MORE THAN - UCSB Economics
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Transcript MORE THAN - UCSB Economics
Monopoly, Market Power, and
Economies of Scale
Today: Introduction of situations
in which the Invisible Hand breaks
down
Up until now…
…we have typically analyzed markets
with no control over market price
Each firm was a price taker, since it only
produced a very small fraction of quantity
supplied in the market
Many sellers vs. one seller
Many sellers
No control over price
One seller, also known as a monopolist
Complete control over price (sort of)
Sort of?
Recall that demand curves are
downward-sloping
Each time price increases, fewer people
are willing to pay the price to purchase
the good
The monopolist can control price, but must
face the consequences that price
determines quantity sold
MB in a competitive vs.
monopolistic environment
Competitive environment
MB is price, since price does not depend on
quantity supplied by an individual firm
Monopolistic environment
We will see that MB decreases as quantity
supplied increases
What happens to the monopolist
when it sells another unit?
Each time another
unit is sold, price of
the good decreases
We will go through a
simple example,
shown to the right,
to determine MR for
the monopolist
P
4
Q
0
3
1
2
2
1
3
0
0
Marginal revenue
Marginal revenue
How much additional
is received by selling
one more unit of the
good?
We must first
calculate TR
Notice that for
Q > 1, MR < P
P
4
Q
0
TR
0
MR
3
3
1
3
1
2
2
4
-1
1
3
3
-3
0
4
0
Market inefficiencies of
monopoly
Decreasing marginal revenue creates
inefficiencies in the market
We will talk about this more in the next
lecture
And now, onto the big
question of the day?
How Do Firms Gain Market Power?
Exclusive control over important inputs
Patents and copyrights
Government licenses or franchises
Economies of scale Natural monopoly
Networks
Exclusive control over
important inputs
If a company controls a significant
portion of the important inputs to a
product, it can have significant
influence on price
Exclusive control over
important inputs
Example: De Beers
Rough diamond explorer
Around 40% of world diamond production
by value
Sales and marketing through the Diamond
Trading Company
This company sells almost half of the world’s
rough diamonds by value
(Information from http://en.wikipedia.org/wiki/De_Beers, checked
Feb. 3, 2008)
De Beers
Such large control over the market
makes De Beers able to act similarly to
a monopolist
Marketing of diamond jewelry does not
have to be brand specific
"A Diamond is Forever" attempts to prevent old
jewelry from entering the market
De Beers does have some control over
world prices
Patents and copyrights
Patents and copyrights prohibit others
from copying private work and
discoveries
Example: Copying songs and movies that
are copyrighted are typically prohibited by
law
Government licenses or
franchises
Government owned property often
allows exclusive operation of the
property for various uses
This is to prevent competition that
could deteriorate a natural destination
Government licenses or
franchises
Example: Yosemite
National Park
Limited parking
Tasteful hotels
Most of the park is
undeveloped
Most of park development
is in only 7 square miles
Park is 1,200 square miles
Vernal Fall
Economies of scale
Some technologies are such that as the
quantity produced increases, ATC
decreases for all reasonable quantities
produced
This is due to increasing returns to scale
This happens when ALL inputs double and
production MORE THAN doubles
Often happens with large fixed costs and
nearly-linear variable costs
Example where a single firm
could gain market power
When a firm gains
market control with
economies of scale, it
is called a natural
monopoly
There are problems
with natural
monopolies if left
uncontrolled
Price ($)
D
ATC
Deal with this later
Quantity
Network economies
What do the following products have in
common?
Skype
Sony IVE
Microsoft's MSN Messenger
Ojo
Network economies
They are all trying
to become the
leader in video
calling programs
This technology has
improved since the
PicturePhone was
unveiled in 1964
Monopoly inefficiency
As we will see, monopolies typically
produce quantities that are less than
efficient
This leads to positive economic profits
Controlling monopolies
Laws have been passed to control
monopoly profits
Regulation typically tries to set
economic profit to be about zero
This sometimes makes regulated stocks a
relatively safe investment
Controlling monopolies
Why are monopolies typically regulated?
We will analyze this in the next lecture
In the absence of regulation, a monopoly will
usually produce a quantity that is below the
optimal amount in order to make positive
economic profits
Monopolies can increase efficiency by price
discrimination
However, the monopolist sometimes benefits more than
consumers do