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7/29/2019 Monopoly SlidesMonopoly slidesMonopoly slidesMonopoly slidesMonopoly slidesMonopoly slidesMonopoly slidesMonopoly slidesMonopoly slidesMonopoly slides

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that has no close substitutes and faces many

.

he firm and the industr are identical.

The demand curve faced by the firm is the

downward-sloping industry demand curve.

A monopo y acts as a price-ma er


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-

demand curve sets a constraint on the

The monopolist can either set the price

demand curve

r e erm ne e quan y o e so anthen find the price at which this quantitycan e so


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That is, it can set a price above marginal cost

depends on the definition of the market

product has no close substitutes

If we define the market too broadl a

monopolist may appear to have rivals

If we define it too narrowl we ma identif afirm as a monopoly when it is not


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Where Do Mono olies Come From?1 Government blocks the entry of more than

one rm n o a mar e . y2 One firm has control of a ke resource

necessary to produce a good.

firm has a natural monopoly.

4 Being first to produce a new product (iPod)


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Where Do Mono olies Come From?Entry Blocked by Government Action

The government blocks entry in two main ways:

1 By granting apatentor copyrightto anindividual or firm, giving it the exclusive rightto produce a product.

2 By granting a firm apublic franchise, making

service.


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Where Do Monopolies Come From?

Entry Blocked by Government Action

Patent The exclusive right to a product for some.

Copyright A government-granted exclusive rightto pro uce an se a creat on.

Public Franchises

Public franchise A designation by the

of a good or service.


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Where Do Mono olies Come From?Control of a Key Resource

Another way for a firm to become a monopoly isby controlling a key resource.

ALCOA example


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Forever?

Monopoly

sentimental value of diamonds as

a way to maintain its position inthe diamond market.

.logue.htm


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a profit because AClies below thedemand curve at

some quantities wo firms cannot

make positive profits

es a ove half orall quantities

17-9


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-

curve facing the monopolist be P = P(Q),.

The total cost function is C = C(Q). e monopo st tr es to max m ze

= TR C,

where TR = P(Q).Q and TC = C(Q).


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-

d/dQ = dTR/dQ dC/dQ = 0,

.e., = .

=> MR = MC.The second order condition is

2 2

=


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$

ro axmza onC

400Rt'

300

c

150

200

Profits

t

100

50c

Quantity0 5 10 15 20


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P = a bQ,

w at s t e equat on

TR = PQ = aQ bQ2

Then

= = AR = TR/Q = a bQ for Q > 0.


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Average and Marginal Revenue$ per 7

un o

output 6

4

5

Average Revenue (Demand)

3

1MarginalRevenue

Output0 1 2 3 4 5 6 7


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.

But TR = PXQ.

ence

MR = P + Q(dP/dQ) = P(1 1/e)


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Maximizing Profit When Marginal Revenue

E uals Mar inal Cost

$ per

P1

MC

un o

output

AC

P*

Lostprofit

=

2

Lostprofit

MR

Q1 QuantityQ* Q2


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-,

for e < 1, MR will be negative

So long as MC > 0, profit-maximization,

i.e. e > 1.

The monopolist will operate on the elasticportion of the demand curve.


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The Monopolists Output Decision

An Example

C(Q) = 50 + Q2

P(Q) = 40 Q

,

= => = =


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ro ax m za on$/Q

MC40

AC

30

ro

AR

20

15

MR

10

Quantity

0 5 10 15 20


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Curve

- The elasticity of demand affects amonopo st s pr ce re at ve to ts marg nacost

- Check the price-marginal cost margin: MC


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Then MR = MC implies

= p p = e

For a competitive firm, p = MC=> L = 0

,and the greater the monopolists ability to

.


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,

benefit to being a monopolist,

perfectly competitive market


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monopolist?- ,

that there will be no effect on either,

monopolist will now be maximizing T.


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imposed.

P = a Q, C = cQ, a > c. hen Q* = (a c)/2 and P* = (a + c)/2.

Next let the tax be im osed on uantit

at the rate t, a > (c+t).


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becomes C = (c+t)Q.=

price P** = (a+c+t)/2.

ence, - = t , w c s ows t atprice has increased by only half the

amoun o e ax per un .


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However it is not enerall true that the rice

increases by less than the tax. Suppose that the demand curve is a constant-

. MR = P(1 1/e).

E uatin this to MC = c and solvin we et P =c/(1 1/e).

After the tax is imposed, price is P = (c+t)/(1 .

P P = t/(1 1/e). Since e > 1 1 1 e is a fraction and therefore

the increase in price exceeds t.


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MONOPOLY

e E ect o a Tax

Suppose a specific tax oftdollars per unit is levied, so that the

sells. If MC was the firms original marginal cost, its optimalproduction decision is now given by

Effect of Excise Tax on Monopolist

With a tax tper unit, the firmseffective marginal cost isincreased by the amount ttoMC + t.

In this example, the increase inprice Pis larger than the tax t.


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Res onse to Chan es in Cost How do monopolies and perfectly competitive markets

Consider the case of a marginal cost increase by agiven amount at every level of output xamp e: a spec c ax, , on rms

Thepass-through rateis the increase in price that

occurs in response to a small increase in marginal cost,measure per o ar o increase in margina cost

In a competitive market, the pass-through rate is neverreater than one

The monopolists pass-through rate depends on theshape of the demand curve -

curve


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.

in two respects.,

equilibrium is when price is driven down to

curve productive efficiency is attained.

onopo s s no orce o pro uce a elowest point of the average cost.


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.

where the potential gains from trade

realized allocative efficiency

The monopoly charges a price that is

g er an marg na cos an ere s adeadweight loss under monopoly.


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Does Monopoly Reduce Economic Efficiency?

Comparing Monopoly and Perfect Competition

What Happens If a Perfectly Competit ive

Industry Becomes a Monopoly?


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and lower quantities,

consumers and producers in the

We can compare producer and consumer

surp us w en n a compe ve mar e anin a monopolistic market


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Does Monopoly Reduce Economic Efficiency?

Measuring the Efficiency Losses from Monopoly

The Ineffic iency of Monopoly


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Firms can make investments in an effort tobecome a monopolist Example: cable TV firms lobbying government

If firms compete to become a monopolist, they

will spend up to the full monopoly profit (Richardosner If they spend on socially wasteful things (e.g.,

olf outin s for local officials the loss from

monopoly may be larger than deadweight lossand include all monopoly profit


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devoted to securing a monopoly position

always be so bad

xpen tures rms ma e to ga nmonopoly positions can be socially

va ua e e.g., spen ng n esearch for patentable drugs)


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and a lower output than a comparable,

restrict monopoly power in various ways.


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- anges t e eman curve ac ng t e rm

- The profit-maximizing output formonopoly becomes the same as theperfectly competitive output


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If price is lowered to PC outputincreases to its maximum QC and

MR

ere s no ea we g oss. $/Q

MCPm

AC

P2 = PC

If left alone, a monopolistproduces Qm and charges Pm.

Qm QuantityQc


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e oc a os s o onopo y ower

Natural Monopoly

an industry at a cost lower than what it would

be if there were several firms. C(Q) < C(q1) + C(q2) + C(q3) + .. +

C(qn), where Q = q1+q2+ ..+qn

e average cos curve s ownwarsloping, then there is natural monopoly

,


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Su ose that the total cost function is C = 50 +

10Q. If output per day is 25, one firm can produce thisamount at an average cost o s. an totacost of Rs.300.

,produces 12 units while the other produces 13units, the total cost of production is 170 + 180 =

Rs.350 which is greater than the cost ofproduction of a single firm.

Regulating the Price


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Regulating the Priceof a Natural Mono ol

$/Q

Natural monopolies occur

economies of scale

Quantity

Regulating the Price


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Regulating the Priceof a Natural Mono ol

$/Q

Unregulated, the monopolis twould produce Qm and

char e P .

If the price were regulate to be PC,the firm would lose money

and go out of business.

Setting the price at Pryields the largest possib le

output;excess profi t is zero.

Pm

MC

ACPr

AR

MR

C

QuantityQr QCQm

i d


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First-Best vs. Second-Best

rce eguaton Under regulation, ideally prices will be set at the competitive

pr ce

Price at which demand and supply curves intersect A re ate sur lus will be maximized First-best solutionto problem of price regulation

Two problems with achieving this lead to second-best

re ulation Regulator may not know the firms marginal costs First-best solution would cause the monopolist to lose money

Best the regulator can do is set a price that makes

aggregate surplus as large as possible, allow the firm to

Set P = AC17-43


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regulation:'

and demand functions because they change

with evolvin market conditions Regulated monopolists make many decisions

other than about rice re ulation ma lead

to inefficiencies wrt these decisions


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the maximization of aggregate surplus-

objectives, e.g. provision of services to

oor consumers- Regulators may be appointed/elected

they can try to improve chances of repeat

appointment or reelection- Regulators may be captured by the

regulated firm


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- There is no need for elaborate regulatory

- Managers have no incentive to overstate

But there is no focus on profits which

- the politicians and bureaucrats have their


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-

- Adds to cost- ut s ts eman curve

Letp = price

=

q = q(a, p), q/a > 0, q/p < 0.

q = o er cos s


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Dorfman-Steiner model

Consider a profit-maximizing monopolist:

= pq a, p q a, p a

To maximize profit:

p = q + pq/p (C/q)(q/p) = 0 (1)

a = pq/a (C/q)(q/a) 1 = 0 (2)From (1),

+ =

[p C/q]/p = -(q/p)/(q/p) = 1/ep (3)


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Dorfman-Steiner model

,

(p C/ q)(q/ a) = 1 p q = q a

(p C/q) = (a/q)/(a/q)(q/a)(p C/q) = (a/q)/(1/ea) (4)

,

[(a/q)/ea][1/p] = 1/epa pq = ea ep


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-= a p

| |

as a proportion of sales elasticities

revenue

Ifep is large, then less will be spent onadvertising the product

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