Transcript Lecture 18 Monopoly

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Monopoly
The definition of monopoly
– From the Latin: “single seller”
A structural view
– Unique product/service
– Large relative to market
A theoretical view
– Must lower price to sell more units
– Must find best price for output, so better
name is “price searcher” or “price maker”
Sources of monopoly
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Unique talent
– LeBron James
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Patent or copyright
– Intel chip
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Location
– McDonald’s in airport
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Regulation
– Professions
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Collusion
– OPEC
Consider this Price Maker Market
You think so hard in econ class you have a headache!
You go to buy a bottle of 100
generic aspirin. Consider these
options: 1. Wal-Mart
2. Grocery Store
3. Small convenience store
Which has highest price and lowest price?
Is the market competitive?
What does monopoly mean in practice?
Marginal Revenue schedule
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Marginal revenue (MR) is the change in total
revenue (TR) when there is a change in
quantity (Q) sold. To sell more, you must cut
price (P) – move down the demand curve – so
MR is always less than P. Price to the seller is
the revenue received.
Because a price cut to sell more units reduces
revenue on “earlier” units, extra revenue (the
marginal revenue) is less than price. Assuming
all sales at the same price — P is Average
Revenue — measured by the Demand Curve.
Anatomy of a Demand Curve
Demand reflects what consumers pay for a good.
They pay a price, P’, which
is Average Revenue to the $
seller (AR). Total revenue in
D = AR
a given time period is
P’ x Q’ = TR. Marginal
P’
Revenue (MR) is the
MR
change in TR given a
change in Q sold, which
Q’
requires P to change.
Q
Madonna’s problem:
How many songs?
TC
3.5
7
10.5
14
17.5
21
24.5
28
Q
1
2
3
4
5
6
7
8
Price
$10m/song
9
8
7
6
5
4
3
TR
10
18
24
28
30
30
28
24
MC
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
At each price, recording company demands (will buy) the
number of songs shown, Q
-- Price-quantity combinations shown are points on
demand curve
What is the best price; or how many songs?
Is maximum total revenue the best solution?
Marginal revenue is less than price
New
TC
3.5
7
10.5
14
17.5
21
24.5
28
MR
10
8
6
4
2
0
-2
-4
Q
1
2
3
4
5
6
7
8
Price
$10m/song
9
8
7
6
5
4
3
TR
10
18
24
28
30
30
28
24
MC
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
What is the most profitable P and Q?
The solution: marginal revenue = marginal cost
New
TC
3.5
7
10.5
14
17.5
21
24.5
28
Profit
6.5
11
13.5
14
12.5
9
3.5
-4
MR
10
8
6
4
2
0
-2
-4
Q Price/song
1
$10m
2
9
3
8
4
7
5
6
6
5
7
4
8
3
TR
10
18
24
28
30
30
28
24
MC
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
Find the price that maximizes profits for Madonna (the
seller)
The solution: Choose Q such that MR = MC
Note that P > MC at best Q
The solution graphically
The profit-maximizing price is the one that induces demanders
to choose Q such that MR = MC
$
At any higher price,
MR > MC
 lost profits
P*=7
At any lower price,
MC=3.5
MR < MC
 lost profits
MC = S
D
MR
Only at P* is MR = MC
 maximum profits
1 2 3 4 5
6
7 8
Quantity
The Price Maker: Common in
Highly Competitive Markets
Setting price at movie theater $
that has 1,000 seats in it.
Assume fixed costs of $2,000 for
movie rental, $250 for labor, &
$6
$250 for building per night.
$5
You know your customers from $4
experience—what price do you
charge if only one price can be set?
Highly competitive market for
entertainment dollars.
D
MR
400 500
600
Q
Setting Prices
What is Marginal Cost in this situation?
All costs are fixed, so MC = $0
At what quantity does MC = MR?
500 seats
What price can be charged?
$5 (price is Average Revenue—Demand Curve)
What is Total Revenue?
TR = P * Q = $5 x 500 = $2500
Can we do better?
There are unsold seats — and it costs $0 to serve another
customer (MC=$0) — so should we cut the price to $4
to fill more seats? Cut price to $4, add 100 customers,
but TR falls $100, so MR per extra customer is -$1.
Some customers value the movie at more than $5. Should
we charge a higher price, say $6? We go from TR =
$2500 to TR = $2400, so TR falls $100, or -$1 as
customer base falls from 500 to 400.
Nothing beats the golden rule of MC = MR
Same example with positive MC
Now presume movie distributor
$
charges a rental fee of $2 per
customer let into the theater,
so MC=$2 per customer let in.
Building cost of $250 and labor cost
$6
Of $250 per night are still fixed.
D
MR
$6x400=$2400 is where MC=MR
$2
Compare to $5 price (TR=$2500),
for 100 more customers, $100 more
TR or MR = $1 per customer. MC = $2 for each
customer (TC=$1500), so net loss of $100.
MC
400
Q
A “monopolist” has competition
This is called the monopoly pricing
model or price maker model.
The market for movie theaters is
competitive —between theaters as
well as with substitutes such as DVDs.
The market is competitive, but firms act
as if they are a monopoly.
Trying to apply model in real world—
where do you have ability to set price?
Parker Hannifin: Industrial parts maker:
$9.4 billion revenue 2006; 800,000 parts sold.
Traditional policy: “cost” plus 35% (the
“strategy” used by ~ half US manufacturers)
Net income in 2002: $130 million
Net income in 2006: $673 million
Return on invested capital up from 7% to 21%
in same time.
How: Be a “monopolist” when possible
Some things are “monopolistic,”
some are not, from same seller
New Strategy: 4 Basic Categories of products
A.
Ones in highly competitive markets—charge
the market price; no price changes
B.
Partially differentiated products—common
products changed a bit for a customer;
prices up 0-9%
C.
Differentiated products—engineered for a
customer; up 0-25%
D. Specials—custom designed; no close
substitutes; prices up over 25%