Lecture 20

Monopoly

Market structureMarket structures:

A monopolized market - a single seller. Monopoly affects the price (has market power)

Takes the price effect into account Today: choice without disctimination

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N 1 2 3-10 10-…

Name

yyp 1 0)(

Monopoly

What causes monopolies?

1. large fixed costs (Natural Monopoly)

2. a legal fiat (US Postal Service)

3. a patent (a new drug)

4. sole ownership of a good ( a toll highway)

5. formation of a cartel (OPEC)

Profit Maximization Secret of happiness (FOC):

Intuition: the last unit gives the same in terms of revenue as it costs

Competitive firm Monopoly: MR not equal to price

( ) ( ) ( )y T R y TC y

Marginal Revenue and Price Competitive firm

Monopoly ( ) 1 0p y y

Profit of a Monopoly Profit of the monopoly

Suppose Total Revenue Marginal Revenue

( ) ( ) ( )y p y y T C y

( ) 1 0p y y

y maximizing profit Secret of happiness (FOC):

Intuition: the last unit gives the same in terms of revenue as it costs

Difference: MR not equal to price

( ) ( ) ( )y T R y TC y

y maximizing profit: geometry

( ) 1 0p y y 2( ) 0 .5TC y y( )MC y ( )MR y

p

y

*

*

p

y

Pareto Efficiency

Competitive markets efficient Is outcome Pareto Efficient when one

“trader” is big? Loss of efficiency – deadweight loss

Total Potential Surplus

– competitive benchmark

– monopoly

Gains to trade

( ) 1 0p y y 2( ) 0 .5TC y y Gains to trade-Total Potential Surplus (TPS)

Competitive Benchmark

( ) 1 0p y y 2( ) 0 .5TC y y Competitive supply: p=MC Consumer’s and Producers Surplus

Monopoly: Deadweight loss

( ) 1 0p y y 2( ) 0 .5TC y y Monopoly

How to measure market power?

Candidate 1: Problem: Candidate 2:

Measurement of market power

( ) 1 0p y y

( ) 1 0y p p

Regulation of a Natural Monopoly( ) 1TC y y ( ) 1 0p y y

Regulating a Natural Monopoly

So a natural monopoly cannot be forced to use marginal cost pricing. Doing so makes the firm exit, destroying both the market and any gains-to-trade.

Regulatory schemes can induce the natural monopolist to produce the efficient output level without exiting.