econ 308 week 06 monopoly & monopoly pricing (chapter 7)

ECON 308

Week 06

Monopoly & Monopoly Pricing

(Chapter 7)

Market structure

• What is a market?• All firms and individuals willing and able to

buy or sell a particular product

• What is market structure?• Defined by attributes of the market

environment

Demand Facing the Firm

$P $P $P $P

Q Q Q Q

D1

D2

D3 D4

Increasing degrees of Competition Increasing degrees of Market Power

Market structurethe archetypes

• Monopoly

• Oligopoly

• Monopolistic competition

• Perfect competition

Perfect competitioncharacteristics

• Many buyers and sellers

• Product homogeneity

• Low cost and accurate information

• Free entry and exit

• Best regarded as a benchmark

Price Taker Firm Demand CurvePrice Taker Firm Demand Curve$P

Q/T

Pe

Qe

$P

Q/T

Pe

Market Firm

D=MR

D

DS

S

Qe

Firm supply

• Short run– Marginal cost curve above average

variable cost– P* = SRMC

• Long run– Long-run marginal cost curve

above long-run average cost

Long-Run Industry EquilibriumLong-Run Industry Equilibrium$P

Q/T

Pe

Qe

$P

Q/T

Pe

Market Firm

D

D

DS

SMC

ATC

Qe

Monopoly

• Strong barriers to entry single supplier

• Profit maximization– faces market demand and sets MR=MC

• Unexploited gains from trade

Sources of Market Power:Barriers to entry

Incumbent reactions

• Specific assets• Economies of scale• Excess capacity• Reputation effects

Incumbent advantages• Precommitment

contracts• Licenses and patents• Learning-curve effects• Pioneering brand

advantages

Demand Facing the Firm$Price

Qty/T

Demand

D

$10 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 8

Total Revenue $Price

Qty/T

Demand

D

$10 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7

Marginal Revenue =Additional Revenue $Price

Qty/T

Demand

D

$10 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7

Derivation of Marginal RevenuePrice Quantity Total

RevenueMarginal Revenue

$ 10.00 1 $ 10.00

$ 9.00 2 $ 18.00 $ 8.00

$ 8.00 3 $ 24.00 $ 6.00

$ 7.00 4 $ 28.00 $ 4.00

$ 6.00 5 $ 30.00 $ 2.00

$ 5.00 6 $ 30.00 $ 0

$ 4.00 7 $ 28.00 - $ 2.00

$ 3.00 8 $ 24.00 - $ 4.00

$ 2.00 9 $ 18.00 - $ 6.00

Marginal Revenue

$Price

Qty/T

Demand

MR

D

Marginal Revenue & Elasticity$Price

Qty/T

DemandMR

Ed > 1

Ed < 1

Ed = 1

Monopoly Output$Price

Qty/T

Demand

MR

MC

D

Qm

Pm

Mc

Market Power: No Close Substitutes$Price

Qty/T

Demand

MR

MC

D

Qm

Pm

Mc

Market Power: Few Close Substitutes$Price

Qty/T

Demand

MR

MC

D

Qm

Pm

Mc

Market Power: Many Close Substitutes$Price

Qty/T

Demand

MR

MC

D

Qm

Pm

Mc

No Market Power: Many Identical Substitutes$Price

Qty/T

Demand

MC

P = MR

Qm

P = Mc

Monopoly Profit?Monopoly Profit?

Qty/T

Demand

MR

MC

D

Qm

PmACProfit

Monopoly After Entry of CompetitionMonopoly After Entry of Competition

Qty/T

Demand

MR

MC

D

Qm

PmAC

$ Price

Efficiency Loss ?Efficiency Loss ?

Qty/T

Demand

MR

MC

D

Qm

Pm

Mc

Sources of Monopoly Power Barriers to Entry

• Absolute Cost Advantage: Unique access to production technique or an essential input.

• Natural Monopoly: Economies of Scale

• Product differentiation

• Regulatory Barriers: Patents, copyrights, franchise, license.

Price DiscriminationPrice Discrimination

• Charging different prices for different units sold.

• Allows firms to increase sales and capture more of consumer surplus.

Monopoly Pricing: Single PriceMonopoly Pricing: Single Price

$ Price

Qty/T

Demand

Marginal Cost

MR

Pm

Qm

Potential Efficiency loss

First DegreeFirst Degree: Charging different : Charging different customers different prices.customers different prices.

• Auction

• College scholarships

First DegreeFirst Degree: Different Prices for different buyers

$ Price

Qty/T

Demand

Marginal Cost

MR

Tuition

Qm

Scholarship Amount

First DegreeFirst Degree: Charging different : Charging different customers different prices.customers different prices.

• Auction

• College scholarships

• IBM Punch Cards

• Polariod Camera, Film

• Ink Jet Printers, Cartridges

• Swiffer, pads

• Glllette Razor, Blades

Second DegreeSecond Degree:: (Quantity Forcing)

• Offering a schedule of prices to all buyers, which successively lowers the price for additional units, purchased (Moving down each buyers individual demand)

• Tires: Buy 3, get 4th free.• Soft Drinks:Product prices,

– medium16 oz. $ 1.09, .07/oz.– large: 22 oz. $ 1.19, extra 6 oz. @ .02/oz.– extra large:32 oz. $1.29, extra 10 oz. @ .01/ oz.

• Two Part Tariff: Entry Fee plus per unit– Costco: Membership & Price

Third DegreeThird Degree:: Charging different prices to different

groups according to different elasticity of Demand. • Grocery coupons• Prescription drugs in different countries.• Doctors medical services• Newly released unique products • Movies: Children, Seniors, Middle; Matinee • Mail Order Catalogues: Old vs. New Customer• Freeway Adjacent Restaurant• Brand name mixers on Holiday Sale• Mattresses: Match any advertised price• Menu

Necessary Conditions for Successful Necessary Conditions for Successful Price DiscriminationPrice Discrimination

• Ability to identify and separate buyers by elasticity of demand.

• Collect different prices from the different buyers

• Prevent Resale