Handout 10: Monopoly and Monopsony Flashcards
Monopoly
A firm that is the sole provider of a good or service to a market.
Why might monopolies exist?
1) legal barriers to entry: patents, franchises, licenses
2) technical barriers to entry: ex. production of a good requires large fixed inv., but marginal costs of producing good (once fixed inv. is in place) are low. In this case, long-run avg. costs for a specific firm would decline as output expands. Since one big firm can produce any quantity at a lower avg. cost than several smaller firms, one firm will come to dominate the industry.
Barriers to entry
Factors that prevent new firms from entering the market
Natural monopoly
Firms with declining long-run avg. costs since their monopoly power is due to technological rather than legal factors
How will monopolists choose the quantity to produce and the price at which they sell their output?
-Choose output so that MR = MC, since they want to profit maximize but because they are NOT price-takers MR does NOT equal price. Increases in output result in reductions in market price, so MR will be less than price
Avg. revenue curve for monopolist
- Market demand curve for the good since monopolist is the only producer in market
- Traces out quantities of goods that will be purchased at different prices (since avg. revenue just equals the price that the firm receives for the good)
Marginal revenue
- Always less than the price of the good, since price elasticity of demand is negative
- Will be negative if demand for the good is inelastic (ie E^D is between -1 and 0). Therefore, no monopolist will ever produce an output level for which demand is inelastic.
- MR = P [1 + (1/E^D)]
Economic profits earned by monopolists
Price minus average cost
Why are monopoly markets inefficient?
Bc monopolist produces where the price (amount consumers are willing to pay for an extra unit of the good) exceeds the marginal cost (amount it would cost firm to produce an extra unit of the good) and creates a deadweight loss
Perfectly discriminating monopolist
- Firm able to charge each consumer the absolute maximum he or she is willing to pay for each additional unit of the good.
- Extracts all of the consumer surplus available in a given market
Monopsonist
- A firm that is the sole hirer of a particular input
- Employment and wages are lower in the presence of monopsony
What is the relationship between marginal expense and wage rate of additional person hired?
Marginal expense always exceeds the wage rate paid to that person. This is because not only does a newly hired warden receive the higher wage, but all previously hired wardens also get a higher wage. A monopsonist will take these extra expenses into account in its hiring decision.
Marginal expense
The cost of hiring one more unit of an output.
Where does monopsonist profit maximize?
Where MVP of labor = ME of labor
Why is the marginal expense of hiring an additional unit of input greater than market price for that input with a monopsony?
Since the monopsony is the only buyer of an input, the firm faces the entire market supply curve for the input. In order to increase its hiring of labor, the firm must move to a higher point on this supply curve. This will involve not only a higher wage to the last worker hired but also additional wages to those workers already employed.
-ME = w[1 + (1/E^S)]
