Econ chap 8

Monopoly

-Monopoly power -Sources of monopoly power -Maximizing profits -Implications of entry barriers

Firms operating in a perfectly competitive market take the market price as given

-Produce output where 𝑃=𝑀𝐶. -Firms may earn profits or losses in the short run.... but, in the long run, entry or exit forces economic profits to zero.

Marginal Revenue and Elasticity Monopolists marginal revenue function:

𝑀𝑅=𝑃[(1+𝐸)/𝐸] , where 𝐸 is the elasticity of demand for the monopolist's product and 𝑃 is the price charged. -For 𝑃>0 *𝑀𝑅>0 when 𝐸<−1. *𝑀𝑅=0 when 𝐸=−1. *𝑀𝑅<0 when −1<𝐸<0.

Marginal Revenue and Linear Demand Function in a Monopoly market:

𝑃(𝑄)=𝑎+𝑏𝑄 , where 𝑎>0 𝑎𝑛𝑑 𝑏<0, the associated marginal revenue is 𝑀𝑅(𝑄)=𝑎+2𝑏𝑄

-Two strategies monopolistically competitive firms use to persuade consumers:

*Comparative advertising *Niche marketing

Monopoly and Monopoly Power

-A market structure in which a single firm serves an entire market for a good that has no close substitutes. -Sole seller of a good in a market gives that firm greater market power than if it competed against other firms.

Monopolistic competition

-Conditions for monopolistic competition -Profit maximization -Long-run equilibrium -Implications of product differentiation

Perfect competition

-Demand at the market and firm levels -Short-run output decisions -Long-run decisions

Sources of Monopoly Power

-Economies of scale -Economies of scope -Cost complementarity -Patents and other legal barriers

Perfect Competitive Firm's Demand and formula

-The demand curve for a competitive firm's product is a horizontal line at the market price. This price is the competitive firm's marginal revenue. 𝐷^𝑓=𝑃=𝑀𝑅

Perfectly competitive markets are characterized by:

-The interaction between many buyers and sellers that are "small" relative to the market. -Each firm in the market produces a homogeneous (identical) product. -Buyers and sellers have perfect information. -No transaction costs. =Free entry into and exit from the market.

Short-Run Output Decisions in a Perfect Competitive market

-The short run is a period of time over which some factors of production are fixed. -To maximize short-run profits, managers must take as given the fixed inputs (and fixed costs), and determine how much output to produce by changing the variable inputs.

An industry is monopolistically competitive if:

-There are many buyers and sellers. -Each firm in the industry produces a differentiated product. -There is free entry into and exit from the industry. **A key difference between monopolistically competitive and perfectly competitive markets is that each firm produces a slightly differentiated product. -Implication: products are close, but not perfect, substitutes; therefore, firm's demand curve is downward sloping under monopolistic competition

Perfect Competitive Output Rule and formula

-To maximize profits, a perfectly competitive firm produces the output at which price equals marginal cost in the range over which marginal cost is increasing. 𝑃=𝑀𝐶(𝑄)

implications for a Perfectly competitive market are:

-a single market price is determined by the interaction of demand and supply -firms earn zero economic profits in the long run.

Implications of Product Differentiation in a Monopolistic Competitive Market:

-implies that firms in these industries must continually convince consumers that their products are better than their competitors. -Two strategies monopolistically competitive firms use to persuade consumers: *Comparative advertising *Niche marketing

Implication for Monopoly

-market demand curve is the monopolist's demand curve. -However, a monopolist does not have unlimited market power

Implications of Entry Barriers in a Monopoly market

A monopolist may earn positive economic profits, which in the presence of barriers to entry prevents other firms from entering the market to reap a portion of those profits. Implication: monopoly profits will continue over time provided the monopoly maintains its market power. Monopoly power, however, does not guarantee positive profits.

Absence of a Supply Curve in Monopoly market:

A monopolist's market power implies 𝑃>𝑀𝑅=𝑀𝐶. Thus, there is no supply curve for a monopolist, or in markets served by firms with market power.

Output Rule in a Monopoly market and Equation:

A profit-maximizing monopolist should produce the output, 𝑄^𝑀, such that marginal revenue equals marginal cost: 𝑀𝑅(𝑄^𝑀 )=𝑀𝐶(𝑄^𝑀 )

Pricing Rule in a Monopoly market

Given the level of output, 𝑄^𝑀, that maximizes profits, the monopoly price is the price on the demand curve corresponding to the 𝑄^𝑀 units produced: 𝑃^𝑀=𝑃(𝑄^𝑀 )

Optimal Advertising Decisions

How much should a firm spend on advertising to maximize profits?

Long-Run Competitive Equilibrium and equations

In the long run, perfectly competitive firms produce a level of output such that 𝑃=𝑀𝐶 𝑃=𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑜𝑓 𝐴𝐶

Multiplant Output Rule of a Monopoly market

Let 𝑀𝑅(𝑄) be the marginal revenue of producing a total of 𝑄=𝑄_1+𝑄_2 units of output. Suppose the marginal cost of producing 𝑄_1 units of output in plant 1 is 〖𝑀𝐶〗_1 (𝑄_1 ) and that of producing 𝑄_2 units in plant 2 is 〖𝑀𝐶〗_2 (𝑄_2 ). The profit-maximizing rule for the two-plant monopolist is to allocate output among the two plants such that: 𝑀𝑅(𝑄)=〖𝑀𝐶〗_1 (𝑄_1 ) 𝑀𝑅(𝑄)=〖𝑀𝐶〗_2 (𝑄_2 )

Deadweight Loss of Monopoly

The consumer and producer surplus that is lost due to the monopolist charging a price in excess of marginal cost.

In the Long-Run, Monopolistic Competition firms produce

a level of output such that: -𝑃>𝑀𝐶 -𝑃=𝐴𝑇𝐶>𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑜𝑓 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡𝑠

-Perfect competition. -Monopoly. -Monopolistic competition. are market environments that:

are used by managers to determine the optimal price, quantity and advertising decisions

The optimal amount of advertising

balances the marginal benefits and marginal costs. Profit-maximizing advertising-to-sales ratio is: 𝐴/𝑅=𝐸_(𝑄,𝐴)/(−𝐸_(𝑄,𝑃) )

A monopolistically competitive firm can earn profits:

in the short run, but entry by competing brands will erode these profits in the long run.

perfectly competitive Firm's Short-Run Supply Curve

marginal cost curve above the minimum point on the 𝐴𝑉𝐶 curve.

Long-Run Equilibrium in a Monopolistic Competitive Market:

markets earn short-run -profits, additional firms will enter in the long run to capture some of those profits. -losses, some firms will exit the industry in the long run

Profit-Maximization Rule in a Monopolistic Competitive Market:

produces where its marginal revenue equals marginal cost. The profit-maximizing price is the maximum price per unit that consumers are willing to pay for the profit-maximizing level of output. In other words, the profit-maximizing output, 𝑄^∗, is such that 𝑀𝑅(𝑄^∗ )=𝑀𝐶(𝑄^∗ ) and the profit-maximizing price is 𝑃^∗=𝑃(𝑄^∗ ).

A monopoly firm can earn persistent profits :

provided that the source of monopoly power is not eliminated

Short-Run Output Decision to maximize short-run profits in a a perfectly competitive firm

should produce in the range of increasing marginal cost where 𝑃=𝑀𝐶, provided that 𝑃≥𝐴𝑉𝐶. If 𝑃<𝐴𝑉𝐶, the firm should shut down its plant to minimize it losses.

Monopolist's power is constrained by what

the demand curve