Monopoly Chapter 15-5 Comparison of Perfect Competition & Monopoly.
Monopoly, Market Power, and Economies of Scale Today: Introduction of situations in which the...
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Transcript of Monopoly, Market Power, and Economies of Scale Today: Introduction of situations in which the...
Monopoly, Market Power, and Economies of Scale
Today: Introduction of situations in which the
Invisible Hand breaks down
Up until now…
…we have typically analyzed markets with no control over market price Each firm was a price taker, since it
only produced a very small fraction of quantity supplied in the market
Today, we begin Unit 4 What happens when there are
significant imperfections in a market?
Many sellers vs. one seller
Many sellers No control over price
One seller, also known as a monopolist Complete control over price (sort of)
Sort of?
Recall that demand curves are downward-sloping
Each time price increases, fewer people are willing to pay the price to purchase the good The monopolist can control price, but
must face the consequences that price determines quantity sold
MB in a competitive vs. monopolistic environment
Competitive environment MB is price, since price does not
depend on quantity supplied by an individual firm
Monopolistic environment We will see that MB decreases as
quantity supplied increases
What happens to the monopolist when it sells another unit?
Each time another unit is sold, price of the good decreases
We will go through a simple example, shown to the right, to determine MR for the monopolist
P Q
4 0
3 1
2 2
1 3
0 0
Marginal revenue Marginal revenue
How much additional is received by selling one more unit of the good?
We must first calculate TR
Notice that for Q > 1, MR < P
P Q TR MR
4 0 0
3
3 1 3
1
2 2 4
-1
1 3 3
-3
0 4 0
Market inefficiencies of monopoly
Decreasing marginal revenue creates inefficiencies in the market We will talk about this more in the
next lecture
And now, onto the big question of the day
How Do Firms Gain Market Power? Exclusive control over important
inputs Patents and copyrights Government licenses or franchises Economies of scale Natural
monopoly Networks
Exclusive control over important inputs
If a company controls a significant portion of the important inputs to a product, it can have significant influence on price
Exclusive control over important inputs Example: De Beers
Rough diamond explorer Around 40% of world diamond
production by value Sales and marketing through the
Diamond Trading Company This company sells almost half of the
world’s rough diamonds by value(Source: http://en.wikipedia.org/wiki/De_Beers, checked Feb.
3, 2008)
De Beers Such large control over the market
makes De Beers able to act similarly to a monopolist Marketing of diamond jewelry does
not have to be brand specific "A Diamond is Forever" attempts to
prevent old jewelry from entering the market
De Beers does have some control over world prices
Patents and copyrights
Patents and copyrights prohibit others from copying private work and discoveries Example: Copying songs and movies
that are copyrighted are typically prohibited by law
Government licenses or franchises
Government-owned property often allows exclusive operation of the property for various uses
In some cases, this is to prevent competition that could deteriorate a natural destination
Government licenses or franchises Example: Yosemite
National Park Limited parking Tasteful hotels Most of the park is
undeveloped Most of park
development is in only 7 square miles
Park is 1,200 square miles Vernal Fall
Economies of scale Some technologies are such that
as the quantity produced increases, ATC decreases for all reasonable quantities produced This is due to increasing returns to
scale This happens when ALL inputs double
and production MORE THAN doubles Often happens with large fixed costs and
nearly-linear variable costs
Example where a single firm could gain market power When a firm gains
market control with economies of scale, it is called a natural monopoly
There are problems with natural monopolies if left uncontrolled
Deal with this later
Price ($)
Quantity
D
ATC
Network economies Some technologies are slow
to get adopted due to not enough people entering the market Video phones (early version at
right, the PicturePhone) Fax machines HD DVDs versus Blu-ray
See additional reading for more Why? Costs are very high
initially
Network economies The internet has created a frenzy of
network economies eBay
On-line auctions Facebook and MySpace
Social networking As more people use eBay, Facebook,
and MySpace, the respective companies increased in value Competition became difficult
Monopoly inefficiency
As we will see, monopolies typically produce quantities that are less than efficient
This leads to positive economic profits
Controlling monopolies
Laws have been passed to control monopoly profits
Regulation typically tries to set economic profit to be about zero This sometimes makes regulated
stocks a relatively safe investment
Controlling monopolies Why are monopolies typically regulated? We will analyze this in the next lecture
In the absence of regulation, a monopoly will usually produce a quantity that is below the optimal amount in order to make positive economic profits
Monopolies can increase efficiency by price discrimination
However, the monopolist sometimes benefits more than consumers do
The rest of today
Introducing profit maximization from the monopolist’s point of view All units must be sold for the same price
Profit maximization of the monopolist As usual, set MB = MC to maximize profit
Revenue is the benefit for the monopolist Remember that MB is decreasing for the
monopolist
Single-price profit maximization Remember that
marginal revenue is below the price received by the monopolist (except for the first unit in a discrete case)
See our continuous example we will use today
Single-price profit maximization We will find
the point where MR and MC are equal
Surplus and deadweight loss will then be calculated
Important fact to note for linear demand curves MR has same
vertical intercept as D, with twice the slope Read Ch. 8
Appendix for algebraic approach to solving monopoly problems
Simple monopoly example For this problem,
note: Linear downward-
sloping demand curve
Linear upward-sloping MC curve
Remember: We maximize profit by setting MR = MC
Simple monopoly example In an efficient
market with many buyers and sellers, point I is the intersection of the supply (MC) and demand curves Price is G,
quantity is H
Simple monopoly example As we will see
with a monopoly, a different, less efficient outcome, occurs
Simple monopoly example Point K
MR = MC At quantity A,
the monopolist can see from point E on the demand curve that price C can be charged
Simple monopoly example Calculating
surplus if this was an efficient market
Recall that triangle JI0 is total surplus in an efficient market
Triangle JIG for consumers
Triangle GI0 for suppliers
Simple monopoly example At price C,
consumer surplus falls to triangle JCE
TR for monopolist is price C times quantity A
Surplus for monopolist is trapezoid CEK0
Simple monopoly example What is lost?
Triangle EIK is lost, since the monopolist stops producing once quantity reaches A
This triangle is deadweight loss (DWL)
Friday
More on profit maximization from the monopolist’s point of view
Inefficiencies of monopoly Is discrimination legal?