Theme Three:

Monopoly Power
 Introduction
Alfred Marshall:
“The prima facie interest of the owner of a
monopoly is clearly to adjust the supply to
the demand, not in such a way that the
price at which he can sell his commodity
shall just cover its expenses of production
but in such a way as to afford him the
greatest possible total net revenue.”
 Theoretical Contributions (1)
Joan Robinson, (1933). The Economics of
Imperfect Competition.
Edward Chamberlin, (1933). The theory of
Monopolistic Competition.
Abba Lerner, (1934). The Measurement of
Monopoly Power.
Michal Kalecki, (1940). Supply curve of an
industry under Imperfect Competition.
 Theoretical Contributions (2)
E.S. Mason, (1939). Price and production
policies of large scale enterprises.
J.S. Bain, (1941). The profit rate as a
measure of monopoly power.
John Nash, (1950). The theoretical
indeterminacy addressed in Game Theory
by integrating bargaining theory with
Cournot’s approach to duopoly.
 Sources of Monopoly
What are the sources of monopoly power?
i.e. how and why does a firm have the
freedom to raise P above MC?
1. Price elasticity of firm demand.
2. The number of firms.
3. Barriers to entry (and exit).
4. Interaction between firms.
5. Time and the long run.
 Degree of Monopoly
Price exceeds marginal cost according to
the price elasticity of demand ‘e’.
or, p = (dc/dy) (e/e+1)
so, (e+1)p = (dc/dy)e
so, ep-(dc/dy)e = -p
This results in the ‘degree of monopoly’
developed by Abba Lerner. That is,
(p-dc/dy)/p = -1/e
 The Lerner Index
A measure of monopoly power is a useful tool of
analysis. Under perfect competition the price =
marginal cost. In a monopoly, price > marginal
cost since the firm is a price-setter. The Lerner
Index (L):
L = P – MC/P = 1- MC/P

L ranges from 0 to 1. For the perfectly competitive

firm L = 0; and L is close to 1 the more the firm
can raise P above MC.
 Price Discrimination
If firms are no longer price-takers, then price
discrimination will follow.
First Degree: this is based on a take it or
leave it price, fixed price output at p*.
Second Degree: this is based on non-linear
pricing and quantity discounts i.e.
differential prices depending on quantities.
Third Degree: this is based on different
prices but for all units of consumption.
 The S-C-P Paradigm
Structure► Number of competing firms;
market concentration; barriers to entry;
plus vertical and horizontal integration.
Conduct► Pricing strategy; product
differentiation; collusion and capture; non-
price competition and R&D.
Performance► Industrial efficiency; growth;
profitability; and technical advance. So,
there is a feedback loop: S↔C↔P.
 Key Models
There are key models which need to be
assessed under non-collusive oligopoly:
1. A. Cournot, (1838). Each firm has
identical goods and costs.
2. J. Bertrand, (1883). Each firm is faced
with identical market demand.
3. H. von Stackelberg, (1952). Firms
recognise the reaction curve of the rival.
 Economic Welfare
Why is economic welfare reduced?
Max u(y) – c(y) implies optimal output where
du/dy = dc/dy = p
Monopoly implies p(y) + ydp/dy = dc/dy
Evaluating changes in welfare with respect
to competition implies comparing price
and marginal cost so that:
p(y) – dc/dy = -ydp/dy
 Some Conclusions
In Cournot, each firm treats the output of its rival
as given. In Bertrand, each firm threats the
price of its rival as given. The Nash-Cournot
equilibrium entails lower output, higher prices
and profits. The Nash-Bertrand equilibrium
entails pricing at marginal cost.
By deducing the reaction of its rival, the firm as a
Stackelberg leader has first-mover advantage
and produces higher output (knowing its rival will
have to produce lower output).