MONOPOLY Chapter 25

MONOPOLYChapter 25

3 Questions

What price will the monopolist charge?

How much output will the monopolist produce?

Are consumers better or worse off when only one firm controls an entire market?

Summary

Monopoly is the only firm in an industry. Nobody else is selling anything like what

the monopolist is producing (DeBeers diamonds…. used to be AT & T… cable?)

No close substitutes Is imperfect competition Profit maximizing MC=MR

Summary Continued

The Monopolist lowers price to sell more output, the price is lowered on ALL units of

output, not just on the last one. This drives down MR faster than

price. MR curve descends twice as quickly

as the D Curve.

Summary Continued The perfect competitor produced at the

most profitable output, which in the LR always happened to be the most efficient output.(i.e. at the minimum point of the ATC curve.

The monopolist does NOT produce where output is at its most efficient level (i.e. the minimum point of the ATC curve.)

Summary Continued

Distinguishing characteristic: firm’s demand curve is no longer a

perfectly elastic horizontal line. This means that the imperfect

competitor will have to lower price to sell more.

Marginal Cost is the additional cost of producing one more unit of output.

Summary Continued Monopolist makes a profit whereas in the LR

the perfect competitor makes normal or zero profit

Monopolist operates at less than peak efficiency- perfect competitor operates at peak efficiency.

Perfect competitor charges a lower price and produces a larger output than the monopolist.

http://video.answers.com/chris-anderson-on-monopolies-293408822

Characteristics

No close substitutes – examples? Single Seller – (Microsoft Office?) Price Maker – ($300 ?) Blocked Entry- (Patent?) Advertising – (Why?)

Monopolies not permitted in U.S.

WAIT!!!!!!!!!!!!

Don’t we have them anyway?Sure – (natural and companies with large percentage of market.

What keeps monopolies from forming in our market economy? 1887 Interstate Commerce Act Initially established to curtail abuse by railroads. The Interstate Commerce Act challenged the

philosophy of laissez-faire economics by clearly providing the right of Congress to regulate private corporations engaged in interstate commerce. The Act, with its provision for the ICC, remains one of America’s most important documents serving as a model for future government regulation of private business.

Progression of legislationSherman Act – 1890

Clayton Act – 1914

FTC – 1914

Barriers to Entry

There are six barriers to entry. Patents – offers a producer 20 years of

exclusive rights to produce a particular product. (drugs, inventions, items on cars, etc)

Monopoly franchises – governments also create and maintain monopolies by giving a single firm the exclusive right to supply a particular good or service. (lotteries, liquor stores, licensing, taxicabs,)

Barriers to Entry Continued

Control of key inputs – a company may lock out competition by securing exclusive access to key inputs.(bauxite… aluminum, Tiffany- diamonds)

Lawsuits – may be used to prevent new companies from successfully entering an industry.(threaten patent violation, rich vs poor company) (Standard Oil vs xyz oil)

Entry Barriers Continued

Acquisition – when all else fails, purchase a potential competitor. (AOL/Time/Warner) (Bank of America/Republic Bank)

Economies of scale – a monopoly may persist because of cost advantages over smaller firms (more cost-effective) (Utility companies in a state – Con Edison- NY, SW Bell in TX, TV air waves)

OK! Let’s Take a Deeper Look Are Monopolies Beneficial to a Market

Economy?

It is conceivable that monopolies could benefit society.

If economies of scale exist, the monopolist may attain much greater efficiency than a large number of competitive firms.

Economies of scale act as a “natural” barrier to entry.

Examples of natural monopolies used to include local telephone services, and other local utility services. Local cable is no longer an example of monopoly due to Fios.

Only Two Justifications for Monopoly

1. Natural monopolyLocal gas and electric companies… provide

cheaper service as monopolies than could several competing firms. They are government regulated to insure against price gouging.

2. Economies of ScaleJustify bigness because only a firm with a

large output can produce near the minimum point of its long-run ATC curve

3. Natural monopoly: a single firm can produce the entire market Q at lower ATC than could several firms

Q

Cost

ATC

1000

$50

Example: 1000 homes need electricity. Electricity

Economies of scale due to

huge FC

ATC is lower if one firm services

all 1000 homes

than if two firms

each service 500 homes.

500

$80

Deregulation June, 2013

Why are monopolies so bad?

Monopolies tend to be inefficient. because the production is Not at the

minimum point of its ATC curve, the monopolist restricts output to some

point to the left of that minimum and hence prevents resources from being

allocated in the most efficient manner) (wastes resources!)

Two terms to remember… allocative efficiency and productive efficiency.

Why We Don’t Like Monopolies

The idea of only one seller is not conducive to getting the best price on the market as compared to competition.

Look at the Post Office…. Look at Amtrak….look at trying to get Microsoft to Repair Outlook Express…..have to pay

Profit Maximization

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Quantity (baskets per hour)

d

Demand

Marginal revenue

Marginal cost

Average total cost

D

Profits

What actually IS Market Power?

Market power is the ability to alter the market price of a good or service.

The demand curve facing the monopoly firm is identical to the market demand curve for the product.(the firm IS the market)

Monopoly is a firm that produces the entire market supply of a particular good or service.

Price and Marginal RevenueUnlike competitive firms, marginal

revenue for a monopolist is not equal to price.

So long as the demand curve is downward-sloping, MR will always be less than price.

Profit Maximization

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Pric

e or

Cos

t (pe

r ba

sket

)

Quantity (baskets per hour)

dDemand

Marginal revenue

Marginal cost

Average total cost

D

Profits

Marginal Revenue/Price

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101112 C

DE

FG

b

c

d

e

f

g

Demand (= price)

Marginal revenue

QUANTITY (baskets per hour)

Declining Marginal Revenue and Price Monopolist’s MR from each unit sold does not

remain constant (as does Pure Competitor Monopolist has downward sloping demand

curve which means the price that the monopolist can get for each additional output must fall as monopolist increases its output.

Hence MR will fall as Monopolist increases output.

If you assume NO price discrimination, then MR from each unit produced will not equal the price the monopolist charges.

Three implications of a downward sloping demand curve

1. Price exceeds marginal revenue

A down sloping demand curve means that a pure monopoly can increase its sales ONLY by charging a lower unit price for its product. The fact that he must lower price to boost sales causes MR to be less than P for every level of output EXCEPT the first.

For a Monopolist, P > MR

To sell an additional unit of its good, a monopolist needs to lower price. This price reduction both gains revenue and loses revenue for the monopolist. In the exhibit, the revenue gained and revenue lost are shaded and labeled. Marginal revenue is equal to the larger shaded area minus the smaller shaded area.

Demand and Marginal Revenue Curves The demand curve

plots price and quantity.

The marginal revenue curve plots marginal revenue and quantity.

For a monopolist, P > MR, so the marginal revenue curve must lie below the demand curve.

How does a monopolist figure profit?

Agreed……..monopolist has to lower unit price to sell more…for every level of output but the first… So, how does he know where to produce?

Maximize profit :MC= MRWhere should monopolist produce?

Output Price TR MR TC ATC MC

1 $16 $16 $16 $20 $20 -2 $15 $30 $14 $30 $15 $103 $14 $42 $12 $36 $12 $ 64 $13 $52 $10 $42 $10.50 $ 6

5 $12 $60 $ 8 $50 $10 $86 $11 $66 $ 6 $63 $10.50 $13

7 $10 $70 $ 4 $84 $12 $21

Profit MaximizationOutput Price TR MR TC ATC MC

1 $16 $16 $16 $20 $20 -2 $15 $30 $14 $30 $15 $103 $14 $42 $12 $36 $12 $ 64 $13 $52 $10 $42 $10.5

0$ 6

5 $12 $60 $ 8* $50 $10 $8*6 $11 $66 $ 6 $63 $10.5

0$13

7 $10 $70 $ 4 $84 $12 $21

Implication #2Price Maker

This means that the imperfectly competitive markets in which demand curves are relevant, the firms have a price policy. Because of their ability to influence TOTAL SUPPLY, the output decisions of such firms necessarily affect product price.

The monopolist determines price by deciding what volume of output to produce.

He chooses both price and output

Implication #3

Price ElasticityThe total revenue test for price elasticity of

demand is the third reason for the down sloping demand curve.

Total revenue test tells us that when demand is elastic a decline in price will increase total revenue. P R

When demand is inelastic decrease in price will decrease total revenue.) P R

Actually, inelastic demand for a product is not absolutely necessary… but if product demand is elastic, it not only has to lower price, but suggests substitutes. Cable television????

For inelastic to be the decision, in order to increase revenue, monopolist would have to raise price.

*when MR is negative, demand is inelastic

Because he has to lower price to sell more, will attempt to stay in elastic segment. Decline in P will increase R

Monopolist wants to avoid the inelastic segment

Why did the Dallas Tollway Raise Price?

Because they had a monopoly? No!

Because they had selected clientele? Very possible

Equilibrium for Monopolist

Equilibrium output for a monopolist is determined where MC=MR

The price the monopolist charges is determined by taking the point on the Demand curve directly above the intersection of the MC and MR curves.

Bottom Line

***The monopolist will never choose a price quantity combination where TR is decreasing (or stated another way… MR is negative.)

Stated another way… the profit-maximizing monopolist will always want to avoid the inelastic segment of its demand curve in favor of some price-quantity combination in the elastic segment. (in the inelastic segment, he loses a % of his profit)

Initial Conditions in the Monopolized Computer Market

1200

1000

800

600

400

200

0 24,000P

rice

(per

com

pute

r)

Quantity(computers per month)

A

X

Market demand

Competitive market supply$1200

1000

800

600

400

200

0 200 400 800 1200 1600

Pric

e (p

er c

ompu

ter)

Quantity (computers per month)

W

C

M

B

Average total cost

Demandcurve facingsingle plant

Marginal revenue of single plant

Marginal cost

Monopoly outcomeCompetitive

outcomeMonopoly outcome

Monopoly Curve

$1200

1000

800

600

400

200

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Pric

e (p

er c

ompu

ter)

Quantity (computers per month)

W

C

M

B

Average total cost

Demandcurve facingsingle plant

Marginal revenue of single plant

Marginal cost

Monopoly Profits

M

$1200

1000

800

600

400

200

0

Pric

e (p

er c

ompu

ter)

Quantity (computers per month)200 400 600 800 1000 1200 1400

W

K B

Average total cost

Marginal cost

Demand curve facing single plant

Marginal revenue of single plant

C

Profit

Misconceptions Concerning Monopoly Pricing

1) Not the highest Price… Monopolist will charge the price where he can obtain maximum total profit…. Not maximum total price.

2) Total…. Not Unit… Profit……….Monopolist seeks maximum TOTAL profit, not maximum UNIT profit.

Continued Misconceptions

3) Monopolist cannot lose money… While the Perfect competitor is destined for normal profit in the long run… and no barriers from everyone in the world entering the purely competitor’s world… which drives down prices….

But contrary to conventional wisdom, the monopolist is not immune to changes by the demands of the consumer… and more important … the monopolist is not immune from upward-shifting cost curves caused by escalating resource prices.

Think about the discriminating monopolist and the non-discriminating monopolist. Or, stated another way… think about the various types of discrimination or not that a monopolist can engage in!!!!

What does this mean? How would the two types have a different look for their monopoly graph?

Selling a specific product at more than one price (remember price differences are not justified by cost differences)

QDMR

MC

ATC

P

Q1

Pric

e an

d C

osts

Economic profits witha single MR=MC

price

NON-DISCRIMINATING

Price Discrimination: Give me examples????Examples: Electric utilities (vary prices amid

some competition in certain areas) Golf courses (play 18 at prime time

or “off-hours” Water usageMovie ticketsSeats for Ranger World Series

Outcomes of Price Discrimination:More Profit (if the monopolist can identify the

buyers who will pay more… segregate them, charge the maximum price each would be willing to pay, TR and economic profit will increase

QD

MC

ATC

P

Q1

Pric

e an

d C

osts

PRICE DISCRIMINATION

Q2

A perfectly discriminatingmonopolist has MR=D,producing more product

and more profit!

MR=D

QD

MC

ATC

P

Q1

Economic profits withprice discrimination

Q2

MR=D

Q

DMR

S = MC

QcQm

At MR=MCA monopolistwill sell fewer

units at ahigher price

than incompetition

Inefficiencies ofA pure monopoly

The pure competitorWill produce whereS & D intersect

What is Rent Seeking

Rent Seeking= transferring income or wealth to a particular firm or resource supplier at someone else’s or even society’s expense.

Best example is getting government to regulate something in the industry that has monopoly power (special licensing, special subsidies, anything directed to help that industry regardless of cost of resource mix or societal costs. Exxon did a lot of rent-seeking. What about pharmaceuticals today? – Solar today?

Regulated MonopoliesNATURAL MONOPOLIES –Example???

Rate RegulationSocially Optimum Price

P = MCFair-Return Price

P = ATCDilemma of Regulation

Regulated Monopolies

Q

DMR

MCATC

PMR = MC

Fair-Return Price

Socially-OptimumPrice

Qm Qf Qr

Pm

Pf

Pr

Socially optimumIs supposed to beAllocative efficiency

Examples:

Government Power The AT&T Case The federal government dismantled AT&T in 1984. Prior to the break-up, AT&T supplied 96 percent of all

long-distance service and over 80 percent of local telephone service.

Remember, de-regulation of utilities . Still have natural gas, local phone service being

regulated. Is it possible Health Care will eventually be here?

Government Power Continued

Government Power Continued Antitrust Laws Sherman Act (1890) – prohibits “conspiracies in

restraint of trade.

Clayton Act (1914) – principally aimed at preventing the development of monopolies by prohibiting price discrimination, exclusive dealing agreements, certain types of mergers, and interlocking boards of directors among competing firms

The Federal Trade Commission Act (1914) – created the FTC to study industry structures and behavior so as to identify anti-competitive practices.

Should Government Regulate the Chicken IndustryFinancial IndustryAirline Industry?

REGULATION IS DUE TO INCREASE… lack of safety,Health, environment in question today.Banking,Cap and Trade, CEO salaries, securities, FAA, FTC, Housing, etc….