Chapter 11 - Monopoly and monopsony. This chapter presents the following content: the monopolist’s profit maximization problem, multi-plant monopoly and cartel production, the welfare economics and monopoly.
Chapter 11 Copyright (c)2014 John Monopoly and Monopsony Chapter Eleven Overview The Monopolist’s Profit Maximization Problem • • • The Profit Maximization Condition Equilibrium The Inverse Pricing Elasticity Rule Copyright (c)2014 John Multi-plant Monopoly and Cartel Production The Welfare Economics and Monopoly Chapter Eleven A Monopoly Definition: A Monopoly Market consists of a single seller facing many buyers Max (Q) = TR(Q) - TC(Q) Q where: TR(Q) = QP(Q) and P(Q) is the (inverse) market demand curve The monopolist's profit maximization condition: TR(Q)/ Q = TC(Q)/ Q MR(Q) = MC(Q) Chapter Eleven Copyright (c)2014 John The monopolist's profit maximization problem: Monopolist’s demand Curve is downward-sloping • • Chapter Eleven 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 (the differential between price) Copyright (c)2014 John A Monopoly – Profit Maximizing A Monopoly – Profit Maximizing • • • Demand Curve: P(Q) 12 Q Total Revenue: TR (Q) Q P(Q) 12Q Q Total Cost (Given): TC (Q ) Q Copyright (c)2014 John • Profit-Maximization: MR = MC Chapter Eleven • • Chapter Eleven As Q increases TC increases, TR increases first and then decreases Profit Maximization is at MR = MC Copyright (c)2014 John 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 Copyright (c)2014 John And, writing this as MCT as a function of QT: Multi-Plant Monopolistic Maximization Example: P = 120 - 3Q …demand… MC1 = 10 + 20Q1 …plant 1… MC2 = 60 + 5Q2 …plant 2… Copyright (c)2014 John B What is the optimal division of output across the monopolist's plants? MCT* = 50 + 4(7) = 78 Therefore, Q1* = -1/2 + (1/20)(78) = 3.4 Q2* = -12 + (1/5)(78) = 3.6 Chapter Eleven 51 Cartel Chapter Eleven Copyright (c)2014 John Definition: A cartel is a group of firms that collusively determine the price and output in a market In other words, a cartel acts as a single monopoly firm that maximizes total industry profit 52 Cartel 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 the industry is from the collusive equilibrium Chapter Eleven 53 Copyright (c)2014 John The problem of optimally allocating output across cartel members is identical to the monopolist's problem of allocating output across individual plants The Welfare Economies of Monopoly Suppose that we compare a monopolist to a competitive market, where the supply curve of the competitors is equal to the marginal cost curve of the monopolist Chapter Eleven 54 Copyright (c)2014 John Since the monopoly equilibrium output does not, in general, correspond to the perfectly competitive equilibrium it entails a dead-weight loss 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 B PC DWL = C+E C E D Demand QM MR QC Chapter Eleven 55 Copyright (c)2014 John PM MC 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 Benchmark: Produce where P = AC Chapter Eleven 56 Copyright (c)2014 John Natural Monopolies Natural Monopolies Price Copyright (c)2014 John Natural Monopoly falling average costs AC Demand Quantity Chapter Eleven 57 Barriers to Entry Structural Barriers to Entry – occur when incumbent firms have cost or demand advantages that would make it unattractive for a new firm to enter the industry Legal Barriers to Entry – exist when an incumbent firm is legally protected against competition Strategic Barriers to Entry – result when an incumbent firm takes explicit steps to deter entry Chapter Eleven 58 Copyright (c)2014 John Definition: Factors that allow an incumbent firm to earn positive economic profits while making it unprofitable for newcomers to enter the industry A Monopsony The monopsonist's profit maximization problem: Max = TR – TC = P*f(L) – w*L where: Pf(L) is the total revenue for the monopsonist and w*L is the total cost The monopsonist's profit maximization condition: MRPL = P*MPL = P ( Q/ L) = TC/ L = w + L ( w/ L) = MEL Chapter Eleven 59 Copyright (c)2014 John Definition: A Monopsony Market consists of a single buyer facing many sellers Monopsony - Example Copyright (c)2014 John Q = 5L P = $10 per unit w = + 2L MEL = w + L ( w/ L) = + 4L 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 equilibrium condition results in: L,w where: is the price elasticity of labor supply, (w/L)( L/ w) Chapter Eleven 61 Copyright (c)2014 John MRPL w w Copyright (c)2014 John The Welfare Economies of Monopsony Chapter Eleven 62 ... solution As b -> (demand becomes everywhere less elastic), P* -> infinity and P - MC, the "price-cost margin" also increases to infinity As b -> cost , the monopoly price approaches marginal Chapter. .. have: Q1 = -1 /2 + (1/20)MCT Q2 = -1 2 + (1/5)MCT Chapter Eleven 49 Multi-Plant Monopolistic Maximization Let MCT equal the common marginal cost level in the two plants Then: • QT = Q1 + Q2 = -1 2.5... 120 - 6QT = 50 + 4QT QT* = P* = 120 - 3(7) = 99 Chapter Eleven 50 Copyright (c)2014 John And, writing this as MCT as a function of QT: Multi-Plant Monopolistic Maximization Example: P = 120 - 3Q