Transcript ECONOMICS - Student Forum

Monopoly
PowerPoint Slides prepared by:
Andreea CHIRITESCU
Eastern Illinois University
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Barriers to Entry
• Monopoly
– Sole supplier of a product with no close
substitutes
• Barrier to entry
– Any impediment that prevents new firms
• From entering an industry
• And competing on an equal basis with
existing firms
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2
Barriers to Entry
• Barriers to entry
– Legal restrictions
– Economies of scale
– Control of essential resources
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Barriers to Entry
• Legal restrictions
– Patents and invention incentives
• Exclusive right to sell a product for 20 years
from the date the patent application is filed
• Incentive for innovation
– Licenses and other entry restrictions
• Government awarding an individual firm the
exclusive right to supply a particular good or
service
• Federal and state license
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Barriers to Entry
• Economies of scale
– Natural monopoly
– Downward-sloping long-run average cost
curve
• One firm can supply market demand at a
lower average cost per unit than could two
firms
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Exhibit 1
Economies of Scale as a Barrier to Entry
Cost per unit
$
Long-run
average cost
A monopoly sometimes emerges
naturally when a firm
experiences economies of scale
as reflected by a downwardsloping long-run average cost
curve. One firm can satisfy
market demand at a lower
average cost per unit than could
two or more firms, each
operating at smaller rates of
output.
Quantity
per period
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Barriers to Entry
• Control of essential resources
– Firm’s control over some resource critical
to production
– Alcoa (aluminum)
• Control the supply of bauxite
– Professional sports leagues
– China (pandas)
– DeBeers Consolidated Mines (diamonds)
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Barriers to Entry
• Supplying something that other
producers can’t match
– Unique experience
• Monopolies
– Local, national, international
• Long-lasting monopolies
– Rare - economic profit attracts
competitors
– Technological change
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Revenue for the Monopolist
• Monopoly
– Supplies the market demand
• Downward-slopping (law of demand)
– To sell more: must lower the price on all
units sold
• Total revenue TR=pˣQ
• Average revenue AR=TR/Q
– For monopolist: p=AR
• Demand curve = average revenue curve
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Exhibit 2
A Monopolist’s Gain and Loss in Total Revenue from Selling
a Fourth Unit
Dollars per
diamond
$7,000
6,750
0
Loss
D = Average revenue
Gain
3
4
1-carat diamonds
per day
If De Beers increases
quantity supplied from 3 to 4
diamonds per day, the gain in
revenue from the fourth
diamond is $6,750. But the
monopolist loses $750 from
selling the first 3 diamonds
for $6,750 each instead of
$7,000 each. Marginal
revenue from the fourth
diamond equals the gain
minus the loss, or $6,750
$750 $6,000. Thus, the
marginal revenue of $6,000 is
less than the price of $6,750.
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Revenue for the Monopolist
• Marginal revenue MR=∆TR/∆Q
– For monopolist: MR<p
– Declines, can be negative
• Marginal revenue curve
– Downward sloping
– Below the demand curve (average
revenue curve)
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Exhibit 4
Monopoly Demand, Marginal Revenue, and Total Revenue
Dollars per diamond
(a) Demand and marginal revenue
Elastic
Unit elastic
$3,750
Inelastic
0
MR
16
D=Average revenue
32
Where demand is price elastic,
marginal revenue is positive, so total
revenue increases as the price falls.
Where demand is price inelastic,
marginal revenue is negative, so total
revenue decreases as the price falls.
1-carat diamonds per day
(b) Total revenue
Total dollars
$60,000
Total revenue
0
16
32
Where demand is unit elastic,
marginal revenue is zero, so total
revenue is at a maximum, neither
increasing nor decreasing.
1-carat diamonds per day
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Revenue for Monopolist
• Total revenue curve
• Reaches maximum where MR=0
• Demand curve: p=AR
• Where demand is elastic, as price falls
– Total revenue increases
– MR>0
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Revenue for Monopolist
• Where demand is inelastic, as price falls
– Total revenue decreases
– MR<0
• Where demand is unit elastic
– Total revenue is maximized
– MR=0
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Costs and Profit Maximization
• Monopolist
– Choose the price
– OR the quantity
– ‘Price maker’
• Price maker
– Firm with some power to set the price
– Demand curve for its output slopes
downward
– Firms with market power
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Costs and Profit Maximization
• Profit maximization
– Profit = total revenue minus total cost
– Supply the quantity where
• Total revenue exceeds total cost by the
greatest amount
• Marginal revenue equals marginal cost
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Monopoly & Allocation of Resources
• Monopoly
– Marginal benefit (p) > marginal cost
– Restrict quantity below what would
maximize social welfare
– Smaller consumer surplus
– Economic profit
– Deadweight loss of monopoly
– Allocative inefficiency
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Monopoly & Allocation of Resources
• Deadweight loss of monopoly
– Net loss to society
– When a firm with market power restricts
output and increases the price
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Exhibit 8
Perfect Competition and Monopoly Compared
Dollars per unit
a
pm
pc
m
c Sc=MC=ATC
b
D
MRm
0
Qm
Qc
Quantity
per period
A perfectly competitive industry
would produce output QC,
determined by the intersection of
the market demand curve D and
the market supply curve SC. The
price would be pC. A monopoly
that could produce output at the
same minimum average cost as
a perfectly competitive industry
would produce output Qm,
determined at point b, where
marginal cost intersects marginal
revenue. The monopolist would
charge price pm. Thus, given the
same costs, output is lower and
price is higher under monopoly
than under perfect competition.
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Estimating Deadweight Loss
• Deadweight loss of monopoly might be
lower
– Substantial economies of scale
• Lower cost per unit
– Keep price below the profit maximizing
value
• Public scrutiny, political pressure
• Avoid attracting competition
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Estimating Deadweight Loss
• Deadweight loss of monopoly might be
higher
– Secure and maintain monopoly position
• Use resources; social waste
• Influence public policy (Rent seeking)
– Inefficiency
– Slow to adopt new technology
– Reluctant to develop new products
– Lack innovation
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Price Discrimination
• Price discrimination
– Increasing profit
– Charging different groups of consumers
• Different prices
• For the same product
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Price Discrimination
• Conditions for price discrimination
– Downward sloping demand curve
• Some market power
– At last two groups of consumers
• With different price elasticity of demand
– Ability to charge different prices
• At low cost
– Prevent reselling of the product
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A Model of Price Discrimination
• Two groups of consumers
– One group (a): less elastic demand
– The other (b): more elastic demand
• Maximize profit
– MR=MC in each market
– Lower price for group (b)
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Exhibit 9
Price Discrimination with Two Groups of Consumers
(b) Consumer group
with more elastic demand
Dollars
per unit
Dollars
per unit
(a) Consumer group
with less elastic demand
$3.00
LRAC, MC
1.00
MR
0
400
$1.50
1.00
LRAC, MC
MR’
D
Quantity per period
0
500
D’
Quantity per period
A monopolist facing two groups of consumers with different demand elasticities may be
able to practice price discrimination to increase profit or reduce loss. With marginal
cost the same in both markets, the firm charges a higher price to the group in panel
(a), which has a less elastic demand than group in panel (b).
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Examples of Price Discrimination
• Airline travel
• Businesspeople (business class)
– Less elastic demand
– Higher price
• Even within the same class
– Different prices
– Discount fares
– Weekend stay
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Examples of Price Discrimination
• Amusement parks
• Out-of-towners: less elastic demand
– Higher prices
• Locals: more elastic demand
– Discount coupons available at local businesses
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Perfect Price Discrimination
• Perfectly discriminating monopolist
– Monopolist who charges a different price
– For each unit sold
– The monopolist’s dream
• Charge different price for each unit sold
– D curve becomes MR curve
– Convert consumer surplus into economic
profit
– Allocative efficiency: No deadweight loss
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Exhibit 10
Dollars per unit
Perfect Price Discrimination
c
a
Profit
c
Long-run average
cost = Marginal cost
D=Marginal revenue
0
Q
Quantity per period
If a monopolist can charge a different price for each unit sold, it may be able to
practice perfect price discrimination. By setting the price of each unit equal to the
maximum amount consumers are willing to pay for that unit (shown by the height of
the demand curve), the monopolist can earn a profit equal to the area of the shaded
triangle. Consumer surplus is zero. Ironically, this outcome is efficient because the
monopolist has no incentive to restrict output, so there is no deadweight loss.
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