This is “End-of-Chapter Material”, section 14.4 from the book Theory and Applications of Microeconomics (v. 1.0).
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There are very few examples of truly competitive markets. Most firms in the economy possess a certain amount of market power because their product, service, or location is distinctive. This means that most prices in the economy are in excess of marginal cost.
That said, the degree of market power of most firms is relatively small. Canon has some market power for its cameras because Canon cameras are not identical to Nikon, Olympus, or Sony cameras. But the presence of these other manufacturers severely limits Canon’s ability to charge high prices. Your local Thai restaurant has some market power because its food is different from that of other restaurants in the neighborhood. Again, though, this does not mean it can charge very high prices because customers can easily eat at other restaurants instead.
Occasionally, however, firms are so large relative to their markets that they have substantial market power. This distorts prices and output in the economy. Firms with such market power can make a lot of money by restricting their output and charging very high prices. This is where the antitrust authorities come into play. Their task is to identify firms that are abusing their market power in this way. In effect, their job is to try to bring the economy closer to the economists’ ideal world, where markets are competitive, there are no distortions, and all possible gains from trade are realized.
In some cases, though, governments have reasons to create and support market power through patents and copyrights. They do so because the benefits from innovation outweigh the distortions associated with monopoly. Policy in this area is highly contentious because the right balance between encouraging innovation and fostering competition is unclear. Economists and policymakers continue to struggle with this and are likely to do so for years to come.
(Advanced) Looking again at the following table (with marginal cost equal to $4), calculate the marginal revenue. What is its relationship to price? Explain your findings.
Table 14.2 Price Discrimination by a Monopolist
|Household||Quantity||Household Valuation||Price||Total Revenue||Marginal Cost||Total Cost||Profit|