In the news lately, stories of the big bad monopolies abound. We constantly
hear of government regulation in software, utilities, transportation, and
financial institutions. The justice department closely scrutinizes mergers and
acquisitions so that firms don't end up with too much market power. All of this
begs the question, what's the big deal? Where does our fear of monopolies
originate? After all, in a free market economy, there is no coercion.
Presumably, the economy is still driven solely by mutually beneficial exchange
whether one firm exists or many.
Thus far in our treatment of economics, we have assumed that there exist a large
number of firms in a market. This assumption enabled us to treat firms as price
takers, since no firm in particular had any more market power than any other.
In this Sparknote, we will investigate the impact of a relaxation of the
multiple firms assumption on equilibrium. We will demonstrate the importance of
the assumption in our understanding of perfect competition.
In the first
section,
we will define a monopoly and walk through the mechanics behind calculating
equilibrium in a monopolistic market. We will also investigate the monopoly's
impact on social welfare. In the second
section,
we
extend the model of a monopoly to 2 firms and then to n firms. We define the
assumptions underlying Cournot, Bertrand, and Stackelberg duopolies. We then
walk through examples designed to clarify the mechanics behind the various
models of duopoly, and generalize to the n firm case in a Cournot framework.
