Market Structure: Monopoly

BA 1310 Week 10-1 M AR K E T S T R UC T U R E : M ON OP OLY Focus of Lecture In this lecture, we continue our investigation of different market structures. We look at the idealized case of monopoly, which is at the opposite side of the spectrum as perfect competition. Along the way, we will draw...

BA 1310 Week 10-1 M AR K E T S T R UC T U R E : M ON OP OLY Focus of Lecture In this lecture, we continue our investigation of different market structures. We look at the idealized case of monopoly, which is at the opposite side of the spectrum as perfect competition. Along the way, we will draw contrasts with perfect competition. What is a Monopoly? A monopoly refers to a firm that is the only producer of a good or service with no close substitutes. ◦ A firm is a perfect monopoly if it controls the entire market. ◦ A firm has monopoly power if it can manipulate the price. A natural monopoly refers to a market where a single firm can produce the entire market quantity demanded at a lower cost than multiple firms. Why Do Monopolies Exist? Monopolies exist because of barriers to entry that prevent other firms from entering the market. ◦ Scarce resources ◦ Government intervention (e.g., patents/copyright or regulations) ◦ Economies of scale, including “network externalities” ◦ Aggressive business tactics Monopoly versus Competition Competitive firm Monopoly firm Price taker Price maker, Small, one of many market power Faces individual Faces the entire demand at P: market demand: perfectly elastic downward sloping demand demand Monopolists and the Demand Curve Perfectly competitive Monopolistic Price ($) Price ($) Any price higher than the market 1. A monopolist price results in can charge any zero quantity 5,000 price… demanded. 2. But the price 1,000 D 2,500 affects the quantity Producers can sell demanded any quantity at market price. D 0 0 3 8 Quantity of diamonds Quantity of diamonds Firms cannot affect the market Monopolists can affect the price through their production market price, but are decisions. constrained by the market demand curve. Monopoly Revenue When a monopolist produces more of a good, the market price is driven down. Therefore, producing an additional unit of output has two effects on total revenue: ◦ Quantity effect: Revenue increases on strength of new sales. ◦ Price effect: Revenue decreases because price is now lower on all sales (new and old). Total revenue might increase or decrease, depending on which effect is larger. Therefore, marginal revenue is always less than price! Review the chapter on elasticity of you need a refresher or more detail. Monopoly Revenue (1) (2) (3) (4) (5) The table displays TR, AR, M arginal A verage P rice Quantity sold Total revenue and MR. revenue R evenue ( $/ diamond) ( Violet diamonds) ( $) ( $) ( $/ diamond) Total revenue is maximized 6,500 0 0 6,000 0 6,000 1 6,000 6,000 when MR = $0. 5,000 5,500 2 11,000 5,500 4,000 Notice AR = P and are 5,000 3 15,000 3,000 5,000 4,500 4 18,000 4,500 greater than or equal to 4,000 5 20,000 2,000 4,000 MR. 3,500 6 21,000 1,000 3,500 0 3,000 7 21,000 3,000 Again, we see that MR < P. 2,500 8 20,000 -1,000 2,500 -2,000 2,000 9 18,000 2,000 -3,000 1,500 10 15,000 1,500  Monopoly Revenue When marginal revenue is 25,000 1. A The MR curve intersects the x-axis at monopolist's the revenue-maximizing quantity. greater than 0, then total total revenue revenue increases. 20,000 first increases... When marginal revenue is less 2. …then than zero, then total revenue 15,000 decreases. decreases. The total revenue maximizing 10,000 TR point is identified where MR = $0. 5,000 Think about grades. If you have a B D (=AR) average, but get: 0 1 2 3 4 5 6 7 8 9 1 0 11 12 An A in this class, your GPA increases. MR A C in this class, your GPA decreases. - 5,000 Quantity of violet diamonds Monopoly Profit-Maximizing Quantity While revenue is important, firms maximize profits. The profit-maximizing quantity of output for a monopoly is found where marginal revenue equals marginal cost. ◦ This is the same marginal decision-making analysis used in perfectly competitive markets.  Monopoly Profit Maximization MC, MR, ATC ($) 8,000 The profit-maximizing 7,000 MC quantity is identified where MR = MC, point B. 6,000 5,000 ATC The price is determined A 4,500 by the point on the 4,000 demand curve that 3,000 B corresponds to the profit- maximizing quantity, 2,000 D point A. 1,000 MR Price is higher than the 0 marginal revenue. 1 2 3 4 5 6 7 8 9 10 Quantity of violet diamonds  Monopoly Profit Maximization MC, MR, ATC ($) Monopoly Profit per unit = P- 8,000 profit ATC. 7,000 MC Profit per Vertical distance between unit 6,000 A and B. ATC 5,000 A Profit = (P - ATC) × Q. 4,500 4,000 B Since P > MC and barriers 3,000 to entry exist, 2,000 monopolists earn positive D economic profits in the 1,000 long-run. MR 0 1 2 3 4 5 6 7 8 9 10 Quantity of violet diamonds  Exit the market if: TR < TC Monopolist Long-Run (same Decision​ as: P < Enter theATC)​ market if: TR > TC ​ (same Short-run Decision to Shut Down As with the competitive firm, a monopoly firm will choose to shut down if TR < TVC, or P < AVC ◦ Produce Q = 0 in the short run Efficiency Loss of Monopoly  Unlike perfectly competitive firms, monopolies may earn economic profit in the Monopoly versus long run. All else equal, a Competition monopoly market will have a higher price and lower output than a perfectly competitive market. Problems with Monopoly Monopoly power benefits monopolists but causes social welfare losses. In a competitive market, the equilibrium price and quantity maximize total surplus. Monopolists produce at a lower quantity than the efficient level. ◦ Total surplus is not maximized. ◦ Producer surplus (monopolist profit) increases. ◦ Consumer surplus decreases. ◦ The loss of total surplus is a deadweight loss equal to the total surplus under perfect competition minus the total surplus under a monopoly. Monopoly vs. Perfect Competition (a) Competitive Market (b) Competitive Firm Price Dollars per per 2. and each firm produces Unit Unit 1,000 units, where P = MC. S MC ATC E $10 3. When monopoly $10 d takes over, the old market supply curve... D Quantity of Quantity of 100,000 1,000 Output Output 1. In this competitive market of 100 firms, equilibrium price is $10  (c) Monopoly Price per Unit S = MC F 4. becomes the monopoly's MC curve. $15 E 5. The monopoly produces where MR = MC, 10 6. with a higher price and lower market output than under perfect competition. MR D Quantity of 100,000 Output 60,000 The Welfare Cost of Monopolies Competitive market equilibrium: ◦At P = MC and maximizes total surplus Monopoly equilibrium: at P > MR = MC ◦The value to buyers of an additional unit (P) exceeds the cost of the resources needed to produce that unit (MC). ◦The monopoly Q is too low – could increase total surplus with a larger Q. ◦Single-price Monopoly results in a deadweight loss. The Welfare Costs of Monopolies Efficient market Inefficient monopoly MC, MR ($)equilibrium MC, MR ($) market Consumer Consumer surplus surplus Producer Producer surplus surplus Deadweight MC A loss MC 4,500 C 3,500 B 2,250 D D MR MR 0 6 0 4 Quantity of violet Quantity of violet diamonds diamonds Total surplus is maximized and Consumer surplus decreases there is no deadweight loss. because of the lower quantity and higher price. Monopolists earn positive economic profits. Price Discrimination  Price discrimination occurs when a firm charges different prices to different customers for reasons other than differences in costs. Price Consumers with less elastic demands Discrimination are charged higher prices. Consumers with more elastic demands are charged lower prices. Price discrimination increases output and profits.  Market Power Price Ability to Identify Discrimination Differing Willingness Requirements to Pay Ability to Prevent Resale Type of Price Discrimination First-degree price Second-degree discrimination Third-degree price price (perfect price discrimination discrimination discrimination) First-degree price Second-degree Third-degree discrimination price price involves selling a discrimination discrimination product at the targets groups of sets different exact price that consumers with prices based on each customer is lower prices the demographics willing to pay. made possible of subsets of a No DWL through bulk client base. buying. Also known as volume discounting  Market Power and Price Discrimination Suppose Microsoft has the following potential customers for MS Office. Only Price business 1 million ‘business owner’ customers willing ($) owners buy Business 225 owners and to pay $225. standard users buy 1 million ‘standard user’ customers willing 150 to pay $150. All customers buy 1 million ‘student’ customers willing to pay 75 $75. Deman Microsoft also has fixed costs of $50 million. d 0 1 2 3 Millions of copies of Office Market Power and Price Discrimination What price should Microsoft charge for Office to maximize profits without price discrimination? Price Number of Total Fixed Costs Profits ($) ($) copies Revenue ($) ($) 75 3,000,000 225,000,000 50,000,000 175,000,00 0 150 2,000,000 300,000,000 50,000,000 250,000,00 0 225 1,000,000 225,000,000 50,000,000 175,000,00 0 A price of $150 maximizes profits. Charging $150, Microsoft loses the business of students. Perfect Price Discrimination No price discrimination Imperfect price Perfect price discrimination Price discrimination Price Price ($) ($) Consumer ($) surplus 300 300 Producer 300 surplus Business price = Deadweight loss 225 $225 Standard price = 150 150 $150 Student price = 75 $75 D D D 0 0 2 4 0 1 2 3 4 Millions of copies of Millions of copies of Millions of copies of Office Sets price equal to Officeprice of $150 to One Office Sets price per each each customer’s all customers. group of customers. willingness to pay. Loses student Earns profits Earns profits from customers. from all all customers. Results in a customers. Zero deadweight deadweight loss. Results in smaller loss and consumer deadweight loss.  Price discrimination can raise the price for some consumers above the price they would pay under a single- price policy. The additional profit for the firm comes at the expense of the Welfare Effects consumers who pay more. of Perfect Price Price discrimination can lower the Discrimination price for some consumers below the price they would pay under a single- price policy. Those consumers benefit, while the firm earns higher profit. What To Do With Monopolies? Use available anti-trust laws to break-up the company into smaller components ◦ Standard Oil, AT&T, current discussion surrounding big-tech. Use regulation to limit the monopolist’s pricing ability ◦ Utility companies Public ownership ◦ Utility companies Do nothing ◦ Recent history … but maybe changing Antitrust law 1890 1914 The Sherman Antitrust Act The Federal Trade Commission Act The Sherman Antitrust Act declared monopoly illegal The Federal Trade Commission Act created the and prohibited restraint of trade (price-fixing). Federal Trade Commission (FTC) to investigate unfair business practices and false advertising. The Clayton Act The Clayton Act specified unreasonable trade restraints or unfair business practices to clarify the Sherman Act. 1914  Natural Monopoly Profit A natural monopolist produces QM and charges PM and earns a profit. PM Average Cost CM If the government regulates a competitive solution where P=MC, the monopolist charges PC and produces QC for a CC loss. Loss ATC PC MC MR D 0 QM QC Quantity