Econ 101 Principles of Microeconomics Lecture Notes PDF

ECON 101 – Principles of Microeconomics Instructor: Kairon Shayne D. Garcia TA: Keanu Hua Office: SSPA 351 Office: SSPA 323 Office Hours: 9:00am-11:00am M/W Office Hours: 3:30pm-4:30pm W/Th (in-person) (in-person) Email: k...

ECON 101 – Principles of Microeconomics Instructor: Kairon Shayne D. Garcia TA: Keanu Hua Office: SSPA 351 Office: SSPA 323 Office Hours: 9:00am-11:00am M/W Office Hours: 3:30pm-4:30pm W/Th (in-person) (in-person) Email: [email protected] Email: [email protected] Module 27: Monopoly in Practice Learning Points Monopoly characteristics Effect of monopoly on a firm’s price and output decisions Learning Points Recall the firm’s optimal output rule: a profit-maximizing firm produces the quantity of output at which the marginal cost of producing the last unit of output equals marginal revenue. That is, at the profit-maximizing quantity of output, 𝑀𝑅 = 𝑀𝐶. Although the optimal rule holds for all firm, its application leads to a different profit-maximizing output levels for a monopolist compared to a firm in a perfectly competitive industry. HOW A MONOPOLIST MAXIMIZES PROFIT Competitive firms cannot choose price. Figure 27-1 (a) Because an individual perfectly competitive producer cannot affect the market price of a good, it faces the horizontal demand curve 𝐷𝐶. It allows to sell as much as it wants at the market price. HOW A MONOPOLIST MAXIMIZES PROFIT Monopolists can affect the price. Figure 27-1 (b) A monopolist can affect price. Because it is the sole supplier in the industry, it faces the market demand curve 𝐷𝑀. To sell more output, it must lower the price; by reducing output, it raises the price.  PROFIT- MAXIMIZING RULE All firms follow the same rule: – Profit is maximized at the Q where MR = MC. So what does MR look like? MR = ∆TR / ∆Q MARGINAL REVENUE AND THE DEMAND CURVE An increase in production by a monopolist has two opposing effects on revenue: – A quantity effect: one more unit is sold, increasing total revenue by the price at which the unit is sold. – A price effect: to sell the last unit, the monopolist must cut the market price on all units sold; this decreases total revenue. MARGINAL REVENUE AND THE DEMAND CURVE 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. In other words, a monopolist’s marginal revenue from selling an additional unit is always less than the price the monopolist receives for the previous unit. HOW A MONOPOLIST MAXIMIZES PROFIT Monopolists can affect the price. Figure 27-1 (b) This downward slope creates a difference – a “wedge”– between the price of the good and the marginal revenue received by the monopolist for that good. DEMAND, TOTAL REVENUE, AND MARGINAL REVENUE TABLE 27-1 Demand, Total Revenue, and Marginal Revenue for the De Beers Monopoly WHY MARGINAL REVENUE DIFFERS FROM PRICE FOR A MONOPOLIST After the first diamond, the marginal revenue a monopolist receives from selling one more unit is less than the price at which that unit is sold. For example, if De Beers sells 10 diamonds, The price at which the 10th diamond is sold is $500. The marginal revenue is only $50 WHY MARGINAL REVENUE DIFFERS FROM PRICE FOR A MONOPOLIST The marginal revenue from that 10th diamond is less than the price because an increase in production by a monopolist has two opposing effects: 1. A quantity effect. One more unit is sold, increasing total revenue by the price at which the unit is sold (in this case, +$500). 2. A price effect. To sell the last unit, the monopolist must cut the price on all units sold. ❑ This decreases total revenue: 9 x -$50 = -$450 – Hence, the marginal revenue from selling 9 units to 10 units is $50.  Figure 27-2 (a,b) A MONOPOLIST’S DEMAND, TOTAL REVENUE, AND MARGINAL REVENUE CURVES  A MONOPOLIST’S DEMAND, TOTAL REVENUE, AND MARGINAL REVENUE CURVES Consider point A on the demand curve, where 9 diamonds are sold at $550 each, generating a total revenue of $4,950. To sell a 10th diamond, the price on all 10 diamonds must be cut to $500, as shown in point B.  A MONOPOLIST’S DEMAND, TOTAL REVENUE, AND MARGINAL REVENUE CURVES As a result: Total revenue increases by the green area (the quantity effect: +$500) But decreases by the yellow area (the price effect: -$450). So the marginal revenue from the 10th diamond is $50 (the difference between the green and yellow areas).  A MONOPOLIST’S DEMAND, TOTAL REVENUE, AND MARGINAL Figure 27-2 (a,b) REVENUE CURVES Panel (b) shows the monopolist’s total revenue curve for diamonds. As output goes from 0 to 10 diamonds, total revenue increases. It reaches its maximum at 10 diamonds, and declines thereafter.  A MONOPOLIST’S DEMAND, TOTAL REVENUE, AND MARGINAL Figure 27-2 (a,b) REVENUE CURVES The quantity effect dominates the price effect when total revenue is rising The price effect dominates the quantity effect when total revenue is falling. PROFIT MAXIMIZATION FOR A MONOPOLY Profit maximization consists of two steps: 1. Choosing a quantity ▪ 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. THE MONOPOLIST’S PROFIT-MAXIMIZING OUTPUT AND PRICE Figure 27-2 Note: Here, the MC curve is simplified to be constant. We can relax this simplification later. PROFIT MAXIMIZATION FOR A MONOPOLY Profit = 𝑇𝑅 − 𝑇𝐶 = 𝑷𝑴 × 𝑸𝑴 − 𝑨𝑻𝑪𝑴 × 𝑸𝑴 = 𝑷𝑴 − 𝑨𝑻𝑪𝑴 × 𝑸𝑴  PITFALLS: IS THERE A MONOPOLY SUPPLY CURVE? You might be tempted to ask about the supply curve of a monopolist. Monopolists don’t have supply curves—since they control prices there is no set relationship between price and quantity supplied.  GRAPHING THE MONOPOLIST’S PROFIT Figure 27-4 As long as the monopoly has strong barriers to entry, profit will stay. iClicker Question iClicker QUESTION How are you? a) Great b) Good c) Been better d) Not sure Module 28: Monopoly, Government Policy, and Social Welfare Learning Points Monopoly and social welfare Policy tools to address the problem of monopoly Sample of monopolists  MONOPOLY AND PUBLIC POLICY A monopolist, by reducing output and raising prices, benefits at the expense of consumers. It’s profitable to be a monopolist, but it’s not so beneficial to be a monopolist’s customer. Buyers and sellers always have conflicting interests: buyers want lower prices, while sellers want higher prices.  MONOPOLY AND PUBLIC POLICY Is the conflict under monopoly any different than it is under perfect competition? – Yes, because monopoly is a source of inefficiency: the losses to consumers from monopoly behavior are larger than the gains to the monopolist.  MONOPOLY AND PUBLIC POLICY Monopoly leads to net losses to society’s welfare. Governments often try to either prevent or to limit monopolies. – Anti-trust policies Federal judge rules against Google in massive antitrust lawsuit https://youtu.be/THqS8799JkM?si=LaMZJ6PP4WELOlp4  MONOPOLY CAUSES INEFFICIENCY Figure 28-1 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.  MONOPOLY CAUSES INEFFICIENCY Figure 28-1 Comparing panels (a) & (b), we see Redistribution of surplus from consumers to the monopolist The sum of profit and consumer surplus –total surplus –is smaller under monopoly than under perfect competition. Total surplus shrinks by the yellow triangle, DWL, as the market goes from perfect competition to monopoly.  SOURCES OF MONOPOLY POWER 1. Source: Control of a scarce resource or input. – Policy Prescription: break up the monopoly by compelling the monopolist to share the scarce resource or input with rivals. ▪ For example, in the case of De Beers, regulators can force the company to sell its mines to rivals. ▪ Today, regulators today actively seek to prevent creation of monopoly by disallowing mergers between rivals when their combined market share would give them substantial market power.  SOURCES OF MONOPOLY POWER 2. Source: Technological Superiority. ▪ Over time, rivals will innovate to overcome the monopolist’s technological advantage. ▪ For example, in the 1960s and 1970s, the market for computers was dominated by IBM’s mainframe computers. Overtime, IBM’s market power melted away as innovation led to the creation of personal computers, smartphones, and cloud computing.  SOURCES OF MONOPOLY POWER 3. Source: Government-Created Barriers such as Patents. ▪ Government itself has created the monopoly for a limited time as a reward for innovation.  SOURCES OF MONOPOLY POWER 4. Source: Network Externalities. ▪ A single, dominant firm, arising from network externalities, such as Facebook, is typically aware that if it tries to raise price or degrade quality (such as running lots of ads), a rival network can quickly emerge. ▪ Network externality monopolists are usually limited in the harm they can inflict on consumers.  SOURCES OF MONOPOLY POWER 5. Source: Natural Monopoly. ▪ The optimal government policy is to allow the monopoly to operate, but to mitigate its adverse effects, usually by public ownership or regulation.  DEALING WITH NATURAL MONOPOLY Natural monopolies are a different story: a large producer has lower average total cost than small producers and shouldn’t be broken up. Yet, even a natural monopolist causes inefficiencies. Two policy options: – Public ownership: the government establishes a public agency to provide the good and protect consumers’ interests. This solution often works badly because publicly owned companies are often poorly run. – Regulation: a price ceiling imposed on a monopolist does not create shortages if it is not set too low.  UNREGULATED AND REGULATED NATURAL MONOPOLY Figure 28-2 If the monopoly’s price is regulated at PR, consumer surplus rises (and profits fall). Module 29: Price Discrimination Learning Points Price Discrimination Examples  PRICE DISCRIMINATION So far we’ve been assuming our firm is a single-price monopolist: it offers its product to all consumers at the same price. Some firms practice price discrimination: they charge different prices to different consumers for the same good. PRICE DISCRIMINATION AND PROFIT MAXIMIZATION Recall the profit-maximizing rule for firms with monopoly power: – Produce the Q at which MR = MC. – Based on that Q, charge as much as the market will bear (found by the position of the demand curve). But what if you sell to more than one market, each with its own demand curve? – Example: senior citizens and young people, business travelers and leisure travelers.  THE LOGIC OF PRICE DISCRIMINATION Figure 29-1 This airline has two types of customers: – Business travelers willing to pay at most $550 per ticket – Students willing to pay at most $150 per ticket.  THE LOGIC OF PRICE DISCRIMINATION Figure 29-1 There are 2,000 of each kind of customer. The airline has a constant marginal cost (MC) of $125 per seat.  THE LOGIC OF PRICE DISCRIMINATION Figure 29-1 If the airline could charge two types of customers two different prices, it would capture of all of the consumer surplus as profit. PRICE DISCRIMINATION AND ELASTICITY Firms would distinguish between groups of customers on the basis of their sensitivity to the price—their price elasticity of demand. Example: – Business travelers have lower price elasticity of demand than nonbusiness travelers. – Airlines impose rules that indirectly charge business and nonbusiness travelers different fares: fares are higher if you don’t stay over a Saturday night. PRICE DISCRIMINATION INCREASES SALES AND PROFITS Figure 29-2  PERFECT PRICE DISCRIMINATION When perfect price discrimination can be employed, a firm will charge each customer a different price, the maximum price each is willing to pay. Under perfect price discrimination, the firm captures all consumer surplus as profit. Haggling at the flea market: perfect price discrimination GRAPHING PERFECT PRICE DISCRIMINATION There is no deadweight loss because all mutually beneficial transactions are exploited. There is zero consumer surplus because the entire surplus is captured by the monopolist in the form of profit. Figure 29-2 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 COMMON TECHNIQUES FOR PRICE DISCRIMINATION 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. iClicker Question iClicker QUESTION 1 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? a) $24 b) $49 c) –$1 d) –$10 iClicker Question Practice Question 2 This fishing company is the only licensed fly-fishing guide in Matane, Quebec. If they maximize profit, then their profit will be equal to: a) (𝑃1 − 𝑃5 ) × 𝑄2 b) (𝑃1 − 𝑃4 ) × 𝑄2 c) (𝑃4 − 𝑃5 ) × 𝑄2 d) (𝑃2 − 𝑃3 ) × 𝑄3 Figure: Fly-Fishing Salmon Monopoly iClicker Question iClicker QUESTION 3 Suppose the elasticity of demand for tickets to hockey games is 0.3 for fans, and 2.0 for nonfans. To achieve higher profit through price discrimination, ticket sellers should charge lower prices to ____, since their demand is more _____. a) fans; elastic than that of nonfans b) fans; inelastic than that of nonfans c) nonfans; elastic than that of fans d) nonfans; inelastic than that of fans iClicker Question iClicker QUESTION 1 (Answer) 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? a) $24 b) $49 𝑇𝑅 = 𝑃 ∗ 𝑄 c) –$1 (correct answer) At price=5, d) – $10 𝑇𝑅 = 5 × 5 = 25 At price=4, 𝑇𝑅 = 4 × 6 = 24 ∆𝑇𝑅 24−25 𝑀𝑅 = = = −1 ∆𝑄 6−5 iClicker Question 2 (Answer) This fishing company is the only licensed fly-fishing guide in Matane, Quebec. If they maximize profit, then their profit will be equal to: a) (𝑃1 − 𝑃5 ) × 𝑄2 b) (𝑷𝟏 − 𝑷𝟒 ) × 𝑸𝟐 c) (𝑃4 − 𝑃5 ) × 𝑄2 d) (𝑃2 − 𝑃3 ) × 𝑄3 Figure: Fly-Fishing Salmon Monopoly iClicker QUESTION 3 Suppose the elasticity of demand for tickets to hockey games is 0.3 for fans, and 2.0 for nonfans. To achieve higher profit through price discrimination, ticket sellers should charge lower prices to ____, since their demand is more _____. a) fans; elastic than that of nonfans b) fans; inelastic than that of nonfans c) nonfans; elastic than that of fans d) nonfans; inelastic than that of fans