Download 8 March, 2006 - people.vcu.edu

16 April, 2006
Tests: Returned Next Time
Reading: Chapter 8. Finish
Chapter 11 next
Homework. Hand out Problem 14
Lecture 33
REVIEW___________________________________________________:
VII. Chapter 8. Managing in Competitive, Monopolistic and Monopolistically
Competitive Markets.
A. Competition.
1. Assumptions
2. Optimal short run decisions:
3. Long run decisions.
Preview__________________________________________________________
B. Monopoly
1. Assumptions, Sources of monopoly power.
2. Characterization:
3. Optimizing decisions.
a. Optimizing with Demand Curve
4. Observations: Social Costs of Monopoly
.
C. Monopolistic Competition
1. Assumptions
2. Characterization:
3. Optimizing decisions.
4. Observations.
a. Social cost of product differentiation
b. Optimal Advertising decisions.
Lecture____________________________________________________________
Now we turn our attention to the case exactly opposite to the competitor: The monopolist.
The insight critical to understanding monopoly is that for one reason or another (reasons
that we will discuss momentarily) the monopolist is the market. Cost conditions, on the
other hand do not necessarily differ) Thus, to analyze optimizing decisions for the
monopolist, we must combine the market demand curve with the firm’s supply curves.
.
P
MC
ATC
S
Pc
P*
c =0
Market
D
Q
Firm Q*
Q
1. Reasons for monopoly: A single firm may come to dominate a market for a variety of
reasons.
a) Economies of scale. If it is the case that production is characterized by economies of
scale over range under the market demand curve, then only a single firm can efficiently
exist in an industry. These types of cases are typically regulated monopolies, such as
electric utilities and water and sewer service.
b) Patents. Many monopolies are the consequence of government activity. If an inventor
develops a cost saving technology, or a unique product, and secures a defensible patent
for the invention, the inventor has a legal monopoly for 17 years following the patent.
This monopoly power is provided as an incentive for creative activity. In the absence of
patents, new developments would be copied by firms that did not incur the product
development costs, undercutting the incentive for new product development.
c) Economies of Scope and Cost Complementarities. If firms enjoy economies of scope,
and particularly cost complementarities, they can produce a product more cheaply than
any rival, because costs are defrayed by the production of the complementary product.
2. Characterizing the problem for a monopolist.
a. Demand. Critically, when a firm faces a downsloping demand curve, P=AR no
longer equals MR. This is true as long as the monopolist cannot price discriminate, or
charge different prices to different consumers. In this case, the Marginal Revenue is
different from P = AR. The reason is that in order to sell additional units, the firm must
lower the price, causing the firm to lose sales on units that would have sold at the higher
price.
Po
P1
MR for the range Po - P1
D = AR= P
Qo Q1
MR
In terms of the above graph, the marginal revenue from lowering the price from
Po to P1 is the change in total revenues over that range. Essentially, it is the “quantity
box” less the “price box.”
b. Costs and Monopoly Supply: As we will demonstrate formally in a moment, for
any linear demand curve, the MR curve has exactly twice the slope of the demand curve.
There is no well-defined supply curve for the monopolist. Unlike the competitor, the
monopolist does not produce goods until P = MC. Thus, the MC curve is not a supply
curve. Rather, willingness-to-produce is the combination of MC and the demand curve.
2. Optimization for the Monopolist.
a. A Homogeneous Product Monopolist, with a down-sloping demand curve.
Placing the market demand curve over the cost curves for the firm generates, the
optimizing decisions for the monopolist follow the same rules as for a competitor. (For
simplicity, AVC is again suppressed.)
P
MC
.......
. Profits . .
........
ATC
D = AR = P
Q
Q*
MR
i) The optimal quantity Q* is determined by the intersection of MR and
MC curves.
ii) The optimal price is the intersection of the demand curve and the
vertical line extending up from AR.
iii) Profits are the difference between the price, and ATC, multiplied by
Q*
An algebraic example. Suppose you are a monopolist of a firm. Your
total cost and inverse demand curves are, respectively
TC = 50 + .5Q2
P = 200 - 2Q
a. What is the marginal revenue curve for the monopolist?
b. What is the optimal quantity for the monopolist?
c. Determine monopoly profits.
Observations: The social costs of monopoly. There is no entry and exit, so
monopoly profits can be permanent.
b) Monopoly pricing is inefficient. The monopolist produces less, at a higher cost and
price than would a competitor. The monopolist also earns persistent profits.
P
Pm
MC
ATC
c
P .
D = AR = P
Qm
charge?
MR
Qc
Q
Continuing with the above example, what would a competitor be forced to
MC = ATC Calculate profits, price and ATC.
C. Monopolistic Competition. The third structural model we consider in this evening’s
class combines important components of the preceding two models.
1. Assumptions
(a) There are many buyers and sellers
(b) Entry and exit is easy.
(c) Products are differentiated.
As indicated at the beginning of class, examples of monopolistic competition
include restaurants and beer, soft drinks, and many food products.
2. Characterization. Due to product differentiation monopolistic competitors face
downsloping demand curves. Thus in the optimum, monopolistically competitive firms
will not produce at the point where ATC = MC, as in the competitive case. However, due
to entry and exit, all profits will be driven to zero.
a. Short Run Decisions. In the short run, the decision-calculus is exactly as the
monopolist.
P
MC
.......
. Profits . .
........
AC
D = AR = P
Q
Q*
MR
Optimal quantity Q* is determined by the intersection of Marginal Revenue and Marginal
cost curves. The optimal price is the intersection of the vertical extending from Q* and
the demand curve. Profits are the difference between AR and ATC multiplied by the
number of units produced.
b. Long Run Decisions. Due to free entry and exit, however, profits in a
monopolistically competitive firm are driven to zero. The dynamic motivating this
outcome involves shifts in the firm’s demand curve. As new competitors enter the
market, the monopolistic competitor still has his or her “following”, however, some
consumers will switch to one of the entrants, shift the demand curve for the firm inward.
Inward shifts of this nature will persist until the demand curve is just tangent to the ATC
curve at the optimum.
P
MC
.
..
..
AC
D’ = AR = P
Q
Q*
MR’
3. Implications of Product Differentiation.
a. Product Differentiation and Social Welfare. Notice that although
monopolistically competitive firms earn zero economic profits, MC does not equal ATC
in the long run. Some would argue that this is a social cost associated with this industry
structure. Others, however, would (I think quite reasonably) contend that the welfare loss
is the cost of product differentiation. Consumers value differentiation, and if they did
not, homogenous product competitive industries would prevail.
b. The nature of Managerial Decisions and the Industry Structure. Note the
difference in managerial decisions in each industry structure. In the competitive industry,
the primary focus of managerial decisions will be on reducing costs. Monopolists, on the
other hand, are frequently regulated. Even if not, they are concerned with pricing as well
as output level decisions. Finally, the monopolistic competitor will typically engage in
considerable advertising, and new product development in order to make demand more
inelastic, and to capture short term profits.