Transcript Lecture Slides 9

Econ 2610: Principles of
Microeconomics
Yogesh Uppal
Email: [email protected]
Chapter 9
Monopoly, Oligopoly, and
Monopolistic Competition
Imperfect Competition

Imperfectly competitive firms have some
control of price



Long-run economic profits possible
Reduce economic surplus
Three types
1.
2.
Monopoly has only one seller, no close
substitutes
Monopolistic competition has many firms with
differentiated products

3.
These products are all close substitutes
Oligopoly is a small number of firms producing
close substitutes
Monopolistic Competition
Perfect
Competition
Monopolistic
Competition
Many firms
Many firms
Price taker
Limited
flexibility
Free
Free
Standardized
Differentiated
Economic
Profits
Zero in long run
Zero in long run
Decisions
Q only
P, Q, product
differentiation
Number of
Firms
Price
Entry and
Exit
Product
Oligopoly
Perfect Competition
Number of
Firms
Price
Entry and Exit
Product
Economic
Profits
Decisions
Many firms
Price taker
Free
Oligopoly
Few firms,
each large
Some flexibility
Large size firm
Standardized
Differentiated or
standardized
Zero in long run
Possible
Q only
P, Q, differentiation,
advertising
The Essential Difference

Imperfectly
Competitive Firm
Perfectly
Competitive Firm
Price

Market power is the firm's ability to raise its price
without losing all its sales
Any firm facing a downward sloping demand curve
 Firm picks P and Q on the demand curve
Market power comes from factors that limit competition
Price

D
D
Quantity
Quantity
Five Sources of Market Power
1.
2.
3.
4.
5.
Exclusive control over inputs
Patents and copyrights
Government licenses or franchises
Economies of scale (natural monopolies)
Network economies
Market Power: Economies of
Scale

Returns to scale refers to the percentage
change in output from a given percentage
change in ALL inputs



Long-run idea
Constant returns to scale: doubling all inputs
doubles output
Increasing returns to scale: output increases
by a greater percentage than the increase in
inputs
Average costs decrease as output increases
 Natural monopoly: a monopoly that results from

Market Power: Network
Economies

Network economies occur when the value
of the product increases as the number of
users increases





VHS format for video tapes, Blu-ray for DVDs
Telephones
Windows operating system
eBay
Facebook and MySpace
Economies of Scale and Start-Up
Costs
products can have a large fixed development cost
TC = F + M Q
F
Average cost ($/unit)
Total cost ($/year)
New
ATC = F/Q + V/Q
M
Quantity
However,
Quantity
the operational costs are not significant relative to
the start-up costs.
Intel's Advantage




Development cost of a new chip $2 billion
Marginal cost of making a chip Pennies
Dominating the market
Priceless
Intel supplies more than 80% of the
processors for PCs
Monopolist


Pure monopoly: the only seller of a unique
product which has no close substitutes
Like all other firms, a monopolist


Maximizes profits
Applies the Cost-Benefit Principle



Increase output if marginal benefit > marginal cost
Decrease output is marginal benefit < marginal cost
Marginal benefit for a monopolist is different
than for a perfectly competitor
Profit Maximization for the
Monopolist
For the monopolist, selling one more unit


Decreases market price
Reduces marginal revenue by more than the price

Lower price applied to all units
Price ($/unit)

6
5
D
2
3
Quantity (units/week)
Price & marginal revenue ($/unit)
Monopolist's Marginal
Revenue
8
3
D
1
2
-1
3
4
8
5
MR
Quantity (units/week)
Price
Quantity
Total Revenue
$6
2
$12
Marginal
Revenue
$5
3
$15
3
$4
4
$16
1
$3
5
$15
-1
Monopoly Demand and
Marginal Revenue

Price
a
In general, the
monopolist's
marginal revenue
curve

a/2
D
MR

Q0
Q0/2
Quantity

Has the same
intercept as demand
Has twice the slope
of demand
Lies below demand
Deciding Quantity




A monopolist knows his
demand and marginal
revenue curves
Marginal cost is also
known
If he operates at P = $3
and Q = 12, MC > MR
 Decrease output
If the firm operates at Q =
8, then MC = MR = 2
 The demand curve sets
the price, P = $4
At any output below 8,
MC < MR
6
Price ($/unit of output)

MC
4
3
D
2
MR
12
8
Quantity (units/week)
Monopoly Losses and Profits
Economic profit
= $400,000/day
Price ($/minute)
0.12
ATC
0.10
MC
0.05
MR
Price ($/minute)
Economic loss
= $400,000/day
0.10
0.08
ATC
MC
0.05
D
20
24
Minutes (millions/day)
MR
D
20
24
Minutes (millions/day)
The Invisible Hand Fails
Price ($/unit of output)
6
The monopolist's optimal
amount occurs where
MC = MR, Q = 8 units
and P = $4
4
Marginal Cost
The socially optimal
amount occurs where
MC = MB, Q = 12 units
and P = $3
3
2
MR
D
8
12
Quantity (units/week)
24
Monopoly and Perfect
Competition
Monopoly
Perfect Competition
MC = MR
MC = MR
P >MR
P = MR
P > MC
P = MC
Deadweight
Loss
No Deadweight
Loss
Price Discrimination

Price discrimination means charging
different buyers different prices for essentially
the same good or service



Separate the groups
No side trades among buyers
Many forms of price discrimination


Hurdle method: discounts for identifiable groups
(e. g., students, AARP)
Perfect discrimination: negotiate separate
deals with each customer
Carla the Editor
What's Carla's
revenue?
 Opportunity
What is the
social optimum?
cost of Carla's time is $29
Reservatio Total
Student
n Price Revenue
A
$40
$40
B
38
$76
C
36
$108
D
34
$136
E
32
$160
F
30
$180
G
28
$196
Carla the Editor
What's Carla's
revenue?
What if Carla
maximizes her profit?
 Opportunity
cost of Carla's time is $29
Reservatio Total
Student
n Price Revenue
A
$40
$40
B
38
$76
C
36
$108
D
34
$136
E
32
$160
F
30
$180
G
28
$196
MR
$40
$36
$32
$28
$24
$20
$16
Carla the Editor

What
if Carla
is
What's
Carla's
perfect discriminator?
revenue?
Opportunity cost of Carla's time is $29
Reservatio Total
Student
n Price Revenue
A
$40
$40
B
38
$78
C
36
$114
D
34
$148
E
32
$180
F
30
$210
G
28
$238
Carla Offers a Rebate

If reservation price < $36, mail in rebate
Reservation
Student
Price
A
$40
B
38
C
36
Total
Revenue
$40
76
108
Discounted Price Submarket
D
$34
$34
E
32
64
F
30
90
MR
$40
36
32
$34
30
26
Carla's Choices
Perfect
Social Single
Program
Optimum Price Discriminat
or
Papers
3
6
Edited
6
$36
Price
$30
Reservatio
n
$108
Total
$180
Revenue
$210
$87
Carla's Time
$174
$174
$21
Economic
$6
$36
Profit
$27
$36
Total Surplus $26
Hurdle
5 = (3 +
2)
$36, $4
rebate
$172
$145
$27
$35
Hurdle Method of Price
Discrimination

The hurdle method of price discrimination is
the practice of offering a discount to all
buyers who overcome some obstacle.






Temporary Sales
Hard cover and paperback books
Multiple car models from one manufacturer
Commercial air carriers
Movie producers and phased releases
Scratch and Dent appliance sales
Monopoly and Public Policy


Challenge: create the greatest increase in
total surplus
Policy options




Government ownership and operation
Regulation
Competitive bids for natural monopoly services
Break up
Anti-Trust Laws

Two landmark laws

Sherman Act of 1890


Clayton Act of 1914


Declared conspiracy to create a monopoly illegal
Outlawed transactions that would "substantially lessen
competition"
Applies to mergers and acquisitions today


IBM avoided break-up; AT&T did not
Microsoft survived