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Introduction to EC202 Intermediate Microeconomics

• Instructor: George Symeonidis

• Office: 5B.215

• Academic Support Hours: Thursdays 11-12 or by appointment

• Email: symeonid@essex.ac.uk

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Course Structure

Teaching Format

• 10 two-hour lectures

• Weekly one-hour classes

Textbooks

1. Perloff

2. Varian

3. Morgan, Katz and Rosen

Resources

• Lecture notes, Module Outline, and Problem sets available on Moodle

Prerequisites

• Introductory economics preferred

• Basic algebra (solving systems of linear equations, understanding graphs) required

• Calculus useful, but not essential

Assessment

• Coursework and a final examination (both contribute to the aggregate module mark)

• Coursework this term includes a test (details forthcoming)

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Course Schedule for Spring Term

• Weeks 16-17: Monopoly I and II

• Week 18: Introduction to Game Theory

• Weeks 19-20: Oligopoly I and II

• Week 21: Intertemporal Decisions: Consumption and Investment

• Weeks 22-23: Behaviour under Uncertainty I and II

• Weeks 24-25: Asymmetric Information I and II

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Lecture Notes

• Lecture Topic: Monopoly

• Instructor: George Symeonidis

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Understanding Monopoly

• Prior studies focused on firms as price takers, suitable under certain conditions:

  • Large number of firms in an industry

  • Firms produce similar goods

• Example of monopoly: Amazon, Google - firms influencing market prices via market power.

• Analysis focus: how to study firms with significant market power.

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Monopoly vs Perfect Competition

Characteristics of Monopoly

• One seller

• Price-making seller

• No close substitutes; no other firms in the market

• No market entry barriers

Characteristics of Perfect Competition

• Many small sellers

• Price-taking sellers

• Many small buyers

• Perfectly informed buyers

• Homogeneous products

• Equal access to resources

• Free entry

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Sources of Monopoly

Real-World Monopolies

• Indefinite legal monopolies: Electricity generation, railway systems

• Temporary legal monopolies: Patents, trade secrets

• De facto monopolies: Unique access to specific inputs

• Discussion on natural monopolies follows

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Sources of Market Power

Factors Leading to Significant Market Power

• Large economies of scale (high fixed or sunk costs)

• High switching costs for consumers (e.g., network goods)

• Cost or product advantages through innovation

• Examples: Firms like Facebook or Microsoft exhibit significant market power.

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The Profit-Maximising Monopolist

Profit Function

• Profit (Π) = Revenue (R(Q)) - Cost (C(Q))

• R(Q) = P(Q) * Q

• Important: C(Q) refers to the firm’s cost function

• For monopolists, the quantity sold depends on pricing adjustments due to demand dynamics.

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Conditions for Profit Maximisation

Key Concept

• Required condition: Marginal Revenue (MR) = Marginal Cost (MC)

• Under perfect competition, MR = P, but for monopolists, MR < P for all output levels greater than zero.

Reasons

1. Uniform pricing (same price for all units sold)

2. Lowering prices to sell more units involves reducing prices on previously sold units as well.

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Understanding Marginal Revenue (MR)

• Visualization of MR change:

1. Revenue gain = P1 for an extra unit sold

2. Revenue loss = Q0 * ΔP (where ΔP = P1 - P0 < 0)

Key Formula

• More generally, for non-unit changes,:

  • MR = P + Q * (ΔP/ΔQ) < P

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Deriving the MR Curve

• Given demand: Q = 12 - ½P

• Inverse demand: P = 24 - 2Q

MR Calculation

• MR = 24 - 2Q + Q(-2) = 24 - 4Q

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MR Curve vs Demand Curve

• Visualization shows MR < P, implying that MR curve lies below demand curve for all Q > 0.

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Price Elasticity and MR Relationship

• Key Formula: MR = P * (1 - 1/ε)

• As demand becomes more elastic, MR approaches P.

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Profit Maximisation Framework

• Visual representation:P, MC, and Demand curves showing equilibrium output Q*

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Steps for Profit Maximisation

1. Derive MR curve

2. Set MR = MC to find optimal output Q*

3. Find market price P* corresponding to Q* using demand curve.

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Example of Profit Maximisation

• Given inverse demand: P = 24 - 2Q; MR = 24 - 4Q

• MC assumed constant at 4.

Outcomes

• MR = MC leads to Q* = 5; price P* = 14.

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Measuring Profit

• Profit (Π) expressed as:

  • Π = (P - AC) * Q

• Meaning: Profit = Producer Surplus - Fixed Cost

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Profit Area Visualization

• Graph shows profitability regions and their definitions including areas related to P, AC, and MC.

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Shut-Down Decision for Monopolists

• Similar to competitive firms, a monopolist may shut down if unable to cover average economic costs.

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About Market Power

• Definition: Market power exists if a firm sets its price above marginal cost.

Lerner Index

• Measures market power: L = (P - MC)/P

• Greater demand elasticity indicates lesser market power.

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Monopoly and Welfare Considerations

• Importance of caring about market power: Price above MC leads to resource misallocation.

• Implications of P > MC result in lower overall welfare due to deadweight loss.

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Deadweight Loss in Monopoly

• Graph illustrating deadweight loss due to monopoly pricing behavior.

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Tax Implications for Monopolies

• Considering tax on monopolies:

• Lump sum tax shifts profits but outputs remain unchanged unless causing shutdown.

• Per unit tax exacerbates inefficiency by raising MC and reducing output.

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Subsidising Monopolies

• Subsidies could counteract inefficiency, allowing for socially optimal production with respected MR = MC.

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Assessing Social Cost of Market Power

• Evidence on deadweight loss varying; also considers productivity and innovation impacts.

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Static vs Dynamic Efficiency

• Monopolies may encourage R&D if increased profits from innovation cover costs but effects vary.

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Innovation Perspective

• Higher market power may not optimize innovation; perfect competition might be more conducive under certain circumstances.

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Rent-Seeking Behavior and Welfare

• Monopolies may invest considerable resources to protect their positions, impacting overall welfare negatively.

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Antitrust Policy Overview

• Antitrust authorities aim to mitigate market power abuse.

• Concerns with digital giants prevalent.

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Antitrust Remedies

Types of Remedies

1. Conduct remedies: Monitor behavior with fines to deter bad practices.

2. Structural remedies: Prevent abusive behaviors through alterations in market structure.

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Structural Remedies Challenges

• Technology and consumer behavior influence market structure challenges; economies of scale complicate assessment of firms.

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Ambiguities in Antitrust Effectiveness

• Outcomes of mergers or specific business practices can have conflicting welfare implications.

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Challenges in Assessing Market Power

• Evaluating market power impacted by defining relevant markets, knowledge gaps, and dynamic market conditions.

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Understanding Natural Monopoly

• Cost-effective to produce a single product in one firm rather than multiple; moderation of production efficiency and allocative efficiency a challenge.

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Characteristics of Natural Monopoly

• Average costs can decline consistently or within a relevant output range.

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Examples of Natural Monopolies

• Relevant industries include: gas networks, electricity grid, railways, and fibre-optic broadband.

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Regulation of Natural Monopolies

Regulatory Frameworks

1. Rate of return regulation

2. Strict price caps to incentivize cost investment

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Welfare Maximization Challenges with Regulation

• Aim to set P = MC; conflicts arise with declining AC resulting in firm losses.

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Regulating Monopolies with Known Costs

• Situations where firms unable to charge sufficiently to cover costs lead to potential losses.

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Solutions for Declining AC Firms

1. Price set at demand curve and AC curve intersection allows for some break-even production.

2. Two-part tariffs to eliminate deadweight loss and maintain breakeven.

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Regulation Difficulties

• Firms often have asymmetric information; balancing returns on investment while minimizing misallocative inefficiencies proves complex.

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Quiz Question 1

• Question: "An increase in either fixed cost or marginal cost will cause a monopolist to reduce output in the short run."

• Answer: True or False?

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Quiz Question 2

• Question: "For a monopolist facing an upward-sloping MC curve, the imposition by the government of a fixed price below the monopoly price will..."

• Options: (a) Increase output (b) Decrease output (c) Not affect output (d) Any of the above.

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Quiz Question 3

• Question: "Monopoly can sometimes be more efficient than perfect competition because..."

• Options: (a) Better cost incentives (b) Subject to antitrust policy (c) Lobbying activities (d) Creates shareholder income.