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Unformatted text preview: Chapter 23 Monopoly We will now turn toward an analysis of the polar opposite of the extreme assumption of perfect competition that we have employed thus far. 1 Under perfect competition, we have assumed that industries are composed of so many small firms that each firm has no impact on the economic environment in which decisions are made. As a result, we could assume that individual firms in an industry simply take the market price as given as they determine how much to produce in order to maximize profits. In the case of a monopoly, on the other hand, the firm must make a decision not only on how much to produce but also on what price to charge. There is, in the case of monopoly, no market to set the price. In this sense, the monopolist has some control over her economic environment (i.e. prices) that the competitive producer lacks. While we will often talk about a monopoly as if it was a fixed concept, it is important to keep in mind that monopoly power comes in more and less concentrated doses. Under perfect competition, the demand that a firm faces for its product is perfectly elastic because of the existence of many firms that produce the same product at the market price. Whenever a firm faces a demand curve for its product that is not perfectly elastic, it has some market power. For instance, I might produce a particular soft drink in a largely competitive market for soft drinks, but my soft drink is nevertheless a bit distinctive. In a sense, my soft drink is therefore a separate product with a separate market, but in another sense it is part of a larger market in which other firms produce close but imperfect substitutes. The demand curve for my soft drink may then not be perfectly elastic giving me some market power, but that power is limited by the fact that there are close substitutes in the larger soft drink market. If, on top of the existence of close substitutes, there is free entry into the soft-drink market, my market power is limited even more. We will treat this type of market in Chapter 26 as one characterized by monopolistic competition. In other settings, of course, there is less of an availability of substitutes for a particular firms product. If there are market entry barriers that keep potential competitors from producing sub- stitutes, my monopoly power would then be considerably more pronounced, and the demand for my product considerably less elastic. For now, we will simply treat monopolies as firms that face downward sloping demand curves in an environment where barriers to entry keep other firms from entering to produce substitute goods, and we will simply keep in mind that the elasticity of demand 1 This chapter presumes a basic understanding of demand and makes frequent references to the partial equilibrium models of Chapters 14 and 15. It furthermore presumes a basic understanding of cost curves as derived in Chapter 11 and summarized in Section 13A.1 of Chapter 13. 856 Chapter 23. MonopolyChapter 23....
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