Part 2 Monopoly Market power and dominant firms Non-linear pricing and price discrimination Market power and product quality
Part 2 Monopoly Market power and dominant firms Non-linear pricing and price discrimination Market power and product quality
Ch 4 Market power and dominant firms Market power-the ability of a firm to profitably raise prices above marginal cost Sources of market power: maintenance of market power requires barriers that prohibit or restrict entry of new firms A dominant firm with a competitive fringe: 2 factors that might limit the ability of a dominant firm to exercise market power are a competitive fringe and the impact of product durability Durable goods monopoly Market power: a second look Benefits of monopol Summar
Ch.4 Market power and dominant firms • Market power-the ability of a firm to profitably raise prices above marginal cost. • Sources of market power: maintenance of market power requires barriers that prohibit or restrict entry of new firms. • A dominant firm with a competitive fringe: 2 factors that might limit the ability of a dominant firm to exercise market power are a competitive fringe and the impact of product durability. • Durable goods monopoly • Market power: a second look • Benefits of monopoly • Summary
Sources of market power( To maximize profits the monopolist produces where marginal revenue equals marginal cost The role of economic profits is to provide a signal regarding the social value of interindustry resource allocation. Positive economic profits in a market indicates that the social value of resources producing that product exceeds their value in their next best alternative use We expect that economic profits will attract entrants: entrepreneurs have an incentive to bid resources away from alternative uses and enter If the new entrants have access to the same technology as the incumbent monopolist we would expect that over time, the incumbents market power would be eroded and eventually eliminated. Entrants provide alternative sources of supply to which consumers can substitute, reducing the profitability of raising price above marginal cost. If entry is easy-there are no barriers to entry-then in the long run market power is eliminated by entry and the equilibrium price pc should equal marginal cost and economic profits will be zero. Market power-when there is not relatively large economies of scale-can only persist in the long run if there are barriers to entry that limit the extent of competition If there are economies of scale then free entry will eliminate economic profits and firms will only be able to exercise sufficient market power to ensure that their economic profits are zero
Sources of market power (1) • To maximize profits, the monopolist produces where marginal revenue equals marginal cost. • The role of economic profits is to provide a signal regarding the social value of interindustry resource allocation. Positive economic profits in a market indicates that the social value of resources producing that product exceeds their value in their next best alternative use. We expect that economic profits will attract entrants: entrepreneurs have an incentive to bid resources away from alternative uses and enter. If the new entrants have access to the same technology as the incumbent monopolist we would expect that, over time, the incumbent’s market power would be eroded and eventually eliminated. Entrants provide alternative sources of supply to which consumers can substitute, reducing the profitability of raising price above marginal cost. If entry is easy-there are no barriers to entry-then in the long run market power is eliminated by entry and the equilibrium price pc should equal marginal cost and economic profits will be zero. Market power-when there is not relatively large economies of scale-can only persist in the long run if there are barriers to entry that limit the extent of competition. If there are economies of scale, then free entry will eliminate economic profits and firms will only be able to exercise sufficient market power to ensure that their economic profits are zero
P=P(Q) MC=AC=C MR(Q Qm Monopoly pricing
Qm Qs MR(Q) P=P(Q) Pc MC=AC=c Pm Monopoly pricing
Sources of market power(2) Entry is impeded when entrants anticipate that their profits postentry will be negative Entry barriers are of interest from 2 perspectives: (1) corporate strategy and ( 2) public policy From the perspective of firms, entry barriers are required to protect an incumbent s market power. However, incumbents will be interested in protecting not only their market power, but also their monopoly profits. A key objective of corporate strategy will be profitable entry deterrence Profitable entry deterrence occurs when incumbent firms are able to earn monopoly profits without attracting entry Profitable entry deterrence depends on the interaction of structural entry barriers and the behavior of incumbents postentry Profitable entry deterrence is not necessarily exogenous-incumbent firms can make strategic investments and engage in other behavior that magnifies the effect of, or creates structural entry barriers and shelters both their market power and monopoly profits From a public policy perspective the existence of entry barriers is also very important. If entry is timely, likely, and sufficient then attempts by firms to exercise or create market power will ultimately be unsuccessful New entry will provide consumers with sufficient substitution alternatives that efforts to raise price above competitive levels will not be sustainable
Sources of market power (2) • Entry is impeded when entrants anticipate that their profits postentry will be negative. • Entry barriers are of interest from 2 perspectives: (1) corporate strategy and (2) public policy. • From the perspective of firms, entry barriers are required to protect an incumbent’s market power. However, incumbents will be interested in protecting not only their market power, but also their monopoly profits. A key objective of corporate strategy will be profitable entry deterrence. • Profitable entry deterrence occurs when incumbent firms are able to earn monopoly profits without attracting entry. Profitable entry deterrence depends on the interaction of structural entry barriers and the behavior of incumbents postentry. Profitable entry deterrence is not necessarily exogenous-incumbent firms can make strategic investments and engage in other behavior that magnifies the effect of, or creates, structural entry barriers and shelters both their market power and monopoly profits. • From a public policy perspective, the existence of entry barriers is also very important. If entry is timely, likely, and sufficient then attempts by firms to exercise or create market power will ultimately be unsuccessful. New entry will provide consumers with sufficient substitution alternatives that efforts to raise price above competitive levels will not be sustainable