8
Monopoly
Outline
● Monopoly Defined
● The Monopolist’s Supply Decision
● A Comparison of Monopoly and Perfect
Competition
● Can Anything Good Be Said About
Monopoly?
● Price Discrimination Under Monopoly
Monopoly Defined
●
1.
2.
3.
Very stringent requirements for pure monopoly:
Only one firm in industry.
No close substitutes for the good firm produces.
Some reason why entry and survival of a competing
firm is unlikely.
● Pure monopolies are rare in real world because most
firms face competition from firms producing substitutes.
♦ E.g., sole provider of natural gas in a city is not a pure
monopoly, since other firms provide substitutes like heating
oil and electricity.
♦ E.g., if there is only one railroad, it still competes with bus
lines, trucking companies, and airlines.
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Sources of Monopoly Power:
Barriers to Entry
1.
Legal restrictions: Monopolies are established if gov.
prevents other firms from entering the industry.
●
2.
E.g., licensing 1 cable TV supplier or right to operate a food
stand in a public stadium.
Patents: To encourage innovation, gov. gives exclusive
production rights for 17 years to product's inventors.
Monopoly is protected as long as its patent remains in
effect.
●
E.g., for many years, Xerox had a monopoly in plain paper
copying. Pfizer currently has a patent for Lipitor.
Sources of Monopoly Power:
Barriers to Entry
3.
Control of a scarce resource or input: If a good is
produced with a rare input, a Co. that gains control of
that input can establish a monopoly.
●
4.
E.g., DeBeers diamond syndicate controls S of highest
quality diamonds in the world.
Deliberately erected entry barriers: An incumbent firm
can make it difficult for potential rivals to enter.
●
E.g., Spending huge amounts on advertising forces any
potential entrant to match that expenditure to obtain
customers. Intel has used its "Intel Inside" marketing
campaign to ward off competition from AMD.
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Sources of Monopoly Power:
Barriers to Entry
5.
Large sunk costs: Entry into an industry is risky if it
requires a large sunk I. Most important type of
"naturally imposed" barrier to entry.
●
E.g., Boeing was the only supplier of top-end airplanes for
many years after intro of its 747. Airbus receives gov.
subsidies so it can afford the high I costs.
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Sources of Monopoly Power: Cost
Advantages
6.
Technical Superiority: A firm whose technological
expertise vastly exceeds that of any potential
competitor can maintain a monopoly for a period of
time.
●
7.
E.g., For many years, IBM had little competition in PC
business because of its superior technology.
Economies of scale: If the size of a firm gives a cost
advantage over a smaller rival, it may be impossible
for anyone to compete with largest firm in the
industry.
Natural Monopoly
● Natural monopoly is an industry where advantages of
large scale production makes it possible for a single firm
to S entire market output at a lower AC than a larger
number of firms producing smaller Q.
● Once a firm is big enough, its natural cost advantage will
drive competition out of business.
Average Cost
FIGURE 1. Natural Monopoly
B
$3.00
A
2.50
C
2.00
AC
1
2
2.5
Quantity Supplied
Natural Monopoly
● Fig. 1 considers widget companies with ↓AC.
● Initially 2 firms in industry –larger firm with Q = 2M
and AC = $2.50 and smaller firm with Q = 1M and AC =
$3.00.
● Smaller firm can match P of larger firm only by
operating at a loss.
● Larger firm can drive smaller firm out of business by
selling its Q at $3.00 > P > $2.50 and still earn a profit.
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Natural Monopoly
● Once monopoly is producing 2.5M, IRTS are a barrier to
entry because no entrant can match AC = $2.00.
● If firm uses its low cost to keep P low, this benefits
society. But once rivals exit, monopolist can ↑P.
● Public utilities are regulated because technology of
producing their output enables them to achieve large
↓cost by ↑Q.
● Better to allow these firms to have entire market to
themselves and have regulatory supervision vs. breaking
them up.
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The Monopolist’s Supply
Decision
● Monopoly does not have a S curve.
♦ Unlike competitive firms, monopoly does not take market P as
given. It can select (P,Q) pair on industry D curve that max. Π.
● Monopolist’s D curve is downward sloping, not
horizontal.
● Profits are not competed away by entry of new firms.
● To max profit, monopolist compares MR and MC.
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Relationship Between Price
and Marginal Revenue
● Recall D = AR = P.
● If D curve is downward sloping, then P > MR.
● Monopoly charges same P to all its customers. To ↑Qd
by 1, it must ↓P to all customers. So MR = P firm
collects from the new customer - revenue lost by ↓P to
all "previous" customers. Thus, P > MR.
● MR = P under perfect competition because firm's D
curve was horizontal. Firm could expand Q without ↓P.
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FIGURE 2. Relationship Between
Price and Marginal Revenue
P
$0.10 loss to all
"previous" customers
$2.10
A
$2.00
$2.00 P gained by
selling the 16th unit
B
D
16
P must ↓ to $2.00 to sell
16th unit (pt B).
How much revenue is
gained? TRa = $31.50
and TRb = $32.00 so
MR = $0.50.
So P = $2.00 > MR =
$0.50.
Q
15
Monopolist sells 15
units for $2.10 (pt A)
and wants ↑ sales by 1.
The Monopolist’s Supply
Decision
●
To study P and Q decision of a profit-max
monopolist (graphically):
1. Find Q where MR = MC to select the output
level.
2. Find height of the D curve at that Q to
determine P.
3. Compare P and AC to determine whether the
monopolist earns a profit.
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FIGURE 3. Profit-Maximizing
Equilibrium for a Monopolist
Π-max Q = 150
where MR = MC.
MC
Price per Unit
D
P
$10
AC
Total profit is $6 x
150 = $900 and is
represented by the
area $10 P C 4.
M
8
MC
4
AC
C
D (AR)
MR
0
P = $10 > AC = $4,
so per unit profit =
$6.
150
Quantity
TABLE 1. A Monopolist’s PriceOutput Decision
Quantity
Price
Total
Revenue
Marginal
Revenue
Total
Cost
Marginal
Cost
Total
Profit
0
------
$0
------
$10
------
-$10
1
$140
140
$140
70
$60
70
2
107
214
74
120
50
94
3
92
276
62
166
46
110
4
80
320
44
210
44
110
5
66
330
10
253
43
77
6
50
300
-30
298
45
2
The Monopolist’s Supply
Decision
●
1.
Table 1 illustrates several important points:
↓P will raise (lower) TR when D is elastic (inelastic).
♦
2.
3.
E.g., D is elastic (inelastic) from Q = 1 to Q = 5 (from Q = 5
to Q = 6).
P > MR after 1st unit of output.
Highest profit ($110) at Q = 4 where MR = MC = $44.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
A Comparison of Monopoly
and Perfect Competition
1.
A monopolist' profits persist:
● No barriers to entry in competitive markets so
profits are competed away. In LR, firms only cover
their costs, including opportunity cost of K and L.
● But economic Π can persist under monopoly.
Monopolies are often regulated by gov. agencies
that try to limit Π they earn.
2. Monopoly restricts output to raise price: Compared
with the ideal of perfect competition, monopolist
restricts Q and charges a higher P.
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A Comparison of Monopoly
and Perfect Competition
●
●
Imagine a court order breaks up a monopoly into large
# of competitive firms.
Assume industry D and costs stay same. Somewhat
unrealistic, but it allows us to compare LR (P,Q) pair
under monopoly vs. perfect competition.
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FIGURE 4. Compare Monopoly to
Competitive Industry
Monopoly Q = 150 →
MR = MC (pt M).
MC
Price per Unit
D
AC
P
$10
M
Monopolist produces
less Q and charges a
higher P.
B
8
MC
D (= AR = P = MU)
C
AC
MR
150
Comp. Q = 300 → P
= AC (pt B).
300
Quantity
Monopoly Leads to an Inefficient
Resource Allocation
●
●
●
●
Competitive industries produce what society wants at
min possible cost.
Efficiency in resource allocation requires that MU =
MC. This occurs under competition because industry
produces where D (or MU) = MC.
Yet, monopolist produces smaller Q where MU > MC.
So consumers are willing to pay more for an add. unit
than it would cost to produce it.
Resources are allocated inefficiently under monopoly,
because too few resources are used to produce the
good.
Copyright© 2006 Southwestern/Thomson Learning All rights reserved.
Can Anything Good Be Said
About Monopoly?
● Monopoly may aid innovation:
♦ Monopolies are shielded from competition, so any
innovation that ↓costs → ↑profits.
♦ Monopolies may have more incentive to invest in
R&D.
♦ In SR, ↑AC with R&D spending, but in LR, ↓AC with
use of new technologies or production processes.
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Can Anything Good Be Said
About Monopoly?
● Natural monopoly:
♦ ↓AC as ↑Q
♦ Costs of production would be higher if a natural
monopoly were broken up into many smaller firms.
♦ Society benefits from monopolist’s ↓AC (or IRTS).
♦ Must be regulated for consumers to receive lower P.
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Price Discrimination Under
Monopoly
● Charging different customers different prices when cost
of supplying them is the same.
♦ E.g., airlines charge less to passengers willing to stay overnight
on Sat.
● Or charging different customers same P when cost of
serving them is different.
♦ E.g., U.S.P.S. charges same P for delivery of letters.
Can you think of some examples of P discrimination?
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Price Discrimination Under
Monopoly
● P discrimination occurs in many industries, but it is
easier to accomplish if firm is sole producer of a good.
● P discrimination → more profitable to sell to 1 group
than another.
● With competition, firms enter and steal profitable
customers away by charging them slightly lower P.
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Price Discrimination Can
Raise Profits
● Example: Town where widgets are sold
100 rich families → willing to buy 1 if P = $30
1,000 poor families → willing to buy 1 if P = $10
● If firm cannot P discrim. → charge everyone P =$10.
♦ TR = $10 x 1,100 = $11,000
If instead, it charged P = $30 to everyone
♦ TR = $30 x 100 = $3,000
● If firm can P discrim. (and keep poor from reselling to
the rich). → TR = $13,000 = $10 x 1,000 + $30 x 100.
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FIGURE 5. Prices and Quantities
under Price Discrimination
Customer Group A
Customer Group B
Da
Db
Pa
Price
Pb
MC
0
J
Qa
K
MRa
Quantity
Da
0
Qb
MC
MRb
Quantity
Find Π-max (P,Q) for each group by: (a) optimal Q is where MR =
MC; and (b) P is determined by height of D curve at optimal Q.
Db
Price Discrimination Under
Monopoly
●
Profit max. requires MRa = MRb = MC.
♦ E.g., if MRa = $18 and MRb = $15 → switching sales from
group B to group A raises TR by $3.
● Fig. 5 assumes MC are equal across the 2 groups and that
MC is constant.
● Optimally, sell Qa to group A and Qb to group B. These
quantities ensure that MRa = MRb = MC.
● Group B (with more elastic D) is charged a lower P than
group A (with less elastic D).
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Price Discrimination Under
Monopoly
● A seller facing 2 identifiably different groups of buyers
with diff. D curves, can ↑Π by setting diff. P for 2
groups.
● Monopolist will always charge group with more elastic
D a lower P; as these customers are more sensitive to P.
♦ E.g., discount coupons for supermarkets are a means of
offering lower P to more P sensitive customers. Shoppers who
clip coupons have a lower value of time and do more
comparison-shopping. A supermarket should charge less to
customers who would otherwise shop elsewhere.
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Is Price Discrimination Always
Undesirable?
● May not be such a bad thing.
♦ E.g., movie ticket discounts for seniors or doctors ↓fees to
needy patients.
● Sometimes it’s impossible for a firm to stay in business
without P discrim.
♦ E.g., widgets: if TC of 100 = $4,000 and TC of 1,100 =
$11,500 → firm can’t cover costs with uniform P. But can
survive with P discrim. as TR = $13,000 > TC of 1,100.
● May allow firms with IRTS to lower P (even to group
paying more). If P discrim. allows ↑Q (via attracting new
customers) → ↓AC → firm can offer lower P.