Imperfect Competition (Monopoly) Chapters 15 Mankiw

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1 Imperfect Competition (Monopoly) Chapters 15 Mankiw

2 What did we learn one week ago? Regulated prices Effect of a ceiling price Effect of a floor price. The cost of taxes and subsidies. Tax on producers or consumers. Effects of a tax on efficiency and surpluses Determinants of the deadweight loss Elasticities and the distortion of taxes/subsidies. Incidence of a tax/subsidy.

3 Market When markets are not efficient we say that there is a market failure then...?

4 then...? We need government intervention in order to markets to function efficiently.

5 Examples of Market Market Power Asymmetric Information Externalities Pubic Goods

6 Market Power

7 Market Power Market power exists when at least one agent (buyer or seller) has the capacity to change the market price, i.e. is not a price-taker. Examples Monopoly: only one firm. Oligopoly: few firms. Monopolistic Competition: many firms that sell differentiated products.

9 Monopoly A firm is a monopoly if it is the only one that sells a good that does not have close substitutes. As this firm does not have any competitors, it can alter the selling price in order to maximize its benefits.

10 Why monopolies arise?

11 If you were the owner of the only water well in the desert, for how much will you sell it for?

12 Why a monopoly arises? 1. Only one firm is owner of an essential good

14 Why do monopolies arise? 2. The government gives exclusive licenses to produce a good or exploit a resource. Promote R+D: Patents. Promote creation: copyrights. Exploit natural resources.

16 Why do monopolies arise? 3. The production of a good requires high fixed costs relative to the market size (Electric networks, train networks etc. ) Therefore, only one firm can operate with profit Natural Monopoly

18 Why do monopolies arise? 4. One firm adopts methods to limit the entry of its competitors. A firm that makes market dumping in order to make entry for the competitors more expensive. A firm that is the owner of an essential input/ infrastructure for the production of other goods that denies access of its competitors to that input.

19 How does a monopolist behave?

20 The monopolist chooses the price (or the quantity) that maximizes its profits, just as a competitive firm, but

22 Reminder: Max. Profits in perfect competition P,MgC ( ) (MgR=)P=MgC MgC P=MgR

23 Reminder: Marginal revenue under perfect competition P Production effect 6 P=MgR 4 5 Q

24 Marginal revenue of a monopolist Price ( ) Price effect Production effect

25 Total and marginal revenue of a monopolist Demand Price (P) Quantity (Q) Total revenue (IT=PxQ) Marginal revenue (IM= IT/ΔQ) Marginal revenue can be negative!!!

26 Deman Curve Price ( ) D teddy

27 Marginal revenue curve is below the demand curve since there is no price descrimination

28 Marginal revenue of the monopolist Price ($) D MgR

29 Monopolist: profit maximization Price (x100 ) MgC MgR D N. houses

30 Maximization of the benefit of the monopoly Price A Marginal Cost Monopoly Price Monopoly Benefit B C Marginal Revenue Demand 0 Monopoly Quantity Quantity

31 Profit Maximization Comparing Monopoly and Competition For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. P > MR = MC Copyright 2004 South-Western

32 Price A Marginal Cost Monopoly Price B C Marginal Revenue Demand 0 Monopoly Quantity Quantity

33 EXAMPLE The Market for Drugs Costs and Revenue Price during patent life Price after patent expires Marginal revenue Demand Marginal cost 0 Monopoly quantity Competitive quantity Quantity Copyright 2004 South-Western

34 The inefficiency of monopoly While pursuing its own interest, does it also pursue others interests?

35 Efficiency in perfect competition Price A Marginal Cost Price in perfect competition Consumer Surplus Producer Surplus B B Demand C 0 Quantity in Quantity Perfect competition

36 Welfare loss due to monopoly Price Monopoly Price A Consumer surplus Deadweight loss B Benefit of monopoly Marginal Cost Demand C Marginal Revenue 0 Monopoly Quantity Quantity

37 Exercise ( not easy ) Consider the following data for a Monopolist: the price that maximises profit is 16 euros, Marginal income equals marginal cost when 10 units are produced and the marginal cost is equal to 8, total surplus is maximum when 14 units are produced. Therefore, deadweight loss equals: A) 8. B) 16. C) 48. D). Impossible to find

38 Are monopolies desirable from a social point of view? Should we?

39 Inefficiency of monopoly The monopolist stops producing units for which the cost is lower than the value that the society gives them; and this results in a welfare loss.

41 Can he help us?

42 Public Policy over Monopolies Competition Policy: ensuring that markets are more competitive. Regulation: Regulating the conduct of monopolies. Public Companies: the government is the provider of the good (or service)

43 Comparative statics of the monopoly How does the price of a monopoly change if its costs increase? In which markets we face higher prices?

44 Monopoly price is higher if its marginal cost increases Price P P MC MC Demand Marginal Revenue 0 Quantity

45 What does the monopoly s behavior depend on? The monopoly price will be greater in markets where The demand is less elastic.

47 Figure 10 Welfare with and without Price Discrimination Price (a) Monopolist with Single Price Consumer surplus Monopoly price Profit Deadweight loss Marginal cost Marginal revenue Demand 0 Quantity sold Quantity Copyright 2004 South-Western

50 Examples of Market Market Power Asymmetric Information Externalities then...? Pubic Goods

51 Asymmetric Information Moral Hazard

52 What did we learn today? The market fails if there is market power, asymmetric information, adverse selection, externalities or public goods. A monopoly maximizes its benefits equating marginal revenue and marginal cost, which means that the prices are higher than the marginal cost and there is a loss of economic welfare. More segregated market structures (oligopoly, monopolistic competition) also generates losses in economic welfare, however they do better than monopoly. This justifies state intervention through Regulation and Competition Policy.

53 SEE YOU SOON...

Monopoly. Cost. Average total cost. Quantity of Output

Monopoly. Cost. Average total cost. Quantity of Output While a competitive firm is a price taker, a monopoly firm is a price maker. A firm is considered a monopoly if... it is the sole seller of its product. its product does not have close substitutes. The