notes6 - Intermediate Microeconomics Part 6 Market...

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Intermediate Microeco- nomics Part 6: Market Structure II: Monopoly Jim Campbell The monopolist’s problem Graphical analysis Markup Inefficiency of monopoly Natural monopoly Price discrimination Monopsony Intermediate Microeconomics Part 6: Market Structure II: Monopoly Jim Campbell October 10, 2007 Intermediate Microeco- nomics Part 6: Market Structure II: Monopoly Jim Campbell The monopolist’s problem Graphical analysis Markup Inefficiency of monopoly Natural monopoly Price discrimination Monopsony What’s market structure? Let’s turn to one of the most loaded words in economics: monopoly. Recall from part 5 that monopoly is “one large price-setting firm in an industry with barriers to entry.” As we’ll see, the reason why “monopoly” is such a dirty word is that at worst they create inefficiency, and at best they transfer surplus from consumers to producers. Intermediate Microeco- nomics Part 6: Market Structure II: Monopoly Jim Campbell The monopolist’s problem Graphical analysis Markup Inefficiency of monopoly Natural monopoly Price discrimination Monopsony The monopolist’s problem The monopolist faces the entire demand curve, being the only firm in the industry. The monopolist’s objective is profit maximization: max y π = max y p ( y ) y c ( y ) dp ( y ) dy y + p ( y ) dc ( y ) dy = 0 dp ( y ) dy y + p ( y ) = dc ( y ) dy MR = MC The major difference from the perfectly competitive case is that the monopolist doesn’t simply face market price p , but faces price as a function of his output, p ( y ): since he faces the whole demand curve, his choice of y affects the market equilibrium price in the usual partial equilibrium way. Intermediate Microeco- nomics Part 6: Market Structure II: Monopoly Jim Campbell The monopolist’s problem Graphical analysis Markup Inefficiency of monopoly Natural monopoly Price discrimination Monopsony MR=MC The solution to the monopolist’s problem that we just derived was MR = MC . That shouldn’t be surprising at all! If MR > MC , increasing y yields more revenue than costs, so profit can be increased. If MR < MC , a decrease in output saves more in costs than the loss in revenue, so profits can be increased. And since there are barriers to entry in this industry, entry is not possible to exploit profitable opportunities (whose existence we’ll prove shortly). The long run analysis is identical: the monopolist can make profit in the long run.
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Intermediate Microeco- nomics Part 6: Market Structure II: Monopoly Jim Campbell The monopolist’s problem Graphical analysis Markup Inefficiency of monopoly Natural monopoly Price discrimination Monopsony Drawing the picture The diagram for the monopolist’s decision is quite complicated but very important.
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