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ECO 305 — FALL 2003 — November 11
MONOPOLY
CAUSES OF MONOPOLY
1. Legal grant — historically sold by kings
Now — public utilities, “national champions”
2. Exclusive ownership — DeBeers, OPEC?
3. Large sunk costs or scale economies — Microsoft?
4. Predatory action to exclude others — Microsoft?
Modern governments regulate 3, outlaw 4
MONOPOLIST’S BEHAVIOR
Even a monopolist competes for consumer’s $
with firms producing all other goods
But no strategic interaction (game theory)
Profit-maximization given demand curve
Direct x = D(p), inverse p = P (x)
Two equivalent solutions
[1] Choose x to max x p − C(x)
FONC [p + x dp/dx] = C 0 (x) (MR = M C)
SOSC (M R − MC) ↓; MC cuts M R from below
Can have M C itself falling; some incr. rets. OK
[2] Choose p to max p x − C(x)
FONC x + p dx/dp − C 0 (x) dx/dp = 0
Same since dx/dp = 1/(dp/dx)
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Elasticity of direct demand
p dx
²=−
,
x dp
MC
so mark-up p =
1 − 1/²
Dead-weight loss because p > MC
hence need for antitrust policy
KEY TRADEOFF — Price ↓ / quantity ↑ implies
profit ↑ (P − M C) dx from marginal sales,
↓ x dp on inframarginal sales
PRICE DISCRIMINATION — Attempt to escape tradeoff
[1] Perfect — separate price for each buyer, unit
Efficient, but monopolist extracts all surplus
Needs detailed info; must prevent resales
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[2] Grouping — indiv. membership observable
Separate, uniform price for members of each group
Less info needed; must prevent resale
Two-group case:
max x1 P1 (x1 ) + x2 P2 (x2 ) − C(x1 + x2 )
FONCs
p1 + x1 dp1 /dx1 ≡ MR1 = M C ≡ C 0 (x1 + x2 )
p2 + x2 dp2 /dx2 ≡ MR2 = M C ≡ C 0 (x1 + x2 )
p1 = MC / [1 − 1/²1 ], p2 = M C / [1 − 1/²2 ]
Group with less elastic demand pays higher price
e.g. airfare discounts for senior citizens
[3] Versioning — individual demands unobservable
But distribution in population known
Offer multiple “packages”
Separate by self-selection (screening)
e.g. Saturday night stay requirement in airfares
May be easier to prevent resales
Details later in information theory
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OLIGOPOLY
GENERAL ISSUES
1. How to define “industry”
Close substitutes (or complements), matter of degree
2. Why is number of firms in industry small?
Large fixed costs or scale economies
3. Forms of strategic interactions
a. Choice variables — quantities or prices
Others — investment, R-and-D, advertising, ...
b. Simultaneous vs. sequential actions
leadership and followership advantage
c. One-time vs. repeated interaction
tacit collusion possible if repeated
d. Explicit or implicit collusion or competition,
depends on information, time-span, law, ...
No combination of these universally true
Study some special models for insight, techniques
Key concept — Each firm’s price or quantity choice
shifts others’ demand curves, affects profits
Like an externality, negative if substitutes
Conflict between joint and individual profit-max
Result — game-theoretic interaction, equilibrium
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DEMAND FUNCTIONS
Result of maximizing quasilinear utility u(x1 , x2 , y) =
y + a1 x1 + a2 x2 −
1
2
[ b1 (x1 )2 + 2 k x1 x2 + b2 (x2 )2 ]
subject to budget constraint y + p1 x1 + p2 x2 = M
Inverse:
p1 = a1 − b1 x1 − k x2 ,
p2 = a2 − k x1 − b2 x2
ai ,bi > 0, k 2 ≤ b1 b2
Substitutes: k > 0, complements: k < 0
Perfect 1-for-1 substitutes: p1 = p2 = a − b (x1 + x2 )
Direct:
x1 = α1 − β1 p1 + κ p2 ,
x2 = α2 + κ p1 − β2 p2
αi , βi > 0. κ2 ≤ β1 β2
Substitutes: κ > 0, complements κ < 0
Perfect 1-for-1 complements: x1 = x2 = α − β (p1 + p2 )
QUANTITY-SETTING (COURNOT) DUOPOLY
Constant marginal costs c1 , c2 ; fixed costs “in background”
Firm 1’s profit
Π1 (x1 , x2 ) = (p1 − c1 ) x1 = [(a1 − c1 ) − b1 x1 − k x2 ] x1
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3-D and contour graphs (a1 − c1 = 1, b1 = k = 1)
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