MicroEconomics 5e by besanko braeutigam chapter 11

Copyright (c)2014 John Wiley & Sons, Inc Chapter 11 Monopoly and Monopsony Chapter Eleven Overview The Monopolist’s Profit Maximization Problem • • • The Profit Maximization Condition Equilibrium The Inverse Pricing Elasticity Rule Multi-plant Monopoly and Cartel Production The Welfare Economics and Monopoly Chapter Eleven Copyright (c)2014 John Wiley & Sons, Inc A Monopoly Definition: Definition:AAMonopoly MonopolyMarket Marketconsists consistsofofaasingle singleseller sellerfacing facingmany manybuyers buyers The Themonopolist's monopolist'sprofit profitmaximization maximizationproblem: problem: Max Maxπ(Q) π(Q)==TR(Q) TR(Q)- -TC(Q) TC(Q)QQ where: where:TR(Q) TR(Q)==QP(Q) QP(Q)and andP(Q) P(Q)isisthe the(inverse) (inverse)market marketdemand demandcurve curve Copyright (c)2014 John Wiley & Sons, Inc The Themonopolist's monopolist'sprofit profitmaximization maximizationcondition: condition: ∆TR(Q)/∆Q ∆TR(Q)/∆Q==∆TC(Q)/∆Q ∆TC(Q)/∆Q MR(Q) MR(Q)==MC(Q) MC(Q) Chapter Eleven A Monopoly – Profit Maximizing Monopolist’s demand Curve is downward-sloping • Along the demand curve, different revenues for different quantities • Profit maximization problem is the optimal trade-off between volume (number of units sold) and margin Copyright (c)2014 John Wiley & Sons, Inc (the differential between price) Chapter Eleven A Monopoly – Profit Maximizing P (Q) = 12 − Q Demand Curve: Total Revenue: TR (Q) = Q × P (Q) = 12Q − Q • Total Cost (Given): • Profit-Maximization: MR = MC 2 TC (Q ) = Q Copyright (c)2014 John Wiley & Sons, Inc • • Chapter Eleven A Monopoly – Profit Maximizing • As Q increases TC increases, TR increases first and then decreases • Profit Maximization is at MR = Copyright (c)2014 John Wiley & Sons, Inc MC Chapter Eleven A Monopoly – Profit Maximizing • MR>MC, firm can increase Q and increase profit MR 120 - 6QT = 50 + 4QT QT * = P* = 120 - 3(7) = 99 Chapter Eleven 50 Multi-Plant Monopolistic Maximization Example: P = 120 - 3Q …demand… MC1 = 10 + 20Q1 …plant 1… MC2 = 60 + 5Q2 …plant 2… monopolist's plants? MCT* = 50 + 4(7) = 78 Copyright (c)2014 John Wiley & Sons, Inc B What is the optimal division of output across the Therefore, Q1* = -1/2 + (1/20)(78) = 3.4 Q2* = -12 + (1/5)(78) = 3.6 Chapter Eleven 51 Cartel Definition: Definition: AAcartel cartelisisaagroup groupofoffirms firmsthat thatcollusively collusively determine determinethe theprice priceand andoutput outputininaamarket market InInother other words, words, aa cartel cartel acts acts as as aa single single monopoly monopoly firm firm that that Copyright (c)2014 John Wiley & Sons, Inc maximizes maximizestotal totalindustry industryprofit profit Chapter Eleven 52 Cartel The problem of optimally allocating output across cartel members is identical to the monopolist's problem of allocating output across individual plants Therefore, a cartel does not necessarily divide up market shares equally among members: higher marginal cost firms produce less This gives us a benchmark against which we can compare actual industry and firm output to see how far Copyright (c)2014 John Wiley & Sons, Inc the industry is from the collusive equilibrium Chapter Eleven 53 The Welfare Economies of Monopoly Since Since the the monopoly monopoly equilibrium equilibrium output output does does not, not, inin general, general, correspond correspondtotothe theperfectly perfectlycompetitive competitiveequilibrium equilibriumititentails entailsaadeaddeadweight weightloss loss Suppose Supposethat thatwe wecompare compareaamonopolist monopolisttotoaacompetitive competitivemarket, market, where wherethe thesupply supplycurve curveofofthe thecompetitors competitorsisisequal equaltotothe themarginal marginal Chapter Eleven Copyright (c)2014 John Wiley & Sons, Inc cost costcurve curveofofthe themonopolist monopolist 54 The Welfare Economies of Monopoly CS with competition: A+B+C ; CS with monopoly: A PS with competition: D+E ; PS with monopoly: B+D A M B P DWL DWL==C+E C+E C C E D Demand Q M MR Q C Chapter Eleven 55 Copyright (c)2014 John Wiley & Sons, Inc P MC Natural Monopolies Definition: A market is a natural monopoly if the total cost incurred by a single firm producing output is less than the combined total cost of two or more firms producing this same level of output among them Copyright (c)2014 John Wiley & Sons, Inc Benchmark: Produce where P = AC Chapter Eleven 56 Natural Monopolies Price Natural Monopoly falling average costs Natural Monopoly falling average costs Copyright (c)2014 John Wiley & Sons, Inc AC Demand Quantity Chapter Eleven 57 Barriers to Entry Definition: Definition: Factors Factorsthat thatallow allowan anincumbent incumbentfirm firmtotoearn earnpositive positiveeconomic economicprofits profitswhile whilemaking makingititunprofitable unprofitable for fornewcomers newcomerstotoenter enterthe theindustry industry 1.1 Structural StructuralBarriers BarrierstotoEntry Entry––occur occurwhen whenincumbent incumbentfirms firmshave havecost costorordemand demandadvantages advantagesthat thatwould wouldmake makeitit unattractive unattractivefor foraanew newfirm firmtotoenter enterthe theindustry industry Legal LegalBarriers BarrierstotoEntry Entry––exist existwhen whenan anincumbent incumbentfirm firmisislegally legallyprotected protectedagainst againstcompetition competition Strategic StrategicBarriers BarrierstotoEntry Entry––result resultwhen whenan anincumbent incumbentfirm firmtakes takesexplicit explicitsteps stepstotodeter deterentry entry Copyright (c)2014 John Wiley & Sons, Inc 2.2 3.3 Chapter Eleven 58 A Monopsony Definition: Definition:AAMonopsony MonopsonyMarket Marketconsists consistsofofaasingle singlebuyer buyerfacing facingmany manysellers sellers The Themonopsonist's monopsonist'sprofit profitmaximization maximizationproblem: problem: Max Maxππ==TR TR––TC TC==P*f(L) P*f(L)––w*L w*L where: where:Pf(L) Pf(L)isisthe thetotal totalrevenue revenuefor forthe themonopsonist monopsonistand andw*L w*Lisisthe thetotal totalcost cost The Themonopsonist's monopsonist'sprofit profitmaximization maximizationcondition: condition: Chapter Eleven Copyright (c)2014 John Wiley & Sons, Inc MRP MRPLL==P*MP P*MPLL==PP(∆Q/∆L) (∆Q/∆L) ==∆TC/∆L ∆TC/∆L==ww++LL(∆w/∆L) (∆w/∆L)==ME MELL 59 Monopsony - Example Q = 5L P = $10 per unit w = + 2L MEL = w + L (∆w/∆L) = + 4L Copyright (c)2014 John Wiley & Sons, Inc MRPL = P*(∆Q/∆L) = 10*5 = 50 MEL = MRPL + 4L = 50 (or) L = 12 W = + 2L = $26 Chapter Eleven 60 Inverse Elasticity Pricing Rule Monopsony Monopsonyequilibrium equilibriumcondition conditionresults resultsin: in: Copyright (c)2014 John Wiley & Sons, Inc MRPL − w = w ε L,w where: where:εεisisthe theprice priceelasticity elasticityofof labor laborsupply, supply, (w/L)(∆L/∆w) (w/L)(∆L/∆w) Chapter Eleven 61 Copyright (c)2014 John Wiley & Sons, Inc The Welfare Economies of Monopsony Chapter Eleven 62 ... subjecttotothe theconstraint constraintthat thatprice pricebe bedetermined determinedby bythe thedemand demandcurve curve Chapter Eleven 22 Price Elasticity of Demand Market A profit maximizing price... (c)2014 John Wiley & Sons, Inc • • • Chapter Eleven 12 Average Revenue Since TR PxQ AR = = =P Q Q The price a monopolist can charge to sell quantity Q is determined by the market demand curve the monopolists’... (c)2014 John Wiley & Sons, Inc below the demand curve Chapter Eleven 14 Marginal Revenue and Average Revenue ∆P = −1 ∆Q When P decreases by $3 per ounce, TR = P × Q = × = $35 million per year