polar case (low conc; high comp), where rational decision-making at the individual level (consumer; firm) adds up to optimal outcomes at the social level – The Invisible Hand Theorem of Welfare Economics.
Once we move away from the perfect case, firms can exploit market power: their behavior can influence prices (and profits). Monopoly is the case where a single firm has market power. Later we will consider what happens when several firms have power in the market (oligopoly). Here, competitive strategy comes to the fore.
Market Structure
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Output MR = MC = P ??? MR = MC < P
Profit 0 ? Yes
Efficiency Yes ???
POINT 1:
Under every market
structure, all firms attempt to maximize profits, s.t., MR = MC.
POINT 1:
The number of firms in the market is
determined by entry
conditions.
Market Structure
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Output MR = MC = P ??? MR = MC < P
Profit 0 ? Yes
Efficiency Yes ???
POINT 1:
Under every market
structure, all firms attempt to maximize profits, s.t., MR = MC.
POINT 1:
Profits signal entry. For a firm to remain
profitable, there must be
barriers to entry (or the market is too
small for a second firm).
Market Structure
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Optimality MR = MC = P ??? MR = MC < P
Profit 0 ? Yes
Efficiency Yes ???
POINT 2:
Under every market
structure, all firms attempt to maximize profits, s.t., MR = MC.
Market Structure
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Optimality MR = MC = P ??? MR = MC < P
Profit 0 ? Yes
Efficiency Yes ???
POINT 2:
… but under perfect
competition P = MR
and under monopoly P > MR.
Market Structure
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Optimality MR = MC = P ??? MR = MC < P
Profit No ? Yes
Efficiency Yes ???
POINT 3:
Thinking about market
structure raises welfare
questions.Perfect
competition implies
efficiency.
Market Structure
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Optimality MR = MC = P ??? MR = MC < P
Profit No ? Yes
Efficiency Yes ???
POINT 3:
What are the welfare
implications of other market structures?
Market Structure
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Optimality MR = MC = P ??? MR = MC < P
Profit No ? Yes
Efficiency Yes ? ???
Market Structure
• Firms are price-takers: can sell all the output they want at P*; can sell nothing at any price > P*.
• Homogenous product: e.g., wheat, t-shirts, long-distance phone minutes
• Perfect factor mobility: in the long run, factors can move costlessly to where they are most productive (highest w, r).
• Perfect Information: firms know everything about costs, consumer demand, other profitable opportunities, etc.
Perfect Competition
Market Structure
• Firms are price-setters: one firm supplies entire market, faces downward-sloping demand curve.
• Homogenous product: necessarily so for a single firm.
• Barriers to entry: no perfect factor mobility. E.g., patents; licenses; franchises.
• Perfect Information: firms know everything about costs, consumer demand, other profitable opportunities, etc.
Monopoly
Monopoly
Barriers to Entry: The number of firms is determined by entry conditions.
As we have learned, profits are the incentive for entry. The only way a firm can remain profitable (and a monopoly) is if there are very strong barriers to entry, or if the market is too small for a second firm.
• Some of these barriers are natural (technology)
• Some are created by regulators (franchise, license)
• Some are created by the monopolist to deter entry by potential rivals (competitive strategy)
Monopoly
Remember that a perfectly competitive firm can sell all it wants at the market price. This means that any time it wants to increase revenues, it needs only to produce more output. For this reason in perfect competition marginal revenue and price were equal, MC = MR = P.
Since a monopolist necessarily faces the entire market demand, it faces a downward sloping demand curve. This means that, if the firm wishes to increase revenues it must lower price. If it wishes to sell less it must raise price. As it turns out this means that, for a monopolist marginal revenue is different from market price,
MC = MR < P.
Monopoly
Marginal Revenue the additional revenue from a unit increase in output.
Remember, the firm must sell it’s entire output at the same price. Therefore, marginal revenue will be the price of that extra unit minus the change in revenue on all earlier (inframarginal) units
MR = dTR/dQ = d(PQ)/dQ = P + Q(dP/dQ)
= P + P(Q/P)(dP/dQ)=
= P[1 + Q/P(dP/dQ)] = P(1 + 1/E)
dP/dQ is neg, for downward sloping demand curve
Monopoly
Marginal Revenue the additional revenue from a unit increase in output.
Remember, the firm must sell it’s entire output at the same price. Therefore, marginal revenue will be the price of that extra unit minus the change in revenue on all earlier (inframarginal) units
MR = dTR/dQ = d(PQ)/dQ = P + Q(dP/dQ)
= P + P(Q/P)(dP/dQ)=
= P[1 + Q/P(dP/dQ)] = P(1 + 1/E)
E = P/Q(dQ/dP) price elasticity of demand
Monopoly
Marginal Revenue the additional revenue from a unit increase in output.
Remember, the firm must sell it’s entire output at the same price. Therefore, marginal revenue will be the price of that extra unit minus the change in revenue on all earlier (inframarginal) units
MR = dTR/dQ = d(PQ)/dQ = P + Q(dP/dQ)
= P + P(Q/P)(dP/dQ)=
= P[1 + Q/P(dP/dQ)] = P(1 + 1/E)
> -1; MR < 0 E = -1; MR = 0
< -1; MR > 0
$
$
D
Q Q
Monopoly
TR = PQ
Price-Taker Price-Setter
D: P = AR
Q Qo Q1 Q2 Q
P0
P1
P2
P1Q1
P2Q2
P0Q0
TR
$
$
TR
D: P = AR
= MR
Q Q
Monopoly
TR
Price-Taker Price-Setter
D: P = AR
Q Q
MR
MR > 0 (Elastic)
MR < 0 (Inelastic)
$
$
TR
D: P = AR
= MR
Q Q
AC
Monopoly
TR
D: P = AR
Q Q
A monopolist will never
produce at an
inelastic portion
of the demand curve
MR > 0 (Elastic)
MR < 0 (Inelastic)
Multiplant Monopolist
Now consider a monopolist who operates several plants.
Plant A Plant B Market qa q qb q Q Q
$
P
mca MCmcb
MR
D
MCa = MCb = MR
Not to scale
Perfect Competition
Competitive equilibrium. Firms are producing at the efficient scale. P* = acmin; = 0.
$
P*
q* q Q* Q
$
LRS
mc
ac
D
What would happen if a monopolist owned all the
plants?
Multiplant Monopolist
Monopoly equilibrium. Prices rise, total market quantity falls …
$
Pm
P*
q* q Qm Q* Q
$
mc
ac
D
MCsr
Not to scale
Multiplant Monopolist
Monopoly equilibrium. Plants are producing at less than efficient scale. P* > ACmin; > 0.
$
Pm
P*
qm q* q Qm Q* Q
$
mc
ac
D
There is no supply curve (Q = f(P)) for a monopolist
Not to scale
MR
Multiplant Monopolist
Monopply equilibrium. Plants are producing at less than efficient scale. P* > ACmin; > 0.
$
Pm
P*
qm q* q Qm Q* Q
$
mc
ac
D
Not to scale
Profit
MCsr
Multiplant Monopolist
Monopoly equilibrium. Plants are producing at less than efficient scale. P* > ACmin; > 0.
$
Pm
P*
qm q* q Qm Q* Q
$
mc
ac
D
Not to scale
Profit
Dead Weight Loss
Max SS – Actual SS
DWL
MCsr
MR
Monopoly
If the firm has access to many identical plants: Plants
are producing at their efficient scale. P* > ACmin; > 0.
q* q Qm Q* Q
$
mc
ac
D
DWLProfit
MClr
$
Pm
P*
MR
Monopoly
Natural Monopoly. Sometimes, one large firm can
produce more efficiently than many small ones. $
P*
q* q Q* Q
$
mc
ac
D
tc = 100 + q2 QD = 1000 – 10P
MR
Monopoly
Natural Monopoly. Sometimes, one large firm can
produce more efficiently than many small ones. $
P*
q* q Q* Q
$
mc
ac
D
acm
QD = 1000 – 10P tcm = 1000 + 2q
MR
Monopoly
Natural Monopoly. Sometimes, one large firm can
produce more efficiently than many small ones. $
Pm
P*
$
mc
ac
D
acm
MC
qm q* q Qm Q* QMR
tcm = 1000 + 2q
mcm = 2
QD = 1000 – 10P P = 100 - .1Q
MR = 100 - .2Q
= MC = 2
Qm = 490
Monopoly
Natural Monopoly. Sometimes, one large firm can
produce more efficiently than many small ones. $
Pm
P*
$
mc
ac
D
acm
MC
qm q* q Qm Q* QMR
tcm = 1000 + 2q
mcm = 2
What are the welfare implications?
Price Discrimination
When a firm has market power, it will attempt to capture as much of the consumer surplus as it can.
Goods susceptible to price discrimination:
– Personal services (e.g., hair cuts)– Utilities (e.g., water; electricity)
Price Discrimination
3rd Degree (Market Segmentation): Now consider a monopolist who sells in several markets.
Market A Market B Firm qa q qb q Q Q
$
Pa
da
MC
MRbMR
Pb
MRa
MRa = MRb = MC
db
Higher price in the less elastic market
Price Discrimination
2nd Degree (Block Pricing): Firm charges different price for different units; all consumers face the same price schedule.
$
10
8
5
100 150 Q
0-100 $10
101-150 8
151- 5
CS
CS
CSPS
CS
PS
D
Price Discrimination
1st Degree (Perfect): Firm charges different price for to different consumers and different price for different units to the same consumer.
$
Q
D
Entire area under demand curve capture
by producer
What are the welfare
implications?
MC
Market Structure
POINT 1: The number of firms in the market is determined by entry conditions. Profits signal entry. For a firm to remain profitable, there must be barriers to entry (or the market is too small for a second firm).
POINT 2: Under every market structure, all firms attempt to maximize profits, s.t., MR = MC. But under perfect competition P = MR and under monopoly P > MR.
POINT 3: Thinking about market structure raises welfare questions. Perfect competition implies efficiency. What are the welfare implications of other market structures?
Next Time
Perfect Comp Oligopoly Monopoly
No. of Firms infinite (>)2 1
Output MR = MC = P ??? MR = MC < P
Profit No ? Yes
Efficiency Yes ? ???