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Chapter 10
Market Power:
Monopoly andMonopsony
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Chapter 1 2
Topics to be Discussed Monopoly
Monopoly Power Sources of Monopoly Power
The Social Costs of Monopoly Power
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Chapter 1 3
Topics to be Discussed Monopsony
Monopsony Power Limiting Market Power: The Antitrust Laws
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Chapter 1 4
Perfect Competition Review of Perfect Competition
P = LMC = LRAC
Normal profits or zero economic profits in thelong run
Large number of buyers and sellers
Homogenous product
Perfect information Firm is a price taker
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Perfect Competition
Q Q
P PMarket Individual Firm
D S
Q0
P0 P0D = MR = P
q0
LRACLMC
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Chapter 1 6
Monopoly Monopoly
1) One seller - many buyers2) One product (no good substitutes)
3) Barriers to entry
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Chapter 1 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 ofoutput where marginal revenue equalsmarginal cost.
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Chapter 1 8
Monopoly Finding Marginal Revenue
As the sole producer, the monopolist works
with the market demand to determine outputand price.
Assume a firm with demand:
P =6 - Q
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Chapter 1 9
Total, Marginal, and Average Revenue
$6 0 $0 --- ---
5 1 5 $5 $54 2 8 3 4
3 3 9 1 3
2 4 8 -1 21 5 5 -3 1
Total Marginal AveragePrice Quantity Revenue Revenue RevenueP Q R MR AR
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Chapter 1 10
Average and Marginal Revenue
Output0
1
2
3
$ perunit ofoutput
1 2 3 4 5 6 7
4
5
6
7
Average Revenue (Demand)
MarginalRevenue
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Chapter 1 11
Monopoly Observations
1) To increase sales the price must fall2) MR < P
3) Compared to perfect competition No change in price to change sales MR = P
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Chapter 1 12
Monopoly Monopolists Output Decision
1) Profits maximized at the output levelwhere MR = MC
2) Cost functions are the same
MRMCor
MRMCQCQRQQCQRQ
0///)()()(
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Chapter 1 13
Maximizing Profit When Marginal RevenueEquals Marginal Cost
At output levels below MR = MCthe
decrease in revenue is greater than thedecrease in cost (MR > MC).
At output levels above MR = MCthe
increase in cost is greater than thedecrease in revenue (MR < MC)
The Monopolists Output Decision
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Chapter 1 14
Lostprofit
P1
Q1
Lostprofit
MC
AC
Quantity
$ perunit ofoutput
D = AR
MR
P*
Q*
Maximizing Profit When Marginal RevenueEquals Marginal Cost
P2
Q2
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Chapter 1 15
Monopoly
An Example
C
MC
QQCCost
2
50)( 2
The Monopolists Output Decision
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Chapter 1 16
Monopoly
An Example
RMR
QQQQPQR
QQPDemand
240
40)()(
40)(
2
The Monopolists Output Decision
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Chapter 1 17
Monopoly
An Example
3010,When
10
2240
PQ
Q
QQorMCMR
The Monopolists Output Decision
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Chapter 1 18
Monopoly
An Example By setting marginal revenue equal to marginal
cost, it can be verified that profit is maximizedat P =$30 and Q= 10.
This can be seen graphically:
The Monopolists Output Decision
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Chapter 1 19
Monopoly
Monopoly pricing compared to perfectcompetition pricing:
MonopolyP > MC
Perfect Competition
P = MC
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Chapter 1 20
Monopoly
Monopoly pricing compared to perfectcompetition pricing:
The more elastic the demand the closer priceis to marginal cost.
IfEd is a large negative number, price is closeto marginal cost and vice versa.
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Chapter 1 21
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 demandcurve.
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Chapter 1 23
Monopoly
Observations
Monopolist may supply many different
quantities at the same price.
Monopolist may supply the same quantity atdifferent prices.
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Chapter 1 24
Monopoly
The Effect of a Tax Under monopoly price can sometimes rise by
morethan the amount of the tax.
To determine the impact of a tax: t = specific tax
MC = MC + t
MR = MC + t : optimal production decision
price change?
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Chapter 1 25
Monopoly
The Multiplant Firm For many firms, production takes place in two
or more different plants whose operating costcan differ.
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Chapter 1 26
Monopoly
The Multiplant Firm Choosing total output and the output for each
plant: The marginal cost in each plant should be equal. The marginal cost should equal the marginal
revenue for each plant.
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Chapter 1 27
Production with Two Plants
Quantity
$/Q
D = AR
MR
MC1
MC2
MCT
MR*
Q1
Q2
Q3
P*
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Chapter 1 28
Production with Two Plants Observations:
1) MCT= MC1+ MC2
2) Profit maximizingoutput:
MCT = MR at QT and P * MR = MR* MR* = MC1 at Q1, MC*
= MC2 at Q2 MC1 + MC2 = MCT, Q1 +
Q2 = QT,and MR = MC1 + MC2
Quantity
$/Q
D = AR
MR
MC1 MC2
MCT
MR*
Q1 Q2 Q3
P*
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Chapter 1 29
Monopoly Power
Monopoly is rare. However, a market with several firms,
each facing a downward sloping demandcurve will produce so that price exceedsmarginal cost.
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Chapter 1 30
Monopoly Power
Scenario: Four firms with equal share (5,000) of a
market for 20,000 toothbrushes at a price of$1.50.
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Chapter 1 31
Monopoly Power
Measuring Monopoly Power In perfect competition: P = MR = MC
Monopoly power: P > MC
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Elasticity of Demand and Price Markup$/Q $/Q
Quantity Quantity
AR
MR
MR
AR
MC MC
Q* Q*
P*
P*
P*-MC
The more elastic isdemand, the less the
markup.
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Chapter 1 33
Sources of Monopoly Power
Why do some firms have considerablemonopoly power, and others have little or
none?A firms monopoly power is determined by
the firms elasticity of demand.
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Chapter 1 34
Sources of Monopoly Power
The firms elasticity of demand isdetermined by:
1) Elasticity of market demand2) Number of firms
3) The interaction among firms
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Chapter 1 35
The Social Costs of Monopoly Power
Monopoly power results in higher pricesand lower quantities.
However, does monopoly power makeconsumers and producers in theaggregate better or worse off?
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Chapter 1 36
BA
Lost Consumer Surplus
DeadweightLoss
Because of the higherprice, consumers loseA+Band producer
gains A-C.
C
Deadweight Loss from Monopoly Power
Quantity
AR
MR
MC
QC
PC
Pm
Qm
$/Q
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Chapter 1 37
Rent Seeking Firms may spend to gain monopoly power
LobbyingAdvertising Building excess capacity
The Social Costs of Monopoly Power
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Chapter 1 38
The incentive to engage in monopolypractices is determined by the profit to be
gained. The larger the transfer from consumers to
the firm, the larger the social cost of
monopoly.
The Social Costs of Monopoly Power
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Chapter 1 39
Example 1996 Archer Daniels Midland (ADM)
successfully lobbied for regulations requiringethanol be produced from corn
Question
Why only corn?
The Social Costs of Monopoly Power
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Chapter 1 40
Price Regulation Recall that in competitive markets, price
regulation created a deadweight loss. Question:
What about a monopoly?
1990s?
The Social Costs of Monopoly Power
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Chapter 1 41
Monopsony
Amonopsony is a market in which there isa single buyer.
An oligopsony is a market with only a fewbuyers.
Monopsony power is the ability of the
buyer to affect the price of the good andpay less than the price that would exist ina competitive market.
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Chapter 1 42
Monopsony
Competitive Buyer Price taker
P = Marginal expenditure = Averageexpenditure
D = Marginal value
Competitive Buyer
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Competitive BuyerCompared to Competitive Seller
Quantity Quantity
$/Q $/Q
AR = MR
D = MV
ME = AE
P*
Q*
ME = MV at Q*ME = P*
P* = MV
P*
Q*
MC
MR = MCP* = MRP* = MC
Buyer Seller
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Chapter 1 44
ME
S = AE
The market supply curve is the monopsonists
average expenditure curve
Monopsonist Buyer
Quantity
$/Q
MV
Q*m
P*m
MonopsonyME > P & above S
PC
QC
CompetitiveP = PCQ = Q+C
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Chapter 1 45
Monopoly and Monopsony
Quantity
AR
MR
MC
$/Q
QC
PC
MonopolyNote: MR = MC;AR > MC; P > MC
P*
Q*
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Chapter 1 46
Monopoly and Monopsony
Quantity
$/Q
MV
ME
S = AE
Q*
P*
PC
QC
MonopsonyNote: ME = MV;
ME > AE; MV > P
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Chapter 1 47
Monopoly and Monopsony
Monopoly MR < P
P > MC Qm< QC Pm> PC
Monopsony ME > P
P < MV Qm< QC Pm< PC
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Chapter 1 48
Monopsony Power
A few buyers can influence price (e.g.automobile industry).
Monopsony power gives them the abilityto pay a price that is less than marginalvalue.
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Chapter 1 49
Monopsony Power
The degree of monopsony powerdepends on three similar factors.
1) Elasticity of market supply The less elastic the market supply, the greater
the monopsony power.
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Chapter 1 50
Monopsony Power
The degree of monopsony powerdepends on three similar factors.
2) Number of buyers The fewer the number of buyers, the less elastic
the supply and the greater the monopsonypower.
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Chapter 1 51
Monopsony Power
The degree of monopsony powerdepends on three similar factors.
3) Interaction Among Buyers The less the buyers compete, the greater the
monopsony power.
Monopsony Power:
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ME
S = AE
ME
S = AE
Monopsony Power:Elastic versus Inelastic Supply
Quantity Quantity
$/Q $/Q
MV MV
Q*
P*
MV - P*
P*
Q*
MV - P*
Deadweight Loss from
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Chapter 1 53
A
Deadweight Loss fromMonopsony Power
Determining thedeadweight loss inmonopsony Change in sellers
surplus = -A-C Change in buyers
surplus =A - B
Change in welfare =-A - C + A - B = -C - B
Inefficiency occursbecause less is purchased
Quantity
$/Q
MV
ME
S = AE
Q*
P*
PC
QC
B
C
Deadweight Loss
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Chapter 1 54
Monopsony Power
Bilateral Monopoly
Bilateral monopoly is rare, however, marketswith a small number of sellers with monopolypower selling to a market with few buyerswith monopsony power is more common.
The Social Costs of Monopsony Power
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Chapter 1 55
Monopsony Power
Question
In this case, what is likely to happen to price?
The Social Costs of Monopsony Power
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Chapter 1 56
Summary
Market power is the ability of sellers orbuyers to affect the price of a good.
Market power can be in two forms:monopoly power and monopsony power.
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Chapter 1 57
Summary
Monopoly power is determined in part bythe number of firms competing in the
market. Monopsony power is determined in part bythe number of buyers in the market.
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Chapter 1 58
Summary
Market power can impose costs onsociety.
Sometimes, scale economies make puremonopoly desirable. We rely on the antitrust laws to prevent
firms from obtaining excessive market
power.
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End of Chapter 10
Market Power:
Monopoly andMonopsony
