Lecture 6. Monopoly Market
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1. Monopoly Market
2. (Conceptual distinction) Monopolistic Competition Market
3. (Conceptual distinction) Perfectly Competitive Market
4. (Conceptual distinction) Oligopoly Market
1. Monopoly (monopoly) (e.g., municipal water supply, cable TV)
⑴ Overview
① Definition: There is only one firm in the market, and the (downward‑sloping) demand faced by that firm is the market demand.
② Characteristic 1. A single supplier
③ Characteristic 2. No close substitutes
④ Characteristic 3. Complete barriers to entry
⑵ Causes of monopoly
① Economies of scale
○ Natural monopoly: A monopoly arising from economies of scale
○ Minimum efficient scale (MES): The output level at which average cost reaches its minimum
○ When the average cost curve keeps declining: If MES occurs only at a very high level of output, monopoly/oligopoly tends to arise
○ Reason: Only the firm with the largest output can produce at the lowest cost, i.e., most efficiently
② Government policy
○ Example 1. Patents
○ Example 2. Exclusive sales rights or state monopoly rights: In Korea, for instance, tobacco, ginseng, etc.
③ Competitive strategy
○ Example 1. Advertising (advertisement)
○ Positive aspects: [1] Intensifies competition and lowers market prices. [2] Provides information
○ Negative aspects: [1] False/exaggerated advertising that misleads consumers. [2] Can function as a barrier to entry
○ Example 2. Product differentiation
○ Example 3. Predatory pricing: Temporarily lowering prices to exclude competitors
○ Example 4. Tying: Bundling a monopoly product with another product to strengthen monopoly power in the other product as well
④ Lack of information
⑶ Comparison: perfect competition vs. monopoly
Table. 1. Comparison of a perfectly competitive market and a monopoly market
⑷ Equilibrium in a monopoly market
① Market demand curve: Because there is only one supplier, the demand faced by the firm is the market demand. It is also the AR (average revenue) curve.
Figure. 1. Market demand curves in perfect competition vs. monopoly
② Market supply curve
○ In a monopoly market, a supply curve is not defined
○ Reason 1. Since the monopolist controls price, the relationship between price and quantity supplied is not meaningful
○ Reason 2. A monopolist is a price setter and does not take the market price as given
○ Instead, price and output are determined where MC = MR
③ Market equilibrium: Production occurs at the profit‑maximizing output level qₘ.
④ Relationship between marginal cost and marginal revenue
⑤ Example: Suppose a monopolist has demand q(P) = 100 − P (where 0 ≤ P ≤ 100), and cost C(q) = q².
⑸ Welfare in a monopoly market
① (Reference) Gross benefit
② Total surplus (net social benefit, total welfare): A measure of the total satisfaction of producers and consumers
③ Deadweight loss (DWL): Also called the welfare triangle, excess burden, economic net loss, etc.
○ Case 1. Perfect competition: Total surplus is maximized. From the firm’s perspective, there is some loss.
○ P = MC
○ This situation is called the benevolent social planner’s problem.
○ The resulting market outcome is the socially optimal outcome.
Figure. 2. p‑q curve under perfect competition
○ Case 2. Monopoly: The monopolist’s surplus increases, but total surplus decreases by the amount of DWL.
○ P > MC
○ Why the MR curve lies below the demand curve: Because of the price effect and the quantity effect
○ Quantity effect: When one more unit is sold, total revenue increases by the price at which that unit is sold
○ Price effect: To sell the last unit, the monopolist must lower the price for all units sold, reducing total revenue
○ Due to the price effect, the MR curve lies below the demand curve (and thus below where MC would meet demand)
Figure. 3. p‑q curve under monopoly
○ Inefficiencies of monopoly
○ With profits largely guaranteed, incentives to work hard/innovate may be weak
○ Wasteful expenditures may be made to maintain barriers to entry
○ Monopoly can hinder technological progress (though some argue it can also promote innovation)
⑹ Price discrimination (price discrimination)
① Definition: Charging different prices to different buyers for the same product
② Prerequisites
○ The firm must have market power (so it can set prices)
○ Resale must be impossible (if resale is possible, arbitrage complicates the model)
○ Price elasticities of demand must differ across buyers/markets
③ Methods of price discrimination
○ Advanced purchase restrictions
○ Volume discounts
○ Two‑part tariffs
④ Case 1. Pure monopoly: No price discrimination
⑤ Case 2. Price discrimination using two prices
Figure. 4. Price discrimination using two prices
Figure. 5. Profit maximization of a discriminating monopolist
○ MRA = MRB: If profits differ, the firm produces more for the side with higher profit
○ MRA = MRB = MC: The supplier increases total output up to the point that maximizes total profit
○ Consumers with lower price elasticity are less sensitive to price, so they are charged a relatively higher price
○ Compared to pure monopoly, output is higher and the welfare loss is smaller
⑥ Case 3. Perfect price discrimination (perfect price discrimination): Also called first‑degree price discrimination
○ Definition: The monopolist knows each consumer’s maximum willingness to pay and charges exactly that amount
○ Characteristic 1. No deadweight loss: Output is the same as under perfect competition
○ Characteristic 2. Consumer surplus is zero: All surplus is captured as the monopolist’s profit
○ Example: Flea markets
○ In practice, it is difficult because the firm does not know consumers’ reservation prices
⑺ Government policies toward monopoly
① Nationalization (state ownership)
○ Inefficient because there is no incentive to minimize costs
② Price regulation
○ For a natural monopoly, average cost slopes downward; marginal cost should of course lie below average cost
Figure. 6. Price–demand curve for a natural monopoly firm
○ Marginal‑cost pricing: Set price at P = MC
○ Advantage: Efficient resource allocation
○ Disadvantage: Deficits occur. For natural monopolies with economies of scale, the firm may incur losses.
○ Average‑cost pricing: Set price at P = AC
○ Advantage: No deficit (prevents the monopolist from losing money)
○ Disadvantage: Inefficient resource allocation
○ Mankiw’s view: No matter what price regulation is chosen, it is hard to avoid inefficiency due to the capture theory of regulation
○ Capture theory of regulation: If regulation persists for a long time, a close relationship forms between regulators and the regulated, and regulators end up setting policy in the direction desired by the regulated party
○ Krugman’s view: It is acceptable as long as the price ceiling is not set too high
③ Pro‑competition policy
○ Privatization to encourage competition
○ In the U.S., when the electric power infrastructure industry was broken up and privatized, blackouts and fires occurred frequently
④ Antitrust law
○ Sherman Antitrust Act (1890): Defined agreements among oligopolistic firms as criminal acts
○ Clayton Act (1914): Strengthened antitrust law further and enabled private lawsuits even against attempts to collude
2. (Conceptual distinction) Monopolistic competition market (monopolistic competitive market) (e.g., novels, movies)
⑴ Characteristics
① Many suppliers: Similar to perfect competition in terms of the number of sellers
② Product differentiation: Individual firms are not price takers
○ They face a downward‑sloping demand curve
○ Each product attempts differentiation under a brand name, gaining some degree of market power
○ Non‑price competition: Competition via means other than price
③ Free entry: Firms enter and exit until economic profit becomes zero
⑵ Formalization
① Profit maximization problem
② Elasticity of demand: If ε_{q,P} > 1, demand is said to be elastic
③ Lerner index: Also called percentage markup, market power
⑶ Short‑run market equilibrium
Figure. 7. Short‑run equilibrium curve in monopolistic competition
① The diagram is the same as the short‑run equilibrium curve under monopoly, but differs in that it represents an individual firm’s curves
② Production occurs where ε > 1. Positive profit is earned
⑷ Long‑run market equilibrium
As other firms enter, the demand curve continues to shift downward from the short‑run equilibrium.
Figure. 8. Long‑run equilibrium curve in monopolistic competition
① Characteristic 1. Output below the minimum point of the long‑run average cost curve: implies excess capacity
② Characteristic 2. Why the ATC curve is tangent to the demand curve at the Q where MR = MC: because profit is maximized at zero
3. (Conceptual distinction) Perfectly competitive market (perfectly competitive market) (e.g., agricultural products, milk)
4. (Conceptual distinction) Oligopoly market (oligopoly market) (e.g., tennis balls, cigarettes)
Posted: 2020.04.14 22:58