ECO 1MONOPOLY AND MONOPOLISTIC COMPETITION

Erkmen Giray ASLIM (erkmengirayaslim.com)

e-mail: era314@Lehigh.edu

10/22/2015

Department of Economics

Lehigh University

DEFINING MONOPOLY

• What is a monopoly? Give an example.

• Single supplier and we do not observe close substitutes. But how do you define close substitutes?• Ignoring actions of other firms– ex. Candles and electric lights.

MORE ON MONOPOLY

• High barriers to entry:

• Government restriction.

• Control of a key resource. Ex. Aluminum Company of America (Alcoa), and the International Nickel Company of Canada.

• Network externalities. Ex. Twitter, HD television etc.

• Economies of scale (cost advantages) are so large – natural monopoly.

GOVERNMENT RESTRICTION

• Two possibilities:

• Patent or copyright• Patent: Exclusive right to produce a product for 20 years. Ex. Microsoft’s patent on Windows.• Copyright: Exclusive right (70 years after the creator’s

death) to produce and sell a creation. Ex. Books, film etc.

• Public franchise• Only legal provider of a good or service. Ex. Single

provider of electricity, natural gas, or water.

NATURAL MONOPOLY

• Large economies of scale – long-run average cost falls as production goes up.

CHOOSING PRICE AND OUTPUT

• Decision rule for maximizing profit :

• Monopolies are price makers. If price makers raise their prices, they will lose some, but not all, of their consumers. Compare this outcome with perfect competition. We will come back to this point.

• We have a downward sloping demand and MR curve.

MR = MC

PRICE QUANTITYTOTAL

REVENUE

MARGINAL REVENUE

(MR = ΔTR/ΔQ)TOTAL COST

MARGINAL COST(MC = ΔTC/ΔQ)

$17 3 $51 – $56 –

16 4 64 $13 63 $7

15 5 75 11 71 8

14 6 84 9 80 9

13 7 91 7 90 10

12 8 96 5 101 11

CHOOSING PRICE AND OUTPUT

MONOPOLY VERSUS PERFECT COMPETITION

MONOPOLY VERSUS PERFECT COMPETITION

BRIEF DISCUSSION ON ANTITRUST LAWS

• Aims to eliminate collusion and promotes competition.

• First important law in the US was called the Sherman Act (1890).

MONOPOLISTIC COMPETITION

• What are the properties of the market?

• Many buyers and sellers

• Low barriers to entry

• Firms do not sell identical products

THE EFFECT OF A PRICE CUT

MAXIMIZING PROFIT

MR = MC

LONG-RUN ANALYSIS

DISCUSSION ON EFFICIENCY

• Productive Efficiency: Producing at the minimum point of ATC curve.• Perfect competition: • Monopolistic competition:

• Allocative Efficiency: P = MC (MB = MC) – consider consumer preferences.• Perfect competition: • Monopolistic competition: