CHAPTER 9:
MARKET POWER AND MONOPOLY

9.1 – Sources of Market Power

The key difference between perfect competition and a market structure in which firms have pricing power is the presence of barriers to entry.
Factors that prevent entry into markets with large producer surpluses
Normally, positive producer surplus in the long run will induce additional firms to enter the market (long run the market supply curve is perfectly elas7c reflec7ng zero profit and zero producer surplus)
The presence of barriers to entry means firms may be able to maintain positive producer surplus indefinitely

Extreme Scale Economies: Natural Monopoly
One common barrier to entry results from a production process that exhibits economies of scale at every quantity level
Long-run average total cost curve is downward sloping; diseconomies never emerge
Results in a situation called a natural monopoly
More efficient for a single firm to produce the entire industry output
Splitting output across multiple firms raises the average cost of production
Consider a production process with the following total cost structure

Switching Costs
Another barrier to entry results from the presence of consumer-switching costs; switching costs can result from
Brand-related opportunity costs (e.g., preferred status on an airline)
Technology constraints (e.g., software compatibility issues between Apple and Microsoft Windows-based operating systems)
Search costs (e.g., health insurance plans)
Some goods have characteristics that make them network goods
A good whose value to each consumer increases with the number of other consumers of the product Ex: Twitter, Facebook, telephone

Product Differentiation
For most non-commodity markets, consumers may not treat products from different firms as perfect substitutes
Product differentiation refers to a situation in which there is imperfect substitutability across varieties of a product
Prevents new firms from entering the market and stealing most of the market demand just by pricing their product version a bit below the incumbents’ price.

Absolute Cost Advantages or Control of Key Inputs
Many production processes rely on scarce inputs (e.g., natural resource products)
For instance, Saudi Aramco (Saudi Arabia’s state-run oil company) maintains control over a vast oil supply, with relatively low extraction costs
In other circumstances, firms may develop absolute cost advantages by engaging in long-term contracts with intermediate suppliers
Apple has developed this type of relationship with Foxconn, a Chinese company that assembles many of Apple’s products

Government Regulation
A final important barrier is the presence of government regulation that limits entry to a market
Patents
Licensing requirements (e.g., medical board certification)
Prohibition of competition (e.g., U.S. Postal Service)

9.2 – Market Power and Marginal Revenue

A true monopolist faces the market demand curve
There are no competing firms in this market
Price is not fixed; the only way to sell more of a product is to lower the price
Other market structures also associated with downward-sloping demand:
Oligopoly is a market structure in which a few competitors operate (e.g., the automobile industry)
Monopolistic competition is a market structure with a large number of firms selling differentiated products (e.g., the fast food industry)
In these structures, the demand curve facing a given firm depends on the production decisions of other firms – strategic behavior

Marginal Revenue
Marginal revenue: Change in revenue resulting from a one-unit increase in output
In perfect competition, the demand curve facing an individual firm is horizontal, and marginal revenue is equal to price
If a firm has market power, the demand curve for its product(s) will have a downward slope (Price is a function of Q)

It is important to note that marginal revenue is not equivalent to price for a firm facing a downward-sloping demand curve
When a firm produces more of a