3.1 Market Power Introduction

This chapter will certainly discover firms that have actually industry power, or the capability to set the price of the excellent that they produce.

You are watching: The supply curve for a monopolist is:

Market Power = Ability of a firm to collection the price of an excellent. Also called monopoly power.

A monopoly is characterized as a solitary firm in an market with no cshed substitutes. An industry is characterized as a group of firms that develop the very same great.

Monopoly = A single firm in an industry with no cshed substitutes.

The phrase, “no close substitutes” is crucial, since tbelow are many type of firms that are the sole producer of a good. Consider McDonalds Big Mac hamburgers. McDonalds is the just provider of Big Macs, yet it is not a monopoly because tbelow are many kind of close substitutes available: Burger King Whoppers, for instance.

Market power is additionally dubbed monopoly power. A competitive firm is a “price taker.” Thus, a competitive firm has actually no capability to readjust the price of an excellent. Each competitive firm is little loved one to the market, so has no influence on price. On the various other hand, firms with market power are also called “price devices.”

Price Taker = A competitive firm via no ability to set the price of a great.

Price Maker = A noncompetitive firm via sector power, defined as the capability to set the price of a good.

A monopolist is taken into consideration to be a price maker, and also have the right to collection the price of the product that it sells. However before, the monopolist is constrained by customer willingness and capacity to purchase the excellent, additionally referred to as demand. For example, intend that an agricultural chemical firm has a patent for an agricultural chemical used to kill weeds, a herbicide. The patent is a legal restriction that permits the patent holder to be the only seller of the herbicide, as it was invented by the agency via their research study regimen. In Figure 3.1, an agricultural chemical firm faces an inverse demand curve equal to: P = 100 – Qd, where P is the price of the farming chemical in dollars per ounce (USD/oz), and also Qd is the amount demanded of the chemical in million ounces (m oz).


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Figure 3.1 Demand also Facing a Monopolist: Agrisocial Chemical

The monopolist have the right to set a price, however the resulting quantity is established by the consumers’ willingness to pay, or the demand curve. For instance, if the price is collection at P0, consumers will certainly purchase Q0. Conversely, the monopolist might set quantity at Q0, and also consumers would be willing to pay P0 for Q0 units of the chemical. Thus, a monopolist has the ability to collection any price that it would certainly like to, but through vital limitation: the monopolist is constrained by consumer willingness to pay for the product.


3.2 Monopoly Profit-Maximizing Solution

The profit-maximizing solution for the monopolist is found by locating the biggest difference in between full profits (TR) and full expenses (TC), as in Equation 3.1.

(3.1) max π = TR – TC

3.2.1 Monopoly Revenues

Revenues are the money that a firm receives from the sale of a product.

Total Revenue = The amount of money received when the producer sells the product. TR = PQ

Median Revenue = The average dollar amount receive per unit of output offered AR = TR/Q

Marginal Revenue = the addition to total revenue from offering an additional unit of output.

MR = ΔTR/ΔQ = ∂TR/∂Q.

TR = PQ (USD)

AR = TR/Q = P(USD/unit)

MR = ΔTR/ΔQ = ∂TR/∂Q (USD/unit)

For the agricultural chemical company:

TR = PQ = (100 – Q)Q = 100Q – Q2

AR = P = 100 – Q

MR = ∂TR/∂Q = 100 – 2Q

Total revenues for the monopolist are displayed in Figure 3.2. Total Revenues are in the shape of an inverted parabola. The maximum value deserve to be found by taking the initially derivative of TR, and establishing it equal to zero. The first derivative of TR is the slope of the TR attribute, and also once it is equal to zero, the slope is equal to zero.

(3.2) max TR = PQ ∂TR/∂Q = 100 – 2Q = 0 Q* = 50

Substitution of Q* earlier into the TR attribute yields TR = USD 2500, the maximum level of complete earnings (Figure 3.2).


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Mean revenue (AR) and also marginal revenue (MR) are presented in Figure 3.3. The marginal revenue curve has the very same y-intercept and twice the slope as the average revenue curve. This is always true for direct demand (average revenue) curves. This is among the major take home messages of economics: maximize earnings may expense as well a lot to make it worth it. For instance, a corn farmer who maximizes yield (output per acre of land) may be spfinishing too much on inputs such as fertilizer and chemicals make the better yield payoff. From an economic perspective, the corn farmer have to take into consideration both earnings and also costs.

3.2.2 Monopoly Costs

The costs for the chemical incorporate complete, average, and marginal costs.

Total Cost = The amount of all payments that a firm need to make to purchase the components of manufacturing. The amount of Total Fixed Costs and also Total Variable Costs. TC = C(Q) = TFC + TVC.

Total Fixed Costs = Costs that do not vary with the level of output.

Total Variable Costs = Costs that carry out differ through the level of output.

Median Cost = full costs per unit of output. AC = TC/Q. Keep in mind that the terms, Mean Costs and also Typical Total Costs are interchangeable.

Marginal Cost = the rise in full expenses as a result of the production of an additional unit of output. MC = ΔTC/ΔQ = ∂TC/∂Q.

TC = C(Q)(USD)

AC = TC/Q(USD/unit)

MC = ΔTC/ΔQ = ∂TC/∂Q (USD/unit)

Suppose that the farming chemical firm is a constant price industry. This suggests that the per-unit cost of creating one more ounce of chemical is the same, no issue what quantity is developed. Assume that the price per unit is ten dollars per ounce (10 USD/oz).

TC = 10Q

AC = TC/Q = 10

MC = ΔTC/ΔQ = ∂TC/∂Q = 10

The full costs are presented in Figure 3.4, and also the per-unit prices are in Figure 3.5.


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3.2.3 Monopoly Profit-Maximizing Solution

Tright here are 3 ways to interact economics: verbally, graphically, and mathematically. The firm’s profit maximizing solution is one of the significant features and also vital conclusions of business economics. The verbal explanation is that a firm must continue any type of activity as long as the added (marginal) benefits are greater than the additional (marginal) costs. The firm should continue the activity till the marginal benefit is equal to the marginal expense. This is true for any type of activity, and for profit maximization, the firm will uncover the optimal, profit maximizing level of output where marginal revenues equal marginal costs (MR = MC).

The graphical solution takes benefit of images that tell the same story, as in Figures 3.6 and 3.7. Figure 3.6 reflects the profit maximizing solution using total earnings and also full expenses. The profit-maximizing level of output is found wbelow the distance in between TR and TC is largest: π = TR – TC. The solution is found by setting the slope of TR equal to the slope of TC: this is where the prices of change are equal to each other (MR = MC).


Figure 3.6 Total Profit Equipment for a Monopolist: Agricultural Chemical

The exact same solution deserve to be uncovered utilizing the marginal graph (Figure 3.7). The firm sets MR equal to MC to find the profit-maximizing level of output (Q*), then substitutes Q* right into the consumers’ willingness to pay (demand also curve) to uncover the optimal price (P*). The profit level is a space in Figure 3.7, characterized by TR and also TC. Total profits are equal to price times amount (TR = P*Q), so TR are equal to the rectangle from the origin to P* and also Q*. Total expenses are equal to the rectangle identified by the per-unit price of ten dollars per ounce times the amount developed, Q*. If the TC rectangle is subtracted from the TR rectangle, the shaded profit rectangle remains: earnings are the residual of profits after all prices have actually been phelp (π = TR – TC).


Figure 3.7 Marginal Profit Systems for a Monopolist: Agricultural Chemical

The math solution for profit maximization is uncovered by using calculus. The maximum level of a role is uncovered by taking the initially derivative and setting it equal to zero. Respeak to that the inverse demand also attribute dealing with the monopolist is P = 100 – Qd, and also the per unit expenses are ten dollars per ounce.


max π = TR – TC

= P(Q)Q – C(Q)

= (100 – Q)Q – 10Q

= 100Q – Q2 – 10Q

∂π/∂Q= 100 – 2Q – 10 = 0

2Q = 90

Q* = 45 million ounces of farming chemical

The profit-maximizing price is found by substituting Q* into the inverse demand also equation:

P* = 100 – Q* = 100 – 45 = 55 USD/ounce of agricultural chemical.

The maximum profit level can be discovered by substitution of P* and also Q* into the profit equation:

π = TR – TC = P(Q)Q – C(Q) = 55*45 – 10*45 = 45*45 = 2025 million USD.

This profit level is equal to the distance between the TR and TC curves at Q* in Figure 3.6, and the profit rectangle determined in Figure 3.7. The profit-maximizing level of output and price have actually been discovered in three ways: verbally, graphically, and mathematically.

3.3 Marginal Revenue and also the Elasticity of Demand

We have located the profit-maximizing level of output and also price for a syndicate. How does the monopolist understand that this is the correct level? How is the profit-maximizing level of output pertained to the price charged, and the price elasticity of demand? This section will certainly answer these inquiries. The firm’s own price elasticity of demand also captures just how consumers of a great respond to a adjust in price. Thus, the very own price elasticity of demand captures the most important point that a firm deserve to know around its customers: just how consumers will react if the good’s price is readjusted.

3.3.1 The Monopolist’s Tradeoff between Price and also Quantity

What happens to profits as soon as output is increased by one unit? The answer to this question reveals valuable information around the nature of the pricing decision for firms via market power, or a downward sloping demand also curve. Consider what happens when output is raised by one unit in Figure 3.8.


Figure 3.8 Per-Unit Revenues for a Monopolist: Agrisocial Chemical

Increasing output by one unit from Q0 to Q1 has 2 effects on revenues: the monopolist gains area B, but loses location A. The monopolist have the right to collection price or amount, yet not both. If the output level is increased, consumers’ willingness to pay decreases, as the great becomes even more available (less scarce). If amount rises, price drops. The advantage of increasing output is equal to ΔQ*P1, since the firm sells one additional unit (ΔQ) at the price P1 (location B). The price associated through raising output by one unit is equal to ΔP*Q0, given that the price decreases (ΔP) for all devices marketed (location A). The monopoly cannot boost quantity without resulting in the price to fall for all systems sold. If the benefits outweigh the expenses, the monopolist should rise output: if ΔQ*P1 > ΔP*Q0, rise output. Conversely, if boosting output lowers earnings (ΔQ*P1 0), then the firm should alleviate output level.


3.3.2 The Relationship between MR and also Ed

There is a useful relationship in between marginal revenue (MR) and the price elasticity of demand (Ed). It is obtained by taking the initially derivative of the full revenue (TR) attribute. The product dominion from calculus is supplied. The product dominance claims that the derivative of an equation via two features is equal to the derivative of the initially attribute times the second, plus the derivative of the second function times the initially function, as in Equation 3.3.

(3.3) ∂(yz)/∂x = (∂y/∂x)z + (∂z/∂x)y

The product rule is used to discover the derivative of the TR function. Price is a duty of quantity for a firm via market power. Recall that MR = ∂TR/∂Q, and the equation for the elasticity of demand:

Ed = (∂Q/∂P)P/Q

This will be supplied in the derivation listed below.

TR = P(Q)Q

∂TR/∂Q = (∂P/∂Q)Q + (∂Q/∂Q)P

MR = (∂P/∂Q)Q + Pnext, divide and also multiply by P:

MR = <(∂P/∂Q)Q/P>P + P

MR = <1/Ed>P + P

MR = P(1 + 1/Ed)

This is a beneficial equation for a monopoly, as it web links the price elasticity of demand also through the price that maximizes earnings. The connection deserve to be seen in Figure 3.9.


Figure 3.9 The Relationship between MR and also Ed

At the vertical intercept, the elasticity of demand also is equal to negative infinity (area 1.4.8). When this elasticity is substituted into the MR equation, the outcome is MR = P. The MR curve is equal to the demand curve at the vertical intercept. At the horizontal intercept, the price elasticity of demand is equal to zero (Section 1.4.8,, resulting in MR equal to negative infinity. If the MR curve were extended to the ideal, it would method minus infinity as Q approached the horizontal intercept. At the midallude of the demand curve, P is equal to Q, the price elasticity of demand also is equal to -1, and MR = 0. The MR curve intersects the horizontal axis at the midsuggest between the origin and also the horizontal intercept.


This highlights the usefulness of understanding the elasticity of demand. The monopolist will certainly want to be on the elastic portion of the demand curve, to the left of the midallude, wbelow marginal earnings are positive. The monopolist will prevent the inelastic percent of the demand curve by decreasing output till MR is positive. Intuitively, decreasing output renders the excellent even more scarce, thereby raising customer willingness to pay for the great.

3.3.3 Pricing Rule I

The beneficial connection between MR and Ed in Equation 3.4 have the right to be used to derive a pricing preeminence.

MR = P(1 + 1/Ed)

MR = P + P/Ed

Assume profit maximization

MC = P + P/Ed

–P/Ed = P – MC

–1/Ed = (P – MC)/P

(P – MC)/P = –1/Ed

This pricing dominion relates the price markup over the cost of production (P – MC) to the price elasticity of demand also.

(3.5) (P – MC)/P = –1/Ed

A competitive firm is a price taker, as shown in Figure 3.10. The sector for a great is illustrated on the left hand also side of Figure 2.10, and the individual competitive firm is uncovered on the right hand also side. The industry price is found at the industry equilibrium (left panel), wbelow industry demand amounts to market supply. For the individual competitive firm, price is addressed and also given at the sector level (ideal panel). Therefore, the demand curve encountering the competitive firm is perfectly horizontal (elastic), as shown in Figure 3.10.

The price is resolved and also provided, no issue what amount the firm sells. The price elasticity of demand for a competitive firm is equal to negative infinity: Ed = -. When substituted into Equation 3.5, this returns (P – MC)P = 0, given that splitting by infinity equals zero. This demonstprices that a competitive firm cannot increase price over the expense of production: P = MC. If a competitive firm increases price, it loses all customers: they have perfect substitutes accessible from numerous various other firms.

Monopoly power, also called sector power, is the capacity to set price. Firms with sector power face a downward sloping demand also curve. Assume that a monopolist has actually a demand also curve with the price elasticity of demand equal to negative two: Ed = -2. When this is substituted into Equation 3.5, the result is: (P – MC)/P = 0.5. Multiply both sides of this equation by price (P): (P – MC) = 0.5P, or 0.5P = MC, which yields: P = 2MC. The markup (the level of price above marginal cost) for this firm is 2 times the cost of production. The dimension of the optimal, profit-maximizing markup is dictated by the elasticity of demand also. Firms with responsive consumers, or elastic requirements, will certainly not desire to charge a big markup. Firms with inelastic demands are able to charge a greater markup, as their consumers are less responsive to price changes.


Figure 3.10 The Demand Curve of a Competitive Firm

In the next section, we will talk about numerous essential features of a monopolist, consisting of the absence of a supply curve, the effect of a tax on monopoly price, and a multiplant monopolist.


3.4 Monopoly Characteristics

3.4.1 The Absence of a Supply Curve for a Monopolist

Tbelow is no supply curve for a monopolist. This differs from a competitive sector, wright here tright here is a one-to-one correspondence in between price (P) and also amount provided (Qs). For a monopoly, the price counts on the form of the demand also curve, as shown in Figure 3.11. A mathematical “function” is characterized as a one-to-one correspondence in between each point in the range (x) and also the doprimary (y). A supply curve, then, needs a single price (P) for each amount (Q). This graph reflects that tbelow is even more than one price connected through each quantity. At quantity Q0, for demand also curve D1, the monopolist maximizes revenues by establishing MR1 = MC, which outcomes in price P1. However before, for demand also curve D2, the monopolist would certainly collection MR2=MC, and charge a reduced price, P2. Because there is even more than one price associated via a solitary quantity (Q0), tright here is no one-to-one correspondence between price and quantity provided, and no supply curve for a monopolist.


3.4.2 The Effect of a Tax on a Monopolist’s Price

In a competitive market, a taxes outcomes in an increase in price that is based on the incidence of the taxes. The price rise is a portion of the taxation, less than the tax amount. The taxation incidence counts on the magnitude of the elasticities of supply and also demand also. In a syndicate, it is possible that the price rise from a taxation is higher than the taxation itself, as displayed in Figure 3.12. This is an exciting and also nonintuitive result!

Before the taxes, the monopolist sets MR = MC at Q0, and also sets price at P0. After the tax is applied, the marginal expenses increase to C + t. The monopolist sets MR = MC = C + t, produces quantity Q1, and charges price P1. The boost in price (P1 – P0) is larger than the taxes price (t), the vertical distance in between the C + t and also MC lines. In this instance, consumers of the monopoly great are paying even more than 100 percent of the taxation rate. This is because of the shape of the demand also curve: it is profitable for the monopoly to minimize quantity produced to increase the price.


3.4.3 Multiplant Monopolist

Suppose that a syndicate has 2 or even more plants (factories). How does the monopolist identify exactly how a lot output must be created at each plant? Profit-maximization argues two guidelines for the multiplant monopolist. Suppose that the monopolist opeprices n plants.

(1) Set MC equal throughout all plants: MC1 = MC2 = … =MCn, and

(2) Set MR = MC in all plants.

A mathematical model of a multiplant monopolist demonstprices profit-maximization. The result is amazing and also vital, as it shows that multiplant firms will not constantly cshed older, much less effective plants. This is true also if the older plants have higher manufacturing expenses than more recent, more efficient plants.

Suppose that a monopolist has actually 2 plants, and also complete output (QT) is the sum of output developed in plant 1 (Q1) and also plant 2 (Q2).

(3.6) Q1 + Q2 = QT

The profit-maximizing model for the two-plant monopolist returns the solution. The costs of developing output in each plant differ. Assume that the old plant (plant 1) is much less efficient than the brand-new plant (plant 2): C1 > C2.

max π = TR – TC

= P(QT)QT – C1(Q1) – C2(Q2)

∂π/∂Q1 = ∂TR/∂Q1 – C1’(Q1) = 0

∂π/∂Q2 = ∂TR/∂Q2 – C2’(Q2) = 0

The profit-maximizing solution is:

(3.7) MR = MC1 = MC2

The multiplant monopolist solution is shown in Figure 3.13. The marginal price curve for plant 1 is greater than the marginal expense curve for plant 2, reflecting the older, much less efficient plant. Rather than shutting the much less efficient plant dvery own, the monopolist need to produce some output in each plant, and also set the MC of each plant equal to MR, as presented in the graph. Let MCT be the full (sum) of the marginal price curves: MT = MC1 + MC2. The profit maximizing quantity (QT) is uncovered by setting MR equal to MCT. At the profit maximizing quantity (QT), the monopolist sets price equal to P, uncovered by plugging QT into the consumers’ willingness to pay, or the demand also curve (D).


Figure 3.13 Multiplant Monopolist

To find the quantity to develop in each plant, the firm sets MC1 = MC2 = MCT to find the profit-maximizing level of output in each plant: Q1 and also Q2. The outcome of the multiplant monopolist returns helpful conclusions for any kind of firm: proceed using any input, plant, or resource until marginal expenses equal marginal earnings. Less effective resources can be usetotally employed, also if even more effective resources are obtainable. The following section will certainly explore the determinants and also measurement of monopoly power, likewise referred to as sector power.


3.5 Monopoly Power

In this area, the components and also measurement of monopoly power are examined.

3.5.1 The Lerner Index of Monopoly Power

Economists usage the Lerner Index to meacertain monopoly power, additionally dubbed industry power. The index is the percent markup of price over marginal cost.

(3.8) L = (P – MC)/P

The Lerner Index is a positive number (L ≥ 0), enhancing in the amount of sector power. A perfectly competitive firm has actually a Lerner Index equal to zero (L = 0), since price is equal to marginal price (P = MC). A monopolist will have actually a Lerner Index greater than zero, and the index will be identified by the amount of market power that the firm has. A bigger Lerner Index suggests even more market power. In Section 3.3.3, a Pricing Rule was derived: (P – MC)/P = – 1/Ed, where Ed is the price elasticity of demand also. Substitution of this pricing dominion right into the meaning of the Lerner Index gives the relationship in between the percent markup and the price elasticity of demand.

(3.9) L = (P – MC)/P = – 1/Ed

An example of a Lerner Index might be Big Macs. Tright here are substitutes obtainable for Big Macs, so if the price increases, consumers deserve to buy a completing brand also such as Whoppers. In the situation of a great via close substitutes, the price elasticity of demand also is larger (even more elastic), bring about the percent markup to be smaller: the Lerner Index is relatively small. A monopoly is identified as a single seller in an sector with no cshed substitutes. Because of this, a syndicate that produces a great via no close substitutes would certainly have a higher Lerner Index.

A second pricing dominion have the right to be acquired from equation (3.9), if we assume that the firm maximizes profits (MR = MC). In that situation, the relationship in between price and also marginal revenue is equal to: MR = P(1 + 1/Ed). If profit-maximization (MR = MC) is assumed, then:

(3.10) MC = P(1 + 1/Ed)

Rearranging:

(3.11) P = MC/(1 + 1/Ed)

This is a valuable equation, as it relates price to marginal price. For example, a perfectly competitive firm has actually a perfectly elastic demand also curve (Ed = negative infinity). Substitution of this elasticity into the pricing ascendancy returns P = MC. For a monopoly that has a price elasticity equal to –2, P = 2MC. The price is 2 times the manufacturing costs in this case. To summarize:

(1) if Ed is huge, the firm has actually less market power, and also a little markup

(2) if Ed is tiny, the firm has even more market power, and also a large markup.

A monopoly instance is valuable to review monopoly and the Lerner Index. Suppose that the inverse demand curve encountering a monopoly is given by: P = 500 – 10Q. The monopoly production expenses are provided by: C(Q) = 10Q2 + 100Q. Profit-maximization yields the optimal monopoly price and also amount.

max π = TR – TC

= P(Q)Q – C(Q)

= (500 – 10Q)Q – (10Q2 + 100Q)

= 500Q – 10Q2 – 10Q2 – 100Q

∂π/∂Q= 500 – 20Q – 20Q – 100 = 0

40Q = 400

Q* = 10 units

P* = 500 – 10Q* = 500 – 100 = 400 USD/unit.

To calculate the value of the Lerner Index, price and also marginal expense are needed (equation 3.9).

MC = C’(Q) = 20Q + 100.

MC* = 20(10) + 100 = 300 units

L = (P – MC)/P = (400 – 300)/400 = 100/400 = 0.25

This result can be checked via the pricing rule: (P – MC)/P = – 1/Ed.

Ed = (∂Q/∂P)(P/Q)

For this monopoly, ∂P/∂Q = –10. This is the initially derivative of the inverse demand also feature. As such, ∂Q/∂P = – 1/10.

Ed = (∂Q/∂P)(P/Q) = (– 1/10)(400/10) = – 400/100 = – 4.

L = (P – MC)/P = – 1/Ed = –1/–4 = 0.25.

The very same result was achieved using both techniques, so the Lerner Index for this monopoly is equal to 0.25.

3.5.2 Welfare Effects of Monopoly

The welfare effects of a industry or policy adjust are summarized as, “who is helped, that is hurt, and by exactly how a lot.” To measure the welfare impact of monopoly, the monopoly outcome is compared through perfect competition. In competition, the price is equal to marginal cost (P = MC), as in Figure 3.14. The competitive price and amount are Pc and Qc. The monopoly price and also amount are uncovered where marginal revenue equals marginal price (MR = MC): PM and also QM. The graph shows that the monopoly reduces output from the competitive level in order to boost the price (PM > Pc and also QM c). The welfare evaluation of a monopoly relative to competition is straightforward.

ΔCS = – AB

ΔPS = +A – C

ΔSW = – BC

DWL = BC

Consumers are losers, and also the benefits of monopoly depend on the magnitudes of locations A and also C. Because a monopolist encounters an inelastic supply curve (no close substitutes), area A is likely to be bigger tha space C, making the net benefits of monopoly positive.


The monopoly instance from the previous area 3.5.1 mirrors the magnitude of the welfare alters. From above, the inverse demand curve is provided by P = 500 – 10Q, and the prices are provided by C(Q) = 10Q2 + 100Q. In this case, PM = 400 USD/unit and also QM = 10 devices (watch section 3.5.1 above). The competitive solution is uncovered where the demand curve intersects the marginal expense curve.

500 – 10Q = 20Q + 100

30Q = 400

Qc = 13.3 units

Pc = 500 – 10(13.3) = 500 – 133 = 367 USD/unit

ΔCS = – AB = –(400 – 367)10 – (0.5)(400 – 367)(13.3 – 10) = – 330 –54.5 = – 384.5 USD

ΔPS = +A – C = +330 – (0.5)(367 – 300)(13.3 – 10) = +330 – 110.5 = +219.5 USD

ΔSW = – BC = (0.5)(100)(3.3) = – 165 USD

DWL = BC = 165 USD

The welfare analysis of monopoly has been provided by the government to justify breaking up monopolies into smaller, contending firms. In food and agriculture, many type of individuals and teams are opposed to big agriorganization firms. One worry is that these large firms have monopoly power, which results in a carry of welfare from consumers to producers, and deadweight loss to culture. It will certainly be displayed listed below that outlawing or banning monopolies would certainly have both benefits and costs. Tbelow is some economic justification for the existence of huge firms due to economies of scale and organic monopoly, as will certainly be explored below. Next, the sources of monopoly power will certainly be provided and defined.

3.5.3 Sources of Monopoly Power

Tright here are 3 major sources of monopoly power:

(1) the price elasticity of demand (Ed),

(2) the number of firms in a sector, and

(3) interactivity among firms.

The price elasticity of demand is the the majority of crucial determinant of sector power, as a result of the pricing rule: L = (P – MC)/P = – 1/Ed. When the price elasticity is huge ( |Ed| > 1), demand is reasonably elastic, and the firm has much less market power. When the price elasticity is small ( |Ed| dfirm| > |Edmarket| .

If the price of the firm’s output is increased, consumers can substitute right into outputs developed by various other firms. However, if all firms in the market boost the price of the excellent, consumers have no cshed substitutes, so should pay the better price (Figure 3.15). As such, the firm’s price elasticity of demand is more elastic than the sector demand also. The firm’s price elasticity of demand also relies on how big the firm is relative to the various other firms in the market.


The second determinant of industry power is the number of firms in an industry. This is pertained to Figure 3.15. If a firm is the just seller in an market, then the firm is the very same as the sector, and also the price elasticity of demand is the exact same for both the firm and the sector. The even more firms tright here are in a industry, the more substitutes a customer has accessible, making the price elasticity of demand more elastic as the number of firms increases. In the excessive situation, a perfectly competitive firm has countless other firms in the industry, bring about the demand curve to be perfectly elastic, P = MC, and L = 0. To summarize, the more firms there are in an industry, the less market power the firm has.

The variety of firms in an market is figured out by the ease or difficulty of enattempt. This industry attribute is captured by the principle of, “Barriers to Enattempt.” Barriers to enattempt include:

(1) patents,

(3) contracts,

(4) economies to scale (herbal monopoly),

(5) excess capacity, and

(6) licenses.

Each of these barriers to entry increases the challenge of entering a industry when positive economic profits exist. Economies to range and also natural monopoly are characterized and also described in the next area. The number of firms is vital, however the number of “major firms” is likewise important. Some sectors are characterized by one or two dominant firms. These large firms regularly exert industry power.

The 3rd source of industry power is interaction among firms. This will be generally debated in Chapter 5, “Oligopoly.” If firms compete aggressively via each other, less industry power results. On the various other hand also, if firms corun and also act together, the firms can have more industry power. When firms join together, they are sassist to “collude,” or act as if they were a single firm. These strategic interactions in between firms develop the heart of the conversation in Chapter 5, and the structure for game theory, explored in Chapters 6 and 7.

3.5.4 Natural Monopoly

A organic monopoly is a firm that has actually a high level of expenses that execute not differ via output.

Natural Monopoly = A firm identified by huge solved expenses.

Recontact that complete costs are the amount of complete variable costs and full solved expenses (TC = TVC + TFC). The fixed prices are those prices that execute not differ with the level of output. When solved prices are high, then average complete costs are decreasing, as watched in Figure 3.16.

Another way of describing high resolved expenses is the term, “economic situations of scale.”

Economies of Scale = Per-unit prices of production decrease once output is increased.

Figure 3.16 shows the defining characteristic of a herbal monopoly: declining average prices (AC). This implies that the demand also curve intersects the AC curve while it is decreasing. At some suggest, the average costs will certainly boost, yet for firms characterized by economic situations of range, the appropriate selection of the AC curve is the declining percentage, of the left side of a typical “U-shaped” price attribute.

The reason for the name, “natural monopoly” deserve to also be discovered in Figure 3.16. The demand also curve has a section over the AC curve, so positive earnings are possible. Suppose that the monopoly was making positive economic profits, and also attracted a challenger right into the sector. The second firm would cause the demand also facing each of the 2 firms to be reduced in fifty percent. This opportunity have the right to be checked out in Figure 3.16: if two firms served the customers, each firm would certainly have actually a demand curve equal to the MR curve. This is bereason for a straight demand curve, the MR curve has the same y-intercept and twice the slope. Notice the place of the MR curve for a organic monopoly: it lies almost everywhere below the AC curve. As such, positive earnings are not possible for 2 firms serving this industry. The demand also is not large sufficient to cover the solved expenses.


The fixed costs are typically big investments that should be made prior to the good have the right to be offered. For instance, an electrical power company need to build both a substantial generating plant and a distribution netjob-related that connects all residences and also businesses to the power grid. These huge costs perform not vary via the level of output: they need to be paid whether the firm sells zero kilowatt hours or one million kilowatt hours. The average fixed prices decline as they are spread out over bigger amounts (AFC = TFC/Q). As the output (Q) rises, average prices (AC = TC/Q) decrease.

This attribute is true for many huge businesses, and offers economic justification for huge firms: the per-unit costs of production are smaller sized, giving reduced costs to consumers. Tbelow is a tradeoff for consumers that purchase items from large firms: the price is lower due to economic climates of range, but the firm may have actually market power, which have the right to lead to greater prices. This tradeoff renders the economic analysis of huge firms both fascinating and also necessary to culture. Current examples include the giant modern technology companies Microsoft, Apple, Google, and also Amazon.

Natural monopolies have vital ramifications for just how huge businesses carry out products to consumers, as is explicitly displayed in Figure 3.16. The industry in Figure 3.16 is a herbal monopoly, since demand also intersects average expenses while they are declining. If a single firm remained in the illustrated sector, it would collection marginal costs equal to marginal earnings (MR = MC), and produce and also sell QM systems of output at a price equal to PM. The price is high: consumers lose welfare and also culture is challenged with deadweight losses.

If competition were feasible, price would certainly be set at marginal price (P = MC). The resulting price and also amount under competition would certainly be PC and also QC (Figure 3.16. This is a preferable outcome for the consumers. However, there is a major difficulty through this outcome: price is below average costs, and any kind of service firm that charged the competitive price COMPUTER would be required out of company. In this case, the firm does not have actually enough revenue to cover the fixed expenses. The herbal monopoly is taken into consideration a “sector failure” given that tright here is no great market-based solution. A single monopoly firm could earn sufficient revenue to stay in business, however consumers would pay a high monopoly price PM). If competition developed, the consumers would pay the price of production (PC), but the firms would certainly not cover their expenses.

One solution to a organic monopoly is federal government regulation. If the government intervened, it can set the regulated price equal to average costs (PR = AC), and the regulated amount equal to QR. This solves the difficulty of organic monopoly through a compromise: consumers pay a price just high enough to cover the firm’s average prices. This analysis describes why the federal government regulates many type of public utilities for electrical power, natural gas, water, sewer, and also garbage collection.

The following section will certainly investigate monopsony, or a single buyer via market power.

3.6 Monopsony

A monopsony is identified as a market characterized by a single buyer.

Monopsony = single buyer of an excellent.

Monopsony power is market power of buyers. A firm through monopsony power is a buyer that is huge enough family member to the industry to affect the price of a great. Competitive firms are price takers: prices are addressed and provided, no issue exactly how bit or how a lot they buy. In food and agriculture, beef packers are often accoffered of having market power, and also pay reduced prices for cattle than the competitive price. This section will discover the causes and also results of monopsony power.

3.6.1 Terminology of Monopsony

Consider any type of decision from an financial allude of see. Thinking choose an economist outcomes in comparing the benefits and costs of any type of decision. This section will certainly apply economic reasoning to the quantity and price of a purchase. It will certainly follow the same economic strategy that has been emphasized, but will certainly define brand-new terminology to identify the buyer’s decision (monopsony) from the seller’s decision (monopoly). It is helpful to respeak to the definition of supply and demand curves. The demand curve represents the consumers’ willingness and capacity to pay for a great. The demand curve is downward sloping, showing scarcity: bigger quantities are much less scarce, and also therefore less practical. The supply curve represents the producers’ price of production, and is upward sloping. As more of a good is created, the marginal prices of production rise, considering that it needs even more resources to create larger quantities. These financial principles will certainly be helpful in what follows, an evaluation of a buyer’s decision to purchase a good.

The economic method to the purchase of a great is to employ marginal decision making by proceeding to purchase a great as lengthy as the marginal benefits outweigh the marginal prices. The complying with terms are characterized to help in our evaluation of buyer’s industry power.

Marginal Value (MV) = The extra benefits of buying another unit of a good.

Marginal Expenditure (ME) = The extra expenses of buying another unit of a great.

Average Expenditure (AE) = The price passist per unit of a good.

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A testimonial of competitive buyers and also sellers is a great founding point for our evaluation.