# CHAPTER

8
CHAPTER OUTLINE
8.1 8.2 8.3 Monopoly Monopoly Power Sources of Monopoly Power

Market Power: Monopoly

8.4

The Social Costs of Monopoly Power

Prepared by:

Fernando Quijano, Illustrator

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Copyright © 2013 Pearson Education. 2 of 52 . ● market power Ability of a seller or buyer to affect the price of a good. • Microeconomics • Pindyck/Rubinfeld. Inc. 8e.● monopoly Market with only one seller.

MARGINAL.8.1 Monopoly Average Revenue and Marginal Revenue ● marginal revenue Change in revenue resulting from a one-unit increase in output.1 PRICE (P) \$6 5 4 3 2 1 TOTAL. Consider a firm facing the following demand curve: P = 6  Q TABLE 10. • Microeconomics • Pindyck/Rubinfeld. Inc. 3 of 52 . 8e. AND AVERAGE REVENUE QUANTITY (Q) 0 1 2 3 4 5 TOTAL REVENUE (R) \$0 5 8 9 8 5 MARGINAL REVENUE (MR) — \$5 3 1 1 3 AVERAGE REVENUE (AR) — \$5 4 3 2 1 Copyright © 2013 Pearson Education.

Inc. Copyright © 2013 Pearson Education.1 AVERAGE AND MARGINAL REVENUE Average and marginal revenue are shown for the demand curve P = 6 − Q.FIGURE 8. 4 of 52 . 8e. • Microeconomics • Pindyck/Rubinfeld.

8e. 5 of 52 . • Microeconomics • Pindyck/Rubinfeld.The Monopolist’s Output Decision FIGURE 8. Inc. Q1—it sacrifices some profit because the extra revenue that could be earned from producing and selling the units between Q1 and Q* exceeds the cost of producing them. Similarly. Copyright © 2013 Pearson Education.2 PROFIT IS MAXIMIZED WHEN MARGINAL REVENUE EQUALS MARGINAL COST Q* is the output level at which MR = MC. expanding output from Q* to Q2 would reduce profit because the additional cost would exceed the additional revenue. If the firm produces a smaller output—say.

. or MR = MC Copyright © 2013 Pearson Education.We can also see algebraically that Q* maximizes profit. Δπ /ΔQ = 0). Profit π is the difference between revenue and cost. Thus the profitmaximizing condition is that MR − MC = 0. Then ∆𝜋 ∆𝑄 = ∆𝑅 ∆𝑄 − ∆𝐶 ∆𝑄 = 0 But ΔR/ΔQ is marginal revenue and ΔC/ΔQ is marginal cost. 6 of 52 .e. Inc. both of which depend on Q: 𝜋 𝑄 = 𝑅 𝑄 − 𝐶 𝑄 As Q is increased from zero. profit will increase until it reaches a maximum and then begin to decrease. • Microeconomics • Pindyck/Rubinfeld. Thus the profit-maximizing Q is such that the incremental profit resulting from a small increase in Q is just zero (i. 8e.

8e. total profit is \$150. and the slopes of the total revenue and total cost curves are equal. The profit per unit is \$15. At this output level. the difference between the two. the point where marginal revenue equals marginal cost. the slope of the profit curve is zero. The profit-maximizing output is Q* = 10.3 C𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛: 𝐶 𝑄 = 50 + 𝑄2 𝐷𝑒𝑚𝑎𝑛𝑑: 𝑃 𝑄 = 40 − 𝑄 EXAMPLE OF PROFIT MAXIMIZATION Part (a) shows total revenue R. Copyright © 2013 Pearson Education.An Example FIGURE 8. and profit. Part (b) shows average and marginal revenue and average and marginal cost. Marginal revenue is the slope of the total revenue curve. • Microeconomics • Pindyck/Rubinfeld. 7 of 52 . Because 10 units are produced. the difference between average revenue and average cost. and marginal cost is the slope of the total cost curve. Inc. total cost C.

The ultimate determinant of monopoly power is therefore the firm’s elasticity of demand. The elasticity of market demand. The number of firms in the market. The interaction among firms. If there are many firms. the less elastic its demand curve. the more monopoly power a firm has. 2. Three factors determine a firm’s elasticity of demand.8. Because the firm’s own demand will be at least as elastic as market demand. the elasticity of market demand limits the potential for monopoly power.4) shows. 8e. 1. Copyright © 2013 Pearson Education.3 Sources of Monopoly Power As equation (10. 8 of 52 . each firm will be unable to profitably raise price very much if the rivalry among them is aggressive. Even if only two or three firms are in the market. Inc. with each firm trying to capture as much of the market as it can. 3. • Microeconomics • Pindyck/Rubinfeld. it is unlikely that any one firm will be able to affect price significantly.

the firm’s degree of monopoly power depends completely on the elasticity of market demand. 8e. A particular firm’s elasticity depends on how the firms compete with one another. OPEC could raise oil prices far above marginal production cost during the 1970s and early 1980s. the elasticity of market demand limits the potential monopoly power of individual producers. Because the demands for such commodities as coffee. tin. and copper are much more elastic. Inc.The Elasticity of Market Demand If there is only one firm—a pure monopolist—its demand curve is the market demand curve. In this case. • Microeconomics • Pindyck/Rubinfeld. When several firms compete with one another. and the elasticity of market demand limits the potential monopoly power of individual producers. Copyright © 2013 Pearson Education. attempts by producers to cartelize these markets and raise prices have largely failed. Because the demand for oil is fairly inelastic (at least in the short run). 9 of 52 . cocoa. In each case. the elasticity of market demand sets a lower limit on the magnitude of the elasticity of demand for each firm.

Sometimes there are natural barriers to entry: • Patents.The Number of Firms Other things being equal. 10 of 52 . we say that the market is highly concentrated. When only a few firms account for most of the sales in a market. ● barrier to entry Condition that impedes entry by new competitors. • Microeconomics • Pindyck/Rubinfeld. Copyright © 2013 Pearson Education. 8e. economies of scale may be so large that it is most efficient for a single firm—a natural monopoly—to supply the entire market. the monopoly power of each firm will fall as the number of firms increases. Inc. In some cases. and licenses • Economies of scale may make it too costly for more than a few firms to supply the entire market. copyrights.

8e. Monopoly power must therefore be thought of in a dynamic context. They might even collude (in violation of the antitrust laws). Because raising prices in concert rather than individually is more likely to be profitable. Other things being equal. Remember that a firm’s monopoly power often changes over time. Furthermore. • Microeconomics • Pindyck/Rubinfeld. 11 of 52 . as its operating conditions (market demand and cost). monopoly power is smaller when firms compete aggressively and is larger when they cooperate. collusion can generate substantial monopoly power. Inc. thereby reducing monopoly power over the longer term. real or potential monopoly power in the short run can make an industry more competitive in the long run: Large short-run profits can induce new firms to enter an industry. Copyright © 2013 Pearson Education. agreeing to limit output and raise prices. and the behavior of its competitors change. undercutting one another’s prices to capture more market share. its behavior. or they might not compete much.The Interaction Among Firms Firms might compete aggressively.

12 of 52 . 8e.4 The Social Costs of Monopoly Power FIGURE 8.10 DEADWEIGHT LOSS FROM MONOPOLY POWER The shaded rectangle and triangles show changes in consumer and producer surplus when moving from competitive price and quantity.8. The deadweight loss is B + C. Because of the higher price. Inc. consumers lose A + B and producer gains A − C. Pc and Qc. Pm and Qm. to a monopolist’s price and quantity. • Microeconomics • Pindyck/Rubinfeld. Copyright © 2013 Pearson Education.