Download Slide 1

Chapter 15: Monopoly
Econ 2100
MONOPOLY
0
Course Outline
What; why;
who?
What works in
the public
sector?
How markets
work?
Why are you
hired?
Are markets
good?
How firms
behave?
Chapters 13 - 17
Chapter 15 Outline
Monopolies:
What & Why
Why MR < P
Impact on
society’s
well-being
Profit Max
Decisionmaking
Gov’t Role in
Monopoly
Markets
MONOPOLY
Price
Discrimination
2
Introduction
• A monopoly is a firm that is the sole seller of a
product without close substitutes.
• In this chapter, we study monopoly and
contrast it with perfect competition.
• The key difference:
A monopoly firm has market power, the ability
to influence the market price of the product it
sells. A competitive firm has no market power.
MONOPOLY
3
Why Monopolies Arise
The main cause of monopolies is barriers
to entry – other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The govt gives a single firm the exclusive right to
produce the good.
E.g., patents, copyright laws
MONOPOLY
4
Why Monopolies Arise
3. Natural monopoly: a single firm can produce the
entire market Q at lower cost than could several
firms.
Example: 1000 homes
need electricity
ATC is lower if
one firm services
all 1000 homes
than if two firms
each service
500 homes.
Cost
$80
Electricity
ATC slopes
downward due
to huge FC and
small MC
$50
ATC
500
MONOPOLY
1000
Q
5
Chapter 15 Outline
Monopolies:
What & Why
Why MR < P
Impact on
society’s
well-being
Profit Max
Decisionmaking
Gov’t Role in
Monopoly
Markets
MONOPOLY
Price
Discrimination
6
Monopoly vs. Competition: Demand Curves
In a competitive market, the
market demand curve slopes
downward.
But the demand curve
for any individual firm’s
product is horizontal
at the market price.
The firm can increase Q
without lowering P,
P
A competitive firm’s
demand curve
D
so MR = P for the
competitive firm.
Q
MONOPOLY
7
Monopoly vs. Competition: Demand Curves
A monopolist is the only
seller, so it faces the market
demand curve.
To sell a larger Q,
the firm must reduce P.
P
A monopolist’s
demand curve
Thus, MR ≠ P.
D
Q
MONOPOLY
8
Common Grounds’ D and MR Curves
Q
P
0 $4.50
1
4.00
2
3.50
3
3.00
4
2.50
5
2.00
6
1.50
MR
$4
3
2
1
0
–1
P, MR
$5
4
3
2
1
0
-1
-2
-3
0
Demand curve (P)
MR
1
2
MONOPOLY
3
4
5
6
7
Q
9
Understanding the Monopolist’s MR
• Increasing Q has two effects on revenue:
– Output effect: higher output raises revenue
– Price effect: lower price reduces revenue
• To sell a larger Q, the monopolist must reduce
the price on all the units it sells.
• Hence, MR < P
• MR could even be negative if the price effect
exceeds the output effect (e.g., when Common
Grounds increases Q from 5 to 6).
MONOPOLY
10
Chapter 15 Outline
Monopolies:
What & Why
Why MR < P
Impact on
society’s
well-being
Profit Max
Decisionmaking
Gov’t Role in
Monopoly
Markets
MONOPOLY
Price
Discrimination
11
Profit-Maximization
• Like a competitive firm, a monopolist
maximizes profit by producing the quantity
where MR = MC.
• Once the monopolist identifies this quantity,
it sets the highest price consumers are willing
to pay for that quantity.
• It finds this price from the D curve.
MONOPOLY
12
Profit-Maximization
1. The profitmaximizing Q
is where
MR = MC.
Costs and
Revenue
MC
P
2. Find P from
the demand curve
at this Q.
D
MR
Q
Quantity
Profit-maximizing output
MONOPOLY
13
The Monopolist’s Profit
Costs and
Revenue
As with a
competitive firm,
the monopolist’s
profit equals
MC
P
ATC
ATC
D
(P – ATC) x Q
MR
Q
MONOPOLY
Quantity
14
A Monopoly Does Not Have an S Curve
A competitive firm
– takes P as given
– has a supply curve that shows how its Q depends on
P.
A monopoly firm
– is a “price-maker,” not a “price-taker”
– Q does not depend on P;
rather, Q and P are jointly determined by
MC, MR, and the demand curve.
So there is no supply curve for monopoly.
MONOPOLY
15
CASE STUDY: Monopoly vs. Generic Drugs
Patents on new drugs give a
Price
temporary monopoly to the
seller.
When the
patent expires,
the market
becomes competitive,
generics appear.
The market for
a typical drug
PM
PC = MC
D
MR
QM
Quantity
QC
MONOPOLY
16
Chapter 15 Outline
Monopolies:
What & Why
Why MR < P
Impact on
society’s
well-being
Profit Max
Decisionmaking
Gov’t Role in
Monopoly
Markets
MONOPOLY
Price
Discrimination
17
The Welfare Cost of Monopoly
• Recall: In a competitive market equilibrium,
P = MC and total surplus is maximized.
• In the monopoly eq’m, P > MR = MC
– The value to buyers of an additional unit (P)
exceeds the cost of the resources needed to
produce that unit (MC).
– The monopoly Q is too low –
could increase total surplus with a larger Q.
– Thus, monopoly results in a deadweight loss.
MONOPOLY
18
The Welfare Cost of Monopoly
Competitive eq’m:
quantity = QC
P = MC
total surplus is
maximized
Monopoly eq’m:
quantity = QM
P > MC
deadweight loss
Price
Deadweight
MC
loss
P
P = MC
MC
D
MR
Q M QC
MONOPOLY
Quantity
19
Chapter 15 Outline
Monopolies:
What & Why
Why MR < P
Impact on
society’s
well-being
Profit Max
Decisionmaking
Gov’t Role in
Monopoly
Markets
MONOPOLY
Price
Discrimination
20
Price Discrimination
• Discrimination: treating people differently
based on some characteristic, e.g. race or
gender.
• Price discrimination: selling the same good
at different prices to different buyers.
• The characteristic used in price discrimination
is willingness to pay (WTP):
– A firm can increase profit by charging a higher
price to buyers with higher WTP.
MONOPOLY
21
Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist
charges the same price
(PM) to all buyers.
A deadweight loss
results.
Price
Consumer
surplus
Deadweight
loss
PM
Monopoly
profit
MC
D
MR
QM
MONOPOLY
Quantity
22
Perfect Price Discrimination vs.
Single Price Monopoly
Here, the monopolist
produces the
competitive quantity, but
charges each buyer his or
her WTP.
This is called perfect
price discrimination.
Price
Monopoly
profit
MC
D
The monopolist captures
all CS
as profit.
MR
Quantity
But there’s no DWL.
Q
MONOPOLY
23
Price Discrimination in the Real World
• In the real world, perfect price discrimination
is not possible:
– No firm knows every buyer’s WTP
– Buyers do not announce it to sellers
• So, firms divide customers into groups
based on some observable trait
that is likely related to WTP, such as age.
MONOPOLY
24
Examples of Price Discrimination
Movie tickets
Discounts for seniors, students, and people
who can attend during weekday afternoons.
They are all more likely to have lower WTP
than people who pay full price on Friday
night.
Airline prices
Discounts for Saturday-night stayovers help
distinguish business travelers, who usually
have higher WTP, from more price-sensitive
leisure travelers.
MONOPOLY
25
Public Policy Toward Monopolies
• Increasing competition with antitrust laws
– Ban some anticompetitive practices,
allow govt to break up monopolies.
– E.g., Sherman Antitrust Act (1890),
Clayton Act (1914)
• Regulation
– Govt agencies set the monopolist’s price.
– For natural monopolies, MC < ATC at all Q,
so marginal cost pricing would result in losses.
– If so, regulators might subsidize the monopolist or
set P = ATC for zero economic profit.
MONOPOLY
26
Public Policy Toward Monopolies
• Public ownership
– Example: U.S. Postal Service
– Problem: Public ownership is usually less efficient
since no profit motive to minimize costs
• Doing nothing
– The foregoing policies all have drawbacks,
so the best policy may be no policy.
MONOPOLY
27
CONCLUSION: The Prevalence of Monopoly
• In the real world, pure monopoly is rare.
• Yet, many firms have market power, due to:
– selling a unique variety of a product
– having a large market share and few significant
competitors
• In many such cases, most of the results from
this chapter apply, including:
– markup of price over marginal cost
– deadweight loss
MONOPOLY
28
Test Bank Questions
MONOPOLY
29
Questions 2 & 3
2.
One difference between a
perfectly competitive firm and a monopoly
is that a perfectly competitive firm
produces where
3.
A monopoly
a. can set the price it charges for its
output and earn unlimited profits.
b. takes the market price as given and
earns small but positive profits.
c. can set the price it charges for its
output but faces a downward-sloping
demand curve so it cannot earn
unlimited profits.
d. can set the price it charges for its
output but faces a horizontal demand
curve so it can earn unlimited profits.
a. marginal cost equals price, while a
monopolist produces where price
exceeds marginal cost.
b. marginal cost equals price, while a
monopolist produces where marginal
cost exceeds price.
c. price exceeds marginal cost, while a
monopolist produces where marginal
cost equals price.
d. marginal cost exceeds price, while a
monopolist produces where marginal
cost equals price.
MONOPOLY
30
Questions 5 & 8
5.
Which of the following are
necessary characteristics of a monopoly?
(i)
(ii)
(iii)
(iv)
8.
Which of the following is not a
reason for the existence of a monopoly?
The firm is the sole seller of its
product.
The firm's product does not have
close substitutes.
The firm generates a large
economic profit.
The firm is located in a small
geographic market.
a. sole ownership of a key
resource
b. patents
c. copyrights
d. diseconomies of scale
a. (i) and (ii) only
b. (i) and (iii) only
c. (i), (ii), and (iii) only
d. (i), (ii), (iii), and (iv)
MONOPOLY
31
Questions 4 & 5
4.
When a firm operates under
conditions of monopoly, its price is
a.
b.
c.
d.
5.
In order to sell more of its
product, a monopolist must
a.
b.
c.
d.
not constrained.
constrained by marginal cost.
constrained by demand.
constrained only by its social
agenda.
MONOPOLY
sell to the government.
sell in international markets.
lower its price.
use its market power to
force up the price of
complementary products.
32
Questions 65, 66 & 67
Price
P
65.
Refer to Figure 15-3. What price
will the monopolist charge?
a.
b.
c.
d.
A
B
A
B
C
F
C
O
J
K
L
ATC
F
G
H
66.
Refer to Figure 15-3. How
much output will the monopolist
produce?
a.
b.
c.
d.
MC
D
O
J K
L
Quantity
MR
67.
Refer to Figure 15-3. What area
measures the monopolist’s profit?
a.
b.
c.
d.
MONOPOLY
(B-F)*K
(A-H)*J
(B-G)*K
0.5[(B-F)*(L-K)]
33
Questions 30, 31 & 32
Price
30.
Refer to Figure 15-7. What is
the socially efficient price and quantity?
a.
b.
c.
d.
MC
F
price = F; quantity = A
price = G; quantity = B
price = G; quantity = A
price = D; quantity = A
G
D
MR
31.
Refer to Figure 15-7.
What is the monopoly price and
quantity?
a.
b.
c.
d.
price = F; quantity = A
price = G; quantity = B
price = G; quantity = A
price = D; quantity = A
A
B
D
Quantity
C
32.
Refer to Figure 15-7. What is
the area of deadweight loss?
a. the rectangle (F-D)xA
b. the triangle 1/2[(F-D)x(B-A)]
c. the triangle 1/2[(F-G)x(B-A)]
d. the rectangle (F-D)xA plus the triangle
1/2[(F-D)x(B-A)]
MONOPOLY
34
Question 4 & 17
50
4.
The practice of selling the
same goods to different customers at
different prices, but with the same
marginal cost, is known as
a.
b.
c.
d.
price segregation.
price discrimination.
arbitrage.
monopoly pricing.
Price
45
40
35
30
25
20
M C=ATC
15
10
MR
5
Demand
50 100 150 200 250 300 350 400 450 500 550 600 Quantity
17 If the monopoly firm perfectly price
discriminates, then consumer surplus
amounts to
a.
b.
c.
d.
MONOPOLY
$0.
$250.
$500.
$1,000.
35
Questions 1 & 2
1.
Which of the following may
eliminate some or all of the inefficiency
that results from monopoly pricing?
2.
Antitrust laws have
economic benefits that outweigh
the costs if they
a. prevent mergers that would decrease
competition and lower the costs of
production.
b. prevent mergers that would decrease
competition and raise the costs of
production.
c. allow mergers that would decrease
competition and raise the costs of
production.
d. None of the above is correct
because antitrust laws never have
economic benefits that outweigh the
costs.
a. The government can regulate the
monopoly.
b. The monopoly can be prohibited from
price discriminating.
c. The monopoly can be forced to operate
at a point where its marginal revenue is
equal to its marginal cost.
d. None of the above would eliminate any
inefficiency associated with a monopoly.
MONOPOLY
36