MicroEconomics theory and application 12th by browning an zupan chapter 15

 Explore the concepts of iterated dominance and commitment in the context of game theory models... 15.1 THE SIZE OF THE DEADWEIGHT LOSS OF MONOPOLYDetermine the relative magnitude of th

MICROECONOMICS: Theory & Applications

By Edgar K Browning & Mark A Zupan

John Wiley & Sons, Inc.

12 th Edition, Copyright 2015

Chapter 15: Using Noncompetitive Market Models

Prepared by Dr Della Lee Sue, Marist College

 Explore whether government intervention can promote

efficiency in the case of natural monopoly

 Explore the concepts of iterated dominance and

commitment in the context of game theory models

15.1 THE SIZE OF THE DEADWEIGHT LOSS OF MONOPOLY

Determine the relative magnitude of the deadweight loss of monopoly.

Figure 15.1 - The Size of the

Deadweight Loss of Monopoly

Why Are the Estimates of the

Deadweight Loss Not Large?

 Estimates of the deadweight loss of monopoly in relation to GNP are not large

 Reasons:

 Deadweight loss is compared to the size of the whole economy (GNP), not to the size of the monopolized

sector

 There are few, if any, pure monopolies in the U.S

 We cannot measure the restriction in output in any

industry, only actual output

Other Possible Deadweight Losses of

 In the absence of competition with other firms, the

monopolist is under less pressure to minimize

(production) cost

 A monopoly may incur other costs (in addition to

production costs) to ensure continuation of its monopoly power

15.2 DO MONOPOLIES SUPPRESS

INVENTIONS?

Ascertain the extent to which, if any, monopolies suppress innovations.

Do Monopolies Suppress Inventions?

 Worthwhile invention: one that allows a firm to produce a

higher-quality product at an unchanged cost or to produce the same-quality product at a lower cost

 Different industry structures:

 Competitive conditions: initial firm can gain until other firms copy it

 A worthwhile invention can be profitable for a monopolist.

 Conclusions:

 Profit incentives lead to the introduction of wortwhile inventions.

 Monopoly power does not necessarily suppress inventions.

Figure 15.2 – Monopoly and Inventions

15.3 NATURAL MONOPOLY

Explore whether government intervention can promote efficiency in the case of natural monopoly.

Natural Monopoly

 the case in which the average cost of a single enterprise

declines over the entire range of market demand

 Production cost if minimized if one firm supplies the entire output for the industry

 Economies of scale extend to very high output levels

Natural Monopoly (continued)

 Dilemma:

 Efficiency in production results from one supplier

 Lack of competition may lead to less output and higher prices

 Alternatives for public policy makers:

 Do nothing and let the monopoly produce unregulated

 Regulate the monopoly

 Governmental ownership and operation of the facility

 Allow the government to accept competitive bids from potential firms for the right to operate the facility

Figure 15.3 -Natural Monopoly

Regulation of Natural Monopoly:

Theory

 Public utilities – public agencies charged with regulating

natural monopolies

 Two pricing approaches:

 Average-cost pricing: AC=demand curve

 Marginal-cost pricing: MC=demand curve

 Average-cost pricing is more practical

 Output is greater and price is lower than if the monopoly were unregulated

 Monopoly’s owners receive no profit

Figure 15.4 - Regulation of Natural

Monopoly

Regulation of Natural Monopoly:

Practice

profit) earned by a monopoly because complete knowledge of cost and demand conditions is unattainable

 The monopolist’s incentive to minimize cost is diminished.

 Regulated rates reduces the incentive to engage in research and development activities designed to develop new services or new products.

 Regulation is not ideal

 Alternatives are likewise unattractive

Application 15.2 - Regulating Natural

Monopoly through Public Ownership

 Example: United States Postal Service (USPS)

 Objective: P=AC, not profit maximization

 Profit is constrained to equal zero

 Incentive to innovate and/or to encourage cost-minimization

is attenuated

15.4 MORE ON GAME THEORY:

ITERATED DOMINANCE AND

COMMITMENT

Explore the concepts of iterated dominance and commitment in the

context of game theory models.

Iterated Dominance

 Iterated dominance – the concept of eliminating any

strategy that is inferior to or dominated by another strategy

 Nash equilibrium

Table 15.1

 Commitment – the strategy of adopting a particular course

of action, constraining one’s choice of strategies, in order to increase your equilibrium payoff

 Effectiveness depends on credibility

 Appearance: competitive pricing

 Reality: allows two sellers to overcome the prisoner’s

dilemma with the consumer being charges the highest

possible price to the benefit of the two sellers

Table 15.2

(continued)

Table 15.3