Ch 22. Pure Monopoly

From the Greek ‘monos’ = single (one)

    British East India Company; created as a legal trading monopoly in 1600. Standard Oil; broken up in 1911, two of its surviving "baby companies" are ExxonMobil and the Chevron Corporation. Major League Baseball; survived U.S. anti-trust litigation in 1922, though its special status is still in dispute as of 2009. Microsoft; settled anti-trust litigation in the U.S. in 2001; fined by the European Commission in 2004 for 497 million Euros, which was upheld for the most part by the Court of First Instance of the European Communities in 2007. The fine was 1.35 Billion USD in 2008 for noncompliance with the 2004 rule.

Buys and controls 98% of coffee A.

Monopoly – single seller 1.

2.

3.

4.

No substitutes Price maker Blocked entry Nonprice competition -- Blocked entry due to certain barriers to keep new firms out of industry.

-- Nonprice competition monolopies are either standardized (utilities; PR advertising) or differentiated (De Beers, 60%; advertise attributes).

B.

Barriers to entry 1.

Economies of scale 2.

Patent or licensing -- Some barriers may be economic, technologic, legal, ownership of resources, the gov’t requiring a license, or other form.

Monopoly Demand

Three assumptions:  Patents, economies of scale, or resource ownership secure our monopolist’s status.

  No unit of gov’t regulates the firm.

The firm is a single price monopolist; it charges the same price for all units of production. -- Biggest difference between a pure monopolist and a purely competitive seller is on the demand side of the market.

-- P & MR in pure monopoly.

-- A pure monopolist (or any imperfect competitor) must reduce P to make / sell more.

-- MR for 4 th unit is $102 (= $132-$30), much less than the $132 price.

Price and Marginal Revenue

Marginal Revenue is Less Than Price

• • • •

A Monopolist is Selling 3 Units at $142 To Sell More (4), Price Must Be Lowered to $132 All Customers Must Pay the Same Price

$142 132 122 112 102

TR Increases $132 Minus $30 (3x$10)

92 82 Loss = $30 Gain = $132

D

0 1 2 3 4 5 6

Price and Marginal Revenue

Marginal Revenue is Less Than Price

• • • • • •

A Monopolist is Selling 3 Units at $142 To Sell More (4), Price Must Be Lowered to $132 All Customers Must Pay the Same Price

$142 132 122 112 102

TR Increases $132 Minus $30 (3x$10) $102 Becomes a Point on the MR Curve

92 82 Loss = $30 Gain = $132

MR D Try Other Prices to Determine Other MR Points

0 1 2 3 4 5 6

The Constructed Marginal Revenue Curve Must Always Be Less Than the Price

Monopolist is a Price Maker: All imperfect competitors have downward-sloping D curves.

      Demand, MR, & TR for an imperfectly competitive firm.

(a) Must lower P on all units to curve.

 sales, the firm’s MR curve lies below its downsloping D (b) TR  at a decreasing rate, reaches a max., then  .

 In elastic region, TR is so MR is positive.

When TR reaches its max, MR is zero.

In inelastic region of D, TR is  so MR is negative.

Monopoly Revenue and Costs Revenue and Cost Data of a Pure Monopolist

(1) Quantity Of Output Revenue Data (2) Price (Average Revenue) (3) Total Revenue (1) X (2) (4) Marginal Revenue Cost Data (5) Average Total Cost (6) Total Cost (1) X (5) (7) Marginal Cost (8) Profit (+) or Loss (-) 0 1 2 3 4 8 9 10 5 6 7 $172 162 152 142 132 122 112 102 92 82 72 $0 162 304 426 528 610 672 714 736 738 720 ] ] ] ] ] ] ] ] ] ] $162 142 122 102 82 62 42 22 2 -18 $190.00

135.00

113.33

100.00

94.00

91.67

91.43

93.75

97.78

103.00

$100 190 270 340 400 470 550 640 750 880 1030 ] ] ] ] ] ] ] ] ] ] $90 80 70 60 70 80 90 110 130 150

Can you See Profit Maximization?

$-100 -28 +34 +86 +128 +140 +122 +74 -14 -142 -310

Monopoly Revenue and Costs

Demand, Marginal Revenue, and Total Revenue for a Pure Monopolist

Demand and Marginal Revenue Curves Elastic Inelastic

$200 150 100 50 0 $750 2 4 MR 6 8 10 12

Total-Revenue Curve

14 16 D 18 500 250 0 TR 2 4 6 8 10 12 14 16 18

Profit Maximizing & the MR = MC Rule

-- The profit-maximizing position of a pure monopolist.

-- Max profit by producing the MR=MC output, here Qm = 5 units.

-- From the D curve, will charge price Pm=$122.

-- ATC will be A=$94, meaning that per-unit profit is Pm-A and total profit is 5 x (Pm A).

-- Total economic profit is therefore represented by the blue triangle.

Profit Maximization

By A Pure Monopolist

$200 175 150 125 P

m

=$122 Economic Profit 100 75 A=$94 50 25

MR=MC MR MC ATC D

0 1 2 3 4 5

Quantity

6 7 8 9 10

Misconceptions

Concerning Monopoly Pricing



Not the Highest Price



Total, Not Unit, Profit



Possibility of Losses

The Loss-Minimizing position of a pure monopolist

-- If D is weak and costs are high, the pure monopolist may be able to make a profit.

-- Because Pm exceeds V, the AVC at the MR=MC output Qm, the monopolist will minimize losses in the SR by producing at that output.

-- The loss per unit is A – Pm and the total loss is indicated by the blue rectangle.

Loss Minimization

By A Pure Monopolist A P m

Loss

V MC ATC AVC D

0

MR=MC Q m Quantity MR

Inefficiency of Pure Monopoly relative to a Purely Competitive market

-- (a) In a purely competitive industry, entry & exit of firms ensures that Pc = MC and that minimum ATC output (Qc) is produced; P=min ATC, and P=MC.

-- (b) In pure monopoly, the MR curve lies below the demand curve.

-- The monopolist maximizes profit at output Qm, where MR=MC, and charges price Pm.

-- Thus, output is lower (Qm rather than Qc) and price is higher (Pm rather than Pc) in monopoly.

-- Monopoly is inefficient since output is less than that required for achieving min ATC (at Qc) and because monopolist’s price exceeds MC.

Economic Effects of Monopoly

Price, Output, and Efficiency

Purely Competitive Market Pure Monopoly S=MC MC

b P c

P=MC= Minimum ATC

P m P c c a D Q c Q m Q c

MR

Pure Competition is Efficient Monopoly Price is Greater Than MC And Is Therefore Inefficient D

C.

D.

Simultaneous consumption Network effects -- Simultaneous consumption – product’s ability to satisfy a large number of consumers at same time (wireless company).

-- Network effects – increases in value of a product to each user, including existing users, as total number of users increases (computer software, phones).

E.

X-Inefficiency -- The ATC curve is assumed to reflect the minimum cost of producing each particular level of output.

-- Any point above ‘lowest-cost’ ATC curve (X or X 1 ) implies X-inefficiency: operation at greater than lowest cost for a particular level of output.

-- Assumes the most efficient technology is being utilized.

Economic Effects of Monopoly



X-Inefficiency

ATC X ATC 1 ATC X’ ATC 2

X X ’

Average Total Cost

  

Q 1 Quantity Q 2

Rent-Seeking Expenditures



Rent-Seeking Behavior Technological Advance Assessment and Policy Options

Economic Effects of Monopoly

GLOBAL PERSPECTIVE

Representative Highly Competitive Foreign Multinational Corporations

Company (Country) Bayer (Germany) BP Amoco (United Kingdom Michelin (France) NEC (Japan) Nestl é (Switzerland) Nokia (Finland) Royal Dutch/Shell (Netherlands) Royal Philips (Netherlands) Sony (Japan) Toyota (Japan) Unilever (Netherlands) Main Products Chemicals Gasoline Tires Computers Food Products Wireless Phones Gasoline Electronics Electronics Automobiles Food Products

Source: Fortune.com

F.

G.

Rent-seeking behavior Price discrimination -- Rent-seeking behavior: activity designed to transfer income or wealth to a particular firm or resource supplier at someone else’s (or society’s) expense.

-- P discrimination: practice of selling a specific product at more than 1 P when the P differ ences are not justified by cost differences.

-- Purpose of price discrimination is generally to capture the market's consumer surplus. -- P discrimination transfers some of surplus from the consumer to the producer/marketer. -- Oppty for P discrimination when: 1) seller is monopolist, 2) seller segregates buyers into classes (diff. P’s), & 3) original purchaser can’t resell the product or service.

Sales revenue without and with Price Discrimination

Single-price versus perfectly discriminating monopoly pricing

-- (a) The single-price monopolist produces output Q1 where MR=MC, charges P1 for all units, incurs an ATC of A1, and realizes an economic profit represented by abcd.

-- (b) Monopolist has MR=D and as a result produces output Q2 (where MR=MC).

-- It then changes the max price for each unit of output, incurs ATC A2, and realizes an economic profit represented in area hfgh.

Regulated Monopoly

-- The socially optimal price (P monopoly.

-- The fair-return price P f r ), found where D and MC intersect, will result in an efficient allocation of resources but may entail losses to the -- Fair-return Price: P=MC pricing.

will allow the monopolist to break even but will not fully correct the underallocation of resources.

Regulated Monopoly

Dilemma of Regulation

P m P f a P r

0 Monopoly Price Fair-Return Price

f Q m MR

Quantity

Q f b

Socially Optimal Price

ATC r D MC Q r

H.

Deadweight Loss    In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal.

In other words, either people who would have more marginal benefit than marginal cost are not buying the good or service, or people who would have more marginal cost than marginal benefit are buying the product.

Causes of deadweight loss can include monopoly pricing (see artificial scarcity), externalities, taxes or subsidies (Case and Fair, 1999: 442), and binding price ceilings or floors. The term deadweight loss may also be referred to as the "excess burden of monopoly" or the "excess burden of taxation".