Chapter 10 Market Power: Monopoly Topics to be Discussed  Monopoly  Monopoly Power  Sources of Monopoly Power  The Social Costs of Monopoly Power  Limiting Market Power: The Antitrust Laws Chapter 10 Slide Perfect Competition  Review of Perfect Competition P = LMC = LAC  Normal profits or zero economic profits in the long run  Large number of buyers and sellers  Homogenous  Perfect  Firm Chapter 10 product information is a price taker Slide Perfect Competition Market P D P S Individual Firm LMC P0 P0 Q0 Q LAC D = MR = P q0 Q Monopoly  Monopoly 1) One seller - many buyers 2) One product (no good substitutes) 3) Barriers to entry Chapter 10 Slide 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 Monopoly  Finding Marginal Revenue  As the sole producer, the monopolist works with the market demand to determine output and price.  Assume  Chapter 10 a firm with demand: P=6-Q Slide Average and Marginal Revenue $ per unit of output Average Revenue (Demand) Marginal Revenue Chapter 10 Output Slide Total, Marginal, and Average Revenue Average Price Revenue $6 P Chapter 10 Total Marginal Quantity Revenue Revenue Q $0 R --MR $5 -1 -3 --AR $5 Slide Monopoly  Monopolist’s Output Decision 1) Profits maximized at the output level where MR = MC 2) Cost functions are the same π (Q) = R (Q) − C (Q) ∆π / ∆Q = ∆R / ∆Q − ∆C / ∆Q = = MC − MR or MC = MR Chapter 10 Slide Sources of Monopoly Power  Why 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 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 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 Deadweight Loss from Monopoly Power $/Q Lost Consumer Surplus Deadweight Loss Pm A Because of the higher price, consumers lose A+B and producer gains A-C. MC B C PC AR MR Qm Chapter 10 QC Quantity Slide The Social Costs of Monopoly Power  Rent Seeking  Firms may spend to gain monopoly power  Lobbying  Advertising  Building excess capacity Chapter 10 Slide The Social Costs of Monopoly Power  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. Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Antitrust Laws:  Promote a competitive economy  Rules and regulations designed to promote a competitive economy by:  Prohibiting actions that restrain or are likely to restrain competition  Restricting the forms of market structures that are allowable Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Sherman Act (1890)  Section  Prohibits contracts, combinations, or conspiracies in restraint of trade   Chapter 10 Explicit agreement to restrict output or fix prices Implicit collusion through parallel conduct Slide Limiting Market Power: The Antitrust Laws  Sherman Act (1890)  Section  Chapter 10 Makes it illegal to monopolize or attempt to monopolize a market and prohibits conspiracies that result in monopolization. Slide Limiting Market Power: The Antitrust Laws  Clayton Act (1914) 1) Makes it unlawful to require a buyer not to buy from a competitor 2) Prohibits predatory pricing Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Clayton Act (1914) 3) Prohibits mergers and acquisitions if they “substantially lessen competition” or “tend to create a monopoly” Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Robinson-Patman Act (1936)  Prohibits price discrimination if it is likely to injure the competition Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Federal Trade Commission Act (1914, amended 1938, 1973, 1975) 1) Created the Federal Trade Commission (FTC) 2) Prohibitions against deceptive advertising, labeling, agreements with retailer to exclude competing brands Chapter 10 Slide Summary  Market power is the ability of sellers or buyers to affect the price of a good.  Monopoly power is determined in part by the number of firms competing in the market. Chapter 10 Slide Summary  Market power can impose costs on society.  We rely on the antitrust laws to prevent firms from obtaining excessive market power. Chapter 10 Slide End of Chapter 10 [...]... pricing Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Clayton Act (1914) 3) Prohibits mergers and acquisitions if they “substantially lessen competition” or “tend to create a monopoly” Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Robinson-Patman Act (1936)  Prohibits price discrimination if it is likely to injure the competition Chapter 10 Slide Limiting Market Power: ... Measuring Monopoly Power  In perfect competition: P = MR = MC  Monopoly Chapter 10 power: P > MC Slide Monopoly Power  Lerner’s Index of Monopoly Power L = (P - MC)/P  L is expressed in terms of Ed   Chapter 10 The larger the value of L (between 0 and 1) the greater the monopoly power L = (P - MC)/P = -1/Ed Ed is elasticity of demand for a firm, not the market Slide Monopoly Power  The Rule... demand Chapter 10 Slide 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 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. .. demand Chapter 10 Slide Monopoly  Monopoly pricing compared to perfect competition pricing:  Monopoly P > MC  Perfect Competition P = MC Chapter 10 Slide 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  oligopoly: a few firms each with market power Chapter 10 Slide Monopoly Power. .. conspiracies in restraint of trade   Chapter 10 1 Explicit agreement to restrict output or fix prices Implicit collusion through parallel conduct Slide Limiting Market Power: The Antitrust Laws  Sherman Act (1890)  Section  Chapter 10 2 Makes it illegal to monopolize or attempt to monopolize a market and prohibits conspiracies that result in monopolization Slide Limiting Market Power: The Antitrust Laws ... the social cost of monopoly Chapter 10 Slide Limiting Market Power: The Antitrust Laws  Antitrust Laws:  Promote a competitive economy  Rules and regulations designed to promote a competitive economy by:  Prohibiting actions that restrain or are likely to restrain competition  Restricting the forms of market structures that are allowable Chapter 10 Slide Limiting Market Power: The Antitrust Laws... Deadweight Loss from Monopoly Power $/Q Lost Consumer Surplus Deadweight Loss Pm A Because of the higher price, consumers lose A+B and producer gains A-C MC B C PC AR MR Qm Chapter 10 QC Quantity Slide The Social Costs of Monopoly Power  Rent Seeking  Firms may spend to gain monopoly power  Lobbying  Advertising  Building excess capacity Chapter 10 Slide The Social Costs of Monopoly Power  The incentive... Prohibitions against deceptive advertising, labeling, agreements with retailer to exclude competing brands Chapter 10 Slide Summary  Market power is the ability of sellers or buyers to affect the price of a good  Monopoly power is determined in part by the number of firms competing in the market Chapter 10 Slide ... = P + Q = P + P   ∆Q   ∆Q  P    P  ∆Q  3 Ed =    ∆P   Q  Chapter 10 Slide A Rule of Thumb for Pricing  Q  ∆P = 1 4    ∆Q  E  P  d  1 5 MR = P +P E  d Chapter 10     Slide A Rule of Thumb for Pricing 6 π is maximized at MR = MC  1  P + P  = MC E D  MC P= 1 + (1 E D ) Chapter 10 Slide A Rule of Thumb for Pricing 1 = the markup over MC as a 7 − Ed percentage... with monopoly power  If Ed is large, markup is small  If Ed is small, markup is large Chapter 10 Slide Elasticity of Demand and Price Markup $/Q $/Q The more elastic is demand, the less the markup P* MC MC P* AR P*-MC MR AR MR Q* Quantity Q* Quantity 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 . 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  Limiting Market Power: . 19 Monopoly Power  Measuring Monopoly Power  In perfect competition: P = MR = MC  Monopoly power: P > MC Chapter 10 Slide 20 Monopoly Power  Lerner’s Index of Monopoly Power  L = (P. rare.  However, a market with several firms, each facing a downward sloping demand curve will produce so that price exceeds marginal cost  oligopoly: a few firms each with market power. Chapter 10 Slide