Economics 2 Spring 2018 Professor Christina Romer Professor David Romer LECTURE 9 MONOPOLY February 13, 2018 I. OVERVIEW OF MARKET FAILURES A. What are market failures and why do they matter? B. Definition and source of monopoly II. THE KEY FEATURE OF A MONOPOLIST: DECLINING MARGINAL REVENUE A. Review of firm demand curve and marginal revenue under perfect competition B. Demand curve facing a monopolist C. Marginal revenue for a monopolist 1. Graphical derivation 2. Derivation using calculus III. SHORT-RUN PROFIT MAXIMIZATION FOR A MONOPOLIST A. MR = MC B. Implications IV. WELFARE ANALYSIS OF MONOPOLY A. Allocative inefficiency B. Distributional effects V. LONG-RUN PROFIT MAXIMIZATION FOR A MONOPOLIST A. Positive, negative, or zero economic profits B. The possibility of persistent positive profits and long-run inefficiency C. Example: An increase in demand VI. GOVERNMENT RESPONSES TO MONOPOLY
Economics 2 Spring 2018 Christina Romer David Romer LECTURE 9 Monopoly February 13, 2018
Midterm 1 Logistics: Announcements Tuesday, February 20, 2:10 3:30 If your GSI is Maxime Sauzet (Sections 103 & 104) or Wesley Huang (Sections 111 &112) go to 10 Evans. If your GSI is Todd Messer (Sections 107 & 108) go to 101 Life Sciences Addition Students with DSP accommodations should hear from Todd Messer about arrangements. Everyone else come to usual room.
Announcements (continued) Midterm 1 Format: Sample midterm. Short-answer questions; problems; multiple choice. You do not need a bluebook. Midterm 1 Coverage: Everything up through lecture on Thursday, February 15 (Externalities). Lecture, section, textbook, and additional readings.
Announcements (continued) Hints for Studying: Start now! Review lecture notes and slides; study problem set suggested answers. Pose yourself problems. Do the sample midterm by yourself.
Announcements (continued) Places to Get Help: Professor and GSI office hours. Review session: Friday, February 16, 4-6 p.m. in 2050 VLSB.
I. INTRODUCTION TO MARKET FAILURES
Overview So far we have been talking about well-functioning markets (lots of competition, no external effects). In this case, the market outcome maximizes the total surplus. Now we are going to think about market failures (when markets don t function well). Will show that market outcomes in these cases do not maximize the total surplus. Government intervention can make things better (reduce the deadweight loss).
Monopoly There is only one supplier of a good.
Barriers to Entry A barrier to entry is any force that prevents firms from entering a market. Main types of barriers to entry: Patents and other legal protections. High fixed costs. Anti-competitive practices.
II. KEY FEATURE OF A MONOPOLIST: DECLINING MARGINAL REVENUE
Perfect Competition Market Individual Firm P S 1 P mc 1 P 1 δ 1, mr 1 D 1 Q q 1 q Profit maximization: P=mr=mc
Marginal Revenue The additional revenue associated with producing and selling one more unit. The change in total revenue when one more unit is produced and sold.
Marginal Revenue for a Competitive Firm P P 1 δ a b q 1 q 1 +1 q
Monopoly P Q
Marginal Revenue for a Monopolist P P 1 a D 01 Q
Marginal Revenue for a Monopolist P P 2 P 3 b c d D Q 2 Q 2 +1 Q
Marginal Revenue for a Monopolist P P 4 P 5 e f g D Q 4 Q 4 +1 Q
The Marginal Revenue Curve of a Monopolist P Q
Relationship between Total Revenue and Marginal Revenue for a Monopolist Suppose the demand curve is: P = α βq Then total revenue as a function of Q is: Thus, marginal revenue is:
Relationship between Total Revenue and Marginal Revenue for an Individual Competitive Firm Suppose the demand curve is: P = α Then total revenue as a function of q is: Thus, marginal revenue is:
III. SHORT-RUN PROFIT MAXIMIZATION FOR A MONOPOLIST
Profit Maximization for a Monopolist P Q
Implications of Monopoly
IV. WELFARE ANALYSIS OF MONOPOLY
Comparison with Perfect Competition P MC D,MB MR Q
Welfare Comparison with Perfect Competition P a b MC P 1 P c c f d g e h D,MB Consumer Surplus Producer Surplus Total Surplus Deadweight Loss MR Q 1 Q c Q Competition (Q c ) Monopoly (Q 1 )
Distributional Effects of Monopoly P a b MC P 1 P c c f d g e h D,MB Q 1 Q c MR Q
V. LONG-RUN PROFIT MAXIMIZATION FOR A MONOPOLIST
P Positive Economic Profits P 1 MC D Q 1 MR Q
Negative Economic Profits P P 1 MC D Q 1 MR Q
Zero Economic Profits P P 1 MC D Q 1 MR Q
How Does a Monopolist Respond to Profits? If it is making negative profits, the monopolist will want to leave the industry. If it is making zero profits, it will be covering all of its opportunity costs. A monopolist can make positive economic profits in the long run.
Increasing Prevalence of Food Allergies
Increasing Prevalence of Food Allergies
Example: Increase in Demand P MC 1 P 1 D 1 Q 1 MR 1 Q
VI. GOVERNMENT RESPONSES TO MONOPOLY
Policies to Deal with Monopoly