Monopoly

one seller of a good with no close substitutes downward sloping DD market entry difficult / prohibited leads to p > MC

Profit max: MC = MR N.B. Shortcut: For all linear DD curves, MR has the same vertical intercept & twice the slope of DD.
MR p p Q Q

MC p 2Q

Monopoly eqm: Note that profit is maxd in the elastic portion of the DD curve; a monopoly never operates in the inelastic part of the curve (because then MR would be < 0). Shutdown decision: Shut down if p < AC (LR) or p < AVC (SR).

Market power ability of a firm to charge p > MC & earn economic profit. can be measured by p/MC ratio

Market power & elasticity: MR = MC p (1 + 1/) = MC p/MC = 1/ (1 + 1/) So if =- p/MC = 1 p = MC (perf comp) Lerner index (price markup): another measure of mkt power; ranges from 0 1. LI = (p MC) / p p/MC = 1/ (1 + 1/) (p MC) / p = - 1/ Perf comp: LI = 0 More market power higher LI

A firms DD becomes more elastic when: better substitutes are introduced; more firms enter selling the same product; firms selling the same good / service move closer. firm has to lower its price. Sources of monopoly power: cost advantages govt actions Cost advantages because firm: controls key input uses better technology or organises production better e.g. SAB produces good value cheap beer; not because protected, but efficient. Natural monopoly: One firm can produce total market output at a lower cost than two or more firms. C (Q) < C (q1) + C (q2) + + C (qn), Where: Q = q1 + q2 + + qn. N.B. economies of scale; e.g. public utilities. Govt actions that create monopolies: state ownership entry barriers: o licensing; o right to operate public utility; o patents. Govt actions that reduce mkt power: price regulation encourage competition Price regulation: Optimal price regulation can eliminate deadweight loss But losses remain if govt gets price wrong: o P < AVC? o P < MC? o P = MC for a natural monopoly? Problems in Regulating Prices Due to limited information about demand & Mc curves ,government may set price ceiling above/below the competitive level. Regulation maybe ineffective when regulators are captured: influence by the firms they regulate. Because regulators cannot generally subsidise the monopoly ,they maybe unable to set the price as low as they want because the firm may shut down.

Increasing competition: Competition policy (more later) Imports Network externalities: One persons DD depends on consumption by others. Critical mass of users needed so in some markets only one large firm survives. Behavioural economics: bandwagon effects (or snob effects?). Bandwagon Effect: A person places greater value on a good as more & more other people posses it. Snob Effect: A person places a greater value on a good as fewer & fewer people posses it. Network externalities can stem from complementary goods, e.g. software & hardware. Monopoly may start off with lower introductory prices to max LR profit. Welfare effects

Welfare: consumer surplus + producer surplus Welfare is maximised in a perfectly competitive market. Welfare effects: W = CS + PS is lower than under perf comp, because monopoly p > MC Consumer surplus: The monetary difference between what a consumer is willing to pay for the quantity of the good purchased & what the good actually costs. Producer surplus: The difference between the amount for which a good sells & the minimum amount necessary for the seller to be willing to produce the good. Deadweight loss: The amount of consumer surplus & producer surplus lost when firms don't produce at the competitive output.