Daniel l. Rubinfeld

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PART 3 examines a broad range of markets and explains how the pricing, inveshnent, and output decisions of firms depend on market structure and the behavior of competitors, Chapters 10 and 11 examine market power: the ability to affect price, either by a seller or a buyer. We will see how market power arises, how it differs across firms, how it affects the welfare of consumers and producers, and how it can be limited by government. We will also see how firms can design pricing and advertising sh'ategies to take maximum advantage of their market power, Chapters 12 and 13 deal with markets in which the number of firms is limited. We will examine a variety of such markets, ranging from monopolistic competitiolZ, in which many firms sell differentiated products, to cartels, in which a group of firms coordinate decisions and act as a monopolist. We are particularly concerned with markets in which there are only a few firms. In these cases, each firm must design its pricing, output, and investment strategies while keeping in mind how competitors are likely to react. We will develop and apply principles from game theory to analyze such strategies. Chapter 14 shows how markets for factor inputs, such as labor and raw materials, operate. We will examine the firm's input decisions and show how those decisions depend on the struchlre of the input market. Chapter 15 then focuses on capital investment decisions, We will see how a firm can value the profits it expects an investment to yield in the fuhlre, and then compare this value with the cost of the investment to determine "vhether the investment is worthwhile.
I I n a perfectly competitive market, the large number of sellers and buyers of a good ensures that no single seller or buyer can affect its price. The market forces of supply and demand determine price. Individual firms take the market price as a given in deciding how much to produce and sell, and consumers take it as a given in deciding how much to buy. MOllopoly and monopsony, the subjects of this chapter~ are the polar opposites of perfect competition. A monopoly is a market that has only one seller but many buyers. A monospony is just the opposite: a market with many sellers but only one buyer. Monopoly and monopsony are closely related, which is vvhy we cover them in the same chapter. First we discuss the behavior of a monopolist. Because a monopolist is the sole producer of a product, the demand curve that it faces is the market demand curve. This market demand curve relates the price that the monopolist receives to the quantity it offers for sale. We will see how a monopolist can take advantage of its control over price and how the profitmaximizing price and quantity differ from ""hat would prevail in a competitive market. In general, the monopolist's quantity will be lower and its price higher than the competitive quantity and price. This imposes a cost on society because fewer consumers buy the product, and those who do pay more for it. This is why antitrust laws exist which forbid firms from monopoliZing most markets. When economies of scale make monopoly desirable-for example, with local electric power companieswe will see how the government can then increase efficiency by regulating the monopolist's price. Pllre monopoly is rare, but in many markets only a few firms compete with each other. The interactions of firms in such markets can be complicated and often involve aspects of sh'ategic gaming, a topic covered in Chapters 12 and B. In any case, the firms may be able to affect price and may find it profitable to charge a price higher than marginal cost. These firms have monopoly power. We will discuss the determinants of monopoly pmver, its measurement, and its implications for pricing.
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Daniel l. Rubinfeld

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