,Chapter 10,Market Power: Monopoly and Monopsony,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,Topics to be Discussed,Monopsony Monopsony Power Limiting Market Power: The Antitrust Laws,Chapter 10,Slide 4,Perfect Competition,Review of Perfect Competition P = LMC = LRAC Normal profits or zero economic profits in the long run Large number of buyers and sellers Homogenous product Perfect information Firm is a price taker,Perfect Competition,Q,Q,P,P,Market,Individual Firm,Chapter 10,Slide 6,Monopoly,Monopoly 1) One seller - many buyers 2) One product (no good substitutes) 3) Barriers to entry,Chapter 10,Slide 7,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 8,Monopoly,Finding Marginal Revenue As the sole producer, the monopolist works with the market demand to determine output and price. Assume a firm with demand: P = 6 - Q,Chapter 10,Slide 9,Total, Marginal, and Average Revenue,$6 0 $0 - - 5 1 5 $5 $5 4 2 8 3 4 3 3 9 1 3 2 4 8 -1 2 1 5 5 -3 1,Total Marginal Average Price Quantity Revenue Revenue Revenue P Q R MR AR,Chapter 10,Slide 10,Average and Marginal Revenue,Output,0,1,2,3,$ per unit of output,1,2,3,4,5,6,7,4,5,6,7,Chapter 10,Slide 11,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 12,Monopoly,Monopolists Output Decision 1) Profits maximized at the output level where MR = MC 2) Cost functions are the same,Chapter 10,Slide 13,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 Monopolists Output Decision,Chapter 10,Slide 14,Quantity,$ per unit of output,Maximizing Profit When Marginal Revenue Equals Marginal Cost,Chapter 10,Slide 15,Monopoly,An Example,The Monopolists Output Decision,Chapter 10,Slide 16,Monopoly,An Example,The Monopolists Output Decision,Chapter 10,Slide 17,Monopoly,An Example,The Monopolists Output Decision,Chapter 10,Slide 18,Monopoly,An Example By setting marginal revenue equal to marginal cost, it can be verified that profit is maximized at P = $30 and Q = 10. This can be seen graphically:,The Monopolists Output Decision,Chapter 10,Slide 19,Quantity,$,0,5,10,15,20,100,150,200,300,400,50,Example of Profit Maximization,Chapter 10,Slide 20,Example of Profit Maximization,Observations Slope of rr = slope cc and they are parallel at 10 units Profits are maximized at 10 units P = $30, Q = 10, TR = P x Q = $300 AC = $15, Q = 10, TC = AC x Q = 150 Profit = TR - TC $150 = $300 - $150,Chapter 10,Slide 21,Example of Profit Maximization,Quantity,$/Q,0,5,10,15,20,10,20,30,40,15,Chapter 10,Slide 22,Example of Profit Maximization,Observations AC = $15, Q = 10, TC = AC x Q = 150 Profit = TR = TC = $300 - $150 = $150 or Profit = (P - AC) x Q = ($30 - $15)(10) = $150,Chapter 10,Slide 23,Monopoly,A Rule of Thumb for Pricing 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. This can be demonstrated using the following steps:,Chapter 10,Slide 24,A Rule of Thumb for Pricing,Chapter 10,Slide 25,A Rule of Thumb for Pricing,Chapter 10,Slide 26,A Rule of Thumb for Pricing,Chapter 10,Slide 27,= the markup over MC as a percentage of price (P-MC)/P,A Rule of Thumb for Pricing,8. The markup should equal the inverse of the elasticity of demand.,Chapter 10,Slide 28,A Rule of Thumb for Pricing,Chapter 10,Slide 29,Monopoly,Monopoly pricing compared to perfect competition pricing: Monopoly P MC Perfect Competition P = MC,Chapter 10,Slide 30,Monopoly,Monopoly pricing compared to perfect competition pricing: The more elastic the demand the closer price is to marginal cost. If Ed is a large negative number, price is close to marginal cost and vice versa.,Chapter 10,Slide 31,Astra-Merck Prices Prilosec,1995 Price of Prilosec = $3.50/daily dose Price of Tagamet and Zantac = $1.50 - $2.25/daily dose MC of Prolosec = 30 - 40 cents/daily dose,The Monopolists Output Decision,Chapter 10,Slide 32,Astra-Merck Prices Prilosec,The Monopolists Output Decision,Price of $3.50 is consistent with “the rule of thumb pricing”,Chapter 10,Slide 33,Monopoly,Shifts in Demand In perfect competition, the market supply curve is determined by marginal cost. For a monopoly, output is determined by marginal cost and the shape of the demand curve.,Chapter 10,Slide 34,Shift in Demand Leads to Change in Price but Same Output,Quantity,$/Q,Chapter 10,S