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Pure Monopoly
Look for:
Determination of the profit maximizing price and quantity.
Implications for efficiency
What should the government do?
Study monopoly as a Market Structure
To Better Understand monopolistic competition and oligopoly
Consist of elements of pure competition and pure monopoly
Please listen to the audio as you work through the slides.
Creative Commons Attribution 4.0 License, Charles Hackner Houston Community College unless otherwise noted CC BY NC
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1
Learning objectives
Students should be able to thoroughly and completely explain:
The characteristics of pure monopoly
The various barriers to entry that can be exploited by the monopolist.
In what region of the demand curve is the monopolist most likely to set price and why.
How the monopolist determines the profit maximizing level of output and price.
Price Discrimination and discuss the likely outcomes.
The dilemma of regulation
Summary of topics
Characteristics of Pure Monopoly
Sources of monopoly power
Barriers to entry
Model of monopoly demand
Analyze price and output decisions
Output and price determination
At what price – quantity pair will a profit maximizing monopolist choose to operate?
Cost considerations
Economic effects of pure monopoly
Efficiency issues
Price Discrimination
Regulated Monopoly issues
Market Structure Continuum
Pure
Competition
Pure
Monopoly
Monopolistic
Competition
Oligopoly
Four Market Models
Pure Monopoly:
Characteristics
Single Seller (seller = industry)
No Close Substitutes for the product sold
Price Maker – controls total quantity supplied and therefore price
Faces downward sloping demand curve
To increase sales, must lower price
Market Structure Continuum
Pure
Competition
Pure
Monopoly
Monopolistic
Competition
Oligopoly
Four Market Models
Pure Monopoly:
Characteristics
5. Entry blocked by monopolist
Blocking tools: Economic, technological, legal, etc.
6. Pure Monopoly firm sells:
Standardized product – natural gas, PR advertising
Differentiated product – cars, attribute advertising
Monopoly Examples
Pure Monopoly
Regulated Monopoly
local electric utility, cable TV
Check Texas PUC
Unregulated or near Monopoly
Branack Device Company – 80% Market
Luxottica – eyewear multinational (Italy)
Intel 90% market share
Barriers to Entry
1. Economies of Scale – declining ATC with increasing firm size - often due to technology, Intel
http://dividendmonk.com/7-companies-with-unrivaled-economies-of-scale/
2. The Natural Monopoly Case – market demand curve cuts the LR ATC curve where ATC are still declining
“When long run ATC is declining, only a single producer can produce any particular output at minimum LR ATC.”
Key Points:
Low unit cost does not equal low price charged
P > ATC leads to economic profit increase, and possible regulation – we will see this later
Average Total Cost
Quantity
$20
15
10
0
50
100
200
ATC
If ATC declines over extended output range, least-cost production is realized only if there is one producer - a natural monopoly.
The Natural Monopoly Case
D
Barriers to Entry
Legal Barriers to Entry (government created)
3. Patents – pharmaceutical industry, R&D
4. Licenses – FCC radio & TV stations, cable TV
5. Ownership or Control of Essential Resources – At one time, International Nickel of Canada controlled 90% of world’s nickel.
At local level – single Cement company may control access to sand and gravel in the area.
Barriers to Entry
6. Pricing and Other Strategic Barriers to Entry:
In anticipation of a potential competitor:
Temporarily cut prices, or
Increase advertising,
Examples of the use of barriers:
2001 Microsoft – 95% market share, threatened by Netscape, made IE free bundled with OS, restrict resellers of product, preserve long run near monopoly position
2005 Dentsply – maker of false teeth (70% market share) - charging higher prices to distributors that sold a competitors product
Agenda
Monopoly Demand
Output and price determination
Implications for efficiency
Assessment of government policy options
Cost considerations
Price Discrimination
Government approaches to regulating the monopoly
Monopoly Demand
3 Basic Assumptions:
Monopoly Status is Secured by:
patents,
economies of scale,
resource ownership.
No Governmental Regulation
Firm Charges the Same Price for all Units Sold
The crucial difference between a pure monopolist and a purely competitive seller – demand is elastic versus perfectly elastic!!!!
3 implications of the monopolist’s downward sloping demand curve:
Marginal revenue is less than price.
The monopolist is a price maker
The monopolist sets prices in the elastic region of the demand curve
Monopoly demand
Monopoly demand
The monopolist’s downward sloping demand curve means it can increase sales only by charging a lower price.
Consequently marginal revenue is less than price for every level of output except the first.
MR < P
Marginal revenue is less than price.
Monopoly Demand
The monopolist is a price maker
Firms facing downward sloping demand curves can influence total supply through their own output decisions.
The monopolist firm controls output.
Each level of output is related to a unique price.
Control output, control price
Monopoly Demand
The monopolist sets prices in the elastic region of the demand curve.
When demand is elastic,
a decline in price will increase total revenue.
When demand is inelastic,
a decline in price will reduce total revenue.
In the inelastic region:
Monopolist must lower price to increase output.
Lower price means less total revenue.
Increased output means increased total cost
Less total revenue and increased total cost means less profit.
The monopolist will never choose a price-quantity pair in the inelastic part of the demand curve where total revenue could be reduced.
Monopoly Revenues and Costs
Dollars
Dollars
$200
150
200
50
$750
500
250
MR
Elastic
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
D
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
TR
Q
Monopoly Revenues and Costs
Q
Total Revenue
In Dollars
Price in
Dollars
$200
150
200
50
$750
500
250
TR
MR
D
Inelastic
Elastic
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Output and Price Determination for the Pure Monopolist At what price quantity combination will monopolist operate? MR = MC Rule – applies to the monopolist
Output and Price Determination
Add production Cost to the analysis:
monopolist buys resources in purely competitive market
No Monopoly Supply Curve –
no unique relationship between price and Quantity supplied.
The monopolist does not equate MC to price, therefore
it is possible for different demand conditions to bring about different prices for the same output.
Monopoly Pricing Misconceptions
it’s maximum total profit, Not Highest Price
Total, Not Unit Profit
Possibility of Losses – monopolists also can minimize losses.
Profit Maximization Under Monopoly
D
MC
ATC
MR
ATC=$94
P=$122
Profit
MR = MC
Profit
Per Unit
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Price, costs, and revenue
Remember the MR=MC Rule?
Output and Price Determination
Profit Maximization Under Monopoly
D
MC
ATC
MR
$94
$122
Profit
MR = MC
Profit
Per Unit
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Price, costs, and revenue
What About
Loss Minimization?
Due to cost or demand changes
Output and Price Determination
Loss Minimization Under Monopoly
D
MC
ATC
MR
ATC
Pricem
Loss
MR = MC
Loss
Per Unit
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Price, costs, and revenue
AVC
Qm
AVC
Since Pm exceeds AVC,
the firm will produce
Output and Price Determination
Loss Minimization Under Monopoly
D
MC
ATC
MR
A
Pm
Loss
MR = MC
Loss
Per Unit
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Price, costs, and revenue
AVC
Qm
V
What are the
Economic Effects
of Monopoly?
Output and Price Determination
Q
Inefficiency of Pure Monopoly
P
D
MR
S = MC
Pc
Pm
Qc
Qm
At MR=MC
A monopolist
will sell less
units at a
higher price
than a firm in pure
competition
An industry in pure competition
sells where supply and
demand are equal
The efficiency issue
In pure competition we had P = MC = minimum ATC
P = minimum ATC (productive efficiency)
P = MC (allocative efficiency)
Monopoly yields neither productive efficiency nor allocative efficiency
Monopoly price exceeds minimum ATC
Monopoly price exceeds MC
The monopolist’s profit maximizing output results in an under allocation of resources.
Output is less than that found in the purely competitive model.
Not productively efficient - P Minimum ATC
Not allocatively efficient - Price MC
Profit Maximization Under Monopoly
D
MC
ATC
MR
ATC=$94
P=$122
Profit
MR = MC
Profit
Per Unit
Output and Price Determination
Q
200
175
150
125
100
75
50
25
0 1 2 3 4 5 6 7 8 9 10
Price, costs, and revenue
Remember the MR=MC Rule?
Q
Inefficiency of Pure Monopoly
P
D
MR
S = MC
Pc
Pm
Qc
Qm
At MR=MC
A monopolist
will sell less
units at a
higher price
than in pure
competition
Monopoly pricing effectively
creates an income transfer from
buyers to the seller!
Cost Complications
Costs may not be the same for purely competitive and monopolistic producers.
Reasons for the difference in costs between purely competitive and monopolistic firms.
Economies of scale – three factors that contribute
Market demand may not be sufficient to support a large number of competing firms each producing at MES.
Simultaneous consumption – product’s ability to satisfy a large number of consumers at once. Software, music, etc. ATC decreases as number of customers increase.
Network effects – increase in value of a product to each user as the total number of users rises. Buyers tend to purchase the products that everyone else buys. Producers able to expand and achieve economies of scale. Cell phones
Cost Complications
Costs may not be the same for purely competitive and monopolistic producers.
Reasons for the difference:
X inefficiency -
A firm’s actual cost of producing any output is greater than the lowest possible cost of producing it.
why?
managers’ goals conflict with cost minimization.
firms becomes lethargic and complacent.
Cost Complications
Graphic Representation
Of X-Inefficiency
Average total costs
Quantity
Average
Total Costs
X
X’
Q1
Q2
ATCx
ATC1
ATC2
ATCx’
X-Inefficiency
Inefficient internal
operation leads to
higher-than-
necessary costs
Cost Complications
The need for monopoly preserving expenditures
Activity designed to transfer income or wealth to a particular firm or resource supplier at someone else’s expense.
Monopolist would do anything to maintain a patent, license, or other factor that ensures monopoly position.
Cost Complications
A pure monopolist will not be technologically
progressive!
Absence of rivals reduces the motivation to innovate
Agenda
Price Discrimination
Government policy options about Monopolies
The regulation dilemma
Price Discrimination
Under certain conditions the monopolist can increase its profit by
charging different prices to different buyers.
Forms of Price Discrimination:
Charging each customer in a market the maximum price they will pay
Charging each customer one price for the first few units and a lower price for subsequent units
Charging some customers one price and other customers another price
Monopoly Power:
Seller must be monopolist, or possess some degree of monopoly power, (some control over price and output)
Market Segregation:
At relatively low cost to itself, the seller must be able to segregate buyers into distinct classes, each with a different willingness or ability to pay for the product. (different price elasticity of demand)
No Resale:
The original purchaser cannot resell the product. Some examples: service industries like transportation, legal, medical
3 Price Discrimination Conditions
Examples of Price Discrimination
Electric utilities (peak and off peak pricing),
Movie theaters (time of day pricing)
Airlines (buy early or buy late)
Golf courses (time of day pricing)
Railroads (by type of freight)
Discount coupons vs no coupon
Outcomes
Greater profits and output than a single price monopolist
Some consumers pay more and some pay less than the single price case
Perfect price discriminating monopolist and pure competition are equally efficient!
Price Discrimination
Government policy options toward monopoly: Rules of thumb
If:
Monopoly is achieved / sustained through anticompetitive actions, creates substantial economic inefficiency, or appears to be long lasting.
Government would Pursue antitrust action
2. If:
It’s a Natural monopoly or there is no emerging competition,
Government may regulate prices and operations.
3. If, Monopoly appears to be unsustainable over a long period of time, or competitors might emerge.
Leave it alone
Natural Monopolies
The Dilemma of Regulation:
what to do with the Monopoly?
Choices
Socially Optimum Price
P = MC (allocative efficiency)
Fair-Return Price
P = ATC (productive efficiency)
No regulation
Monopolist sets price to maximize profits
Regulated Monopoly
Regulated Monopoly
Q
D
MR
MC
ATC
P
Price and Costs
Monopoly Price
MR = MC
Qm
Pm
The Unregulated Monopoly.
P>ATC means economic profit
Demand curve cuts LR ATC while it is falling.
Achieving economies of scale.
Only one seller needed.
P>MC means under-allocation of
resources to the product
Regulated Monopoly
Q
D
MR
MC
ATC
P
Price and Costs
Socially-Optimal
Price model
P = MC
Qr
Pr
Can government cause a better allocation of resources?
Set price ceiling to eliminate incentive to restrict output to Qm
and therefore maximize profits
Price is below ATC and the firm incurs a loss
Regulated Monopoly
Q
D
MR
MC
ATC
P
Price and Costs
Fair-Return Price model
Normal Profit Only
Qf
Pf
P=ATC
Regulated Monopoly
Q
D
MR
MC
ATC
P
Price and Costs
MR = MC
Fair-Return Price
Socially-Optimum
Price
Qm
Qf
Qr
Dilemma of Regulation
Which Price to use?
Pm
Pf
Pr