Monopoly
Four Basic Market Structures <ul><li>Perfectly Competitive : many firms, identical products, free entry and exit, full and...
Competitive Market <ul><li>This is the classic “textbook” market structure. </li></ul><ul><li>Firms in a competitive marke...
Monopoly <ul><li>The single seller makes a product that has no “good” substitute. </li></ul><ul><li>Other firms may be abl...
Oligopoly <ul><li>A few sellers make products that are good, but not perfect, substitutes. </li></ul><ul><li>Consumers can...
Monopolistic Competition <ul><li>The market has many firms but each supplier’s product is differentiated. </li></ul><ul><l...
Question <ul><li>What is the market structure for each of these products or firms: competitive, monopoly, oligopoly, monop...
Answer <ul><li>The Campus Store: most products competitive, textbooks oligopoly, but location is very important. </li></ul...
Monopoly <ul><li>single firm </li></ul><ul><li>no close substitutes </li></ul><ul><li>barriers to entry </li></ul><ul><li>...
Sources of Monopoly Entry Barriers <ul><li>Natural monopoly: the most efficient scale of production is so large, relative ...
Natural Monopolies <ul><li>Goods and services whose delivery requires the construction of a physical network (wires, pipes...
Patents:  Are There “Good” Monopolies?  <ul><li>Consider the protease inhibitor Crixivan from Merck. </li></ul><ul><li>A v...
What is a “Good” Monopoly? <ul><li>Why is Merck given a monopoly? </li></ul><ul><li>The granting of a patent on the drug C...
“Good” Monopolies <ul><li>The granting of patent protection (legal monopoly) gives firms a strong incentive to invest in n...
“Other” Monopolies - Good? Bad? <ul><li>Input Ownership </li></ul><ul><ul><li>DeBeer’s and diamonds </li></ul></ul><ul><li...
Caveats <ul><li>monopoly  does not =>  big </li></ul><ul><li>big  does not =>  monopoly </li></ul><ul><li>monopoly  does n...
Classic Simple Monopoly <ul><li>Polar extreme from perfect competition. </li></ul><ul><li>Monopolist is a “price maker.” <...
The Simple Monopolist <ul><li>The simple monopolist abides by the “law of one price.”  Everyone pays the same market price...
The Simple Monopolist: Rules for Profit Maximization <ul><li>Suppose we are in the short run. </li></ul><ul><li>Rules for ...
Simple Monopoly <ul><li>Economic profits equal total revenue minus total costs. </li></ul><ul><li>Marginal revenue is the ...
Graphical Display of Monopolist’s Solution <ul><li>The monopolist sets marginal revenue equal to marginal cost at MR=MC=$1...
Implications of the Monopolist’s Profit Maximum <ul><li>Price will exceed the competitive price. </li></ul><ul><li>Quantit...
Simple Monopoly- Performance <ul><li>Efficiency: </li></ul><ul><ul><li>Is the monopoly equilibrium  Pareto Efficient?   Th...
Simple Monopoly- Performance Answers <ul><li>The simple monopoly equilibrium is not Pareto Efficient.  </li></ul><ul><ul><...
Price Discriminating Monopolists <ul><li>A monopolist might be able to charge different prices for different units sold an...
Requirements for Price Discrimination <ul><li>Some amount of monopoly power. </li></ul><ul><li>An ability to prevent resal...
Believe It Or Not <ul><li>What would you do to prevent resale??? </li></ul><ul><li>when:  1940’s </li></ul><ul><li>market:...
Two classic forms of Price Discrimination <ul><li>Perfect or First Degree Price Discrimination </li></ul><ul><ul><li>charg...
Question <ul><li>The data on your handout show the demand curves for movie tickets of adults and seniors. The market descr...
Two Prices are Better than One for Movie Tickets <ul><li>The best single price in this market is $7.50/ticket, which makes...
Summary of Price Discrimination Example <ul><li>Calculating economic profits separately for the two markets (adult and sen...
Believe It Or Not <ul><li>when:  early 1990’s </li></ul><ul><li>market: contact lenses </li></ul><ul><li>firm: Bausch & Lo...
Believe It Or Not <ul><li>They were all the same lenses! </li></ul><ul><li>Just packaged differently! </li></ul><ul><li>Wh...
First Degree Price Discrimination <ul><li>The monopolist charges the demand price for each unit sold. </li></ul><ul><li>In...
Should the Government Regulate Monopolies? <ul><li>Essentially all monopolies are regulated. </li></ul><ul><li>Natural mon...
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Monopoly

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Monopoly

  1. 1. Monopoly
  2. 2. Four Basic Market Structures <ul><li>Perfectly Competitive : many firms, identical products, free entry and exit, full and symmetric info </li></ul><ul><li>Monopoly : single firm, no close substitutes, barriers to entry, full and symmetric info </li></ul><ul><li>Oligopoly : several firms, similar products, degree of product differentiation varies depending upon the market, might be barriers, full and symmetric info </li></ul><ul><li>Monopolistic competition : many firms, similar products, slightly differentiated products, free entry and exit, full and symmetric info </li></ul>
  3. 3. Competitive Market <ul><li>This is the classic “textbook” market structure. </li></ul><ul><li>Firms in a competitive market all make a product that is perfectly substitutable: all demanders are equally satisfied with any supplier’s product. </li></ul>
  4. 4. Monopoly <ul><li>The single seller makes a product that has no “good” substitute. </li></ul><ul><li>Other firms may be able to produce the good or service but choose not to enter the market or are barred from it. </li></ul>
  5. 5. Oligopoly <ul><li>A few sellers make products that are good, but not perfect, substitutes. </li></ul><ul><li>Consumers can be induced to change suppliers but have only a limited number of choices. </li></ul>
  6. 6. Monopolistic Competition <ul><li>The market has many firms but each supplier’s product is differentiated. </li></ul><ul><li>Consumers can be induced to change brands but they have brand preferences. </li></ul>
  7. 7. Question <ul><li>What is the market structure for each of these products or firms: competitive, monopoly, oligopoly, monopolistic competition? </li></ul><ul><ul><li>The Campus Store </li></ul></ul><ul><ul><li>Kinko’s </li></ul></ul><ul><ul><li>Pepperidge Farm’s Whole Wheat Bread </li></ul></ul><ul><ul><li>PowerMac computer </li></ul></ul><ul><ul><li>Windows computer </li></ul></ul><ul><ul><li>NYSEG (electricity utility) </li></ul></ul><ul><ul><li>Morton salt </li></ul></ul><ul><ul><li>AT&T long distance </li></ul></ul>
  8. 8. Answer <ul><li>The Campus Store: most products competitive, textbooks oligopoly, but location is very important. </li></ul><ul><li>Kinko’s: monopolistic competition (differentiated service) </li></ul><ul><li>Pepperidge Farm’s Whole Wheat Bread: competition or monopolistic competition (slightly differentiated recipes) </li></ul><ul><li>PowerMac computer and clones: monopoly, under license. </li></ul><ul><li>Windows computer: monopolistic competition (differentiated features) </li></ul><ul><li>NYSEG (electricity utility): monopoly </li></ul><ul><li>Morton salt: competitive </li></ul><ul><li>AT&T long distance: oligopoly </li></ul>
  9. 9. Monopoly <ul><li>single firm </li></ul><ul><li>no close substitutes </li></ul><ul><li>barriers to entry </li></ul><ul><li>full and symmetric information </li></ul>
  10. 10. Sources of Monopoly Entry Barriers <ul><li>Natural monopoly: the most efficient scale of production is so large, relative to market demand, that a single firm dominates the market. </li></ul><ul><li>Patents, copyrights, licenses, franchises: government protection of a firm’s right to produce a unique product. </li></ul><ul><li>Economic and/or legal restrictions, strategies or situations that make entry more difficult for new competitors than for the existing monopoly firm. </li></ul>
  11. 11. Natural Monopolies <ul><li>Goods and services whose delivery requires the construction of a physical network (wires, pipes, etc..) </li></ul><ul><li>In such industries (local phone service, water, sewage removal, electricity, gas) the physical networks display decreasing marginal cost over essentially all quantities. </li></ul><ul><li>Thus, average total cost is always declining and the minimum efficient scale is much larger than the size of the market. </li></ul><ul><li>Natural monopolies are often regulated: they cannot charge a higher price without government approval. </li></ul>
  12. 12. Patents: Are There “Good” Monopolies? <ul><li>Consider the protease inhibitor Crixivan from Merck. </li></ul><ul><li>A very effective AIDS therapy. </li></ul><ul><li>Development costs were more than one billion dollars. </li></ul><ul><li>Annual revenue now from treating around 90,000 patients is $500,000,000. </li></ul>
  13. 13. What is a “Good” Monopoly? <ul><li>Why is Merck given a monopoly? </li></ul><ul><li>The granting of a patent on the drug Crixivan guarantees that Merck can earn monopoly profits on its sale. </li></ul><ul><li>These monopoly profits provide the incentive to invest in the research and development required to create the new drug. </li></ul>
  14. 14. “Good” Monopolies <ul><li>The granting of patent protection (legal monopoly) gives firms a strong incentive to invest in new product development. </li></ul><ul><li>Would firms make the R&D investments if they could not protect them through patents and trade secrets? </li></ul><ul><li>Probably not because competitors could steal the design at a fraction of the cost after the product is brought to market. </li></ul>
  15. 15. “Other” Monopolies - Good? Bad? <ul><li>Input Ownership </li></ul><ul><ul><li>DeBeer’s and diamonds </li></ul></ul><ul><li>Industry Secret or Know-how </li></ul><ul><ul><li>IBM and mainframes? </li></ul></ul><ul><li>Strategic Behavior </li></ul><ul><ul><li>buy ‘em up </li></ul></ul><ul><ul><li>blow’ em up </li></ul></ul><ul><ul><li>let’s make a deal </li></ul></ul><ul><ul><li>Microsoft and operating systems? </li></ul></ul>
  16. 16. Caveats <ul><li>monopoly does not => big </li></ul><ul><li>big does not => monopoly </li></ul><ul><li>monopoly does not => absolute and unlimited control over price </li></ul><ul><li>monopoly does not => must have economic profit </li></ul><ul><li>short run profit does not => monopoly power </li></ul><ul><li>monopoly does not => badly behaved firm </li></ul>
  17. 17. Classic Simple Monopoly <ul><li>Polar extreme from perfect competition. </li></ul><ul><li>Monopolist is a “price maker.” </li></ul><ul><li>Cost curves are pretty much the same (except in the case of natural monopoly). </li></ul><ul><li>The big change from before is in the demand side of the profit function. </li></ul>
  18. 18. The Simple Monopolist <ul><li>The simple monopolist abides by the “law of one price.” Everyone pays the same market price for all units purchased. </li></ul><ul><li>A monopolist faces the declining market demand curve for its product and simultaneously chooses price and quantity. </li></ul><ul><li>Now P>MR (before P=MR) because the simple monopolist must lower the price on all preceding units to sell an additional unit. </li></ul><ul><li>A monopolist has no “supply curve.” </li></ul>
  19. 19. The Simple Monopolist: Rules for Profit Maximization <ul><li>Suppose we are in the short run. </li></ul><ul><li>Rules for profit maximization are the same as before. </li></ul><ul><li>If X SM maximizes profit, then </li></ul><ul><ul><li>MR(X SM ) = MC(X SM ) </li></ul></ul><ul><ul><ul><li>very important note: for a simple monopolist P>MR at all positive levels of X. </li></ul></ul></ul><ul><ul><li>X SM is a max and not a min. </li></ul></ul><ul><ul><li>at X SM it’s worth operating. </li></ul></ul>
  20. 20. Simple Monopoly <ul><li>Economic profits equal total revenue minus total costs. </li></ul><ul><li>Marginal revenue is the rate of change of total revenue (just like marginal cost is the rate of change of total cost) as quantity increases. </li></ul><ul><li>Economic profits are maximized when marginal revenue equals marginal costs </li></ul>
  21. 21. Graphical Display of Monopolist’s Solution <ul><li>The monopolist sets marginal revenue equal to marginal cost at MR=MC=$10. </li></ul><ul><li>The optimal quantity is thus 90 units, which implies a market price of $55/unit. </li></ul><ul><li>The monopoly profits (light blue in the graph) are the difference between price ($55) and average total cost ($44.44) times the number of units sold. </li></ul><ul><li>Notice that our monopolist is a “natural monopoly” the average total costs decline over the entire relevant range of production and the minimum efficient scale (150) is bigger than the entire market. </li></ul><ul><li>Notice that if our monopolist operated at the competitive equilibrium (Price=MC=$30, Quantity=140), the firm would make a loss (ATC>Price). </li></ul>
  22. 22. Implications of the Monopolist’s Profit Maximum <ul><li>Price will exceed the competitive price. </li></ul><ul><li>Quantity will be less than the competitive quantity. </li></ul><ul><li>The monopolist sells the output at a price greater than marginal costs but the monopoly price can be above or below average total costs. Thus, the monopolist need not always make a profit. In the long run, of course, unprofitable monopolists will either stop production or raise the price further above marginal cost until it covers average total costs. </li></ul><ul><li>The monopolist will always try to operate on the elastic portion of the demand curve because when the elasticity of demand is greater than -1 (inelastic, between 0 and 1 in absolute value), marginal revenue is negative and, necessarily, less than marginal cost. </li></ul><ul><li>Since there is no entry to consider monopolists can have persistent long run economic profit. </li></ul>
  23. 23. Simple Monopoly- Performance <ul><li>Efficiency: </li></ul><ul><ul><li>Is the monopoly equilibrium Pareto Efficient? That is, at X SM is net social surplus maximized? Does $MB=$MC at X SM ? </li></ul></ul><ul><ul><li>Is the monopolist productively efficient? Does the monopolist operate at minimum efficient scale? </li></ul></ul><ul><li>Equity: </li></ul><ul><ul><li>Is the outcome of monopoly fair? Equitable? Just? </li></ul></ul>
  24. 24. Simple Monopoly- Performance Answers <ul><li>The simple monopoly equilibrium is not Pareto Efficient. </li></ul><ul><ul><li>The simple monopolist creates “dead-weight-loss.” </li></ul></ul><ul><ul><li>At X SM , $MB>$MC . Recall: $MR=$MC at X SM while $P SM >$MR at all X. So $P SM >$MC. Since $P=$MB, then $MB>$MC. </li></ul></ul><ul><li>The simple monopolist may or may not be productively efficient. </li></ul><ul><li>Compared to the competitive equilibrium, there is a transfer of surplus from consumers to producers. </li></ul>
  25. 25. Price Discriminating Monopolists <ul><li>A monopolist might be able to charge different prices for different units sold and enhance its profits. </li></ul><ul><ul><li>charge different people different prices </li></ul></ul><ul><ul><li>charge the same person different prices for different units </li></ul></ul><ul><li>price discrimination </li></ul><ul><ul><li>charging different prices for different units with no cost basis </li></ul></ul><ul><ul><li>charging the same price for different units when there are cost differences </li></ul></ul>
  26. 26. Requirements for Price Discrimination <ul><li>Some amount of monopoly power. </li></ul><ul><li>An ability to prevent resale. </li></ul><ul><li>Detailed information about who is buying what unit and what demanders are willing to pay. </li></ul>
  27. 27. Believe It Or Not <ul><li>What would you do to prevent resale??? </li></ul><ul><li>when: 1940’s </li></ul><ul><li>market: plastic molding powder </li></ul><ul><ul><li>industrial users: .85/pound </li></ul></ul><ul><ul><li>denture manufacturers: $22/pound </li></ul></ul><ul><li>firm: Rohm and Haas </li></ul><ul><li>problem: resale from industrial users to denture manufacturers </li></ul><ul><li>solution: rumor you are mixing arsenic in the powder sold to industrial users! </li></ul>
  28. 28. Two classic forms of Price Discrimination <ul><li>Perfect or First Degree Price Discrimination </li></ul><ul><ul><li>charge a different price for each unit sold </li></ul></ul><ul><ul><li>the most extreme form of price discrimination </li></ul></ul><ul><li>Third Degree Price Discrimination </li></ul><ul><ul><li>segment market and then charge a different price in each market </li></ul></ul><ul><ul><li>exploit the observation that at the simple monopoly price the own price elasticity of demand differs across the defined segmented markets </li></ul></ul><ul><li>Price discrimination comes in many other “flavors” </li></ul>
  29. 29. Question <ul><li>The data on your handout show the demand curves for movie tickets of adults and seniors. The market described has only one movie theatre. </li></ul><ul><ul><li>Find the best single price. </li></ul></ul><ul><ul><li>If the movie theater can charge separate prices for adults and seniors, what are the best two prices? </li></ul></ul>
  30. 30. Two Prices are Better than One for Movie Tickets <ul><li>The best single price in this market is $7.50/ticket, which makes economic profits of $4,225 (blue entries). Set marginal cost = marginal revenue with the single price. </li></ul><ul><li>The price discriminating monopolist can make more economic profits by charging adults $8.50 (yellow entries) and seniors $6.50 (green entries). Set marginal cost = marginal revenue separately for each market. </li></ul>
  31. 31. Summary of Price Discrimination Example <ul><li>Calculating economic profits separately for the two markets (adult and senior) shows that the total is greater than with the best single price. </li></ul><ul><li>Taking advantage of different elasticities of demand. </li></ul>
  32. 32. Believe It Or Not <ul><li>when: early 1990’s </li></ul><ul><li>market: contact lenses </li></ul><ul><li>firm: Bausch & Lomb </li></ul><ul><li>Lenses: </li></ul><ul><ul><li>Optima @ $70/pair - wash and keep 1 year </li></ul></ul><ul><ul><li>Medalist @ $15/pair - wash and keep 2 months </li></ul></ul><ul><ul><li>SeeQuence 2 @ $8/pair - wash and keep 2 weeks </li></ul></ul><ul><ul><li>Occasions @ $3/pair - daily and disposable each day </li></ul></ul><ul><li>Guess what? </li></ul>
  33. 33. Believe It Or Not <ul><li>They were all the same lenses! </li></ul><ul><li>Just packaged differently! </li></ul><ul><li>What would you pay for a year? </li></ul><ul><ul><li>Optima = $70/pair - wash and keep 1 year </li></ul></ul><ul><ul><li>Medalist = $15x6=$90 (last 2 months) </li></ul></ul><ul><ul><li>SeeQuence 2 = $8x26=$208 (last 2 weeks) </li></ul></ul><ul><ul><li>Occasions = $3x365 = $1095 </li></ul></ul><ul><li>What would I do? Buy the Occasions and wash and wear until my eyes hurt. </li></ul><ul><li>Class action suits were eventually settled. </li></ul>
  34. 34. First Degree Price Discrimination <ul><li>The monopolist charges the demand price for each unit sold. </li></ul><ul><li>In this case the market demand curve becomes the monopolist’s marginal revenue curve. </li></ul><ul><li>The monopolist sets MR=MC to get X FDPD . </li></ul><ul><li>The monopolist charges a different price for each unit according to the demand curve. </li></ul><ul><li>Performance: X FDPD is Pareto Efficient and all the net social surplus goes to the monopolist as producer surplus. Consumer surplus = $0! </li></ul>
  35. 35. Should the Government Regulate Monopolies? <ul><li>Essentially all monopolies are regulated. </li></ul><ul><li>Natural monopolies are regulated by price commissions that determine the rates the monopolies may charge. </li></ul><ul><li>Patent, copyright and license protections are a form of ex ante regulation: firms that follow the rules for establishing the validity of their innovations receive the protection of the patent, copyright or license. </li></ul><ul><li>Should the government do more? Good question. </li></ul>

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