Chapter 10 Monopoly

Chapter 10

Monopoly

3 Properties of Monopoly

1) One Seller2) No Close Substitutes

3) Extremely High Barriers to Entry

What are the barriers to entry?

1) Government Restrictions – Patents

2) Economies of Scale – Natural Monopoly

3) Restricted Ownership of Raw Material - ALCOA

Monopoly and Microsoft

Computers in the early 1980’s1) Apple II

2) Commodore PC3) Atari 400 (48k)

4) TRS-805) IBM PC

All had incompatible operating systems

Next Generation – Mid 1980’s

1) Early Macs2) Commodore Amiga

3) Atari ST4) ---

5) IBM 386’s, 486’s

The Amiga and Atari ST are dying of software suffocation.

By the late 1990’s, only the IBM and its clones, and the Mac are

IBM doesn’t have near monopoly because of the clones, but

Microsoft does for Windows

Microsoft starts to use this monopoly of Windows to take over word processing and web browsing

Government Antitrust Suit Against Microsoft (1999)

Bush wins the election of 2000 and the Republican lawyers drop the

case in return for Microsoft’s promise not to do it again.

This is a variation of the economies of scale. How can you make a computer/operating system to

compete with Microsoft when the software industry is designed to work with Windows? You would

have to provide your own software, which would mean

starting on a huge scale.

If this is the market demand curve for the monopoly’s product, what is the monopoly firm’s demand curve?

Market

The firm’s demand curve is the same as the market’s because the firm is

the market.

Market

What’s the relationship between price and marginal revenue for a monopoly? Q P TR MR 0 $10 $0 -- 1 $8 $8 $8 2 $6 $12 $4 3 $4 $12 $0 4 $2 $8 -$4 5 $0 $0 -$8

What’s the relationship between price and marginal revenue for a monopoly? Q P TR MR 0 $10 $0 -- Marginal revenue is 1 $8 $8 $8 below price because 2 $6 $12 $4 each additional unit 3 $4 $12 $0 you sell causes the 4 $2 $8 -$4 price of the other 5 $0 $0 -$8 units to drop also.

Suppose McDonalds is currently selling 100 hamburgers at 50 cents

each. TR = $50

They lower their price to 40 cents and now sell 150. Will their total revenue rise by 50 hamburgers

times 40 cents = $20?

No. Total revenue rises by 50 hamburgers times 40 cents minus 100 hamburgers times 10 cents = $10.

Let’s double-check. Q x P = TR

100 hamburgers x 50 cents = $50150 hamburgers x 40 cents = $60

Yep, it checks.

How to graph the demand and marginal revenue curve for a

monopoly.

For straight lines, the MR curve hits the horizontal axis halfway between where the demand curve does and the origin.0

So how much will the monopolist produce, and what price will he charge? Q P TR TC π MR MC 0 $10 $0 $0 -$10 --- --- 1 $8 $8 $3 $5 $8 $3 2 $6 $12 $6 $6 $4 $3 3 $4 $12 $9 $3 $0 $3 4 $2 $8 $12 -$4 -$4 $3 5 $0 $0 $15 -$15 -$8 $3

The Marginal Decision Rule AgainProduce the Quantity Where

Then up to the demand curve to determine the price.

Profit or Loss? Same rule as before.P>ATC ProfitP<ATC Loss

Price and quantity of donuts in a market with perfect competition.

MC=ATCPc=0.4

Qc=600

Perfect Competition

Price and quantity of donuts in a monopoly.

MC=ATCPc=0.4

Qc=600

Monopoly MR=MC

MRQm=300

Pm=0.7

m for monopolyc for competitive

With perfect competition, the price of donuts is 40 cents and 600 are made.

With monopoly, the price of the donuts is 70 cents and 300 are made.

The monopolist makes less of the product to create a scarcity and raise

the price up.

Price discrimination is charging different prices to different

customers.

You would like to charge a higher price to the customers at the higher end of the

demand curve.

Who are these people? Sometimes they are richer people.

What traits are associated with being poor?

Traditionally, retired seniors have been poor, and students.

It costs $6 to make dinners at your restaurant. When you charge $12, you get

one customer, when you charge $10, you get two. Would you rather charge $12 or $10?

Can you do better with price discrimination?

What if you have noticed the additional customers when it is cheaper are mostly

seniors?

Charge straight $12Profit = $12 - $6 = $6

Charge straight $10Profit = $20 - $12 = $8

Charge one customer $12 and the other (senior) $10.

Profit = $22 - $12 = $10

This could also explain student discounts at the movie theater.

What else could distinguish people from the high price end of the

demand curve and the lower end?

Think about men and women if this was demand for baseball tickets.

And what if it was demand at the hair salon?

There’s a reason the Washington

Nationals have ladies night and not mens night. There’s a reason California

hair salons were sued for charging

women higher prices.

What about quantity discounts? There’s a reason bakers give a free donut if you buy a dozen. Donuts price = $1. Cost of making

donuts = 50 cents.

Sell 8 and charge for them all.Profit = $8 - $4 = $4

Sell 13 and charge for 12.Profit = $12 - $6.50 = $5.50

NEW YORK NYC Human Rights Commission Drops Charges Against Chinese Restaurant

By Meg Marco May 2, 2007 The case of the Wisconsin man who

filed a complaint with the NYC Human Rights Commission has come to a close with the commission dropping charges

against the restaurant.

… “We saw other customers getting a different menu. We were told we

could order from it if we spoke Chinese.” The Chinese menu had prices that were, on average, $1

cheaper per dish.

Soon after the dust-up, Mayor Bloomberg urged a boycott of the shady Chinese restaurant. “It’s unconscionable

to use race on any of these things, in terms of what kind of service, or how you charge, or whatever,” Bloomberg

told the Daily News.

The Human Rights Commission dropped the charges after the guy from Wisconsin settled with the

restaurant for an undisclosed sum and, “a promise to change its

menu – by “listing identical prices in English and Chinese for the

same dishes,”

Chapter 11Monopolistic Competition and

Oligopoly

Monopolistic Competition

1) Many Sellers2) Similar Products or

Differentiated Products3) Easy Entry/Exit

Restaurants are the “typical” example of monopolistic

competition that we are usually going to use. Other examples are barbers and hair salons, and auto-

repair shops.

So what does the demand curve look like for a firm in monopolistic

competition?

Perfect Competition Monopoly

If McDonalds raises the price of the Big Mac by 10 cents, do they lose

all of their customers?

Do they have to lower their price to sell more?

So McDonalds demand curve slopes down like a monopoly. It does probably lose more

customers with a price increase than a monopoly, so it will be flatter.

Monopolistic Competition Monopoly

You don’t have to worry about drawing it flatter. We’ll assume the units on the axis take card of that.

Monopolistic Competition Monopoly

Since the demand curve slopes down showing that Rosa has to lower the price of all her spaghetti dinners to sell more, her

marginal revenue is below price.

Now it is simply adding the MC and setting MR=MC as before.

And guess what? The rule about showing a profit and loss is the same too. P> ATC then profit. P<ATC then

What about profits in the long-run?

What happens when you have both easy entry and differentiated

goods?

Imagine restaurants in Bakersfield are making positive economic profits. What

will happen to the number of restaurants?

These new restaurants will keep opening until profits for the typical restaurant are driven to $0. Does

this mean all restaurants are making $0 profit like the wheat farms in perfect competition?

Some places, probably only a few, will be able to differentiate themselves enough from the

their competitors to keep their profits.

So the result will be that profits usually go to zero in the long-run,

but not always.

Though even if you have a better restaurant in some way and can

make profits even in the long-run, it will be hard to maintain that

advantage.

Oligopoly1) Few Sellers

2) Identical or Differentiated Products

3) High Barriers to Entry

Most of the famous brand name competition you know falls in this category: 1) Ford, GM, Chrysler 2) Coca-Cola and Pepsi 3) Nike and Adidas

The high barrier to entry is often that the factories have economies

of scale, so there is a high fixed cost to enter.

There might also be strong brand loyalty and its associated high

advertising cost.

For once we don’t have a demand curve and the rule to set MC=MR.

Why not?

Ford currently has price P1 and is selling Q1 cars. What happens if

they have a 20% off sale? D1 – GM doesn’t change priceD2 – GM cuts price 10%D3 – GM cuts price 20%

Q1 ? ? ?

Unless Ford knows how GM is going to respond, they don’t know

many additional sales they are going to get with a price cut.

The key word for oligopoly is interdependence.

Why haven’t we worried about how competitors respond to our

price changes before?

1) Monopolies don’t have competitors.

2) In Perfect Competition, we don’t lower our price. If we did, our

competitors would laugh at us and keep charging the equilibrium

price.3) What about Monopolistic

Competition?

400 restaurants in Bakersfield. Rosa’s Italian Restaurant serves 200 dinners in a typical night.

Rosa cuts her price by 20% and gains 20% more customers. BTW, what is her elasticity of demand if

this happens?

Rosa’s gets 40 more customers a night. How many customers do most

of the 400 other restaurants in Bakersfield lose?

So how do they respond?

Rosa's Italian Restaurant Open everyday! (661) 872-1606

This is Rosa’s demand curve for her spaghetti dinners. What am I assuming the other restaurants are doing as she lowers her price from P1 to P2? P1P2

Can I make the same assumption between Ford and GM?

So what are we going to do?

East U.S. Steel and West U.S. Steel are the two competing steel companies in the country. Steel costs $10 a ton to make. Currently they are competing and have a price of $11 a ton.

If they cooperate in setting a price that will make the most money for them jointly, how would you find that price?

Act like a monopoly, reduce output and raise price until MR = MC. Now the price is $13 and they are jointly producing Qm.

$11$13

These two firms are price fixing. Price fixing is when firms agree to

jointly produce less output and raise the price.

A cartel is a group of businesses that are price fixing or in collusion.

This is in many cases illegal. But it is like everything else, it is only

illegal if you get caught.

You don’t announce it or admit it … unless you get caught.

So, is that it? Big firms will always successfully collude unless the

government stops them?

No, there is something else, something called the Prisoner’s Dilemma.

Suppose the police pick up 2 men they suspect of bank robbery. They have enough evidence to convict them for illegal possession of a gun,

but need a confession to get them for bank robbery.

Prisoner 2

Prisoner 1

Hold Out ConfessHold Out

Confess

Pris 1: 1 YearPris 2: 1 Year

Pris 1: 0 YearsPris 2: 20 Years

Cooperation in holding out is the best joint outcome, but it is hard to get their because, given what the other person has done, confessing is always the best choice for each

individual to make.

The Dark Knight Film Clip

So what does this all have to do with cartels?

Firm 2

Firm 1

Keep Agreement Cheat

Keep Agreement

Firm 1: $60Firm 2: $60

Firm 1: $10Firm 2: $90

Firm 1: $90Firm 2: $10

Firm 1: $30Firm 2: $30

So we have two forces acting on the firms at the same time.

1) The awareness that they make more money if they cooperate than

if they both don’t.2) The awareness each has that he

makes the most money if he says he will cooperate, but then doesn’t.

So it is not certain in this model what will happen, but that fits real

life, where many different outcomes have occurred.

What makes a cartel more likely to work?

1) Less Firms2) More Personal Trust

3) Easier to Watch the Other Guy4) A Way to Punish the Other Guy5) Stable Demand For the Product

6) Repeated Opportunities

Suppose it costs $100 to fly someone from LAX to SFO. The airlines could

agree on a price of $200 but would be vulnerable to the prisoner’s dilemma

What if they can get the government to set them a price of

$160? Are they safe from the prisoner’s dilemma?

How else do airlines compete besides price?

This quality of service competition raises the cost of flying a passenger up close to

$160. So are the airlines making high profits from their guaranteed high price of

The same story explains why banks famously used to give something away when you opened a bank

account.

What happened to the free toasters?

Chapter 12

Wages and Employment in Perfect Competition

What does economics have to say about the wages workers make and

how many are hired?

N Q MPPL N=Number Workers3 150 -- Q=Quantity Cookies4 200 50 MPPL=Marginal 5 240 40 Physical 6 270 30 Product of7 290 20 Labor

New Term – Marginal Revenue Product of Labor = Increase in Total Revenue Achieved by Adding One More Worker

N Q MPPL MRPL

3 150 -- 4 200 50 5 240 40 6 270 30 7 290 20

If the price of a box of cookies is 3 dollars each, then:

N Q MPPL MRPL

3 150 -- 4 200 50 $150 5 240 40 $120 6 270 30 $90 7 290 20 $60

Marginal Factor Cost = MFC = Increase in total cost caused by

buying one more input.

If MFC = $135, how many workers would you hire? What if MFC = $75?

N Q MPPL MRPL

3 150 -- 4 200 50 $150 5 240 40 $120 6 270 30 $90 7 290 20 $60

So the rule is buy workers up to the point where MRP = MFC.

Graph of MRP for this business.

$120$90

4 5 6 7

The MRP curve is the demand curve for labor

$120$90

4 N1 5 6 N2 7

Now that we have the individual firm’s demand curve for labor, we

can add all the firm’s individual demand curves to get the market

demand for that kind of labor.

Here is the total demand curve. Now we add in the supply curve.

$120$90

40 50 60 70

$60Firm demand curves

Equilibrium wage is $90 and 55 workers are hired.

$120$90

40 50 60 70

What if technological progress increases MRP and thus Demand?

$120$90

40 50 60 70

$60DL2

Increase in equilibrium wage from $90 to $120 and number of

workers hired from 55 to 60.

The name for the theory of wages we are using here is the Marginal

Productivity Theory of Factor Input Prices. It state that under

competition, factor inputs are paid the marginal revenue produce.

Imagine a bag of fertilizer that has a MRP of $90. In other words, one bag

used on farm land will cause $90 more wheat to grow. What will its price in the farm supply store be? Could it be $60?

At $60, there will be a rush to buy it. Buying it is like buying a box that you can put $60 in one end

and $90 comes out the other. This will cause a shortage that will drive up the price. The rush will last till

the price reaches $90.

If the price starts at $120, then no one will want to buy it until the

price falls to $90. The equilibrium price will adjust to its MRP of $90.

Same for pop singers. Suppose Shakira makes $5 million revenue for her

record company. Further suppose they are currently paying her $1 million. Do

they like that deal?

Of course they do. But how can the record company across the street see a way to make money for themselves out of this situation when her contract with theoriginal company expires?

With many firms “bidding” for her services, her price should end up at

$5 million.

If there was only the one firm, they could stand firm at $1 million.

As for pop singers, so for accountants. If accountants make

an MRP of $80,000 for their businesses, their wage should be $80,000. Can you explain why?

Let’s clear up a couple of loose ends.

1) When we say workers are paid their MRP, do we mean they all get the same wage or different wages.2) If a business pays all its workers

all they produce, how can they stay in business? Will there be anything

left over for profit?

Let’s attach names to our workers. Remember, price = $3.

N Q MPPL MRPL

3 150 -- Amy 4 200 50 $150 Bart 5 240 40 $120 Carla 6 270 30 $90 David 7 290 20 $60

What is the most the company is willing to pay David to show up?

N Q MPPL MRPL

If the workers are interchangeable, what is the most they are willing to pay Amy to show up?

N Q MPPL MRPL

So long as the workers are interchangeable, all of them end

up getting paid $60, not just David. The MRP of a person is not

necessarily the same as the MRP of the job they are doing.

If Amy is not interchangeable with the others, then she can get $150

while they get $60 each.

What is total revenue to the company from 290 cookies. What is the labor bill?

N Q MPPL MRPL

Total Revenue P x Q = $870.Wage Bill = $60 x 7 = $420.

This does not guarantee a profit as there are other costs, but there is a

chance for one.

What if the market wage is $90 and government raises it to $120?

N Q MPPL MRPL

Raising the minimum wage from $90 to $120.

$120$90

4 5 6 7

Minimum wage of $120.

$120$90

40 N2 50 N1 60 70

SLSurplus Labor

Let’s tell a long-term story of men, women, technology, and MRP

In the old days (say 1014), we know that men and women had

different rights and responsibilities. By our standards, it was an

unequal society. Why?

What percentage of the jobs depending at least partly on

physical strength to do the job well?

(Almost) everyone is poor, what is your retirement plan?

Given your retirement plan, and given that half your kids are going

to die before adulthood, how many kids do you want to have?

How many jobs depend heavily on physical strength now?

What caused this?

In the terminology of this chapter, technology has made the MRP of men and women equal. And this

has had great social consequences.

What matters know is what you know, not how big a rock

you can lift.

This same thing has increased the inequality between the educated

and the uneducated.

Who knows what the future will bring … but I do know one thing.

You want training that will work with the machines and not against

Chapter 7

The Analysis ofConsumer Choice

So you go to the store and buy a bag of groceries. I stop you

outside the store and ask why you bought that combination of goods and not a different combination.

You answer something like, “These are the things I like the best for the

money.”

Economists call the benefit or satisfaction you get from

something its utility.

You make your choices on what to buy or do to get the most utility possible. Utility is an all things

considered measure of benefit, not just how pleasurable something is.

1st Donut 2nd 3rd 4th Marginal 10 utils 8 utils 3 utils -1 utils Utility

Total 10 utils 18 utils 21 utils 20 utilsUtility

If the donuts are free, how many donuts would you take?

Law of Diminishing Marginal Utility – As you get more of a good or

activity, the increase in total utility decreases with each additional

Are there are any goods or activities that do not have

diminishing marginal utility?

Does money have diminishing marginal utility?

Since goods have diminishing marginal utility and money is used to buy goods, money should also. The dollar you get that you use to

buy donut number 3 is less beneficial to you than the dollar you get to buy donut number 1.

Do people get utility from things that happen after they are dead?

If they don’t, how do you explain buying life insurance?

So how does all this explain how much of everything we buy at the

store?

You want to get as much benefit as you can for the money you have.

This means you want to get as many utils per dollar as you can.

Shopping is trying to get the most bang for the buck.

Imagine everything in the store costs $1 and how much of each would you buy if you had $1 … $2 … $3 … $4?

Candy Milk Eggs1st 14 8 62nd 10 4 53rd 7 2 3

Now what if you had $4 and candy cost $2 while the rest cost $1? Assume you can buy fractions of candy.

The benefit you get from buying something is determined by

comparing how much you like it to its price. Of course we call how

much you like it the marginal utility. So the benefit of spending a

dollar on good X is MUx/Px

MUx/Px for our 3 goods when price of candy is $2 so this is the return in utils per dollar spent.

Candy Milk Eggs1st 7 8 62nd 5 4 53rd 3.5 2 3

So our decision rule in choosing between 2 goods is to buy the one

for which MU/P is higher.

You are going to buy either an apple or orange. The MU of the apple is

12 and the orange is 4. The price of the apple is $4 and the orange is $2,

which do you buy?

The apple, because you like it three times as much and it is only twice as expensive.

12 utils > 4 utils$4 $2

To the economist, shopping is always and only about comparing how much you like the thing to

its price.

But what if you are going to buy more than one apple or one

orange? You start out buying the one with the higher MU/P, but as you buy more of it, its MU drops, and eventually its MU/P becomes

lower than for the other good, then you switch over to buying the other

That’s exactly what happened in our candy, milk, and eggs example.

When you are done with shopping, it should be the case that how much you like the last unit of each item you buy compared to its

price should be close to how much you like the last unit of every other item purchased

compared to its price.

If that’s not true, then you should put back the item which has an MU/P less than the other things and buy more of the item which

has the higher MU/P.

Carried to its logical conclusion, this means buy your items so that

all your money is spent and for everything you buy

MUA = MUB = MUC = … = MUZ

PA PB PC PZ

What about things in the store you don’t buy at all? For those items, MU/P for even the first item you would buy would be below MU/P for the last item of everything you

do buy.

Another way to look at it is to realize MU/P is the return in utils for $1 more spent on the good. Given a choice, you will always spend so that you get the most

utils per dollar (the most bang for the buck).

MU is the benefit from getting one more unit, and 1/P is how many

units you get for one dollar. So the benefit from one more dollars

worth is MU x 1/P = MU/P.

When you head to the check-out stand, the return to spending one dollar more on anything in your

card should be the same as spending one dollar more on

anything else in your cart. The equation is just the mathematical

way of saying this.

Question 1:

The utility of an orange is higher than the utility of an apple. Can we be sure the shopper will buy

the orange over the apple?

Question 2:

The price of a donut and the price of an apple are the same, and the utility of the donut is higher, but

the person is on a diet. Can we be sure the person will buy a donut

over buying an apple?

Question 3: 1st Donut 2nd 3rd 4th

Marginal 10 utils 8 utils 3 utils -1 utils Utility

Total 10 utils 18 utils 21 utils 20 utilsUtility

Would you necessarily buy 3 donuts?

Last topic – Yay!!!!

So how does all this create the demand curve? We’ve actually

done it already.

Imagine everything in the store costs $1 and how much of each would you buy if you had $1 … $2 … $3 … $4?

Now what if you had $4 and candy cost $2 while the rest cost $1? Assume you can buy fractions of candy.

Here is the demand curve for candy.

At a dollar a piece, you buy candy until the return to another dollars worth of candy is below whatever else you could spend that money

Now the price doubles to $2. You only get half as much candy for a dollar, so you are getting half the

return in utils for that dollar spent on candy. Better to spend that

money on other things (more bang for the buck).

But as you buy less candy, the MU of the candy rises till finally a

dollars worth of candy is equal in utils to everything else again, and that is the new smaller amount of

candy you buy.

PA PB PC PZ

https://www.youtube.com/watch?v=W_WU-q9wQ8I&list=RDW_WU-q9wQ8I

And now … 40 hours of microeconomics summed up in 5 minutes.

Chapter 10 Monopoly

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