Monopoly 2024 PDF

Imperfect Market- Monopoly Dr. Sanja Samirana Pattnayak Monopoly ⚫ Monopoly 1. One seller - many buyers 2. One product (no good substitutes) 3. Barriers to entry 4. Price Maker – but a single price 2 What is Monopoly? ⚫ A monopoly...

Imperfect Market- Monopoly Dr. Sanja Samirana Pattnayak Monopoly ⚫ Monopoly 1. One seller - many buyers 2. One product (no good substitutes) 3. Barriers to entry 4. Price Maker – but a single price 2 What is Monopoly? ⚫ A monopoly exists when there is only one firm in the industry. ⚫ But whether an industry can be classified as monopoly is not always clear. It depends on how narrowly the industry is defined. Example: a textile company may have a monopoly on certain types of fabric, but it does not have a monopoly on fabrics in general. The consumer can buy fabrics other than those supplied by the company. 3 What is Monopoly? ⚫ To some extent the boundaries of an industry are arbitrary. what is more important for a firm is the amount of monopoly power it has, and that depends on substitutes produced by the rival industries. ⚫ The post office earlier had a monopoly over the delivery of letters, but it faces competition in communications from telephone, faxes and e-mail. 4 Source of Monopoly power ⚫ Ownership/Control over key inputs: if a firm governs the supply of vital inputs(say by owning the sole supplier of some components part, it can deny access to these inputs to potential rivals. ⚫ Example: on a world scale, the de Beers company has a monopoly in fine diamonds because all diamond producers market their diamonds through de Beers. 5 Source of Monopoly power ⚫ Economies of scope: A firm producing a range of products is also likely to experience a lower average cost of production. ⚫ Example: A large pharmaceutical company producing range of drugs and toiletries can use shared research, marketing, storage and transport facilities across its range of products. ⚫ These lower costs make it difficult for a new single- product entrant to enter market, since large firm will be able to undercut its price and drive it out of the market. 6 Source of Monopoly power ⚫ Legal protection: the firm’s monopoly position may be protected by patents on essential processes, by copy rights, by various forms of licensing (allowing say, only one firm to operate in a particular area) and by tariffs and trade restrictions to keep out foreign competitors. ⚫ Example: monopolies protected by patents include most new medicines developed by pharmaceutical companies, agro chemical companies such as Monsanto, with various genetically modified plant varieties and pesticides. 7 Source of Monopoly power ⚫ Mergers and takeovers: The monopolist can put in a takeover bid for any new entrants in the market. The threat of takeover may discourage new entrants. ⚫ Retained profits*: An established firm is likely to have some retained profits behind it. If a new firm enters the market the established firm could reduce prices and thus start a price war. The threat of this can act as a barriers to entry. ⚫ *The percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business. 8 Average & Marginal Revenue ⚫ The monopolist’s average revenue, price received per unit sold, is the market demand curve. ⚫ Monopolist also needs to find marginal revenue, change in revenue resulting from a unit change in output. 9 Average & Marginal Revenue ⚫ Finding Marginal Revenue As the sole producer, the monopolist works with the market demand to determine output and price. An example can be used to show the relationship between average and marginal revenue Assume a monopolist with demand: P=6-Q 10 Total, Marginal, and Average Revenue 11  Average and Marginal Revenue $ per 7 unit of output 6 For a linear demand curve, the marginal revenue has the same P 5 intercept and is twice as steep. 4 Average Revenue (Demand) 3 2 Marginal 1 Revenue 0 1 2 3 4 5 6 7 Output 12  Marginal Revenue and Own Price Elasticity of Demand $ per 7 unit of output 6 5 elastic 4 Unitary elastic 3 2 inelastic Marginal 1 Revenue Demand 0 1 2 3 4 5 6 7 Output 13 Why MR is less than P ? 14 A simple Example 15 Why MR is less than P ? 16 Why MR is less than P ? 17 Why MR is less than P ? 18 Why MR is less than P ? 19 20 21 22 23 Marginal Revenue and Elasticity ⚫ 24 25 Marginal Revenue and Linear Demand ⚫ 26 Marginal Revenue In Action ⚫ 27 Answer ⚫ 28 Monopolist Does not have a supply curve 29 Monopolist Does not have a supply curve ⚫ For monopolist, price is endogenous i.e., monopolist determines both quantity and price. ⚫ Depending on the shape of the demand curve, the monopolist might supply the same quantity at two different prices or different quantities at same price. ⚫ The unique association between price and supply does not exist as we see in perfect competition. ⚫ Thus a monopolist does not have a supply curve. 30 Monopolist Does not have a supply curve ⚫ Figure (slide 30) explains that for demand curve D1, the profit maximizing quantity is 5 million units per year and price $15 per unit. If the monopolist’s demand curve shifts to D2 the profit maximizing quantity continues to be 5 million but price per unit becomes $20. ⚫ It is thus possible, depending on the market demand, for a monopolist to sell a given profit maximizing quantity (5 million units) at different prices ($15 and $20). ⚫ Therefore, no unique supply curve exists for a monopolist. 31 Monopolist’s Output Decision ⚫  (Q) = R(Q) − C (Q)  / Q = R / Q − C / Q = 0 = MC − MR or MC = MR 32 Costs, Revenues, and Profits Under Monopoly 33 Under Monopoly with Profit curve 34  Monopolist’s Output Decision $ per unit of A profit output MC maximizing monopolist will P1 never price on the inelastic portion P* AC of the demand curve. Why? P2 Lost profit D = AR Lost MR profit Q1 Q* Q2 Quantity 35 Monopoly: An Example Cost = C (Q ) = 50 + Q 2 C MC = = 2Q Q Demand : P (Q ) = 40 − Q R(Q ) = P (Q )Q = 40 Q − Q 2 R MR = = 40 − 2Q Q 36 Monopoly: An Example MC = MR P (Q ) = 40 − Q 2Q = 40 − 2Q P (Q ) = 40 − 10 4Q = 40 P (Q ) = 30 Q = 10 37  Example of Profit Maximization $/Q 40 MC Profit = (P - AC) x Q = ($30 - $15)(10) = $150 P=30 AC Profit 20 AR AC=15 10 MR 0 5 10 15 20 Quantity 38 How Does a Monopolist Maximizes Profit Monopoly In Action ⚫ Answer ⚫ 41 Market Power ⚫ An economic agent has Market Power if s/he can affect (through his/her own actions) the price that prevails in the market. ⚫ Sometimes this is thought of as the degree to which a firm can raise price above marginal cost. 43 44 Market Pricing in Super Market ⚫ Consider a supermarket chain. Although the elasticity of market demand for food is small (about -1), several supermarkets usually serve most areas. ⚫ Thus no single supermarket can raise its prices very much without losing customers to other stores. As a result, the elasticity of demand for any one supermarket is often as large as (-10). ⚫ Substituting this number for Ed in equation (obtained in last slide), we find P = MC/(1 - 0.1) = MC/(0.9) = (1.11) MC. 45 ⚫ In other words, the manager of a typical supermarket should set prices about 11 percent above marginal cost. ⚫ For a reasonably wide range of output levels (over which the size of the store and the number of its employees will remain fixed), marginal cost includes the cost of purchasing the food at wholesale, plus the costs of storing the food, arranging it on the shelves, etc. ⚫ For most supermarkets, the mark-up is indeed about 10 or 11 percent. 46 The Multi-plant Firm ⚫ Many firms operate more than one production facility or serve more than one market each with different costs. ⚫ Example: Electric utility uses several power plants for generating electricity. ⚫ The theory of monopoly can be extended to cover the case of a multi-plant firm. 47 ⚫ 48 Multiplant Output Rule ⚫ Profit Maximization Rule for a two-plant monopolist: ⚫ Produce output in each plant such that MC of producing in each plant = MR of total output 49 ⚫ 50 The Multi-plant Firm ⚫ Therefore we can see that the firm should choose to produce where MR = MC1 = MC2 ⚫ We can show this graphically MR = MCT gives total output This point shows the MR for each firm Where MR crosses MC1 and MC2 shows the output for each firm 51 Production with Two Plants $/Q MC1 MC2 MCT P* MR* D = AR MR Q1 Q2 QT Quantity 52 Numerical Example ⚫ Suppose a monopolist’s analytics team estimated a inverse demand function as ⚫ P(Q)=70-0.5Q ⚫ The monopolist can produce output in two plants. The marginal cost of producing in plant 1 is MC1=3Q1 and in plant 2 is MC2=Q2. How much output should be produced in each plant to maximize profits, and what price should be charged for the product? Welfare Analysis of Monopoly ⚫ Monopoly outcomes results in higher prices and lower quantities. ⚫ However, does the monopoly outcome make consumers and producers in the aggregate better or worse off? ⚫ We can compare producer and consumer surplus when in a competitive market and in a monopolistic market 54 Deadweight Loss from Monopoly Power ⚫ We assume competitive market and the monopolist have same cost curves. ⚫ To maximize profit, the monopolist produces at the point where MR=MC, so price and quantity are pm and Qm. ⚫ In a competitive firm, P=MC and competitive price is pc and quantity is Qc (point of intersection of the AR curve and MC curve. 55 Deadweight Loss from Monopoly Power ⚫ Now compare surplus when we move from competitive price (pc) and quantity(Qc) to monopoly price (pm) and quantity (Qm). ⚫ Due to higher price, consumers who buy the good lose surplus of an amount given by rectangle A. ⚫ Those consumers who do not buy the good at price pm but who would buy at price pc also lose surplus, namely by an amount given by triangle B. 56 Deadweight Loss from Monopoly Power ⚫ Total loss of consumer surplus is given by A+B ⚫ The producer however, gains rectangle A by selling at a higher price but loses triangle C, the additional profit it would have earned by selling QcQm at price Pc. ⚫ Total gain in producer surplus is A-C. ⚫ Subtract the loss of consumer surplus from the gain in producer surplus, we see a net loss of surplus given by B+C. this is a deadweight loss from monopoly power. 57 Deadweight Loss from Monopoly Power ⚫ The deadweight loss is the social cost of this inefficiency. ⚫ Because of its social cost, antitrust laws prevent firms from accumulating excessive amount of monopoly power. ⚫ Price regulation is another means that govt. can use to limit monopoly power. 58  Deadweight Loss from Monopoly Power $/Q Lost Consumer Surplus Because of the higher price, consumers lose A+B MC and producer gains Deadweight Loss A-C. So from the Pm managerial perspective this A gives us benchmarks B for performance. PC C AR=D MR Qm QC Quantity 59 The Social Costs of Monopoly ⚫ Perfectly competitive firm will produce where MC = D → PC and QC ⚫ Monopoly produces where MR = MC, getting their price from the demand curve → PM and QM ⚫ There is a loss in consumer surplus when going from perfect competition to monopoly ⚫ A deadweight loss is also created with monopoly 60 Natural Monopolies ⚫ Natural Monopoly A firm that can produce the entire output of an industry at a cost lower than what it would be if there were several firms. Usually arises when there are large economies of scale. We can show that splitting the market into two firms results in higher AC for each firm than when only one firm was producing. 61 Natural Monopolies ⚫ Because AC is declining everywhere, MC is always below AC. ⚫ If unregulated, it produces Qm and sell at a price Pm. ⚫ Ideally, the regulatory agency would like to push the firm’s price down to the competitive level Pc. ⚫ At that price, however, price would not cover average cost and the firm would go out of business. ⚫ The best alternative however, is to set the price at Pr, where AC and AR curve intersect. ⚫ In that case, firm earns no monopoly profit, while output remains as large as possible without driving firm out of business. 62 Regulating the Prices of a Natural Monopoly $/Q Unregulated, the monopolist If the price were regulate to be Pc, would produce Qm and the firm would lose money charge Pm. and go out of business. Can’t cover average costs Setting the price at Pr giving profits as large as Pm possible without going out of business AC Pr MC PC AR MR Qm Qr QC Quantity 63 Examples ⚫ Example: ⚫ Satellite television broadcasting ⚫ Cost of satellite is fixed: it does not go up as the number of subscribers goes up. ⚫ A single firm needs just one satellite to serve the market, while two independent firms require two satellite to serve the same number of subscribers. Examples ⚫ Example: in 1990s British satellite broadcasting and sky television entered the satellite broadcasting market in UK ⚫ But with both firms neither could make profit ⚫ One point in time both losing more than 1 million dollar a day. ⚫ Eventually both merged forming BSkyB as monopolist 65 Cartel as a Monopoly 66 How does OPEC Allocates Production ⚫ To increase the world price of oil, OPEC must restrict their outputs, or else they will produce more oil than the world will demand. ⚫ Each member nation must therefore agree to an output quota. For example, in 1982, OPEC set an overall output limit of 18 million barrels per day, down from 31 million barrels per day in 1979. ⚫ Prices were to be maintained at $34 per barrel. Each member nation had an individual production quota, except for Saudi Arabia (the largest OPEC producer), which adjusted its output as necessary to maintain prices. 67 68 69