Lecture Principles of Microeconomics: Chapter 10 - James D. Miller

Lecture Practical business math procedures (11/e) - Chapter 10: Simple interest. The main contents of the dissertation consist of three main parts: Calculation of simple interest and maturity value, finding unknown in simple interest formula, U.S. rule -- making partial note payments before due date.

Chapter 10

Challenge To Market

Learning Objectives

• What is monopoly?

• What are the barriers to entry?

• How is the demand curve for a monopoly?

• How does a monopoly decide quantity of output to produce?

• What are the social costs of monopoly?

• What is price discrimination?

Monopoly

• A pure monopoly is a firm without any

competition

• Pure monopolies do not exist in the real world

• The fewer the substitutes there are for a firm’s products, the more monopolistic the firm is

• A monopolist can earn long term profits if it

keeps other firms from entering its market

• Entry barriers stop firms from entering a market and destroying monopoly profits

Barriers To Entry

The Government:

members of protected professions to earn monopoly profits, e.g teachers, lawyers

outlaw competition to a monopolist e.g U.S post office

religious monopolies

Barriers To Entry

Unions:

with employers

Control of a vital resource:

controlling a vital resource, e.g silk in

ancient China, alum in Ottoman empire

Barriers To Entry

Incompatibility:

complementary goods of its rival, a firm can

create and maintain its monopoly

entry are a prime source of Microsoft’s riches

strong barrier to entry, protecting all

professional sports leagues

Barriers To Entry

Economies of scale:

• If in an industry average total

costs decrease as output

increases, then a new firm’s

costs are extremely high

compared to the monopolist’s

economies of scale are called

“natural monopolies,” e.g

utility companies.

Barriers To Entry

Intellectual property:

demand payment from all who would use that property

can legally sell the copyright-protected work

sell the invention Patents confer a benefit on innovators proportional to the social benefits of their innovation

Monopolist Pricing

• A monopolist can set its own price.

• The Law of Demand constraints a

monopolist’s price-setting powers.

• If a monopolist wants to increase sales, it must lower its price.

• Unlike a firm in perfect competition,

monopolist’s output influences the market price.

Marginal Revenue and Monopolist Pricing

Marginal Revenue

= The increase in total revenue a firm

receives by selling one more good.

For a competitive firm:

• Marginal Revenue = Price

For a monopolist:

• Marginal Revenue Price

Marginal Revenue and Monopolist Pricing

Customer Most Willing to

Monopolist’s Profit Maximization

$14

$8

100

The price the

monopolist will choose.

The Social Cost of Monopolies

• Monopolists do not produce at the lowest possible

average total cost.

• Monopolies usually produce output below the level that maximizes the wealth of society.

Deadweight Loss of Monopoly

Price

Quantity

Marginal Cost

Demand

$12

• A monopolist will produce

until Marginal cost =

marginal revenue.

• The wealth maximizing

level of output is where

Marginal cost = demand.

• Adam Smith’s invisible

hand breaks down.

If the monopolist produces 150 units

The monopolist will not produce this much output.

D

Ways to Reduce Deadweight Loss

• Competition

• Price discrimination

• Antitrust laws

Competition and Deadweight Loss of Monopoly

• Competition lowers prices and expands output, thereby reducing deadweight loss

For example:

• U.S post office and fax, email, FedEx

• Microsoft and Linux

• Cable television and satellite television

• De Beers’ diamonds and artificial diamonds

• Even the mere threat of potential competition

can induce a monopolist to expand output and reduce deadweight loss

customers by selling to them at lower prices.

• For economists, price discrimination is beneficial because it increases the wealth of society

Price Discrimination

Perfect price discrimination:

• The monopolist charges every customer the maximum they are willing to pay.

• The total consumer surplus becomes zero.

• The deadweight loss of monopoly is completely

eliminated.

Imperfect price discrimination:

• Monopolists separate customers into groups and then charge separate groups different price.

• The deadweight loss of monopoly is reduced but not

completely eliminated, e.g student discounts, financial aid, airline tickets.

reselling the good to those customers who paid a high price.

Self selection of customers:

different visible actions By inducing customers to

voluntarily self-select into separate groups, firms can price discriminate e.g coupons, airline tickets

Innovation and Monopoly

• Because it does not have to share its

benefits, a monopolist gets great monetary rewards from innovation Hence,

monopolies encourage innovations.

• However, strong entry barriers protect a

monopoly even without innovation A

monopolist’s employees may not have

incentives to work hard to innovate.

Do You Know?

• How can economies of scale create barriers to entry?

Economies of scale means average total costs decrease

as output increases Since its costs are extremely high compared to the monopolist’s costs, it is difficult for a

new firm to challenge a monopoly.

• Why must a monopolist who can’t price discriminate give

a discount to old customers if it wants to sell to new

customers?

The Law of Demand constraints a monopolist’s

price-setting powers As consumers buy more only at lower price monopolist must lower its price to increase sales.

• Why are coupons a form of price discrimination?

Coupons induce consumers to self-select into two

groups: price-sensitive and price-insensitive Coupons allow price-sensitive consumers to trade time for money

Summary

• A pure monopoly is a firm without any competition.

• The fewer the substitutes there are for a firm’s products, the more monopolistic the firm is.

• Entry barriers stop firms from entering a market and

destroying monopoly profits such as government

regulations, unions, control of vital resource,

incompatibility, economies of scale and intellectual

property.

• If a monopolist wants to increase sales, it must lower its price.

• Monopolist’s profits are maximum when marginal

revenue = marginal cost.

Summary

• Monopolies usually produce output below the

level that maximizes the wealth of society and creates deadweight loss

• Competition, price discrimination and antitrust laws can reduce the social cost of monopolies

• Price discrimination occurs when a firm charges separate customers different prices

• Price discrimination is beneficial because it

increases the wealth of society

Coming Up

What is the other challenge to

market effectiveness?