Multi-Plant FirmSocial Cost of Monopoly PowerPrice RegulationMonopsonyCite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 1 1 Multi-Plant Firm 14.01 Principles of Microeconomics, Fall 2007 Chia-Hui Chen November 9, 2007 Lecture 23 Monopoly and Monopsony Outline 1. Chap 10: Multi-Plant Firm 2. Chap 10: Social Cost of Monopoly Power 3. Chap 10: Price Regulation 4. Chap 10: Monopsony 1 Multi-Plant Firm How does a mo nopolist allocate production between plants? Suppose the firm produces quantity Q1 with cost C1(Q1) for plant 1, and quan-tity Q2 with cost C2(Q2) for plant 2. The total qua ntity is QT = Q1 + Q2. And the profit is π = QT P (QT ) − C1(Q1) − C2(Q2) = (Q1 + Q2)P (Q1 + Q2) − C1(Q1) − C2(Q2). To solve, use the first o rder constraint: dπ dP (Q1 + Q2) dC1 = P (Q1 + Q2) + (Q1 + Q2) − = 0, dQ1 dQ1 dQ1 Since dP (QT ) dP (QT )P (QT ) + QT = P (QT ) + QT = MR(QT ), dQ1 dQT M R(QT ) = MC1(Q1). Similarly, M R(QT ) = MC2(Q2). Thus, M R(QT ) = MC1(Q1) = MC2(Q2).Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 2 2 Social Cost of Monopoly Power 0 1 2 3 4 5 6 7 8 9 10 PA B C PM PC QM QC MR D=AR MR MC 2 Social Cost of Monopoly Power Firstly, compare the producer and c onsumer surplus in a competitive market and a monopolistic market. In the competitive ma rket, the quantity is determined by M C = AR, while in the monopolistic market, the quantity is determined by M C = M R (see Figure 1). Therefore, in going from a perfectly competitive market to a 0 1 2 3 4 5 6 7 8 9 10 Q Figure 1: Consumer and Producer Surplus in Monopolist Market. monopolistic market, the change of consumer surplus and producer surplus are, respectively, ΔCS = −(A + B), and ΔP S = A − C. The deadweight loss is DW L = B + C. In fact, social cost should not only include the deadweight loss but also rent seek-ing. The firm mig ht spe nd to gain monopoly power by lobbying the government and building excess capacity to threaten opponents.Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 3 Price Regulation 3 3 Price Regulation In per fectly co mpetitive markets, price regulation causes deadweight loss, but in monopoly, price regulatio n might improve efficiently. Now we discuss four possible price regulations in monopolistic markets. P1, P2, P3, P4 are: • P1 ∈ (PC , PM ); • P2 = PC ; • P3 ∈ (P0, PC ); • P4 < P0. 0 1 2 3 4 5 6 7 8 9 10 Q Figure 2: Comparing Competitive and Monopolist Market. Price between the competitive market price and monopolist market price. Suppose the price ceiling is P1. The new corresponding AR and M R curves are shown in Figure 3. Given the new M R curve, the equilibrium quantity will b e Q1. Q1 ∈ (QM , QC ). 0 1 2 3 4 5 6 7 8 9 10 P PM PC QM QC MR D=AR MC AC P0Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 3 Price Regulation 4 0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 Q PPM PC QM QC MR AR MC P1 Q1 Figure 3: P rice between the Competitive Market Price and Monopolist Market Price. Price equal to the competitive market price. The new corresponding MR and AR curves are shown in Figure 4. In this case the equlibrium price and quantity are as same as those of the competitive market. Price between the competitive market price and the lowest average cost. Suppose the price ceiling is P3. The new corresponding MR and AR curves are shown in Figure 5. T he equilibrium quantity will be Q3. Q3 ∈ (QC , Q0). The new bold line describes the relation between price and quantity. Price lower than the lowest average cost. The firm’s revenue is not enough for the co st, thus it will quit the market. There is no production. The analysis shows that if the government sets the price ceiling equal to P2, the outcome is the same as in a competitive market, and there is no deadweight loss. Natural monopoly. In a natural monopoly, a firm can produce the entire output of the industry and the cost is lower than what it would be if there were other firms. Natural monopoly arises w hen there are large economies of scale (see Figure 6). If the mar ket is unregulated, the pr ice will be PM and the quantity will be QM . To improve efficiency, the government can regulate the price. If the price is regulated to be PC , the firm cannot cover the average cost and will go o ut of business. PR is the lowest price that the government can s et so that the monopolist will stay in the mar ket.Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 5 3 Price Regulation 10 9 8 9 100 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 8 Q P PC QC MR AR MC Figure 4: Price Equal to the Competitive Market Price. 10 9 8 7 P PCPQC MR0 3 AR MC AC P3 Q6 5 4 3 2 1 0 0 1 2 3 4 5 6 7 8 9 10 Q Figure 5: Price between the Competitive Ma rket Pr ic e and the lowest Average Cost.10 9 8 7 6 5 4 3 2 1 0 0 1 2 3 4 5 6 7 8 9 10 P MRQQC AR MC AC M QR PM PR PC Q Cite as: Chia-Hui Chen, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY]. 6 4 Monopsony Figure 6: Regulating the Price of a Natural Monopoly. 4 Monopsony Monopsony re fers to a mar ket with only one buyer. In this market, the buyer will maximize its profit, which is the difference o f value and expenditure: max Π(Q) =