Transcript lecture seven - Webster in china

Lecture seven
© copyright：qinwang 2013
[email protected]
SHUFE school of international business
Firm decision in monopoly
 The reason for monopoly
 Price strategy
 Short-run decision
 Long-run decision
 Warfare loss in monopoly
 the Theory of Contestable Markets
Why to be monopoly
 Resources monopoly: ALCOA
(aluminum); DeBeers (diamond)
 Natural monopoly: it is efficient for
one firm to supply the whole market.
 Government-authorized franchise:
only one firm is approved by
government.
 Competition lead to monopoly
 Patent or copyright
Monopolist: price decision
Would Monopolist be in loss?
P
P
SMC
SMC
SAC
P0
MR
0
Q0
Super profit
SAC
P0
MR
0
SMC
SAC
P0
D
Q
P
D
Q0
Break even
Q
MR
0
Q0
D
Q
loss
Long-run decision in monopoly
Monopolist maximizes profit by choosing to
produce output where MR = LMC, as long as
P  LAC
 Will exit industry if P < LAC
 Monopolist will adjust plant size to the optimal
level
Optimal plant is where the short-run average
cost curve is tangent to the long-run average
cost at the profit-maximizing output level
Monopolist’s decision in long-run
P
LAC
SMC0
SAC0
SMC1
LMC
SAC1
P0
AC0
P1
AC1
D
MR
0
Q0
Q1
Q
Monopolist will loss in long-run?
P
LMC
LAC
P0
AC0
P0
D
MR
0
LMC
LAC
P
Q0
MR
Q
0
Q0
D
Q
Optimal markup, contribution margin
and gross profit margin.
 Optimal markup
 MR=MC
 MR=P(1+1/Ep);so P=MC*Ep/(Ep+1)
 Contribution margin: P-MC
 Contribution margin percentage: (PMC)/P
 Gross profit margin: P-MC-FC
the Theory of Contestable Markets
 In 1982, William．Baumol set up this theory.
 a perfectly contestable market would have no barriers
to entry or exit. Contestable markets are
characterized by "hit and run" competition; if a firm in
a contestable market raises its prices much beyond
the average price level of the market, and thus begins
to earn excess profits, potential rivals will enter the
market, hoping to exploit the price level for easy
profit. When the original incumbent firm(s) respond
by returning prices to levels consistent with normal
profits, the new firms will exit. Because of this, even a
single-firm market can show highly competitive
behavior.
Barriers to Entry
 Entry of new firms into a market
erodes market power of existing firms
by increasing the number of
substitutes
 A firm can possess a high degree of
market power only when strong
barriers to entry exist
 Conditions that make it difficult for new
firms to enter a market in which
economic profits are being earned
Common Entry Barriers
 Economies of scale
 When long-run average cost declines
over a wide range of output relative to
demand for the product, there may not
be room for another large producer to
enter market
 Product differentiation
 Barriers created by government
 Licenses, exclusive franchises
Common Entry Barriers
 Essential input barriers
 One firm controls a crucial input in the
production process
 Brand loyalties
 Strong customer allegiance to existing
firms may keep new firms from finding
enough buyers to make entry worthwhile
Common Entry Barriers
 Consumer lock-in
 Potential entrants can be deterred if they
believe high switching costs will keep
them from inducing many consumers to
change brands
 Network externalities
 Occur when benefit or utility of a product
increases as more consumers buy & use it
 Make it difficult for new firms to enter
markets where firms have established a
large base or network of buyers
Monopoly profit and limit pricing
A limit price is the price set by a
monopolist to discourage entry into a
market, and is illegal in many countries.
When MR=MC, monopolist may earn
short-run profit maximization, that
would inducing new entries. Monopolist
falls its price to discourage entry, that
may reduce its shout-rum profit but
would gain more in long-run.
E.g: price strategy of Galanz
The sale of Galanz’s microwave (sales volume):
 1993:10000 ; 1994:100000;
 1995:250000,market share 25.1%(Xianhua
24.8%);
 1996:600000,market share 34.7%；
 1997:1250000, market share 49.6%； sales
profit rate 11%
 1998:3150000(export),2130000(demestic),ma
rket share 61.43%,sales profit rate 9%
 1999,price falled and reduce sales profit rate to
6%.
limit pricing
limit pricing
Long-run
Short-run
Natural monopoly and price regulation
 A natural monopoly by contrast is a condition
on the cost-technology of an industry whereby
it is most efficient (involving the lowest longrun average cost) for production to be
concentrated in a single form.
 Examples: power grid companies, gas
companies, electric power companies
price discrimination
 Price discrimination or price
differentiation exists when sales of
identical goods or services are transacted
at different prices from the same provider
 Doctors or lawyers charge for different fee
for the same service.
 Power plant differents its price to firm and
individual.
 Restaurant charges different price for old
and young person.
First-Degree (Perfect)
Price Discrimination
 Every unit is sold for the maximum
price each consumer is willing to pay
 Allows the firm to capture entire consumer
surplus
 Difficulties
 Requires precise knowledge about every
buyer’s demand for the good
 Seller must negotiate a different price for
every unit sold to every buyer
First-Degree (Perfect) Price
Discrimination (Figure 14.2)
Second-Degree Price Discrimination
 Lower prices are offered for larger quantities and
buyers can self-select the price by choosing how much
to buy
 When the same consumer buys more than one unit of a
good or service at a time, the marginal value placed on
additional units declines as more units are consumed
Declining block pricing
Offers quantity discounts over successive
discrete blocks of quantities purchased
Block Pricing with Five Blocks
D
Two-part pricing
Charges buyers a fixed access charge (A) to
purchase as many units as they wish for a
constant fee (f) per unit
Total expenditure (TE) for q units is:
TE  A  fq
Third-Degree Price Discrimination
If a firm sells in two markets, 1 & 2; ask for
different price for each market.
How to allocate output?
Allocate output (sales) so MR1 = MR2
Optimal total output is that for which
MRT = MC
For profit-maximization, allocate sales of total
output so that
MRT = MC = MR1 = MR2
Why choose price discrimination?
 Different Demand elasticity?
 Different cost?
 Different time?