Econ 410: Micro Theory Monopoly, Monopsony, and Monopolistic Competition

Econ 410: Micro Theory Monopoly, Monopsony, and Monopolistic Competition Wednesday, November 28 th, 2007

Announcement Bennett Harman, Deputy Assistant U.S. Trade Representative, is speaking on campus tomorrow. He is the lead trade negotiator for Latin America, and has been heavily involved in a variety of recent trade negotiations. The talk will be geared especially for UNC undergraduates Thursday, 3:30-4:30 pm 211 Gardner Hall

Social Costs of Monopoly We know from last time that monopoly power results in: Higher prices for a good than under competition Lower quantities sold However, does monopoly power make consumers and producers in the aggregate better or worse off? To find out, we can compare producer and consumer surplus between a competitive market and a monopoly

Social Costs of Monopoly We know that a perfectly competitive firm will produce where MC = D P C and Q C $ Lost Consumer Surplus MC But, a monopoly produces where MR = MC, getting their price from the demand curve P M and Q M P m P C A B C AR=D Because of the higher price, consumers lose A+B and the producer gains A-C. Deadweight loss is equal to B+C. MR Q m Q C Quantity

Sample Exam Question Maui Macadamia Inc. has a monopoly in the macadamia nut industry. Their demand, marginal revenue and marginal cost curves are: P = 360-4Q MR = 360-8Q MC = 4Q What level of output maximizes the sum of consumer and producer surplus? a) 0 b) 30 c) 45 d) 60 e) None of the above

Sample Exam Question Maui Macadamia Inc. has a monopoly in the macadamia nut industry. Their demand, marginal revenue and marginal cost curves are: P = 360-4Q MR = 360-8Q MC = 4Q What level of output maximizes the sum of consumer surplus & producer surplus? a) 0 b) 30 c) 45 d) 60 e) None of the above Quantity where P=MC

Sample Exam Question Maui Macadamia Inc. has a monopoly in the macadamia nut industry. Their demand, marginal revenue and marginal cost curves are: P = 360-4Q MR = 360-8Q MC = 4Q What is the profit maximizing level of output? a) 0 b) 30 c) 45 d) 60 e) None of the above

Sample Exam Question Maui Macadamia Inc. has a monopoly in the macadamia nut industry. Their demand, marginal revenue and marginal cost curves are: P = 360-4Q MR = 360-8Q MC = 4Q What is the profit maximizing level of output? a) 0 b) 30 c) 45 d) 60 e) None of the above Quantity where MR=MC

Sample Exam Question Maui Macadamia Inc. has a monopoly in the macadamia nut industry. Their demand, marginal revenue and marginal cost curves are: P = 360-4Q MR = 360-8Q MC = 4Q At the profit maximizing level of output, what is the level of consumer surplus? a) 0 b) 1,800 c) 2,700 d) 3,600 e) 4,800

Social Costs of Monopoly The social cost of a monopoly is likely to exceed deadweight loss due to rent seeking behavior Economic rents are those profits above and beyond a normal level Rent Seeking Firms may spend money to gain or continue to hold monopoly power Examples of rent seeking behavior Lobbying Advertising

Social Costs of Monopoly Example Phone Lobbies Phone Giants Are Lobbying Hard To Block Towns' Wireless Plans By JESSE DRUCKER and LI YUAN, THE WALL STREET JOURNAL June 23, 2005 Around the country, governments are contracting with providers other than the local telephone or cable companies to build or run wireless networks using Wi-Fi technology or fiber-optic cables. Wi-Fi provides high-speed access to the Web. Traditional telecom providers view such projects as a threat and are pushing for laws to curtail them. While the phone and cable companies control the valuable 'last mile' wired connections into homes and offices, the wireless networks bypass those lines and can connect directly to the networks of long-distance companies or fiber-optic providers. Are phone companies participating in rent-seeking behavior? Why or why not?

Natural Monopolies A natural monopoly is a firm that can produce the entire output of an industry at a cost lower than what it would be if there were several firms Usually arises when there are large economies of scale or high fixed costs If this type of market is split into two firms: Higher average costs for each firm will result than when only one firm is producing

Monopsonies A monopsony is a market in which there is a single buyer Similarly, 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 Monopsony buyers pay less than the price that would exist in a competitive market These buyers typically choose to buy until the benefit from last unit equals that unit s cost

Monopsonies How does a monopsonist compare with a buyer in a competitive market? A competitive buyer is a price taker P = Marginal expenditure = Average expenditure D = Marginal value For a monopsonist, the decision to buy an extra unit raises the price paid for all units. How are monopsonists are similar to monopolists? The marginal expenditure for an extra unit of a good exceeds price for a monopsonist A few large buyers in an industry is a more common case than a pure monopsony

Monopsony Power The degree of monopsony power for a firm depends on three factors: Number of buyers The fewer the number of buyers, the less elastic the supply and the greater the monopsony power Interaction Among Buyers The less competition, the greater the monopsony power Elasticity of market supply If supply is very elastic, markdowns below marginal value will be small The more inelastic the supply, the more monopsony power

Monopolistic Competition So far, we have discussed extreme cases of market structures Perfect Competition, Monopoly, Monopsony We can now begin to analyze markets that combine various aspects of all of these industries A monopolistically competitive industry is characterized by: A large number of firms Free entry and exit Differentiated products

Monopolistic Competition In this type of industry, the amount of monopoly power a firm has depends on the degree of product differentiation Brand preference can play a large role in product differentiation Examples of monopolistic competition Clothing and shoes (Nike, Adidas, etc.) Cleaning products (Lysol, Pine Sol, etc.) In this industry, products are differentiated but highly substitutable

Monopolistic Competition In the short run A firm s demand is downward sloping there is product differentiation Demand is relatively elastic the products are good substitutes A firm is making economic profits, MR < P In the long run Profits will attract new firms to the industry No barriers to entry A firm s output & price falls, industry output rises No economic profit (P = AC)

Monopolistic Competition $ Short Run MC $ Long Run MC AC AC P SR P LR D SR D LR MR SR MR LR Q SR Quantity Q LR Quantity

Economic Efficiency $/Q Are there social costs associated with monopolistically competitive markets? Perfect Competition MC AC $/Q Monopolistic Competition Deadweight loss MC AC P P C D = MR D LR MR LR Q C Quantity Q MC Quantity

Economic Efficiency The monopoly power inherent in this industry yields a higher price than perfect competition. If price was lowered to the point where MC = D, surplus would increase The amount of this increase is the yellow triangle deadweight loss. But, there are still no economic profits in the long run The firm is not producing at minimum AC Excess capacity exists.

Economic Efficiency The firm faces a downward sloping demand curve Because of this, the zero profit point is to the left of minimum average cost Excess capacity is inefficient LRAC would be lower with fewer firms Inefficiencies make consumers worse off Should these markets be regulated? Market power and deadweight loss are usually relatively small. The benefit of increased product diversity could easily outweigh deadweight loss.

For next time Please Read Pages 364-366 and 368-370 of your textbook The first parts of sections 10.5 and 10.6 Sections 12.1 and 12.2 Quiz Reminder This Friday Covering the concepts from sections 10.1, 10.3, and 10.4 that were emphasized in class Bring a basic calculator