Lecture Oligopoly

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Lecture Oligopoly

  1. 1. Monopoly and Oligopoly November 3, 1999
  2. 2. Announcements <ul><li>See web page for all exam information. </li></ul><ul><li>Please get to exam rooms on time and have your CU ID ready to show the proctor. </li></ul><ul><li>For room assignments, see the web page </li></ul><ul><li>Check the web page over the weekend for problem set #7 sometime on Sunday, maybe. </li></ul><ul><li>Otherwise we’ll have it in class on Monday. </li></ul><ul><li>How are the projects going?????? </li></ul>
  3. 3. Themes of Today’s Lecture <ul><li>Monopoly </li></ul><ul><li>Oligopoly </li></ul>
  4. 4. Monopoly - Structure <ul><li>single firm </li></ul><ul><li>no close substitutes </li></ul><ul><li>barriers to entry </li></ul><ul><li>full and symmetric information </li></ul>
  5. 5. Sources of Monopoly Entry Barriers <ul><li>Natural monopoly: the most efficient scale of production is so large, relative to market demand, that a single firm dominates the market. </li></ul><ul><li>Patents, copyrights, licenses, franchises: government protection of a firm’s right to produce a unique product. </li></ul><ul><li>Economic and/or legal restrictions, strategies or situations that make entry more difficult for new competitors than for the existing monopoly firm. </li></ul>
  6. 6. “Other” Monopolies - Good? Bad? <ul><li>Input Ownership </li></ul><ul><ul><li>DeBeer’s and diamonds </li></ul></ul><ul><li>Industry Secret or Know-how </li></ul><ul><ul><li>IBM and mainframes? </li></ul></ul><ul><li>Strategic Behavior </li></ul><ul><ul><li>buy ‘em up </li></ul></ul><ul><ul><li>blow’ em up </li></ul></ul><ul><ul><li>let’s make a deal </li></ul></ul><ul><ul><li>Microsoft and operating systems? </li></ul></ul>
  7. 7. Caveats <ul><li>monopoly does not => big </li></ul><ul><li>big does not => monopoly </li></ul><ul><li>monopoly does not => absolute and unlimited control over price </li></ul><ul><li>monopoly does not => must have economic profit </li></ul><ul><li>short run profit does not => monopoly power </li></ul><ul><li>monopoly does not => badly behaved firm </li></ul>
  8. 8. Classic Simple Monopoly <ul><li>Polar extreme from perfect competition. </li></ul><ul><li>Monopolist is a “price maker.” </li></ul><ul><li>Cost curves are pretty much the same (except in the case of natural monopoly). </li></ul><ul><li>The big change from before is in the demand side of the profit function. </li></ul>
  9. 9. The Simple Monopolist - Conduct <ul><li>The simple monopolist abides by the “law of one price.” Everyone pays the same market price for all units purchased. </li></ul><ul><li>A monopolist faces the declining market demand curve for its product and simultaneously chooses price and quantity. </li></ul><ul><li>Now P>MR (before P=MR) because the simple monopolist must lower the price on all preceding units to sell an additional unit. </li></ul><ul><li>A monopolist has no “supply curve.” </li></ul>
  10. 10. The Simple Monopolist: Rules for Profit Maximization <ul><li>Suppose we are in the short run. </li></ul><ul><li>Rules for profit maximization are the same as before. </li></ul><ul><li>If Q SM maximizes profit, then </li></ul><ul><ul><li>MR( Q SM ) = MC( Q SM ) </li></ul></ul><ul><ul><ul><li>very important note: for a simple monopolist P>MR at all positive levels of Q. </li></ul></ul></ul><ul><ul><li>Q SM is a max and not a min. </li></ul></ul><ul><ul><li>at Q SM it’s worth operating. </li></ul></ul>
  11. 11. Simple Monopoly <ul><li>Economic profits equal total revenue minus total costs. </li></ul><ul><li>Marginal revenue is the rate of change of total revenue (just like marginal cost is the rate of change of total cost) as quantity increases. </li></ul><ul><li>Economic profits are maximized when marginal revenue equals marginal costs </li></ul>
  12. 12. Graphical Display of Monopolist’s Solution <ul><li>The monopolist sets marginal revenue equal to marginal cost at MR=MC and considers producing Q=90. </li></ul><ul><li>The monopolist then gets the price off the demand curve. This implies a market price of $55/unit. </li></ul><ul><li>The monopoly profits (light blue in the graph) are the difference between price ($55) and average total cost ($44.44) times the number of units sold. </li></ul><ul><li>Notice that our monopolist is a “natural monopoly” since the average total costs decline over the entire relevant range of production. </li></ul><ul><li>Notice that if our monopolist operated at the competitive equilibrium (Price=MC=$30, Quantity=140), the firm would make a loss (ATC>Price). </li></ul>
  13. 13. Implications of the Monopolist’s Profit Maximum <ul><li>Price will exceed the competitive price. </li></ul><ul><li>Quantity will be less than the competitive quantity. </li></ul><ul><li>The monopolist sells the output at a price greater than marginal costs but the monopoly price can be above or below average total costs. Thus, the monopolist need not always make a profit. In the long run, of course, unprofitable monopolists will either stop production or raise the price further above marginal cost until it covers average total costs. </li></ul><ul><li>The monopolist will always try to operate on the elastic portion of the demand curve because when the elasticity of demand is greater than -1 (inelastic, between 0 and 1 in absolute value), marginal revenue is negative and, necessarily, less than marginal cost. </li></ul><ul><li>Since there is no entry to consider monopolists can have persistent long run economic profit. </li></ul>
  14. 14. Simple Monopoly- Performance <ul><li>Efficiency: </li></ul><ul><ul><li>Is the monopoly equilibrium Pareto Efficient? That is, at Q SM is net social surplus maximized? Does $MB=$MC at Q SM ? </li></ul></ul><ul><ul><li>Is the monopolist productively efficient? Does the monopolist operate at minimum efficient scale? </li></ul></ul><ul><li>Equity: </li></ul><ul><ul><li>Is the outcome of monopoly fair? Equitable? Just? </li></ul></ul>
  15. 15. Simple Monopoly- Performance Answers <ul><li>The simple monopoly equilibrium is not Pareto Efficient. </li></ul><ul><ul><li>The simple monopolist creates “dead-weight-loss.” </li></ul></ul><ul><ul><li>At Q SM , $MB>$MC . Recall: $MR=$MC at Q SM while $P SM >$MR at all Q. So $P SM >$MC. Since $P=$MB, then $MB>$MC. </li></ul></ul><ul><li>The simple monopolist may or may not be productively efficient. </li></ul><ul><li>Compared to the competitive equilibrium, there is a transfer of surplus from consumers to producers. </li></ul>

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