Sources of Monopoly Power

Why do some firms have considerable monopoly power while other firms have little or none? Remember that monopoly power is the ability to set price above marginal cost and that the amount by which price exceeds marginal cost depends inversely on the elasticity of demand facing the firm. As equation (10.4) shows, the less

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The Social Costs of Monopoly Power

In a competitive market, price equals marginal cost. Monopoly power, on the other hand, implies that price exceeds marginal cost. Because monopoly power results in higher prices and lower quantities produced, we would expect it to make consumers worse off and the firm better off. But suppose we value the welfare of consumers the

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Introduction to Monopsony

So far, our discussion of market power has focused entirely on the seller side of the market. Now we turn to the buyer side. We will see that if there are not too many buyers, they can also have market power and use it profitably to affect the price they pay for a product.

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Monopsony Power

Much more common than pure monopsony are markets with only a few firms competing among themselves as buyers, so that each firm has some monop- sony power. For example, the major U.S. automobile manufacturers compete with one another as buyers of tires. Because each of them accounts for a large share of the tire

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Limiting Market Power: The Antitrust Laws

We have seen that market power—whether wielded by sellers or buyers—harms potential purchasers who could have bought at competitive prices. In addition, market power reduces output, which leads to a deadweight loss. Excessive mar- ket power also raises problems of equity and fairness: If a firm has significant monopoly power, it will profit at

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Capturing Consumer Surplus

All the pricing strategies that we will examine have one thing in common: They are means of capturing consumer surplus and transferring it to the producer. You can see this more clearly in Figure 11.1. Suppose the firm sold all its output at a single price. To maximize profit, it would pick a price

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Price Discrimination

Price discrimination can take three broad forms, which we call first-, second-, and third-degree price discrimination. We will examine them in turn. 1. First–Degree Price Discrimination Ideally, a firm would like to charge a different price to each of its customers. If it could, it would charge each customer the maximum price that the

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Intertemporal Price Discrimination and Peak-Load Pricing

Two other closely related forms of price discrimination are important and widely practiced. The first of these is intertemporal price discrimination: sep- arating consumers with different demand functions into different groups by charging different prices at different points in time. The second is peak-load pricing: charging higher prices during peak periods when capacity constraints

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The Two-Part Tariff

The two-part tariff is related to price discrimination and provides another means of extracting consumer surplus. It requires consumers to pay a fee up front for the right to buy a product. Consumers then pay an additional fee for each unit of the product they wish to consume. The classic example of this strat-

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Bundling

You have probably seen the 1939 film Gone with the Wind. It is a classic that is nearly as popular now as it was then.13  Yet we would guess that you have not seen Getting Gertie’s Garter, a flop that the same company (MGM, a division of Loews) also distributed. And we would also

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Advertising

We have seen how firms can utilize their market power when making pricing decisions. Pricing is important for a firm, but most firms with market power have another important decision to make: how much to advertise. In this sec- tion, we will see how firms with market power can make profit-maximizing advertising decisions, and

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The Vertically Integrated Firm

Many firms are integrated—they consist of several divisions, each with its own managers. Some firms are horizontally integrated: There are several divisions that produce the same or closely related products. We saw an example of this when we discussed the multi-plant firm in Section 10.1. Some firms are verti- cally integrated: They have several

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Monopolistic Competition

In many industries, the products are differentiated. For one reason or another, con- sumers view each firm’s brand as different from other brands. Crest toothpaste, for example, is perceived to be different from Colgate, Aim, and other toothpastes. The difference is partly flavor, partly consistency, and partly reputation—the con- sumer ’s image (correct or

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Oligopoly

In oligopolistic markets, the products may or may not be differentiated. What matters is that only a few firms account for most or all of total production. In some oligopolistic markets, some or all firms earn substantial profits over the long run because barriers to entry make it difficult or impossible for new firms

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Price Competition

We have assumed that our oligopolistic firms compete by setting quantities. In many oligopolistic industries, however, competition occurs along price dimen- sions. For example, automobile companies view price as a key strategic variable, and each one chooses its price with its competitors in mind. In this section, we use the Nash equilibrium concept to

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Competition versus Collusion: The Prisoners’ Dilemma

A Nash equilibrium is a noncooperative equilibrium: Each firm makes the deci­sions that give it the highest possible profit, given the actions of its competitors. As we have seen, the resulting profit earned by each firm is higher than it would be under perfect competition but lower than if the firms colluded. Collusion, however,

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Implications of the Prisoners’ Dilemma for Oligopolistic Pricing

Does the prisoners’ dilemma doom oligopolistic firms to aggressive competition and low profits? Not necessarily. Although our imaginary prisoners have only one opportunity to confess, most firms set output and price over and over again, continually observing their competitors’ behavior and adjusting their own accordingly. This allows firms to develop reputations from which trust

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Cartels

Producers in a cartel explicitly agree to cooperate in setting prices and output levels. Not all the producers in an industry need to join the cartel, and most cartels involve only a subset of producers. But if enough producers adhere to the cartel’s agreements, and if market demand is sufficiently inelastic, the cartel may

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Dominant Strategies

How can we decide on the best strategy for playing a game? How can we deter- mine a game’s likely outcome? We need something to help us determine how the rational behavior of each player will lead to an equilibrium solution. Some strategies may be successful if competitors make certain choices but fail if

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Gaming and Strategic Decisions

First, we should clarify what gaming and strategic decision making are all about. A game is any situation in which players (the partici­pants) make strategic decisions—i.e., decisions that take into account each other’s actions and responses. Examples of games include firms competing with each other by setting prices, or a group of consumers bidding

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