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### Transcript of UNIT III: MONOPOLY & OLIGOPOLY Monopoly Oligopoly Strategic Competition 7/12

• Slide 1
• UNIT III: MONOPOLY & OLIGOPOLY Monopoly Oligopoly Strategic Competition 7/12
• Slide 2
• Monopoly Market Structure Monopoly Multiplant Monopoly: 1 Firm 2 Plants Price Discrimination: 1 Firm 2 Markets Next Time: Review
• Slide 3
• 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?
• Slide 4
• 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.
• Slide 5
• Market Structure Perfect Comp Oligopoly Monopoly No. of Firms infinite (>)2 1 Output MR = MC = P ??? MR = MC < P Profit0 ? 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.
• Slide 6
• Market Structure Perfect Comp Oligopoly Monopoly No. of Firms infinite (>)2 1 Output MR = MC = P ??? MR = MC < P Profit0 ? 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).
• Slide 7
• Market Structure Perfect Comp Oligopoly Monopoly No. of Firms infinite (>)2 1 Optimality MR = MC = P ??? MR = MC < P Profit0 ? Yes Efficiency Yes ??? POINT 2: Under every market structure, all firms attempt to maximize profits, s.t., MR = MC.
• Slide 8
• Market Structure Perfect Comp Oligopoly Monopoly No. of Firms infinite (>)2 1 Optimality MR = MC = P ??? MR = MC < P Profit0 ? Yes Efficiency Yes ??? POINT 2: but under perfect competition P = MR and under monopoly P > MR.
• Slide 9
• Market Structure Perfect Comp Oligopoly Monopoly No. of Firms infinite (>)2 1 Optimality MR = MC = P ??? MR = MC < P ProfitNo ? Yes Efficiency Yes ??? POINT 3: Thinking about market structure raises welfare questions. Perfect competition implies efficiency.
• Slide 10
• Market Structure Perfect Comp Oligopoly Monopoly No. of Firms infinite (>)2 1 Optimality MR = MC = P ??? MR = MC < P ProfitNo ? Yes Efficiency Yes ??? POINT 3: What are the welfare implications of other market structures?
• Slide 11
• Market Structure Perfect Comp Oligopoly Monopoly No. of Firms infinite (>)2 1 Optimality MR = MC = P ??? MR = MC < P ProfitNo ? Yes Efficiency Yes ? ???
• Slide 12
• 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
• Slide 13
• 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
• Slide 14
• 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)
• Slide 15
• 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.
• Slide 16
• Monopoly Marginal Revenue the additional revenue from a unit increase in output. Remember, the firm must sell its 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
• Slide 17
• Monopoly Marginal Revenue the additional revenue from a unit increase in output. Remember, the firm must sell its 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
• Slide 18
• Monopoly Marginal Revenue the additional revenue from a unit increase in output. Remember, the firm must sell its 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 0
• Slide 19
• \$\$\$\$ D Q Q Monopoly TR = PQ Price-TakerPrice-Setter D: P = AR Q Q o Q 1 Q 2 Q P0P1P2P1Q1P2Q2P0Q0P0P1P2P1Q1P2Q2P0Q0 TR
• Slide 20
• \$\$\$\$ D: P = AR = MR Q Q Monopoly TR Price-TakerPrice-Setter D: P = AR Q Q MR MR > 0 (Elastic) MR < 0 (Inelastic)
• Slide 21
• \$\$\$\$ 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)
• Slide 22
• Multiplant Monopolist Now consider a monopolist who operates several plants. Plant A Plant B Market q a q q b q Q Q \$P\$P mc a MC mc b MR D MC a = MC b = MR Not to scale
• Slide 23
• Perfect Competition Competitive equilibrium. Firms are producing at the efficient scale. P* = ac min ; = 0. \$ P* q* q Q* Q \$ LRS mc ac D What would happen if a monopolist owned all the plants?
• Slide 24
• Multiplant Monopolist Monopoly equilibrium. Prices rise, total market quantity falls \$ P m P* q* q Q m Q* Q \$ mc ac D MCsr Not to scale
• Slide 25
• Multiplant Monopolist Monopoly equilibrium. Plants are producing at less than efficient scale. P* > AC min ; > 0. \$ P m P* q m q* q Q m Q* Q \$ mc ac D There is no supply curve (Q = f(P)) for a monopolist Not to scale MR
• Slide 26
• Multiplant Monopolist Monopply equilibrium. Plants are producing at less than efficient scale. P* > AC min ; > 0. \$ P m P* q m q* q Q m Q* Q \$ mc ac D Not to scale Profit MCsr
• Slide 27
• Multiplant Monopolist Monopoly equilibrium. Plants are producing at less than efficient scale. P* > AC min ; > 0. \$ P m P* q m q* q Q m Q* Q \$ mc ac D Not to scale Profit Dead Weight Loss Max SS Actual SS DWL MCsr MR
• Slide 28
• Monopoly If the firm has access to many identical plants: Plants are producing at their efficient scale. P* > AC min ; > 0. q* q Q m Q* Q \$ mc ac D DWL Profit MClr \$ P m P* MR
• Slide 29
• 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 + q 2 Q D = 1000 10P MR
• Slide 30
• Monopoly Natural Monopoly. Sometimes, one large firm can produce more efficiently than many small ones. \$ P* q* q Q* Q \$ mc ac D ac m Q D = 1000 10P tc m = 1000 + 2q MR
• Slide 31
• Monopoly Natural Monopoly. Sometimes, one large firm can produce more efficiently than many small ones. \$ P m P* \$ mc ac D ac m MC q m q* q Q m Q* Q MR tc m = 1000 + 2q mc m =