Monopoly (KINH tế VI mô SLIDE)

Why Monopolies Arise  The production process  A single firm can produce output at a lower cost than can a larger number of producers  Natural monopoly  Arises because a single firm c

Chapter 6

Part 2: Monopoly

Microeconomics

Why Monopolies Arise

 Monopoly

 Firm that is the sole seller of a product

without close substitutes

Why Monopolies Arise

 Government gives a single firm the exclusive

right to produce some good or service

 Government-created monopolies

 Patent and copyright laws

 Higher prices; Higher profits

Why Monopolies Arise

 The production process

 A single firm can produce output at a lower cost

than can a larger number of producers

 Natural monopoly

 Arises because a single firm can supply a good

or service to an entire market at a smaller cost than could two or more firms

 Economies of scale over the relevant range of

output

5

Economies of scale as a cause of monopoly

Average total cost

Demand and Revenue

 Monopoly versus competition

 Demand – horizontal line (Price): P = Pmarket

7

Demand curves for competitive and monopoly firms

Price

Because competitive firms are price takers, they in effect face horizontal demand curves, as in panel (a) Because a monopoly firm is the sole producer in its market, it faces the downward-

Quantity of output 0

(a) A Competitive Firm’s Demand Curve

Price

Quantity of output 0

(b) A Monopolist’s Demand Curve

Demand Demand

A monopoly’s total, average, and marginal revenue

Quantity of

water

(Q)

Pric e (P)

Total revenue (TR=P ˣ Q)

Average revenue (AR=TR/Q)

Marginal revenue (MR=ΔTR/ΔQ)

0 gallons

1 2 3 4 5 6 7 8

$11 10 9 8 7 6 5 4 3

$0 10 18 24 28 30 30 28 24

-$10 9 8 7 6 5 4 3

$10 8 6 4 2 0 -2 -4

Price

2 1

-1 -2 -3

5 4 3

6 7 8 9 10

Marginal revenue

 Produce quantity where MR=MC

 Intersection of the marginal-revenue curve and the marginal-cost curve

Average total cost

Demand

Marginal revenue Marginal cost

QMAX

B Monopoly

The area of the box BCDE equals the profit of the monopoly firm The height of the box

(BC) is price minus average total cost, which equals profit per unit sold The width of the

box (DC) is the number of units sold.

Quantity 0

Measurement of Monopoly Power

 A firm's market power: its ability to price above

marginal cost. 

 Lerner index, named after the American

economist Abba Lerner (1903-1982), was

formalized in 1934

 The index ranges from a high of 1 to a low of 0,

with higher numbers implying greater market

L = −

Case study: Monopoly drugs versus generic drugs

17

The market for drugs

Costs

and

Revenue

When a patent gives a firm a monopoly over the sale of a drug, the firm charges the

monopoly price, which is well above the marginal cost of making the drug When the patent

Quantity 0

Demand Marginal revenue

Monopoly quantity

The Welfare Cost of Monopolies

 Benevolent planner – maximize total surplus

 Total surplus

 Economic well-being of buyers & sellers in a market

 Sum of consumer surplus & producer surplus

 Produce quantity where marginal cost curve

intersects demand curve

19

The efficient level of output

7

Costs

and

Revenue

A benevolent social planner who wanted to maximize total surplus in the market would choose the

level of output where the demand curve and marginal-cost curve intersect Below this level, the value

Quantity 0

Demand (value to buyers)

Efficient quantity

Marginal cost

Value to buyers

Value to buyers

Cost to monopolist

Cost to monopolist

Value to buyers is greater than cost to sellers

Value to buyers is less than cost to sellers

The Welfare Cost of Monopolies

The deadweight loss

 Produce quantity where MC = MR

 Produces less than the socially efficient quantity

Because a monopoly charges a price above marginal cost, not all consumers who value the good at more

than its cost buy it Thus, the quantity produced and sold by a monopoly is below the socially efficient level

Quantity 0

Demand

Marginal revenue

Monopoly quantity

Marginal cost

Monopoly

price

Efficient quantity

Deadweight loss

The Welfare Cost of Monopolies

 The monopoly’s profit: a social cost?

 Higher profit

 Not a reduction of economic welfare

 Bigger producer surplus

 Smaller consumer surplus

 Monopoly profit

 Not a social problem

23

 Charges each customer a price closer

to his or her willingness to pay

 Sell more than is possible with a single price

25

Price Discrimination

 Lessons from price discrimination

2. Requires the ability to separate customers

according to their willingness to pay

 Arbitrage – buy a good in one market, sell

it in other market at a higher price

3. Can raise economic welfare

 Can eliminate the inefficiency of monopoly pricing

 More consumers get the good

 Higher producer surplus (higher profit)

Perfect First-Degree Price

Discrimination

 If the firm can perfectly price discriminate,

each consumer is charged exactly what they are willing to pay

 Additional profit from producing and

selling an incremental unit is now the difference between demand and

marginal cost

Consumer surplus is the area above P* and between

First-Degree Price Discrimination

 In practice perfect price discrimination is

almost never possible

 Firms can discriminate imperfectly

on some estimates of reservation prices

First-Degree Price Discrimination

 Examples of imperfect price discrimination

 Colleges and universities (differences in

financial aid)

Six prices exist resulting

in higher profits With a single price P* 4 , there are fewer consumers.

P* 4

Q*

Discriminating up to

P 6 (competitive price) will increase profits

Second-Degree Price

Discrimination

many units of a good over time

 Demand for that good declines with

increased consumption

 Electricity, water, heating fuel

discrimination

 Practice of charging different prices per unit for different quantities of the same good or service- Block pricing

Second-Degree Price Discrimination

$/Q Without discrimination: P

= P 0 and Q = Q 0 With second-degree discrimination there are three blocks with prices

P 1 , P 2 , & P 3 .

Quantity

D MR

MC AC

or “blocks” of same

good

Third-Degree Price Discrimination

 Practice of dividing consumers into two or

more groups with separate demand curves and charging different prices to each group

non-premium liquor, discounts to students and senior citizens, frozen v canned vegetables, magazines.

Third-Degree Price Discrimination

 How can the firm decide what to charge each

group of consumers?

groups so that MR for each group are equal.

2. Total output is chosen so that MR for

each group of consumers is equal to the

MC of production

Third-Degree Price

Discrimination

 Algebraically

 P1: price first group

 P2: price second group

 C(QT) = total cost of producing output

QT = Q1 + Q2

 Profit: π = P1Q1 + P2Q2 - C(QT)

Third-Degree Price

Discrimination

 Firm should increase sales to each group until

incremental profit from last unit sold is zero

 Set incremental π for sales to group 1 and 2 =

0

 Combining these conclusions gives

 MR1 = MR2 = MC

Third-Degree Price Discrimination

MR T

MR T = MR 1 + MR 2

•Group 1: more inelastic

•Group 2: more elastic

Other Types of Price

Discrimination

 Intertemporal Price Discrimination

different demand functions into different groups by charging different prices at

different points in time

 Initial release of a product, the demand

is inelastic

 Hard back v paperback book

 New release movie

 Technology

Other Types of Price

Discrimination

 Practice of charging higher prices during peak

periods when capacity constraints cause marginal costs to be higher.

particular times.

 Rush hour traffic

 Electricity - late summer afternoons

 Ski resorts on weekends

 Movies on weekends

demand during peak times

Competition versus monopoly: A summary comparison

2

Competition Monopoly Similarities

Goal of firms

Rule for maximizing

Can earn economic profits

Entry in long run?

Can earn economic profits

in long run?

Price discrimination possible?

Maximize profits MR=MC

Yes

Many MR=P P=MC

Yes Yes

No

No

Maximize profits MR=MC

Yes

One MR<P P>MC

No

No Yes Yes