Download Energy Economics and Policy

Energy Economics and Policy
Spring 2012
Instructors: Chu Xiaodong , Zhang Wen
Email：[email protected],
[email protected]
Office Tel.: 81696127
10
Pure Monopoly
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Four Market Models
Characteristics of the Four Basic Market Models
Characteristic
Pure
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Number of firms
A very large
number
Many
Few
One
Type of product
Standardized
Differentiated
Standardized or
differentiated
Unique; no
close subs.
Control over
price
None
Some, but within rather
narrow limits
Limited by mutual
inter-dependence;
considerable with
collusion
Considerable
Conditions of
entry
Very easy, no
obstacles
Relatively easy
Significant
obstacles
Blocked
Nonprice
competition
None
Considerable emphasis
on advertising, brand
names, trademarks
Typically a great
deal, particularly
with product
differentiation
Mostly public
relation
advertising
Examples
Agriculture
Retail trade, dresses,
shoes
Steel, auto, farm
implements
Local utilities
LO1
10-3
An Introduction to Pure Monopoly
•
•
•
•
•
Single seller – a sole producer
No close substitutes – unique product
Price maker – control over price
Blocked entry – strong barriers to entry block potential
competition
Non-price competition – mostly PR or advertising the
product
Public utility
companies
• Natural Gas
• Electric
• Water
LO1
Near
monopolies
• Intel
• Wham-O
Professional
sports teams
10-4
Barriers to Entry
• Barrier to entry: a factor that keeps firms
from entering an industry
• Economies of scale
• Legal barriers: patents and licenses
• Ownership of essential resources
• Pricing
LO1
10-5
Monopoly Demand
• The pure monopolist is the industry
• Demand curve is the market demand
•
LO1
curve
• Downsloping demand curve
Marginal revenue is less than price
10-6
Monopoly Demand
• Marginal revenue < price
• Monopolist is a price maker
• Monopolist sets prices in elastic region of
demand curve
LO2
10-7
Output and Price Determination
Steps for Graphically Determining the Profit-Maximizing Output, ProfitMaximizing Price, and Economic Profits (if Any) in Pure Monopoly
Step 1
Determine the profit-maximizing output by finding where MR=MC.
Step 2
Determine the profit-maximizing price by extending a vertical line
upward from the output determined in step 1 to the pure monopolist’s
demand curve.
Step 3
Determine the pure monopolist’s economic profit by using one of two
methods:
Method 1. Find profit per unit by subtracting the average total cost of
the profit-maximizing output from the profit-maximizing price. Then
multiply the difference by the profit-maximizing output to determine
economic profit (if any).
Method 2. Find total cost by multiplying the average total cost of the
profit-maximizing output by that output. Find total revenue by
multiplying the profit-maximizing output by the profit-maximizing price.
Then subtract total cost from total revenue to determine the economic
profit (if any).
LO2
10-8
Output and Price Determination
$200
Price, Costs, and Revenue
175
Pm=$122
MC
150
125
100
75
Economic
Profit
ATC
D
A=$94
MR=MC
50
25
0
LO2
MR
1
2
3
4
5
6
Quantity
7
8
9
10
10-9
Misconceptions of Monopoly Pricing
• Not highest price
• Total profit
• Possibility of losses
LO2
10-10
Misconceptions of Monopoly Pricing
Price, Costs, and Revenue
MC
A
Pm
ATC
Loss
AVC
V
D
MR=MC
MR
0
Qm
Quantity
LO2
10-11
Economic Effects of Monopoly
Pure competition is efficient
Monopoly is inefficient
S=MC
MC
P=MC=
Minimum
ATC
Pc
D
Qc
(a)
Purely Competitive Market
LO3
Pm
Pc
b
d
c
a
MR
D
Qm Qc
(b)
Pure Monopoly
10-12
Economic Effects of Monopoly
• Income transfer
• Cost complications
• Economies of scale
• X-Inefficiency
• Rent seeking expenditures
• Technological advance
LO3
10-13
X-Inefficiency
X
Average total costs
ATCx
ATC1
X'
ATCx'
ATC2
0
LO3
Average
Total Cost
Q1
Quantity
Q2
10-14
Price Discrimination
• Price discrimination
Price Discrimination
• Charging different buyers different
prices
• Price differences are not based on cost
differences
• Examples: business travel, electric
utilities, movie theaters, golf courses,
railroad companies, coupons,
international trade
LO4
10-15
Price Discrimination
• Conditions for success:
• Monopoly power
• Market segregation
• No resale
LO4
10-16
Regulated Monopoly
• Natural monopolies
• Socially optimal price
• Set price = marginal cost
• Fair return price
• Set price = ATC
LO5
10-17
Regulated Monopoly
Price and Costs (Dollars)
Monopoly
Price
Pm
Pf
Fair-Return
Price
a
f
Pr
LO5
ATC
r
MR
0
Socially
Optimal
Price
Qm
MC
D
b
Qf
Quantity
Qr
10-18
11
Monopolistic Competition and Oligopoly
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Four Market Models
Characteristics of the Four Basic Market Models
Characteristic
Pure
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Number of firms
A very large
number
Many
Few
One
Type of product
Standardized
Differentiated
Standardized or
differentiated
Unique; no
close subs.
Control over
price
None
Some, but within rather
narrow limits
Limited by mutual
inter-dependence;
considerable with
collusion
Considerable
Conditions of
entry
Very easy, no
obstacles
Relatively easy
Significant
obstacles
Blocked
Nonprice
competition
None
Considerable emphasis
on advertising, brand
names, trademarks
Typically a great
deal, particularly
with product
differentiation
Mostly public
relation
advertising
Examples
Agriculture
Retail trade, dresses,
shoes
Steel, auto, farm
implements
Local utilities
LO1
11-20
Monopolistic Competition
• Relatively large number of sellers
• Differentiated products
• Easy entry and exit
• Advertising
LO1
11-21
Monopolistically Competitive
• Industry concentration
• Measured by:
• Four-firm concentration ratios
• Percentage of 4 largest firms
4-Firm CR =
Output of four largest firms
Total output in the industry
• Herfindahl index
• Sum of squared market shares
HI = (%S1)2 + (%S2)2 + (%S3)2 + …. +
(%Sn)2
LO1
11-22
Price and Output in Monopolistic Comp
• Demand is highly elastic
• Short run profit or loss
• Produce where MR=MC
• Long run normal profit
• Entry and exit
• Inefficient
• Product variety
LO2
11-23
The Short Run: Profit or Loss
Price and Costs
MC
ATC
P1
A1
Economic
Profit
D1
MR = MC
MR
0
Q1
Quantity
LO2
11-24
The Short Run: Profit or Loss
Price and Costs
MC
ATC
A2
P2
Loss
D2
MR = MC
MR
0
Q2
Quantity
LO2
11-25
The Long Run: Only a Normal Profit
MC
ATC
Price and Costs
P3 = A 3
D3
MR = MC
MR
0
Q3
Quantity
LO2
11-26
Monopolistic Competition: Efficiency
• Inefficient
• Productive inefficiency
• P > ATC
• Allocative inefficiency
• P > MC
LO2
11-27
Monopolistic Competition: Efficiency
P=MC=Min ATC for pure competition (recall)
MC
Price and Costs
ATC
P3 = A 3
P4
Price is Lower
D3
MR = MC
Excess Capacity at
Minimum ATC
0
Q3
MR
Q4
Quantity
Monopolistic competition is not efficient
LO2
11-28
Product Variety
• The firm constantly manages price,
•
LO2
product, and advertising
• Better product differentiation
• Better advertising
The consumer benefits by greater array of
choices and better products
• Types and styles
• Brands and quality
11-29
Oligopoly
• A few large producers
• Homogeneous or differentiated products
• Limited control over price
• Mutual interdependence
• Strategic behavior
• Entry barriers
• Mergers
LO3
11-30
Oligopolistic Industries
• Four-firm concentration ratio
• 40% or more to be oligopoly
• Shortcomings
• Localized markets
• Inter-industry competition
• World price
• Dominant firms
LO3
11-31
Game Theory Overview
• Oligopolies display strategic pricing
behavior
• Mutual interdependence
• Collusion
• Incentive to cheat
• Prisoner’s dilemma
LO4
11-32
Game Theory Overview
RareAir’s Price Strategy
LO4
High
A
Uptown’s Price Strategy
•2 competitors
•2 price strategies
•Each strategy has
a payoff matrix
•Greatest
combined
profit
•Independent
actions
stimulate a
response
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
11-33
Game Theory Overview
RareAir’s Price Strategy
LO4
High
A
Uptown’s Price Strategy
•Independently
lowered prices in
expectation of
greater profit
leads to worst
combined
outcome
•Eventually low
outcomes make
firms return to
higher prices.
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
11-34
Three Oligopoly Models
• Kinked-demand curve
• Collusive pricing
• Price leadership
• Reasons for 3 models
• Diversity of oligopolies
• Complications of interdependence
LO5
11-35
Kinked-Demand Curve
Rivals Ignore
Price Increase
MC1
e
P0
f
Rivals Match
Price Decrease
0
P0
MR2
e
f
MC2
MR2
g
g
D1
Q0
Quantity
LO5
D2
Price
Price
D2
MR1
D1
0
Q0
MR1
Quantity
11-36
Kinked-Demand Curve
• Criticisms
• Explains inflexibility, not price
• Prices are not that rigid
• Price wars
LO6
11-37
Cartels and Other Collusion
Price and Costs
MC
P0
ATC
A0
MR=MC
Economic
Profit
Q0
LO6
D
MR
Quantity
11-38
Overt Collusion
• Cartels - a group of firms or nations that
•
•
LO6
collude
• Formally agreeing to the price
• Sets output levels for members
Collusion is illegal in the United States
OPEC
11-39
Obstacles to Collusion
• Demand and cost differences
• Number of firms
• Cheating
• Recession
• New entrants
• Legal obstacles
LO6
11-40
Price Leadership Model
• Price Leadership
• Dominant firm initiates price changes
• Other firms follow the leader
• Use limit pricing to block entry of new
•
LO6
firms
Possible price war
11-41
Oligopoly and Advertising
• Prevalent to compete with product
development and advertising
• Less easily duplicated than a price
change
• Financially able to advertise
LO7
11-42
Advertising
Positive Effects
Negative Effects
Low-cost way of providing
information to consumers
Can be manipulative
Enhances competition
Contains misleading claims that
confuse consumers
Speeds up technological progress Consumers pay high prices for a
good while forgoing a better, lower
priced, unadvertised version of the
product
Can help firms obtain economies
of scale
LO7
11-43
Oligopoly and Efficiency
• Oligopolies are inefficient
• Productively inefficient P > minATC
• Allocatively inefficient P > MC
• Qualifications
• Increased foreign competition
• Limit pricing
• Technological advance
LO7
11-44
Next Lecture
• The main topic will be Coal Markets and Oil
Markets
• Pages from textbooks are good learning
reference including Chapters 18 and 19 of
[Evans & Hunt, 2009]