Markups, Elasticity and Monopoly

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Markups, Elasticity and Monopoly
ECO 105 Lecture 2.9 7 March 2007
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Profit-Maximizing Markup
From Monday
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P MC x
1
1
ed
3
Example

• Suppose ed -1.5.
• Then the mark-up factor is
• 1 divided by (1 1/-1.5)
• 1/(1- 0.667) 1/0.333
• 3
• P 3 x MC

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Another Example

• Suppose ed -2.0.
• Then the mark-up factor is
• 1 divided by (1 1/-2)
• 1/(1- 0.5) 1/0.5
• 2
• P 2 x MC a smaller markup.

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Locating on the Demand Curve

• Firms never choose to operate on the
  _______________ of the demand curve.
• Why?
• Because when ed lt 1, MR ______.
• Unless MC is negative, it cant intersect MR at a
  point at which ed lt 1.
• But _____________________. QED.

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A Visual Example
P, MC
MC
ed 1
P0
MC0
D
MR
Q
Qmax
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What if

• ed were only 0.5?
• Then the markup would be
• 1 divided by (1 1/-0.5)
• 1/(1- 2) 1/-1 -1
• Does this make sense?
• ________

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What determines ed?

• Key determinant number of good, available
  ______________
• Implication ed for a firm is greater than ed in
  the _________________________
• Why?
• More ______________ exist for the firms product.

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Substitutes and Price-taking Firms

• Do good substitutes exist for the products of
  price-taking firms?
• ________
• The existence of nearly perfect _______ is what
  eliminates their ______________.
• ed is _____ no one will pay more when a good
  substitute is readily available.

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Examples

• Multiple gas stations on the ___________
• Intel vs. _________ chips
• Corn (of course)
• Since ed negative infinity, the mark-up factor
  is 1 P MC at Qmax.

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Substitutes and Price-Searching Firms

• Substitutes arent as numerous or, often, as
  good.
• Firms differentiate their ___________
• Avantis Italian food
• Biaggis Italian food
• Location ___________
• Neighborhood convenience stores
• Supermarkets in strip malls

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• Resource immobility
• Canoeing on the Current River vs. on the Mackinaw
  River
• Barriers to entry
• Technological secrets
• Patents
• Economies of scale
• Legal barriers

It just aint the same.
Rogaine
Pharmaceutical drugs
Local phone service
Franchises or licenses
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Monopolies

• Why do they arise and how should we react?

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Technological innovation

• Research and development enable one company to
  produce at a lower cost than _____________________
  _.
• Consider software Nearly the entire cost is in
  __________. Producing CD Roms is
  _____________________.
• Microsoft!

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Government protection

• Government may prohibit ___________
  ____________from operating in a market.
• Example U.S. ________________
• Example Patents on ________________
• Research is very ________
• Few research projects produce effective drugs.
• Profits from winners _______ losers more
  research.

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Public Policy Toward Monopolies

• Monopolies reduce total gains _________.
• Why not break them up?
• Or at least regulate them?
• Its all _____________.

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Welfare Loss from Monopoly
Lost Consumer Surplus
MC
Pmax
Pefficient
Lost Producer Surplus
D
MR
Qmax
Qefficient
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Antitrust Policy

• Prohibit individual companies from obtaining or
  maintaining _____________
• Historical fact ______________ usually does
  this without government intervention.

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Regulation

• Often applied to ____________________
• Setting P MC produces _________
• Alternative Set P ____
• Firm earns normal profit
• Problem No incentive to ____________ cost,
  since P rises with ATC
• Problem Profits not available to fund
  ____________________________.

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Regulated Natural Monopoly
Pmax
Regulated Equilibrium
D
ATC
Pregulated
MR
MC
Qmax
Qregulated
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Public Ownership

• Many nations have _____________ large firms,
  especially utilities
• Nationalized firms are nearly always poorly
  _____________
• High costs, excess labor, losses covered by tax
  revenue usually result

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Doing Nothing

• In technologically advancing industries, Do
  Nothing may be ________________.
• Dynamic competition ____________ most monopolies
  over time.
• Most technological innovation is funded by
  __________________ earned by firms that have
  temporary monopolies.