monopoly and mpnopolistic competition

8/2/2019 Monopoly and Mpnopolistic Competition.

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Managerial Decisions for

Firms with Market Power

-Monopoly


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Market Power

Ability of a firm to raise price without losingall its sales

Any firm that faces downward sloping demandhas market power

Gives firm ability to raise price aboveaverage cost & earn economic profit (if

demand & cost conditions permit)


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Monopoly

Single firm

Produces & sells a particular good orservice for which there are no goodsubstitutes

New firms are prevented from enteringmarket


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Measurement of Market

Power Degree of market power inversely related toprice elasticity of demand

The less elastic the firms demand, the greater its

degree of market power The fewer close substitutes for a firms product, the

smaller the elasticity of demand (in absolute value) &the greater the firms market power

When demand is perfectly elastic (demand ishorizontal), the firm has no market power


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Power Lerner index measures proportionateamount by which price exceeds marginalcost:

P MC

P

Lerner index


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Power If consumers view two goods assubstitutes, cross-price elasticity ofdemand (EXY) is positive

The higher the positive cross-price elasticity,the greater the substitutability between twogoods, & the smaller the degree of market

power for the two firms


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Determinants of Market

Power Entry of new firms into a market erodesmarket power of existing firms by increasingthe number of substitutes

A firm can possess a high degree of marketpower only when strong barriers to entryexist

Conditions that make it difficult for new firmsto enter a market in which economic profits

are being earned


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Common Entry Barriers

Economies of scale

When long-run average cost declines over a widerange of output relative to demand for the

product, there may not be room for another largeproducer to enter market

Barriers created by government

Licenses, exclusive franchises


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Input barriers

One firm controls a crucial input in the productionprocess

Brand loyalties Strong customer allegiance to existing firms may

keep new firms from finding enough buyers tomake entry worthwhile


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Consumer lock-in Potential entrants can be deterred if they believe

high switching costs will keep them from inducingmany consumers to change brands

Network externalities Occur when value of a product increases as more

consumers buy & use it

Make it difficult for new firms to enter marketswhere firms have established a large network ofbuyers


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Demand & Marginal Revenue for

a Monopolist Market demand curve is the firms demand curve

Monopolist must lower price to sell additional unitsof output Marginal revenue is less than price for all but the first unit

sold

WhenMR is positive (negative), demand is elastic(inelastic)

For linear demand,MR is also linear, has the same

vertical intercept as demand, & is twice as steep


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Demand & Marginal Revenue for

a Monopolist (Figure 12.1)


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Short-Run Profit Maximizationfor Monopoly

Monopolist will produce a positive output ifsome price on the demand curve exceedsaverage variable cost

Profit maximization or loss minimizationoccurs by producing quantity for whichMR =MC


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Short-Run Profit Maximization

for Monopoly

If P >ATC, firm makes economic profit

IfATC> P > AVC, firm incurs loss, but

continues to produce in short run

If demand falls below AVC at every level ofoutput, firm shuts down & loses only fixedcosts


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Short-Run Profit Maximization

for Monopoly (Figure 12.3)


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Short-Run Loss Minimization for

Monopoly (Figure 12.4)


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Long-Run Profit Maximization forMonopoly

Monopolist maximizes profit by choosing toproduce output whereMR = LMC, as long asP LAC

Will exit industry if P < LAC Monopolist will adjust plant size to the optimal

level Optimal plant is where the short-run average cost

curve is tangent to the long-run average cost atthe profit-maximizing output level


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Profit-Maximizing Input Usage

Profit-maximizing level of inputusageproduces exactly that level of outputthatmaximizes profit


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Marginal revenue product (MRP)

MRP is the additional revenue attributable to hiring one

more unit of the input

When producing with a single variable input:

Employ amount of input for whichMRP = inputprice

Relevant range ofMRP curve is downward sloping,positive portion, for whichARP > MRP

TRMRP MR MPL


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Monopoly Firms Demand for

Labor (Figure 12.6)


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For a firm with market power, profit-maximizing conditions MRP = w andMR= MCare equivalent

Whether Q or L is chosen to maximize profit,resulting levels of input usage, output, price, &profit are the same


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Monopolistic Competition

Large number of firms sell a differentiatedproduct Products are close (not perfect) substitutes

Market is monopolistic Product differentiation creates a degree of

market power

Market is competitive Large number of firms, easy entry


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Monopolistic Competition

Short-run equilibrium is identical tomonopoly

Unrestricted entry/exit leads to long-runequilibrium

Attained when demand curve for each

producer is tangent toLAC

At equilibrium output,P = LACand MR =

LMC

Sh R P fi M i i i f


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Short-Run Profit Maximization for

Monopolistic Competition(Figure

12.7)

L R P fi M i i i f


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Long-Run Profit Maximization for

Monopolistic Competition(Figure

12.8)

monopoly and mpnopolistic competition

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