Chapter 8 - Monopoly, oligopoly, and monopolistic competition. Our agenda in chapter 7 is to develop more carefully and fully the concept of economic surplus introduced in part 1 and to investigate the conditions under which unregulated markets generate the largest possible economic surplus. We will also explore why attempts to interfere with market outcomes often lead to unintended and undesired consequences.
Monopoly, Oligopoly, and Monopolistic Competition Chapter McGrawHill/Irwin Copyright © 2015 by McGrawHill Education (Asia). All rights reserved.81 Learning Objectives Distinguish among three types of imperfectly competitive industries and describe how imperfect competition differs from perfect competition Identify the five sources of monopoly power and describe why economies of scale are the most enduring of the various sources of market power Apply the concepts of marginal cost and marginal revenue to find the output and price that maximizes a monopolist's profits Explain why the profit-maximizing output level for a monopolist is too small from society's perspective Discuss why firms offer discounts to buyers who are willing to jump a hurdle Discuss public policies that are often applied to natural monopolies 82 Imperfect Competition • Imperfectly competitive firms have some ability to set their own price: they are price setters – – • Long-run economic profits possible Reduce economic surplus Three types: Monopoly has only one seller, no close substitutes Monopolistic competition has many firms producing slightly differentiated products that are reasonably close substitutes Oligopoly has a small number of large firms producing products that are close substitutes 83 Monopolistic Competition Monopolistic Competition Perfect Competition Many firms Many firms Price Entry and Exit Product Limited flexibility Free Differentiated Price taker Free Standardized Economic Profits Zero in long run Zero in long run Decisions P, Q, product differentiation Q only Number of Firms 84 Oligopoly Oligopoly Perfect Competition Number of Firms Few firms, each large Many firms Price Entry and Exit Some flexibility Price taker Difficult Free Differentiated or standardized Standardized Economic Profits Possible Zero in long run Decisions P, Q, differentiation, advertising Q only Product 85 Imperfect Competition • Examples of monopoly – • Examples of monopolistic competition – – • Electricity and Magic Cards Retail gas stations Convenience stores Examples of oligopoly – – – Wireless phone service Cement Automobiles and tobacco 86 The Essential Difference • Imperfectly Competitive Firm Perfectly Competitive Firm Price • Market power is the firm's ability to raise its price without losing all its sales Any firm facing a downward sloping demand curve – Firm picks P and Q on the demand curve Market power comes from factors that limit competition Price • Quantity D D Quantity 87 Five Sources of Market Power Exclusive control over inputs Patents and copyrights Government licenses or franchises Economies of scale (natural monopolies) Network economies 88 Market Power: Economies of Scale Returns to scale refers to the percentage change in output from a given percentage change in ALL inputs • Long-run idea Constant returns to scale: doubling all inputs doubles output Increasing returns to scale: output increases by a greater percentage than the increase in inputs – – – • • Average costs decrease as output increases Natural monopoly: a monopoly that results from economies of scale 89 Market Power: Network Economies • Network economies occur when the value of the product increases as the number of users increases – – – – – VHS format for video tapes, Blu-ray for DVDs Telephones Windows operating system eBay Facebook and Whatsapp 810 Carla the Editor: Marginal Revenue What is Carla's marginal revenue? • papers with an economic profit of $21 Opportunity cost of Carla's time is $29 Student A B C D E F G Reservation Total Price Revenue $40 $40 38 $76 36 $108 34 $136 32 $160 30 $180 28 $196 MR $40 $36 $32 $28 $24 $20 $16 831 Carla the Editor: Price Discriminator What if Carla is a perfect price discriminator? • Opportunity cost of Carla's time is $29 Student A B C D E F G Reservation Total Price Revenue $40 $40 38 $78 36 $114 34 $148 32 $180 30 $210 28 $238 What is Carla's total revenue? papers with an economic profit of $36 832 Hurdle Method of Price Discrimination • The hurdle method of price discrimination is the practice of offering a discount to all buyers who overcome some obstacle – – – – – – Temporary sales Hard cover and paperback books Multiple car models from one manufacturer Commercial air carriers, e.g CX, JAL, SQ Movie producers, 2D and 3D versions Discount coupons with spending requirements 833 Carla Offers a Rebate papers, price $36, rebate $4, economic profit $27 • If reservation price < $36, student will mail in rebate Student Reservation Price Total Revenue A $40 $40 B 38 C 36 76 108 Discounted Price Submarket D $34 $34 E 32 64 F 30 90 MR $40 36 32 $34 30 26 834 Carla's Choices Program Social Optimum Single Price Perfect Discriminator Hurdle Papers Edited 6 = (3 + 2) Price $30 $36 Reservation $36, $4 rebate Total Revenue $180 $108 $210 $172 Carla's Time $174 $87 $174 $145 Economic Profit $6 $21 $36 $27 Total Surplus $26 $27 $36 $35 835 Monopoly and Public Policy • • Challenge: create the greatest increase in total surplus Policy options – – – – Government ownership and operation Regulation Competitive bids for natural monopoly services Break up 836 State-Owned Natural Monopoly • Marginal cost is always less than average cost Marginal cost pricing produces losses – • Options Fund losses from tax revenues Fixed monthly fee plus usage fee – – • • • Fixed fee covers losses Limited incentives to innovate and cut costs Commonly used for water, Post Office, and some electricity 837 Regulated Monopolies • • Cost-plus regulation sets price at per unit explicit costs plus a mark-up for implicit costs Used for electricity, telephone, and cable – • Policies vary by state Disadvantages – – – High administrative cost Reduced incentive for cost-saving innovation Price is greater than marginal cost 838 Exclusive Contracting for Natural Monopolies • Government awards contract to low bidder for natural monopoly services – • • Garbage collection, fire protection, road construction, Department of Defense Could achieve marginal cost pricing IF government pays the resulting losses Asset transfer for large fixed investment is complex 839 Enforcement of Anti-Trust Laws • Two landmark laws in the United States Sherman Act of 1890 – • Clayton Act of 1914 – • • Declared conspiracy to create a monopoly illegal Outlawed transactions that would "substantially lessen competition" Applies to mergers and acquisitions today – – IBM avoided break-up; AT&T did not Microsoft survived 840 Another Policy Option: Ignore Monopoly • Two objections to monopolies Restrict output, decrease total surplus Raise price, earn economic profits – – • Analysis Discount offers allow some customers to pay less than average cost, though more than marginal cost – • Economic profits generated by customers who pay list price – their choice About two-thirds of economic profits are taxed away – • Remainder accrues to shareholders 841 Imperfect Competition Imperfect Competition Monopolistic Competition and Oligopoly Sources of Market Power Monopoly Public Policy 842 The Algebra of Monopoly Maximization Chapter Appendix 843 From Demand to Marginal Revenue • • • Given a demand curve such as P = 15 – Q We can write the marginal revenue curve as MR = 15 – Q Suppose marginal cost is a line with zero intercept and a slope of MC = Q • The remaining step is to set marginal revenue equal to marginal cost 844 MR = MC • Let Q* be the profit maximizing level of output MC = MR Q* = 15 – Q* Q* = 15 Q* = • To find P, substitute Q = into the demand equation P = 15 – Q* P = 15 – (3) P=3 845 ... economic profit of $6 Opportunity cost of Carla's time is $29 Student A B C D E F G Total Reservatio n Price Revenue $40 $40 38 $76 36 $1 08 34 $136 32 $160 30 $ 180 28 $196 What if Carla is a profit... (units/week) 8 23 Monopoly Profit • • • • • • • Profit = Total revenue – total cost Total cost = ATC x Q Profit = P x Q – ATC x Q Profit = (P-ATC) x Q If P > ATC then the firm earns a profit If P... Intel supplies more than 80 % of the processors for PCs 8 18 Profit Maximization for the Monopolist • Like all other firms, a monopolist: – – Maximizes profits Applies the Cost-Benefit Principle: •