1 1 ba 445 lesson a.9 monopolistic markets readingsreadings baye 6 th edition or 7 th edition,...

1 1BA 445 Lesson A.9 Monopolistic Markets

Readings

Readings

Baye 6th edition or 7th edition, Chapter 8


Overview

Overview

3 3

Overview

BA 445 Lesson A.9 Monopolistic Markets

Monopolistic Price and Quantity starts with quantity set where marginal cost equals marginal revenue, then price set to the maximum willingness to pay for the last unit.

Inefficient Output is implied when price and willingness to pay is greater than marginal cost. — So, after your market purchases, there is a deal between you and Microsoft that can benefit you both.

Monopolistically Competitive Entry and Exit drives profits to zero as in competitive markets. — So, Pizza Hut profits from stuffed-crust pizza eventually vanish, and profits require new variations.

Comparing Markets reveals different equilibrium for perfect competition, monopoly, and monopolistic competition — So, Monsanto’s seed monopoly has equilibrium unlike Pizza Hut’s pizza.


Monopolistic Price and Quantity


5 5

Overview

Monopolistic Output maximizes profit with quantity equating marginal revenue to marginal cost, then price equals the maximum willingness to pay for that quantity.



6 6

Monopoly verses Perfect Competition • Monopoly verses Perfect Competition differ in the price

or quantity interaction between firms: Perfect competition has other firms producing perfect

substitutes. That makes each firm’s demand perfectly elastic, and each firm has to match other firms’ price.

Monopoly has no other firm producing perfect substitutes. That makes each firm’s demand less than perfectly elastic.• Demand inelasticity is called monopoly or market

power. If no one produces close substitutes to the monopolist, there is more inelasticity and power.



7 7

Monopoly verses Perfect Competition • The simplest monopoly model further assumes the price

and quantity chosen by the monopolist does not interact with the prices and quantities chosen by other firms.

That is never perfectly accurate since demand for each good is affected by the prices of most other goods, at least through the income effect.• For example, the demand for computers is affected by the

price of gas. We later (Part B) consider more complex and realistic

monopoly models where prices and quantity choices interact with other firms, with those firms producing either substitutes (like different kinds of computers) or complements (like computer hardware and software).



8 8

Monopoly verses Perfect Competition • Monopoly verses Perfect Competition differ in the

potential entry of new firms: Perfect competition has free entry of firms producing

perfect substitutes.• Any such entry takes the long-run since it takes the

long-run to adjust rented or owned capital.• Monopoly has no entry of firms producing perfect

substitutes. • The simplest monopoly model further assumes there is

no entry of firms whose prices or quantities affect the demand for the monopolist’s product.



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Natural Source of Monopoly Power• The primary natural source of monopoly power is

economies of scale, meaning it is cheaper for one firm to produce or supply a single product that it is to divide production or supply between many firms.

• For example, it is cheaper to have a single grocery in a neighborhood.

When monopoly power comes from being the only supplier in a neighborhood, call it a local monopoly.



10 10

Artificial Sources of Monopoly Power• Patents, copyrights, and other legal barriers to enter

an industry generate and sustain monopoly power. Copyrighted movies are monopolies because

there are no perfect substitutes. Monopoly power is limited by the closeness of

substitutes (like pirated copies of Armageddon, or similar movies like Deep Impact)

• Collusion can generate monopoly power. OPEC (Organization of the Petroleum Exporting

Countries) would be a monopoly if all exporting countries were included. • Its monopoly power is limited by substitutes for

gas (like fuel efficient cars) BA 445 Lesson A.9 Monopolistic Markets


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Review: Monopolist’s Marginal Revenue

QQ

PTR

100

0 010 20 30 40 50 10 20 30 40 50

800

60 1200

40

20

Inelastic

Elastic

Elastic Inelastic

Unit elastic

Unit elastic

MR



12 12

$

Q

ATCMC

D

MRQM

PM

Set Monopolistic Quantity by increasing production output until MR(QM) = MC(QM) . Then, charge the price on the demand curve that corresponds to that quantity.



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$

Q

ATCMC

D

MRQM

PM

Profit

ATC

Profit ComputationP = (P-ATC) x Q (from before)



14 14

Marginal Revenue Formulae • What is MR if a firm faces a linear demand curve for its

product?

• What is MR if a firm faces a general demand curve (with elasticity E)?

bQaP .0,2 bwherebQaMR

E

EPMR1



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Marginal Revenue Formulae and Monopoly Power

• MR = P(1+1/E) means, if demand is more elastic (E more negative), then MR is higher, so MC(Q) = MR(Q) is higher, so Q is higher, so P is lower.

• Likewise, demand less elastic implies Q is lower and P is higher.• Lower demand elasticity (fewer substitutes) thus means more

monopoly power. Product differentiation increases monopoly power. Apple

computers are artistic, so Apple has more monopoly power, and higher prices.

Jimmy Choo is fashionable, and so more power and higher prices.

E

EPMR1



16 16

A Numerical Example• Given estimates of

• Demand: P = 10 - Q• Cost: C(Q) = 6 + 2Q

• Monopolistic output?• MR = 10 - 2Q, since R(Q) = (10-Q) x Q• MC = 2• 10 - 2Q = 2• Q = 4 units

• Monopolistic price?• P = 10 - (4) = $6

• Monopolistic profits?• PQ - C(Q) = (6)(4) - (6 + 8) = $10



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Long Run Adjustments?• None, as long as the source of monopoly power

remains.




Inefficient Output

Inefficient Output

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Overview

Inefficient Output is implied when price and willingness to pay is greater than marginal cost. — So, after your market purchases, there is a deal between you and Microsoft that can benefit you both.


Inefficient Output

20 20

Inefficient Output is implied when P > MC• Inefficiency means it is possible for some people to help

themselves without hurting anyone else.• For example, consider DVDs selling at monopoly price P

= $20 while MC = $1. There now exist “victimless crimes” if consumers adopt a policy

of paying for a DVD if they value the DVD at the monopoly price P = $20 or more, but they illegally download the DVD if they value it less than the monopoly price P (and at more than the cost of the download).

Those victimless crimes help the consumers when they download DVDs, without hurting the monopolist since the monopolist has the same sales as when there is no downloading.


Inefficient Output

21 21

Measuring Social Inefficiency• Deadweight loss of monopoly.

There is a loss in the total of consumer surplus plus producer surplus.

That is a loss in total happiness (a loss in the American Pie).


Inefficient Output

22 22

$

Q

ATCMC

D

MRQM

PM

MC

Deadweight Loss of Monopoly

Deadweight Loss of Monopoly


Inefficient Output

23 23

Arguments for Monopoly are that the negative

effects (deadweight loss) of monopoly market power may be outweighed by beneficial effects, including• the beneficial effects of economies of scale that reduce

cost • the beneficial effects of patents and copyrights that

encourage the development of new products


Inefficient Output


Monopolistically Competitive Entry and Exit


25 25

Overview

Monopolistically Competitive Entry and Exit drives profits to zero as in competitive markets. — So, Pizza Hut profits from stuffed-crust pizza eventually vanish, and profits require new variations.



26 26

Monopolistic competition is one market environment

that lies between Monopoly and Perfect Competition.

Price or quantity competition with other firms:• Like perfect competition, monopolistic competition has other firms

producing substitutes (but not perfect substitutes), and so each firm’s demand is affected by other firms’ prices and quantities.

• But like the simplest monopoly model, we do not consider the monopolist’s prices and quantities affecting other firms own prices and quantities, which in turn affect the monopolist’s profit.

Entry into the industry:• Like perfect competition, monopolistic competition has free entry of

firms producing substitutes (but not perfect substitutes).



27 27

When are markets monopolistically competitive?• Numerous buyers and sellers

Implication: There is little or no strategic interaction between sellers (unlike the forthcoming analysis of oligopoly).

• Differentiated products Implication: Since products are differentiated (not perfect

substitutes), each firm faces a downward sloping demand curve. • Consumers view differentiated products as close substitutes:

there exists some willingness to substitute.

• Free entry and exit of production of close substitutes --- What is a close substitute for the movie “Spiderman”?

Implication: Firms will earn zero profits in the long run.



28 28

Managing a Monopolistically Competitive Firm

• Like a monopoly, monopolistically-competitive firms have market power that permits pricing above marginal cost. level of sales depends on the price it sets.

• But … The presence of other brands in the market makes the

demand for your brand more elastic than if you were a monopolist.• Monopolistically-competitive firm’s demand is more

elastic, and so prices are lower than monopoly prices. Free entry and exit cause zero economic profit in the long

run.

• Therefore, monopolistically-competitive firms have limited market power.



29 29

Marginal Revenue Like a Monopolist

QQ

PTR

100

0 010 20 30 40 50 10 20 30 40 50

800

60 1200

40

20

Inelastic

Elastic

Elastic Inelastic

Unit elastic

Unit elastic

MR



30 30

$ATC

MC

D

MRQM

PM

Profit

ATC

Quantity of Brand X


Short-Run (fixed number of firms) Monopolistic Competition• Maximize profits like a monopolist

Produce output where MR = MC. Charge the price on the demand curve that corresponds to that

quantity.


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Long Run Adjustments?• If the industry is monopolistically competitive, there is

free entry. In this case other firms start producing close substitutes, and

their new brands steal market share. This reduces the demand for your product until economic profits

are zero.



32 32

$AC

MC

D

MR

Q*

P*

Quantity of Brand XMR1

D1

Entry

P1

Q1

Long Run Equilibrium(P = AC, so zero profits)

Long-Run monopolistic competition, as entry decreases demand.




Comparing Markets

Comparing Markets

34 34

Overview

Comparing Markets reveals different equilibrium for perfect competition, monopoly, and monopolistic competition — So, Monsanto’s seed monopoly has equilibrium unlike Pizza Hut’s pizza.


Comparing Markets

35 35

A Numerical Example• C(Q) = 125 + 4Q2

• Determine the profit-maximizing output and price, and discuss its implications, if

You are a price taker and other firms charge $40 per unit; You are a monopolist and the inverse demand for your product is

P = 100 - Q; You are a monopolistically competitive firm and the inverse

demand for your brand is P = 100 – Q.


Comparing Markets

36 36

Price Taker or Perfect Competition• MC = 8Q• MR = P = $40.• Set MR = MC.

• 40 = 8Q.• Q = 5 units.

• Cost of producing 5 units.• C(Q) = 125 + 4Q2 = 125 + 100 = $225.

• Revenues:• PQ = (40)(5) = $200.

• Maximum profits of -$25.• Implications: Expect exit in the long-run.


Comparing Markets

37 37

Monopoly and Monopolistic Competition• MR = 100 - 2Q (since P = 100 - Q).• Set MR = MC, or 100 - 2Q = 8Q.

Optimal output: Q = 10. Optimal price: P = 100 - (10) = $90. Maximal profits:

• PQ - C(Q) = (90)(10) -(125 + 4(100)) = $375.

• Implications Monopolist will not face entry (unless patent or other entry

barriers are eliminated). Monopolistically competitive firm should expect other firms to

clone (produce close substitutes), so profits will decline over time.


Comparing Markets


Summary

Summary

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Summary• Firms operating in a perfectly-competitive market take

the market price as given. Produce output where MC = P. Firms may earn profits or losses in the short run. But, in the long run, entry or exit forces profits to zero.

• A monopoly firm, in contrast, can earn persistent profits provided that source of monopoly power continues.

• A monopolistically-competitive firm can earn profits in the short run, but entry by competing brands (producing close substitutes) will erode these profits over time.


Summary

40 40

Review Questions


Review Questions You should try to answer some of the review questions

(see the online syllabus) before the next class. You will not turn in your answers, but students may

request to discuss their answers to begin the next class. Your upcoming Exam 1 and cumulative Final Exam will

contain some similar questions, so you should eventually consider every review question before taking your exams.

41 41

End of Lesson A.9

BA 445 Managerial Economics


1 1 ba 445 lesson a.9 monopolistic markets readingsreadings baye 6 th edition or 7 th edition,...

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