Transcript Lecture13 - UCSB Economics

Introduction to Economics
Microeconomics
The US Economy
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Market Power and Monopoly
Is monopoly a good thing or not?
 How about Microsoft, is this firm good or
bad for consumers?

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Market Power & Market Structure

No market power: competition
 many
producers
 firms are price takers
 no excess profit
 price to consumer = long run average cost

Market power: monopoly
 one
producer
 monopolist is price setter
 monopolist makes profits at expense of the
consumer
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The Brief for Competition

.... and against monopoly
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Outline: Lecture Thirteen

Competitive Industries
 agriculture
 construction
Market Supply in the Short Run
 The Optimal Plant Size
 Market Supply in the Long Run

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Competitive Markets

In the long run, resources will flow to a
competitive market if firms are making
excess profits
 new
firms will enter the industry
 if
returns to scale are constant, then price will be
driven down to long run average total cost
 if returns to scale first increase and then decrease,
price will be driven down to minimum long run
average cost
Consumers benefit from the efficient, lowest
cost use of resources and the lowest price
for the product

Profits are driven to Zero
Llad Excess
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
Competitive Industries: Agriculture
Product
cattle
corn
soybeans
wheat
dairy products
tobacco
peanuts
rice
# of Firms Producing
1176346
789326
441899
352237
162555
136682
18905
12013
source: Census of Agriculture, 1987
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Competitive Industries
Product
# of Firms Producing
contract construction
1951509
apparel
22872
millwork, plywood
7930
household furniture
5606
book publishers
2856
computer/office Equip
2134
knitted textiles
2130
iron/steel foundry Pdt
1231
footwear
479
petroleum refining
331
sources: Census of Manufactures, 1987
Census of Construction Industries, 1987
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Short Run

Plant Size of a firm is fixed
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Short Run Market Supply: Two Firm Industry
MC,
AVC
MCII
MCI
AVCI
QI
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Market
Supply
AVCII
QII
QI + QII
Quantity
10
Market Supply and Demand in the Short Run
MC,
Market
Price
pM
Demand
QM
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Supply
Quantity
11
MC,
AVC,
ATC
PM
Short Run Market Supply: Two Firm Industry
ATCI
MCII
MCI
AVCI
ATCII
AVCII
Market
Supply
Market
Demand
Quantity
QI
QII
QI + QII
In the short run, both firms are making excess profits. This may
motivate them to find the lowest cost size for plant and
equipment.
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Short Run* World Supply: Copper
Country Marginal Cost
Zaire
0.49 $ per #
Zambia
0.54 $ per #
Chile
0.58 $ per #
US
0.68 $ per #
Peru
0.79 $ per #
Canada
0.88 $ per #
Metric Tons, 000
560.0
363.0
1356.4
1007.3
397.2
724.4
* Existing Mines Fixed
Source: Minerals Yearbook, 1985
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Short Run Supply of World Copper, 1985 .
0.9
Canada
0.8
Peru
Marginal Cost, $ per # .
0.7
US
0.6
Chile
0.5
Zaire
0.4
Zambia
0.3
0.2
0.1
0
0
1000
2000
3000
4000
5000
Production, Thousands of Metric Tons .
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Long Run

What is the optimal plant size?
 constant
returns to scale
 increasing, then decreasing returns
 increasing returns to scale
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Optimal Size of the Firm: Constant Returns to Scale
MC, ,
ATC
pM
SMCI
SATCI
SMCII
SATCII
LATC, LMC
Quantity
If market price is above long run marginal cost, the firm will
make the same excess profit per unit of output in a large plant as
in a small plant. The firm may prefer larger to smaller. As long as
firms are making excess profits, other firms will enter the industry,
increasing supply, and driving price down to LMC.
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Long Run Equilibrium Supply with the Free Entry of Firms:
Constant Returns to Scale
Market
Price
Demand
Short Run Supply
Supply after
Entry of Profit
Seeking Firms
PM
PM = LMC =
LATC
Long Run Supply
Quantity
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Optimal Size of the Firm: Constant Returns to Scale
MC, ,
ATC
SMCI
SATCI
SMCII
SATCII
LATC, LMC
pM
Quantity
If market price is above long run marginal cost, the firm will
make the same excess profit per unit of output in a large plant as
in a small plant. The firm may prefer larger to smaller. As long as
firms are making excess profits, other firms will enter the industry,
increasing supply, and driving price down to LMC.
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Optimal Size of Plant with Variable Returns to Scale
LMC
LATC
Market
LATC
Price
SMCIV
SATCI
SATCIV
SATCII
SMCIII
pM
SATCIII
Quantity
If market price is above long run average cost, then firms with
efficient scale of plant, SATCIII ,will make an excess profit. In the
long run other firms in the industry will move to this efficient size
plant. As long as there are excess profits to be made, new firms
will enter the industry, driving market price down to minimum
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long
run average total cost, LATC.
Long Run Equilibrium Supply with the Free Entry of Firms:
Variable Returns to Scale, Deceasing and then Increasing
Market
Price
Demand
Short Run Supply
Supply after
Entry of Profit
Seeking Firms
PM
PM = LMC =
Minimum
LATC
Long Run Supply
Quantity
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Optimal Size of Plant with Variable Returns to Scale
LMC
LATC
Market
LATC
Price
SMCIV
SATCI
SATCIV
SATCII
SMCIII
pM
SATCIII
Quantity
If market price is above long run average cost, then firms with
efficient scale of plant, SATCIII ,will make an excess profit. In the
long run other firms in the industry will move to this efficient size
plant. As long as there are excess profits to be made, new firms
will enter the industry, driving market price down to minimum
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long
run average total cost, LATC.
Competitive Markets

In the long run, resources will flow to a
competitive market if firms are making
excess profits
 new
firms will enter the industry
 if
returns to scale are constant, then price will be
driven down to long run average total cost
 if returns to scale first increase and then decrease,
price will be driven down to minimum long run
average cost
Consumers benefit from the efficient, lowest
cost use of resources and the lowest price
for the product

Profits are driven to Zero
Llad Excess
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
Natural Monopoly

Increasing Returns to Scale
 optimal
 larger

is better
Constant Returns to Scale
 optimal
 LAC

size of the firm
size of the firm: indeterminate
= LMC = same at all outputs
Increasing then Decreasing Returns to Scale
 optimal
size of the firm: minimum LAC
 minimum
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LAC where LAC = LMC
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Optimal Size of Plant with Increasing Returns to Scale:
Bigger is Better
Price
LATC
SATCI
SATCII
LATC
Quantity
LMC
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Market Power: Size in 1994
Country
Sweden
Corporation GDP, $B Sales, $B
169
GM
155
Taiwan
150
Ford
129
Norway
105
Exxon
101
Toyota
95
Hong Kong
91
Wal-Mart
83
ATT
75
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source: World Bank & Fortune 500
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Market Power: Market Share
Product
inst. breakfast
tennis balls
disp. diapers
breakfast cereal
video game
player
cameras, film
car rental
credit cards
beer
detergent
records & tapes
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Firms
Mkt Shr
Carnation, Pillsbury
100/3
Gen Corp, Pepsico
100/4
P&G, Kimberly
99/4
Kellogg, Gen Mills
98/4
Nintendo, Sega
98/2
Kodak, Polaroid
Hertz, Avis
VISA, MasterCard
Anheuser-Busch
P&G, Lever Bros
Time-Warner, Sony
98/4
95/4
92/3
90/4
86/3
77/4
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How does a monopolist use
power to maximize profits?

marginal principle: increase output until
marginal revenue = marginal cost
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Monopoly Sales
Price
$10
Price
Market Demand
A
B
0
0
Quantity
10
9
8
7
6
5
4
3
2
1
0
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
Revenue
0
9000
18000
21000
24000
25000
24000
21000
18000
9000
0
Marginal Revenue
9000
9000
3000
3000
1000
-1000
-3000
-3000
-9000
-9000
Quantity
Revenue
$25,000
A
0
B
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Quantity
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Increasing Returns to Scale and Long Run Total Costs
$
Long Run Total Costs
Quantity
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Maximum Monopoly Profits: Marginal Revenue = Marginal Cost
$
LTC
R
Revenue
LTC
Quantity
$
Excess
Profit
0
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Quantity
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Monopoly Profits with Increasing Returns to Scale
Price
Market Demand
MR
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Quantity
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Monopoly Profits with Increasing Returns to Scale
Price
LATC
Market Demand
PM
MR
LATC
Quantity
LMC
Q
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Maximum Monopoly Profits: Marginal Revenue = Marginal Cost
$
LTC
R
Revenue
LTC
Quantity
$
Excess
Profit
0
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Quantity
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The Social Cost of Monopoly: Example, Constant Returns to Scale
Competition
Monopoly
Market Demand
Market Demand
Consumer Surplus
LATC = LMC
PM
LATC = LMC
PM
MR
QCOMP
QMONOP
Under monopoly, consumers pay a higher price and consume less
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The Social Cost of Monopoly: Example, Constant Returns to Scale
Competition
Monopoly
Market Demand
Market Demand
Consumer Surplus
Dead Weight Loss
PM
Profit
PM
LATC = LMC
LATC = LMC
MR
QCOMP
QMONOP
Under monopoly, some consumer surplus is redistributed to the
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monopolist
Social Policy

If returns to scale are constant
 regulate
 make
the monopolist charge a price equal to
marginal cost
• obtain the competitive solution

If returns to scale are increasing
 regulation
is not so easy
 can
not set monopolist’s price equal to marginal
cost: monopolist will suffer losses
• because marginal cost is less than average cost
 could
socialize the industry and the government
could subsidize the losses
 could live with monopoly
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Society
How can we control it?
Regulation,
Franchises,
Patents
Higher Prices
Less Goods
Excess Profits
MONOPOLY POWER
Political
Influence
Strategic Planning
Entrepreneurs
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How do we get it?
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Strategic Planning: Brand Names
Brand
Marlboro
Coca-Cola
Budweiser
Pepsi-Cola
Nescafe
Kellogg
Winstons
Pampers
Camels
Campbell
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Company
Value, $B
Philip Morris
31
Coca-Cola
24
Anheuser-Busch
10
PepsiCo
10
Nestle
9
Kellogg
8
RJR Nabisco
6
Procter & Gamble
6
RJR Nabisco
4
Campbell Soup
4
source: USA Today , 1992
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Advertising Cost of a Car
company
Mercedes
Nissan
Toyota
GM
Chrysler
Ford
$ per sale
620
435
381
198
198
123
TV, $M, ‘91
49
267
403
978
335
408
source: Fortune
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Strategic Action: Advertising
Company
Proctor & Gamble
Philip Morris
General Motors
Ford Motor Co.
Sears, Roebuck
AT&T
PepsiCo
Chrysler
Disney
Johnson & Johnson
Advertising, ‘94: $B
2.7
2.4
1.9
1.2
1.1
1.1
1.1
1.0
0.9
0.9
source: Advertising Age
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Classification of US Industry
Sector
% Pvt Domestic Output
Ag, Forestry & Fishg
1.9
Mining
0.9
Construction
5.3
Manufacturing
21.0
Transport, Commun
8.6
Wholesale Trade
6.8
Retail Trade
10.2
Finance, Insur, Real
18.6
Services: Pers & Bus
26.8
Total
100.0
source: Survey of Current Business
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Summary-Vocabulary-Concepts











competitive industries
short run
short run marginal cost
optimal plant size
long run
long run marginal cost
constant returns to scale
free entry
long run equilibrium
variable returns to scale
excess profits
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









increasing returns to scale
natural monopoly
market share
marginal revenue
monopoly profit
social cost of monopoly
consumer surplus
dead weight loss
regulation of monopoly
brand names
strategic planning
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