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Chapter 24 Monopoly
55

Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

Dec 25, 2015

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Page 1: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

Chapter 24Monopoly

Page 2: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

2

Pure Monopoly

A monopolized market has a single seller.

The monopolist’s demand curve is the (downward sloping) market demand curve.

So the monopolist can alter the market price by adjusting its output level.

2

Page 3: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

3

Pure Monopoly

Output Level, y

$/output unit

p(y)Higher output y causes alower market price, p(y).

3

Page 4: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

4

Why Monopolies?

Some examples:a patent; e.g. a new drugsole ownership of a resource; e.g. a toll

highwayformation of a cartel; e.g. OPEC large economies of scale; e.g. local

utility companies.

4

Page 5: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

5

Pure Monopoly

Suppose that the monopolist seeks to maximize its economic profit,

What output level y* maximizes profit?

( ) ( ) ( ).y p y y c y

5

Page 6: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

6

Profit-Maximization( ) ( ) ( ).y p y y c y

At the profit-maximizing output level y*

d ydy

ddy

p y ydc ydy

( )( )

( ) 0

so, for y = y*,

ddy

p y ydc ydy

( )( ).

6

Page 7: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

7

Profit-Maximization

At the profit-maximizing output level the slopes of the revenue and total cost curves are equal:

MR(y*) = MC(y*).

7

Page 8: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

8

Marginal RevenueMarginal revenue is the rate-of-change of revenue as the output level y increases: MR y

ddy

p y y p y ydp ydy

( ) ( ) ( )( ).

dp(y)/dy is the slope of the market inverse demand function so dp(y)/dy < 0. ThereforeMR y p y y

dp ydy

p y( ) ( )( )

( )

for y > 0.

8

Page 9: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

9

Marginal RevenueE.g. if p(y) = a - by then R(y) = p(y)y = ay - by2

and therefore MR(y) = a - 2by < a - by = p(y) for y > 0.

p(y) = a - bya

ya/bMR(y) = a - 2by

a/2b9

Page 10: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

10

Marginal CostMarginal cost is the rate-of-change of total cost as the output level y increases;

MC ydc ydy

( )( ).

E.g. if c(y) = F + y +y2 then

MC y y( ) . 2

10

Page 11: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

11

Marginal Cost

Fy

y

c(y) = F + y + y2

$

MC(y) = + 2y

$/output unit

11

Page 12: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

12

Profit-Maximization: An ExampleAt the profit-maximizing output level y*,MR(y*) = MC(y*). So if p(y) = a - by and ifc(y) = F + y + y2 thenMR y a by y MC y( *) * * ( *) 2 2

and the profit-maximizing output level is y

ab

*( )

2

causing the market price to be

p y a by a bab

( *) *( )

. 2

12

Page 13: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

13

Profit-Maximization; An Example$/output unit

y

MC(y) = + 2y

p(y) = a - by

MR(y) = a - 2by

a

13

Page 14: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

14

Profit-Maximization; An Example$/output unit

y

MC(y) = + 2y

p(y) = a - by

MR(y) = a - 2by

y

ab

*

( )

2

a

14

Page 15: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

15

Profit-Maximization; An Example$/output unit

y

MC(y) = + 2y

p(y) = a - by

MR(y) = a - 2by

y

ab

*

( )

2

p y

a bab

( *)

( )

2

a

15

Page 16: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

16

Monopolistic Pricing & Own-Price Elasticity of Demand Suppose that market demand

becomes less sensitive to changes in price (i.e. the own-price elasticity of demand becomes less negative). Does the monopolist exploit this by causing the market price to rise?

16

Page 17: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

17

Monopolistic Pricing & Own-Price Elasticity of Demand

MR yddy

p y y p y ydp ydy

p yyp y

dp ydy

( ) ( ) ( )( )

( )( )

( ).

1

Own-price elasticity of demand is

p yy

dydp y

( )( )

so MR y p y( ) ( ) .

11

17

Page 18: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

18

Monopolistic Pricing & Own-Price Elasticity of Demand

MR y p y( ) ( ) .

11

Suppose the monopolist’s marginal cost ofproduction is constant, at $k/output unit. For a profit-maximum

MR y p y k( *) ( *)

1

1

which isp y

k( *) .

1 1 18

Page 19: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

19

Monopolistic Pricing & Own-Price Elasticity of Demand

p yk

( *) .1 1

E.g. if = -3 then p(y*) = 3k/2, and if = -2 then p(y*) = 2k. So as rises towards -1 the monopolist alters its output level to make the market price of its product to rise.

19

Page 20: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

20

Monopolistic Pricing & Own-Price Elasticity of Demand

Notice that, since

p y( *) 11

0 11

0

That is,1

1 1

.

So a profit-maximizing monopolist always selects an output level for which market demand is own-price elastic. 20

,1

1*)(*)( kypyMR

Page 21: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

21

Markup Pricing

Markup pricing: Output price is the marginal cost of production plus a “markup.”

How big is a monopolist’s markup and how does it change with the own-price elasticity of demand?

21

Page 22: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

22

Markup Pricingp y k p y

k k( *) ( *)1

1

11 1

is the monopolist’s price. The markup is

p y kk

kk

( *) .

1 1

E.g. if = -3 then the markup is k/2, and if = -2 then the markup is k. The markup rises as the own-price elasticity of demand rises towards -1. 22

Page 23: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

23

A Profits Tax Levied on a Monopoly A profits tax levied at rate t reduces

profit from (y*) to (1-t)(y*). Q: How is after-tax profit, (1-t)(y*),

maximized? A: By maximizing before-tax profit, (y*). So a profits tax has no effect on the

monopolist’s choices of output level, output price, or demands for inputs.

I.e. the profits tax is a neutral tax.23

Page 24: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

24

Quantity Tax Levied on a Monopolist A quantity tax of $t/output unit

raises the marginal cost of production by $t.

So the tax reduces the profit-maximizing output level, causes the market price to rise, and input demands to fall.

The quantity tax is distortionary.

24

Page 25: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

25

Quantity Tax Levied on a Monopolist$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)

25

Page 26: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

26

Quantity Tax Levied on a Monopolist$/output unit

y

MC(y)

p(y)

MR(y)

MC(y) + tt

y*

p(y*)

26

Page 27: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

27

Quantity Tax Levied on a Monopolist$/output unit

y

MC(y)

p(y)

MR(y)

MC(y) + tt

y*

p(y*)

yt

p(yt)

27

Page 28: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

28

Quantity Tax Levied on a Monopolist$/output unit

y

MC(y)

p(y)

MR(y)

MC(y) + tt

y*

p(y*)

yt

p(yt)

The quantity tax causes a dropin the output level, a rise in theoutput’s price and a decline indemand for inputs.

28

Page 29: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

29

Linear Demand

p=a-by, MR=a-2by With tax, MC=c+t Profit maximization: a-2by=c+t

y=(a-c-t)/2bp(y)=a-by=a-(a-c-t)/2

dp/dt=1/2 The monopolist passes on half of the

tax.29

Page 30: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

30

Linear Demand

Page 31: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

31

Constant Elasticity Demand

Can a monopolist “pass” all of a $t quantity tax to the consumers in the case of constant elasticity demand?

Suppose the marginal cost of production is constant at $k/output unit.

With no tax, the monopolist’s price isp yk

( *) .1

31

Page 32: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

32

Constant Elasticity Demand

The tax increases marginal cost to $(k+t)/output unit, changing the profit-maximizing price to

The amount of the tax paid by buyers is

p yk tt( )( )

.

1

p y p yt( ) ( *).

32

Page 33: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

33

Constant Elasticity Demand

p y p yk t k tt( ) ( *)( )

1 1 1

is the amount of the tax passed on to buyers. E.g. if = -2, the amount of the tax passed on is 2t.Because < -1, ) > 1 and so the monopolist passes on to consumers more than the tax!

33

Page 34: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

34

The Inefficiency of Monopoly

Social welfare=consumer surplus+ producer surplus

A market is Pareto efficient if it achieves the maximum possible total gains-to-trade (i.e. social welfare).

Otherwise a market is Pareto inefficient.

34

Page 35: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

35

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

ye

p(ye)

The efficient output levelye satisfies p(y) = MC(y).

35

Page 36: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

36

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

ye

p(ye)

The efficient output levelye satisfies p(y) = MC(y).

CS

36

Page 37: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

37

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

ye

p(ye)

The efficient output levelye satisfies p(y) = MC(y).

CS

PS

37

Page 38: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

38

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

ye

p(ye)

The efficient output levelye satisfies p(y) = MC(y).Total gains-to-trade ismaximized.

CS

PS

38

Page 39: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

39

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)

39

Page 40: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

40

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)CS

40

Page 41: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

41

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)CS

PS

41

Page 42: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

42

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)CS

PS

42

Page 43: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

43

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)CS

PS

43

Page 44: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

44

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)CS

PS

MC(y*+1) < p(y*+1) so bothseller and buyer could gainif the (y*+1)th unit of outputwas produced. Hence the market is Pareto inefficient.

44

Page 45: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

45

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)DWL

Deadweight loss measuresthe gains-to-trade notachieved by the market.

45

Page 46: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

46

The Inefficiency of Monopoly$/output unit

y

MC(y)

p(y)

MR(y)

y*

p(y*)

ye

p(ye) DWL

The monopolist produces less than the efficient quantity, making the market price exceed the efficient market price.

46

Page 47: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

47

Natural Monopoly

A natural monopoly occurs when a firm cannot operate at an efficient level of output without losing money.

When there are large fixed costs and small marginal costs, you can easily get the kind of situation described above.

Many public utilities are natural monopolies of this sort.

47

Page 48: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

48

Natural Monopoly

Page 49: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

49

Inefficiency of a Natural Monopoly Like any profit-maximizing monopolist,

the natural monopolist causes a deadweight loss.

If allowing a natural monopolist to set the monopoly price is undesirable due to the Pareto inefficiency, and forcing the natural monopoly to produce at the competitive price is infeasible due to negative profits, what is left?

For the most part natural monopolies are regulated or operated by governments.

49

Page 50: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

50

Natural Monopoly: Solutions

Pricing policy: Set the prices that just allow the firm to break even – produce at a point where price equals average costs. But it is difficult to determine the true costs of the firm…

The other solution is to let the government operate it at price equals marginal cost and provide a lump-sum subsidy to keep the firm in operation.

Page 51: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

51

What Causes Monopolies?

1. Nature of technology. If the minimum efficient scale (MES) is

large relative to demand, then the market is likely to be monopolized. But if the MES is small relative to demand, there is room for many firms in the industry, and there is a hope for a competitive market structure.

Page 52: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

52

What Causes Monopolies?

Page 53: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

53

What Causes Monopolies? 2. Cartel. Several different firms in an industry

might be able to collude and restrict output in order to raise prices and thereby increase their profits. When firms collude in this way and attempt to reduce output and increase price, we say the industry is organized as a cartel.

Cartels are illegal.

Page 54: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

54

What Causes Monopolies? 3. Entry deterrence. An industry may have one dominant firm

purely by historical accident. If one firm is first to enter some market, it may have enough of a cost advantage to be able to discourage other firms from entering the industry. The incumbent may be able to convince potential entrants that it will cut its prices drastically if they attempt to enter the industry.

By preventing entry in this manner, a firm can eventually dominate a market.

Page 55: Chapter 24 Monopoly. 2 Pure Monopoly A monopolized market has a single seller. The monopolist’s demand curve is the (downward sloping) market demand curve.

55

What Causes Monopolies?

4. Patent. A patent offers inventors the

exclusive right to benefit from their inventions for a limited period of time.

Thus a patent offers a kind of limited monopoly.