Transcript Choice, Change, Challenge, and Opportunity

Ch. 12: Monopoly
Causes of monopoly
Monopoly pricing and output determination
Performance and efficiency of single-price
monopoly and competition
Price discrimination
Regulation of monopoly
Market Power
• Market power
– the ability to influence the market price, by
influencing the total quantity offered for sale.
– greater when there are fewer close substitutes
and demand is more inelastic
• Monopoly
– A firm that produces a good or service for
which no close substitute exists
– One supplier that is protected from competition
by a barrier preventing the entry of new firms.
Causes of monopoly
• Legal monopoly
– Patents
• Inventions protected from copying, usually 20 years.
– Copyrights
• Musical and literary works protected from copying.
–
–
–
–
Public franchise
Zoning
Licensing
Why do we create legal monopolies?
• Sole Ownership of Key Input
• Natural Monopoly
– Scale economies
An example of a natural monopoly
Demand and Cost for Electrical Production
Figure 1
1. Total cost if one firm produces 3,000 GW
would be
1.
2.
3.
4.
$100
$100,000
$300,000
$1,200,00
25%
$100
25%
25%
$100,000
$300,000
25%
$1,200,00
2. Total profit for 1 firm producing 3,000 and
selling at $100 per GW would be
1.
2.
3.
4.
$0
$100
$100,000
-$100,000
25%
$0
25%
25%
25%
$100
$100,000
($100,000)
3. Total cost for each of 3 firms producing
1,000 and selling at $100 per GW would be
1. $400
2. $100,000
3. $300,00
4. $400,000
25%
$400
25%
$100,000
25%
$300,00
25%
$400,000
4. Total profit for each of 3 firms producing 1,000
GW and selling at $100 per GW would be:
1. -$300
2. -$300,000
3. $0
4. $100,000
25%
($300)
25%
25%
($300,000)
$0
25%
$100,000
What will eventually happen if one large firm
produces 3000 and competed with any small firm
that produces 1000?
1. The small firm will
lose the competition.
2. The large firm will
lose the competition.
3. Neither firm can
survive
4. Both firms will survive
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Natural Monopoly
• Natural monopoly occurs when
– there are scale economies
– when LATC is dropping below the demand
curve
– One large firm can produce at a lower cost
per unit than many small firms.
Monopoly Price-Setting
• Single-price monopoly
– sells each unit of its output for the same
price to all its customers.
• Price discriminating monopoly
– Sells different units of a good or service
for different prices.
– Many firms price discriminate, but not all
of them are monopoly firms.
A Single-Price Monopoly’s
Output and Price Decision
Price and Marginal Revenue
• A monopoly is a price setter, not a price taker.
• Demand curve for the monopoly’s output is
the market demand curve.
• TR = P * Q
• MR = increase in TR from selling one more
unit
• For a single-price monopoly, MR < P
A Single-Price Monopoly’s
Output and Price Decision
P
Q
TR
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MR
• MR<P
• MR
falls at twice
the rate as price.
•Demand is
inelastic when
MR is negative
•Demand is
elastic when MR
is positive
• If demand is inelastic, a fall in price brings
a decrease in total revenue and marginal
revenue is negative.
– The firm produces the output at which MR =
MC and sets the price to sell that quantity.
– Never produce an output at which demand is
inelastic (i.e. where MR<0).
Figure 2
At what price is demand unit elastic?
1.
2.
3.
4.
25%
$10
$10
$20
$25
$30
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25%
$20
$25
25%
$30
At a price of $10, demand is ______ because
marginal revenue will be ______
1. Elastic; positive.
2. Elastic; negative
3. Inelastic; positive
4. Inelastic; negative.
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The profit maximizing price is _____ and the profit
maximizing output is ____.
1. Elastic; positive.
2. Elastic; negative
3. Inelastic; positive
4. Inelastic; negative.
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The profit maximizing firm will have a profit of
1.
2.
3.
4.
25%
$0
$0
$200
$400
$600
25%
25%
$200
$400
25%
$600
Single-Price Monopoly vs. Competition
Single-Price Monopoly vs. Competition
– Because marginal revenue is less than price
at each output level for a monopoly,
• QM < QC
• PM > PC.
– Compared to perfect competition, monopoly
restricts output and charges a higher price.
Single-Price Monopoly vs. Competition
Compared to perfect
competition
a. Consumer surplus
b. Producer surplus
c. Deadweight loss
Single-Price Monopoly and
Competition Compared
• Rent Seeking
– May reallocate benefits of monopoly
– any attempt to capture consumer surplus,
producer surplus, or economic profit.
– Rent seeking is not confined to monopoly.
• Forms of rent seeking
– Political activities
– Auctions of monopoly rights
– Licenses
Price Discrimination
– Price discrimination is the practice of selling
different units of a good or service for different
prices.
– To be able to price discriminate, a monopoly
must:
• Identify and separate different buyer types
• Sell a product that cannot be resold
• Price differences that arise from cost
differences are not price discrimination.
Price Discrimination
• Examples of price discrimination
– Quantity discounts
• quantity discounts that reflect lower costs at higher
volumes are not price discrimination.
– Among groups of buyers.
• Business versus vacation travelers.
• Senior citizen discounts.
– Time of purchase
• Weekend vs. weekday activities.
• Day vs. night phone rates.
Price Discrimination
 Single price monopolist
would charge $1200 and
sell 8,000 trips to
maximize profits.
 Price discriminating
monopolist would charge
different price for each
trip to convert consumer
surplus into its own
revenue.
Price Discrimination
• Perfect price
discrimination
extracts the entire
potential consumer
surplus and converts
it to economic profit.
– Demand curve
becomes MR curve.
Price Discrimination
• Output increases to the
quantity at which price
equals marginal cost
• Economic profit
increases above that
earned by a single-price
monopoly.
• Deadweight loss is
eliminated
Price discrimination and elasticity
D
MC
MC
MR
D
MR
• If a firm has constant MC and markets with different elasticity of
demand, where should it charge the higher price?
Pepsi has information about customer purchases
of products and wants to decide who to send
coupons for Pepsi. Based on principles of profit
maximization, it should send coupons to the
customers who:
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1. Have the most price
elastic demand
2. Have the least price
elastic demand.
3. Purchase the most Pepsi.
4. Purchase the least Pepsi.
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A gas company sells its products in two cities. It
owns the only gas station within 20 miles of Alton.
It has one of 6 gas stations in Lemars. Based on
this, the price elasticity of demand for gasoline
should be greater in _____ and gas prices should
be higher in ______.
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Efficiency and Rent Seeking with P Discrim.
• The more perfectly a monopoly can price
discriminate,
• the closer q gets to the competitive output (P = MC)
• the more efficient is the outcome (less DW loss)
– But this outcome differs from the outcome of perfect
competition in two ways:
• firm captures the entire consumer surplus.
• increase in economic profit attracts even more rentseeking activity that leads to an inefficient use of
resources.
Monopoly Policy Issues
• Gains from Monopoly
– A single-price monopoly creates inefficiency
(DWL).
– A price discriminating monopoly captures
consumer surplus and converts it into
producer surplus and economic profit
(equity).
– The possibility of monopoly profits
encourages rent-seeking, which wastes
resources.
– But monopoly can bring benefits.
Monopoly Policy Issues
• Product innovation
– Patents and copyrights provide protection
from competition and let the monopoly enjoy
the profits stemming from innovation for a
longer period of time.
• Economies of scale and scope
– Lower cost with one large producer than
many small producers.
Regulating Natural Monopoly
Different types of
regulations:
• MC pricing
- socially efficient
- economic losses
- subsidies or allow price
discrimination?
• AC pricing
– not socially efficient
– zero economic profit