Transcript Monopoly
Monopoly Overheads A firm is a monopoly if it is the only supplier of a product for which there is no close substitute A monopoly sets the price of its product without concern that the price might be undercut by rivals A monopoly faces a downward sloping demand curve Monopoly and substitutes Being the only seller of a narrowly defined product does not make one a monopoly Cola products Computer chips Novels Mountain bikes Pure monopoly One seller of a good with few substitutes Impure Monopoly Any firm with downward sloping demand Creating and maintaining a monopoly Monopolies exist because of barriers to entry There are many different barriers to entry Economies of scale If marginal cost is decreasing as production rises, one firm will emerge as the only survivor in an industry When total production costs would rise if two or more firms produced instead of one, the single firm in the industry is called a natural monopoly A natural monopoly exists when, due to economies of scale, one firm can produce at a lower cost per unit than can two or more firms Natural monopolies and limit pricing New firm (entrant) considers entry Incumbent firm sets price just below average cost of entrant Why can the incumbent do so? Entrant goes away! Life is good!! Local (natural) monopolies service station movie theatre doctor feed store Control of scarce inputs Alcoa De Beers Big Bear’s Burro Rides Special knowledge prevents imitation KFC Slick 50 Bagel recipes Special knowledge lowers cost Robotics in automobile manufacturing Chemical process for crushing soybeans Legal protection Intellectual property literary works paintings musical compositions scientific inventions Intellectual property rights - an incentive for innovation Innovation is risky and costly Profit incentives counteract risk and cost Intellectual property rights create a monopoly Government strikes a compromise Creators of intellectual property get a monopoly The monopoly has a limited time frame Patents Cover scientific discoveries and products Provide protection for about 20 years drugs herbicides computer chips Copyrights Cover literary, musical and artistic works Provide protection for about 50 years songs books plays software Government restrictions or franchise When there is a natural monopoly, society may be better off with monopoly Government usually reserves right to regulate taxi-cabs electricity cable television or local phone service postal service Single Price Monopoly A monopoly is a price setter A monopoly is a price maker A monopoly is a price searcher Price makers face downward sloping demand curves and set price Demand The individual demand curve facing a firm tells us, for different prices, the quantity of output that customers will choose to purchase from the firm. The demand curve facing the firm show us the maximum price the firm can charge to sell any given amount of output A monopolist faces a downward sloping demand curve Q = D(p) p = D-1 (Q) = g(Q) 1 Q 18 p 14 p 25214 Q Single-price monopoly A firm which is limited to charging the same price for each unit of the product is called a single-price monopoly Total Revenue Revenue is the total income that comes from the sale of the output (goods and services) of a given firm or production process Revenue R (p , Q) p Q p f (x1 , x2 , , xn ) g (Q) Q Linear inverse demand p A BQ R pQ g (Q) Q R ( A BQ)Q AQ BQ 2 Example p 25214 Q R p Q g(Q) Q R ( 252 14 Q) Q 252 Q 14 Q 2 Marginal Revenue (MR) Marginal revenue is the increment, or addition, to revenue that results from producing one more unit of output Marginal revenue is the change in total revenue from producing one more unit of output change in revenue ΔR(Q, p) ΔTR(Q, p) MR change in output ΔQ ΔQ Demand /Price Q 0 252 TR 0 MR MR 252 238 1 238 238 224 210 2 224 448 196 182 3 210 630 168 154 4 196 784 140 126 5 182 910 112 98 6 168 1008 84 70 7 154 1078 56 42 8 140 1120 28 Example Increase output from 3 to 4 units ΔTR(Q,p) MR ΔQ (784630 ) (4 3) 154 154 1 Linear inverse demand p A BQ R pQ g (Q) Q R ( A BQ)Q AQ BQ 2 MR A 2 BQ Marginal revenue has the same price intercept as the inverse demand curve Marginal revenue has twice the slope as the inverse demand curve Example computation (Q = 4) p A BQ 252 14Q MR A 2 BQ 252 (2)(14)Q 252 (2)(14) (4) 252 (8)(14) 252 112 140 A note on marginal revenue and price Marginal revenue is always less than or equal to price WHY? The firm must lower price in order to sell more units Price taker p p0 1 2 q0 3 4 5 q Price Searcher p p0 p1 B Demand A Q Q0 Q1 The lower price applies to all units and so the revenue per unit will be less than the price Marginal revenue is given by the area A-B since the firm now sells Q1 units at a price of p1 The gain in revenue is given by (Q1 - Q0) p1 while the loss is given by (p1 - p0) Q0 MR (Q1 Q0) p1 (p1 p0) Q0 p1 Q1 p1 Q0 p1 Q0 p0 Q0 p1 Q1 p0 Q0 TR1 TR0 p p0 p1 B Demand A Q0 Q1 Q For the example in the table, note that when Q increases from 3 to 4, that the firm gains (Q1 Q0 )p1 (4 3) (196) 196 Demand /Price Q 2 224 TR 448 MR MR 196 182 3 210 630 168 154 4 196 784 140 126 5 182 910 112 But the firm has a loss of (p1 p0 )Q0 (196 210) (3) ( 14)(3) 42 Demand /Price Q 2 224 TR 448 MR MR 196 182 3 210 630 168 154 4 196 784 140 The firm then has a net gain of 154 (196 - 42) as before The monopolist will never produce at an output level where MR < 0 Cost for the monopolist C(Q, w1 ,w2 ,) n min x1 ,x2 , , x n Σ wi xi such that Q f (x1 ,x2 ,xn ) i 1 Cost TC C(x1 , x2 , , w1 , w2 , ) n Σ wi x i i 1 C(Q, w1 , w2 , ) Q FC VC C MR Profit 0 100 0 100 AFC AVC ATC MC MC D Price TR 252 0 120 1 100 120 220 100.00 120 220.00 320 50.00 110 109 160.00 238 238 406 33.33 92 102 135.33 224 448 484 25.00 81 96.0 121.00 210 630 560 76 20.00 92.0 112.00 196 784 640 77 16.67 90.0 106.67 182 910 730 84 14.29 90.0 104.29 168 1008 836 97 12.50 92.0 104.50 154 1078 964 116 11.11 96.0 107.11 140 1120 56 348 28 284 0 170 14 141 126 1134 156 10 1001020 1120 10.00 102 112.00 368 42 128 9 100864 84 70 106 8 100736 112 350 98 90 7 100630 140 300 126 80 6 100540 168 224 154 76 5 100460 196 128 182 78 4 100 384 224 18 210 86 3 100 306 252 -100 238 100 2 100 220 MR -14 172 112 1120 -28 0 Marginal cost (MC) Marginal cost is the increment, or addition, to cost that results from producing one more unit of output change in cost MC change in quantity ΔC(Q, w) ΔTC(Q, w) ΔQ ΔQ Q FC VC C MR Profit 4 100 384 484 D MC MC Price TR 76 196 784 76 5 100 460 560 182 910 80 300 112 350 84 368 56 348 98 84 168 1008 90 7 100 630 730 140 126 77 6 100 540 640 MR 70 97 154 1078 ΔC(Q, w) MC ΔQ (640560) ( 6 5) 80 80 1 Returns (Profit) π Revenue Costs R C n π p QΣ wi xi i 1 n g(Q) QΣ wi xi i 1 g(Q) Q C(Q, w) The profit max problem max g(Q)Q C(Q, w) Q max (252 14Q) Q C(Q, w) Q max 252Q 14Q 2 C(Q, w) Q Maximizing profit Choose the level of output where the difference between TR and TC is the greatest Profit Max Using MR and MC An increase in output will always increase profit if MR > MC An increase in output will always decrease profit if MR < MC The rule is then Increase output whenever MR > MC Decrease output if MR < MC Choose output where MR = MC Q FC VC C Profit 4 100 384 484 D MC MC Price TR 76 196 784 76 5 100 460 560 182 910 80 300 112 350 84 368 56 348 98 84 168 1008 90 7 100 630 730 140 126 77 6 100 540 640 MR MR 70 97 154 1078 Should we increase output from 4 to 5? Yes Should we increase output from 5 to 6? Yes Should we increase output from 6 to 7? No ! Cost Curves, Demand and Marginal Revenue 300 $ Demand MR MC 250 200 150 100 50 0 0 2 4 6 8 10 12 14 16 Output 18 Cost Curves, Marginal Revenue and Optimal Price 300 $ Demand MR MC 250 200 Q Opt P Opt 150 100 50 0 0 2 4 6 8 10 12 14 16 Output 18 Optimal Q = 6 Optimal p = $168 Measuring Total Profit Profit is always given by Profit π Total revenue Total cost pQ C ( Q, w1 , w2 , ) Graphically it is the distance between total revenue and total cost Cost Curves 2000 $ 1800 1600 1400 1200 1000 800 600 400 200 0 TR C 0 2 4 6 8 10 12 14 16 18 Output Profit, price, and average total cost Profit per unit is given by Profit per unit π Q pQ C(Q, w1 , w2 , ) Q pQ TC Q Q p ATC Cost Curves, Marginal Revenue and Profit 300 $ Profit per unit Demand MR MC ATC Q Opt P Opt ATC Opt 250 200 150 100 50 0 0 2 4 6 8 10 12 14 16 18 Output The distance between price and ATC at the optimum output level is profit per unit Total profit is given by the area of the box bounded by price, the optimum quantity, average total cost at the optimum quantity, and the price axis Cost Curves, Marginal Revenue and Profit 300 $ Profit 250 Demand MR MC ATC Q Opt P Opt ATC Opt 200 150 A 100 50 0 0 2 4 6 8 10 12 14 16 Output 18 Q C AVC 4 484 96.00 ATC MC 121.00 MC Price TR Profit 76 196 784 300 77 182 910 350 84 168 1008 368 97 154 1078 348 76 5 560 92.00 112.00 80 6 640 90.00 106.67 90 7 730 90.00 104.29 (168 - 106.666) = 61.333 (61.333) (6) = $368 The firm earns a profit whenever p > ATC A firm suffers a loss whenever p < ATC at the optimum level of output Let p = 165 - 14 Q The optimum quantity is 3 units The market price is $128 Profit = $-37 Q 0 C 100 AVC ATC Demand Price 165 TR 0 109 151 151 92 137 274 81 123 369 76 109 436 77 95 475 84 81 486 97 67 469 116 53 424 141 39 351 172 25 250 MC ) MC 120 1 220 120 220.00 100 2 320 110 160.00 86 3 406 102 135.33 78 4 484 96 121.00 76 5 560 92 112.00 80 6 640 90 106.67 90 7 730 90 104.29 106 8 836 92 104.50 128 9 964 96 107.11 156 10 1120 102 112.00 MR ) MR 165 151 137 123 109 95 81 67 53 39 25 11 -3 -17 -31 -45 -59 -73 -87 -101 -115 Profit -100 -69 -46 -37 -48 -85 -154 -261 -412 -613 -870 Q 0 1 2 3 4 5 6 C 100 220 320 406 484 560 640 MC 132 109 92 81 76 77 84 Demand Price 165 151 137 123 109 95 81 TR 0 151 274 369 436 475 486 MR 165 137 109 81 53 25 -3 Profit -100 -69 -46 -37 -48 -85 -154 Cost Curves, Marginal Revenue and Optimal Price 300 $ Demand MR MC ATC Q Opt P Opt 250 200 Loss 150 ATC Opt 100 50 0 0 2 4 6 8 10 12 14 16 Output 18 Monopoly in the Short Run Does the monopoly keep producing if it is losing money? It depends In the short-run, to maximize profit, the single price monopolist should Produce at a level where MR = MC (and MC crosses MR from below) Continue to produce if total revenue exceeds total variable costs or equivalently price (p) is greater than average variable cost (AVC); Otherwise, it should shut down Cost Curves, Marginal Revenue and Loss 300 $ Don’t shut down! Demand MR MC ATC Q Opt P Opt 250 200 Loss 150 ATC Opt AVC AVC Opt 100 50 0 0 2 4 6 8 10 12 14 16 Output Return above variable cost 18 The shutdown rule In the short-run, the firm should continue to produce if total revenue exceeds total variable costs; otherwise, it should shut down Monopoly in the Long Run Unlike perfectly competitive firms, a monopoly may earn economic profit in the long run A privately owned monopoly suffering an economic loss in the long run will exit the industry, just as would any other business firm Comparing Monopoly to Perfect Competition Main result All else equal, a monopoly market will have higher prices and lower output than a purely competitive market Example problem 100 competitive firms Q = 100q C(q, w) = 100 + 10q + q2 MC(q, w) = 10 + 2q P = 70 - 0.04 QD QD = 1750 - 25 P For the individual firm we set P = MC MC 10 2q P 2q P 10 1 q P 5 2 For the industry 1 q P 5 2 Q 100 q 1 (100) ( P 5) 2 50P 500 Now setting supply equal to demand Q S 50P 500 1750 25P Q D 75P 2250 P 30 Q 1,000 Equilibrium for 1000 Competitive Firms P = MC = 30, Q = 1000 70.00 $ Demand 60.00 Supply 50.00 Price 40.00 30.00 Q Opt 20.00 10.00 0.00 0 200 400 600 800 1000 1200 1400 Output Optimum for the individual firm 1 q P 5 2 1 q (30) 5 2 15 5 10 This is a long run equilibrium; there are zero profits R (30)(10) 300 C 100 (10)(10) 10 300 2 Individual Firm 80.00 ATC $ 60.00 MC 40.00 Price 20.00 Q Opt 0.00 0.00 5.00 10.00 15.00 20.00 Output - q Now consider a monopoly firm which buys all 100 competitive firms and operates them as previously The marginal cost curve for the monopolist will be the same as the supply curve for the 100 firms Why? The monopolist will produce such that each plant has the same marginal cost So, the cost of producing one more unit of the good is the cost of producing one more unit at one of the plants We need to find aggregate marginal cost from the supply equation Q S 50P 500 S 50P Q 500 1 S P Q 10 50 MC 0.02 Q 10 S Revenue = PQ = (70 - 0.04Q)Q MR = 70 - 0.08Q Setting marginal cost equal to marginal revenue MC 0.02 Q 10 70 0.08Q MR 0.1 Q 60 Q 600 How do we get price? Substitute the quantity in the inverse demand P = 70 - 0.04 QD = 70 - 0.04 (600) = 70 - 24 = 46 Profit Max for Monopolist P = 46, MC = 20, Q = 600 80 $ Demand 70 MR 60 MC 50 40 Q Opt 30 Price 20 10 0 0 200 400 600 800 1000 1200 Output - Q Competition P = MC = 30, Q = 1000 Monopoly P = 46, MC = 20, Q = 600 Do monopolies use the same technology and have the same costs? A monopoly may be able to specialize and reduce costs or consolidate plants and realize economies of scale Why monopolies may have zero economic profit Regulation Rent seeking Rent seeking is any costly action undertaken by a firm to establish or maintain its monopoly status Rent seeking may well reduce profits to zero Why? The End Profit Max for Monopolist 22 $ 20 18 16 Price 14 MR 12 MC 10 8 PU 6 QU 4 2 0 0 1 2 3 4 5 6 7 8 9 10 11 Output 12