Transcript An Independent Relationship between Variables

ECON 2001
Microeconomics II
2014 2nd semester
Elliott Fan
Economics, NTU
Monopoly
Microeconomics, 2014-2
Elliott Fan
Lecture 2
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Introduction
• Interpretation of monopoly definition
• Monopoly or market power
– Downward sloping demand curve
• Price setting and quantity
– Welfare consequences
• Sources of monopoly power
• Profitable pricing strategies
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Competition recap
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Introduction
• Brotherhood for the Respect, Elevation, and
Advancement of Dishwashers
• Impact of achieving goal
– SR life better for dishwashers
– LR wages of dishwashers decrease by full amount of tips
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Introduction
• Why wages bid down by full amount of tips
• Who benefits from tipping
• Tools for analyzing competitive industry
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Section 7.1
THE COMPETITIVE FIRM
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Competitive Firm
• Firm sells any quantity wants at going market price
– Classic example farm
• Small part of market served by each firm
– Horizontal demand curve
• Products are interchangeable
• Buyers can easily buy from another producer
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Revenue
• TR = P X Q
• MR ≡ P
• MR curve is flat
– Coincides with demand curve
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Firm’s Supply Decision
• Produce good until MR = MC
• Competitive firm produces a quantity where P =
MC
– Note: P ≡ MR
• Supply curve
– MC and supply are inverse functions
– Supply curve looks like upward sloping portion of MC
curve as long as MC curve upward sloping
– SR and LR supply curves exist for the firm
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Shutdowns and Exits
• Does the producer want to produce the good?
• Two distinctions
– Shutdown: firm stops producing the good but still pays
fixed costs
– Exit: firm leaves the industry entirely and no longer
faces any costs
• Firms, in SR, can shutdown but not exit
– Remains operational if P > AVC
• In LR, can exit
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Short-Run Supply Curve
• Firms SR supply curve identical to part of SRMC curve
that lies above AVC curve
– Shutdown otherwise
– Upward sloping due to AC and MC U-shape
• Diminishing marginal returns to variable factors of production
• Elasticity of supply
– Percent change in quantity supplied resulting from a 1% change
in price
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Section 7.2
THE COMPETITIVE INDUSTRY IN
THE SHORT RUN
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Competitive Industry in the SR
• All firms in industry competitive
• SR is period of time in which no firm can enter or exit the
industry
• Number of firms cannot change
• LR is period of time in which any firm can enter or leave the industry
• Industry’s SR supply curve
– Sum of SR individual firm supply curves
– More elastic than individual supply curves
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Supply, Demand, and Equilibrium
• Each firm operates where supply meets demand
• Industry equilibrium consequence of optimizing behavior
on part of individuals and firms
– Intersecting industry wide supply and industry wide demand
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Competitive Equilibrium
• Firms produces where supply (or MC) curve crosses
horizontal line at market going price
• Increase in FC
– Price and quantity remain unchanged
• Increase in VC
–
–
–
–
Raises firms MC curve
Causes some firms to shutdown
Higher market equilibrium price
Firm’s output could go up or down
• Increase in industry demand
– Higher market equilibrium price
– Increase in firm’s output
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Change in Fixed Cost
• Increase in FC
– Price and quantity remain unchanged
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Change in Variable Cost
• Increase in VC
–
–
–
–
Raises firms MC curve
Causes some firms to shutdown
Higher market equilibrium price
Firm’s output could go up or down
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Change in Industry Demand
• Increase in industry demand
– Higher market equilibrium price
– Increase in firm’s output
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Industry’s Costs
• Sum of total cost of all individual firms
• To minimize cost of all firms, use equimarginal principle
– Insure that MC same for all producers in industry
– Automatic because all firms have same price
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Section 7.3
THE COMPETITIVE FIRM IN THE
LONG RUN
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Competitive Firm in the LR
• Some fixed cost in SR become variable cost in the LR
• Firms can enter and exit in the LR
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Profit and the Exit Decision
• Profit = TR – TC
– Costs includes all foregone opportunities
• SR versus LR supply response
– Firm LR supply curve more elastic than SR supply curve
• Shuts down if price of output falls below average variable cost
• Exits if price of output falls below average cost
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LRMC and Supply
• Firms operate where P = LRMC
– Remain in industry, LR supply curve identical to LRMC curve
• Exit decision is made at the point P=AC (note that there is
no more fixed cost in the LR)
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Section 7.4
THE COMPETITIVE INDUSTRY IN
THE LONG RUN
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Competitive Industry in the LR
• Firms wishing to enter or exit the market do so in the LR,
flatting out the LR supply curve
• So unlike the case in the SR, the LR supply curve is a
horizontal line.
• Important assumption: all firms are identical in costs
• Break-even price plays an important role here (1) all
firms produce at the break-even price; (2) it determines
the level of LR supply curve
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Zero Profit Condition
• Economic versus accounting profit
– Accounting profit refers to total revenue minus total financial
cost
– Economic profit refers to accounting profit minus the value of the
best foregone opportunity
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Industry’s LR Supply Curve
• All firms identical
– Industry supply curve flat at the break-even price
• Break-even price and the LR supply
– Break-even price (P = AC) at which a seller earns zero
profit
– LR supply curve identical with part of firm’s LRMC
curve lying above LRAC curve
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Flat LR Supply Curve
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•
•
•
Flatness based on entry and exit
P < AC, all firms exit
P > AC, unlimited number of firms enter
LR zero profit equilibrium almost never reached
– Demand and cost curves shift so often that entry and exit never
settles down
– Approximation to the truth
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Equilibrium
• LR same as SR between firm and industry
– Market price determined by intersection of industrywide
demand and supply
– Firms face flat demand curves at market price
• Analysis of changes to equilibrium
– Changes in FC
– Changes in VC
– Changes in demand
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Application: Government as a Supplier
• In SR, government policy to build and operate apartment
complex increasing housing
• In LR, supply curve does not shift
– Determined by break-even price
– Number of privately owned apartments withdrawn from the
market equals number of apartments built by government
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Relaxing the Assumptions
• Assumption 1: All firms are identical, have
identical cost curves
– True in industries that do not require unusual skills
• Assumption 2: Cost curves do not change as
industry expands or contracts
– True in industries not large enough to affect input
prices
• Without these assumptions, all firms do not have
the same break-even price
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Constant Cost
• Constant cost industry
– Satisfies the 2 assumptions
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Increasing Cost
• Increasing cost industry
– Break-even price for new entrants increases as
industry expands
– Assumption 1 violated: Less-efficient firms
– Assumption 2 violated: Factor-price effect
– LR industry supply curve slopes upward
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Decreasing Cost
• Decreasing cost industry
– Break-even price for new entrants decreases as
industry expands
– LR industry supply curve slopes downward
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Applications
• A tax on motel rooms
• Tipping the busboy
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Using the Competitive Model
• Fundamentals of competitive analysis
– Industry versus firm demand and supply
– SR versus LR
– Entry and exit decisions
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PRICE AND OUTPUT UNDER
MONOPOLY
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Price
• Pricing operates where MR = MC
• MR curves lies everywhere below demand curve
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Output
• Lower price to increase output
• Monopolist operates on elastic portion of demand curve
– Ex. Prices of gasoline, oranges, and music CDs
• No supply curve
– No going market price
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Measuring Monopoly Power
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Welfare
• Assumption about same industry wide MC curve for
competitive and monopolistic industries
• Social welfare loss under monopoly
– Marginal value exceeds marginal cost
– Monopolist could produce additional good
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Subsidies and Public Policy
• Subsidies for monopolist
– Induce monopolist to provide competitive quantity
•
•
•
•
Arises from “ideal” subsidy
Could encourage inefficient production
Creates price ceilings
Follows rate-of-return regulation
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Sources of Monopoly Power
• Natural monopoly
– Industry where AC curve decreasing at point where crosses
market demand
– Industry survive only if monopolized
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Sources, cont.
• Welfare economics
– Monopoly outcome best for some
• Imperfect competition
– Downward pressure on prices
– Innovation
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Other Sources of Monopoly Power
• Patents
– Ex. photography
• Resource monopolies
– Single firm controls productive input
• Legal barriers to entry
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Monopoly, market, and government
• This video explains why the concept of monopolies are
incompatible with the free market, and actually the result
of non-market (government) forces.
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Price Discrimination
• Charging different prices for identical items
• Ability to prevent resell of low-price units
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First Degree
• First-degree
– Charging each customer most willing to pay
– Welfare gains
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Third-Degree
• Charging different prices in different markets
–
–
–
–
Groups of consumers identifiable
Different downward sloping demand curve
Producer profit
Production of goods where MR same in both markets and equal
to MC
– More elastic demand group receives lower price
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• Third-degree: the most common form of
price discrimination (student discounts,
senior citizens’ discounts). Suppose there are
two groups of people and there is no resale.
Then the monopolist’s profit maximization
problem becomes
maxy , y (=p1(y1)y1+ p2(y2)y2-c(y1+y2)).
Hence FOC becomes
MR1(y1)=MC(y1+y2)=MR2(y2).
1
2
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• Since MR1(y1)=p1(y1)[1-1/|1|] and
MR2(y2)=p2(y2)[1-1/|2|], hence p1>p2 if
and only if |1|<|2|. The market with
lower absolute value of elasticity has a
higher price. Quite sensible since
elasticity measures how sensitive the
group is to price changes.
• There are some other often-observed
practices used by firms with monopoly
power.
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• Second-degree: also known as nonlinear pricing since the price per unit of
output is not constant, but depends on
how much you buy. The monopolist can
offer different price-quantity packages
so that the consumers can self select.
• Note that the low-end consumer’s
package is distorted so that the highend consumer will not choose the lowend package.
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• Compared to perfect price discrimination,
without high-end, low-end is offered higher
quantity but still ends up with zero surplus.
Without low-end, high end gets zero surplus,
now gets positive surplus and the quantity
offered is the same.
• Applying this to air travels, by offering a
downgraded product, the airlines can charge
the consumers who need flexible travel
arrangements more for their tickets.
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Many many examples of PD
• Coupons, rebates, free delivery, coffee lids……
• The spirit of PD – to offer lower prices to customers who
are more sensitive to price. There is no point to offer
coupons if everyone redeemed them, and there is no
point to coupons if only a random set of customers
redeemed them.
• Note: almost everything that appears to be price
discrimination admits at least one alternative
explanation. For example, coupon clippers temp to go
shopping when the shop is not crowded.
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Pricing strategies by monopolist:
versioning
• Versioning is a practice of offering an inferior product to
charge differently for different customers. For example,
hardcopy and paperback of the same book. Another
example is the same printers designed to print slower
deliberately.
• Strictly speaking, versioning should not be considered as
a form of PD in some cases as products involved are
different.
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Pricing strategies by monopolist:
Two-Part Tariff
• First part
• Entry fee allows purchase of goods or services
– Meaning of tariff
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Pricing strategies by monopolist:
Two-Part Tariff
• Second part
• Customers are charged maximum willing to pay
– Charge competitive price as long as no difference in consumers
– Charge low initial fee and high usage fee
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Pricing strategies by monopolist:
Two-Part Tariff
• By implementing the two-part tariff, a monopoly firm can
produces at the competitive market level, enhancing the
efficiency.
• Examples
– Clubs that charge a member fee and an usage fee
– Health insurance – copayment increases efficiency.
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Pricing strategies by monopolist:
Bundling
• packages of related goods are often offered
for sale together: software suite (word
processor, spreadsheet, presentation tool),
cosmetic products, etc.
• Bundling may be cost saving or it may be due
to complementarities among the goods
involved. But there can be reasons involving
consumer behavior. Consider the following
example. Assume the marginal cost of
producing is zero.
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• Type of consumers
word pro
spreadsheet
A
120
100
B
100
120
• Suppose the willingness to pay for the bundle
is the sum. If each item is sold separately,
then revenue will be 400. If instead bundling
two goods together, can get the revenue of
440. In other words, the dispersion of
willingness to pay may be reduced.
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