séance 6 Flashcards
what is the key points to define a monopoly?
- Only one firm/supplier in the industry
- Barriers to entry: limits market entry
- Market power
- wants to maximize profit
what are the 3 types of barriers to entry?
- economic barriers
- legal barriers
- deliberately created barriers by actions taken by incumbent firms
when it comes to profit maximization, what is the difference between firms in perfect competition and monopoly?
profit maximization MR(q) = MC(q), but P>MR in monopolies, where as P=MR in perfect competition
what is the difference between the firm in perfect competition demand curve and the monopoly demand curve?
the demand curve of a perfect competition firm is horizontal: perfectly elastic.
the demand curve of a monopoly is a downward slope.
what can we say about the marginal revenue curve of a monopoly?
the marginal revenue curve lies below the demand curve
what is the trade off that monopolies face?
selling more units or selling at a higher price
what are the steps to be taken in order for the monopolist’s to find the optimal decision?
1) Solve Q: MR(Q) = MC(Q)
2) Find P using the demand curve
3) Compute the profit(Q) = R(Q) – C(Q) or profit(Q) = [P – AC(Q)] x Q
can monopolies have negative profits?
yes, monopolies can have negative profits in the short run: if F cost changes = average cost is higher
what is the definition of market power?
The ability to charge a price greater than the marginal cost without losing all its customers
what is a measure of market power?
the lerner index
the more market power a firm has, the higher…
the more market power a firm has, the higher the margin between price and marginal cost will be
how is the lerner index computed?
L=(P-MC)/P
a perfect competition firm has a lerner index of L=…
L=0, because P=MC
in regardes to the lerner index, the larger the difference between P and MC, the larger…
the larger L and the greater market power
if L=0,67 for a certain monopoly, what does that mean?
it means that, at the margin, 67% of the sales price contributes to the monopolist’s profit
how can the lerner index be rewritten in regards to the elasticity of demand?
L = -1 / Ed
why does trade-off depend on the elasticity of demand?
when demand is very elastic, an increase in price to increase the profit margin leads to a large decrease in volume; in that case, volume is more important than margin. when demand is fairly inelastic, one can achieve a good margin without loosing too much volume
TF: market power is directly linked to the elasticity of demand of the firm’s product
True
what does the rewritten form of the lerner index tells us? (L = -1/Ed)
when monopolists set the profit-maximizing price, its profit margin, expressed as a % of the price, is inversely proportinal to the elasticity of demand.
the more inelastic is the demand, the higher…
the more inelastic is the demand, the higher… the higher margin the monopolist can charge
what can we say about the market power and the margin of a monopoly facing elastic demand?
if elastic demand, Ep < -1, small L = weak market power and low margins
what can we say about the market power and the margin of a monopoly facing inelastic demand?
if inelastic demand, -1 < Ep < 0, large L = strong market power and high margins
where does market power comes from and what are the sources of market power?
Market power comes from demand inelasticity:
- Lack of substitute products
- Barriers to entry
- Transaction costs
- Legislation
what is the difference between the price in a competitive market and the price in the case of a monopoly?
- in a competitive market, P=MC
- under monopoly or market power, P>MC
why do monopolies lead to economic inefficiencies?
because a part of the surplus is lost: the DWL represents the social loss = loss economic efficiency and not just a transfer from consumers to the monopolist
what does the DWL measures in the case of a monopoly?
The DWL due to the monopoly provides a measure of how much worse-off people are paying the monopoly price than paying the competitive price.
what are the characteristics of a monopolistic competition?
- many firms and none have complete control on the market price
- firms have some market power
- firms compete by selling differentiated products that are highly substitutable for one another but not perfect substitutes: cross-price elasticities of demand are large but not infinite
- free entry and exit
what is product differentiation?
Product differentiation is the effort by firms to produce goods or services that are superior to those of other firms
what are the common types of differentiation?
- physical characteristics (quality, service, etc)
- convenience (location or time)
- lifestyle
what is a good tool for product differentiation?
advertising
what creates market power under monopolistic competition?
product differentiation
a monopolist faces a …. demand curve
a monopolist faces a downward sloping demand curve
a monopolist maximizes profits when …
MR(Q)=MC(Q)
the monopoly price is … than the competitive price
the monopoly price is higher than the competitive price
the monopolist’s output is … than the competitive output
the monopolist’s output is lower than the competitive output
what does the existence of a monopoly leads to?
- inefficient resource allocation
- decrease in consumer welfare
- overall loss for society: the DWL
TF: a monopoly can earn persistent economic profits
T, provided that source of monopoly power is not eliminated
TF: monopolistically competitive can earn positive economic profit?
A monopolistically competitive firm can earn economic profits in the short run, but entry by competing brands will erode these profits over time. Economic profit will be equal to 0 in the long run
