Business

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4. Market Structure 4.1 Monopoly 4.1.1 Monopolistic Competition 5. Externalities

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• Mandatory: Varian, H., Intermediate Microeconomics, 5th edition, Norton, 1999. Chapter 24.

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In previous lectures we have seen how firms choose the pricequantity combination in

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, a market

structure characterised by a great number of firms. We are now going to study the behaviour of a firm that faces no competition, i.e. the behaviour of a PRQRSROLVW. In the case of monopoly, the firm has control over the price of output. Therefore, it will choose the level of price and output that maximises profits. Remember that in the situation of perfect competition, firms could only choose the quantity, since the control over the price was out of their reach. Since the monopolists supplies the whole market, it can either choose the price and let consumers pick the quantity transacted in the market, or it can choose the quantity and see what price consumers are willing to pay for that quantity. Either way, we will get the same outcome.

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• Denoting the inverse demand function by cost function by as

U \ F \

S \

0 5 and the

profit-

0 5, we can write the revenue function

Thus, the monopolist’s

0 5= 0 5 .

S \ \

maximisation problem can be defined as:

max U

\

0 5− 0 5

\ F \

• By setting the problem in this way, we immediately see that the optimality condition implies having the marginal revenue equal to the marginal cost:

05

= 0&

RU

GU G\

=

GF G\

• Notice that the same optimality condition holds for the competitive firm. The difference is now in the marginal revenue function. For the competitive firm, the marginal revenue is just equal to the market price, which is constant and unaffected by the actions of any individual firm. •...