Chapter 10

Market
Market Power:
Power:
Monopoly
Monopoly and
and
Monopsony
Monopsony
Topics to be Discussed
• Monopoly
• Monopoly Power
• Sources of Monopoly Power
• The Social Costs of Monopoly Power

Chapter 1 2
Topics to be Discussed
• Monopsony
• Monopsony Power
• Limiting Market Power: The Antitrust Laws

Chapter 1 3
Perfect Competition
• Review of Perfect Competition
– P = LMC = LRAC
– Normal profits or zero economic profits in the
long run
– Large number of buyers and sellers
– Homogenous product
– Perfect information
– Firm is a price taker

Chapter 1 4
Perfect Competition
P Market P Individual Firm
D S
LMC LRAC

P0 P0
D = MR = P

Q0 Q q0 Q
Monopoly
• Monopoly
1) One seller - many buyers

2) One product (no good substitutes)

3) Barriers to entry

Chapter 1 6
Monopoly
• The monopolist is the supply-side of the
market and has complete control over the
amount offered for sale.

• Profits will be maximized at the level of

output where marginal revenue equals
marginal cost.

Chapter 1 7
Monopoly
• Finding Marginal Revenue
– As the sole producer, the monopolist works
with the market demand to determine output
and price.
– Assume a firm with demand:
•P = 6 - Q

Chapter 1 8
Total, Marginal, and Average
Total Revenue Average
Marginal
Price Quantity Revenue Revenue Revenue
P Q R MR AR
$6 0 $0 --- ---
5 1 5 $5 $5
4 2 8 3 4
3 3 9 1 3
2 4 8 -1 2
1 5 5 -3 1

Chapter 1 9
Average and Marginal Revenue
$ per
7
unit of
output
6

4 Average Revenue (Demand)

2
Marginal
1 Revenue

0 1 2 3 4 5 6 7 Output
Chapter 1 10
Monopoly
• Observations
1) To increase sales the price must fall

2) MR < P

3) Compared to perfect competition

• No change in price to change sales
• MR = P

Chapter 1 11
Monopoly
• Monopolist’s Output Decision
1) Profits maximized at the output level
where MR = MC

2) Cost functions are the same

 (Q )  R (Q )  C (Q )
 / Q  R / Q  C / Q  0  MC  MR
or MC  MR
Chapter 1 12
 Maximizing Profit When Marginal Revenue
Equals Marginal Cost

The
The Monopolist’s
Monopolist’s Output
Output Decision
Decision

• At output levels below MR = MC the

decrease in revenue is greater than the
decrease in cost (MR > MC).
• At output levels above MR = MC the
increase in cost is greater than the
decrease in revenue (MR < MC)

Chapter 1 13
Maximizing Profit When Marginal Revenue
Equals Marginal Cost

$ per
unit of
output MC

P1

P*
AC
P2
Lost
profit

D = AR

Lost
MR profit

Q1 Q* Q2 Quantity

Chapter 1 14
Monopoly
The
The Monopolist’s
Monopolist’s Output
Output Decision
Decision

• An Example
Cost  C (Q)  50  Q 2

C
MC   2Q
Q

Chapter 1 15
Monopoly
The
The Monopolist’s
Monopolist’s Output
Output Decision
Decision

• An Example
Demand  P (Q )  40  Q
R (Q)  P (Q )Q  40Q  Q 2

R
MR   40  2Q
Q
Chapter 1 16
Monopoly
The
The Monopolist’s
Monopolist’s Output
Output Decision
Decision

• An Example
MR  MC or 40  2Q  2Q
Q  10
When Q  10, P  30

Chapter 1 17
Monopoly
The
The Monopolist’s
Monopolist’s Output
Output Decision
Decision

• An Example
– By setting marginal revenue equal to marginal
cost, it can be verified that profit is maximized
at P = $30 and Q = 10.
– This can be seen graphically:

Chapter 1 18
Monopoly
• Monopoly pricing compared to perfect
competition pricing:
– Monopoly
P > MC
– Perfect Competition
P = MC

Chapter 1 19
Monopoly
• Monopoly pricing compared to perfect
competition pricing:
– The more elastic the demand the closer price
is to marginal cost.
– If Ed is a large negative number, price is close
to marginal cost and vice versa.

Chapter 1 20
Monopoly
• Shifts in Demand
– In perfect competition, the market supply
curve is determined by marginal cost.
– For a monopoly, output is determined by
marginal cost and the shape of the demand
curve.

Chapter 1 21
Monopoly
• Observations
– Shifts in demand usually cause a change in
both price and quantity.

– A monopolistic market has no supply curve.

Chapter 1 22
Monopoly
• Observations
– Monopolist may supply many different
quantities at the same price.

– Monopolist may supply the same quantity at

different prices.

Chapter 1 23
Monopoly
• The Effect of a Tax
– Under monopoly price can sometimes rise by
more than the amount of the tax.
• To determine the impact of a tax:
– t = specific tax
– MC = MC + t
– MR = MC + t : optimal production decision
• price change?
Chapter 1 24
Monopoly
• The Multiplant Firm
– For many firms, production takes place in two
or more different plants whose operating cost
can differ.

Chapter 1 25
Monopoly
• The Multiplant Firm
– Choosing total output and the output for each
plant:
• The marginal cost in each plant should be equal.
• The marginal cost should equal the marginal
revenue for each plant.

Chapter 1 26
Production with Two Plants
$/Q
MC1 MC2

MCT

P*

MR* D = AR

MR

Q1 Q2 Q3 Quantity

Chapter 1 27
Production with Two Plants
• Observations:
1) MCT = MC1 + MC2
$/Q
2) Profit maximizing MC1 MC2
output: MCT
• MCT = MR at QT and P *
• MR = MR* P*
• MR* = MC1 at Q1, MC*
= MC2 at Q2
• MC1 + MC2 = MCT, Q1 +
Q2 = QT, MR* D = AR
and MR = MC1 + MC2
MR

Q1 Q2 Q3
Quantity

Chapter 1 28
Monopoly Power
• Monopoly is rare.
• However, a market with several firms,
each facing a downward sloping demand
curve will produce so that price exceeds
marginal cost.

Chapter 1 29
Monopoly Power
• Scenario:
– Four firms with equal share (5,000) of a
market for 20,000 toothbrushes at a price of
$1.50.

Chapter 1 30
Monopoly Power
• Measuring Monopoly Power
– In perfect competition: P = MR = MC
– Monopoly power: P > MC

Chapter 1 31
 Elasticity of Demand and Price Markup
$/Q The more elastic is $/Q
demand, the less the
markup.

MC P* MC

P*
AR
P*-MC

MR

AR
MR

Q* Quantity Q* Quantity
Sources of Monopoly Power
• Why do some firm’s have considerable
monopoly power, and others have little or
none?
• A firm’s monopoly power is determined by
the firm’s elasticity of demand.

Chapter 1 33
Sources of Monopoly Power
• The firm’s elasticity of demand is
determined by:
1) Elasticity of market demand
2) Number of firms
3) The interaction among firms

Chapter 1 34
The Social Costs of Monopoly Power

• Monopoly power results in higher prices

and lower quantities.
• However, does monopoly power make
consumers and producers in the
aggregate better or worse off?

Chapter 1 35
Deadweight Loss from Monopoly Power
Because of the higher
$/Q price, consumers lose
A+B and producer
Lost Consumer Surplus
gains A-C.

MC
Deadweight
Loss
Pm
A
B
PC C
AR

MR

Qm QC Quantity

Chapter 1 36
The Social Costs of Monopoly Power

• Rent Seeking
– Firms may spend to gain monopoly power
• Lobbying
• Advertising
• Building excess capacity

Chapter 1 37
The Social Costs of Monopoly Power

• The incentive to engage in monopoly

practices is determined by the profit to be
gained.
• The larger the transfer from consumers to
the firm, the larger the social cost of
monopoly.

Chapter 1 38
The Social Costs of Monopoly Power

• Example
– 1996 Archer Daniels Midland (ADM)
successfully lobbied for regulations requiring
ethanol be produced from corn
• Question
– Why only corn?

Chapter 1 39
The Social Costs of Monopoly Power

• Price Regulation
– Recall that in competitive markets, price
regulation created a deadweight loss.
• Question:
– What about a monopoly?
• 1990s?

Chapter 1 40
Monopsony
• A monopsony is a market in which there is
a single buyer.
• An oligopsony is a market with only a few
buyers.
• Monopsony power is the ability of the
buyer to affect the price of the good and
pay less than the price that would exist in a
competitive market.
Chapter 1 41
Monopsony
• Competitive Buyer
– Price taker
– P = Marginal expenditure = Average
expenditure
– D = Marginal value

Chapter 1 42
 Competitive Buyer
Compared to Competitive Seller

$/Q Buyer $/Q Seller MC

ME = AE AR = MR
P* P*

MR = MC
ME = MV at Q* P* = MR
ME = P* P* = MC
P* = MV D = MV

Quantity Quantity
Q* Q*
 Monopsonist
$/Q
The marketBuyer
supply curve is the monopsonist’s
average expenditure curve

ME
Monopsony
•ME > P & above S
S = AE

PC
Competitive P*m
•P = PC
•Q = Q+C MV

Q*m QC Quantity

Chapter 1 44
Monopoly and Monopsony
$/Q Monopoly
Note: MR = MC;
AR > MC; P > MC

MC
P*

PC

AR

MR

Q* QC Quantity

Chapter 1 45
Monopoly and Monopsony
$/Q
ME Monopsony
Note: ME = MV;
ME > AE; MV > P

S = AE

PC
P*

MV

Q* QC Quantity
Chapter 1 46
Monopoly and Monopsony
• Monopoly • Monopsony
– MR < P – ME > P
– P > MC – P < MV
– Qm < QC – Q m < QC
– Pm > PC – Pm < PC

Chapter 1 47
Monopsony Power
• A few buyers can influence price (e.g.
automobile industry).
• Monopsony power gives them the ability
to pay a price that is less than marginal
value.

Chapter 1 48
Monopsony Power
• The degree of monopsony power
depends on three similar factors.
1) Elasticity of market supply
• The less elastic the market supply, the greater
the monopsony power.

Chapter 1 49
Monopsony Power
• The degree of monopsony power
depends on three similar factors.
2) Number of buyers
• The fewer the number of buyers, the less elastic
the supply and the greater the monopsony
power.

Chapter 1 50
Monopsony Power
• The degree of monopsony power
depends on three similar factors.
3) Interaction Among Buyers
• The less the buyers compete, the greater the
monopsony power.

Chapter 1 51
 Monopsony Power:
Elastic versus Inelastic Supply

ME
$/Q $/Q MV - P*
MV - P* S = AE

ME

S = AE
P*

P*

MV MV

Q* Quantity Q* Quantity
Deadweight Loss from
Monopsony Power

• Determining the
deadweight loss in
monopsony $/Q
– Change in seller’s ME
surplus = -A-C Deadweight Loss
– Change in buyer’s S = AE
surplus = A - B B
– Change in welfare = PC A C
-A - C + A - B = -C - B P*
– Inefficiency occurs
MV
because less is purchased

Q* QC Quantity

Chapter 1 53
Monopsony Power
The
The Social
Social Costs
Costs of
of Monopsony
Monopsony Power
Power

• Bilateral Monopoly
– Bilateral monopoly is rare, however, markets
with a small number of sellers with monopoly
power selling to a market with few buyers
with monopsony power is more common.

Chapter 1 54
Monopsony Power
The
The Social
Social Costs
Costs of
of Monopsony
Monopsony Power
Power

• Question
– In this case, what is likely to happen to price?

Chapter 1 55
Summary
• Market power is the ability of sellers or
buyers to affect the price of a good.
• Market power can be in two forms:
monopoly power and monopsony power.

Chapter 1 56
Summary
• Monopoly power is determined in part by
the number of firms competing in the
market.
• Monopsony power is determined in part by
the number of buyers in the market.

Chapter 1 57
Summary
• Market power can impose costs on
society.
• Sometimes, scale economies make pure
monopoly desirable.
• We rely on the antitrust laws to prevent
firms from obtaining excessive market
power.

Chapter 1 58
End of Chapter 10
Market
Market Power:
Power:
Monopoly
Monopoly and
and
Monopsony
Monopsony