Topics to be DiscussedvMonopolyvMonopoly PowervSources of Monopoly PowervThe Social Costs of Monopoly Power1Chapter 10Topics to be DiscussedvMonopsonyvMonopsony PowervLimiting Market Power: The Antitrust Laws2Chapter 10Perfect CompetitionvReview of Perfect CompetitionP = LMC = LRACNormal profits or zero economic profits in the long runLarge number of buyers and sellersHomogenous productPerfect informationFirm is a price taker3Chapter 10Perfect CompetitionQQPPMarketIndividual FirmDSQ0P0P0D = MR = Pq0LRACLMCMonopolyvMonopoly1) One seller - many buyers2) One product (no good substitutes)3) Barriers to entry5Chapter 10MonopolyvThe monopolist is the supply-side of the market and has complete control over the amount offered for sale.vProfits will be maximized at the level of output where marginal revenue equals marginal cost.6Chapter 10MonopolyvFinding Marginal RevenueAs the sole producer, the monopolist works with the market demand to determine output and price.Assume a firm with demand:vP = 6 - Q7Chapter 10Total, Marginal, and Average Revenue$60$0-515$5$54283433913248-12155-31TotalMarginalAveragePriceQuantityRevenueRevenueRevenuePQRMRAR8Chapter 10Average and Marginal RevenueOutput0123$ perunit ofoutput12345674567Average Revenue (Demand)MarginalRevenue9Chapter 10MonopolyvObservations1) To increase sales the price must fall2) MR MC).vAt output levels above MR = MC the increase in cost is greater than the decrease in revenue (MR MCPerfect CompetitionP = MC28Chapter 10MonopolyvMonopoly 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.29Chapter 10Astra-Merck Prices Prilosecv1995Price of Prilosec = $3.50/daily dosePrice of Tagamet and Zantac = $1.50 - $2.25/daily doseMC of Prolosec = 30 - 40 cents/daily doseThe Monopolists Output Decision30Chapter 10Astra-Merck Prices PrilosecThe Monopolists Output DecisionPrice of $3.50 is consistent with “the rule of thumb pricing”31Chapter 10MonopolyvShifts in DemandIn perfect competition, the market supply curve is determined by marginal cost.For a monopoly, output is determined by marginal cost and the shape of the demand curve.32Chapter 10D2MR2D1MR1Shift in Demand Leads toChange in Price but Same OutputQuantityMC$/QP2P1Q1= Q233Chapter 10D1MR1Shift in Demand Leads toChange in Output but Same PriceMC$/QMR2D2P1 = P2Q1Q2Quantity34Chapter 10MonopolyvObservationsShifts in demand usually cause a change in both price and quantity.A monopolistic market has no supply curve.35Chapter 10MonopolyvObservationsMonopolist may supply many different quantities at the same price.Monopolist may supply the same quantity at different prices.36Chapter 10MonopolyvThe Effect of a TaxUnder monopoly price can sometimes rise by more than the amount of the tax.vTo determine the impact of a tax:t = specific taxMC = MC + tMR = MC + t : optimal production decision37Chapter 10Effect of Excise Tax on MonopolistQuantity$/QMCD = ARMRQ0P0MC + taxtQ1P1Increase in P: P0P1 increase in tax38Chapter 10vQuestionSuppose: Ed = -2How much would the price change?Effect of Excise Tax on Monopolist39Chapter 10vAnswervWhat would happen to profits?Effect of Excise Tax on Monopolist40Chapter 10MonopolyvThe Multiplant FirmFor many firms, production takes place in two or more different plants whose operating cost can differ.41Chapter 10MonopolyvThe Multiplant FirmChoosing total output and the output for each plant:vThe marginal cost in each plant should be equal.vThe marginal cost should equal the marginal revenue for each plant.42Chapter 10MonopolyvAlgebraically:The Multiplant Firm43Chapter 10MonopolyvAlgebraically:The Multiplant Firm44Chapter 10MonopolyvAlgebraically:The Multiplant Firm45Chapter 10MonopolyvAlgebraically:46Chapter 10Production with Two PlantsQuantity$/QD = ARMRMC1MC2MCTMR*Q1Q2Q3P*47Chapter 10Production with Two PlantsvObservations:1)MCT = MC1 + MC22)Profit maximizing output:vMCT = MR at QT and P *vMR = MR*vMR* = MC1 at Q1, MC* = MC2 at Q2vMC1 + MC2 = MCT, Q1 + Q2 = QT, and MR = MC1 + MC2 Quantity$/QD = ARMRMC1MC2MCTMR*Q1Q2Q3P*48Chapter 10Monopoly PowervMonopoly is rare.vHowever, a market with several firms, each facing a downward sloping demand curve will produce so that price exceeds marginal cost.49Chapter 10Monopoly PowervScenario:Four firms with equal share (5,000) of a market for 20,000 toothbrushes at a price of $1.50.50Chapter 10Quantity10,0002.00QA$/Q$/Q1.501.0020,00030,0003,0005,0007,0002.001.501.001.401.60At a market priceof $1.50, elasticity ofdemand is -1.5.Market DemandThe Demand for ToothbrushesThe demand curve for Firm Adepends on how muchtheir product differs, andhow the firms compete.At a market priceof $1.50, elasticity ofdemand is -1.5.Quantity10,0002.00QA$/Q$/Q1.501.0020,00030,0003,0005,0007,0002.001.501.001.401.60DAMRAMarket DemandFirm A sees a much more elastic demand curve due tocompetition-Ed = -.6. StillFirm A has some monopoly power and charges a pricewhich exceeds MC.MCAThe Demand for ToothbrushesMonopoly PowervMeasuring Monopoly PowerIn perfect competition: P = MR = MCMonopoly power: P MC53Chapter 10Monopoly PowervLerners Index of Monopoly PowerL = (P - MC)/PvThe larger the value of L (between 0 and 1) the greater the monopoly power.L is expressed in terms of EdvL = (P - MC)/P = -1/EdvEd is elasticity of demand for a firm, not the market54Chapter 10Monopoly PowervMonopoly power does not guarantee profits.vProfit depends on average cost relative to price.vQuestion:Can you identify any difficulties in using the Lerner Index (L) for public policy?55Chapter 10Monopoly PowervThe Rule of Thumb for PricingPricing for any firm with monopoly power vIf Ed is large, markup is smallvIf Ed is small, markup is large56Chapter 10Elasticity of Demand and Price Markup$/Q$/QQuantityQuantityARMRMRARMCMCQ*Q*P*P*P*-MCThe more elastic isdemand, the less themarkup.Markup Pricing:Supermarkets to Designer JeansvSupermarkets58Chapter 10vConvenience StoresMarkup Pricing:Supermarkets to Designer Jeans59Chapter 10vConvenience stores have more monopoly power.vQuestion:Do convenience stores have higher profits than supermarkets?Markup Pricing:Supermarkets to Designer JeansConvenience Stores60Chapter 10Designer jeansEd = -3 to -4vPrice 33 - 50% MCvMC = $12 - $18/pairvWholesale price = $18 - $27Markup Pricing:Supermarkets to Designer JeansDesigner Jeans61Chapter 10The Pricing ofPrerecorded Videocassettes19851999TitleRetail Price($)TitleRetail Price($)Purple Rain$29.98Austin Powers$10.49Raiders of the Lost Ark24.95A Bugs Life17.99Jane Fonda Workout59.95Theres Something about Mary13.99The Empire Strikes Back79.98Tae-Bo Workout24.47An Officer and a Gentleman24.95Lethal Weapon 416.99Star Trek: The Motion Picture 24.95Men in Black12.99Star Wars39.98Armageddon15.86vWhat Do You Think?Should producers lower the price of videocassettes to increase sales and revenue?The Pricing ofPrerecorded VideocassettesSources of Monopoly PowervWhy do some firms have considerable monopoly power, and others have little or none?vA firms monopoly power is determined by the firms elasticity of demand.64Chapter 10Sources of Monopoly PowervThe firms elasticity of demand is determined by:1) Elasticity of market demand2) Number of firms3) The interaction among firms65Chapter 10The Social Costs of Monopoly PowervMonopoly power results in higher prices and lower quantities.vHowever, does monopoly power make consumers and producers in the aggregate better or worse off?66Chapter 10BALost Consumer SurplusDeadweight LossBecause of the higherprice, consumers loseA+B and producer gains A-C.CDeadweight Loss from Monopoly PowerQuantityARMRMCQCPCPmQm$/Q67Chapter 10vRent SeekingFirms may spend to gain monopoly powervLobbyingvAdvertisingvBuilding excess capacityThe Social Costs of Monopoly Power68Chapter 10vThe incentive to engage in monopoly practices is determined by the profit to be gained.vThe larger the transfer from consumers to the firm, the larger the social cost of monopoly.The Social Costs of Monopoly Power69Chapter 10vExample1996 Archer Daniels Midland (ADM) successfully lobbied for regulations requiring ethanol be produced from cornvQuestionWhy only corn?The Social Costs of Monopoly Power70Chapter 10vPrice RegulationRecall that in competitive markets, price regulation created a deadweight loss.vQuestion:What about a monopoly?The Social Costs of Monopoly Power71Chapter 10ARMRMCPmQmACP1Q1Marginal revenue curvewhen price is regulatedto be no higher that P1.If left alone, a monopolistproduces Qm and charges Pm.If price is lowered to P3 outputdecreases and a shortage exists. For output levels above Q1 ,the original average andmarginal revenue curves apply.If price is lowered to PC outputincreases to its maximum QC andthere is no deadweight loss.Price Regulation$/QQuantityP2 = PCQcP3Q3Q3Any price below P4 resultsin the firm incurring a loss. P472Chapter 10vNatural MonopolyA firm that can produce the entire output of an industry at a cost lower than what it would be if there were several firms.The Social Costs of Monopoly Power73Chapter 10Regulating the Priceof a Natural Monopoly$/QNatural monopolies occurbecause of extensive economies of scaleQuantity74Chapter 10MCACARMR$/QQuantitySetting the price at Pr yields the largest possibleoutput;excess profit is zero.QrPrPCQCIf the price were regulate to be PC,the firm would lose moneyand go out of business.PmQmUnregulated, the monopolistwould produce Qm and charge Pm.Regulating the Priceof a Natural Monopoly75Chapter 10vRegulation in PracticeIt is very difficult to estimate the firms cost and demand functions because they change with evolving market conditionsThe Social Costs of Monopoly Power76Chapter 10vRegulation in PracticeAn alternative pricing technique-rate-of-return regulation allows the firms to set a maximum price based on the expected rate or return that the firm will earn.vP = AVC + (D + T + sK)/Q, whereP = price, AVC = average variable costD = depreciation, T = taxess = allowed rate of return, K = firms capital stockThe Social Costs of Monopoly Power77Chapter 10vRegulation in PracticeUsing this technique requires hearings to arrive at the respective figures.The hearing process creates a regulatory lag that may benefit producers (1950s & 60s) or consumers (1970s & 80s).vQuestionWho is benefiting in the 1990s?The Social Costs of Monopoly Power78Chapter 10MonopsonyvA monopsony is a market in which there is a single buyer.vAn oligopsony is a market with only a few buyers.vMonopsony power is the ability of the buyer to affect the price of the good and pay less than the price that would exist in a competitive market.79Chapter 10MonopsonyvCompetitive BuyerPrice takerP = Marginal expenditure = Average expenditureD = Marginal value80Chapter 10Competitive BuyerCompared to Competitive SellerQuantityQuantity$/Q$/QAR = MRD = MVME = AEP*Q*ME = MV at Q*ME = P*P* = MVP*Q*MCMR = MCP* = MRP* = MCBuyerSellerMES = AEThe market supply curve is the monopsonistsaverage expenditure curveMonopsonist BuyerQuantity$/QMVQ*mP*mMonopsonyME P & above SPCQCCompetitiveP = PCQ = Q+C82Chapter 10Monopoly and MonopsonyQuantityARMRMC$/QQCPCMonopolyNote: MR = MC; AR MC; P MCP*Q*83Chapter 10Monopoly and MonopsonyQuantity$/QMVMES = AEQ*P*PCQCMonopsonyNote: ME = MV;ME AE; MV P84Chapter 10Monopoly and MonopsonyvMonopolyMR MCQm PCvMonopsonyME PP MVQm QCPm PC85Chapter 10Monopsony PowervA few buyers can influence price (e.g. automobile industry).vMonopsony power gives them the ability to pay a price that is less than marginal value. 86Chapter 10Monopsony PowervThe degree of monopsony power depends on three similar factors.1) Elasticity of market supplyvThe less elastic the market supply, the greater the monopsony power.87Chapter 10Monopsony PowervThe degree of monopsony power depends on three similar factors.2) Number of buyersvThe fewer the number of buyers, the less elastic the supply and the greater the monopsony power.88Chapter 10Monopsony PowervThe degree of monopsony power depends on three similar factors.3) Interaction Among BuyersvThe less the buyers compete, the greater the monopsony power.89Chapter 10MES = AEMES = AEMonopsony Power:Elastic versus Inelastic SupplyQuantityQuantity$/Q$/QMVMVQ*P*MV - P*P*Q*MV - P*ADeadweight Loss fromMonopsony PowervDetermining the deadweight loss in monopsonyChange in sellers surplus = -A-CChange in buyers surplus = A - BChange in welfare = -A - C + A - B = -C - BInefficiency occurs because less is purchasedQuantity$/QMVMES = AEQ*P*PCQCBCDeadweight Loss91Chapter 10Monopsony PowervBilateral MonopolyBilateral monopoly is rare, however, markets with a small number of sellers with monopoly power selling to a market with few buyers with monopsony power is more common.The Social Costs of Monopsony Power92Chapter 10Monopsony PowervQuestionIn this case, what is likely to happen to price?The Social Costs of Monopsony Power93Chapter 10Limiting Market Power: The Antitrust LawsvAntitrust Laws:Promote a competitive economyRules and regulations designed to promote a competitive economy by:vProhibiting actions that restrain or are likely to restrain competitionvRestricting the forms of market structures that are allowable94Chapter 10vSherman Act (1890)Section 1vProhibits contracts, combinations, or conspiracies in restraint of tradeExplicit agreement to restrict output or fix pricesImplicit collusion through parallel conductLimiting Market Power: The Antitrust Laws95Chapter 10v1983 Six companies and six executives indicted for price of copper tubingv1996Archer Daniels Midland (ADM) pleaded guilty to price fixing for lysine - three sentenced to prison in 1999Limiting Market Power: The Antitrust LawsExamples of Illegal Combinations96Chapter 10v1999Roche A.G., BASF A.G., Rhone-Poulenc and Takeda pleaded guilty to price fixing of vitamins - fined more than $1 billion.Limiting Market Power: The Antitrust LawsExamples of Illegal Combinations97Chapter 10vSherman Act (1890)Section 2vMakes it illegal to monopolize or attempt to monopolize a market and prohibits conspiracies that result in monopolization. Limiting Market Power: The Antitrust Laws98Chapter 10vClayton Act (1914)1) Makes it unlawful to require a buyer or lessor not to buy from a competitor2) Prohibits predatory pricingLimiting Market Power: The Antitrust Laws99Chapter 10vClayton Act (1914)3) Prohibits mergers and acquisitions if they “substantially lessen competition” or “tend to create a monopoly”Limiting Market Power: The Antitrust Laws100Chapter 10vRobinson-Patman Act (1936)Prohibits price discrimination if it is likely to injure the competitionLimiting Market Power: The Antitrust Laws101Chapter 10vFederal 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 brandsLimiting Market Power: The Antitrust Laws102Chapter 10vAntitrust laws are enforced three ways:1) Antitrust Division of the Department of JusticevA part of the executive branch-the administration can influence enforcementvFines levied on businesses; fines and imprisonment levied on individualsLimiting Market Power: The Antitrust Laws103Chapter 10vAntitrust laws are enforced three ways:2) Federal Trade CommissionvEnforces through voluntary understanding or formal commission orderLimiting Market Power: The Antitrust Laws104Chapter 10vAntitrust laws are enforced three ways:3) Private ProceedingsvLawsuits for damagesvPlaintiff can receive treble damagesLimiting Market Power: The Antitrust Laws105Chapter 10vTwo ExamplesAmerican Airlines - Price fixingMicrosoftvMonopoly powervPredatory actionsvCollusionLimiting Market Power: The Antitrust Laws106Chapter 10SummaryvMarket power is the ability of sellers or buyers to affect the price of a good.vMarket power can be in two forms: monopoly power and monopsony power.107Chapter 10SummaryvMonopoly power is determined in part by the number of firms competing in the market.vMonopsony power is determined in part by the number of buyers in the market.108Chapter 10SummaryvMarket power can impose costs on society.vSometimes, scale economies make pure monopoly desirable.vWe rely on the antitrust laws to prevent firms from obtaining excessive market power.109Chapter 10 End of Chapter 10Market Power:Market Power:Monopoly and Monopoly and MonopsonyMonopsony