VI. Market power

    Introduction

    Focus now is on situations in which markets do not perform as we want them to

    Market power: markets are not competitive. The problem in this case is that we don't reach the competitive market price and output, even though that is where we want to be.
    Market failure: the competitive market price and output is not where we want to be–it's not optimal.

    In this section we cover market power.
    Product markets:
        D: universally perfectly competitive (pc)
        S: sometimes not true
    Resource markets: Both D and S not always PC

    A. Demand for firms with market power

    Market power means the power to influence price by varying output

    Key consequence of market power: Firms see downward sloping D:
        Up Q --> Dn P
        => firms are price makers or price searchers instead of price takers

    1. Demand and marginal revenue

    Worksheet: Demand conditions for firms with market power
        --top part

    ? What does MR tell us?

    MR is important because firms use it to maximize profits

    ? Conceputally, why is MR<P for a firm with simple market power?

    Recall in general, P = P(Q)

    A firm with the entire demand curve to itself can use this relationship:
        If I sell Q0, each unit will fetch me P.
        If I sell Q0+1, each unit will fetch me P'.

    What will happen to my TR?
    I.e., what will my MR be?

Example: P=8,6, Q=2,3     MR = DTR/DQ     = P + Q.DP/DQ     A = price fetched by the extra unit–raises TR     B = revenue lost by selling the rest of the output for a lower price.         = Q0.DP–lowers TR.

    For firms with market power, MR < P.

    D and MR tell us two different things.
    For any Qo:
    (1) D tells us what price all Qo units will sell for.
    (2) MR tells us the net contribution of unit Qo to TR.

    Another way to think of D: D=firm's AR.
    D = AR and it is falling
    ? What must be true about the relationship between MR and AR if AR is falling?

    2. P, MR and elasticity (e)

    Handout: Price, marginal revenue and elasticity

    Recall
    (1) MR = P + Q^.DP/DQ
    (2) |e| = - (DQ/DP)^.(P/Q)

    (1) => MR = P^.[1 + (DP/DQ)^.(Q/P)]
    (2) => (DP/DQ)^.(Q/P) = -1/|e|

    Substituting -1/|e| into (1) =>
    MR = P(1 - 1/|e|) =>

MR = P.	|e| - 1 -------   |e|

    Note 1: MR is always < or = P
        = P if e = infinity, as for PC firm

    Note 2: MR > 0 iff e>1
        Recall: MR tells us what is happening to TR:
    Selling more raises TR if e>1
    Selling less raises TR if e<1

    Worksheet: Demand conditions for firms with market power
        --bottom part

    Note1: monopolist gets industry to self: therefore, e_firm = e_industry

    Note2: In general, a firm gets less than the entire industry, so e_firm > e_industry
    (competitors' Q is a good substitute)

    Sum up: market power
    => D slopes down
    => MR no longer = P; MR<P instead

    The problem:
        (1) Profit maximization => MR=MC
        (2) Efficiency => P=MC
    If P does not = MR, we can't be sure we have efficiency

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