Notes for Chapter 10 Monopoly

Notes for Chapter 10 Monopoly - Lecture Notes for Pindyck...

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Lecture Notes for Pindyck and Rubinfeld Chapter 10 Market Power: Monopoly and Monopsony Monopoly • A monopoly is a market with only one firm. • Entry into the market is blocked by technological or legal barriers. - e.g. Patents, trademarks, copyrights, or need a license from the government to produce • A natural monopoly is a monopoly that occurs because a firm benefits from economies of scale. This situation is likely to occur either when the market is small or when fixed costs are necessarily very large. e.g. Utilities (electricity, water and sanitation, etc.) - Until a few years ago it had been argued that the telecoms market was a natural monopoly. The massive fixed costs of laying cables into millions of homes meant that it was sensible to allow one company to have a monopoly. However, in recent years governments have deliberately broken up these monopolies or allowed new firms to enter the market. Technological advances, such as the invention of mobile phones, have removed the necessary conditions of natural monopoly. The Monopolist • The monopolist has market power. In other words, the monopolist is a price maker. ( Recall: perfectly competitive firms are price takers .) • The monopolist chooses price and quantity conditional on the consumers’ willingness to pay that price for that quantity of the good. • Essentially, the monopolist chooses a point on the demand curve.
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• The monopolist cannot choose any point above the demand curve because the consumers would not be willing to pay that price for that quantity of the good. • Likewise, the monopolist would not want to choose a point below the demand curve because the consumers would be willing to pay a higher price for that quantity of the good. Therefore, the monopolist chooses a point (a price and quantity) on the demand curve, since the demand tells us the willingness to pay for each quantity. D Willing to pay more Not willing to pay
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Revenue Effects When a monopolist increases output, price decreases, and there are two effects on revenue: 1. Revenue increases by the extra output times the price (area B). 2. Revenue decreases by output times the change in price (area C). With Monopoly, Initial Revenue (at p 1 ): A+C Revenue with one more unit: A+B Marginal Revenue: B – C = p 2 – C For a monopolist, since p is given by the demand curve, p = AR. However, as we see here, p is NOT equal to MR for the monopolist. Q Q + 1 Quantity, Q Units per year p 1 p 2 Price, p $ per unit Monopoly Demand curve A B C
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Recall that for a competitive firm, p=MR=AR Price, p , $ per unit q q + 1 Quantity (units per year) p 1 Recall that for a Competitive Firm: Demand curve A B
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The M onopolist’s Profit Maximization Problem: • Like all firms, the monopolist chooses output by setting marginal revenue equal to marginal cost. MR = MC
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Notes for Chapter 10 Monopoly - Lecture Notes for Pindyck...

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