Transcript Session 8 Monopoly VIDEO LECTURE

Session 8 Monopoly
Outline
Chapter 9 in the text
Tips for Navigation in the presentation:
Right mouse click to advance, or
Use the arrow keys to navigate in the presentation :
the up or right arrow to advance,
the down or left arrow to go back;
This image house appears on every slide in the
upper left and operates as a hyper link to the
slide “Lecture Outline”
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
1.1Monopoly
CHAPTER 9
AT&T: Ernestine
calls Mr. Veedle:
Ernestine the
operator is a favorite
of anyone who has
ever called Directory
Assistance.
Outline
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
2
End
Outline
1.2 Online Prescription Drugs: Canada
An example of how open borders can eat
into profits of a US monopolist.
Imports of Prescription Drugs from Canada
What's Left for Canadians If Americans Buy Their
Drugs?
Online Pharmacy Sales To the U.S. Raise Risk Of Some
Supply Shortages By TAMSIN CARLISLE Staff Reporter
of THE WALL STREET JOURNAL, November 4, 2004
U.S. patients can obtain prescription medications
from Canadian Internet pharmacies at substantial
discounts to their retail prices in the U.S. Some U.S.
patients, especially senior citizens without medical
insurance, say this is the only way they can afford to
fill their prescriptions. But big drug companies say
they depend on profits from U.S. sales to fund
pharmaceutical research and development. They
also point out that the cross-border drug trade is
illegal under U.S. federal law.
Source: AARP
Bulletin
Outline
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
1.3 Creating a Monopoly: Advantages of…
Source
AC/DC is set to become the next major band to sell a new
album only through Wal-Mart, a deal highlighting the chain's
rising music-industry clout. The arrangement comes at a time
when the retail giant is signaling plans to stock fewer CDs.
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
Lecture Outline Session 8
First Slide
2.0 Monopoly Market Structure
3.0 Downward Sloping Demand Curve
4.0 Profit Maximization (MR=MC)
5.0 Compare with Perfect Competition
6.0 Price Discrimination
7.0 Self Evaluation: Flash, Excel, Draw Tool
End of Presentation
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
2.0 Monopoly Market Structure
2.1 Terminology
2.2 Single firm
2.3 Barriers to Entry
A. Legal Restrictions
B. Patents
C. Licenses
D. Resource Control
E. Economies of
Scale
F. Natural Monopoly
Matrix
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
2.1 Market Structure Terminology
Key Characteristics Describing Market Structure
Number of suppliers
• Many or few
Product’s degree of uniformity
• Do firms in the market supply identical products or are
there differences across firms?
The ease of entry into the market
• Can new firms enter easily or are they blocked by
natural or artificial barriers?
Control over Price
• Do sellers have full control over the selling price?
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
2.2 Single Firm
Outline
Monopoly Narket Structure
Many buyers and one seller  the monopolist
is the sole supplier and there are so many
buyers that each buys only a tiny fraction
of the total amount exchanged in the
market. The seller is a price maker.
The monopolist sells a product for which
there are no close substitutes.
There are significant barriers to resource
mobility  over time they can not easily
enter or leave the industry
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
2.3 Barriers to Entry
Outline
The most important characteristic of a
monopolized market is barriers to entry
 new firms cannot profitably enter the
market
Barriers to entry are restrictions on the
entry of new firms into an industry
1.
2.
3.
4.
Patents
Licenses
Resource Control
Economies of Scale (Natural Monopoly)
Barriers
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
2.3.1 Patent and Invention Incentives
Outline
A patent awards an inventor the
exclusive right to produce a good or
service for 20 years
Patent laws
Encourage inventors to invest the time and
money required to discover and develop
new products and processes
Also provide the stimulus to turn an
invention into a marketable product, a
process called innovation
Barriers
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
2.3.2 Licenses and other Entry Restrictions
Outline
Governments often confer monopoly
status by awarding a single firm the
exclusive right to supply a particular
good or service
These create Local Monopolies
Broadcast TV and radio rights
State licensing of hospitals
Barriers
Cable TV and electricity on local level
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
2.3.3 Control of Essential Resources
Outline
Another source of monopoly power is a
firm’s control over some
nonreproducible resource critical to
production
Barriers
Professional sports teams try to block the
formation of competing leagues by signing
the best athletes to long-term contracts
Alcoa was the sole U.S. maker of aluminum
for a long period of time because it
controlled the supply of bauxite
China is the monopoly supplier of pandas
DeBeers controls the world’s diamond trade
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
2.3.4 Economies of Scale as a Barrier to Entry
(NATURAL MONOPOLY)
Outline
$
Cost per unit
When market demand is not
great enough to permit
more than one firm to
achieve sufficient economies
of scale  a single firm will
emerge from the
competitive process as the
sole seller in the market.
Because such
a monopoly
emerges from
the nature of
costs, it is
called a
natural
monopoly
Long-run
average cost
Barriers
Quantity per period
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
2.4 Matrix of Market Structure Characteristics
# of
suppliers
Product
Entry/Exit
Standardized
Control over
Price
Perfect
Competition
Many
Yes
Very easy
None
Monopoly
One
Unique, no
close
substitutes
Blocked
Considerable
Monopolistic
Competition
Many
Not much as
Relatively
much differences easy
as they want you
to think
Some, but within
narrow limits
Oligopoly
Few
Not much
Limited by
interdependence,
but considerable
with collusion
First slide
2 Structure
3 Demand
4 Profit
Significant
obstacles
5 Comparison
6 Discrimination
End
Outline
3.1
3.2
3.3
3.4
3.0 Downward Sloping Demand Curve
Revenue for the Monopolist
Revenue in a Table
Revenue in a Graph
Elasticity & Total Revenue
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
3.1 Revenue for the Monopolist
Because a monopoly, by definition,
supplies the entire market, the demand for
goods or services produced by a
monopolist is also the market demand
The demand curve for the monopolist’s
output therefore slopes downward,
reflecting the law of demand
This has important implications for the
relation between average revenue (which
is price) and marginal revenues.
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
3.2 Revenue in a Table
Outline
Revenue for De Beers, a Monopolist
1-Carat
Price
diamonds (average
Total
Marginal
per day
revenue)
revenue
revenue
(Q) (p=TR/Q) (TR = Q x p) (MR = TR / Q)
(1)
(2)
(3) =(1) x (2)
(4)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
$7,750
7,500
7,250
7,000
6,750
6,500
6,250
6,000
5,750
5,500
5,250
5,000
4,750
4,500
4,250
4,000
3,750
3,500
First slide
0
$7,500
14,500
21,000
27,000
32,500
37,500
42,000
46,000
49,500
52,500
55,000
57,000
58,500
59,500
60,000
60,000
59,500
2 Structure
Total revenue (quantity times price) is
provided in the third column. As De
Beers expands output, total revenue
increases until quantity reaches 15
diamonds when total revenue tops out.
$7,500
7,000
6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
-500
3 Demand
The first two columns contain the
hypothetical price and quantity
information for De Beers the monopoly
supplier of diamonds.
Marginal revenue (the change in total
revenue from selling one more diamond)
appears in the fourth column. Note that
for all units of output except the first,
marginal revenue is less than the price,
and the gap between the two widens as
the price declines because the loss from
selling all diamonds at this lower price
increases.
4 Profit
5 Comparison
6 Discrimination
End
3.3 Revenue in a Graph
Outline
$7,000
LOSS
6,750
Price per
Diamond
G
A
I
N
D = Average
revenue
By selling another diamond, De Beers gains
the revenue from that sale, $6,750 from the
4th diamond as shown by the blue-shaded
vertical rectangle marked gain.
However, to sell that 4th unit, De Beers
must sell all four diamonds for $6,750 each
 it must sacrifice $250 on each of the
first three diamonds which could have sold
for $7,000 each.
The loss in revenue from the first three
units, $750, is shown by the red shaded
horizontal rectangle marked Loss.
The net change in total revenue from selling
the 4th diamond equals the gain minus the
loss  $6,750 - $750 = $6,000.
0
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
3.4 Demand Elasticity and Total Revenue
Demand and marginal revenue are
shown in the upper panel and total
revenue is in the lower panel.
Notice also that when demand is
elastic, a decrease in price
increases total revenue 
marginal revenue is positive.
Conversely, when demand is
inelastic, a decrease in price
reduces total revenue  marginal
revenue is negative
Dollars per diamond
Elastic
Unit elastic
$3,750
Inelastic
0
D = Average revenue
Marginal revenue
16
32
1-carat diamonds per day
(b) Total Revenue
$60,000
Total dollars
Note that the marginal revenue
curve is below the demand curve
and total revenue is at a maximum
when marginal revenue equals
zero.
(a) Demand and Marginal Revenue
Total revenue
1-carat diamonds per day
First slide
2 Structure
3 Demand 0 4 Profit
5 Comparison
16
6 Discrimination
32
End
Outline
4.1
4.2
4.3
4.4
4.0 Profit Maximization
Profit Maximization: (MR=MC)
Graph
Table
Shut Down
4.5 Supply Curve
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
4.1 Monopolist Profit Maximization:
The intersection of the two marginal curves
at point e in panel (a) indicates that profit
is maximized when 10 diamonds are sold.
At this rate of output, we move up to the
demand curve to find the profitmaximizing price of $5,250. The average
total cost of $4,000 is identified by point b
 the average profit per diamond equals
the price of $5,250 minus the average total
cost of $4,000  $1,250  economic profit
is the equal to $1,250 * 10 units sold 
$12,500 as shown by the blue shaded area.
In panel (b), the firm’s profit or loss is
measured by the vertical distance
between the total revenue and total cost
curves  again profit is maximized
where De Beers produces 10 diamonds
per day
(a) Per-Unit Cost and Revenue
Marginal cost
Average total cost
a
$5,250
4,000
Profit
e
2 Structure
3 Demand
D = Average revenue
MR
0
10
32
16
Diamonds per day
(b) Total Cost and Revenue
Maximum
profit
Total cost
$52,500
40,000
Total revenue
15,000
0
First slide
b
4 Profit
10
16
5 Comparison
32 Diamonds per day
6 Discrimination
End
Outline
4.2 Graph
Select Output: below MR = MC
Select Price : on Demand Curve above MR = MC
Profit increased by
reducing price and
increasing output
Maximum Profit
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
Profit increased by
increasing price and
reducing output
6 Discrimination
End
4.3 Table
Outline
Short-run Costs and Revenue for a Monopolist
Diamonds
per day
(Q)
(1)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
Price
(average
Total
revenue) revenue
(p)
(TR = Q x p)
(2)
(3) =(1) x (2)
$7,750
7,500
7,250
7,000
6,750
6,500
6,250
6,000
5,750
5,500
5,250
5,000
4,750
4,500
4,250
4,000
3,750
3,500
0
$7,500
14,500
21,000
27,000
32,500
37,500
42,000
46,000
49,500
52,500
55,000
57,000
58,500
59,500
60,000
60,000
59,500
First slide
Marginal
Revenue
(MR =
TR / Q)
(4)
Total
Cost
(TC)
(5)
$7,500
7,000
6,500
6,000
5,500
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
-500
$15,000
19,750
23,500
26,500
29,000
31,000
32,500
33,750
35,250
37,250
40,000
43,250
48,000
54,500
64,000
77,500
96,000
121,000
2 Structure
3 Demand
Marginal
Average
Total
Cost
Total Cost Profit or
( MC =
(ACT =
Loss =
TC / Q)
TC/Q)
TR - TC
(6)
(7)
(8)
4,750
3,750
3,000
2,500
2,000
1,500
1,250
1,500
2,000
2,750
3,250
4,750
6,500
9,500
13,500
18,500
25,000
4 Profit
$19,750
11,750
8,830
7,750
6,200
5,420
4,820
4,410
4,140
4,000
3,930
4,000
4,190
4,570
5,170
6,000
7,120
-$15,000
-12,250
9,000
-5,500
-2,000
1,500
5,000
8,250
10,750
12,250
12,500
11,750
9,000
4,000
-4,500
-7,500
-36,000
-61,500
5 Comparison
The profitmaximizing
monopolist
employs the same
decision rule as the
competitive firm 
the monopolist
produces that
quantity where
total revenue
exceeds total cost
by the greatest
amount  $12,500
per day when
output is 10 units
per day. Total
revenue is $52,500
and total cost is
$40,000
6 Discrimination
End
Outline
4.4 Short Run Losses &Shut Down Point Run
Recall that average variable cost and
average fixed cost sum to average
total cost .
Loss minimization occurs at
point e, where the marginal
revenue curve intersects the
marginal cost curve  Q and p
are the loss minimization
quantity and price, respectively.
Marginal cost
a
Loss
Average total cost
b
p
Average variable cost
c
Notice that at point b, the firm is
covering its average variable cost
 it is making some contribution
to its fixed costs. However, it is
not covering all of its costs. The
average loss per unit, measured by
ab, is identified by the yellow
0
shaded area.
First slide
2 Structure
3 Demand
e
Demand = Average revenue
Marginal revenue
Quantity per period
Q
4 Profit
5 Comparison
6 Discrimination
End
4.5 Supply Curve
Outline
The intersection of a monopolist’s
marginal revenue and marginal cost
curve identifies the profit maximizing
quantity, but the price is found on the
demand curve
Thus, there is no curve that shows both
price and quantity supplied  there is
no monopolist supply curve
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
5.0 Comparison with Perfect Competition
5.1 Higher price, Lower output
5.2 Smaller consumer surplus
Deadweight loss
5.3 Summary
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
5.1 Higher Price, Lower Output
For simplicity, we use a
horizontal supply curve based on
the assumption of a constant-cost
industry. Equilibrium in perfect
competition is at point c, where
market demand and supply
intersect to yield price pc and
quantity Qc.
The monopolist maximizes
profit by equating marginal
revenue with marginal cost
 point b  equilibrium
price pm and output Qm.
a
Dollars per unit
Outline
m
p'm
b
pc
c
Sc = MC = ATC
D = AR
MRm
0
Q'm
Q'c Quantity per period
The price shows the consumers’ marginal benefit at that output rate, point m, which
exceeds the marginal cost, point b. Because the marginal benefit consumers attach to
additional units exceeds the marginal cost of producing those additional units, society would
be better off if output were expanded beyond Qm  the monopolist restricts output below
the level that maximizes social welfare  consumer surplus is shown by the yellow triangle
ampm
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
5.2 Smaller Consumer Surplus
Outline
The monopolist earns economic
profit equal to the blue shaded
rectangle  a transfer from
consumer surplus to monopoly
profit  this amount is not lost to
society and so is not considered a
welfare loss from monopoly.
Dollars per unit
a
Consumer surplus under perfect
competition is the large pink triangle
acpc while under monopoly it shrinks
to the smaller yellow triangle ampm p'm
m
pc
c
b
Sc = MC = ATC
D = AR
MRm
0
Q'm
Q'c Quantity per period
Notice that consumer surplus has been reduced by more than the profit triangle.
Consumers have also lost the red triangle mcb which was part of the consumer surplus
under perfect competition  the deadweight loss of monopoly because it is a loss to
consumers but a gain to nobody. This loss results from the allocative inefficiency
arising from the higher price and reduced output.
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
28
End
5.3 Summary
Outline
For the monopolist compared to perfect
competition:
1.
2.
3.
4.
5.
6.
Price to consumer is higher
Price exceeds MC
Output is less
Consumer surplus is smaller
Deadweight Loss
Economic profits are positive
Exception: Perfect Price Discrimination:
mitigates #3, and #5
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
6.0 Price Discrimination
6.1 Examples
6.2 Necessary conditions
6.3 Two Markets
6.4 Separate Markets, Different Elasticities
6.5 Perfect Price Discrimination
eliminates deadweight loss
Self_Evaluation: Flash, Excel, Draw Tool
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
6.1a Examples of Price Discrimination
College Text Book Prices are Less Abroad
NATIONAL DESK | October 21, 2003, Tuesday
Students Find $100 Textbooks Cost $50, Purchased Overseas
By TAMAR LEWIN (NYT) 1667 words
Late Edition - Final , Section A , Page 1 , Column 4
ABSTRACT - American college students find that their textbooks cost
far less overseas than they do in United States; more and more individual
students and college bookstores are ordering textbooks from abroad;
National Assn of College Bookstores has written to all leading publishers
asking them to end practice they see as unfair to American students;
publishing industry defends its pricing policies, saying foreign sales would
be impossible if book prices were not pegged to local market conditions;
textbook publishers have tried to block re-importing of American texts
from overseas; Supreme Court ruled in 1998 that federal copyright law
does not protect American manufacturers from having products they
arrange to sell overseas at discount shipped back for sale in US.
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
31
End
6.1c More Examples
Outline
Business v Leisure Travel Rates
Business people are less sensitive to price than householders
Telephone companies sort customers by charging
different rates based on the time of day .
Long-Distance Rates—nights/weekends vs. weekdays
different elasticities/willingness to pay between personal and
business
Subscription vs. New stand prices
volume discount (firms like certainty of sales)
Early Bird” specials
and other discounts for seniors elderly on fixed incomes have
more elastic demand/lower willingness to pay
Coupons
Outline
different elasticities/willingness to pay between those who
clip and those who don’t clip: those with a low opportunity
cost of time more likely to clip coupons.
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
32
End
Outline
6.2 Conditions for Price Discrimination
4 Conditions
1.
2.
3.
4.
The demand curve for the firm’s product
must slope downward  the firm has
some market power and control over price
There are at least two groups of
consumers for the product, each with a
different price elasticity of demand
The producer must be able, at little cost,
to charge each group a different price for
essentially the same product
The producer must be able to prevent
those who pay the lower price from
reselling the product to those who pay the
higher price
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
6.3a Two Markets
Outline
(b)
Dollars per unit
Dollars per unit
(a)
$3.00
Profit
$1.50
1.00
Profit
LRAC, MC
D'
MR
D
MR'
Quantity per period
0
400
0
500 Quantity per period
At a given price, the price elasticity of demand in panel b(elastic) is greater than in panel a (inelastic).
For simplicity, assume the firm produces at a constant long-run average and marginal cost of $1. This
firm maximizes profits by finding the price in each market that equates marginal revenue with
marginal cost  consumers with the lower price elasticity pay $3 and those with the higher price
elasticity pay $1.50 in markets with elastic demand the price will be lower than in markets where
demand is inelastic.
34 End
Outline 3 Demand 4 Profit 5 Comparison 6 Discrimination
First slide 2 Structure
1.00
LRAC, MC
Outline
6.3b Two Markets
Charging two
prices
Compared to
charging a
single price
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
6.4 It is no more that dividing markets by demand elasticity
Demand and marginal revenue are
shown in the upper panel and total
revenue is in the lower panel.
Notice also that when demand is
elastic, a decrease in price
increases total revenue 
marginal revenue is positive.
Conversely, when demand is
inelastic, a decrease in price
reduces total revenue  marginal
revenue is negative
Dollars per diamond
Elastic
Unit elastic
$3,750
Inelastic
0
D = Average revenue
Marginal revenue
16
32
1-carat diamonds per day
(b) Total Revenue
$60,000
Total dollars
Note that the marginal revenue
curve is below the demand curve
and total revenue is at a maximum
when marginal revenue equals
zero.
(a) Demand and Marginal Revenue
Total revenue
1-carat diamonds per day
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
36
End
Outline
6.5a Perfect Price Discrimination
If a monopolist could charge a
different price for each unit sold,
the firm’s marginal revenue curve
from selling one more unit would
equal the price of that unit  the
demand curve would become the
marginal revenue curve
A perfectly discriminating monopolist
charges a different price for each unit of
the good
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
6.5b Graph
Outline
A perfectly discriminating
monopolist would maximize
profits at point e where
marginal revenue equals
marginal cost  price set at
point e
D o lla r s p e r u n it
a
Profit
e
c
Long-run
average cost
= marginal cost
D = Marginal
revenue
Quantity per period
0
First slide
2 Structure
3 Demand
Q
4 Profit
5 Comparison
6 Discrimination
End
Self Evaluation: Flash
Outline
Use objects to represent revenue and cost concepts.
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
Self Evaluation Exercise
From a table identify revenue cost concepts, and also in another example
generate a table from information on TR and TC.
Profit Maximizing Output is 24.9
Profit Maximizing Price is
$70
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End
Outline
Draw Tool
You can draw
and drop the
objects to
practice price
discrimination
in 2 markets
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
41
End
Outline
End of Presentation
Click a pic to review the topic
First slide
2 Structure
3 Demand
4 Profit
5 Comparison
6 Discrimination
End