EC 109: Microeconomics
Topic 5: Market Structure
Monopoly
- When discussing markets, we assumed firms were price takers
Market Power: ability to affect market price
Monopsony: single buyer in a market
Monopoly: single seller in a market
- There are very few examples of pure monopolies
Armed services
Air traffic control
- But this depends on how we define the market
What counts as a substitute?
- There are many examples of near monopolies:
Google
Monsanto
Wikipedia
Luxottica
Koenig and Bauer
Natural Monopoly: only large-scale producer can lower average costs enough so LRAC < Price
- This is typically in an industry with large fixed cots
Power, water, telecoms
- But the largest and most valuable firms in the world do not typically look this way
Apple, Amazon, Alphabet, Microsoft, Facebook do not have large fixed costs
Platform: brings together different parties (buyers and seller, advertisers and viewers, etc.)
- They experience strong network effects
Network effects: new users increase surplus for current users
- This makes it more attractive, and new users join
Lock-in: makes it hard to establish a new firm since users would need to jointly move
Incumbent Competitor
Incumbent 5,5 0 ,−2
Competitor −2 , 0 8,8
- Monopolists exist due to some form of barrier to entry
Otherwise, profits would draw the attention of competitors
- Technical barriers include:
Strong increasing returns to scale due to large fixed costs or network effects
Access to specific raw materials (rare earth metals, oil)
Tacit expertise ('learning-by-doing’)
- Legal barriers could be:
Patents, copyrights, trademarks
Government licenses
- Monopolists will work hard to create additional barriers to entry:
Maintaining company secrecy
, Buying unique resources
Political lobbying
- May also lower durability of their product to reduce competition with future sales
- To find where they would price their product?
To maximize revenue, they must produce where MR=0
o Slope of MR is 1/2 the slope of the demand curve for linear demand
To maximize profits, they will produce at MR=MC
π ( p )=Q ( p ) p−c ( Q ( p ) ) −FC
π (Q )=Qp (Q )−c (Q )−FC
d π (Q) dp dc
= p (Q ) + Q − =0
dQ dQ dQ
MR=MC
- Average profit per unit is the difference price and AC
For monopolists, this is positive
- If monopolists maximize profits, this leads to underproduction relative to social optimum
¿∗¿¿
Social optimum is at Q where p ( Q )=c ' (Q):
o Marginal social benefit of extra Q is p ( Q )
o Marginal social cost of extra Q is c ' (Q)
- SO, deadweight loss is created
Perfect Competition
- Perfect competition usually assumes:
Many small buyers and sellers
Undifferentiated products (perfect substitutes)
Perfect information about prices
Equal access to resources and production technologies
- Hard to find many convincing real-world examples
But value of theory is that it gives a benchmark case to evaluate effects of competition
- Main implications are that:
Firms are price takers due to lack of differentiation
Transaction occur at a single market price due to perfect information
Free entry
- The slope of a demand function is affected by the elasticity of demand
Elasticity of demand is affected by:
Topic 5: Market Structure
Monopoly
- When discussing markets, we assumed firms were price takers
Market Power: ability to affect market price
Monopsony: single buyer in a market
Monopoly: single seller in a market
- There are very few examples of pure monopolies
Armed services
Air traffic control
- But this depends on how we define the market
What counts as a substitute?
- There are many examples of near monopolies:
Monsanto
Wikipedia
Luxottica
Koenig and Bauer
Natural Monopoly: only large-scale producer can lower average costs enough so LRAC < Price
- This is typically in an industry with large fixed cots
Power, water, telecoms
- But the largest and most valuable firms in the world do not typically look this way
Apple, Amazon, Alphabet, Microsoft, Facebook do not have large fixed costs
Platform: brings together different parties (buyers and seller, advertisers and viewers, etc.)
- They experience strong network effects
Network effects: new users increase surplus for current users
- This makes it more attractive, and new users join
Lock-in: makes it hard to establish a new firm since users would need to jointly move
Incumbent Competitor
Incumbent 5,5 0 ,−2
Competitor −2 , 0 8,8
- Monopolists exist due to some form of barrier to entry
Otherwise, profits would draw the attention of competitors
- Technical barriers include:
Strong increasing returns to scale due to large fixed costs or network effects
Access to specific raw materials (rare earth metals, oil)
Tacit expertise ('learning-by-doing’)
- Legal barriers could be:
Patents, copyrights, trademarks
Government licenses
- Monopolists will work hard to create additional barriers to entry:
Maintaining company secrecy
, Buying unique resources
Political lobbying
- May also lower durability of their product to reduce competition with future sales
- To find where they would price their product?
To maximize revenue, they must produce where MR=0
o Slope of MR is 1/2 the slope of the demand curve for linear demand
To maximize profits, they will produce at MR=MC
π ( p )=Q ( p ) p−c ( Q ( p ) ) −FC
π (Q )=Qp (Q )−c (Q )−FC
d π (Q) dp dc
= p (Q ) + Q − =0
dQ dQ dQ
MR=MC
- Average profit per unit is the difference price and AC
For monopolists, this is positive
- If monopolists maximize profits, this leads to underproduction relative to social optimum
¿∗¿¿
Social optimum is at Q where p ( Q )=c ' (Q):
o Marginal social benefit of extra Q is p ( Q )
o Marginal social cost of extra Q is c ' (Q)
- SO, deadweight loss is created
Perfect Competition
- Perfect competition usually assumes:
Many small buyers and sellers
Undifferentiated products (perfect substitutes)
Perfect information about prices
Equal access to resources and production technologies
- Hard to find many convincing real-world examples
But value of theory is that it gives a benchmark case to evaluate effects of competition
- Main implications are that:
Firms are price takers due to lack of differentiation
Transaction occur at a single market price due to perfect information
Free entry
- The slope of a demand function is affected by the elasticity of demand
Elasticity of demand is affected by:
