Intermediate Microeconomics

1
Intermediate Microeconomics

• Monopoly

2
Pure Monopoly

• A Monopolized market has only a single seller.
• Examples?
• XM radio?
• Microsoft?
• Walmart in a small town?

3
Monopolies

• So what causes monopolies?
• Legal Constraints
• e.g patents for new drugs
• Ownership of a fixed resource
• e.g. toll highway, land in a given area.
• Collusion
• e.g. several producers act as one (OPEC)
• Large economies of scale
• e.g. land line phone service, utilities

4
Monopolies

• Why are we concerned about Monopolies?

5
Implications of Monopoly

• Key to Monopoly Seller is not a price taker.
• Specifically, since monopolist chooses market
  supply, it essentially picks a point on the
  market demand curve to operate on.
• This means that for a monopolist, equilibrium
  price is a function of the quantity they supply,
  so
• p(q) (Inverse Demand Curve)

QD(p)
Q
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Monopolists Problem

• In perfect competition, a firm wanted to choose a
  quantity to maximize profits, given it is a
  price taker.
• max p(q) R(q) C(q)
• pq C(q)
• Which led to profit maximizing condition of p
  MC(q)
• Like any firm, a monopolist wants to choose
  quantity to maximize profits, but by doing so
  effectively chooses price as well.
• max p(q) R(q) C(q)
• p(q)q C(q)
• So what will be profit maximization condition for
  the monopolist?

7
Monopolists Problem

c(Q)
R(Q) p(Q)Q
q
p(Q)
8
Marginal Revenue for Monopolist

• Profit max condition is always MR(q) MC(q)
• For firm in perfect competition, firm is a price
  taker so MR(q) p for all q.
• For monopolist MR(q) p(q)q p(q)
• Since p(q) is the inverse of the market demand
  curve, we know p(q) lt 0.
• Therefore, p(q)q p(q) lt p(q), implying
  MR(q) lt p(q)
• What is intuition?
• Ex Consider a Market Demand Curve QD(p) 400
  5p
• What is Equation for the Inverse Demand curve?
• What is Equation for Marginal Revenue curve?
• Graphically?

9
Monopolist Behavior

• Consider a monopolist
• Cost function given by C(q) q2 8q 20
• Market Demand Curve of QD(p) 400 5p.
• What will be equilibrium price and quantity?
• Graphically?

10
Profit Maximization and Demand Elasticity

• Recall that R(q) p(q)q
• So MR(q) p(q) q p(q)
• p(q)p(q) q/p(q) 1
• Recall e(p) Q(p) p/Q(p)
• slope of demand curve times price
  divided by quantity
• So 1/e slope of inverse demand curve times
  quantity divided by price
• p(q) q/p(q)
• So MR(q) p(q)1/e 1
• Recalling e lt 0, what does this immediately tell
  us about output under a monopoly and demand
  elasticity recognizing that Monopolist will
  choose q to equate MR(q) to MC(q)?

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Profit Maximization and Demand Elasticity

• We can actually learn even more from elasticity.
• In competitive markets, firms produced until
• p MC(q)
• Alternatively, monopolist supplies until MR(q)
  MC(q), or until
• p(q)1/e 1 MC(q)
• Re-writing we get
• p(q) MC(q)e /e 1
• So how does monopoly mark-up depend on
  elasticity of demand?

12
Monopoly and Efficiency

• The key implication of a Pareto Efficient outcome
  is that all possible gains from trade are
  exhausted.
• Will this be true in a monopolized market?
• Consider first what it means for all gains from
  trade to be exhausted.
• Output is produced as long as marginal cost of
  last unit is less than what a consumer is willing
  to pay for that unit.
• How do we know this wont be true under a profit
  maximizing monopolist? How would we see this
  graphically?

13
Taxing a Monopolist

• What if government imposes a tax on monopolist
  equal to t/unit sold. Will this somehow increase
  efficiency?
• Consider again monopolist with MC(q) 2Q 8
  that faces a demand curve such that MR(Q) 80
  2Q/5
• We know that without tax, Q 30 and p 74
• What will change with tax?
• Graphically?

14
Entry

• If a monopolist is making all these economic
  profits, can this monopoly be maintained?
• Entry constrained by law (patents,
  patronage/political favors)
• Natural Monopoly - firms technology has
  economies-of-scale large enough for it to supply
  the whole market at a lower average cost than is
  possible with more than one firm in the market.
• Essentially high fixed costs of entry.
• Examples?

15
Entry

• Consider the prospect of entry by a new firm,
  where
• If it successfully enters and offers a lower
  price, it could capture whole market.
• Alternatively, if it successfully enters and
  offers the same price at incumbent monopolist, it
  could get 1/2 of the market with remainder going
  to incumbent monopolist.
• Could a natural monopolist successfully deter a
  potential entrant, even if that entrant had the
  same technology?

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Entry
p
p
MC
MC
p
AC
AC
pL
QD(p)
MR
QD(p)/2
q
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Monopoly Policy

• Under natural monopoly it is best for one firm to
  supply whole market.
• To prevent inefficiencies of monopoly, there are
  a couple of strategies.
• Have government run/regulate industry.
• e.g. Utilities
• Break-up monopolist
• Especially relevant when declining marginal cost
  structure due to high entry costs (e.g. software,
  drugs)
• Block mergers that could allow monopolies to form
  in the first place.
• Problems?