Econ Chapter 9 - Market Power & Monopoly

Name and describe three barriers to entry.

(1) Extreme Scale Economies/ Natural Monopolies: Markets that experience extreme returns to scale ( the bigger the firm gets, the lower its ATC, even if it sells the entire market Q itself. (ie: Natural Monopolies -- a market in which it is efficient for the single firm to produce for the entire industry) (2) Switching Costs: Consumers have to give up something to go with the competing product. High switching costs generates market power for the incumbent and makes entry difficult. (ie: airline frequent flier miles). (3) Product Differentiation: Different firms' goods may not be perfect substitutes. Prevents new firms from coming into the market and stealing most of the market demand just by pricing their product version a bit below the incumbents' prices.

Describe the connection between the slope of the demand curve for a good and a firm's marginal revenue.

A firm's marginal revenue is two times as steep as the slope of the demand curve.

Section 9.2

A monopoly is the sole supplier of a good in a market and represents the extreme case of a firm with complete market power. Monopolies and other firms with market power base their production decisions in part on their marginal revenue, the revenue from selling an additional unit of a good. Unlike perfectly competitive firms, these firms' marginal revenue falls, because it must sell all units of the good (not just the additional unit) at a lower price.

What are characteristics of a natural monopoly? Why is it efficient for society for a natural monopoly to produce all the output of an entire industry?

A natural monopoly is a market in which it is efficient for a single firm to produce the entire industry output. It is efficient for a society if a single firm produces the entire industry input because splitting output across more firms would raise the average total cost of production.

Name some regulations the government imposes on firms with market power.

(1) Direct Price Regulation (2) Antitrust Laws: laws designed to promote competitive markets by restricting firms from behaviors that limit competition. (3) Patents, Licenses and Copyrights: promote competition and innovation.

Compare the consumer and producer surplus of perfectly competitive firms with that of firms with market power.

CScomp = A+B+C CSmark = A PScomp = 0 PSmark = B *The producers gain, and the consumers lose.* *Great for firms, bad for consumers... Restrict output and raise prices.*

Why does the profit-maximizing strategy of a firm with market power create deadweight loss?

Deadweight loss is equal to the area of C = 0.5*(Pm-Pc)*(Qc-Qm). TSmark < TScomp... the missing surplus has been destroyed by exercising market power... this lost surplus is NOT transferred it is totally lost, no one gets it... similar to the loss from imposing a tax in the market. *Inefficiency of Market Power*

Why do firms with market power have only demand -- and not supply -- curves?

Firms with market power don't have supply curves -- their profit maximizing price and quantity combinations are not supply curves because those combinations depend on the demand curves the firm faces.

Why do firms with market power respond differently to changes in consumers' price sensitivity than do perfectly competitive firms?

For a perfectly competitive market, a rotation in the demand curve does not change the equilibrium quantity and price. For a firm with market power, a rotation in the demand curve also rotates the marginal revenue curve, which impacts the equilibrium price and quantity.

Section 9.6

Governments often intervene to reduce the DWL created by firms with market power. Direct price regulation and antitrust laws are aimed at reducing firms' market power to firms through patents, copyrights, and other laws as a way of promoting innovation.

Section 9.3

The profit-max output level for a monopolist is found where marginal revenue equals marginal cost, MR = MC. A monopoly will charge a price above its marginal cost, meaning that the market price for a monopoly is higher than that for a perfectly competitive firm. The Lerner Index computes how much a firm should mark up its price; the more inelastic the demand for a product, the higher the firm's Lerner index and markup.

What is the profit-maximizing output level for a firm with market power?

To maximize profit, a firm should choose its quantity where its marginal revenue equals its marginal cost: MR = MC. (1) Derive the marginal revenue curve from the demand curve. (2) Find the output quantity at which marginal revenue equals marginal cost. (3) Determine the profit-max price by locating the point on the demand curve at the optimal quantity level.

Section 9.5

When a firm exercises its market power, it increases its producer surplus, decreases consumer surplus, and creates a deadweight loss. Producer surplus is greater when consumers are relatively price-insensitive and the demand curve is steep.

When does a firm have market power?

When they have the ability to manipulate price by influencing an item's supply, demand or both. A company with market power would be able to affect price to its benefit. Firms with market power are said to be "price makers" as they are able to set the price for an item while maintaining market share.

Section 9.1

Most firms have some market power, meaning that the firm's production decisions affect the market price of the good it sells. Firms maintain market power through barriers to entry into the market. These barriers include natural monopolies, switching costs, product differentiation, and absolute cost advantages of key inputs.

Section 9.4

THe changes in quantity supplied and price created by cost and demand shocks have the same direction, but different magnitudes, for firms with market power as for perfectly competitive firms. However, firms with market power respond differently to changes in consumers' price sensitivities -- that is, rotations in the demand curve -- than do competitive firms.