Lecture 10

• Microeconomics Lecture 10: Market structures B: Monopoly and monopolistic competition
• Prof. Dr. Sebastian van Baal
• Course outline


  • 1 Introduction
  • 2 The basic market forces: Supply and demand A
  • 3 The basic market forces: Supply and demand B
  • 4 Quantitative analysis of supply and demand: Elasticities
  • 5 Background to demand: The theory of consumer choice A
  • 6 Background to demand: The theory of consumer choice B
  • 7 Background to supply: The theory of the firm A
  • 8 Background to supply: The theory of the firm B
  • 9 Market structures A: Perfect competition
  • 10 Market structures B: Monopoly and monopolistic competition
  • 11 Market structures C: Oligopoly
  • 12 Introduction to game theory
  • 13 Market failure and the role of the government
  • 14 Exam preparation

  
• Market structures


  The four basic market structures based on the number of firms and the homogeneity/differentiation of the good
• The four basic market structures

  • Monopoly
  • Perfect competition
  • Oligopoly
  • Monopolistic competition
• Monopoly


  • There are many consumers (buyers), but only a single firm (seller) that serves the entire market
  • The firm produces a good for which there are no close substitutes
  • There are barriers to entry - other firms cannot (easily) enter the market
• Relevant market


  The boundaries of the relevant market can be identified with the cross-price elasticity of demand between two goods: If it is zero, the two goods are not sold in the same market
• Sources of barriers to entry for monopolies


  • A key factor of production is owned by a single firm
  • Society or the government grants a firm an exclusive right to supply a good
  • There are large economies of scale
  • A firm grows externally through mergers and acquisitions
  • There are strong positive network externalities
• Demand curve for a monopolist


  The demand curve from the firm's perspective is identical to the market demand curve, since there is only one firm
• A monopolist has limited market power: The firm can choose any point on the demand curve, but it cannot choose a point off the demand curve
• Marginal revenue (MR)


  In imperfect competition, the price is not fixed from a firm's perspective: If the firm wants to sell more, it has to reduce its price, since the demand curve for the firm is downward-sloping. Marginal revenue is less than price (except for the first unit): P > MR
• Profit maximization for a monopolist

  1. Determine the quantity where MR = MC

  2. The monopoly price PM is the price on the demand curve that allows the firm to sell the optimal quantity QM
• Since PM > MR = MC, the monopoly price is not equal to marginal revenue or marginal cost at QM
• A monopolist charges a price that is higher than marginal cost: PM > MC
• The difference between PM and MC is the benefit a monopolist derives from his market power
• Maximizing profit is not the same as maximizing total revenue (if MC != 0)
• At the revenue-maximizing combination of P and Q, MR = 0: Total revenue is highest when the quantity is such that marginal revenue is zero
• The profit-maximizing quantity is less than the revenue-maximizing quantity, and the profit-maximizing price is higher than the revenue-maximizing price
• Calculus derivation of the profit-maximizing output

  1. max π = TR - TC

  2. dπ/dQ = dTR/dQ - dTC/dQ = 0

  3. MR = MC

  4. P(Q) > MR (for all Q > 0, since dP(Q)/dQ < 0)

  5. PM > MC (since MR = MC)
• Monopoly


  The difference to perfect competition is that P depends on Q
• Optimal output and price for a monopolist

  P > MR = MC
• Determining the monopolist's optimal quantity and price

  1. Find MR = MC to get optimal quantity QM

  2. Find price PM on demand curve that corresponds to QM
• A monopolist's total cost of producing "unique widgets" is TC = 100 - 30Q + 5Q2. The demand function for widgets is Q = 11 - 0.1P. Its inverse is P = 110 - 10Q, and total revenue is therefore TR = 110Q - 10Q2
• Steps to find the monopolist's optimal quantity and price

  1. Find MR = MC to get QM

  2. Use inverse demand function to find PM that corresponds to QM
• The optimal quantity for the monopolist is QM = 4.67
• The optimal price for the monopolist is PM = 63.33
• At the optimal quantity, MR = MC = 16.67
• Long-run equilibrium in a monopoly

  A positive profit is possible
• Possible long-run outcomes for a monopolist

  • PM < ATC, π < 0 (monopolist exits)
  • PM = ATC, π = 0
  • PM > ATC, π > 0 (standard case)
• Monopoly


  • Does not ensure productive efficiency
  • Allows the monopolist to earn abnormal profits
  • Does not achieve allocative efficiency
• Deadweight loss of monopoly


  The loss in social welfare compared to perfect competition
• Public policy options towards monopolies

  • Prevent monopolies and make markets more competitive
  • Regulate a monopolist's behavior
  • Turn a private monopoly into a public enterprise
  • Do nothing
• Monopolistic competition


  Lies between the extremes of perfect competition and monopoly
• Characteristics of monopolistic competition


  • Many consumers and firms
  • Firms produce differentiated goods
  • No barriers to entry or exit
• Demand curve in monopolistic competition

  Downward-sloping but more elastic than monopoly, less elastic than perfect competition
• Determining the profit-maximizing quantity and price for a monopolistically competitive firm

  1. Find MR = MC to get optimal quantity QM

  2. Find price PM on demand curve that corresponds to QM
• Long-run equilibrium in monopolistic competition


  The zero-profit condition applies
• In the long run, a monopolistically competitive firm can only have a positive profit in the short run
• In monopolistic competition, firms produce below the minimum efficient scale, so goods could be produced at lower cost
• The reason is that firms incur their own "costs of differentiation"