ajaz_eco_204_2012_2013_chapter_16_Market_Power - University...

University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute.
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ECO 204 Chapter 16: Analysis of Firms with Market Power (this version 2012-2013)
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Department of Economics (STG), ECO 204, Sayed Ajaz Hussain
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HAPTER
16: Analysis of Firms with Market Power
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Updated: 4/13/2013
Fixed typos are shaded yellow
1. Introduction
In the previous chapter we showed that a competitive firm does not have market power because its output does not
impact the market price, i.e. or that ( ) . In contrast, a “ monopolist ” – in the literal sense or in the
sense of being a dominant firm
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with – has total market power, where the market price is solely (or mostly)
determined by its output, i.e. ( ) where ( ) .
In this chapter we analyze and model a monopoly’s or a dominant firm ’s (hereafter “monopoly”) “optimal output and
price” . Indeed, we will even (temporarily) apply these “monopoly” models to analyze some types of “oligopolistic firms”
with partial market power. How? We will suspend reality and assume that these oligopolistic firms ‘compete’ with
“dormant /passive ” rivals – it is as if the oligopolistic firm competes in a vacuum and therefore can be modeled as a
“monopoly”. The main impetus fo r temporarily modeling an oligopolistic firm as a “monopoly” is because it provides a
“benchmark” for later chapters where we relax the assumption of “dormant rivals” and rigorously model strategic
interaction between firms.
2. Market Power
In this chapter, m arket “power” does not mean (as do “leftist” pseudo-intellectual pundits) that the monopolist “ forces
customers to buy its product or use its service ” ( only North Korea ’s Dear leader has that kind of power!). Rather, total
market power (“monopoly”) means that the price depends solely on one firm’ s output. For example, the only way the
monopolist can sell more output is by lowering the price. It goes without saying that most companies possess some
degree of market power. Here are some factors by which firms acquire some degree of market power:
Physical/Perceptual Product differentiation (literal or perceived): From ECO 100 you know that a lack of product
differentiation (“homogeneous good”) leads to price taking behavior or loss of market power. Hence, one way to have
some market power is by physical product differentiation (for example, the different types of hotels in the Starwood and
Marriott chain). However, from consumer theory we know that identical products may be perceived differently (the
linear utility model says that the consumer perceives goods to be the same, not that the goods are the same). Thus, even
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Thanks: Asad Priyo, Adam Michael Lavecchi, Francesca’s Crosstown Rebels Mix , and especially Akber Nafeh for typing practice problems and solutions. For
feedback, comments and typos please e-mail [email protected] Note to self: (1) Look at Ken Corts ’ cereal product proliferation case as an example of product