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Chapter10:MarketPower:MonopolyandMonopsony120PARTIIIFIRMSTRUCTURECHAPTER10MARKETPOWER:MONOPOLYANDMONOPSONYTEACHINGNOTESThischaptercoversbothmonopolyandmonopsonyinordertohighlightthesimilaritybetweenthetwotypesofmarketpower.Thechapterbeginswithadiscussionofmonopolyinsections1-4.Section5firstdiscussesmonopsony,andthenoffersaninstructivecomparisonofmonopolyandmonopsony.Section6discussessourcesofmonopsonypowerandthesocialcostsofmonopsonypower,whilesection7concludeswithadiscussionofantitrustlaw.Ifyouarepressedfortimeyoumightchoosetoonlycoverthefirstfoursectionsonmonopolyandskiptheremainderofthechapter.Section7canbecoveredevenifyouchoosetoskipsections5and6.Thelastpartofsection1onthemultiplantfirmcanalsobeskippedifyouarepressedfortime.Althoughchapter8presentedthegeneralruleforprofitmaximization,youshouldreviewmarginalrevenueandpriceelasticityofdemandthroughacarefulderivationofEquation10.1.AdiscussionofthederivationofEquation10.1willelucidatethegeometryofFigure10.3.Pointoutthatbecausemarginalrevenueispositiveattheprofitmaximizinglevelofpriceandquantityforamonopolist,demandatthatquantityiselastic.Equation10.1alsoleadsdirectlytotheLernerIndexinSection10.2.Thisprovidesfruitfulgroundforadiscussionofamonopolist’smarketpower.Forexample,ifEdislarge(e.g.,becauseofclosesubstitutes),then(1)thedemandcurveisrelativelyflat,(2)themarginalrevenuecurveisrelativelyflat(althoughsteeperthanthedemandcurve),and(3)themonopolisthaslittlepowertoraisepriceabovemarginalcost.Toreinforcethesepoints,introduceanon-lineardemandcurveby,forexample,showingthelocationofthemarginalrevenuecurveforaunit-elasticdemandcurve.Oncethisconcepthasbeenclearlypresented,thediscussionoftheeffectofanexcisetaxonamonopolistwithnon-lineardemand(Figure10.5)willnotseemoutofplace.Thesocialcostsofmarketpowerareagoodtopicforclassdiscussion,andthistopiccanbeintroducedbycomparingthedeadweightlossassociatedwithmonopolywiththeanalysisofmarketinterventiongiveninChapter9.Forexample,compareFigure10.10withFigure9.5.GiventhatExercises(9),(13),and(15)involve“kinkedmarginalrevenuecurves,”youshouldpresentFigure10.11ifyouplantoassignthoseproblems.AlthoughFigure10.11iscomplicated,exposuretoitherewillhelpwhenitreappearsinChapter12.REVIEWQUESTIONS1.Amonopolistisproducingatapointatwhichmarginalcostexceedsmarginalrevenue.Howshoulditadjustitsoutputtoincreaseprofit?Whenmarginalcostisgreaterthanmarginalrevenue,theincrementalcostofthelastunitproducedisgreaterthanincrementalrevenue.Thefirmwouldincreaseitsprofitbynotproducingthelastunit.Itshouldcontinuetoreduceproduction,therebydecreasingmarginalcostandincreasingmarginalrevenue,untilmarginalcostisequaltomarginalrevenue.2.Wewritethepercentagemarkupofpricesovermarginalcostas(P-MC)/P.Foraprofit-maximizingmonopolist,howdoesthismarkupdependontheelasticityofdemand?Whycanthismarkupbeviewedasameasureofmonopolypower?Wecanshowthatthismeasureofmarketpowerisequaltothenegativeinverseofthepriceelasticityofdemand.PMCPED1Chapter10:MarketPower:MonopolyandMonopsony121Theequationimpliesthat,astheelasticityincreases(demandbecomesmoreelastic),theinverseofelasticitydecreasesandthemeasureofmarketpowerdecreases.Therefore,aselasticityincreases(decreases),thefirmhasless(more)powertoincreasepriceabovemarginalcost.3.Whyistherenomarketsupplycurveunderconditionsofmonopoly?Themonopolist’soutputdecisiondependsnotonlyonmarginalcost,butalsoonthedemandcurve.Shiftsindemanddonottraceoutaseriesofpricesandquantitiesthatwecanidentifyasthesupplycurveforthefirm.Instead,shiftsindemandleadtochangesinprice,output,orboth.Thus,thereisnoone-to-onecorrespondencebetweenthepriceandtheseller’squantity;therefore,amonopolizedmarketlacksasupplycurve.4.Whymightafirmhavemonopolypowerevenifitisnottheonlyproducerinthemarket?Thedegreeofmonopolypowerormarketpowerenjoyedbyafirmdependsontheelasticityofthedemandcurvethatitfaces.Astheelasticityofdemandincreases,i.e.,asthedemandcurvebecomesflatter,theinverseoftheelasticityapproacheszeroandthemonopolypowerofthefirmdecreases.Thus,ifthefirm’sdemandcurvehasanyelasticitylessthaninfinity,thefirmhassomemonopolypower.5.Whataresomeofthesourcesofmonopolypower?Giveanexampleofeach.Thefirm’sexploitationofitsmonopolypowerdependsonhoweasyitisforotherfirmstoentertheindustry.Thereareseveralbarrierstoentry,includingexclusiverights(e.g.,patents,copyrights,andlicenses)andeconomiesofscale.Thesetwobarrierstoentryarethemostcommon.Exclusiverightsarelegallygrantedpropertyrightstoproduceordistributeagoodorservice.Positiveeconomiesofscaleleadto“naturalmonopolies”becausethelargestproducercanchargealowerprice,drivingcompetitionfromthemarket.Forexample,intheproductionofaluminum,thereisevidencetosuggestthattherearescaleeconomiesintheconversionofbauxitetoalumina.(SeeU.S.v.AluminumCompanyofAmerica,148F.2d416[1945],discussedinExercise8,below.)6.Whatfactorsdeterminetheamountofmonopolypoweranindividualfirmislikelytohave?Explaineachonebriefly.Threefactorsdeterminethefirm’selasticityofdemand:(1)theelasticityofmarketdemand,(2)thenumberoffirmsinthemarket,and(3)interactionamongthefirmsinthemarke