Economics 2 Professor Christina Romer Spring 2019 Professor David Romer LECTURE 9 MONOPOLY February 19, 2019 I. O VERVIEW OF M ARKET F AILURES A. What are market failures and why do they matter? B. Definition and source of monopoly II. T HE K EY F EATURE OF A M ONOPOLIST : D ECLINING M ARGINAL R EVENUE A. Review of firm demand curve and marginal revenue under perfect competition B. Demand curve facing a monopolist C. Marginal revenue for a monopolist 1. Graphical derivation 2. Derivation using calculus III. S HORT -R UN P ROFIT M AXIMIZATION FOR A M ONOPOLIST A. MR = MC B. Implications IV. W ELFARE A NALYSIS OF M ONOPOLY A. Allocative inefficiency B. Distributional effects V. L ONG -R UN P ROFIT M AXIMIZATION FOR A M ONOPOLIST A. Positive, negative, or zero economic profits B. The possibility of persistent positive profits and long-run inefficiency C. Example: An increase in demand VI. G OVERNMENT R ESPONSES TO M ONOPOLY
Economics 2 Christina Romer Spring 2019 David Romer L ECTURE 9 Monopoly February 19, 2019
Announcements • Midterm 1 Logistics: • Tuesday, February 26, 2:10–3:30 • Students with DSP accommodations should hear from Todd Messer about arrangements. If you don’t, please email him at: messertodd@berkeley.edu.
Announcements (continued) • Midterm 1 Format: • Sample midterm. • Short-answer questions; problems; multiple choice. • You do not need a bluebook. • Midterm 1 Coverage: • Everything up through lecture on Thursday, February 21 (Externalities). • Lecture, section, textbook, and additional readings.
Announcements (continued) • Hints for Studying: • Start now! • Review lecture notes and slides; study problem set suggested answers. • Pose yourself problems. • Do the sample midterm by yourself.
Announcements (continued) • Places to Get Help: • Professor and GSI office hours. • Review session: Friday, February 22, 6-8 p.m. in 2050 VLSB.
I. I NTRODUCTION TO M ARKET F AILURES
Overview • So far we have been talking about well-functioning markets (lots of competition, no external effects). • In this case, the market outcome maximizes the total surplus. • Now we are going to think about market failures (when markets don’t function well). • Will show that market outcomes in these cases do not maximize the total surplus. • Government intervention can make things better (reduce the deadweight loss).
Monopoly • There is only one supplier of a good.
Barriers to Entry • A barrier to entry is any force that prevents firms from entering a market. • Main types of barriers to entry: • Patents and other legal protections. • High fixed costs. • Anti-competitive practices.
II. K EY F EATURE OF A M ONOPOLIST : D ECLINING M ARGINAL R EVENUE
Perfect Competition Market Individual Firm P P S 1 mc 1 δ 1 , mr 1 P 1 D 1 q 1 q Q Profit maximization: P=mr=mc
Marginal Revenue • The additional revenue associated with producing and selling one more unit. • The change in total revenue when one more unit is produced and sold.
Marginal Revenue for a Competitive Firm P δ P 1 a b q q 1 q 1 +1 Marginal revenue from q 1 to q 1 +1: (a+b) − ( a) = b = P 1 . Marginal revenue is the same at every quantity (and equal to P 1 ).
Monopoly P D, δ Q
Marginal Revenue (MR) for a Monopolist P P 1 a D Q 01 Marginal revenue from 0 to 1: a. = P 1 .
Marginal Revenue for a Monopolist P P 2 b P 3 c d D Q Q 2 Q 2 +1 Marginal revenue from Q 2 to Q 2 +1: (c+d ) − (c+b) = d − b < P 3 .
Marginal Revenue for a Monopolist P P 4 e P 5 f g D Q Q 4 Q 4 +1 Marginal revenue from Q 4 to Q 4 +1: (f+g) − ( f+e) = g − e << P 5 .
The Marginal Revenue Curve of a Monopolist P D MR Q
Relationship between Total Revenue and Marginal Revenue for a Monopolist • Suppose the demand curve is: P = α − β Q • Then total revenue as a function of Q is: TR = P Q • = ( α − β Q) Q • = αQ − β Q 2 • Thus, marginal revenue is: dTR MR = dQ = α − 2 β Q
Relationship between Total Revenue and Marginal Revenue for an Individual Competitive Firm • Suppose the demand curve is: P = α • Then total revenue as a function of q is: TR = P q = α q • Thus, marginal revenue is: dTR MR = dq = α
III. S HORT -R UN P ROFIT M AXIMIZATION FOR A M ONOPOLIST
Profit Maximization for a Monopolist P MC P 1 D MR Q 1 Q Profit Maximization: MR = MC
Implications of Monopoly • A monopolist is doesn’t take the price as given. • However, the monopolist is constrained by the demand curve. • A monopolist doesn’t have a supply curve. • For a given demand curve, there is just one quantity the monopolist is willing to supply. • A monopolist doesn’t produce where MC = P. • As a result, a monopolist doesn’t produce where MC = MB.
IV. W ELFARE A NALYSIS OF M ONOPOLY
Allocative Efficiency • The sum of producer and consumer surplus (the total surplus) is as large as possible. • The competitive market outcome is allocatively efficient.
Comparison with Perfect Competition P MC P 1 P c D,MB MR Q 1 Q c Q Q 1 is the monopoly outcome; Q c is what would occur under perfect competition .
Welfare Comparison with Perfect Competition P MC a b P 1 c d e P c g h f D,MB MR Q 1 Q c Q Competition (Q c ) Monopoly (Q 1 ) Consumer Surplus a+b+c+d+e a+b Producer Surplus f+g+h c+d+f+g Total Surplus a+b+c+d+e+f+g+h a+b+c+d+f+g Deadweight Loss e+h
Distributional Effects of Monopoly P MC a b P 1 c d e P c g h f D,MB MR Q 1 Q c Q Area c+d is consumer surplus under perfect competition, but producer surplus under monopoly.
V. L ONG -R UN P ROFIT M AXIMIZATION FOR A M ONOPOLIST
Positive Economic Profits P MC P 1 ATC ATC 1 D MR Q 1 Q
Negative Economic Profits P MC ATC 1 ATC P 1 D MR Q 1 Q
Zero Economic Profits P MC ATC 1 , P 1 ATC D MR Q 1 Q
How Does a Monopolist Respond to Profits? • If it is making negative profits, the monopolist will want to leave the industry. • If it is making zero profits, it will be covering all of its opportunity costs. • A monopolist can make positive economic profits in the long run.
Increasing Prevalence of Food Allergies
Increasing Prevalence of Food Allergies
Example: Increase in Demand P MC 1 P 2 P 1 D 2 MR 2 D 1 MR 1 Q 1 Q 2 Q
VI. G OVERNMENT R ESPONSES TO M ONOPOLY
Policies to Deal with Monopoly • Antitrust laws – laws designed to promote competition and prevent monopolization. • Regulation. • Limits on patents and other legal protections. • Moral suasion.
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