Download Price Discrimination

CHAPTER 14
Monopoly
Monopoly
A monopoly (monopolist) means there is
only one producer of a good.
2
Types of Market Structure
Economists have developed four principal
models of market structure:
perfect competition
monopoly
oligopoly
monopolistic competition
3
The Meaning of Monopoly
A monopoly (monopolist) is a firm that is
the only producer of a good that has no close
substitutes. Examples: De Beers (diamonds)
Hometown newspapers or movie theater
Microsoft (word, power point), E-bay?
Buying food or a drink at Miller Park
The ability of a monopolist to raise its price
above the competitive level by reducing
output is known as market power.
4
What does a
Monopolist
Do?
Reduce supply
and quantity!
Under perfect competition, the price and quantity are determined
by supply and demand. A monopolist reduces the quantity
supplied to QM, raising the price to PM.
5
Why Do Monopolies Exist?
A monopolist has market power and will
charge higher prices and produce less output
than a competitive industry.
Profits will vanish in the long run unless there is
a barrier to entry. Examples -
control of natural resources or inputs,
economies of scale,
technological superiority, or
legal restrictions imposed by governments,
including patents and copyrights.
6
Economies of Scale and Natural Monopoly
A monopoly created and sustained by
economies of scale is called a natural
monopoly.
Economies of scale provide a large cost
advantage to having all of an industry’s output
produced by a single firm.
Under such circumstances, average total cost
is declining over the output range relevant for
the industry.
This prevents new firms from entering.
7
Economies of
Scale Create
Natural
Monopoly
Example:
Electric
utilities
A natural monopoly can arise when fixed costs required
to operate are very high. As a result, output is produced
more cheaply by one large firm than by two or more
smaller firms.
8
How a Monopolist Maximizes Profit
The price-taking (Perfect competition)
firm’s optimal output rule is to produce the
output level at which MC = MR.
A monopolist, in contrast, is the only
supplier of its good. So its demand curve is
simply the market demand curve, which is
downward sloping.
9
Comparing the Demand Curves of a Perfectly
Competitive Firm and a Monopolist
An individual perfectly competitive firm cannot affect the market
price of the good.
A monopolist can affect the price (sole supplier in the industry).
Its demand curve is the market demand curve, as shown in
panel (b). To sell more output it must lower the price; by reducing
output it raises the price.
10
How a Monopolist Maximizes Profit
An increase in production by a monopolist
has two opposing effects on revenue:
A quantity effect. One more unit is sold,
increasing total revenue by the price at which
the unit is sold.
A price effect. In order to sell the last unit,
the monopolist must cut the market price on
all units sold. This decreases total revenue.
11
A Monopolist’s Demand, Total Revenue, and Marginal Revenue Curves
12
The Monopolist’s Demand Curve and
Marginal Revenue
A profit-maximizing monopolist chooses the
output level at which marginal cost is equal
to marginal revenue—not to price.
MC = MR
As a result, the monopolist produces less
and sells its output at a higher price than a
perfectly competitive industry would. It
earns a profit in the short run and the long
run.
13
The Monopolist’s Profit- Maximizing
Output and Price
To maximize profit, the monopolist compares
marginal cost with marginal revenue.
If marginal revenue exceeds marginal cost,
De Beers increases profit by producing
more; if marginal revenue is less than
marginal cost, De Beers increases profit by
producing less. So the monopolist maximizes
its profit by using the optimal output rule:
Output quantity is where MR = MC
14
The
Monopolist’s
ProfitMaximizing
Output and
Price
The optimal output rule: the profit maximizing
level of output for the monopolist is at MR = MC,
shown by point A, where the marginal cost and
marginal revenue curves cross at an output of 8
diamonds.
15
Monopoly versus Perfect Competition
Compared with a competitive industry, a
monopolist does the following:
 Produces a smaller quantity
 Charges a higher price
 Earns an economic (Above normal)
profit
16
The Monopolist’s
Profit
Profit = TR − TC
TR = Q x P
TC = ATC x Q
17
Monopoly and Public Policy
Monopoly = less consumer surplus
Monopoly causes more deadweight loss
When monopolies are “created” rather than
natural, governments should act to prevent
them from forming and break up existing
ones.
This is called anti-trust policy.
18
Monopoly Causes Inefficiency
Blue = consumer
surplus
Green = monopoly
profit
Yellow = D.W. loss
19
Dealing with Natural Monopoly
What can public policy do about this? There
are two common answers…
One answer is public ownership, but publicly
owned companies are often poorly run.
A common response in the United States is
price regulation. A price ceiling imposed on a
monopolist does not create shortages as
long as it is not set too low.
20
Regulated and Unregulated Natural Monopoly
Panel (b) shows the effect of price regulations.The
monopolist makes zero profit. This is the greatest
consumer surplus possible when the monopolist is
allowed to at least break even, making PR* the best
regulated price. (socially optimal price in AP language)
21
Price Discrimination
Can a monopolist charge different customers
different prices?
22
Price Discrimination (continued)
Example: Airline tickets
If you are willing to buy a nonrefundable
ticket two weeks in advance and stay over a
Saturday night, the round trip may cost only
$150,but if you have to go on a business trip
tomorrow, and come back the next day, the
round trip might cost $550.
23
The Logic of Price Discrimination
Price discrimination is profitable when consumers
differ in their sensitivity to the price. A monopolist
would like to charge high prices to consumers
willing to pay them without driving away others
who are willing to pay less.
It is profit-maximizing to charge higher prices to
low-elasticity consumers and lower prices to high
elasticity ones.
24
Two Types of
Airline
Customers
Air Sunshine has two types of customers, business travelers
willing to pay $550 per ticket and students willing to pay $150
per ticket. If Air Sunshine could charge these two types of
customers different prices, it would maximize its profit by
charging two different prices. It would capture all of the
consumer surplus as profit.
25
Price Discrimination and Elasticity
A monopolist able to charge each consumer
his or her willingness to pay for the good
achieves perfect price discrimination and
does not cause inefficiency because all
mutually beneficial transactions are
exploited.
In this case, the consumers do not get any
consumer surplus.
26
Price Discrimination
By increasing the number of different prices
charged, the monopolist captures more of the
consumer surplus and makes a large profit.
27
Perfect Price
Discrimination
In the real
world, this is
probably
impossible.
In the case of perfect price discrimination, a monopolist
charges each consumer his or her willingness to pay; the
monopolist’s profit is given by the shaded triangle. Perfect
price discrimination is probably impossible.
28
Perfect Price Discrimination
Common techniques for price discrimination
are:
Advance purchase restrictions
Volume discounts (Microsoft) UW-Madison
Discounts for locals (Disney World)
Time of day discounts (electric utilities)
Bundled services (cable tv)
Interruptible service discount (Electric)
29
The End of Chapter 14
30