Download Monopoly Monopoly Monopoly

Monopoly
Monopoly
While a competitive firm is a
price taker, a monopoly firm is
a price maker.
Chapter 15
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Monopoly
Because a monopoly is a price maker, a
monopolist gets to choose what price they will
sell their good for rather than having the
market determine the price.
u How does a monopolist decide to price their
good at $100 rather than $1,000?
u Although monopolies can control the prices of
their goods, their profits are not unlimited.
u
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Monopoly
uA firm is considered a monopoly if . . .
…it is the sole seller of its product.
…its product does not have close
substitutes.
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Why Monopolies Arise
Why Monopolies Arise
Barriers to entry have three sources:
Ownership of a key resource.
The government gives a single firm the
exclusive right to produce some good.
u Costs of production make a single producer
more efficient than a large number of
producers.
u
The fundamental cause of
monopoly is barriers to entry.
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u
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Monopoly Resources
Monopoly Resources
Although exclusive ownership of a key
resource is a potential source of
monopoly, in practice monopolies
rarely arise for this reason.
u The
classic example of a company with a
monopoly due to the ownership of a key
resource is DeBeers .
u DeBeers
owns land in South Africa
where more than 80% of the diamonds
are found worldwide.
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DeBeers Example
“A diamond is forever.”
Why does DeBeers advertise if it is a
monopoly?
u Remember a firm is considered a monopoly
when there are no close substitutes.
u DeBeers advertises just to make sure how
important diamonds are compared to other
gems such as emeralds or rubies.
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Government-Created Monopolies
u
u
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Government-Created Monopolies
Patent and copyright laws are two
important examples of how
government creates a monopoly to
serve the public interest.
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Governments may restrict entry by giving a
single firm the exclusive right to sell a
particular good in certain markets.
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Government-Created Monopolies
Because patents and copyrights give one
producer a monopoly, they lead to higher
prices than would occur under competition.
u So why does the government give patents?
u Patents and copyrights give individuals and
firms an incentive for creative research.
u Example: Drug companies spend much money
in the research and development of new drugs
because they know they will have a monopoly
for that drug for the life of the patent.
u
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Natural Monopolies
Natural Monopolies
An industry is a natural monopoly when a
single firm can supply a good or service to
an entire market at a smaller cost than
could two or more firms.
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A natural monopoly arises when there
are economies of scale over the relevant
range of output.
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Economies of Scale as a Cause of
Monopoly...
Natural Monopolies
Cost
u An
Average
total
cost
0
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Quantity of Output
Monopoly versus Competition
Monopoly
example of a natural monopoly is the
local utilities.
u Power lines have to be strung up all
across town which implies a huge fixed
cost.
u It is cheaper for one company to provide
this service rather than having multiple
companies setting up power lines.
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Competition versus Monopoly
Competitive Firm
uIs the sole producer
uIs
uHas
uHas a horizontal demand curve
uIs
uIs
a downward-sloping demand curve
a price maker
uReduces price to increase sales
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one of many producers
a price taker
uSells as much or as little at same price
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Demand Curves for Competitive and
Monopoly Firms...
Price
(a) A Competitive Firm’s
Demand Curve
A Monopoly’s Revenue
(b) A Monopolist’s
Demand Curve
u Total Revenue
Price
P x Q = TR
u Average Revenue
Demand
TR/Q = AR = P
u Marginal Revenue
Demand
0
Quantity of
Output
0
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A Monopoly’s Total, Average, and
Marginal Revenue
Quantity
(Q)
0
1
2
3
4
5
6
7
8
Price
(P)
$11.00
$10.00
$9.00
$8.00
$7.00
$6.00
$5.00
$4.00
$3.00
Total Revenue
(TR=PxQ)
$0.00
$10.00
$18.00
$24.00
$28.00
$30.00
$30.00
$28.00
$24.00
∆TR/∆ Q = MR
Quantity of
Output
Average
Revenue
(AR=TR/Q)
Marginal Revenue
(MR=∆ TR / ∆ Q )
$10.00
$9.00
$8.00
$7.00
$6.00
$5.00
$4.00
$3.00
$10.00
$8.00
$6.00
$4.00
$2.00
$0.00
-$2.00
-$4.00
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A Monopoly’s Marginal Revenue
A monopolist’s marginal revenue is
always less than the price of its good.
uThe
demand curve is downward sloping.
a monopoly drops the price to sell one
more unit, the revenue received from
previously sold units also decreases.
uWhen
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A Monopoly’s Marginal Revenue
When a monopoly increases the
amount it sells, it has two effects on
total revenue (P x Q).
uThe
output effect—more output is
sold, so Q is higher.
uThe price effect—price falls, so P is
lower.
Demand and Marginal Revenue Curves
for a Monopoly...
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Demand
(average revenue)
Marginal
revenue
1
2
3
4
5
6
7
8
Quantity of Water
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Profit Maximization of a Monopoly
uA
monopoly maximizes profit by
producing the quantity at which
marginal revenue equals marginal cost.
u It then uses the demand curve to find the
price that will induce consumers to buy
that quantity.
Profit-Maximization for a Monopoly...
2. ...and then the demand
curve shows the price
consistent with this
quantity.
Costs and
Revenue
B
Monopoly
price
1. The intersection of
the marginal-revenue
curve and the marginalcost curve determines
the profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
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Comparing Monopoly and
Competition
u For a competitive
Quantity
A Monopoly’s Profit
firm, price equals
marginal cost.
Profit equals total revenue minus total costs.
Profit = TR - TC
Profit = (TR/Q - TC/Q) x Q
Profit = (P - ATC) x Q
P = MR = MC
u For a monopoly firm,
QMAX
price exceeds
marginal cost.
P > MR = MC
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The Monopolist’s Profit...
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Average
total cost D
B
ly
po
no fit
Mo pro
Monopoly E
price
Average total cost
The monopolist will receive
economic profits as long as price is
greater than average total cost.
C
Demand
Marginal revenue
0
QMAX
Quantity
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The Market for Drugs...
The Welfare Cost of Monopoly
Costs and
Revenue
uIn
Price
during
patent life
Price after
patent
expires
Marginal
cost
Marginal
revenue
0
Monopoly
quantity
Demand
Competitive
quantity
contrast to a competitive firm, the
monopoly charges a price above the marginal
cost.
uFrom the standpoint of consumers, this high
price makes monopoly undesirable.
uHowever, from the standpoint of the owners
of the firm, the high price makes monopoly
very desirable.
Quantity
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The Efficient Level of Output...
Price
Marginal cost
Value
to
buyers
Because a monopoly sets its price above
marginal cost, it places a wedge between
the consumer’s willingness to pay and the
producer’s cost.
Cost to
monopolist
Value
to
buyers
Cost to
monopolist
0
Demand
(value to buyers)
Efficient
quantity
Value to buyers is greater
than cost to seller.
The Deadweight Loss
uThis
wedge causes the quantity sold to
fall short of the social optimum.
Quantity
Value to buyers is less
than cost to seller.
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The Inefficiency of Monopoly...
Price
The Inefficiency of Monopoly
Deadweight
loss
Marginal cost
Monopoly
price
The monopolist produces less
than the socially efficient
quantity of output.
Marginal
revenue
0
Monopoly
quantity
Efficient
quantity
Demand
Quantity
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The Deadweight Loss
The Deadweight Loss
u The
monopoly profit itself does not
represent a shrinkage in the size of the
economic pie; it merely represents a
bigger slice for producers and a smaller
slice for consumers.
u The problem arises because the firm
produces a quantity of output below the
level that maximizes total surplus.
uThe
deadweight loss caused by a monopoly is
similar to the deadweight loss caused by a tax.
uThe difference between the two cases is that
the government gets the revenue from a tax,
whereas a private firm gets the monopoly
profit.
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Increasing Competition with
Antitrust Laws
Public Policy Toward Monopolies
Government responds to the problem of
monopoly in one of four ways.
Making monopolized industries more
competitive.
u Regulating the behavior of monopolies.
u Turning some private monopolies into public
enterprises.
u Doing nothing at all.
u
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Antitrust laws are a collection of statutes aimed at
curbing monopoly power.
u Antitrust laws give government various ways to
promote competition.
u
u They
allow government to prevent mergers.
allow government to break up companies.
u They prevent companies from performing activities
which make markets less competitive.
u They
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Two Important
Antitrust Laws
u Sherman
Antitrust Act (1890)
u Reduced
the market power of the large and
powerful “trusts” of that time period.
u Clayton
Act (1914)
u Strengthened
the government’s powers and
authorized private lawsuits.
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Regulation
Government may regulate the prices
that the monopoly charges.
uThe
allocation of resources will be
efficient if price is set to equal
marginal cost.
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Regulation
Marginal -Cost Pricing for a Natural
Monopoly...
Price
u
1.
2.
There are two problems with marginal cost
pricing as a regulatory system.
When ATC is declining, MC is less than ATC.
If regulators are to set price equal to MC,
that price will be less than the firm’s ATC,
and the firm will lose money.
The monopolist has no incentive to reduce
costs if they know the regulator will lower
price as costs fall.
Average
total cost
Regulated
price
Loss
Average total cost
Marginal cost
Demand
0
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Regulation
In practice, regulators will allow
monopolists to keep some of the benefits
from lower costs in the form of higher
profit, a practice that requires some
departure from marginal-cost pricing.
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Quantity
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Public Ownership
Rather than regulating a natural
monopoly that is run by a private firm,
the government can run the monopoly
itself. (e.g. in the U.S., the government
runs the Postal Service).
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Public Ownership
Doing Nothing
u Economists
usually prefer private to
public ownership of natural monopolies.
u Firms are motivated by profit (assuming
regulators allow the firm to keep some
profit when the firm reduces costs).
u If government bureaucrats who run a
monopoly do a bad job, the losers are the
customers and tax payers.
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Government can do nothing at all
if the market failure is deemed
small compared to the
imperfections of public policies.
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Price Discrimination
Price Discrimination
Price discrimination is the practice of
selling the same good at different
prices to different customers, even
though the costs for producing for the
two customers are the same.
Price discrimination is not possible
when a good is sold in a competitive
market since there are many firms all
selling at the market price. In order to
price discriminate, the firm must have
some market power.
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Price Discrimination
Perfect Price Discrimination
u In
order for a firm to price discriminate,
it must be able to separate customers
according to their willing to pay.
u Sometimes firms price discriminate by a
consumer’s age.
u Examples: movies and restaurants.
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Perfect price discrimination
refers to the situation when the
monopolist knows exactly the
willingness to pay of each
customer and can charge each
customer a different price.
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Price Discrimination
Price Discrimination
It may be surprising, but price discrimination
raises economic welfare.
u This is accomplished by producers receiving
much more surplus since they can charge
different consumers different prices.
u Consumers are no better off if they are charged
their willingness to pay.
u The entire increase in total surplus from price
discrimination goes to the producer in the form
of higher profit.
u
u Two important effects of price
discrimination:
u It
u It
can increase the monopolist’s profits.
can reduce deadweight loss.
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Welfare Without Price
Discrimination...
Welfare With Price
Discrimination...
(a) Monopolist with Single Price
Price
Price
(b) Monopolist with Perfect Price Discrimination
Consumer
surplus
Deadweight
loss
Monopoly
price
Profit
Profit
Marginal
revenue
0
Quantity sold
Marginal cost
Marginal cost
Demand
Demand
Quantity
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0
tickets
u Airline prices
u Discount coupons
u Financial aid
u Quantity discounts
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Most airlines charge a lower price for a round
trip ticket between two cities if the traveler
stays over a Saturday night.
u Why is this?
u The reason is that this provides a way to
distinguish business travelers from personal
travelers.
u Assuming business travelers have a higher
willingness to pay, this type of price
discrimination makes sense.
u
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Summary
The Prevalence of Monopoly
u How prevalent are the problems of
monopolies?
u Monopolies are common.
u Most
firms have some control over their
prices because of differentiated products.
u Firms with substantial monopoly power are
rare.
u Few goods are truly unique.
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Quantity
Airlines
Examples of Price Discrimination
u Movie
Quantity sold
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uA
monopoly is a firm that is the sole
seller in its market.
u It faces a downward-sloping demand
curve for its product.
u A monopoly’s marginal revenue is
always below the price of its good.
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Summary
u Like
a competitive firm, a monopoly
maximizes profit by producing the
quantity at which marginal cost and
marginal revenue are equal.
u Unlike a competitive firm, its price
exceeds its marginal revenue, so its
price exceeds marginal cost.
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Summary
u Policymakers can respond to the
inefficiencies of monopoly behavior with
antitrust laws, regulation of prices, or by
turning the monopoly into a
government-run enterprise.
u If the market failure is deemed small,
policymakers may decide to do nothing
at all.
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Summary
uA
monopolist’s profit-maximizing level
of output is below the level that
maximizes the sum of consumer and
producer surplus.
u A monopoly causes deadweight losses
similar to the deadweight losses caused
by taxes.
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Summary
u Monopolists
can raise their profits by
charging different prices to different
buyers based on their willingness to
pay.
u Price discrimination can raise
economic welfare and lessen
deadweight losses
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