More on Market Power

April 10, 2013

Announcements

• Problem Set 2 is now posted on the website.• PS2 due at the beginning of Monday’s class.

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Last Class: Comparing Monopoly and Perfect Competition

Learning Goals for Today

• Expertly derive: – Monopoly profit-maximizing conditions– Monopoly profits– Surplus in a market with monopoly

• Derive surplus when monopoly can price discriminate

• Compare and contrast oligopoly and monopolistic competition with pure monopoly

Verizon is the only supplier of cable in a given city because no other can afford to lay down cable. What type of monopoly is it /

what is the source of its market power?

A. Exclusive control of inputs.B. Patents and copyrights.C. Government licenses.D. Network economies.E. Natural monopoly.

Say a monopoly pays 5 for a factory and uses production technology Q=L1/2. The only input, labor (L), costs w=1 per unit. What is TC when Q=5?

A. 10B. 15C. 20D. 25E. 30

As derived, TC=5+Q2. In addition, PD=10-2Q. What is closest to the monopolist’s profit-maximizing level quantity choice?

A. 1B. 1.33C. 1.66D. 2E. 2.5

TC=5+Q2 and PD=10-2Q. What is closest to monopoly profits?

A. Negative profit, shut down.B. 0C. 3.33D. 6.66E. 10

Claim: This is a natural monopoly like Verizon. Recall: FC=5, Q=L1/2, w=1.

A. True.B. False: There is no capital in productionC. False: Fixed costs are too smallD. False: Marginal cost is increasing

Calculate Surplus

• TC=5+Q2 and PD=10-2Q • Take 5 minutes to see if you can calculate CS,

PS, and DWL for this economy on your own.• Hint: DWL is the difference between CS+PS in

perfect competition versus CS+PS with some imperfection.

• Will do on board when finished.

General Form of Monopoly Problems• Given:– Fixed Costs– Production Function: Generally Q=KaL1-a

– Variable Costs: w for L and r for K– Demand

• Derive:– TC, ATC, MC given Fixed Costs, Prod Func, and Var costs– MR given Demand– Profit-max. condition and Profit given the above– Surplus

• Write your own using Q=K1/2 and r=1.

Now let’s switch gears

• Price discrimination• Monopolistic competition• Oligopoly– All of these points are of secondary importance to

monopoly for now.

Price Discrimination• Thus far we have assumed all buyers charged the same.• Price Discrimination: The practice of charging different buyers

different prices for essentially the same good.• How does price discrimination affect output and profits?

P P

Q Q

D D

MC=ATC

MR

MC=ATC PS

DWL

CS

Single-Price MonopolistPerfectly Price

Discriminating Monopolist

PS

Example

• Rebates: The assumption is that people with high reservation prices are wealthy and that the opportunity cost of their time is too high to be bothered to fill out the paperwork to get the rebate.

Which of the following is price discrimination in this case?

A. EfficientB. GoodC. InefficientD. BadE. Can’t Say

Other types of Imperfect Competition Besides Monopoly

Monopolistic Competition:

Examples?

Have some ability to raise price in the short-run, but free entry will lead to zero (economic) profits in the long run.

Most important strategic decision: how to differentiate products from rivals’ products?

Markup

A market in which a large number of firms sell products that are close (but not perfect) substitutes.

Types of Imperfect Competition

3. Oligopoly:

Examples?

Usually arise because of cost advantages of being large—thus, no presumption that free entry will drive profits to zero, but no guarantee that oligopolists will earn zero profits.

A market in which a small number of large firms sell products that are either close or perfect substitutes.

Next Class

• We’ll begin with a clicker quiz on the material covered this week (if I can figure that out.)

• It’s not graded, it’s for you to gauge your understanding.

• If works out well, will make Friday mornings clicker quizzes from here out.