L3: Monopoly

Question 1

monopoly

Answer 1

firm as the only supplier of a product

difference from perfect competition: monopoly fully controls price
- price taker vs. price setter

Question 2

monopolist’s marginal revenue

Answer 2

monopolist trades off loss on inframarginals with gain on marginals
- dp/dq is negative since demand curve is downwards sloping
- moving to the right means you gain marginal units by selling more but losing inframarginals because you charge lower prices

firms under perfect competition do not face this trade off since they are price-takers

Question 3

monopoly price is given by

Answer 3

lerner index = inverse of demand elasticity
- amount of profits firms have are a function of elasticities

p-mc/p = -1/e

Question 4

elasticity

Answer 4

% change in quantities divided by % change in prices

in practice, at an inelastic part of the demand curve, incentive to increase prices and decrease quantities to increase revenue in a proportionally larger way

intuition is that monopolist should be pricing at the elastic part of the demand curve

Question 5

efficiency

Answer 5

by increasing price, monopoly transfers rents from consumers to the firm
by reducing quantity, monopoly generates a deadweight loss so it is not pareto-optimal

deadweight loss where if the monopolist was pricing at MC, total surplus would be larger to include deadweight loss, but all of it would be consumer surplus
- social loss where monopolist takes advantage of dominant position to extract rents from consumers at the cost of social loss

Question 6

deadweight loss and lerner index

Answer 6

dwl = 1/2 |e| pqL^2

higher market power does not always imply higher deadweight loss
- deadweight loss depends on elasticities, other goods and prices

Question 7

sources of market power

Answer 7

government restrictions to entry
- natural monopoly
- property right to incentive innovation (drug patents)

structural barriers to entry that reduce profitability of entry
- economies of scale so entrant would have to be large
- sunk costs that cannot be recovered upon exit
- switching costs, search costs, differentiation, etc. that limit substitution

strategic behaviour and entry deterrence
- firms behave strategically to prevent firms from entering (i.e. predatory pricing)

Question 8

monopoly with a competitive fringe

Answer 8

monopoly with a dominant power but a fringe that competes with the monopolist
- monopolist can affect prices but the fringe cannot since they are price-takers

dominant firm may:
- hold a cost advantage potentially due to scale
- offer a higher quality product

Question 9

residual demand of the monopolist

Answer 9

demand the monopolist gets after the fringe sells their products
- what they choose to sell not given by market demand but market demand - units sold by fringe

MR is now marginal to residual demand

Question 10

result for the dominant firm with a competitive fringe

Answer 10

market demand decreases as a result of higher prices

increase price induces firms to increase output, which reduces residual demand

MR decreases less when the fringe is marginal

Question 11

multiproduct monopoly

Answer 11

monopolist sells two goods, with two different MC

direct effect: increasing price of good 1 reduces demand for good 1

cross-product effects: increasing price of good 1 affects demand for good 2
- increase in market power if they are substitutes
- loses market power if they are compliments