ECON 130 - Public Policy Slides 3

Market Power

The firm’s ability to raise its price without losing all sales; occurs when the firm faces a downward-sloping demand curve.

Imperfectly Competitive Firm

A firm with market power that can choose both price and quantity on the demand curve.

Perfectly Competitive Firm

A firm that must take the market price as given and sells as much as it wants at that price.

Market Failure – Imperfect Competition

When one or few firms have significant control over price, leading to inefficiency and welfare loss.

Monopoly

A single firm that is the only seller of a good or service with no close substitutes and high barriers to entry.

Barriers to Entry

Factors that prevent new firms from entering a market, such as patents, exclusive rights, resource ownership, economies of scale, and network effects.

Patent or Copyright

Legal barrier granting exclusive production rights to a firm or inventor for a period of time.

Exclusive Rights

Government-granted monopoly to provide a service (e.g., utilities, postal service).

Ownership of a Scarce Resource

Market power resulting from control over a critical input or resource.

Economies of Scale

When average cost decreases as production increases, favoring large producers.

Network Effects

When a product becomes more valuable as more people use it (e.g., social media, software platforms).

Profit Maximization Condition

A firm maximizes profit where marginal revenue (MR) equals marginal cost (MC).

Total Revenue (TR)

The total amount a firm receives from sales, equal to price (P) times quantity (Q).

Marginal Revenue (MR)

The additional revenue gained from selling one more unit of output.

Key Difference Between Perfect Competition and Monopoly

In perfect competition, P = MR = MC; in monopoly, P > MR = MC.

Monopolist’s Tradeoff

Lowering price increases quantity sold but decreases revenue on existing sales.

Monopoly Profit Maximization Rule

Choose output where MR = MC, then charge the highest price consumers will pay for that quantity.

Linear Demand Curve

For a demand curve P = a – bQ, the marginal revenue curve has the same intercept (a) and twice the slope (–2b).

Marginal Revenue Curve (Linear Demand)

Lies below the demand curve and declines twice as steeply.

Deadweight Loss from Monopoly

The reduction in total surplus (efficiency loss) caused by monopoly output being lower and price higher than in a competitive market.

Consumer Surplus under Monopoly

Smaller than in perfect competition because consumers pay a higher price and buy less quantity.

Producer Surplus under Monopoly

Larger than under competition, as the monopolist captures more profit.

Total Welfare under Monopoly

Lower than in a competitive market due to deadweight loss.

Natural Monopoly

A market where one firm can supply the entire market at a lower cost than multiple firms due to high fixed costs and low marginal costs.

Fixed Costs

Costs that do not vary with output (e.g., building a refinery, maintenance, or taxes).

Marginal Cost (MC)

The additional cost of producing one more unit of output.

Average Cost (AC)

Total cost divided by output (TC/Q); decreases when fixed costs are spread over more units.

Why Natural Monopolies Exist

Large fixed costs and low marginal costs make it inefficient for multiple firms to compete.

Natural Monopoly Example

Oil refining or utilities—high infrastructure costs but low marginal cost of production.

If Price = MC in a Natural Monopoly

The firm would operate at a loss because price would be below average cost.

Government Regulation for Natural Monopolies

Regulate prices to balance efficiency and firm viability through marginal or average cost pricing.

Marginal Cost Pricing Regulation

Forces monopolist to charge P = MC; government may subsidize losses.

Average Cost Pricing Regulation

Sets price equal to AC, allowing firm to break even but causing smaller efficiency loss.

State Ownership or Contracting

Government can own or contract private operators to manage natural monopolies.

Sherman Antitrust Act (1890)

Outlaws monopolization, price-fixing, and conspiracies that restrain trade; penalties include fines and imprisonment.

Amended Sherman Act Penalties

Increased to $100 million fines and up to 10 years imprisonment (H.R. 1086, 2004).

Government Responses to Monopoly

1) Break up monopolies, 2) Regulate prices, 3) Subsidize or own natural monopolies.

Goal of Antitrust Policy

Promote competition, prevent abuse of market power, and protect consumer welfare.

Example of Monopoly Question

If one textbook seller raises prices, will sales fall? Yes — monopolists face downward-sloping demand, so quantity demanded decreases with price.

Effect of Market Power on Efficiency

Creates deadweight loss by restricting output below the competitive level.

Difference Between MR and Demand Curve

MR declines faster than demand because lowering price affects all previous units sold.

Profit Formula for Monopolist

Profit (π) = Total Revenue (TR) – Total Cost (TC).

Monopolist’s Price Choice

Chooses price from demand curve corresponding to quantity where MR = MC.

Competitive vs Monopoly Pricing

Competitive: P = MC; Monopoly: P > MC.

Reason Monopoly is Inefficient

It restricts quantity to raise prices, reducing total welfare.

Example of Economies of Scale

Utilities like electricity or water distribution where cost per user decreases with more users.

Example of Network Effects

Products like social media, messaging apps, or operating systems that gain value as usage increases.