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Econ 2610: Principles of Microeconomics Yogesh Uppal Email: [email protected] Chapter 9 Monopoly, Oligopoly, and Monopolistic Competition Imperfect Competition Imperfectly competitive firms have some control of price Long-run economic profits possible Reduce economic surplus Three types 1. 2. Monopoly has only one seller, no close substitutes Monopolistic competition has many firms with differentiated products 3. These products are all close substitutes Oligopoly is a small number of firms producing close substitutes Monopolistic Competition Perfect Competition Monopolistic Competition Many firms Many firms Price taker Limited flexibility Free Free Standardized Differentiated Economic Profits Zero in long run Zero in long run Decisions Q only P, Q, product differentiation Number of Firms Price Entry and Exit Product Oligopoly Perfect Competition Number of Firms Price Entry and Exit Product Economic Profits Decisions Many firms Price taker Free Oligopoly Few firms, each large Some flexibility Large size firm Standardized Differentiated or standardized Zero in long run Possible Q only P, Q, differentiation, advertising The Essential Difference Imperfectly Competitive Firm Perfectly Competitive Firm Price Market power is the firm's ability to raise its price without losing all its sales Any firm facing a downward sloping demand curve Firm picks P and Q on the demand curve Market power comes from factors that limit competition Price D D Quantity Quantity Five Sources of Market Power 1. 2. 3. 4. 5. Exclusive control over inputs Patents and copyrights Government licenses or franchises Economies of scale (natural monopolies) Network economies Market Power: Economies of Scale Returns to scale refers to the percentage change in output from a given percentage change in ALL inputs Long-run idea Constant returns to scale: doubling all inputs doubles output Increasing returns to scale: output increases by a greater percentage than the increase in inputs Average costs decrease as output increases Natural monopoly: a monopoly that results from Market Power: Network Economies Network economies occur when the value of the product increases as the number of users increases VHS format for video tapes, Blu-ray for DVDs Telephones Windows operating system eBay Facebook and MySpace Economies of Scale and Start-Up Costs products can have a large fixed development cost TC = F + M Q F Average cost ($/unit) Total cost ($/year) New ATC = F/Q + V/Q M Quantity However, Quantity the operational costs are not significant relative to the start-up costs. Intel's Advantage Development cost of a new chip $2 billion Marginal cost of making a chip Pennies Dominating the market Priceless Intel supplies more than 80% of the processors for PCs Monopolist Pure monopoly: the only seller of a unique product which has no close substitutes Like all other firms, a monopolist Maximizes profits Applies the Cost-Benefit Principle Increase output if marginal benefit > marginal cost Decrease output is marginal benefit < marginal cost Marginal benefit for a monopolist is different than for a perfectly competitor Profit Maximization for the Monopolist For the monopolist, selling one more unit Decreases market price Reduces marginal revenue by more than the price Lower price applied to all units Price ($/unit) 6 5 D 2 3 Quantity (units/week) Price & marginal revenue ($/unit) Monopolist's Marginal Revenue 8 3 D 1 2 -1 3 4 8 5 MR Quantity (units/week) Price Quantity Total Revenue $6 2 $12 Marginal Revenue $5 3 $15 3 $4 4 $16 1 $3 5 $15 -1 Monopoly Demand and Marginal Revenue Price a In general, the monopolist's marginal revenue curve a/2 D MR Q0 Q0/2 Quantity Has the same intercept as demand Has twice the slope of demand Lies below demand Deciding Quantity A monopolist knows his demand and marginal revenue curves Marginal cost is also known If he operates at P = $3 and Q = 12, MC > MR Decrease output If the firm operates at Q = 8, then MC = MR = 2 The demand curve sets the price, P = $4 At any output below 8, MC < MR 6 Price ($/unit of output) MC 4 3 D 2 MR 12 8 Quantity (units/week) Monopoly Losses and Profits Economic profit = $400,000/day Price ($/minute) 0.12 ATC 0.10 MC 0.05 MR Price ($/minute) Economic loss = $400,000/day 0.10 0.08 ATC MC 0.05 D 20 24 Minutes (millions/day) MR D 20 24 Minutes (millions/day) The Invisible Hand Fails Price ($/unit of output) 6 The monopolist's optimal amount occurs where MC = MR, Q = 8 units and P = $4 4 Marginal Cost The socially optimal amount occurs where MC = MB, Q = 12 units and P = $3 3 2 MR D 8 12 Quantity (units/week) 24 Monopoly and Perfect Competition Monopoly Perfect Competition MC = MR MC = MR P >MR P = MR P > MC P = MC Deadweight Loss No Deadweight Loss Price Discrimination Price discrimination means charging different buyers different prices for essentially the same good or service Separate the groups No side trades among buyers Many forms of price discrimination Hurdle method: discounts for identifiable groups (e. g., students, AARP) Perfect discrimination: negotiate separate deals with each customer Carla the Editor What's Carla's revenue? Opportunity What is the social optimum? cost of Carla's time is $29 Reservatio Total Student n Price Revenue A $40 $40 B 38 $76 C 36 $108 D 34 $136 E 32 $160 F 30 $180 G 28 $196 Carla the Editor What's Carla's revenue? What if Carla maximizes her profit? Opportunity cost of Carla's time is $29 Reservatio Total Student n Price Revenue A $40 $40 B 38 $76 C 36 $108 D 34 $136 E 32 $160 F 30 $180 G 28 $196 MR $40 $36 $32 $28 $24 $20 $16 Carla the Editor What if Carla is What's Carla's perfect discriminator? revenue? Opportunity cost of Carla's time is $29 Reservatio Total Student n Price Revenue A $40 $40 B 38 $78 C 36 $114 D 34 $148 E 32 $180 F 30 $210 G 28 $238 Carla Offers a Rebate If reservation price < $36, mail in rebate Reservation Student Price A $40 B 38 C 36 Total Revenue $40 76 108 Discounted Price Submarket D $34 $34 E 32 64 F 30 90 MR $40 36 32 $34 30 26 Carla's Choices Perfect Social Single Program Optimum Price Discriminat or Papers 3 6 Edited 6 $36 Price $30 Reservatio n $108 Total $180 Revenue $210 $87 Carla's Time $174 $174 $21 Economic $6 $36 Profit $27 $36 Total Surplus $26 Hurdle 5 = (3 + 2) $36, $4 rebate $172 $145 $27 $35 Hurdle Method of Price Discrimination The hurdle method of price discrimination is the practice of offering a discount to all buyers who overcome some obstacle. Temporary Sales Hard cover and paperback books Multiple car models from one manufacturer Commercial air carriers Movie producers and phased releases Scratch and Dent appliance sales Monopoly and Public Policy Challenge: create the greatest increase in total surplus Policy options Government ownership and operation Regulation Competitive bids for natural monopoly services Break up Anti-Trust Laws Two landmark laws Sherman Act of 1890 Clayton Act of 1914 Declared conspiracy to create a monopoly illegal Outlawed transactions that would "substantially lessen competition" Applies to mergers and acquisitions today IBM avoided break-up; AT&T did not Microsoft survived