Market Power

Describe a monopoly in the long run.

A monopolist can earn zero economic profit ("normal profit") in the long run, and will have no incentive to go out of business (no better alternative) If a monopolist faces losses in the long run (negative profits), it will go out of business (aside from the specific firms that are not allowed to do so) ***Because of the existence of barriers to entry, a monopolist can earn a positive profit in the long run. (Prevents other firms from entering the market)

Describe a monopolist's output decision. Why is the profit level of output for a monopoly at when MR < P?

Because a monopolist is the only seller in the market, it faces the entire market demand curve (price depends on quantity produced by firm) Since the firm's level of output affects the price, MR and P are not the same as they are for a competitive firm. • If a firm wants to sell an additional unit, it has to lower it's price - not just for that unit, but for ll the previous units it would have been able to sell anyway • As a result, the MR from each unit (after the first) is less than its price: MR < P

control of an important resource

Ex) If DeBeers controls all of the world's diamond mines, nobody else can supply new diamonds (less common)

The amount of market power possessed by firm is typically measured by the extent to which its price exceeds its marginal cost. What does this mean for elasticity?

Higher elasticity -> lower market power (closer to marginal cost) Lower elasticity -> higher market power (further from marginal cost)

Economies of scale (cost structure)

If a firm's average cost decreases as it produces more, one firm can operate at a lower cost than multiple firms (new firms can't compete) --> natural monopoly i.e. existing firms are bigger, better, efficient, cheaper

In the case of a monopoly, how does government regulation affect efficiency?

In a monopoly, there is existing inefficiency to correct, so there is potential for social gains from government regulation.

Describe a monopoly in the short run.

In the short run, a monopolist can make positive, negative, or zero profit (just like a competitive firm). A monopolist's shut-down rule is the same as a competitive firm's: shut down if TR < VC (or, if P < AVC) (some are not allowed to shut down, generally when government run or regulated and providing a vita service; e.g. PGE (utilities))

Describe the profits of a monopolistic competition in the short run and the long run.

In the short run, a monopolistically competitive firm can earn positive, zero, or negative profits, just like any other firm. In the long run, monopolistically competitive firms will always earn a profit of zero. Even though firms possess market power, free entry and exit lead to zero profit in the long run.

Three characteristics of perfect competition:

Market structure: • Large number of buyers and sellers (all small, price takers) • Identical products (product homogeneity) • Free entry and exit Results in economic efficiency: • Quantity produced by perfectly competitive market maximizes total surplus Other: • Demand curve = MR --> (Since MR = MC) so firms produce at P = MC (unless this gives TR < VC, in which case they will shut down) • Every firm will operate at the minimum point of its LRAC curve - firms achieve the lowest possible average cost (produce at minimum efficient scale)

Three characteristics of monopoly:

Market structure: • One seller: (the firm faces the entire market demand curve, and does not take the price as given; they have market power) • one product with no close substitutes • significant barriers to entry (other firms are unable to enter even if there is a profit opportunity in the market)

Describe the market structure of an oligopoly.

Market structure: • Small number of relatively large firms • Products can be identical or differentiated (firms have market power either way due to size) • Barriers to entry Ex) auto industry, Pepsi vs. Coke, airlines, computers, OPEC)

For a monopolist, when the demand curve is linear, the marginal revenue curve ____

The MR curve has the same intercept as the demand curve and twice the slope.

Antitrust laws

a set of laws to promote competition; these laws prevent actions that would "restrain trade" Note: It is not illegal to be a monopolist, just to take anti-competitive actions to acquire or maintain market power

market power

ability to influence price (not price takers)

rent seeking

costly and socially unproductive activities undertaken to acquire or maintain monopoly power Ex) Lobbying Congress for favorable legislation

natural monopoly

monopoly that arises due to economies of scale

legal barriers

patents and copyrights- legal rights/ IP to product/ technology government franchise (e.g. DMV and driver's licenses)

network externality

users benefit more from a good when more people use it; new firms at a huge disadvantage (lack of users make product less valuable) e.g. Facebook, phones, etc.

What are the social costs of monopoly?

• A monopoly will have a higher price and lower output level than a perfectly competitive market would --> DWL due to underproduction • Monopolies can generate costs through rent seeking

How do monopolies arise? (examples of barriers to entry)

Monopolies result from barriers to entry: • Economies of scale (cost structure) • Legal barriers • Network externalities • Control of an important resources

What are the potential benefits of monopoly?

More efficient with one firm: In the case of the natural monopoly, production by one firm is more efficient (average cost is lower with one firm) Dynamic efficiency: since monopolists can sustain long run profits, they have a strong incentive to lower their costs over time (e.g. by improving technology- innovation)- can't get this structure in a competitive market Research and development: Patents and copyrights allow firms to monopolize markets, but without them, these products might not exist in the first place. Ex) Pharmaceuticals

What are the drawbacks of government regulation?

Potential drawbacks of regulation: • Regulation is costly • incentive to innovate is reduced • If regulated at average cost, the firm no longer has any reason to keep its cost down

What are the three most publicized antitrust laws?

Sherman Act (1980): Prohibits firms working together to act like a monopoly Clayton Act (1914): Prohibits predatory pricing (price at a lost to get rid of competitors) and prohibits mergers and acquisitions that would significantly lessen competition. Federal Trade Commission Act (1914): Established FTC; Prohibits various anticompetitive actions such as exclusive dealing arrangements

What are the social costs of monopolistic competition?

Social costs: • differentiated products (value variety) • DWL is not equal to loss to society, but simply the cost of variety.

What is the market structure of monopolistic competition?

Some features similar to perfect competition: • Large number of buyers and sellers • Differentiated products••• • Free entry and exit Differentiated products: Ex) Starbucks vs. Folgers vs. Albertson's Brand Ex) Gas Station on R vs. L (where higher traffic is) Ex) Sugar at Costco, Safeway, Albertson's (same brand, by distance)