Transcript Chapter 12

Chapter 12
Monopoly
Market structure or environment in which one firm produces a
good or service with no close substitutes.
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Chapter Outline
Defining Monopoly
Five Sources Of Monopoly
The Profit-maximizing Monopolist
A Monopolist Has No Supply Curve
Adjustments In The Long Run
Price Discrimination
The Efficiency Loss From Monopoly
Public Policy Toward Natural Monopoly
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What is a Monopoly?
Monopoly: a market structure in which a single seller of a product with
no close substitutes serves the entire market.
– A monopoly has significant control over the price it charges
(Contrast: In Chap. 11, a typical firm is price-taker in P X Q while
in Chap. 12, the firm is a price-maker, i.e. adjusts P to influence Q).
Five Sources Of Monopoly
1.
2.
3.
4.
5.
Exclusive Control over Important Inputs
Economies of Scale –major source of monopoly of the 5!
Patents
Network Economies, e.g. Microsoft’s Window operating system .
Often driven by the demand side and not the Supply side! “Network
externalities” means that there are benefits if many people use the
same thing.
Government Licenses or Franchises, e.g. college campuses granting
exclusive rights to either Coke or Pepsi
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Figure 12.1: Natural Monopoly
When there is only 1 firm, the LAC is LACQ* for producing Q*.
With 2 firms, the LAC is LACQ*/2 for Q*/2
Thus, when the LAC is declining (due to economies of scale/size), it is
optimal to have a single producer.
 For allowing such a monopoly, the government often regulates its behavior,
e.g. SMUD in Sacramento.
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The Profit-maximizing Monopolist
The monopolist’s goal is to maximize economic profit.
– In the short run this means to choose the level of output
for which the difference between total revenue and
short-run total cost is greatest.
Revenue for the Monopolist
 As price falls, total revenue for the monopolist does not rise
linearly with output.
– Instead, it reaches a maximum value at the quantity
corresponding to the midpoint of the demand curve
(ϵp=1)after which it again begins to fall.
– Total revenue (TR) reaches its maximum value when the
price elasticity of demand is unity (εP=1)
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P= 80 – (1/5)*Q
TR= 80Q – (1/5)Q2
MR =dTR/dQ= 80 – 2/5Q
MR
εP = 1 when TR is maximum
Figure 12.2: The Total Revenue Curve
for a Perfect Competitor
The MR curve is identical to the AR, P and
the demand curve facing a typical firm.
Thus, P=MR=AR in Chap.11.
Figure 12.3: Demand, Total Revenue,
and Elasticity
The slope of the MR is twice the slope of the
D=AR curve. That is, the MR curve lies
below the D=AR curve in Chap. 12.
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Figure 12.4: Total Cost, Revenue,
and Profit Curves for a Monopolist
Demand: P = 100 -2Q
Max profit
Econ Profit is positive
The Profit-maximizing Monopolist
Optimality condition for a monopolist: a monopolist maximizes profit
by choosing the level of output where marginal revenue equals marginal
cost (MR=MC is still in Monopoly as it was in Perfect Competition).
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XXX = LOSS
ZZZ = GAIN
∆ TR = ∆PQ + P∆Q + ∆P∆Q
0
Figure 12.5: Changes in Total Revenue
Resulting from a Price Cut
Area B = P ∆Q = 50x50 =$2500= GAIN
Area A = ∆PQ = (60 – 50) x100 =$1000 =
LOSS
Figure 12.6: Marginal Revenue
and Position on the Demand Curve
If Q0 is left of M, GAIN > LOSS
If Q1 is right of M, GAIN<LOSS
If Q is at M, then GAIN = LOSS
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Figure 12.7: The Demand Curve and Corresponding
Marginal Revenue Curve
εP = (∆Q/∆P)*(P/Q)
MRQ = P(1 – 1/| εP |)
Marginal Revenue And Elasticity
The less elastic demand is with respect to price, the more price will exceed
marginal revenue.
For all elasticity values less than 1 in absolute value marginal revenue will
be negative (εP <1and MR<0)
For all elasticity values larger than 1 in absolute value marginal revenue will
be positive ((εP >1and MR>0)
For all elasticity values equal to1 in absolute value marginal revenue will be
zero ((εP =1and MR=0)
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Figure 12.8: A Specific Linear Demand Curve and
the Corresponding Marginal Revenue Curve
Since Q = 4 –(1/3)P (write it in terms of P) implies
that P = 12 -3Q, then TR= PQ =TR = (12 – 3Q)*Q =
12Q – 3Q2
Then the slope of the TR = MR = dTR/dQ = 12 - 6Q
OR that the slope of the TR curve is twice the slope of
demand curve!
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Figure 12.9: The Profit-Maximizing Price
and Quantity for a Monopolist
Ch11: (1)P =MR & (2)MR=MC and thus
(3) P=MC at equilibrium
Ch 12: (1)P > MR & (2) MR = MC and
hence (3) P>MC at equilibrium
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Figure 12.10: The Profit-Maximizing Price and
Quantity for Specific Cost and Demand Functions
Given P = 100 -2Q; STC = 640 + 20Q,
MC=20, find optimal output, price and
profits. Set MR = MC  100 – 4Q = 20 or
Q= 20; P = 100 – 2* 20 = 60.
The profit = 60*20 –(640 + 20*20)
=$160 OR (P – ATC)Q = (60 – 52)*20
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The Profit-maximizing Monopolist
 If a monopolist’s goal is to maximize profits, she
will never produce an output level on the inelastic
portion of her demand curve.
 The profit-maximizing level of output must lie on
the elastic portion of the demand curve.
Monopolist’s Profit-Maximizing Mark-up
Combine MR = P(1 – 1/|εP |) and MR =MC to yield,
(P-MC)/P = 1/|εP |= mark-up over MC
If εP =∞, then the mark-up is zero
If εP =0, then the mark-up has no limit
Example: Suppose εP = 2 => a mark-up =1/2 =50%
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Figure 12.11: A Monopolist who Should Shut
Down in the Short-Run
At MC =MR (Point A), P < AVC, this implies that P < ATC. Thus, the
monopolist must shutdown
A
The Profit-maximizing Monopolist
Shutdown condition for a monopolist: he should
cease production whenever average revenue (AR ≈D =price
value on the demand curve) is less than average variable cost
at every level of output.
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A Monopolist Has No Supply Curve
 The monopolist is a price maker.
– When demand shifts rightward, elasticity at a given price may
either increase or decrease, and vice-versa.
 So there can be no unique correspondence between the price
(P) a monopolist charges and the amount she/he chooses to
produce.
 Monopoly has a supply rule, which is to equate marginal revenue and
marginal cost (MR=MC)
Example:
1) P = 100 -2Q so Q=50(if P=0); TC = 640 + 20Q; MC=20 and Q*=20
and P*=60 Versus
2) P = 100 - Q so Q=100 (if P=0); TC = 640 + 20Q; MC=20 and Q*=40
and P*=60
Identical MCs, different demand curves give rise to different optimal
output values
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Figure 12.12: Long-Run Equilibrium
for a Profit-Maximizing Monopolist
We assume a given technology.
Choose Q* where LMC =MR (point A) and
choose capital stock (K) in the SR that gives
rise to SMC* and ATC*
K
A
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Figure 12.13: The Profit-Maximizing
Monopolist Who Sells in Two Markets
Given MR1 = MR2
MC = MR* = (MR1 +MR2)
Price Discrimination
Price discrimination: a practice where the monopolist charge different prices to
different buyers, i.e. converting CS from buyers to itself!
Third-degree price discrimination: charging different prices to buyers in
completely separate markets.
First-degree price discrimination: is the term used to describe the largest possible
extent of market segmentation.
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MC =Q; Home demand (H)
P=30-Q, Foreign (F)=12;
MRH =30 – 2Q
Figure 12.14: A Monopolist with
a Perfectly Elastic Foreign Market
Charge the maximum the
buyer is willing to pay
Figure 12.15: Perfect Price
Discrimination
Total: MRF =12, MC =Q; Q=12
Domestic : MRH =MRF => 30-2QH=12 so QH =9
Foreign MRF =12 => 12-9 =3=QF
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For this monopolist, set MR
=MC implies that the D curve is
the MR! Creams off all CS!
Seller posts different prices, with
declines as volume purchased
increases
CS captured by the
monopolist
Figure 12.16: The Perfectly
Discriminating Monopolist
Figure 12.17: Second-Degree
Price Discrimination
Second-Degree Price Discrimination
Second-degree price discrimination: price discrimination where the same rate
structure is available to every consumer and the limited number of rate categories
tends to limit the amount of consumer surplus that can be captured.
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Figure 12.18: A Perfect Hurdle
Idea: seller induces buyers with high elastic demand to identify
themselves. That is, the seller sets up a hurdle of some sort that buyers
have to hop over.
Example: hurdle could be a discount coupon (buy it now for retail and get
a coupon; wait for 6 -8 weeks to get a rebate)
Fig. 12.18 shows a perfect hurdle – PH is a regular and PL is the discount
price. Without a hurdle, QL would have been excluded from the market!
Another example: multiple prices on any aircraft!
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Figure 12.19: The Welfare Loss from
a Single-Price Monopoly
Perfect Comp (Chap. 11) – largest total surplus – all potential
trades completed; in Monopoly, this requires production QC at
price PC. However, the optimals here are Q* < QC and P*>PC. Still
exists some trades that could be completed.
The loss to society
Loss to Consumers
The Efficiency Loss From Monopoly
Deadweight loss from monopoly: the loss of efficiency due
to the presence of a Monopoly.
--Is the result of failure to price discriminate perfectly.
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Public Policy Toward Natural Monopoly
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State Ownership And Management
State Regulation Of Private Monopolies
Exclusive Contracting For Natural Monopoly
Vigorous Enforcement Of Antitrust Laws
A Laissez-faire Policy Toward Natural Monopoly
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Figure 12.20: A Natural Monopoly
Suppose TC = F + MQ where Q = output and M = MC: Ideally, produce Q**
and sell at M. Problem: Production at Q* implies loss since P= M< ATC
In reality, the monopolist produces Q* and sells at P*. This reality earns the
monopolist (1) profits = π (Fairness Objection) and (2) causes loss of CS
=Area S (Efficiency objection – P > MC and results in a loss of CS).
These objections lead to 5 ways to remedy the problem.
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Figure 12.21: Cross-Subsidization
to Boost Total Output under State Regulation of Private Firms
If not state ownership, then state regulation. But that has the problem of
having rate-of-return distortions, if the monopolist serves more than one
separate market.
In the Figure, the ATC include the (a) allowed rate of profit and (b) the rate
of profit exceeds the cost of capital. Monopolist is allowed rate of return
which exceeds the cost of capital, the incentive is to set P way above MC in the
inelastic market (Panel A) and earn π1>0 and use these profits to subsidize
Market 2 where P<ATC, i.e. π2<0 . This cross-subsidization, unless disallowed,
can enable a monopolist to retain significant power in the inelastic market!
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Figure 12.22: The Efficiency Losses from
Single-Price and Two-Price Monopoly
Idea: Do nothing, i.e. let the free market rule. Two objections: (a) fairness and
(b) efficiency problems.
Without the Hurdle Model, the inefficiency remains since there is only one
single price (Panel A) where the loss of CS to society = CS.
Assume that TC = F + MQ
With the Hurdle model, the monopolist charges different prices to buyers
who manage the hurdle on the elastic portion of the demand curve. In the
limit, he charges P = MC. The efficiency loss in terms of CS is only Z < W.
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Figure 12.23: Does Monopoly
Suppress Innovation?
Common Assertion: Monopolists deprive consumers of beneficial
technological innovations., i.e. there are social costs to monopoly.
Monopolist currently can produce bulbs that last 1,000 hours at $1.00/per
bulb hour. Finds that he can produce bulb that lasts 10,000 hours at the same
cost (thus, the cost per bulb hr is $0.10). The demand curve is D and the
marginal revenue is MR.
Profit when ATC = $1.00 is area ABCE but when ATC = $0.10, profit is area
FGHK.
The monopolist will produce new bulbs since Area FGHK > Area ABCE. Thus,
the assertion may not always be true!
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