Tài liệu Market Power: Monopoly ppt

Chapter 10
Market Power:
Monopoly
Chapter 10
Slide 2
Topics to be Discussed
 Monopoly
 Monopoly Power
 Sources of Monopoly Power
 The Social Costs of Monopoly Power
Chapter 10
Slide 3
Perfect Competition
 Review of Perfect Competition
z P = LMC = LRAC
z Normal profits or zero economic profits in
the long run
z Large number of buyers and sellers
z Homogenous product
z Perfect information
z Firm is a price taker
Perfect Competition
Q
Q
PP
Market Individual Firm
DS
Q
0
P
0

P
0
D = MR = P
q
0
LRACLMC
Chapter 10
Slide 5
Monopoly
 Monopoly
1) One seller - many buyers
2) One product (no good substitutes)
3) Barriers to entry
Chapter 10
Slide 6
Sources of Monopoly Power
 Why do some firm’s have considerable
monopoly power, and others have little
or none?
 A firm’s monopoly power is determined
by the firm’s elasticity of demand.
Chapter 10
Slide 7
Sources of Monopoly Power
 The firm’s elasticity of demand is
determined by:
1) Elasticity of market demand
2) Number of firms
3) The interaction among firms
Chapter 10

Slide 8
Monopoly
 The monopolist is the supply-side of the
market and has complete control over
the amount offered for sale.
 Profits will be maximized at the level of
output where marginal revenue equals
marginal cost.
Chapter 10
Slide 9
Monopoly
 Finding Marginal Revenue
z As the sole producer, the monopolist works
with the market demand to determine
output and price.
z Assume a firm with demand:
 P = 6 - Q
Chapter 10
Slide 10
Total, Marginal, and Average Revenue
$6 0 $0
51 5$5$5
42 83 4
33 91 3
24 8-1 2
15 5-3 1
Total Marginal Average
Price Quantity Revenue Revenue Revenue
PQ RMRAR
Chapter 10

Slide 11
Average and Marginal Revenue
Output
0
1
2
3
$ per
unit of
output
1234567
4
5
6
7
Average Revenue (Demand)
Marginal
Revenue
Chapter 10
Slide 12
Monopoly
 Observations
1) To increase sales the price must fall
2) MR < P
3) Compared to perfect competition
 No change in price to change sales
 MR = P
Chapter 10
Slide 13
Monopoly

 Monopolist’s Output Decision
1) Profits maximized at the output level
where MR = MC
2) Cost functions are the same
MRMCor
MRMCQCQRQ
QCQRQ
=
−==∆∆−∆∆=∆∆
−
=
0///
)()()(
π
π
Chapter 10
Slide 14
Maximizing Profit When Marginal
Revenue Equals Marginal Cost
 At output levels below MR = MC the
decrease in revenue is greater than the
decrease in cost (MR > MC).
 At output levels above MR = MC the
increase in cost is greater than the
decrease in revenue (MR < MC)
The Monopolist’s Output Decision
Chapter 10
Slide 15
Lost
profit

P
1
Q
1
Lost
profit
MC
AC
Quantity
$ per
unit of
output
D = AR
MR
P*
Q*
Maximizing Profit When Marginal
Revenue Equals Marginal Cost
P
2
Q
2
Chapter 10
Slide 16
Monopoly
 An Example
Q
Q
C
MC

QQCCost
2
50)(
2
=
∆
∆
=
+==
The Monopolist’s Output Decision
Chapter 10
Slide 17
Monopoly
 An Example
Q
Q
R
MR
QQQQPQR
QQ
P
Demand
240
40)()(
40)(
2
−=
∆
∆
=

−==
−
=
=
The Monopolist’s Output Decision
Chapter 10
Slide 18
Monopoly
 An Example
30 10,When
10
2240
==
=
=
−
=
P Q
Q
QQorMCMR
The Monopolist’s Output Decision
Chapter 10
Slide 19
Monopoly
 An Example
z By setting marginal revenue equal to
marginal cost, it can be verified that profit is
maximized at P = $30 and Q = 10.
z This can be seen graphically:
The Monopolist’s Output Decision

Chapter 10
Slide 20
Monopoly
 A Rule of Thumb for Pricing
z We want to translate the condition that
marginal revenue should equal marginal
cost into a rule of thumb that can be more
easily applied in practice.
z This can be demonstrated using the
following steps:
Chapter 10
Slide 21
A Rule of Thumb for Pricing






∆
∆






=









∆
∆






+=
∆
∆
+=
∆
∆
=
∆
∆
=
P
Q
Q
P
E
Q

P
P
Q
PP
Q
P
QPMR
Q
PQ
Q
R
MR
d
.3
.2
)(
.1
Chapter 10
Slide 22
A Rule of Thumb for Pricing








+=
=







∆
∆






d
d
E
PPMR
E
Q
P
P
Q
1
.5
1
.4
Chapter 10
Slide 23
A Rule of Thumb for Pricing

()
D
DD
E11
MC
P
EE
1
P P
MCMR@maximized is
+
=
−=






+
=
1
.6
π
Chapter 10
Slide 24
= the markup over MC as a
percentage of price (P-MC)/P
d
E

1
.7 −
A Rule of Thumb for Pricing
8. The markup should equal the
inverse of the elasticity of demand.
Chapter 10
Slide 25
A Rule of Thumb for Pricing
()
12$
75.
9
4
1
1
9
94
1
1
9
==
−
+
=
=−=







+
=


.
P
MCE
Assume
E
MC
P
d
d
Chapter 10
Slide 26
Monopoly
 Monopoly pricing compared to perfect
competition pricing:
z Monopoly
P > MC
z Perfect Competition
P = MC
Chapter 10
Slide 27
Monopoly
 Monopoly pricing compared to perfect
competition pricing:
z The more elastic the demand the closer
price is to marginal cost.

z If E
d
is a large negative number, price is
close to marginal cost and vice versa.
Chapter 10
Slide 28
Monopoly
 Shifts in Demand
z In perfect competition, the market supply
curve is determined by marginal cost.
z For a monopoly, output is determined by
marginal cost and the shape of the
demand curve.
Chapter 10
Slide 29
Demand shifts
Q
$/Q
B
A
MR
1
MC
MR
2
D
1
D
2
Demand goes up

- Price increases
- Quantity
increases
Chapter 10
Slide 30
MC shifts
Q
$/Q
B
A
MC
1
MR
D
2
MC lower
- Price decreases
- Quantity increases
- Part of the benefits is
transferred to consumers
MC
2
Chapter 10
Slide 31
Monopoly
 Observations
z Shifts in demand usually cause a change
in both price and quantity.
z A monopolistic market has no supply
curve.

Chapter 10
Slide 32
Monopoly
 Observations
z Monopolist may supply many different
quantities at the same price.
z Monopolist may supply the same quantity
at different prices.
Chapter 10
Slide 33
Monopoly
 Algebraically:
21
2
1
MCMCMR
MCMR
MCMR
==
=
−
Chapter 10
Slide 34
Monopoly Power
 Monopoly is rare.
 However, a market with several firms,
each facing a downward sloping
demand curve will produce so that price
exceeds marginal cost.
Chapter 10

Slide 35
Monopoly Power
 Measuring Monopoly Power
z In perfect competition: P = MR = MC
z Monopoly power: P > MC
Chapter 10
Slide 36
Monopoly Power
 Lerner’s Index of Monopoly Power
z L = (P - MC)/P
 The larger the value of L (between 0 and
1) the greater the monopoly power.
z L is expressed in terms of E
d
 L = (P - MC)/P = -1/E
d
 E
d
is elasticity of demand for a firm, not
the market
Chapter 10
Slide 37
Monopoly Power
 Monopoly power does not guarantee
profits.
 Profit depends on average cost relative
to price.
 Question:
z Can you identify any difficulties in using the
Lerner Index (L) for public policy?

Chapter 10
Slide 38
Monopoly Power
 The Rule of Thumb for Pricing
z Pricing for any firm with monopoly power
 If E
d
is large, markup is small
 If E
d
is small, markup is large
()
d
E
MC
P
11+
=
Elasticity of Demand and Price Markup
$/Q $/Q
Quantity Quantity
AR
MR
MR
AR
MC MC
Q* Q*
P*
P*
P*-MC

The more elastic is
demand, the less the
markup.
Chapter 10
Slide 40
The Social Costs of Monopoly Power
 Monopoly power results in higher prices
and lower quantities.
 However, does monopoly power make
consumers and producers in the
aggregate better or worse off?
Chapter 10
Slide 41
B
A
Lost Consumer Surplus
Deadweight
Loss
Because of the higher
price, consumers lose
A+B and producer
gains A-C.
C
Deadweight Loss from Monopoly Power
Quantity
AR
MR
MC
Q
C

P
C
P
m
Q
m
$/Q
Chapter 10
Slide 42
 Rent Seeking
z Firms may spend to gain monopoly power
 Lobbying
 Advertising
 Building excess capacity
The Social Costs of Monopoly Power
Chapter 10
Slide 43
 The incentive to engage in monopoly
practices is determined by the profit to
be gained.
 The larger the transfer from consumers
to the firm, the larger the social cost of
monopoly.
The Social Costs of Monopoly Power
Chapter 10
Slide 44
 Price Regulation
z Recall that in competitive markets, price
regulation created a deadweight loss.
 Question:

z What about a monopoly?
The Social Costs of Monopoly Power
Chapter 10
Slide 45
 Natural Monopoly
z A firm that can produce the entire output of
an industry at a cost lower than what it
would be if there were several firms.
The Social Costs of Monopoly Power
Chapter 10
Slide 46
MC
AC
AR
MR
$/Q
Quantity
Setting the price at P
r
yields the largest possible
output;excess profit is zero.
Q
r
P
r
P
C
Q
C
If the price were regulate to be P

C
,
the firm would lose money
and go out of business.
P
m
Q
m
Unregulated, the monopolist
would produce Q
m
and
charge P
m
.
Regulating the Price
of a Natural Monopoly
Chapter 10
Slide 47
 Regulation in Practice
z It is very difficult to estimate the firm's cost
and demand functions because they
change with evolving market conditions
The Social Costs of Monopoly Power
Chapter 10
Slide 48
 Regulation in Practice
z An alternative pricing technique rate-of-
return regulation allows the firms to set a
maximum price based on the expected rate

or return that the firm will earn.
 P = AVC + (D + T + sK)/Q, where
z P = price, AVC = average variable cost
z D = depreciation, T = taxes
z s = allowed rate of return, K = firm’s capital
stock
The Social Costs of Monopoly Power
Chapter 10
Slide 49
 Regulation in Practice
z Using this technique requires hearings to
arrive at the respective figures.
z The hearing process creates a regulatory
lag that may benefit producers (1950s &
60s) or consumers (1970s & 80s).
 Question
z Who is benefiting in the 1990s?
The Social Costs of Monopoly Power
Chapter 10
Slide 50
Vietnam Competition Law
 Dr. Le Dang Doanh asserted that anti-
monopoly in Vietnam is more complicated
compared to other countries, because firms
gain their monopolistic power not through
competing, but by the support of the
government. He said: “The law create a legal
framework for anti-monopoly and abuse of
market dominant position, how effective that
anti-dumping can go depends on whether

state agencies want to attack the firms that
they have been supporting or not”