Market Power Market power ability of a firm

Market Power § Market power: ability of a firm to influence the prices of its products and develop strategies to earn profits over longer periods of time § Monopoly: single firm producing product with no close substitutes § Price-searchers: firms in imperfect competition © 2005 Prentice Hall, Inc. 8. 1

Monopoly Model with Positive Economic Profit $ Figure 6. 1 a MC PM ATCM A ATC B MR 0 © 2005 Prentice Hall, Inc. QM D Q 8. 2

Monopoly Model with Negative Economic Profit $ Figure 6. 1 b MC B ATCM PM A MR 0 © 2005 Prentice Hall, Inc. QM D Q 8. 3

Monopoly Model § Monopolist maximizes profits by producing where MR = MC and earns positive economic profit due to barriers to entry § The monopolist could suffer losses if ATC is greater than price at the profit-maximizing level of output (previous slide) © 2005 Prentice Hall, Inc. 8. 4

Comparing Monopoly and Perfect Competition Figure 6. 2 $ MC ATC D=P=MR 0 QPC © 2005 Prentice Hall, Inc. $ P 2 MC P 1 ATC 0 MR QM Q 1 Q 8. 5

Comparing Monopoly and Perfect Competition § Monopolistic firm must seek out optimal price, which depends on demand cost conditions § Firms with market power might pursue other profit goals § Price is higher and output lower under monopoly than under perfect competition © 2005 Prentice Hall, Inc. 8. 6

Barriers to Entry § Economies of scale and mergers § Barriers created by government § Input barriers § Brand loyalties § Consumer lock-in and switching costs © 2005 Prentice Hall, Inc. 8. 7

Economies of Scale and Mergers § Exist when a firm’s LRAC slopes downward or when lower production costs are associated with larger scale of operation § Can act as a barrier to entry in different industries § Mergers are particularly important in technology, media, and telecommunications © 2005 Prentice Hall, Inc. 8. 8

Barriers Created by Government § Licenses § Patents and copyrights © 2005 Prentice Hall, Inc. 8. 9

Input Barriers § Control over raw materials § Barriers in financial capital markets • Larger firms can get lower interest rates • Smaller firms need more collateral for loans • Smaller firms are perceived as riskier © 2005 Prentice Hall, Inc. 8. 10

Consumer Lock-In and Switching Costs § When consumers become locked into certain types or brands and would incur substantial switching costs if they changed § Although lock-in types are dominant, they represent managerial strategies that can be used elsewhere to gain market power © 2005 Prentice Hall, Inc. 8. 11

Measures of Market Power § Managers can use measures to better understand the markets • Lerner Index: measure of market power that focuses on the difference between a firm’s product price and marginal cost of production L = (P – MC) P © 2005 Prentice Hall, Inc. 8. 12

Antitrust Issues § Federal legislation that limits market power of firms and regulates how firms use their market power to compete § Major components of antitrust law: • Sherman Act of 1890 • Clayton Act of 1914 • Federal Trade Commission Act of 1914 © 2005 Prentice Hall, Inc. 8. 13

Managerial Rule of Thumb: Understanding Antitrust Laws § Managers must work within antitrust constraints § Because of generalities and ambiguities, managers may not know whether their actions are illegal unless the government initiates litigation © 2005 Prentice Hall, Inc. 8. 14

Assumptions of Monopolistic Competition § Product differentiation exists among firms § Large number of firms exist § No interdependence exists among these firms § Entry by new firms is relatively easy © 2005 Prentice Hall, Inc. 8. 15

Monopolistic Competition, Long Run and Short run Figure 6. 3 $ P 1 $ MC MC ATC 0 MR Q 1 © 2005 Prentice Hall, Inc. ATC P 2 D Q 0 MR D Q 2 Q 8. 16

Managerial Rule of Thumb: Market Power in Monopolistic Competition § Managers must develop a variety of strategies to maintain market power when faced with intense competition § They can exploit geographic advantages, offer improved customer service, become part of a cooperative to lower cost, and develop specialized niches © 2005 Prentice Hall, Inc. 8. 17