Market Power and Monopoly

 Market sets the price. Firm can sell all they want at the market price Demand Curve for the firm is perfectly elastic at the market price. Marginal Revenue = Change Revenue/Change in Output = Market Price. Market Price = D = MR
Market Price Market for Wheat
Chicago Mercantile Exchange

For a Perfectly Competitive firm The Demand = Marginal Revenue

40 30

Market Supply of Wheat

Price

Farmer in Nebraska

40 30

20 15 10

Market Demand for Wheat

Market Quantity Millions of Bushels of Wheat

20 15 10

Market Price = D = MR

1 2 3 4 5 6 7 8

20 40 60 80 100

Farmers Quantity of Wheat

Demand Curve for Firms with Market Power

$200

Market Power means the firm has some control over price which means the demand curve is downward sloping

175 150

Price

125

100 75
50 25

10

Quantity
3

Relation between the Demand Curve and Revenues

Price Discrimination: The firm charges each customer exactly what the customer is willing to pay for the product. No price Discrimination: All customers pay exactly the same price.
4

Demand Curve and Marginal Revenue Perfect Price Discrimination MR = (Change in Rev)/(Change in Q) D = MR only if firms can perfectly price discriminate P 6
Demand Schedule
P $5 $4 $3 $2
Marginal Revenue Cumulative Revenues 5

Qd 1
2 3 4

$5 $4 $3

$5 $9 $12

$2
$1

$14
$15

$1

Revenues = 2 $5 for the 1st + $4 for the second 1 + + $1 for the 5th
0 1 2 3 4 5

D = MR
6 7 8

Demand Curve and Revenues

No Price Discrimination: All customers pay the same price
P
6

Demand Schedule
P $5 $4 $3 $2

Qd 1
2 3 4

Revenues

$5

$8
$9 $8

Revenues = Price X Quantity = $3 X 3 = $9

D
1 2 3 4 5 6 7 8

$1

$5

Two Effects of a Price Change 1. Reprice effect. Change the price for existing customers. (lower price means existing customers pay less. raise price existing customers pay more). 2. Stimulation effect. Gain or lose new customers (Lower prices gain customers. Raise prices you lose customers)
7

No Price Discrimination Charging all customers the same price Example.

P
6

Lower price from $3 to $2.

Reprice effect: 3 existing pay $1 less = -$3 reprice effect. Stimulation effect: Sold to 1 new customer at price of $2 =$2 stim effect. Total effect = Reprice + Stim = -3 + 2 = -$1.
D
1 2 3 4 5 6 7 8

Two Effects of a Price Change 1. Reprice effect. Change the price for existing customers. (lower price means existing customers pay less. raise price existing customers pay more). 2. Stimulation effect. Gain or lose new customers (Lower prices gain customers. Raise prices you lose customers)
8

No Price Discrimination Charging all customers the same price

P
6 5

MR from the 4th unit = $2 - $1 * 3 customers = -$1

D
0 1 2 3 4 5 6 7 8

Demand and Marginal Revenue Curves

MR = (Change in Rev)/(Change in Q)
MR < Price for non price discriminating firm
P
6

Demand Schedule
P $5 $4 $3 $2

Qd 1
2 3 4

Revenues

MR

$5

$5
$3 $1 -$1 -$3
3

$8
$9 $8

$1

$5

D
0 1 2 3 4 5 6 7 8

MR
9

Revenue and Costs for Firms with Market Power

To facilitate comparison to Perfect Competition assume the same Short Run Cost Structure
Revenue Data
(2) Price (1) Quantity (Average Of Output Revenue) (3) Total Revenue (1) X (2) (4) Marginal Revenue

Cost Data
(5) (6) (7) (8) Average Total Cost Marginal Profit (+) Total Cost (1) X (5) Cost or Loss (-)

0 1 2 3 4 5 6 7 8 9 10

$172 162 152 142 132 122 112 102 92 82 72

$0 ] 162 ] 304 ] 426 ] 528 ] 610 ] 672 ] 714 ] 736 ] 738 ] 720

$162 142 122 102 82 62 42 22 2 -18

$190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00

$100 ] 190 ] 270 ] 340 ] 400 ] 470 ] 550 ] 640 ] 750 ] 880 ] 1030

$90 80 70 60 70 80 90 110 130 150

$-100 -28 +34 +86 +128 +140 +122 +74 -14 -142 -310

Can you See Profit Maximization?

10

Profit Maximization
Firms with market power
$200

Price, Costs, and Revenue

175

MC
150 Pm=$122 125 Economic Profit

100 75
50 25

ATC

A=$94

D MR=MC

MR
1 2 3 4 5 6 7 8 9 10

Quantity
11

Firms with Market Power

Monopoly Oligopoly Monopolistically Competitive Firms

12

Monopoly
A single seller in a market Must have barriers to entry else there would be entry and the economic profits would go to zero.
Special Recipe at a restaurant. Patented product Utility company

13

A monopoly can earn economic profits in the long run

$200 175

Price, Costs, and Revenue

MC
150 Pm=$122 125 Economic Profit

100 75
50 25

ATC

A=$94

D MR=MC

MR
1 2 3 4 5 6 7 8 9 10

Quantity
14

Monopolistically Competitive Firm

Product is differentiated from other producers But there are no barriers to entry. Very similar to perfect competition (zero profits)

15

Monopolist and Monopolistically Competitive Firms look the same in the short run.
Short-Run Economic Profits = (P-ATC)*Q = ($10-$9)*1000 =$1,000
MC

Price and Costs

ATC 10 9

Economic Profit
MR = MC

D1

MR 0 1000

Quantity
16

Monopolistically Competitive Firms can not earn economic profits in the long run
Short-Run Economic Profits ==(P-ATC)*Q ==($10-$9)*1000 =$1,000 LONG RUN Economic Profits (P-ATC)*Q ($9-$9)*950 =$0

MC

Price and Costs

ATC 10 9

Economic Profit
MR = MC

D1

MR 0 950 1000

Quantity
17