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P&R Chap. 10
Market Power: Monopoly and Monopsony
47
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Pre-School
10/18/2013

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Term
marginal revenue
Definition
change in revenue resulting from a one-unit increase in output.
i.e. ∆R/∆Q

(∆R = ∆PQ)
Term
demand curve with a monopoly
Definition
= average revenue

straight diagonal, downward sloping (slope of 1)

marginal revenue curve steeper
Term
market power in a monopoly
Definition
ability of a seller of buyer to affect the price of a good
- "price setter"

A monopolist has market power. This means that a firm's actions can influence the price. By producing less, the fim can raise the equilibrium price.
Not a price taker.
Term
when a monopoly produces more goods...
Definition
MR and AR (demand) fall
- MR more steeply
Term
in monopoly, profit is maximized...
Definition
when marginal revenue equals marginal cost
(not just in a monopoly?)
Term
MC=S
Definition
because no one else is producing
- upward sloping due to scarce inputs (gets more expensive to produce as quantity increases)
Term
market equilibrium is where...
Definition
demand (AR) = supply (MC)

higher and to right of prof point
Term
object of regulation with a monopoly is...
Definition
... to recover DWL by facilitating entry into markets
- by inviting firms in and developing competition
(monopolies try to protect their market)
Term
monopolist's output decision/profit maximizing condition:
Definition
MR = MC
aka...
∆R/∆Q = ∆C/∆Q

(∆R = ∆PQ)

*triangle left of prof-max point: below MR, above MC -- lost profit from producing too little and selling at too high of a price

*triangle to the right of prof-max point: above MR and below MC -- lost profit from producing too much and selling at too low of a point
Term
marginal cost
Definition
∆C/∆Q
Term
pricing rule of thumb
Definition
P=MC/[1+(1/Ed)]

The price that the monopolist charges is the price at which buyers are willing to buy the pro t-maximizing quantity.
Term
why doesn't a monopolistic market have a supply curve?
Definition
the monopolist's output decision depends not only on marginal cost, but also on the shape of the demand curve

shifts in demand can lead to changes in price with no change in output, changes in output with no changes in prices, or changes in both price and output.

i.e. there is no one-to-one relationship between price and quantity produced.
Term
shifts in demand curve in monopolistic market
Definition
[review this]
Term
effect of a tax
Definition
new optimal production decision is MR=MC+t

- MC+t line is horizontal and moves up
- less is produced, as the price of the good gets higher, reducing demand
Term
multiplant firms
Definition
[review if need this]
Term
Ability to markup
Definition
(P-MC)/P
- equal to minus the inverse of the elasticity of demand facing the firm
- if demand is elastic, markup is small and firm has little monopoly power (and vice versa)
- will still shut down if not making profits
Term
elasticity of market demand...
Definition
limits the potential monopoly power of individual producers

eg: OPEC could increase oil prices, while attempts by coffee, cocoa, tin, etc producers to cartelize have largely failed
Term
if only one firm "a pure monopolist"...
Definition
its demand curve is the market demand curve.
Term
when only a few firms account for most of the sales in a market...
Definition
market is highly concentrated
Term
problem of collusion
Definition
raising prices in concert is more likely to be profitable than individually.
Term
natural monopoly
Definition
firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms

- because it has economies of scale (declining average and marginal costs) over its entire output range
Term
regulating the price of a natural monpoly
Definition
- if price regulated downward, firm would lose money and go out of business.
- [more....]
Term
why natural monopoly?
Definition
- because it has economies of scale (declining average and marginal costs) over its entire output range
Term
rate-of-return regulation
Definition
maximum price allowed by a regulatory agency is based on the (expected) rate of return that a firm will earn

- difficulty of agreeing on a set of numbers leads to delays in the regulatory response to changes in cost and other market conditions (regulatory lag)
Term
regulatory lag
Definition
- difficulty of agreeing on a set of numbers leads to delays in the regulatory response to changes in cost and other market conditions
Term
*triangle left of prof-max point:
Definition
below MR, above MC -- lost profit from producing too little and selling at too high of a price
Term
*triangle to the right of prof-max point:
Definition
above MR and below MC -- lost profit from producing too much and selling at too low of a point
Term
Price Elasticity (general)
Definition
ED = %∆Qd/%∆p
Term
deadweight loss from monopoly power
Definition
[review map]
Term
pros of price regulations
Definition
allows some DWL recovery
Term
cons of price regulations
Definition
- requires info we dont have
- economics rents (price above market price) = incentive to lobby for industry competitive
- hard to tell where supply curve is... thus hard to regulate at q*
- regs usually cannot pick efficient price

[more...]
Term
supply curve in a monopsony
Definition
average expenditure (price paid per unit of a good)
Term
marginal expenditure
Definition
additional cost of buying one more unit of a good
Term
demand curve in a monopsony
Definition
marginal value -- additional benefit derived from purchasing an additional unit of a good
Term
if competitive buyer takes market price as given...
Definition
marginal expenditure and average expenditure are constant and equal; quantity purchased is found by equating price to marginal value
Term
if competitive seller ALSO takes price as a given...
Definition
marginal revenue and average revenue are constant and equal. quantity sold is found by equating price to marginal cost.
Term
single employer example of a monopsony
Definition
employer "buying" labor
- lower wages, fewer jobs
Term
the monpolist produces where...
Definition
marginal revenue intersects marginal cost.
- average revenue exceeds marginal revenue, so that price exceeds marginal cost.
Term
the monopsonist purchases up to the point where...
Definition
marginal expenditure intersects marginal value.
- marginal expenditure exceeds average expenditure, so that marginal value exceeds price.
Term
effect of elasticity on monopsony power
Definition
- when supply is elastic, marginal expenditure and average expenditure do not differ by much, so price is close to what it would it would be in a competitive market

(and vice versa when supply is inelastic)
Term
bilateral monopoly
Definition
market with only one seller and one buyer
Term
parallel conduct
Definition
form of implicit collusion in which one firm consistently follows actions of another
Term
predatory pricing
Definition
practice of pricing to drive current competitors out of business and to discourage new entrants in a market so that a firm can enjoy higher future profits

(jiffy lube example)
Term
When a monopoly increases amount sold, it has two e ffects on total revenue:
Definition
- the output effect: More output is sold, so Q is higher.
- the price effect: To sell more, the price must decrease, so P is lower.
Term
the price effect in a monopoly
Definition
To sell more, the price must decrease, so P is lower.

- For a competitive firm there is no price effect. The competitive firm can sell all it wants at the given price.

- For a monopoly there is a price effect. It must reduce price to sell additional output.

So the marginal revenue on its additional unit sold is lower than the price, because it gets less revenue for previous units as well (it has to reduce price to the same amount for all units)
Term
- the output effect in a monopoly
Definition
More output is sold, so Q is higher.
Term
The price that the monopolist charges is....
Definition
the price at which buyers are willing to buy the pro t-maximizing quantity.
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