Krugman Economics 6th Edition Chapter 13 PDF

WHAT YOU WILL LEARN IN THIS CHAPTER 13 What is the significance of monopoly, a type of industry in which only one...

WHAT YOU WILL LEARN IN THIS CHAPTER 13 What is the significance of monopoly, a type of industry in which only one producer, a monopolist, operates? How does being a monopolist affect a firm’s price and output decisions? Why does the presence of monopoly typically reduce social welfare? What tools do policy makers use to address the problem of monopoly? How do digital giants like Amazon, Google, and Facebook fit into our model of monopoly, and what special challenges do they represent? Monopoly What is price discrimination, and why is it so prevalent in certain industries? Revised by Vitaly Terekhov Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers TYPES OF MARKET STRUCTURE TYPES OF MARKET STRUCTURE, VISUALLY Figure 13-1 In order to develop models and make predictions about how producers will behave, economists have developed four principal models of market structure: – perfect competition – monopoly – oligopoly – monopolistic competition This system of market structures is based on two dimensions: 1. The number of firms in the market (one, few, or many) 2. Whether the goods offered are identical or differentiated Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers  THE MEANING OF MONOPOLY WHAT A MONOPOLIST DOES Figure 13-2 Monopolist: a firm that is the only producer of a good A monopolist with no close substitutes reduces the Monopoly: an industry controlled by a monopolist quantity supplied Market power: the ability of a firm to raise prices to QM and moves up the demand curve from C to M, raising the price to PM. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers WHY DO MONOPOLIES EXIST? BARRIER #1: CONTROL OF A SCARCE RESOURCE OR INPUT If a monopolist makes profits, why don’t other firms grab a piece of action and drive prices and profits down? For a monopoly to persist, A monopolist that controls a crucial resource or input can something must keep others from going into the same business: a barrier to entry. prevent other firms from entering its market. There are five principal types of barriers to entry: – Control of a scarce resource or input – Increasing returns to scale – Technological superiority – Network externalities – Government-made barriers Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers  BARRIER #2: INCREASING RETURNS TO SCALE BARRIER #2 IN A GRAPH Increasing returns to scale (economies of scale): When average total cost falls Figure 13-3 as output increases, firms tend to grow larger. ‒ The source of increasing returns to scale is large fixed costs. A given quantity ‒ In such an industry, larger companies are more profitable and drive out of output is smaller ones. produced more ‒ Increasing returns to scale can give rise to and sustain monopoly. cheaply by one A monopoly created and sustained by increasing returns to scale is called a natural monopoly. large firm than ‒ The most visible natural monopolies are utilities—water, natural gas, power by two or more generation, and fiber optic cable. smaller firms. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers BARRIER #3: TECHNOLOGICAL SUPERIORITY BARRIER #4: NETWORK EXTERNALITY A firm that maintains a consistent technological advantage Network externality: the value of a good or service to an over potential competitors can establish itself as a individual increases as more individuals use the same good or service monopolist. The firm with the largest network of customers may become a Example: Intel was technologically superior over other monopolist. firms from the 1960s to the 1990s. Examples: eBay, Facebook, Amazon, Netflix, Google, PayPal, and Snapchat. Technological superiority is typically not a barrier to entry over the longer term. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers BARRIER #5: GOVERNMENT-CREATED BARRIER GLOBAL COMPARISON: DRUG PRICES A patent gives an inventor a temporary monopoly in the use or Different drug sale of an invention. prices in different A copyright gives the creator of a literary or artistic work sole countries reflect rights to profit from that work. willingness to pay; The justification for patents and copyrights is a matter of they also reflect incentives: The law allows a monopoly to exist temporarily by that governments granting property rights that encourage invention and creation. in other countries regulate drug prices more actively than the U.S. government does. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers PROFIT- MAXIMIZING RULE HOW A MONOPOLIST MAXIMIZES PROFIT Competitive firms cannot choose price. Monopolists can. All firms follow the same rule: Profit is maximized at Figure 13-4 (a,b) the Q where MR = MC. So what does MR look like? MR = ∆TR / ∆Q Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers MARGINAL REVENUE AND THE DEMAND CURVE DEMAND, TOTAL REVENUE, AND MARGINAL REVENUE MR is below the demand curve … An increase in production by a monopolist has two opposing effects on revenue: TABLE 13-1 Demand, Total – A quantity effect: one more unit is sold, increasing total revenue by Revenue, and Marginal Revenue the price at which the unit is sold. for the De Beers Monopoly – A price effect: to sell the last unit, the monopolist must cut the market price on all units sold; this decreases total revenue. A monopolist’s marginal revenue curve is always below the demand curve because of the price effect: To sell an additional unit, the monopolist must cut the market price on all units sold. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers LEARN BY DOING PRACTICE QUESTION 1 LEARN BY DOING PRACTICE QUESTION 1 (Answer) Suppose that a monopolist can sell 5 units of output at a price of $5, or 6 Suppose that a monopolist can sell 5 units of output at a price of $5, or 6 units of output at a price of $4. What is the marginal revenue of the sixth unit? units of output at a price of $4. What is the marginal revenue of the sixth unit? a) $24 a) $24 b) $49 b) $49 c) –$1 c) –$1 (correct answer) d) $10 d) $10 Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers  Figure 13-5 (a,b) PROFIT MAXIMIZATION FOR A MONOPOLY A MONOPOLIST’S DEMAND, TOTAL REVENUE, AND Profit maximization consists of two steps: MARGINAL 1. Choosing a quantity REVENUE CURVES Rule: Choose Q where MR = MC 2. Choosing a price ▪ Choose the highest price you can get away with, which is the highest price consumers will pay for that quantity. Rule: Once you’ve picked your quantity, follow the graph to the demand curve, which shows you how much consumers will pay. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers PITFALLS: FINDING THE MONOPOLY PRICE THE MONOPOLIST’S PROFIT-MAXIMIZING OUTPUT AND PRICE Figure 13-6 In order to find the profit-maximizing quantity of output for a monopolist, you look for the point where the MR curve crosses the MC curve. But this isn’t the price the monopolist will choose. The firm will want to charge as much as it can. Why stop at MR if it can charge up to what the demand curve says people will pay? Note: Here the MC curve is simplified to be constant. We will relax this simplification later. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers  PITFALLS: IS THERE A MONOPOLY SUPPLY CURVE? GRAPHING THE MONOPOLIST’S PROFIT Figure 13-7 As long as the You might be tempted to ask about the supply curve of a monopoly has monopolist. But this is a meaningless question. strong barriers Monopolists don’t have supply curves—since they to entry, profit control prices there is no set relationship between will stay. price and quantity supplied. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers LEARN BY DOING PRACTICE QUESTION 2 LEARN BY DOING PRACTICE QUESTION 2 (Answer) If the market for some good were converted from a competitive industry to a If the market for some good were converted from a competitive industry to a monopoly, which of the monopoly, which of the following would occur as a result? following would occur as a result? a) Prices would fall on the output produced by the monopolist. a) Prices would fall on the output produced by the monopolist. b) Some consumer surplus would be re-allocated to the monopolist as profit. (correct b) Some consumer surplus would be reallocated to the monopolist as profit. answer) c) The overall level of profit earned in the industry would decrease. c) The overall level of profit earned in the industry would decrease. d) More output would be produced by the monopolist. d) More output would be produced by the monopolist. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers  MONOPOLY AND PUBLIC POLICY MONOPOLY CAUSES INEFFICIENCY Figure 13-8 A monopolist, by reducing output and raising prices, benefits at the expense of consumers. Monopoly is a source of inefficiency: the losses to consumers from monopoly behavior are larger than the gains to the monopolist. Monopoly leads to net losses to society’s welfare. Governments often try to either prevent or to limit monopolies. Panel (a), perfect competition: since price equals the producer’s ATC, there’s no profit and no producer surplus. Total surplus, equal to consumer surplus, is the entire shaded area. Panel (b), monopoly: the monopolist decreases output to QM and charges PM. The blue area shows consumer surplus; the green area shows profit; and the yellow area is a deadweight loss. As a result, total surplus falls. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers POLICY REMEDIES TO MONOPOLY DEALING WITH NATURAL MONOPOLY Natural monopolies are a different story: a large producer has lower If it’s a natural monopoly or a network externality industry, bigger average total cost than small producers and shouldn’t be broken up. is better for a consumer. These monopolies provide value for Yet, even a natural monopolist causes inefficiencies. Two policy options: consumers. If neither of those conditions apply, the best policy is to prevent – Public ownership: the government establishes a public agency to monopoly from arising or to break it up if it already exists. provide the good and protect consumers’ interests. This solution often Example: By 1878 John D. Rockefeller’s Standard Oil controlled works badly because publicly owned companies are often poorly run. almost all U.S. oil refining. But in 1911, a court order broke the – Regulation: a price ceiling imposed on a monopolist does not create company into a number of smaller units, including the companies shortages if it is not set too low. that later became Exxon and Mobil (and merged in 1999 to become ExxonMobil). The government policies used to prevent or limit monopolies are known as antitrust policies. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers  A NEW GENERATION OF MARKET POWER UNREGULATED AND REGULATED NATURAL MONOPOLY The rise of the digital economy and the network externalities provide new Figure 13-9 ways of gaining market power and of becoming a monopolist: Facebook, Microsoft, Apple, Google, eBay, Uber, and PayPal. “Bigger is better”: the biggest firm in the industry gets bigger, while smaller firms shrink. The dominant firm creates a deadweight loss and another inefficiency: stifling innovation. A federal court found Microsoft guilty of using its market dominance against rivals. The EU’s antitrust authorities accused Google of stifling innovation by blocking rivals across platforms. A monopsony exists when there is only one buyer of a good. The classic example is a single employer in a small town that is hiring workers. 2014: the two largest cable providers (Time Warner Cable and Comcast) If the monopoly’s price is regulated at PR, consumer announced their intention to merge. Amid strong opposition, the deal was canceled. surplus rises (and profits fall). Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers LEARN BY DOING DISCUSSION QUESTION PRICE DISCRIMINATION Consider monopolists caused by network externalities: So far we’ve been assuming our firm is a single-price Facebook, Microsoft, Apple, Google, eBay, Uber, and PayPal. monopolist: it offers its product to all consumers at the Choose one company and discuss if we should break the same price. monopolist up. Some firms practice price discrimination: they charge List pros and cons of breaking up this monopolist. different prices to different consumers for the same good. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers PRICE DISCRIMINATION AND PROFIT MAXIMIZATION THE LOGIC OF PRICE DISCRIMINATION Figure 13-10 Recall the profit-maximizing rule for firms with monopoly power: If the airline – Produce the Q at which MR = MC. could charge – Based on that Q, charge as much as the market will bear (found by two types of the position of the demand curve). customers two But what if you sell to more than one market, each with its own demand curve? different prices, – Example: senior citizens and young people, business travelers and leisure it would capture travelers. of all of the consumer surplus as profit. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers PRICE DISCRIMINATION AND ELASTICITY LEARN BY DOING PRACTICE QUESTION 3 Firms would distinguish between groups of customers on Person A reserves a car online weeks before a trip; person B walks up to a Hertz counter the basis of their sensitivity to the price—their price after he walks off an airplane after a four-hour flight. Who probably has more elastic elasticity of demand. demand for a Hertz rental car? Who probably gets charged more? a) Person B a more elastic demand and will be charged less. Example: business travelers have lower price elasticity of b) Person B has a more elastic demand and will be charged more. demand than nonbusiness travelers. Airlines impose rules c) Person A has a more elastic demand and will be charged more. that indirectly charge business and nonbusiness travelers d) Person A has a more elastic demand and will be charged less. different fares: fares are higher if you don’t stay over a Saturday night. Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers  LEARN BY DOING PRACTICE QUESTION 3 (Answer) PRICE DISCRIMINATION INCREASES SALES AND PROFITS Figure 13-11 Person A reserves a car online weeks before a trip; person B walks up to a Hertz counter after he walks off an airplane after a four-hour flight. Who probably has more elastic demand for a Hertz rental car? Who probably gets charged more? a) Person B a more elastic demand and will be charged less. b) Person B has a more elastic demand and will be charged more. c) Person A has a more elastic demand and will be charged more. d) Person A has a more elastic demand and will be charged less. (correct answer) Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers PERFECT PRICE DISCRIMINATION GRAPHING PERFECT PRICE DISCRIMINATION There is no deadweight loss because all mutually When perfect price discrimination can be employed, a firm will charge beneficial transactions are exploited. each customer a different price, the maximum price each is willing to pay. There is zero consumer surplus because the entire Under perfect price discrimination, the firm captures all consumer surplus as profit. surplus is captured by the monopolist in the form of profit. Haggling at the flea market: perfect price discrimination Figure 13-11 Krugman, Economics, 6e, © 2021 2020 Worth Publishers Krugman, Economics, 6e, © 2021 2020 Worth Publishers COMMON TECHNIQUES FOR PRICE DISCRIMINATION Advance purchase restrictions – Prices are lower for those who purchase well in advance Volume discounts – The price is lower if you buy a large quantity Two-part tariffs – A customer pays a flat fee upfront and then a per-unit fee on each item purchased Sales and outlet stores – Holding regular sales such as Black Friday sales, Labor Day sales, and so on; building an outlet store at a distance from the center of the city. Digital personalized pricing – Online retailers gather personal information on shoppers and adjust prices accordingly. Krugman, Economics, 6e, © 2021 2020 Worth Publishers