Chapter 10: Monopoly

Marginal Revenue

change in revenue resulting from a one-unit increase in output.

Profit-Maximization Point

MC=MR

Effects of producing a smaller output

sacrifice some profit because the extra revenue that could be earned from producing and selling the units exceeds the costs of producing them.

Effects of expanding output

reduce profits because the additional cost of producing them exceeds the additional revenue

A monopolistic market has ___

no supply curve

What does the monopolistic output decision depend on?

marginal cost and shape of the demand curve

In a monopolistic market, what can shifts in demand lead to?

1. Changes in price with no change in output

2. Changes in output with no change in price

3. Changes in both price and output

What happens when a specific tax of t dollars per unit is levied?

The monopolist must remit t dollars to the government for ever unit it sells

In an inelastic demand monopoly, markup is ___ than elastic demand

Larger

In an elastic demand monopoly, markup is ___ than inelastic demand

smaller

When a firm has two plants, what should its total output be?

the total output should be divided between the two plants so that MC is the same in each plant.

When a firm has two plants, how much of that output should each plant produce?

Total output must be such that MR = MC, otherwise, the firm could increase its profit by raising or lowering total output.

What should the firm do if MR > MC?

The firm should increase production to capture additional profit.

What should the firm do if MR < MC?

The firm should reduce production to avoid losses on additional units

Total Profit Equation for a firm with two plants

Profit = PQ_T-C₁(Q₁)-C₂(Q₂)

The revenue from producing and selling one more unit equation

Change in (PQ_T)/Q₁

The elasticity of a market is __ than the elasticity of a single firm within that market.

less

What does it mean when the market elasticity of demand for soft drinks is between -0.8 and -1.0?

This means that if all soft drink producers increased the prices of all their brands by 1%, the quantity of soft drinks demanded would fall by 0.8 to 1.0 percent.

What does it mean the elasticity of demand for Coca-Cola is -5?

This means that if Coca-Cola were to raise the price of their products by 1%, the quantity demanded of Coca-Cola would fall by 5%.

How can we measure monopoly power in order to compare one firm with another?

1. Lerner Index of Monopoly Power

2. Markup

3. Elasticity of Demand

What are the sources of monopoly power, and why do some firms have more monopoly power than others?

Lerner Index of Monopoly Power

1. measure of monopoly power calculated as excess of price over marginal cost as a fraction of price.

L = (P-MC)/P

2. This index of monopoly power can also be expressed in terms of the elasticity of demand facing the firm

L = (P-MC)/P = -1/E_D

Larger Lerner Index means what?

More monopoly power

Smaller Lerner Index means what?

less monopoly power

The Rule of Thumb for Pricing

P = MC / 1+(1/E_D)

Markup Equation

(P-MC)/P

If the firm’s demand is elastic, what does that mean for its markup and monopoly power capability?

The firm can charge a small markup and has little monopoly power.

If the firm’s demand is inelastic, what does that mean for its markup and monopoly power capability?

The firm can charge a large markup and has more monopoly power.

What is the ultimate determinant of monopoly power?

Firm’s elasticity of demand

What are the determinants of a firm’s elasticity of demand?

1. The elasticity of market demand

2. The number of firms in the market

3. The interaction among firms

The elasticity of market demand

because the firm’s own demand will be at least as elastic as market demand, the elasticity of market demand limits the potential for monopoly power.

The number of firms in the market

if there are many firms, it is unlikely that any one firm will be able to affect price significantly.

The interaction among firms

even if only two or three firms are in the market, each firm will be unable to profitably raise price very much if the rivalry among them is aggressive, with each firm trying to capture as much of the market as they can.

What is the demand curve of a pure monopolist?

Its market demand curve

What does a pure monopolist degree of monopoly power depend on?

elasticity of market demand

What happens to the elasticity of market demand when several firms compete with one another?

A lower limit on the magnitude of the elasticity of demand for each firm.

What does a particular firm’s elasticity depend on?

the firms competing with one another and the elasticity of market demand limits the potential monopoly power of individual producers.

What happens to monopoly power as the number of firms in a market increases?

The monopoly power of each firm will decrease.

Highly Concentrated Market

when only a few firms account for most of the sales in a market

Barrier to entry

conditions that impede entry by new competitions.

What are examples of natural barriers to entry?

1. Patents, copyrights, and licenses

2. Economies of scale

What happens when firms collude?

This is illegal (in violation of the antirust laws); firms agree to limit output and raise prices.

Monopoly power is ___ when firms compete aggressively and monopoly power is ___ when they cooperate.

smaller; larger

Real or potential monopoly power in the ____ can make an industry more competitive in the ___

short run; long run

Rent Seeking

spending money is socially unproductive efforts to acquire maintain, or exercise monopoly.

Natural Monopoly

a firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms.

How do we know if a firm is a natural monopoly?

The firm has economies of scale over its entire output range

What is the regulation of monopoly sometimes based on?

rate of return that it ears on its capital

What does the regulatory agency determine?

an allowed price, so that this rate of return is in some sense “competitive” or “fair”

What is the maximum price allowed by a regulatory agency based on?

the expected rate of return that a firm will earn

Capital Stock

a key element in determining the firm’s rate of return but difficult to value.

Regulatory Lag

delays in changing regulated prices

What is an approach to regulation?

Setting price caps based on a firm’s variable costs

Price Cap

can allow for more flexibility

How can a firm raise its prices each year without having to get approval from the regulatory agency?

Amount = actual rate of inflation - expected productivity growth

The Effects of excessive market power

1. harms potential purchasers

2. raises problems of equity and fairness

3. Reduces output and leads to a deadweight loss

Direct price regulations

a way to limit the market power of a natural monopoly

Antitrust laws

rules and regulations prohibiting actions that restrain, or are likely to restrain, competition

Is it illegal to be a monopolist or to have market power?

It is not illegal

Patent/copyright laws

protect the monopoly positions of firms

Parallel Conduct

form of implicit collusion in which one firm consistently follows actions of another

Predatory Pricing

practice of pricing to drive current competitors out of business and to discourage new entrants in a market so that a firm can enjoy higher future profits.

Antitrust Division is a part of what U.S. gov’t department?

The Department of Justice

Administrative Procedures is ran by what U.S. gov’t agency?

Federal Trade Commission

Private Proceedings

Individuals or companies can sue for ­treble (three-fold) damages inflicted on their businesses or property.

Laws of the European Union are ___ to the United States

similar

Article 101 of the Treat of the European Community

restraints of trade; much like Section 1 of the Sherman Act

Article 102 of the Treat of the European Community

abuses of market power by dominant firms; much like Section 2 of the Sherman Act

European Merger Act

ensures that big companies merging do not reduce competition, harm consumers, or create monopolies; much like Section 7 of the Clayton Act

Are merger evaluations conducted more quickly in Europe of the U.S.?

Europe; it is easier to prove that a European firm is dominant than in the U.S.

Antitrust enforcement has ___

grown rapidly

International Competition Network

global organization that brings together competition (antitrust) authorities from different countries to promote fair competition and cooperation in enforcement.