Chapter 10

Market Power: Monopoly and Monopsony

Monopoly- a market with only one seller.

Monopsony – Market with only one buyer.

Market Power – ability of buyer or seller to affect the price of a good.

Unlike the competitive firm, the monopolist MR curve and AR curve may not be the same.

When MR>0, revenue increasing; MR<0, revenue decreasing.

P=AR>MR for a downward sloping demand curve.Why?To sell more output, the producer must charge a lower price.

The monopolist follows the same profit maximizing rule as the competitive firm; produce where MR=MC.

A monopolist uses the same profit maximizing rule as a competitive firm, but the market P=AR>MR; therefore P>MC.How much larger is determined by the elasticity of the demand curve.Elastic demand implies little markup and the market looks like a competitive market.

A monopolist has no supply curve.The output is dependent on MC and the shape of the demand curve.A shift in the demand curve does not necessarily represent changes in the quantity supplied.A monopolist may supply different quantities at the same price.(see pages 335-6)

When a monopolist is taxed, MR= MC + t.The increase in the price will depend on the elasticity of the demand curve as with the competitive firm.

The multiplant firm should divide the optimal output between the plants so that MC1=MC2=…=MCN.The optimal output to produce is where MR= MC1=MC2=…=MCN.

Pure monopolies seldomly exist.What does exist is a market with many produces with distinct like products.So that each firm has a monopoly due to the distinctness of its product.As a result, each firm’s demand curve is more elastic than the market demand, but not infinitely elastic like the demand curve for the competitive firm.

Monopoly power can be measured using the Lerner Index of Monopoly Power,

L = (P-MC)/P =1/Ed

However caution should be used when applying this to public policy because what we usually observe is the firm’s AVC not MC and the firm may price below its optimal price.

The elasticity of the demand curve is a good proxy for monopoly power.The more elastic the firm’s demand curve is the less monopoly power the firm has.

The elasticity of the demand curve is determined by 

1.The elasticity of the market demand curve:

a.One firm= pure monopoly and market demand isthe  firm’s demand;

b.Many firms the elasticity of the market demand functions as a bound 

on the elasticity of the firms in the market.

2.The number of firms in the market

a.Concentrated market may have many firms, but only a few account for the majority of market sales.The firms with a smaller portion of the sales have less monopoly power.

b.More firms implies less monopoly power

3.Interaction of other firms

a.If firms compete aggressively monopoly power is less than if they don’t compete or collude.

b.Because the market is always changing, monopoly power is dynamic.

Welfare effects of a monopoly result in a lost of consumer surplus, a gain in producer surplus and deadweight loss. (see page 347)

Because firms engage in rent seeking, spending money in socially unproductive efforts to acquire, maintain, or exercise monopoly power, the welfare effects are usually larger than the deadweight loss.

In a competitive market price regulation always results in deadweight loss.This need not be the case when a firm has monopoly power.

Natural monopolies occur when a firm can produce the entire output for the industry at a lower cost than many firms.This usually occurs because of economies of scale.

To regulate a natural monopoly Q is chosen where A C=AR.To choose Q where AR=MC would not cover the firms AC and they exit the market.

Natural monopolies can also be regulated using a practice called “rate-of-return”.This is done using the expected rate of return on capital and is difficult to use because valuing a firms capital and determining what is fair can be subjective.


Monopsony – only one buyer

Oligopsony – few buyers

Monopsony power – the ability of the buyer to affect the price of a good.

Marginal value – the additional benefit from purchasing an additional unit.Is represented by the demand curve

Marginal expenditure – the additional cost for an additional unit.For a competitive market this is  P = average expenditure.For the monopsonist marginal expenditure lies above the supply curve = average expenditure.

The monopsonist purchases where ME=MV, or where ME intersects the demand curve.

The degree of Monopsony power is determined by 

1.Elasticity of market supply the less elastic the supply the more monopsony power.

2.Number of buyers – more buyers decreases monopsony power

3.Interaction among buyers – if buyers compete aggressively they have less monopsony power than if they collude or do not compete aggressively.

Welfare effects of a monopsony are similar to those of a monopolist.The consumer surplus increases, producer surplus decreases and deadweight loss occurs.

What happens when a market has both a monopolistic and monopsony characteristics?The monopoly and monopsony power counteract and but may not necessarily create a competitive market. 

Antitrust Laws – rules and regulations designed to promote a competitive economy by prohibiting actions that restrain or are likely to restrain competition and by restricting the forms of market structure that are allowable.

Sherman Act (1890)

Section 1 prohibits contacts, combinations for conspiracies in restrain of trade.

Implicit collusion in theform of parallel conduct.

Section 2 makes it illegal to monopolize or to attempt to monopolize a market.

Clayton Act makes it illegal for firms with large market share to require he buyer or lessor of a good not to buy from a competitor.Also make illegal predatory pricing – practice of pricing to drive current competitors out of the market.

Federal Trade Commission – fosters competitions through a set of prohibitions against unfair and anticompetitive practices, such as deceptive advertising and labeling, agreements with retailers to exclude competing brands.

Antitrust Laws are enforced by

1.Federal Trade Commission

2.Antitrust Division of the Department of Justice

3.Private proceedings – individuals or firms suing for treble damages