Chapter 10 Monopoly, Cartels, and Price Discrimination PDF

1 of 23 Chapter 10 Monopoly, Cartels, and Price Discrimination Copyright © 2008 Pearson Education Canada  2 of 23 In this chapter you will learn 1. why marginal revenue is less than price for a profit- maximi...

1 of 23 Chapter 10 Monopoly, Cartels, and Price Discrimination Copyright © 2008 Pearson Education Canada  2 of 23 In this chapter you will learn 1. why marginal revenue is less than price for a profit- maximizing monopolist. 2. how entry barriers allow monopolists to maintain positive profits in the long run. 3. how firms can form a cartel to restrict industry output and increase their profits. 4. why firms can increase their profits through price discrimination. Copyright © 2008 Pearson Education Canada  3 of 23 10.1 A SINGLE-PRICE MONOPOLIST Cost and Revenue in the Short Run A monopolist faces the (downward-sloping) market demand curve. If the monopolist charges the same price for all units sold, its total revenue (TR) is: TR = p x Q Copyright © 2008 Pearson Education Canada  4 of 23 Average revenue (AR) is total revenue divided by quantity: AR = TR/Q = (p x Q)/Q = p Marginal revenue (MR) is the revenue resulting from the sale of an additional unit of production: MR = TR/Q The monopolist must reduce the price to increase sales – therefore the MR curve is below the demand curve. Copyright © 2008 Pearson Education Canada  5 of 23 10 AR (demand MR 8 curve) p Q TR TR (TR/Q) 6 10 0 0 Dollars 4 90 9 9 10 90 70 7 8 20 160 2 50 5 7 30 210 30 3 0 6 40 240 10 1 -2 10 30 50 70 90 100 5 50 250 4 60 240 -10 -1 -4 Quantity -30 -3 3 70 210 -50 -5 -6 2 80 160 1 90 90 -70 -7 -8 MR -90 -9 0 100 0 -10 Copyright © 2008 Pearson Education Canada  6 of 23 Short-Run Profit Maximization MC ATC3 c3 The profit-maximizing ATC2 level of output is c 2 = p0 where MC = MR. ATC1 Price c1 A profit- D maximizing monopolist has MR p > MC. Q0 Output The size of fixed costs determine whether a monopolist earns positive economic profits. Copyright © 2008 Pearson Education Canada  7 of 23 Unlike a competitive firm, the monopolist does not have a supply curve because it chooses its price. Can we compare the monopoly outcome to the competitive outcome? In a perfectly competitive industry price equals MC. But a monopolist produces at a lower level of output, with price exceeding MC. Copyright © 2008 Pearson Education Canada  8 of 23 Copyright © 2008 Pearson Education Canada  9 of 23 Entry Barriers and Long-Run Equilibrium Despite incentives to enter, effective entry barriers allow monopoly profits to persist in the long run. Entry barriers are of two types: - “natural” – such as economies of scale - “created” – by advertising campaigns or – by government regulation Copyright © 2008 Pearson Education Canada  10 of 23 APPLYING ECONOMIC CONCEPTS 10-1 Entry Barriers for Irish Pubs Copyright © 2008 Pearson Education Canada  11 of 23 The Very Long Run and Creative Destruction In the very long run, technological changes and innovations can circumvent effective entry barriers. Joseph Schumpeter defended monopoly on the basis that the pursuit of monopoly profits provides incentives to innovate. He called the replacement of one monopolist by another through innovation the process of creative destruction. Copyright © 2008 Pearson Education Canada  12 of 23 Joseph Schumpeter (1882-1950) “What we have to accept is that [monopoly] has come to be the most powerful engine of progress and in particular of the long-run expansion of total output not only in spite of, but to a considerable extent through, this strategy [of creating monopolies], which looks so restrictive when viewed in the individual case and from the individual point of time.” LESSONS FROM HISTORY 10- 1 Creative Destruction Through History Copyright © 2008 Pearson Education Canada  13 of 23 10.2 CARTELS AS MONOPOLIES Several firms in an industry may form a cartel to maximize joint profits. The Effects of Cartelization S = MC Cartelization will Dollars per Unit pm reduce output and pc raise price from the perfectly competitive levels. D Qm Qc Output Copyright © 2008 Pearson Education Canada MR  14 of 23 Problems That Cartels Face Cartels tend to be unstable because members have an incentive to cheat. Market Equilibrium Firm Incentives Dollars per Unit Dollars per Unit S ATC MC p1 p1 E p0 p0 D MR 0 Q1 Q0 0 q1 q0 q2 Output Output Copyright © 2008 Pearson Education Canada  15 of 23 Any one firm within the cartel has an incentive to cheat. But if all firms cheat, the price will fall back toward the competitive level, and joint profits will not be maximized. Enforcing output restrictions and preventing entry are difficult. Thus, cartels rarely last for long. Copyright © 2008 Pearson Education Canada  16 of 23 10.3 PRICE DISCRIMINATION A producer practices price discrimination by charging different prices for the same products that have the same cost. Central to this is that different consumers value the product at different amounts. Any firm facing a downward-sloping demand curve can increase profits if it is able to price discriminate. Copyright © 2008 Pearson Education Canada  17 of 23 When Price Discrimination Is Possible 1. When firms have market power. 2. When consumers differ in their valuations of the product. 3. When firms can prevent arbitrage. Copyright © 2008 Pearson Education Canada  18 of 23 Different Forms of Price Discrimination Price Discrimination Among Units of Output A firm captures consumer surplus by charging different prices for different units sold. “Perfect” price discrimination transfers all consumer surplus to the seller. Copyright © 2008 Pearson Education Canada  19 of 23 Consumer surplus MC p1 p2 p3 p4 Pric e p5 p6 Demand Q1 Q2 Q3 Q4 Q5 Q6 Quantity Copyright © 2008 Pearson Education Canada  20 of 23 Price Discrimination Among Market Segments Price Price Segment A Segment B pA pB MCA MCB DB DA MRB QA Output QB Output MRA Profit maximization requires that MR be equalized across the two segments.  higher price in the segment with less elastic demand. Copyright © 2008 Pearson Education Canada  21 of 23 In recent years, Canadian entrepreneurs have taken advantage of international price discrimination in prescription drugs by creating on-line businesses to sell inexpensive drugs from Canada to U.S. consumers. For a detailed discussion, look for “The Growing Battle Over On-Line Prescription Drugs” in the Additional Topics section of this book’s MyEconLab. www.myeconlab.com Copyright © 2008 Pearson Education Canada  22 of 23 The Consequences of Price Discrimination Price discrimination increases firms’ profits (otherwise they wouldn’t do it!). For price discrimination by the unit, firms will often increase their output and overall efficiency will increase. The effect on consumers is unclear – they may lose consumer surplus, but they could also gain surplus (if output increases as a result). Copyright © 2008 Pearson Education Canada  23 of 23 Copyright © 2008 Pearson Education Canada