Transcript L14-monopoly

MB MC
Last word on invisible hand…
There are some important projects that need to be up
and running starting like yesterday, because they are
key to human survival. Unfortunately, they cannot be
funded in the usual ways because of the warped nature
of market economics and global finance, which dictates
that the only goal of investing money is to make more
money. The project of averting disastrous outcomes is
not a money-maker, per se, and does not get funded.
But shipping in millions of plastic orange Halloween
pumpkins from China every year is a sure bet, and so
the free market prioritizes orange plastic pumpkins
above doing what is essential to keep us all alive. The
invisible hand of the free market, it turns out, is
attached to an invisible idiot.
Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 1
Monopoly and
imperfect competition
MB
MC
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Imperfect Competition

Imperfectly Competitive Firms
Have some control over price
 Price may be greater than the marginal
cost of production
 Long-run economic profits are possible
 Reduce economic surplus to varying
degrees
 Are very common

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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 3
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Forms of Imperfect Competition

Pure Monopoly (most inefficient)

The only supplier of a unique product with
no close substitutes
 Patents=monopoly

This is the one we’ll pay most attention to
Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 4
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Forms of imperfect Competition

Oligopoly (theoretically more efficient
than a monopoly)
A firm that produces a product for which
only a few rival firms produce close
substitutes
 Many major economic sectors

 Food,
media, banking, energy, garbage,
pharmaceuticals, electricity, water, hospitals,
etc.

Collusion is a big problem
 Oil,
Electricity, Vitamins, potash, ArcherDaniels Midland
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 5
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Forms of imperfect Competition

Monopolistic Competition (closest to
perfect competition)
A large number of firms that produce
slightly differentiated products that are
reasonably close substitutes for one
another
 E.g. cigarettes

Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 6
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Imperfect Competition

The Essential Difference Between
Perfectly and Imperfectly Competitive
Firms
The perfectly competitive firm faces a
perfectly elastic demand for its product.
 The imperfectly competitive firm faces a
downward-sloping demand curve.

Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 7
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Imperfect Competition

In perfect competition
Supply and demand determine equilibrium
price. The firm has no market power.
 At the equilibrium price, the firm sells all it
wishes.
 If the firm raises its price, sales will be
zero.
 The firm’s demand curve is the horizontal
line at the market price.

Copyright c 2004 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 8
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Imperfect Competition

With imperfect competition
The firm has some control over price or
some market power.
 In order to sell more, the firm must lower its
price

 Lower

P x higher Q
The firm faces a downward sloping
demand curve.
Copyright c 2004 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 9
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The Demand Curves Facing Perfectly
and Imperfectly Competitive Firms
D
Market
price
D
Quantity
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Imperfectly competitive firm
Price
$/unit of output
Perfectly competitive firm
Quantity
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 10
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Five Major Sources of Market Power
Market power = barriers to entry
 Exclusive control over inputs
 Patents and copyrights
 Government licenses or franchises
 Economies of scale (natural monopolies)
 Networked economies
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 11
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
Economies of Scale and the
Importance of Fixed Costs
Natural Monopolies: Firms with large
fixed costs and low variable costs
e.g. telephones, electric utilities, sewage,
pharmaceuticals, INFORMATION, etc.
 Have low marginal costs
 Average total cost declines sharply as
output increases
 Economies of scale will exist

Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 12
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Total and Average Total Costs for a
Production Process with Economies of Scale
Average cost ($/unit)
Total cost ($/year)
TC = F + MQ
F + Q0
F
ATC = F/Q + M
M
Q0
Quantity
Total cost rises at a constant
rate as output rises
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Quantity
Average costs decline and is
always higher than marginal cost
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 13
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Costs for Computers
(Hardware+software): Scenario 1
Early Mac
Annual production
Early PC
1,000,000
1,200,000
Fixed cost
$2,000,000
$2,000,000
Variable cost
$8,000,000
$9,600,000
$10,000,000
$11,600,000
Total cost
Average total cost per system
$10.00
$9.70
Observations
•Fixed costs are a relatively small share of total cost
•Variable costs are identical
•Cost/system is nearly the same
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 14
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Costs for for Computers
(Hardware+software): Scenario 2
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 15
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Costs for for Computers: scenario 2
after time passes
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 16
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
Economies of Scale and the
Importance of Fixed Costs
Fixed investment in research and
development has been increasing as a
share of production costs.
Cost of producing a computer
Fixed Cost
Software
1984
1990
Copyright c 2004 by The McGraw-Hill
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20%
80%
Variable Cost
Hardware
80%
20%
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 17
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
Profit Maximization for
the Monopolist
A price taker (perfect competition) and a
price setter (imperfect competition)
share two economic goals. They want
To maximize profits
 To select the output level that maximizes
the difference between TR and TC, where
MB= MC.

Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 18
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
Profit Maximization for
the Monopolist
For any producer
MB = Marginal Revenue (MR) or a change
in a firm’s total revenue that results from a
one-unit change in output
 Increase output when MR > MC.


For competitive producer


MR=P
For a monopolist

MR<P
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 19
The Monopolist’s Benefit
from Selling an Additional Unit
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• If P = $6, then TR = $6 x 2 = $12
• If P = $5, then TR = $5 x 3 = $15
• The MR of selling the 3rd unit = $3 (15-12)
• For the 3rd unit, MR = $3 < P = $5
Price ($/unit)
8
6
5
D
2
3
8
Quantity (units/week)
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 20
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Marginal Revenue

P
Q
TR
6
2
12
5
3
15
4
4
16
3
5
15
Copyright c 2004 by The McGraw-Hill
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MR
Observations


3
1
-1


MR < P
MR declines as quantity
increases
MR is the change between
two quantities
MR < P because price must
be lowered to sell an
additional unit
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 21
P
Q
TR
6
2
12
5
3
15
4
4
16
3
5
15
MR
3
1
-1
Price & marginal revenue ($/unit)
Marginal Revenue in
Graphical Form
MB MC
8
3
D
1
-1
2
3
4
5
8
MR
Quantity (units/week)
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 22
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
Profit Maximization for
the Monopolist
Profit Maximizing Decision Rule
When MR > MC, output should be increased.
 When MR < MC, output should be reduced.
 Profits are maximized at the level of output
for which MR = MC.
 What’s the marginal revenue for a
competitive firm?

Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 23
The Monopolist’s ProfitMaximizing Output Level
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Marginal Cost
Price ($/unit of output)
6
Observations
• If P = $3 & Q = 12 MR < MC
and output should be
reduced
• Profits are maximized at 8
units where MR = MC
• P = $4 where quantity
demanded = quantity
supplied
4
3
2
MR
8
12
D
24
Quantity (units/week)
Copyright c 2004 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 24
The Demand and Marginal Cost
Curves for a Monopolist
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Why the Invisible Hand Breaks Down Under Monopoly
Price ($/unit of output)
6
Marginal cost
Deadweight loss
• Because MR < P, the monopoly
produces less than the socially
optimal amount
• The deadweight loss of the
monopoly to society =
(1/2)($2/unit)(4units/wk) = $4/wk.
4
3
2
MR
8
12
D
24
Quantity (units/week)
Copyright c 2004 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 25
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
Why the Invisible Hand Breaks
Down Under Monopoly
Monopoly




Profits are
maximized where
MR = MC.
P > MR
P > MC
Deadweight loss
Copyright c 2004 by The McGraw-Hill
Companies, Inc. All rights reserved.

Perfect Competition




Profits are
maximized where
MR = MC.
P = MR
P = MC
No deadweight loss
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 26
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
Why the Invisible Hand Breaks
Down Under Monopoly
Difficulties in Reducing the Deadweight
Loss of Monopolies

Enforcing antitrust laws
 Growing
concentration in food, media, energy,
pharmaceuticals, etc.
Patents, copyrights, and innovation
 Natural monopolies

Copyright c 2004 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 27
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Price Discrimination
The practice of charging different buyers
different prices for essentially the same
good or service
 E.g. textbooks, medicine, movies, ski
resorts

 What

about re-importing medicine?
Theoretically maximizes economic surplus,
but reduces consumer surplus to zero
Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 28
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
Public Policy Toward
Natural Monopoly
Methods of Controlling Natural
Monopolies

State ownership/provision and
management
 Weighing
the benefit of marginal cost pricing
versus the cost of less incentive for innovation
 Is it true that there is less incentive for
innovation? WWII, VEIC
 In a democracy, politicians have to provide
public services and keep taxes low to get reelected
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 29
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
Methods of Controlling
Natural Monopolies
State regulation of private monopolies

Cost-plus regulation
 High
administrative cost
 Less incentive for innovation
 P does not equate to MC
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 30
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
Methods of Controlling
Natural Monopolies
Exclusive contracting for natural
monopoly
Competition for the contract theoretically
sets P = MC
 Example of water in Buenos Aires
 Difficulty when fixed costs are high
 No incentive to maintain infrastructure
when contract nears termination

Copyright c 2004 by The McGraw-Hill
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Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 31
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
Methods of Controlling
Natural Monopolies
Vigorous enforcement of anti-trust
laws?
Helps prevent cartels
 May prevent economies of scale

Copyright c 2004 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 9: Monopoly and Other Forms of Imperfect Competition
Slide 32