class: center, middle, inverse, title-slide .title[ # Microeconomics II ] .subtitle[ ## <div class="line-block">Market Power: Monopoly and Monopsony</div> ] .author[ ### Guillermo Woo-Mora ] .date[ ### <div class="line-block">Paris Sciences et Lettres<br /> Spring 2025</div> ] --- <style> .center2 { margin: 0; position: absolute; top: 50%; left: 50%; -ms-transform: translate(-50%, -50%); transform: translate(-50%, -50%); } </style> .center2[ # Introduction ] --- ## Introduction <img src="imgs/markups_1.png" width="70%" style="display: block; margin: auto;" /> --- ## Introduction <img src="imgs/markups_2.png" width="70%" style="display: block; margin: auto;" /> --- ## Introduction <img src="imgs/income-share-of-the-richest-1.svg" width="70%" style="display: block; margin: auto;" /> --- .center2[ # Monopoly ] --- ## Monopoly Market with only one seller. -- The monopolist *is* the market and completely controls the amount of output offered for sale. How to choose how much to sell and at what price? -- - **Marginal Revenue (MR)**: Change in revenue resulting from a one-unit increase in output. - **Marginal Costs (MC)**: Increase in cost resulting from the production of one extra unit of output. --- ## Monopoly: Revenues Demand curve: `$$P = a -bQ$$` -- Revenue (not profit): `$$\textit{Revenue} = P \cdot Q$$` -- $$\Rightarrow \textit{Revenue} = (a-bQ) \cdot Q = aQ -bQ^2 $$ -- .pull-left[ ### Average Revenue $$\textit{Average Revenue} = \frac{\textit{Revenue}}{Q} = a -bQ = P $$ ] -- .pull-right[ ### Marginal Revenue `$$\textit{Marginal Revenue} = \frac{d \textit{Revenue}}{dQ} = a -2bQ$$` ] --- ## Revenue | Price (P) | Quantity (Q) | Total Revenue (R) | Marginal Revenue (MR) | Average Revenue (AR) | |-----------|-------------|-------------------|----------------------|---------------------| | **6** | **0** | **0** | **—** | **—** | --- ## Revenue | Price (P) | Quantity (Q) | Total Revenue (R) | Marginal Revenue (MR) | Average Revenue (AR) | |-----------|-------------|-------------------|----------------------|---------------------| | 6 | 0 | 0 | — | — | | **5** | **1** | **5** | **5** | **5** | --- ## Revenue | Price (P) | Quantity (Q) | Total Revenue (R) | Marginal Revenue (MR) | Average Revenue (AR) | |-----------|-------------|-------------------|----------------------|---------------------| | 6 | 0 | 0 | — | — | | 5 | 1 | 5 | 5 | 5 | | **4** | **2** | **8** | **3** | **4** | --- ## Revenue | Price (P) | Quantity (Q) | Total Revenue (R) | Marginal Revenue (MR) | Average Revenue (AR) | |-----------|-------------|-------------------|----------------------|---------------------| | 6 | 0 | 0 | — | — | | 5 | 1 | 5 | 5 | 5 | | 4 | 2 | 8 | 3 | 4 | | **3** | **3** | **9** | **1** | **3** | --- ## Revenue | Price (P) | Quantity (Q) | Total Revenue (R) | Marginal Revenue (MR) | Average Revenue (AR) | |-----------|-------------|-------------------|----------------------|---------------------| | 6 | 0 | 0 | — | — | | 5 | 1 | 5 | 5 | 5 | | 4 | 2 | 8 | 3 | 4 | | 3 | 3 | 9 | 1 | 3 | | **2** | **4** | **8** | **−1** | **2** | --- ## Revenue | Price (P) | Quantity (Q) | Total Revenue (R) | Marginal Revenue (MR) | Average Revenue (AR) | |-----------|-------------|-------------------|----------------------|---------------------| | 6 | 0 | 0 | — | — | | 5 | 1 | 5 | 5 | 5 | | 4 | 2 | 8 | 3 | 4 | | 3 | 3 | 9 | 1 | 3 | | 2 | 4 | 8 | −1 | 2 | | **1** | **5** | **5** | **−3** | **1** | --- ## Monopoly: Revenues <img src="chapter10_files/figure-html/marginal-revenue1-1.png" width="70%" style="display: block; margin: auto;" /> `$$P = 6 - Q$$` --- ## Monopoly: Revenues <img src="chapter10_files/figure-html/marginal-revenue2-1.png" width="70%" style="display: block; margin: auto;" /> `$$P = 6 - Q \quad \Rightarrow \textit{MR} = 6 - 2Q$$` --- ## Monopolist's Output Decision `$$max_Q \; \Pi(Q) = R(Q) - C(Q)$$` -- `$$\Rightarrow \frac{d\Pi(Q)}{dQ} = \frac{dR(Q)}{dQ} - \frac{dC(Q)}{dQ} = 0$$` -- `$$\frac{dR(Q)}{dQ} = \frac{dC(Q)}{dQ}$$` -- `$$MR = MC$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max01-1.png" width="70%" style="display: block; margin: auto;" /> `$$P = 40 - Q$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max02-1.png" width="70%" style="display: block; margin: auto;" /> `$$MR = 40 - 2Q$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max03-1.png" width="70%" style="display: block; margin: auto;" /> `$$C(Q) = 50 + Q^2$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max04-1.png" width="70%" style="display: block; margin: auto;" /> `$$C(Q) = 50 + Q^2 \quad \Rightarrow AC = 50/Q + Q$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max05-1.png" width="70%" style="display: block; margin: auto;" /> `$$C(Q) = 50 + Q^2 \quad \Rightarrow MC = 2Q$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max06-1.png" width="70%" style="display: block; margin: auto;" /> `$$Q^* \textit{such that} \quad MR = MC$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max07-1.png" width="70%" style="display: block; margin: auto;" /> `$$Q^* \textit{such that} \quad 40 -2Q = 2Q$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max08-1.png" width="70%" style="display: block; margin: auto;" /> `$$Q^* = 10$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max09-1.png" width="70%" style="display: block; margin: auto;" /> `$$P^* = 40 - Q^* = 40- 10 = 30$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max10-1.png" width="70%" style="display: block; margin: auto;" /> `$$AC(Q^*) = 50/10 + 10 = 15$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max11-1.png" width="70%" style="display: block; margin: auto;" /> `$$\Pi(Q^*) = 30 \times 10 - (50 + 10^2) = 300 - 150 = 150$$` --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max12-1.png" width="70%" style="display: block; margin: auto;" /> $$ R = P \cdot Q \quad \Rightarrow \; R(Q) = (40-Q) Q = 40Q - Q^2 $$ --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max13-1.png" width="70%" style="display: block; margin: auto;" /> $$ C(Q) = 50 + Q^2 $$ --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max14-1.png" width="70%" style="display: block; margin: auto;" /> $$ \Pi (Q) = R(Q) - C(Q) = [40Q - Q^2] - [50 + Q^2] = 40Q - 2Q^2 - 50$$ --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max15-1.png" width="70%" style="display: block; margin: auto;" /> $$ \Pi (10) = 40 \times 10 - 2 \times (10)^2 - 50 = 400 - 200 -50 = 150$$ --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max16-1.png" width="70%" style="display: block; margin: auto;" /> $$ \Pi (11) = 40 \times 11 - 2 \times (11)^2 - 50 = 440 - 242 -50 = 148$$ --- ## Monopolist's Output Decision <img src="chapter10_files/figure-html/monop-max17-1.png" width="70%" style="display: block; margin: auto;" /> $$ \Pi (9) = 40 \times 9 - 2 \times (9)^2 - 50 = 360 - 162 -50 = 148$$ --- ## Rule of Thumb for Pricing Most firm managers have limited knowledge of their average and marginal revenue curves. -- `$$MR = \frac{dR}{dQ} = \frac{d(PQ)}{dQ} = \underbrace{P}_{\textit{Extra unit at price P}} + \underbrace{Q \cdot \frac{dP}{dQ}}_{\textit{Extra unit reduces price, reducing revenue per unit}}$$` -- `$$MR = P + Q \cdot \frac{dP}{dQ} = P + P \cdot \frac{Q}{P} \cdot \frac{dP}{dQ}$$` -- Recall: `\(\varepsilon_D = \frac{P}{Q} \cdot \frac{dQ}{dP} \quad \Rightarrow 1/\varepsilon_D = \frac{Q}{P} \cdot \frac{dP}{dQ}\)` -- `$$\Rightarrow MR = P + P \cdot (1/\varepsilon_D) \quad \& \quad MR =MC \quad \Rightarrow MC = P + P \cdot (1/\varepsilon_D)$$` -- `$$\Rightarrow \underbrace{\frac{P - MC}{P}}_{\textit{Markup}} = \underbrace{- (1/\varepsilon_D)}_{\textit{Inverse elasticity of D}} \quad \Rightarrow \quad P = \frac{MC}{1 + (1/\varepsilon_D)}$$` --- ## Elasticities (detour) **(Price) Elasticity of demand**: Percentage change in quantity demanded of a good resulting from a 1-percent increase in its price. -- `$$\varepsilon_D = \frac{\% \Delta Q}{\% \Delta P}$$` -- Suppose `\(Q_2 > Q_1\)` and `\(P_2 < P_1\)`: `$$\varepsilon_D = \frac{Q_2-Q_1}{Q_1} / \frac{P_2-P_1}{P_1}$$` -- Define `\(\Delta Q = Q_2-Q_1\)` and `\(\Delta P = P_2-P_1\)` `$$\varepsilon_D = \frac{\Delta Q}{Q_1} / \frac{\Delta P}{P_1} = \frac{P_1 \cdot \Delta Q }{Q_1 \cdot \Delta P}$$` -- If we are interested in hypothetically predicting the change from a given point `\((P_1 = P, Q_1 = Q)\)` $$ \varepsilon_D = \frac{P}{Q} \cdot \frac{\Delta Q }{\Delta P} < 0$$ --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-01-1.png" width="70%" style="display: block; margin: auto;" /> `$$\underbrace{P = 40 - Q}_{\textit{Inverse Demand}} \quad \iff \quad \underbrace{Q = 40 -P}_{\textit{Direct Demand}}$$` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-02-1.png" width="70%" style="display: block; margin: auto;" /> `$$dQ/dP = -1$$` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-03-1.png" width="70%" style="display: block; margin: auto;" /> At `\(Q=1, P=39 \quad \Rightarrow \varepsilon_D = \frac{39}{1} \cdot (-1) = -39\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-04-1.png" width="70%" style="display: block; margin: auto;" /> At `\(Q=10, P=30 \quad \Rightarrow \varepsilon_D = \frac{30}{10} \cdot (-1) = -3\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-05-1.png" width="70%" style="display: block; margin: auto;" /> At `\(Q=20, P=20 \quad \Rightarrow \varepsilon_D = \frac{20}{20} \cdot (-1) = -1\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-06-1.png" width="70%" style="display: block; margin: auto;" /> At `\(Q=30, P=10 \quad \Rightarrow \varepsilon_D = \frac{10}{30} \cdot (-1) = -1/3\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-06-1-1.png" width="70%" style="display: block; margin: auto;" /> At `\(Q=0, P=40 \quad \Rightarrow \varepsilon_D = \frac{40}{0} \cdot (-1) = - \infty\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-06--1.png" width="70%" style="display: block; margin: auto;" /> At `\(Q=40, P=0 \quad \Rightarrow \varepsilon_D = \frac{0}{40} \cdot (-1) = 0\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-07-1.png" width="70%" style="display: block; margin: auto;" /> Recall Arc-Elasticity: Elasticity across the demand curve `\(\varepsilon_\bar{D} = \frac{dQ}{dP} \cdot \frac{\bar{P}}{\bar{Q}}\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. <img src="chapter10_files/figure-html/pricing-rule-08-1.png" width="70%" style="display: block; margin: auto;" /> In the example, `\(\bar{P}=\)` 20 and `\(\bar{Q}\)` 20. Thus `\(\varepsilon_\bar{D} = -1 \cdot \frac{20}{20} = -1\)` --- ## Rule of Thumb for Pricing Recall that the demand curve has different elasticities at each point. .pull-left[ - `\(|\varepsilon_D | > 1\)` **Elastic**: A 1% increase in price reduces quantity demanded by more than 1%. - `\(|\varepsilon_D | = 1\)` **Unitary**: A 1% change in price leads to a 1% change in quantity demanded. - `\(|\varepsilon_D | < 1\)` **Inelastic**: A 1% increase in price reduces quantity demanded by less than 1%. ] .pull-right[ <img src="chapter10_files/figure-html/pricing-rule-09-1.png" width="100%" style="display: block; margin: auto;" /> ] -- Monopolist will never produce a quantity of output that is on the inelastic portion of the demand curve. --- ## Rule of Thumb for Pricing `$$P = \frac{MC}{1 + (1/\varepsilon_D)}$$` Suposse `\(MC = 9\)` -- .pull-left[ ### Elastic `$$|\varepsilon_D| > 1$$` For instance, `\(\varepsilon_D = -4\)` `$$P = \frac{9}{1 + (-1/4)} = 9/0.75 = 12$$` $$Markup = (12-9)/9 = 3/9 = 1/3 $$ However, as `\(\varepsilon_D \rightarrow \infty \Rightarrow P = MC\)` ] -- .pull-right[ ### Inelastic `$$|\varepsilon_D| < 1$$` For instance, `\(\varepsilon_D = -1/2\)` `$$P = \frac{9}{1 + (-2)} = \frac{9}{-1} = -1$$` `$$Markup = (-1-9)/9 = -10/9$$` Not possible. ] --- ## Monopolist's Supply Curve -- Does not exist. -- A monopolistic market has no supply curve. -- In other words, there is no one-to- one relationship between price and the quantity produced. -- Depending on how demand shifts, a monopolist might supply several different quantities at the same price, or the same quantity at different prices. --- ## Monopolist's Supply Depending on how demand shifts, a monopolist might supply several different quantities at the same price, or the same quantity at different prices. <img src="chapter10_files/figure-html/monop-supply02-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopolist's Supply Depending on how demand shifts, a monopolist might supply several different quantities at the same price, or the same quantity at different prices. <img src="chapter10_files/figure-html/monop-supply03-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopolist's Supply Depending on how demand shifts, a monopolist might supply several different quantities at the same price, or the same quantity at different prices. <img src="chapter10_files/figure-html/monop-supply04-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The effect of taxes Under monopoly, price can sometimes rise by more than the amount of the tax. -- <img src="chapter10_files/figure-html/monop-tax01-1.png" width="70%" style="display: block; margin: auto;" /> $$ P = a \cdot Q^{-b} \quad \Rightarrow R = P \cdot Q = a \cdot Q^{1-b} \quad \Rightarrow MR = a \cdot (1-b) \cdot Q^{-b} $$ --- ## The effect of taxes Under monopoly, price can sometimes rise by more than the amount of the tax. <img src="chapter10_files/figure-html/monop-tax02-1.png" width="70%" style="display: block; margin: auto;" /> Suposse `\(a=100\)`, `\(b=0.5\)`, and `\(MC =10\)`. Then, `\(Q^*\)` such that `\(MR=MC\)`, then `\(P^* = P(Q^*)\)`. --- ## The effect of taxes Under monopoly, price can sometimes rise by more than the amount of the tax. <img src="chapter10_files/figure-html/monop-tax03-1.png" width="70%" style="display: block; margin: auto;" /> Suppose a $5 tax per unit to the monopolist. --- ## The effect of taxes Under monopoly, price can sometimes rise by more than the amount of the tax. <img src="chapter10_files/figure-html/monop-tax04-1.png" width="70%" style="display: block; margin: auto;" /> At `\(MC' = MC + \tau \Rightarrow MC' = 10 + 5 = 15\)`, we have `\(MR(Q'^*) = 15 \quad \Rightarrow Q'^* = 11.11\)` --- ## The effect of taxes Under monopoly, price can sometimes rise by more than the amount of the tax. <img src="chapter10_files/figure-html/monop-tax05-1.png" width="70%" style="display: block; margin: auto;" /> Then `\(P'^* = P(Q'^*) = P(11.11) = 30\)` --- ## The effect of taxes Under monopoly, price can sometimes rise by more than the amount of the tax. <img src="chapter10_files/figure-html/monop-tax06-1.png" width="70%" style="display: block; margin: auto;" /> `\(\Delta MC = \tau = 5\)`, while `\(\Delta P = 30 -20 = 10\)`. --- .center2[ # Monopoly Power ] --- ## Monopoly Power Pure monopoly is rare. -- Markets in which several firms compete with one another are much more common. -- - **Market demand curve** - **Firm demand curve** --- ## Monopoly Power Suppose that four firms produce toothbrushes and have the market demand curve `\(Q = 50,000 - 20,000P\)` <img src="imgs/f10.7_a.png" width="70%" style="display: block; margin: auto;" /> -- These four firms are producing an aggregate of 20,000 toothbrushes per day (5000 each per day) and selling them at $1.50 each. What is the elasticity at this point? --- ## Monopoly Power Firm A must assess its own demand curve, not just the market’s, before lowering prices to boost sales. -- <img src="imgs/f10.7.png" width="70%" style="display: block; margin: auto;" /> The firm’s demand curve `\(D_A\)` is much more elastic than the market demand curve. What is the `\(D_A\)` elasticity here? --- ## Monopoly Power Firm A must assess its own demand curve, not just the market’s, before lowering prices to boost sales. <img src="imgs/f10.7.png" width="70%" style="display: block; margin: auto;" /> Raising the price from 1.50 to 1.60, the firm expects sales to drop from 5000 to 3000 as consumers switch to competitors. -- If all firms raise prices, sales would fall only to 4500. --- ## Monopoly Power Firm A must assess its own demand curve, not just the market’s, before lowering prices to boost sales. <img src="imgs/f10.7.png" width="70%" style="display: block; margin: auto;" /> Lowering its price from 1.50 to 1.40, Firm A expects sales to rise to 7000 but won’t capture the entire market as some consumers prefer competitors, who may also cut prices. --- ## Monopoly Power **Firm A is likely to face a demand curve which is more elastic than the market demand curve, but which is not infinitely elastic like the demand curve facing a perfectly competitive firm** <img src="imgs/f10.7.png" width="70%" style="display: block; margin: auto;" /> --- ## Measuring Monopoly Power - Competitive firm: price equals marginal cost - Firm with monopoly power: price exceeds marginal cost -- **Lerner Index of Monopoly Power**: Measure of monopoly power calculated as excess of price over marginal cost as a fraction of price `$$L=(P-MC)/P \in [0,1]$$` - when `\(L \rightarrow 1\)` greater degree of monopoly power - when `\(L \rightarrow 0\)` closer to a competitive market -- `$$L=(P-MC)/P = -1/\varepsilon_d$$` where `\(\varepsilon_d\)` represents the elasticity of the firm’s demand curve. --- ## Pricing with Monopoly Power Rule of thumb: `\(P = MC / [1 + (1/\varepsilon_d)]\)`. But, `\(\varepsilon_d =\)` elasticity of demand for the firm, not the elasticity of market demand, `\(\varepsilon_{\bar{d}}\)`. <img src="chapter10_files/figure-html/pricing-monopoly-power01-1.png" width="70%" style="display: block; margin: auto;" /> Markup: `\((P-MC)/P = 16/24 = 0.66 = -(1/\varepsilon_d)\)`. Then, `\(\varepsilon_d = -1/0.66 \approx -1.5\)`. --- ## Pricing with Monopoly Power Rule of thumb: `\(P = MC / [1 + (1/\varepsilon_d)]\)`. But, `\(\varepsilon_d =\)` elasticity of demand for the firm, not the elasticity of market demand, `\(\varepsilon_{\bar{d}}\)`. <img src="chapter10_files/figure-html/pricing-monopoly-power02-1.png" width="70%" style="display: block; margin: auto;" /> Markup: `\((P-MC)/P = 10/30 = 0.33 = -(1/\varepsilon_d)\)`. Then, `\(\varepsilon_d = -1/0.33 \approx -3\)`. --- ## Pricing with Monopoly Power **Monopoly power is the ability to price above marginal cost**, with the markup inversely related to demand elasticity. .pull-left[ <img src="chapter10_files/figure-html/pricing-monopoly-power03-1.png" width="100%" style="display: block; margin: auto;" /> ] .pull-right[ <img src="chapter10_files/figure-html/pricing-monopoly-power04-1.png" width="100%" style="display: block; margin: auto;" /> ] .center[ ### The less elastic its demand curve, the more monopoly power a firm has. ] --- .center2[ # Sources of Monopoly Power ] --- ## Sources of Monopoly Power Monopoly power depends on a firm’s demand elasticity. -- So, why do some firms (e.g., supermarkets) face more elastic demand than others (e.g., designer clothing brands)? -- ### 1. Elasticity of Market Demand ### 2. Number of firms ### 3. Interactions among firms --- ### 1. Elasticity of Market Demand - A pure monopolist’s demand curve **is** the market demand curve. - If demand is highly elastic, even a monopolist will have **limited** pricing power. - Market elasticity sets a **lower bound** on firm-level elasticity. - Example: OPEC vs. coffee markets—OPEC had strong monopoly power due to inelastic oil demand, whereas coffee producers faced more elastic demand, limiting price control. .center[ <img src="https://c7.alamy.com/compfr/2pn83tc/les-prix-du-petrole-montent-en-fleche-en-reponse-a-la-baisse-surprise-de-la-production-annoncee-par-opec-cartel-guardian-article-principal-sur-l-energie-5-avril-2023-royaume-uni-2pn83tc.jpg" width="50%" style="display: block; margin: auto;" /> ] --- ### 2. Number of Firms - More firms = **less monopoly power** for each firm. - Key factor: **market concentration**—if a few firms dominate, they may retain power. - High market share by a few firms allows pricing influence, **but competition and new entrants** reduce this power. - Firms often **create barriers to entry** (e.g., patents, government licensing, scale economies) to **maintain power**. .pull-left[ <img src="imgs/no_firms_1.png" width="60%" style="display: block; margin: auto;" /> ] .pull-right[ <img src="imgs/no_firms_2.png" width="120%" style="display: block; margin: auto;" /> ] --- ### 3. Interactions Among Firms - Monopoly power also depends on **competition vs. cooperation**: - **Aggressive competition** → Less pricing power. - **Collusion (explicit or implicit)** → More pricing power. - Even with few firms, **intense price wars** can drive prices close to competitive levels. - **Market power changes over time** as new firms enter, demand shifts, or firms adjust strategies. .center[ <img src="imgs/antitrust_EU.png" width="70%" style="display: block; margin: auto;" /> ] --- .center2[ # The Social Costs of Monopoly Power ] --- ## The Social Costs of Monopoly Power -- .pull-left[ ### Competitive Market `$$P^*_C = MC$$` `$$Q^*_C(P^*_C)$$` ] -- .pull-right[ ### Monopoly (Power) `$$P^*_M > MC$$` `$$Q^*_M(P^*_M) < Q^*_C(P^*_C)$$` ] -- Key Questions: - Is consumer welfare higher or lower under monopoly? - Do producers benefit more, and at whose expense? - How significant is the deadweight loss to society? --- ## The Social Costs of Monopoly Power Suppose `\(Q = 40 - 1.8 \cdot P\)` -- <img src="chapter10_files/figure-html/monop-welfare01-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopoly Power Suppose `\(C(Q) = \frac{1}{16} Q^2 + \frac{1}{24} Q^3\)`. Thus, `\(MC = \frac{1}{8} Q + \frac{1}{8} Q^2\)`. <img src="chapter10_files/figure-html/monop-welfare02-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopoly Power We assume that the competitive market and the monopolist have the same cost curves. <img src="chapter10_files/figure-html/monop-welfare03-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopoly Power Competitive market equilibrium: `\(Q^*_C \approx 11.8\)` and `\(P^*_C \approx 18.8\)` <img src="chapter10_files/figure-html/monop-welfare04-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopoly Power With monopoly power, firms maximize profits such that `\(MR = MC\)`. <img src="chapter10_files/figure-html/monop-welfare05-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopoly Power With monopoly power, firms set `\(P^*_M \approx 24.9\)` and `\(Q^*_M \approx 8.4\)` <img src="chapter10_files/figure-html/monop-welfare06-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopoly Power Welfare analysis. <img src="chapter10_files/figure-html/monop-welfare07-1.png" width="70%" style="display: block; margin: auto;" /> Rectangle A is? -- Loss in consumer surplus and increase in producer surplus. The transfer. --- ## The Social Costs of Monopoly Power Welfare analysis. <img src="chapter10_files/figure-html/monop-welfare08-1.png" width="70%" style="display: block; margin: auto;" /> Triangle B is? -- Loss in consumer surplus. The consumers that are not anymore in the market. --- ## The Social Costs of Monopoly Power Welfare analysis. <img src="chapter10_files/figure-html/monop-welfare09-1.png" width="70%" style="display: block; margin: auto;" /> Triangle C is? -- Loss in producer surplus. The (potential) producer that could not enter the market (if it was competitive). --- ## The Social Costs of Monopoly Power Welfare analysis: **Monopoly power creates deadweight loss** <img src="chapter10_files/figure-html/monop-welfare10-1.png" width="70%" style="display: block; margin: auto;" /> $$\Delta W = \Delta CS + \Delta PS = -A-B + A-C =-B-C $$ --- ## The Social Costs of Monopoly Power The social costs of monopoly power extend beyond deadweight loss. -- **Rent Seeking**: Spending money in socially unproductive efforts to acquire, maintain, or exercise monopoly. -- <img src="https://npr.brightspotcdn.com/dims3/default/strip/false/crop/8256x5504+0+0/resize/1600/quality/85/format/webp/?url=http%3A%2F%2Fnpr-brightspot.s3.amazonaws.com%2F53%2F5c%2Ff9bbb3dc48acbddc521db560c8d7%2Fgettyimages-2198395777.jpg" width="50%" style="display: block; margin: auto;" /> Possible implications for political systems and regimes. --- ## The Social Costs of Monopoly Power Beyond democracy, monopoly power could even affect the very lives of individuals. -- <img src="https://imagenes.elpais.com/resizer/v2/HCVCHHPPNBFRPKIKF4364DIFQA.jpg?auth=2616569c1666528150ded889ab9cd16f68f5759561a03da80d51fc701052a8b1&width=1960&height=1103&focal=2775%2C1216" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopoly Power Beyond democracy, monopoly power could even affect the very lives of individuals. <img src="imgs/homicide-rate-unodc.svg" width="70%" style="display: block; margin: auto;" /> --- ## Price Regulation Price regulation under competitive markets generated deadweight loss. -- What about under markets where there is monopoly power? -- <img src="chapter10_files/figure-html/monop-pricereg01-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Price Regulation Suppose price is regulated to be no higher than `\(P_{reg}=21\)`. <img src="chapter10_files/figure-html/monop-pricereg02-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Price Regulation At `\(P_{reg}=21\)`, `\(Q_D(P_{reg}) \approx 10.5\)`. <img src="chapter10_files/figure-html/monop-pricereg03-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Price Regulation Note that for any quantity less or equal than `\(Q_D(P_{reg}) \approx 10.5\)`, the firm's Marginal Revenue is exactly `\(P_{reg}=21\)`. <img src="chapter10_files/figure-html/monop-pricereg04-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Price Regulation Firm's new MR curve has three parts: .left-column[ 1. Flat Segment: `\(MR = P_{reg} \; for \; Q \leq Q_D(P_{reg})\)` 2. Vertical Jump: MR shifts at `\(Q_D(P_{reg})\)` 3. Original MR Curve: For `\(Q > Q_D(P_{reg})\)` ] .right-column[ <img src="chapter10_files/figure-html/monop-pricereg05-1.png" width="100%" style="display: block; margin: auto;" /> ] --- ## Price Regulation Firm's new MR curve has three parts. But the optimality condition is the same: profits are maximized at `\(MR = MC\)`. Then `\(P'^*_M = 21\)` and `\(Q'^*_M = 10.5\)` <img src="chapter10_files/figure-html/monop-pricereg06-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Price Regulation Does this policy increase welfare compared to a monopoly? <img src="chapter10_files/figure-html/monop-pricereg07-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Price Regulation What happens if the regulator further reduces the price? <img src="chapter10_files/figure-html/monop-pricereg08-1.png" width="70%" style="display: block; margin: auto;" /> -- Reduces output and creates shortage. --- ## Price Regulation If the regulator reduces the price at or below the lowest point in the AC, the monopoly does not produce at all. <img src="chapter10_files/figure-html/monop-pricereg09-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Natural Monopoly Firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms. -- Example: **SNCF** <img src="https://www.francetvinfo.fr/pictures/eP9Rzv9T0qZYKeIUxMXrxx8zczA/0x378:4032x2646/2656x1494/filters:format(avif):quality(50)/2023/06/01/6478c45a58c1c_photo-3-amaury-cornu-hans-lucas-afp.jpg" width="70%" style="display: block; margin: auto;" /> --- ## Natural Monopoly Firm that can produce the entire output of the market at a cost lower than what it would be if there were several firms. Example: **SNCF** .pull-left[ 1. High Fixed Costs & Economies of Scale - Building and maintaining railway tracks, stations, and signaling systems requires massive upfront investment. - Once built, the cost per passenger or freight unit decreases as more people use the service. - Example: If SNCF doubles the number of passengers, its total costs do not double, making additional trips cheaper per passenger. ] .pull-right[ 2. Declining Average & Marginal Costs - Since most railway costs are fixed (tracks, maintenance), the average cost per train trip falls as more people use the service. - Marginal costs (the cost of adding one more train) remain relatively low compared to the infrastructure investment. ] --- ## Regulating the Price of a Natural Monopoly Suppose the following demand for train services (one specific route) `\(Q = 40 - 3.6 \cdot P\)`. <img src="chapter10_files/figure-html/natural-monopoly01-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Regulating the Price of a Natural Monopoly A firm is a natural monopoly because it has economies of scale (declining average and marginal costs) over its entire output range. <img src="chapter10_files/figure-html/natural-monopoly02-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Regulating the Price of a Natural Monopoly Since the firm has monopoly power, it sets the price choosing a quantity that maximizes its profits (namely, `\(MR=MC\)`). <img src="chapter10_files/figure-html/natural-monopoly03-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Regulating the Price of a Natural Monopoly In a competitive market we would have `\(P_C=MC\)`. In this example, `\(P_C \approx 3.3\)` and `\(Q_C \approx 10.2\)`. <img src="chapter10_files/figure-html/natural-monopoly04-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Regulating the Price of a Natural Monopoly If the regulator sets `\(P_{reg} = P_C \approx 3.3\)`. However, the price would not cover average cost and the firm would go out of business. <img src="chapter10_files/figure-html/natural-monopoly05-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Regulating the Price of a Natural Monopoly Setting the price at `\(P_r\)` ensures the highest possible output while keeping the firm operational, with zero excess profit. <img src="chapter10_files/figure-html/natural-monopoly06-1.png" width="70%" style="display: block; margin: auto;" /> --- .center2[ # Monopsony ] --- ## Monopsony - **Monopsony**: Market with a single buyer. -- - **Oligopsony**: Market with a few buyers. -- - **Monopsony power**: a buyer’s ability to affect the price of a good. -- It enables the buyer to purchase a good for less than the price that would prevail in a competitive market. -- Sounds familiar? --- ## Monopsony: Marginal value - **Marginal value (MV)**: Additional benefit derived from purchasing one more unit of a good. - **Marginal utility**: Additional satisfaction obtained from consuming one additional unit of a good. - Recall that an individual demand curve determines marginal value as a function of the quantity purchased -- <img src="chapter10_files/figure-html/utility01-1.png" width="60%" style="display: block; margin: auto;" /> `$$U(q) = 10 \cdot log(q)$$` --- ## Monopsony: Marginal value - **Marginal value (MV)**: Additional benefit derived from purchasing one more unit of a good. - **Marginal utility**: Additional satisfaction obtained from consuming one additional unit of a good. - Recall that an individual demand curve determines marginal value as a function of the quantity purchased <img src="chapter10_files/figure-html/utility02-1.png" width="60%" style="display: block; margin: auto;" /> `$$\Rightarrow U'(q) = 10 \cdot (1/q)$$` --- ## Monopsony: Marginal value - **Marginal value (MV)**: Additional benefit derived from purchasing one more unit of a good. - **Marginal utility**: Additional satisfaction obtained from consuming one additional unit of a good. - Recall that an individual demand curve determines marginal value as a function of the quantity purchased <img src="chapter10_files/figure-html/utility03-1.png" width="60%" style="display: block; margin: auto;" /> **The MV represents the demand curve for the good**. An individual’s demand curve slopes downward because the additional benefit from purchasing one more unit decreases as the total quantity bought rises. --- ## Monopsony: Marginal expenditure If Expenditure is: `$$Expenditure = E = P(Q)Q$$` -- .pull-left[ ### Average Expenditure (AE) Price paid per unit of a good $$AE = \frac{\textit{E}}{Q} = P(Q) $$ ] -- .pull-right[ ### Marginal Revenue Additional cost of buying one more unit of a good `$$ME = \frac{d \textit{E}}{dQ} = \frac{d P(Q)Q}{dQ} = P(Q) + Q \cdot \frac{\Delta P}{\Delta Q}$$` ] -- For sure sounds familiar. --- ## Benchmark: Competitive Buyer Let's assume we are in a competitive market. -- If `\(MV=D\)`, in this case the `\(MV = 6-P\)`. <img src="chapter10_files/figure-html/competitive-buyer01-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Benchmark: Competitive Buyer The competitive buyer takes market price `\(P^* = 3\)` as given. Thus, `\(E = 3 \cdot Q\)`. <img src="chapter10_files/figure-html/competitive-buyer02-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Benchmark: Competitive Buyer The competitive buyer takes market price `\(P^* = 3\)` as given. Thus, `\(E = 3 \cdot Q\)` and `\(ME = AE = 3\)`. <img src="chapter10_files/figure-html/competitive-buyer03-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Benchmark: Competitive Buyer The competitive buyer should buy `\(Q^*\)` such that `\(MV = ME\)`. In this case, `\(Q^* = 3\)`. <img src="chapter10_files/figure-html/competitive-buyer04-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Benchmark: Competitive Buyer vs. Competitive Seller .pull-left[ ### Competitive Buyer <img src="chapter10_files/figure-html/competitive-buyer05-1.png" width="100%" style="display: block; margin: auto;" /> ] -- .pull-left[ ### Competitive Seller <img src="chapter10_files/figure-html/competitive-buyer06-1.png" width="100%" style="display: block; margin: auto;" /> ] --- ## Monopsonist's Purchase Decision `\(V\)`: Value to the buyer of the purchase `\(E\)`: Expenditure -- Net benefit from a purchase: `$$NB = V-E$$` -- $$max_Q NB $$ -- `$$\Rightarrow \frac{d NB}{dQ} = \frac{dV}{dQ} - \frac{dE}{dQ} = 0$$` `$$\Rightarrow MV = ME$$` --- ## Monopsonist's Purchase Decision Suppose `\(D = P_D(Q) = 40 - Q\)`. If the buyer is the *only buyer*, then `\(MV = D\)`. <img src="chapter10_files/figure-html/monopson-max01-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsonist's Purchase Decision Suppose `\(S = P_s(Q) = 2 + (3/4) \cdot Q\)`. -- Then `\(E = P_s(Q) \cdot Q = 2 \cdot Q + (3/4) \cdot Q^2\)`. Note = `\(AE = E/Q = S\)` <img src="chapter10_files/figure-html/monopson-max02-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsonist's Purchase Decision In a competitive market, `\(P_c^*\)` and `\(Q_c^*\)` would be such that `\(D = S\)`. In this case, `\(P_c^* = 18.3\)` and `\(Q_c^* = 21.7\)`. <img src="chapter10_files/figure-html/monopson-max04-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsonist's Purchase Decision However, here the single buyer has market power. So the buyer is not interested in the `\(AE\)`, but the `\(ME\)`. <img src="chapter10_files/figure-html/monopson-max05-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsonist's Purchase Decision Then it will set `\(Q_m^*\)` would be such that `\(ME = MV\)`. In this case, `\(Q_m^* = 15.2\)`. <img src="chapter10_files/figure-html/monopson-max06-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsonist's Purchase Decision The buyer's `\(MV\)` for the good at this quantity is `\(MV(Q_m^*) = 40 - 15.2 = 24.8\)`. <img src="chapter10_files/figure-html/monopson-max07-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsonist's Purchase Decision The buyer's `\(MV\)` for the good at this quantity is `\(MV(Q_m^*) = 40 - 15.2 = 24.8\)`. However, that is not the price that the buyer will be paying. Which one is it? -- `\(P_s(Q_m^*) = 2 + .75 \cdot (15.2) = 13.4\)`. <img src="chapter10_files/figure-html/monopson-max08-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsonist's Purchase Decision Note `\(P_m^* < P_c^*\)` and `\(Q_m^* < Q_c^*\)`. <img src="chapter10_files/figure-html/monopson-max09-1.png" width="70%" style="display: block; margin: auto;" /> --- ## Monopsony and monopoly .pull-left[ ### Monopsony <img src="chapter10_files/figure-html/monopson-max10-1.png" width="100%" style="display: block; margin: auto;" /> A monopsonist reduces purchases to push prices below marginal value. ] .pull-right[ ### Monopoly <img src="chapter10_files/figure-html/monopson-max11-1.png" width="100%" style="display: block; margin: auto;" /> A monopolist restricts output to raise prices above marginal cost. ] Both create inefficiencies by setting quantities lower than competitive levels. --- .center2[ # Monopsony Power ] --- ## Sources of Monopsony Power Markets with a few firms competing as buyers are more common than pure monopsony, giving each firm some degree of monopsony power. -- ### 1. Elasticity of Market Supply ### 2. Number of buyers ### 3. Interactions among buyers --- ### 1. Elasticity of Market Supply .pull-left[ ### Elastic supply <img src="chapter10_files/figure-html/monop-elasticity01-1.png" width="100%" style="display: block; margin: auto;" /> Marginal expenditure and average expenditure do not differ by much ] .pull-right[ ### Inelastic supply <img src="chapter10_files/figure-html/monopson-max10-1.png" width="100%" style="display: block; margin: auto;" /> Big difference between the actual price and marginal expenditure. ] --- ## The Social Costs of Monopsony Power Welfare analysis. <img src="chapter10_files/figure-html/monopson-welfare01-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopsony Power Rectangle A is? Loss in producer surplus and increase in consumer surplus. The transfer. <img src="chapter10_files/figure-html/monopson-welfare02-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopsony Power Triangle B is? Loss in consumer surplus as the buyer buys less. <img src="chapter10_files/figure-html/monopson-welfare03-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopsony Power Triangle C is? Loss in producer surplus as these producers leave the market. <img src="chapter10_files/figure-html/monopson-welfare04-1.png" width="70%" style="display: block; margin: auto;" /> --- ## The Social Costs of Monopsony Power $$\Delta W = \Delta CS + \Delta PS = -A-B + A-C =-B-C $$ <img src="chapter10_files/figure-html/monopson-welfare05-1.png" width="70%" style="display: block; margin: auto;" /> --- .center2[ # Limiting Market Power: Antitrust Laws ] --- .center2[ # Summary ] --- ## Summary 1. **Market Power**: Sellers or buyers influence prices. -- 2. **Types of Power**: - **Monopoly**: Sellers set prices above marginal cost. - **Monopsony**: Buyers pay below marginal value. -- 3. **Determinants**: - Number of firms: More competition reduces monopoly power. - Number of buyers: More buyers reduce monopsony power. - Elasticity: Less elastic demand/supply increases power. -- 4. **Social Costs**: - Both monopoly and monopsony reduce output, causing deadweight loss. - Rent-seeking can add inefficiencies. -- 5. **Regulation**: - Economies of scale sometimes justify monopolies. - Antitrust laws limit excessive market power. --- .center2[ # TD ] --- <img src="imgs/chapter10_excercise06.png" width="70%" style="display: block; margin: auto;" /> --- <img src="imgs/chapter10_excercise14.png" width="70%" style="display: block; margin: auto;" />