monopoly chapter 25
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MONOPOLY Chapter 25. 3 Questions. What price will the monopolist charge? How much output will the monopolist produce? Are consumers better or worse off when only one firm controls an entire market?. Summary. Monopoly is the only firm in an industry. - PowerPoint PPT PresentationTRANSCRIPT
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MONOPOLYChapter 25
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3 Questions
What price will the monopolist charge?
How much output will the monopolist produce?
Are consumers better or worse off when only one firm controls an entire market?
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Summary
Monopoly is the only firm in an industry. Nobody else is selling anything like what
the monopolist is producing (DeBeers diamonds…. used to be AT & T… cable?)
No close substitutes Is imperfect competition Profit maximizing MC=MR
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Summary Continued
The Monopolist lowers price to sell more output, the price is lowered on ALL units of
output, not just on the last one. This drives down MR faster than
price. MR curve descends twice as quickly
as the D Curve.
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Summary Continued
The perfect competitor produced at the most profitable output, which in the LR always happened to be the most efficient output.(i.e. at the minimum point of the ATC curve.
The monopolist does NOT produce where output is at its most efficient level (i.e. the minimum point of the ATC curve.)
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Summary Continued
Distinguishing characteristic: firm’s demand curve is no longer a
perfectly elastic horizontal line. This means that the imperfect
competitor will have to lower price to sell more.
Marginal Cost is the additional cost of producing one more unit of output.
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Summary Continued
Monopolist makes a profit whereas in the LR the perfect competitor makes normal or zero profit
Monopolist operates at less than peak efficiency- perfect competitor operates at peak efficiency.
Perfect competitor charges a lower price and produces a larger output than the monopolist.
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http://video.answers.com/chris-anderson-on-monopolies-293408822
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Characteristics
No close substitutes – examples? Single Seller – (Microsoft Office?) Price Maker – ($300 ?) Blocked Entry- (Patent?) Advertising – (Why?)
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Monopolies not permitted in U.S.
WAIT!!!!!!!!!!!!
Don’t we have them anyway?Sure – (natural and companies with large percentage of market.
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Monopolies do occur …..
http://www.youtube.com/watch?v=Z9zcxt0oCGM&feature=youtu.be
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What keeps monopolies from forming in our market economy? 1887 Interstate Commerce Act Initially established to curtail abuse by railroads. The Interstate Commerce Act challenged the
philosophy of laissez-faire economics by clearly providing the right of Congress to regulate private corporations engaged in interstate commerce. The Act, with its provision for the ICC, remains one of America’s most important documents serving as a model for future government regulation of private business.
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Progression of legislation
Sherman Act – 1890
Clayton Act – 1914
FTC – 1914
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Barriers to Entry
There are six barriers to entry. Patents – offers a producer 20 years of
exclusive rights to produce a particular product. (drugs, inventions, items on cars, etc)
Monopoly franchises – governments also create and maintain monopolies by giving a single firm the exclusive right to supply a particular good or service. (lotteries, liquor stores, licensing, taxicabs,)
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Barriers to Entry Continued
Control of key inputs – a company may lock out competition by securing exclusive access to key inputs.(bauxite… aluminum, Tiffany- diamonds)
Lawsuits – may be used to prevent new companies from successfully entering an industry.(threaten patent violation, rich vs poor company) (Standard Oil vs xyz oil)
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Entry Barriers Continued
Acquisition – when all else fails, purchase a potential competitor. (Google Acquires Admob - $730 mil) (Bank of America/Republic Bank , Bank of NE.)M & A is very powerful tool for corporations.
Economies of scale – a monopoly may persist because of cost advantages over smaller firms (more cost-effective) (Utility companies in a state – Con Edison- NY, SW Bell in TX, TV air waves)
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OK! Let’s Take a Deeper Look Are Monopolies Beneficial to a Market
Economy?
It is conceivable that monopolies could benefit society.
If economies of scale exist, the monopolist may attain much greater efficiency than a large number of competitive firms.
Economies of scale act as a “natural” barrier to entry.
Examples of natural monopolies used to include local telephone services, and other local utility services. Local cable is no longer an example of monopoly due to Fios, and Satillite.
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Only Two Justifications for Monopoly
1. Natural monopolyLocal gas and electric companies… provide
cheaper service as monopolies than could several competing firms. They are government regulated to insure against price gouging.
2. Economies of ScaleJustify bigness because only a firm with a
large output can produce near the minimum point of its long-run ATC curve
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3. Natural monopoly: a single firm can produce the entire market Q at lower ATC than could several firms
Q
Cost
ATC
1000
$50
Example: 1000 homes need electricity. Electricity
Economies of scale due to
huge FC
ATC is lower if one firm services
all 1000 homes
than if two firms
each service 500 homes.
500
$80
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Deregulation June, 2013
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Why are monopolies so bad?
Monopolies tend to be inefficient. because the production is Not at the
minimum point of its ATC curve, the monopolist restricts output to some
point to the left of that minimum and hence prevents resources from being
allocated in the most efficient manner) (wastes resources!)
Two terms to remember… allocative efficiency and productive efficiency.
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Allocative Efficiency The market mechanism works best in
competitive markets. Market mechanism - The market
mechanism is the use of market prices and sales to signal desired output.
Allocative efficiency means that we are producing the right output mix.
The price signal the consumer gets in a competitive market is an accurate reflection of opportunity cost.
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Production Efficiency Production efficiency means that
we are producing at minimum average total cost.
Efficiency (production) – Maximum output of a good from the resources used to produce it.
When competitive pressure on prices is carried to the limit, the products in question are also produced at the least possible cost.
Society is getting the most it can from its available (scarce) resources. This market model is the best “buy” for consumers.
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Why We Don’t Like Monopolies
The idea of only one seller is not conducive to getting the best price on the market as compared to competition.
Look at the Post Office…. Look at Amtrak….look at trying to get Microsoft to Repair Outlook Express, Apple controlling the Ipad if you do not download IOS.
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Profit Maximization
0 1 2 3 4 5 6 7 8 9
123456789
10111213
$14
Quantity (baskets per hour)
d
Demand
Marginal revenue
Marginal cost
Average total cost
D
Profits
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What actually IS Market Power?
Market power is the ability to alter the market price of a good or service.
The demand curve facing the monopoly firm is identical to the market demand curve for the product.(the firm IS the market)
Monopoly is a firm that produces the entire market supply of a particular good or service.
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Price and Marginal Revenue
Unlike competitive firms, marginal revenue for a monopolist is not equal to price.
So long as the demand curve is downward-sloping, MR will always be less than price.
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Profit Maximization
0 1 2 3 4 5 6 7 8 9
123456789
10111213
$14
Pric
e or
Cos
t (p
er
bask
et)
Quantity (baskets per hour)
d
Demand
Marginal revenue
Marginal cost
Average total cost
D
Profits
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Marginal Revenue/Price
0 1 2 3 4 5 6 7 8 9 10
123456789
101112 C
DE
FG
b
c
d
e
f
g
Demand (= price)
Marginal revenue
QUANTITY (baskets per hour)
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Declining Marginal Revenue and Price Monopolist’s MR from each unit sold does not
remain constant (as does Pure Competitor Monopolist has downward sloping demand
curve which means the price that the monopolist can get for each additional output must fall as monopolist increases its output.
Hence MR will fall as Monopolist increases output.
If you assume NO price discrimination, then MR from each unit produced will not equal the price the monopolist charges.
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Three implications of a downward sloping demand curve
1. Price exceeds marginal revenue
A down sloping demand curve means that a pure monopoly can increase its sales ONLY by charging a lower unit price for its product. The fact that he must lower price to boost sales causes MR to be less than P for every level of output EXCEPT the first.
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For a Monopolist, P > MR
To sell an additional unit of its good, a monopolist needs to lower price. This price reduction both gains revenue and loses revenue for the monopolist. In the exhibit, the revenue gained and revenue lost are shaded and labeled. Marginal revenue is equal to the larger shaded area minus the smaller shaded area.
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Demand and Marginal Revenue Curves The demand curve
plots price and quantity.
The marginal revenue curve plots marginal revenue and quantity.
For a monopolist, P > MR, so the marginal revenue curve must lie below the demand curve.
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How does a monopolist figure profit?
Agreed……..monopolist has to lower unit price to sell more…for every level of output but the first… So, how does he know where to produce?
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Maximize profit :MC= MRWhere should monopolist produce?
Output Price TR MR TC ATC MC
1 $16 $16 $16 $20 $20 -
2 $15 $30 $14 $30 $15 $10
3 $14 $42 $12 $36 $12 $ 6
4 $13 $52 $10 $42 $10.50 $ 6
5 $12 $60 $ 8 $50 $10 $8
6 $11 $66 $ 6 $63 $10.50 $13
7 $10 $70 $ 4 $84 $12 $21
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Profit MaximizationOutput Price TR MR TC ATC MC
1 $16 $16 $16 $20 $20 -
2 $15 $30 $14 $30 $15 $10
3 $14 $42 $12 $36 $12 $ 6
4 $13 $52 $10 $42 $10.50
$ 6
5 $12 $60 $ 8* $50 $10 $8*
6 $11 $66 $ 6 $63 $10.50
$13
7 $10 $70 $ 4 $84 $12 $21
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Implication #2Price Maker
This means that the imperfectly competitive markets in which demand curves are relevant, the firms have a price policy. Because of their ability to influence TOTAL SUPPLY, the output decisions of such firms necessarily affect product price.
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The monopolist determines price by deciding what volume of output to produce.
He chooses both price and output
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Implication #3
Price ElasticityThe total revenue test for price elasticity of
demand is the third reason for the down sloping demand curve.
Total revenue test tells us that when demand is elastic a decline in price will increase total revenue. P R
When demand is inelastic decrease in price will decrease total revenue.) P R
Actually, inelastic demand for a product is not absolutely necessary… but if product demand is elastic, it not only has to lower price, but suggests substitutes. Cable television????
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For inelastic to be the decision, in order to increase revenue, monopolist would have to raise price.
*when MR is negative, demand is inelastic
Because he has to lower price to sell more, will attempt to stay in elastic segment. Decline in P will increase R
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Monopolist wants to avoid the inelastic segment
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Why did the Dallas Tollway Raise Price?
Because they had a monopoly? No!
Because they had selected clientele? Very possible
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Equilibrium for Monopolist
Equilibrium output for a monopolist is determined where MC=MR
The price the monopolist charges is determined by taking the point on the Demand curve directly above the intersection of the MC and MR curves.
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Bottom Line
***The monopolist will never choose a price quantity combination where TR is decreasing (or stated another way… MR is negative.)
Stated another way… the profit-maximizing monopolist will always want to avoid the inelastic segment of its demand curve in favor of some price-quantity combination in the elastic segment. (in the inelastic segment, he loses a % of his profit)
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Initial Conditions in the Monopolized Computer Market
1200
1000
800
600
400
200
0 24,000P
rice
(per
com
pute
r)
Quantity(computers per month)
A
X
Market demand
Competitive market supply$1200
1000
800
600
400
200
0 200 400 800 1200 1600
Pric
e (p
er c
ompu
ter)
Quantity (computers per month)
W
C
M
B
Average total cost
Demandcurve facingsingle plant
Marginal revenue of single plant
Marginal cost
Monopoly outcomeCompetitive
outcome
Monopoly outcome
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Monopoly Curve
$1200
1000
800
600
400
200
0 200 400 800 1200 1600
Pric
e (p
er c
ompu
ter)
Quantity (computers per month)
W
C
M
B
Average total cost
Demandcurve facingsingle plant
Marginal revenue of single plant
Marginal cost
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Monopoly Profits
M
$1200
1000
800
600
400
200
0
Pri
ce (
per
com
pute
r)
Quantity (computers per month)200 400 600 800 1000 1200 1400
W
K B
Average total cost
Marginal cost
Demand curve facing single plant
Marginal revenue of single plant
C
Profit
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Misconceptions Concerning Monopoly Pricing
1) Not the highest Price… Monopolist will charge the price where he can obtain maximum total profit…. Not maximum total price.
2) Total…. Not Unit… Profit……….Monopolist seeks maximum TOTAL profit, not maximum UNIT profit.
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Continued Misconceptions
3) Monopolist cannot lose money… While the Perfect competitor is destined for normal profit in the long run… and no barriers from everyone in the world entering the purely competitor’s world… which drives down prices….
But contrary to conventional wisdom, the monopolist is not immune to changes by the demands of the consumer… and more important … the monopolist is not immune from upward-shifting cost curves caused by escalating resource prices.
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Think about the discriminating monopolist and the non-discriminating monopolist. Or, stated another way… think about the various types of discrimination or not that a monopolist can engage in!!!!
What does this mean? How would the two types have a different look for their monopoly graph?
Selling a specific product at more than one price (remember price differences are not justified by cost differences)
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Q
DMR
MC
ATC
P
Q1
Pri
ce a
nd
Co
sts
Economic profits witha single MR=MC
price
NON-DISCRIMINATING
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Price Discrimination: Give me examples????Examples: Electric utilities (vary prices amid
some competition in certain areas) Golf courses (play 18 at prime time
or “off-hours” Water usage
Movie ticketsSeats for Ranger World Series
Outcomes of Price Discrimination:More Profit (if the monopolist can identify the
buyers who will pay more… segregate them, charge the maximum price each would be willing to pay, TR and economic profit will increase
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Q
D
MC
ATC
P
Q1
Pri
ce a
nd
Co
sts
PRICE DISCRIMINATION
Q2
A perfectly discriminatingmonopolist has MR=D,producing more product
and more profit!
MR=D
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Q
D
MC
ATC
P
Q1
Economic profits withprice discrimination
Q2
MR=D
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Q
DMR
S = MC
QcQm
At MR=MCA monopolistwill sell fewer
units at ahigher price
than incompetition
Inefficiencies ofA pure monopoly
The pure competitorWill produce whereS & D intersect
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What is Rent Seeking
Rent Seeking= transferring income or wealth to a particular firm or resource supplier at someone else’s or even society’s expense.
Best example is getting government to regulate something in the industry that has monopoly power (special licensing, special subsidies, anything directed to help that industry regardless of cost of resource mix or societal costs. Exxon did a lot of rent-seeking. What about pharmaceuticals today? – Solar today?
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Regulated MonopoliesNATURAL MONOPOLIES –Example???
Rate RegulationSocially Optimum Price
P = MCFair-Return Price
P = ATCDilemma of Regulation
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Regulated Monopolies
Q
D
MR
MCATC
PMR = MC
Fair-Return Price
Socially-OptimumPrice
Qm Qf Qr
Pm
Pf
Pr
Socially optimumIs supposed to beAllocative efficiency
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Examples:
Government Power The AT&T Case The federal government dismantled AT&T in 1984. Prior to the break-up, AT&T supplied 96 percent of all
long-distance service and over 80 percent of local telephone service.
Remember, de-regulation of utilities . Still have natural gas, local phone service being
regulated. Is it possible Health Care will eventually be here?
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Government Power Continued
Government Power Continued Antitrust Laws Sherman Act (1890) – prohibits “conspiracies in
restraint of trade.
Clayton Act (1914) – principally aimed at preventing the development of monopolies by prohibiting price discrimination, exclusive dealing agreements, certain types of mergers, and interlocking boards of directors among competing firms
The Federal Trade Commission Act (1914) – created the FTC to study industry structures and behavior so as to identify anti-competitive practices.
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Should Government Regulate the Chicken IndustryFinancial IndustryAirline Industry?School lunches and snacks?
REGULATION IS DUE TO INCREASE… lack of safety,Health, environment in question today.Banking,Cap and Trade, CEO salaries, securities, FAA, FTC, Housing, etc….