8 - MS&E 241: ECONOMIC ANALYSIS Thomas A. Weber 8....

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MS&E 241: ECONOMIC ANALYSIS Thomas A. Weber 8. Market Power Winter 2009 Stanford University Copyright © 2009 T.A. Weber All Rights Reserved -2- MS&E-241-Winter-2009-TAW AGENDA What is Market Power? Monopoly Monopsony Price Discrimination Key Concepts to Remember
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-3- MS&E-241-Winter-2009-TAW Definition . Market power is the ability of a firm to increase its output prices above the competitive level , and/or to reduce its input prices below the competitive level . Monopoly - Single seller of a product Oligopoly - Small number of sellers of a product Monopsony - Single buyer of a product Oligopsony - Small number of buyers of a product MARKET POWER Sellers’ Market Buyers’ Market -4- MS&E-241-Winter-2009-TAW ANALYSIS OF MARKET POWER Initial Focus on Single Firm We first examine the case where one single firm has market power , in a monopoly or a monopsony. Other market participants’ actions are aggregated to a market demand (for monopoly) or a market supply (for monopsony). When more than one firm holds market power, it is necessary to model the interactions between those firms explicitly. For this, one needs the tools of Game Theory Since actions of all non-market-power-holding entities (the ‘other’ side of the market) are aggregated into a demand curve (or a supply curve), this is often referred to as partial equilibrium analysis . In general equilibrium analysis , the optimizing behavior of all market participants is explicitly taken into account (they could be price takers or not). We first focus on partial equilibrium analysis of monopoly and monopsony.
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-5- MS&E-241-Winter-2009-TAW AGENDA What is Market Power? Monopoly Monopsony Price Discrimination Key Concepts to Remember -6- MS&E-241-Winter-2009-TAW The quantity of commodity i a monopolist can sell, its “demand” D i (p) , is a decreasing function of the price p i . Equivalently, the price at which the firm can sell the product, referred to as its “inverse demand” p i (q i ,q -i ; p -i ) , is a decreasing function of the quantity q i . DEMAND CURVE Quantity of Good i Price of Good i q i p i (, ) (, ; ) ii i i i i i qD p p p pqq p = = Demand Curve Inverse Demand Curve
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-7- MS&E-241-Winter-2009-TAW () 0 dq d R q d C q dq d dR q d qd q Cq dq dq Π =⇔ = =− q Rq Cq pqq Cq Π= = { 0 dp q dC q pq pq q dq dq < >+ = OPTIMAL CHOICE OF MONOPOLY OUTPUT Assume that a monopolist produces a quantity q of a single output and that the market price at that output is given by the downward-sloping inverse market demand p(q). The monopolist’s cost function C(q) is increasing and convex . Monopolist’s profit: Revenue Cost First-order necessary optimality condition: Hence, In other words, the market price in a monopoly exceeds marginal cost! -8- MS&E-241-Winter-2009-TAW OPTIMAL MONOPOLY OUTPUT (Cont’d) q p q* p(q*) MRq MCq Competitive Output Monopoly Output
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-9- MS&E-241-Winter-2009-TAW () pd D p p D p ε =− MONOPOLY PRICING Inverse Elasticity Rule Consider the monopolist’s choice of a profit-maximizing price p, given its (downward- sloping) demand function D(p).
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8 - MS&amp;E 241: ECONOMIC ANALYSIS Thomas A. Weber 8....

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