EC202_Lecture_notes_11
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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
Perloff
Varian
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
Uniform pricing (same price for all units sold)
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:
Revenue gain = P1 for an extra unit sold
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
Derive MR curve
Set MR = MC to find optimal output Q*
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
Conduct remedies: Monitor behavior with fines to deter bad practices.
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
Rate of return regulation
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
Price set at demand curve and AC curve intersection allows for some break-even production.
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.