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PART III

MARKET STRUCTURE AND COMPETITVE STRATEGY

CHAPTER 10
MARKET POWER: MONOPOLY AND MONOPSONY

TEACHING NOTES

This chapter covers both monopoly and monopsony in order to highlight the similarity between the two types of market power. The chapter begins with a discussion of monopoly in sections 1-4. Section 5 first discusses monopsony, and then offers an instructive comparison ofmonopoly and monopsony. Section 6 discusses sources of monopsony power and the social costs of monopsony power, while section 7 concludes with a discussion of antitrust law. If you are pressed for time you might choose to only cover the first four sections on monopoly and skip the remainder of the chapter. Section 7 can be covered even if you choose to skip sections 5 and 6. The last part ofsection 1 on the multiplant firm can also be skipped if you are pressed for time.

Although chapter 8 presented the general rule for profit maximization, you should review marginal revenue and price elasticity of demand through a careful derivation of Equation 10.1. A discussion of the derivation of Equation 10.1 will elucidate the geometry of Figure 10.3. Point out that because marginalrevenue is positive at the profit maximizing level of price and quantity for a monopolist, demand at that quantity is elastic. Equation 10.1 also leads directly to the Lerner Index in Section 10.2. This provides fruitful ground for a discussion of a monopolist’s market power. For example, if Ed is large (e.g., because of close substitutes), then (1) the demand curve is relatively flat, (2) themarginal revenue curve is relatively flat (although steeper than the demand curve), and (3) the monopolist has little power to raise price above marginal cost. To reinforce these points, introduce a non-linear demand curve by, for example, showing the location of the marginal revenue curve for a unit-elastic demand curve. Once this concept has been clearly presented, the discussion of the effect ofan excise tax on a monopolist with non-linear demand (Figure 10.5) will not seem out of place.

The social costs of market power are a good topic for class discussion, and this topic can be introduced by comparing the deadweight loss associated with monopoly with the analysis of market intervention given in Chapter 9. For example, compare Figure 10.10 with Figure 9.5. Given that Exercises (9),(13), and (15) involve “kinked marginal revenue curves,” you should present Figure 10.11 if you plan to assign those problems. Although Figure 10.11 is complicated, exposure to it here will help when it reappears in Chapter 12.

REVIEW QUESTIONS

1. a monopolist is producing at a point at which marginal cost exceeds marginal revenue. How should it adjust its output to increase profit?When marginal cost is greater than marginal revenue, the incremental cost of the last unit produced is greater than incremental revenue. The firm would increase its profit by not producing the last unit. It should continue to reduce production, thereby decreasing marginal cost and increasing marginal revenue, until marginal cost is equal to marginal revenue.

2. We write the percentagemarkup of prices over marginal cost as (P - MC)/P. For a profit-maximizing monopolist, how does this markup depend on the elasticity of demand? Why can this markup be viewed as a measure of monopoly power?

We can show that this measure of market power is equal to the negative inverse of the price elasticity of demand.
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The equation implies that, as the elasticityincreases (demand becomes more elastic), the inverse of elasticity decreases and the measure of market power decreases. Therefore, as elasticity increases (decreases), the firm has less (more) power to increase price above marginal cost.

3. Why is there no market supply curve under conditions of monopoly?

The monopolist’s output decision depends not only on marginal cost, but also on the...