Transcript MR - UTA Economics

Lecture 14
Monopoly
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The definition of monopoly
– From the Latin: “single seller”
A structural view
– Unique product — famous athlete
– Large relative to market — Michelin tires
A theoretical view
– Must lower price to sell more units
– Must find best price for output, so often
called “price searcher” or “price maker”
Sources of monopoly
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Unique talent
– Beatles, Bono, Yao Ming
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Patent or copyright
– Pentium chip
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Location
– Magazine stand at airport
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Regulation
– Taxicabs
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Collusion
– OPEC
Consider this Price Maker Market
You think so hard in econ class you
have a headache!
You go to buy a bottle of 100
generic aspirin. Consider these
options: Wal-Mart
Grocery Store
Convenience store
Which is highest price and lowest
price? Is the market competitive?
What does monopoly mean in practice?
How can the seller get the
consumer surplus?
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How about an auction?
English auction: seller lets demanders bid against
each other (moving up the demand curve) so the
demander who has the highest value pays close
to that (volunteering to give the seller the
consumer surplus).
Dutch auction: seller starts at a very high price
and comes down until a demander makes a bid.
This works in some markets, but in many markets
the seller must choose one price.
The winner of an auction is said to suffer from a
“winners curse.” Why is that?
Marginal Revenue schedule
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Marginal revenue (MR) is the change in total
revenue (TR) when there is a change in
quantity (Q) sold. To sell more, you must cut
price (P) – move down the demand curve – so
MR is always less than P. Price to the seller is
the revenue received.
Because a price cut to sell more units reduces
revenue on “earlier” units, extra revenue (the
marginal revenue) is less than price. Assuming
all sales at the same price — P is Average
Revenue — measured by the Demand Curve.
Anatomy of a Demand Curve
Demand reflects what consumers pay for a good.
They pay a price, P’, which
$
is Average Revenue to the
seller (AR). Total revenue in
D = AR
a given time period is
P’
P’ x Q’ = TR. Marginal
Revenue (MR) is the
MR
change in TR given a
change in Q sold, which
Q’
Q
requires P to change.
Madonna’s problem:
How many songs?
TC
3.5
7
10.5
14
17.5
21
24.5
28
Q
1
2
3
4
5
6
7
8
Price
$10m/song
9
8
7
6
5
4
3
TR
10
18
24
28
30
30
28
24
MC
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
At each price, recording company demands (will buy) the
number of songs shown, Q
-- Price-quantity combinations shown are points on
demand curve
What is the best price; or how many songs?
Is maximum total revenue the best solution?
Marginal revenue is less than price
New
TC
3.5
7
10.5
14
17.5
21
24.5
28
MR
10
8
6
4
2
0
-2
-4
Q
1
2
3
4
5
6
7
8
Price
$10m/song
9
8
7
6
5
4
3
TR
10
18
24
28
30
30
28
24
MC
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
What is the most profitable P and Q?
The solution: marginal revenue = marginal cost
New
TC
3.5
7
10.5
14
17.5
21
24.5
28
Profit
6.5
11
13.5
14
12.5
9
3.5
-4
MR
10
8
6
4
2
0
-2
-4
Q Price/song
1
$10m
2
9
3
8
4
7
5
6
6
5
7
4
8
3
TR
10
18
24
28
30
30
28
24
MC
3.5
3.5
3.5
3.5
3.5
3.5
3.5
3.5
Find the price that maximizes profits for Madonna (the
seller)
The solution: Choose Q such that MR = MC
Note that P > MC at best Q
The solution graphically
The profit-maximizing price is the one that induces demanders
to choose Q such that MR = MC
$
At any higher price,
MR > MC
 lost profits
P*=7
At any lower price,
MC=3.5
MR < MC
 lost profits
MC = S
D
MR
Only at P* is MR = MC
 maximum profits
1 2 3 4 5
6
7 8
Quantity
The Price Maker: Common in
Highly Competitive Markets
Setting price at movie theater $
that has 1,000 seats in it.
Assume fixed costs of $2,000 for
movie rental, $250 for labor, &
$6
$250 for building per night.
$5
You know your customers from $4
experience—what price do you
charge if only one price can be set?
Highly competitive market for
entertainment dollars.
D
MR
400 500
600
Q
Setting Prices
What is Marginal Cost in this situation?
All costs are fixed, so MC = $0
At what quantity does MC = MR?
500 seats
What price can be charged?
$5
What is Total Revenue?
TR = P * Q = $5 x 500 = $2500
Can we do better?
There are unsold seats — and it costs nothing to
service another customer — so should we cut the
price to $4 to fill more seats? Look at change in
Total Revenue.
We can gouge some customers for more as many
value the movie more than $5 — so can we do
better by charging a higher price, say $6?
Look at change in Total Revenue.
Nothing beats the golden rule of MC = MR
Same example with positive MC
Now presume movie distributor
charges a rental fee of $2 per
customer let into the theater.
$
Building cost of $250 and labor cost
$6
Of $250 per night are still fixed.
What is profit maximizing price to
charge? Same rule: MC = MR
D
MR
$2
Compare this to if you cut price to
$5 and get 500 patrons or raise price
to $7 and get 300 patrons.
MC
400
Q
Questions to Ponder
This is called the monopoly pricing
model or price maker model.
The market for movie theaters is
competitive —between theaters as
well as with substitutes such as DVDs.
The market is competitive, but firms act
as if they are a monopoly.
It Depends What You Are Selling
Parker Hannifin: Industrial parts maker:
$9.4 billion revenue 2006; 800,000 parts sold.
Traditional policy: “cost” plus 35% (the
“strategy” used by ~ 60% US manufacturers)
Net income in 2002: $130 million
Net income in 2006: $673 million
Return on invested capital up from 7% to 21%
in same time.
How: Be a “monopolist” when possible
Some things are “monopolistic”
Some are not.
New Strategy: 4 Basic Categories of products
A.
Ones in highly competitive markets—charge
the market price; no price changes
B.
Partially differentiated products—common
products changed a bit for a customer;
prices up 0-9%
C.
Differentiated products—engineered for a
customer; up 0-25%
D. Specials—custom designed; no close
substitutes; prices up over 25%
The cartel solution…
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The completive outcome is at (Pc, Qc) with P = MC
But for the industry as a whole, MR < MC  lost profits
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Cartel solution is MR = MC  (Pm, Qm) and max. profits
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S=∑MCi
MCi
Pm
Pc
D
MR
qm
To
qc
Qm
Qc
achieve Qm, each firm must restrict its output to qm
BUT—the
incentive to cheat is huge
How to enforce?
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Techniques to prevent cheating
– Require posting of prices
– Central office
DeBeers and diamonds
 OPEC
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– Violence
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Government is best at this
Cheating temptation enormous
Monopoly Question
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Suppose only one train company (a
private company) that operates
between Beijing and Shanghai. Is the
train company a monopoly? Can it
charge any price it wishes?
Ending Monopolies
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Suppose you have industries that have
been protected by the government
against competition for many years. If
the protection is removed and the
industries become competitive, what
will happen?
Effect of Ending Protection
from Competition
Price Reductions in the U.S. Following Deregulation
Billions of 1995 Dollars
Industry
Price Reduction after:
Annual
2 yrs. 5 yrs. 10 yrs.
Savings
Natural Gas 10-38% 34-45% 27-57% n.a.
Long Distance 5-16% 23-41% 40-47%
$5
Airlines
13%
12%
29%
$19.4
Trucking
n.a. 3-17% 28-56% $19.6
Railroads
4%
20%
44%
$9.1