Transcript Pure Monopoly - HCC Learning Web

Look for:
1. Determination of the profit
maximizing price and quantity.
2. Implications for efficiency
3. What should the government do?
Pure
Monopoly
• Study monopoly as a Market Structure
• To Better Understand monopolistic
competition and oligopoly
• Consist of elements of pure competition
and pure monopoly
Please listen to the audio as you work through the slides.
Learning objectives
Students should be able to thoroughly and completely explain:
1. The characteristics of pure monopoly
2. The various barriers to entry that can be exploited by the
monopolist.
3. In what region of the demand curve is the monopolist most
likely to set price and why.
4. How the monopolist determines the profit maximizing level
of output and price.
5. Price Discrimination and discuss the likely outcomes.
6. The dilemma of regulation
Summary of topics
• Characteristics of Pure Monopoly
• Sources of monopoly power
– Barriers to entry
• Model of monopoly demand
– Analyze price and output decisions
• Output and price determination
– At what price – quantity pair will a profit maximizing
monopolist choose to operate?
• Cost considerations
• Economic effects of pure monopoly
– Efficiency issues
• Price Discrimination
• Regulated Monopoly issues
Four Market Models
Pure Monopoly:
Characteristics
•
Single Seller (seller = industry)
• No Close Substitutes for the product sold
• Price Maker – controls total quantity supplied
and therefore price
• Faces downward sloping demand curve
•
To increase sales, must lower price
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
Four Market Models
Pure Monopoly:
Characteristics
•Entry blocked by monopolist
•Blocking tools: Economic, technological, legal, etc.
•Pure Monopoly firm sells:
•Standardized product – natural gas, PR advertising
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
Monopoly Examples
Regulated Monopoly
local electric utility, cable TV
Check Texas PUC
Unregulated or near Monopoly
Branack Device Company – 80% Market
Luxottica – eyewear multinational (Italy) 80% global market share
Intel 90% market share – R&D
Barriers to Entry
Economies of Scale – declining ATC with
increasing firm size - often due to technology, Intel
http://dividendmonk.com/7-companies-with-unrivaled-economies-of-scale/
•The Natural Monopoly Case – market demand
curve cuts the LR ATC curve where ATC are still declining
“When long run ATC is declining, only a single producer can
produce any particular output at minimum LR ATC.”
Key Points:
1. Low unit cost does not equal low price charged
2. P > ATC leads to economic profit increase, and possible
regulation – we will see this later
The Natural Monopoly Case
Average Total Cost
D
$20
15
ATC
10
If ATC declines over extended output
range, least-cost production is realized
only if there is one producer - a natural
monopoly.
0
50
100
Quantity
200
Barriers to Entry
Legal Barriers to Entry (government created)
• Patents – pharmaceutical industry, R&D
• Licenses – FCC radio & TV stations, cable TV
Ownership or Control of Essential Resources
At one time, International Nickel of Canada
controlled 90% of world’s nickel.
At local level – single Cement company may control
access to sand and gravel in the area.
–
Barriers to Entry
Pricing and Other Strategic Barriers to Entry:
In anticipation of a potential competitor:
• Temporarily cut prices, or
• Increase advertising,
Barriers to Entry
•These guys went too far!
•2001 Microsoft – 95% market share, threatened by
Netscape, made IE free bundled with OS, restrict resellers
of product, preserve long run near monopoly position
•2005 Dentsply – maker of false teeth (70% market share)
- charging higher prices to distributors that sold a
competitors product
Agenda
1.Monopoly Demand
2.Output and price determination
3.Implications for efficiency
4.Assessment of government policy options
5.Cost considerations
6.Price Discrimination
7.Government approaches to regulating the
monopoly
Monopoly Demand
3 Basic Assumptions:
1. Monopoly Status is Secured by:
• patents,
• economies of scale,
• resource ownership.
2. No Governmental Regulation
3. Firm Charges the Same Price for all Units
Sold
The crucial difference between a pure monopolist
and a purely competitive seller – demand is elastic
versus perfectly elastic!!!!
Monopoly demand
3 implications of the monopolist’s downward
sloping demand curve:
1.
Marginal revenue is less than price.
2.
The monopolist is a price maker
3.
The monopolist sets prices in the elastic
region of the demand curve
Monopoly demand
Marginal revenue is less than price.
The monopolist’s downward sloping demand
curve means it can increase sales only by charging
a lower price.
Consequently marginal revenue is less than price
for every level of output except the first.
MR < P
Monopoly Demand
The monopolist is a price maker
1. Firms facing downward sloping demand curves
can influence total supply through their own output
decisions.
2. The monopolist firm controls output.
3. Each level of output is related to a unique price.
4. Control output, control price
Monopoly Demand
The monopolist sets prices in the elastic region of the demand curve.
When demand is elastic,
a decline in price will increase total revenue.
When demand is inelastic,
a decline in price will reduce total revenue.
In the inelastic region:
•
•
•
•
Monopolist must lower price to increase output.
Lower price means less total revenue.
Increased output means increased total cost
Less total revenue and increased total cost means less profit.
The monopolist will never choose a price-quantity pair in the inelastic
part of the demand curve where total revenue could be reduced.
Monopoly Revenues and Costs
Elastic
Dollars
$200
150
200
50
MR
D
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
Dollars
$750
500
TR
250
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Monopoly Revenues and Costs
Elastic
Inelastic
Price in
Dollars
$200
150
200
50
MR
D
Total Revenue
In Dollars
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
$750
500
TR
250
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Output and Price Determination
for the Pure Monopolist
At what price quantity combination will
monopolist operate?
MR = MC Rule – applies to the monopolist
Output and Price Determination
Add production Cost to the analysis:
monopolist buys resources in purely competitive market
No Monopoly Supply Curve –
no unique relationship between price and Quantity supplied.
The monopolist does not equate MC to price, therefore
it is possible for different demand conditions to bring about different
prices for the same output.
Monopoly Pricing Misconceptions
• it’s maximum total profit, Not Highest Price
• Total, Not Unit Profit
• Possibility of Losses – monopolists also can minimize
losses.
Output and Price Determination
Profit Maximization Under Monopoly
Remember the MR=MC Rule?
200
Profit
Per Unit
Price, costs, and revenue
175
150
P=$122
125
ATC=$94
100
MC
Profit
ATC
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
6
7
8
9
10
Q
Output and Price Determination
Profit Maximization Under Monopoly
200
Profit
Per Unit
Price, costs, and revenue
175
150
$122
125
$94
100
MC
Profit
ATC
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
6
7
8
9
10
Q
Output and Price Determination
Loss Minimization Under Monopoly
200
Since Pm exceedsLoss
AVC,
Per Unit
the firm will produce
Price, costs, and revenue
175
MC
ATC
AVC
150
ATC
125 Loss
Pricem
100
AVC
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
Qm
6
7
8
9
10
Q
Output and Price Determination
Loss Minimization Under Monopoly
200
Loss
Per Unit
What are the MC
ATC
A
Economic
EffectsAVC
P
V of Monopoly?
Price, costs, and revenue
175
150
Loss
125
m
100
D
75
50
MR = MC
25
0
1
2
3
4
MR
5
Qm
6
7
8
9
10
Q
Inefficiency of Pure Monopoly
P
An industry in pure competition S
sells where supply and
demand are equal
= MC
At MR=MC
A monopolist
will sell less
units at a
higher price
than a firm in pure
competition
Pm
Pc
D
MR
Qm
Qc
Q
The efficiency issue
In pure competition we had P = MC = minimum ATC
P = minimum ATC (productive efficiency)
P = MC (allocative efficiency)
Monopoly yields neither productive efficiency nor allocative efficiency
Not productively efficient - P  Minimum ATC
Not allocatively efficient - Price  MC
Monopoly price exceeds minimum ATC
Monopoly price exceeds MC
1. The monopolist’s profit maximizing output results in an
under allocation of resources.
2. Output is less than that found in the purely competitive
model.
Inefficiency of Pure Monopoly
P
S = MC
At MR=MC
A monopolist
will sell less
units at a
higher price
than in pure
competition
Pm
Pc
Monopoly pricing effectively
creates an income transfer fromD
MR
buyers to the seller!
Qm
Qc
Q
Cost Complications
Costs may not be the same for purely competitive and monopolistic producers.
• Reasons for the difference in costs between purely
competitive and monopolistic firms.
Economies of scale – three factors that contribute
1. Market demand may not be sufficient to support a large number of
competing firms each producing at MES.
2. Simultaneous consumption – product’s ability to satisfy a large number of
consumers at once. Software, music, etc. ATC decreases as number of
customers increase.
3. Network effects – increase in value of a product to each user as the total
number of users rises. Buyers tend to purchase the products that everyone
else buys. Producers able to expand and achieve economies of scale. Cell
phones
Cost Complications
Costs may not be the same for purely competitive and monopolistic
producers.
Reasons for the difference:
X inefficiency A firm’s actual cost of producing any output is greater than the
lowest possible cost of producing it.
•managers’ goals conflict with cost minimization.
•firms becomes lethargic and complacent.
Cost Complications
Graphic Representation
Of X-Inefficiency
Average total costs
X-Inefficiency
ATCx
X
Inefficient internal
operation leads to
higher-thannecessary costs
X’
ATC1
ATCx’
ATC2
Q1 Quantity
Q2
Average
Total Costs
Cost Complications
The need for monopoly preserving expenditures
Activity designed to transfer income or wealth to a
particular firm or resource supplier at someone else’s
expense.
Monopolist would do anything to maintain a patent,
license, or other factor that ensures monopoly position.
Cost Complications
A pure monopolist will not be technologically
progressive!
Absence of rivals reduces the motivation to innovate
Agenda
• Price Discrimination
• Government policy options about Monopolies
• The regulation dilemma
Price Discrimination
Under certain conditions the monopolist can increase its profit by
charging different prices to different buyers.
Forms of Price Discrimination:
1. Charging each customer in a market the maximum price they will
pay
2. Charging each customer one price for the first few units and a
lower price for subsequent units
3. Charging some customers one price and other customers another
price
3 Price Discrimination Conditions
1. Monopoly Power:
• Seller must be monopolist, or possess some degree of
monopoly power, (some control over price and output)
2. Market Segregation:
• At relatively low cost to itself, the seller must be able to
segregate buyers into distinct classes, each with a
different willingness or ability to pay for the product.
(different price elasticity of demand)
3. No Resale:
• The original purchaser cannot resell the product. Some
examples: service industries like transportation, legal,
medical
Examples of Price Discrimination
•
•
•
•
•
•
Electric utilities (peak and off peak pricing),
Movie theaters (time of day pricing)
Airlines (buy early or buy late)
Golf courses (time of day pricing)
Railroads (by type of freight)
Discount coupons vs no coupon
Price Discrimination
Outcomes
1. Greater profits and output than a single price
monopolist
2. Some consumers pay more and some pay less than the
single price case
3. Perfect price discriminating monopolist
and pure competition are equally efficient!
Government policy options toward monopoly:
Rules of thumb
1. If:
• Monopoly is achieved / sustained through anticompetitive
actions, creates substantial economic inefficiency, or appears
to be long lasting.
Government would Pursue antitrust action
2. If:
It’s a Natural monopoly or there is no emerging competition,
Government may regulate prices and operations.
3. If, Monopoly appears to be unsustainable over a long period of
time, or competitors might emerge.
Leave it alone
Regulated Monopoly
Natural Monopolies
The Dilemma of Regulation:
what to do with the Monopoly?
Choices
1.
2.
3.
Socially Optimum Price
P = MC (allocative efficiency)
Fair-Return Price
P = ATC (productive efficiency)
No regulation
Monopolist sets price to maximize profits
Regulated Monopoly
P>ATC means economic profit
Demand curve cuts LR ATC while it is falling.
Achieving economies of scale.
Only one seller needed.
P>MC means under-allocation of
resources to the product
Price and Costs
P
Monopoly Price
MR = MC
The unRegulated Monopoly.
Pm
ATC
MC
D
MR
Qm
Q
Regulated Monopoly
Price and Costs
P
Can government cause a better allocation of resources?
Set price ceiling to eliminate incentive to restrict output to Qm
and therefore maximize profits
Price is below ATC and the firm incurs a loss
Socially-Optimal
Price model
P = MC
ATC
MC
Pr
D
MR
Qr
Q
Regulated Monopoly
Price and Costs
P
Fair-Return Price model
Normal Profit Only
P=ATC
ATC
MC
Pf
D
MR
Qf
Q
Regulated Monopoly
Dilemma of Regulation
MR = MC Which Price to use?
Fair-Return Price
Price and Costs
P
Pm
Socially-Optimum
Price
ATC
MC
Pf
Pr
D
MR
Qm
Qf
Qr
Q
pure monopoly
barriers to entry
simultaneous consumption
network effects
X-inefficiency
rent-seeking behavior
Price Discrimination
socially optimal price
fair-return price