Chapter 10: Market Power - Monopoly and Monopsony

What is the markup equation?

(P - MC)/P This is equal to the negative inverse of the elasticity of market demand. (This figure will be a positive number because the elasticity of demand is negative.)

What are the three problems with applying the Lerner index to the analysis of public policy toward firms?

1. Because marginal cost is difficult to measure, average variable cost is often used in Lerner index calculations. 2. If the firm prices below its optimal price (possibly to avoid legal scrutiny), its potential monopoly power will not be noted by the index. 3. The index ignores dynamic aspects of pricing such as effects of the learning curve and shifts in demand.

The ultimate determinant of monopoly power is the firm's elasticity of demand. What are the three factors thdetermine a firm's elasticity of demand?

1. The elasticity of market demand. Because the firm's own demand will be at least as elastic as market demand, the elasticity of market demand limits the potential for monopoly power. 2. The number of firms in the market. If there are many firms, it is unlikely that any one firm will be able to affect price significantly. 3. The interaction among firms. Even if only two or three firms are in the market, each firm will be unable to profitably raise price very much if the rivalry among them is aggressive, with each firm trying to capture as much of the market as it can.

What is an example of natural barriers to entry?

1.Patent on the required production technology which makes it impossible for other firms to enter the market at least until the patent expire. 2. Copyright - can limit sale of a product to a single firm. 3. Government License 4. Economies of scale may make it too costly for more than a few firms to supply the entire market.

What is a monopoly?

A monopoly is a market that has only one seller but many buyers.

What is a monopsony?

A monopsony is a market with many sellers but only one buyer.

What is a specific tax?

A specific tax is a fixed amount of tax placed on a particular good. It is also referred to as a per-unit tax, and the tax will depend on the quantity sold (not price).

What happens to the the monopolist optimal production decision as a result of a tax?

As Marginal cost is increased by the amount of the tax so does the optimal production decision MR = MC + t

What is the formula for average profit?

Average Revenue (AR) - Average Cost (AC) OR Profit/Quantity.

Marginal Revenue

Change in revenue resulting from a one-unit increase in output.

What is barrier to entry?

Condition that impedes entry by new competitors.

Market with several firms is likely to face a _________________demand curve and why?

Downward-sloping.

True/False The monopolist is the market and completely controls the amount of output offered for sale. This means that the monopolist can charge any price it wants.

False - at least not if its objective is to maximize profit.

True or False Considerable monopoly power implies high profits.

False. Profit depends on average cost relative to price. Firm A might have more monopoly power than Firm B but earn a lower profit because of higher average costs.

What is a natural monopoly?

Firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms. e.g. local utility

What is the difference between a market elasticity of demand and a firm's elasticity of demand within a monopoly?

Firms within a monopoly are likely to face a demand curve that is more elastic than the market demand curve, but which is not infinitely elastic like the demand curve facing a perfectly competitive firm.

When the demand curve is downward sloping, the price or average revenue is (Greater than/ Lesser than) marginal revenue because all units are sold at the same price. If sales are to increase by 1 unit, the price must ______________.

Greater than, Fall hence all units sold will earn less revenue.

What is the relationship between the monopolist price and the elasticity of demand?

If demand is extremely elastic, Ed is a large negative number, and price will be very close to marginal cost. In that case, a monopolized market will look much like a competitive one and there is little benefit to being a monopolist. A monopolist will also never produce a quantity of output that is on the inelastic (<1) portion of the demand curve because at a any point on the demand curve where the price elasticity is inelastic the monopolist could make a greater profit by producing less and selling at a higher price hence, increasing revenue.As the monopolist reduces output and raises price, it will move up the demand curve to a point where the elasticity is greater than 1 in absolute value and the markup rule of equation will be satisfied.

What happens when a monopolist produces greater than the profit maximization quantity (Q*)?

If the monopolist produces at a quantity (Q2) higher than Q*,marginal cost will exceed marginal revenue. Therefore, if the monopolist produced a little less than Q2, it would increase its total profit (by MC − MR). It could increase its profit even more by reducing output all the way to Q*.

How does the price set by a monopolist compare with the price under competition?

In a perfectly competitive market, price equals marginal cost. A monopolist charges a price that exceeds marginal cost, but by an amount that depends inversely on the elasticity of demand.

When marginal revenue is positive, revenue is _____________ with quantity, but when marginal revenue is negative, revenue is _______________

Increasing, Decreasing

Typically, this situation of monopsony occurs in markets for _________________________

Inputs to production. For example, General Motors, the largest U.S. car manufacturer has monopsony power in the markets for tires, car batteries, and other parts.

Other than the Lerner Index of Monopoly Power, the degree of monopoly of a firm can also be expressed in terms of?

It can ALSO be expressed in terms of elasticity of demand facing the firm as L = (P - MC)/P = -1/Ed where Ed is the elasticity of the firm's demand and not the market. If the firm's elasticity of demand is large, this markup will be small and we can say that the firm has very little monopoly power. If the firm's elasticity of demand is small, this markup will be large and the firm will have considerable monopoly power.

In general, the monopolist's quantity will be _________ and its price _________ than the competitive quantity and price.

Lower, Higher

Monopsony power

Market in which a few buyers can purchase the good for less than they would pay in a competitive market.

Monopoly and monopsony power are two forms of

Market power.

Lerner Index of Monopoly Power

Measure of monopoly power calculated as excess of price over marginal cost as a fraction of price. L = (P - MC)/P ALWAYS has a value between zero and one.. For a perfectly competitive firm, P = MC, so that L = 0. The larger is L, the greater is the degree of monopoly power.

A market is considered highly concentrated when?

Only a few firms account for most of the sales in a market.

What is the formulae for calculating the profit-maximization level price of a monopolist?

P = MC/[1 + (1/Ed)].

Monopoly and monopsony are the polar opposites of which market?

Perfect competition.

As Quantity increases , what happens to Profit?

Profit increases as Q increases. Once the maximum level is reached it begins to decrease decreases as Q is increased further.

As a result of fixed cost, what happens to profit when the firm produces little or no output?

Profit is negative.

If marginal cost is greater than zero, what happens to profit when a monopolist reduces output?

Profit would increase by more than the value of the reduction in output because the lower output would reduce the firm's costs.

At the maximum profit level, the slope of the revenue curve is ____________ while the slope of the cost curve is _________.

Slope of R ∆R/∆Q, or marginal revenue. Slope of C ∆C/∆Q, or marginal cost. Because profit is maximized when marginal revenue equals marginal cost, the slopes are equal.

What is Rent seeking?

Spending money in socially unproductive efforts to acquire, maintain, or exercise monopoly.

Suppose a firm has two plants. What should its total output be, and how much of that output should each plant produce?

Step 1. Whatever the total output, it should be divided between the two plants so that marginal cost is the same in each plant. Otherwise, the firm could reduce its costs and increase its profit by reallocating production. Step 2. total output must be such that marginal revenue equals marginal cost. Otherwise, the firm could increase its profit by raising or lowering total output.

What is market power?

The ability of a seller or buyer to affect the price of a good.

When a specific (i.e., per-unit) tax is imposed on a competitive industry, the market price rises by an amount that is less than the tax, Who share the burden of this tax in the competitive market and how is it different than in the monopolist?

The burden of the tax in a competitive market is shared by producers and consumers. Tax on a Monopoly differs from the competitive market as price can sometimes rise by more than the amount of the tax.This would be impossible in a competitive market, but it can happen with a monopolist because the relationship between price and marginal cost depends on the elasticity of demand.

On the monopolist output decision curve, the area above the MR curve and below the MC curve,between Q2 (which is any output decision above the profit maximization level) and Q*( which is the profit maximization level) showcases ____________________

The increased profit that can be achieved by reducing production to Q* from Q2.

What is the problem that monopsonist has?

The issue of choosing the quantity that maximizes net benefit from the purchase.

Average revenue

The price a firm receives per unit sold.

The market demand curve D is the monopolist's average revenue curve. What does it specify?

The price per unit that the monopolist receives as a function of its output level.

Unlike a competitive buyer, a monopsonist pays a price that depends on what?

The quantity that it purchases.

A monopolistic market has no supply curve. In other words, there is no one-to-one relationship between price and the quantity produced. Give the reason for this.

The reason is that the monopolist's output decision depends NOT ONLY on marginal cost but also on the shape of the demand curve. As a result, shifts in demand do not trace out the series of prices and quantities that correspond to a competitive supply curve. Instead, shifts in demand can lead to changes in price with no change in output, changes in output with no change in price, or changes in both price and output.

In a competitive market, what curve showcases the clear relationship between price and the quantity supplied?

The supply curve which represents the marginal cost of production for the industry as a whole. The supply curve tells us how much will be produced at every price.

On the monopolist output decision curve, the area below the MR curve and above the MC curve,between Q1 (which is any output decision below the profit maximization level) and Q*( which is the profit maximization level) showcases ____________________

The total profit lost by the monopolist for producing quantity lower than the profit maximizing level Q*.

If demand is elastic when price increases what happens to expenditure and thus revenue?

They decrease.

Why do antitrust laws exist to forbid firms from monopolizing most markets?

They have been created as monopolies impose a social cost where fewer consumers buy the product and those who do, pay more for it.

When a tax is levelied within a monopoly, what happens to margina and average cost?

They increaase by the amount of the amount of the tax.

If demand is inelastic when price increases what happens to expenditure and thus revenue?

They increase.

If demand is unit elastic, when price increases what happens to expenditure and thus revenue?

They remain unchanged.

What is producer surplus?

This is the analogous measure for producers.

What is consumer surplus?

This is the total benefit or value that consumers receive beyond what they pay for a good.

if the demand curve is written so that price is a function of quantity, P = a - bQ, where P = the price of the good q = the quantity demanded a = the intercept of the curve and the vertical axis, the price when no quantity demanded. b = the slope of the demand function. What is the formula for total revenue and marginal revenue?

Total revenue is PQ = aQ - bQ2 and Marginal revenue (using calculus) is d(PQ)>dQ = a - 2bQ.

True or False In a competitive market, price regulation always results in a deadweight loss. ON the contrary, price regulations can assist to eliminate dead weight in a monopoly.

True.

A competitive industry supplies a specific quantity at every price. How does this differ from that of the monopolist?

Unlike in the competitive market, depending on how demand shifts, monopolist might supply several different quantities at the same price, or the same quantity at different prices.

What happens when a monopolist produces less than the profit maximization quantity (Q*)?

When a monopolist produces a smaller quantity Q1 and receives the corresponding higher price P1, marginal revenue would then exceed marginal cost. In that case, if the monopolist produced a little more than Q1, it would receive extra profit (by MR − MC) and thereby increase its total profit. In fact, the monopolist could keep increasing output, adding more to its total profit until output Q*, at which point the incremental profit earned from producing one more unit is zero.

What is a natural monopoly?

When economies of scale are so large that it is most efficient for a single firm to supply the entire market.

When can the Markup rule of equation not be used to calculate the monopolist profit-maximizing price?

When marginal cost is zero. However, in order to maximize profit, the firm will produce at the point where the elasticity of demand is exactly -1. If marginal cost is zero, maximizing profit is equivalent to maximizing revenue, and revenue is maximized when Ed = -1.

What is the slope of the profit curve at profit-maximizing output level?

Zero.

To maximize profit, a firm must set output so that marginal revenue is

equal to marginal cost.

To maximize profit, the monopolist must first determine

its costs and the characteristics of market demand. Given this knowledge, the monopolist must then decide how much to produce and sell. The price per unit that the monopolist receives then follows directly from the market demand curve.

Because a monopolist is the sole producer of a product, the demand curve that it faces is the?

market demand curve.

What is marginal cost?

the change in variable cost associated with a one-unit increase in output.

If there is only one firm—a pure monopolist—its demand curve is ________________

the market demand curve.

The monopolist's average revenue is precisely

the market demand curve.