PowerPoint to accompany Chapter 8 Monopoly Markets.

PowerPoint

to accompany

Chapter 8

Monopoly Markets

Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia

Learning Objectives

1. Define monopoly.

2. Explain the four main reasons why monopolies arise.

3. Explain how a monopoly determines price and output.

4. Use a graph to illustrate how a monopoly affects economic surplus.

5. Discuss government policies towards a monopoly.


Austar rules the regions

Australian Pay TV industry is dominated by three players: Foxtel, Optus TV and Austar. Austar is the sole provider of Pay TV in rural Australia, i.e.: one of a few firms in Australia enjoying the benefits of being a monopoly.


Monopoly: The only seller of a good or service that does not have a close substitute.

LEARNING OBJECTIVE 1

Is any firm ever really a monopoly?


The End of the Singapore Education Bonanza

At one time, Perth universities earned large profits by exporting education to Singapore. However, many new rivals entered the industry, and now the large profits initially earned are a thing of the past.

MAKING THE CONNECTION8.1


Monopolies emerge due to a lack of competition created by barriers to entry.

The four main reasons for high barriers to entry are:

1. Government blocks the entry of more than one firm into a market.

2. One firm has control of a key resource material necessary to produce a good.


Where do monopolies come from?


3. There are important network externalities in supplying the good or service.

4. Economies of scale are so large that one firm has a natural monopoly.





1. Government blocks entry in two main ways:

i. By granting a patent or copyright to an individual or firm, which gives the exclusive right to produce a product or service for a period of time.

ii. By granting a firm a public franchise, which makes it the exclusive legal provider of a good or service.



2. Another way for a firm to become a monopoly is by controlling a key resource.

This happens infrequently because most resources are widely available from a variety of suppliers.




Are Diamond (Profits) Forever? The De Beers Diamond Monopoly

De Beers promoted the sentimental value of diamonds as a way to maintain its position in the diamond market.



3. Network externalities: These exist when the usefulness of a product increases with the number of consumers who use it.

Network externalities can set off a virtuous cycle: if a firm can attract enough customers initially, it can then attract more customers, which attracts even more customers, and so on.




4. Natural monopoly: A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms.




Price and cost

Quantity

Demand

0

0.06

0.04

30 billion

ATC

15 billion

Average total cost for a natural monopoly: Figure 8.1

B

A


Like every other firm, a monopoly maximises profit at the output when marginal revenue equals marginal cost (MR=MC).

However, the difference is that a monopoly’s demand curve is the same as the demand curve for the product (downward sloping).


How does a monopoly choose price and output?


Monopoly is a price maker. It does not face a horizontal demand curve.

In fact, both its demand curve and marginal revenue curve are downward-sloping; and

the marginal revenue curve is positioned below its demand curve.


How does a monopoly choose price and output?

Calculating a monopoly’s revenue: Figure 8.2


Price and revenue

Quantity

Demand = average revenue

Marginal revenue

0

To sell more, the price must be lowered. The marginal

revenue curve will be below the demand curve.

Profit-maximising quantity and price for a monopolist: Figure 8.3a


Price and cost

Quantity

Demand

MR

0

MC$60

42

6

27

Profit-maximising quantity

Profit-maximising

priceB

A

Profits for a monopolist: Figure 8.3b


Price and cost

Quantity

Demand

MR

0

MC$60

42

6

30

Profit-maximising quantity

Profit-maximising

priceB

A

ATC

Profit


Finding profit-maximising price and output for a monopolist

Suppose that Telstra has a monopoly for telephone lines in Armidale, NSW. The table on the next slide provides Telstra’s hypothetical demand and cost per month for telephone line rentals.

Fill in the missing values in the table.

If Telstra wants to maximise profits what price should it charge and how many line rentals per month should it sell? How much profit will it make? Briefly explain.

Suppose the local government imposes $8 per month tax on telephone line rental providers. Now what price should Telstra charge, how many line rentals should it sell and what will its profit be?



Finding profit-maximising price and output for a monopolist


PRICE QUANTITYTOTAL

REVENUE

MARGINAL REVENUE

(MR = ΔTR/ΔQ)TOTAL COST

MARGINALCOST

(MC = ΔTC/ΔQ)

$30 10 $290

29 11 308

28 12 324

27 13 339

26 14 355

25 15 373


Solving the problem:

STEP 1: Review the section ‘Profit maximisation for a monopolist’.


PRICE QUANTITYTOTAL

REVENUE

MARGINAL REVENUE

(MR = ΔTR/ΔQ)TOTAL COST

MARGINALCOST

(MC = ΔTC/ΔQ)

$30 10 $300 –$29

0 –

29 11 319 19 308 $18

28 12 336 17 324 16

27 13 351 15 339 15

26 14 364 13 355 16

25 15 375 11 373 18


STEP 2: Determine profit-maximising quantity and price to answer question 2.

MC=MR is at the output of 13 line rentals per month. Price is equal to $27 at that output. Telstra's profit is the difference between total revenue and total cost: profit = $351-$339=$12 per month.

STEP 3: To answer question 3 make an adjustment in calculation to incorporate the tax impact.

This tax is a fixed cost to Telstra because it is a flat $8, no matter how many line rentals it sells. Since there is no impact on Telstra’s marginal revenue or marginal cost, the profit-maximising level of output has not changed. Telstra will continue to sell 13 line rentals per month at a price of $27, but profits will fall by the amount of the tax from $12 to $4 per month.



We know that equilibrium in a perfectly competitive market results in the greatest amount of economic surplus, or total benefit to society, from the production of a good or service.

However, a monopoly will produce less and charge a higher price than would a perfectly competitive industry producing the same good.


Does monopoly reduce economic efficiency?

(b) Monopoly

0

(a) Perfect competition

Quantity

Supply

Demand

Pc

Demand

What happens if a perfectly competitive industry becomes a monopoly? Figure 8.4

1. If the industry becomes a monopoly, the supply curve becomes the monopolist’s marginal cost curve.

Qc

Price and

cost per unit

Quantity0 Qc

Pc

If the industry is perfectly competitive, the intersection of the demand and supply curves determines equilibrium price and quantity.


Price and

cost per unit

Pm

Qm

MC

MR

2. The monopolist reduces output to the level where MR = MC, …

3. …and charges a higher price.



The effects of monopoly can be summarised as follows:

1. Monopoly causes a reduction in consumer surplus.

2. Monopoly causes an increase in producer surplus.

3. Monopoly causes a deadweight loss, which represents a reduction in economic efficiency; (allocative inefficiency occurs).


The inefficiency of a monopoly: Figure 8.5


Price and cost

Quantity

DemandMR

0

MC

PM

PC

Qc

MCM

Transfer of consumer surplus to monopoly

BA

Qm

C

Deadweight loss from a monopoly

(B + C)

Marginal cost of the

last unit produced by

the monopoly


Market power and technological change

Market power: The ability of a firm to charge a price greater than marginal cost.

The introduction of new products requires firms to spend funds on research and development. Because firms with market power are more likely to earn economic profits, they are also more likely to introduce new products.




Collusion: An agreement among firms to charge the same price, or to otherwise not compete.

In Australia, trade practices laws are used to deal with monopolies, collusion and other forms of anti-competitive behaviour.

The laws usually make it illegal for large firms with market power to collude, and firms wishing to merge or take over another firm must apply for permission to do so.


Government policy toward monopoly


In Australia, competitive behaviour is monitored by the Australian Competition and Consumer Commission (ACCC).

The major regulatory law regarding trade practices is the Trade Practices Act 1974. It covers the following key areas:

Anti-competitive agreements, such as price fixing.

Exclusive dealing, such as (i) market sharing arrangements; and (ii) third line forcing.




Misuse of market power, such as predatory pricing.

Boycotts, such as an agreement between some suppliers and purchasers not to supply to, or purchase from, a particular firm or competitor.

Resale price maintenance.

Unconscionable and misleading conduct, such as deceiving people into signing contracts that they do not understand.

Product safety and reliability.




Anti-competitive behaviour in the cardboard box industry

Collusion between cardboard box producers raised the prices of many products for consumers.



Horizontal merger: A merger between firms in the same industry.

Vertical merger: A merger between firms at different stages of production of a good.

Mergers: The trade-off between market power and efficiency

Sometimes a merged firm is more efficient and has lower costs, and other times it does not.

The ACCC has the task to evaluate each individual case.



A merger that makes consumers better off: Figure 8.6


Price

Quantity

DemandMR0

MC before the merger

PM

PC

Qc

PMergeMerger with efficiency

gains

Qm

Merger with no efficiency

gains

MC after the merger

QMerge


Regulating natural monopolies:

In Australia, state regulatory commissions normally set the prices for natural monopolies.

The question is what the set price should be equal to?

Common options are: Price = Marginal cost

Price = Average total cost.

Two-part pricing.



Regulating a natural monopoly: Figure 8.7


Price and cost

Quantity

Demand

MR

0

MCPM

PR

QR

PE

Monopoly price

Regulated price

Efficient price

ATC

QEQM

Profit

Loss


An Inside LookMonopoly in the Pay TV industry: The C7 case


An Inside LookFigure 1: A profitable Pay TV company with a monopoly in a local market

Insert Figure 1 from page 245, as large as possible

while retaining clarity


An Inside LookFigure 2: An expanded market increases firm profit

Insert Figure 2 from page 245, as large as possible

while retaining clarity


Collusion

Copyright

Horizontal merger

Market power

Monopoly

Natural monopoly

Network externalities

Patent

Public franchise

Vertical merger

Key Terms


The common argument circulated by the Australian media that petrol prices are high because of, among other things, collusion between large petrol distributors.

Do you think this might be the case?

If so, why has the ACCC not taken decisive action to counteract it?

Find the report of the ACCC inquiry into the price of unleaded petrol published 18 December 2007 at:

http://www.accc.gov.au

Get Thinking!


Price discrimination: Charging different customers different prices for the same product when the price differences are not due to differences in production costs.

APPENDIX

Price discrimination


There are three requirements for successful price discrimination:

• A firm must possess a market power.

• The firm must know what different consumers are willing to pay

• The firm must be able to divide (segment) the market for the product.

APPENDIX



APPENDIX

Price discrimination by a cinema


Airlines: The kings of price discrimination

• Business travellers - more price inelastic

• Holiday travellers - more price elastic

• Economy, business and first class

• Day and time

• Season

Yield management: continually adjusting prices to take into account fluctuations in demand

APPENDIX



Perfect price discrimination: This occurs when each consumer has to pay a price equal to the consumer’s maximum willingness to pay (no consumer surplus).

Two key outcomes of price discrimination are:

• Firm profits increase

• Consumer surplus decreases

APPENDIX



APPENDIX

Perfect price discrimination


Q1. In which of the following situations can a firm be considered a monopoly?

a. When a firm is surrounded by other firms that produce close substitutes.

b. When a firm can ignore the actions of all other firms.

c. When a firm uses other firms’ prices in order to price its products.

d. When barriers to entry are eliminated.

Check Your Knowledge


Q2. If cost conditions are such that competition leads to higher costs and higher prices, how should the market in question be characterised?

a. As a perfectly competitive market.

b. As a monopolistically competitive market.

c. As an oligopoly.

d. As a natural monopoly.



Q3. Refer to the figure below. How much is the amount of profit when the firm serves six subscribers per month?

a. (42 – 27) x 6

b. (42 – 30) x 6

c. (30 – 27) x 6

d. $42.



Q4. Refer to the figure below. Which area shows the reduction in consumer surplus from the existence of monopoly?

a. Area A.

b. Area B + C.

c. Area A + B.

d. None of the areas

indicated on the graph.


PowerPoint to accompany Chapter 8 Monopoly Markets.

Documents

Transcript of PowerPoint to accompany Chapter 8 Monopoly Markets.