Week 9 Flashcards
Market power relates to the ability of sellers to affect __________, and arises because of ____________.
prices; barriers to entry.
Legal market power is created by ___________, and arises due to ____________.
the government; copyrights.
Natural market power is created by ___________, and arises due to ____________.
market forces; economies of scale.
Janet knows a lot of people who do not like Marmite®, a yeast extract that is used as a spread on toast. She says that Marmite is so unpopular that Unilever, the company that manufactures Marmite®, cannot possibly have any monopoly power.
Do you agree with this analysis?
Even if Marmite® is not liked by all (or even many) consumers, Unilever can still be a monopoly and have pricing power among the consumers who do demand the good. As long as this good has no close substitutes, then Unilever may indeed have monopoly power.
Edgar says that a single firm in the wind power industry is unlikely to have a significant degree of monopoly power for an extended period of time. Since the cost of producing an additional unit of wind energy is so low, a large number of firms can enter the market and compete away economic profits.
Do you agree with this analysis?
No, Edgar’s argument ignores potentially large fixed costs that will act as a barrier to entry.
Edgar’s argument completely ignores the fixed costs associated with entering the wind energy market. The cost of producing the first unit is likely high enough to act as a barrier to entry to new firms, which gives the incumbent firm a significant degree of monopoly power
Network externalties
Network externalities occur when a product’s value increases as more consumers begin to use it. An example of this is Facebook, which gains value to users as more people join.
Marginal revenue for a monopolist’s demand curve
1). The marginal revenue curve for a monopolist has the same y-intercept as the demand curve but has twice the slope. Therefore, the marginal revenue curve has a y-intercept of $8 and an x-intercept of 4 units.
Which of the following best describes the relationship between price (P), marginal revenue (MR), and total revenue (TR) for a monopolist?
When MR is positive, TR is rising, and when MR is negative, TR is falling.
TR curve
The total revenue curve starts at 0 and rises as quantity rises as long as MR is above 0. The total revenue curve peaks MR = 0 and then it starts to fall, since MR starts to become negative.
Both competitive firms and monopolies produce at the level where marginal cost equals marginal revenue.
Then, other things remaining the same, why is price lower in a competitive market than in a monopoly?
Competitive markets face perfectly elastic demand and marginal revenue, while monopolies face downward-sloping demand and marginal revenue.
A firm in a competitive industry sets its price where marginal cost equals demand (which also equals marginal revenue in perfect competition), while a monopolist finds its optimal quantity where marginal cost equals marginal revenue and then sets its price based on the demand curve at that quantity.
At this profit-maximizing output level, you earn a profit of
Profit is equal to total revenue minus total cost at the profit-maximizing output level. Since marginal cost is fixed, we can find total cost by multiplying marginal cost by output
Imagine you are operating a monopolistically competitive toothpaste firm. How will you decide what price to charge for your toothpaste?
Imagine you are operating a perfectly competitive cafe. How will you decide what price to charge for your coffee?
Price given by demand curve where MC = MR
You will charge the current market price for coffee
Structure: monopoly
- There is only one firm in the market;
- It is large;
- Product differentiation n/a – it is the only supplier of the product.
- Complete barriers to entry (no market entry)
Should you open on Easter Sunday when you have to pay your staff more. What rule can help
Shutdown if P < AVC
Monopoly is a price maker
(it has full market power, which is a source of market failure)
Price maker
A seller who can alter the price of its good by adjusting the quantity it supplies to the market.
The fundamental cause of monopoly
The fundamental cause of monopoly is barriers to entry — a monopoly remains the only seller in its market because other firms cannot enter the market to compete with it.
3 sources of monopoly power
Resource based monopolies
Government created (legal) monopolies
Natural monopolies
Resource based monopolies
When a single firm owns a key resource for a product.
For e.g. the market for water. If a single firm owns the dams that supply water to a town, then that firm has a monopoly on water.
Monopoly resources are rare. Economies are large and resources are owned by many people.
- Government-created (legal) monopolies
When the government gives one person or firm the exclusive right to sell a good or service.
For e.g. a patent grants an inventor the exclusive right to manufacture and sell their invention and copyright laws grant a writer monopoly control over the sale of their work.
The benefits of patent and copyright laws are the increased incentives for creative activity. However, because these laws give one producer a monopoly, they lead to higher prices than under competition.
Natural monopolies
When a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.
For e.g. the distribution of water. To provide water to a town, a firm has to pay the fixed cost of building a new network of pipes throughout the town. However, after entry, each firm would have a smaller piece of the market.
Natural monopolies and economies of sale
An industry is a natural monopoly when there are economies of scale over the relevant range of output.
For e.g. club goods, such as uncongested toll roads. Because there is a large fixed cost of building the road and a negligible marginal cost of additional trips, the ATC of a trip falls as the number of trips rises.
- 1.1. Structure: sources of monopoly power
3. Natural monopolies
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Structure: monopoly versus perfect competition
The key difference between a competitive firm and a monopoly is the monopoly’s ability to influence the price of its output.
A competitive firm is small relative to its market and is a price taker.
A monopoly is the sole producer in its market and is a price maker.
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Structure: revenue curves
Like monopolistic competition, the MR and D curves always start at the same point on the vertical axis. The monopolist’s MR on all units after the first is less than the P of the good. Thus, a monopoly’s MR curve lies below its D curve
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Because a monopoly faces a downward-sloping D curve
Because a monopoly faces a downward-sloping D curve, to increase the amount sold, a monopoly firm must lower the P of its good. Thus the monopoly faces a tradeoff between the quantity it sells and the price it receives.
