Econ 120

Monopoly! Chapter 13

Chapter 12: Perfect Competition 1. Perfect Competition Characteristics

a. Many Producers and Consumers & a standardized product. i. All Price-Takers

ii. Perfectly Elastic Demand b. Free Entry and Exit

i. Zero economic profit ii. Efficiency

Market Structures Market’s vary in whether or not:

A product is standardized or differentiated.

There can be one, a few, or many producers.

Chapter 13: Monopoly Monopolist: firm that is the only producer of a good with no close substitutes

Monopoly: An industry controlled by a monopolist

1. Only producer 2. No Close Substitutes 3. Barriers to Entry

Results in Market Power: The ability of a firm to raise prices.

They are Price Makers

Monopoly Examples: I don’t know if any actually exist.

● Near Monopolies: A firm that controls almost the entire market. ○ Firm has a very large market share ○ These are more common

■ Microsoft ● 75% of home computers

■ ComEd ■ Luxottica

● 80% of eyewear

Preview 1. Monopolists maximize profits by raising their prices and lowering quantity. 2. Their capacity to do so is called market power. 3. They have market power because of Barriers to Entry. 4. This results in inefficiency. 5. But effects might be mitigated via government intervention.

How do Monopolies even exist? Barriers to Entry ● In competitive industries, raising prices is not feasible.

○ Someone else will sell at a slightly lower price and take your customers.

Suppose your cost is $2. You try to sell for $3.

Someone could easily sell for $2.90 and take your customers.

And then you sell for $2.80 and take their customers.

→ Process repeats until your both selling at $2.

→ People don’t lower their price anymore, price = cost & cost = minimum price

If I’m a Monopolist... I can sell for $3 if I want. Who’s going to stop me?

Current Competitors? There are none.

New competition? Not possible.

Why? Barriers to Entry.

Barriers to Entry Something that prevents other firms from entering the industry

Examples:

1. Control of a Scarce Resource or Input 2. Increasing Returns to Scale 3. Technological Superiority 4. Network Externalities 5. Government Barriers

Barriers to Entry Something that prevents other firms from entering the industry

Examples:

1. Control of a Scarce Resource or Input a. Example: Debeers Diamonds

Why don’t firms enter? The necessary Inputs aren’t available!

Barriers to Entry: Something that prevents other firms from entering the industry Increasing Returns to Scale

a. Decreasing LRATC b. Natural Monopoly:

i. A monopoly resulting from Increasing Returns to Scale c. Example: Utilities

Why don’t firms enter? The costs are extremely high.

Note: Typical response to monopoly is breaking up the company and increasing competition.

But if costs decrease with each firm’s production → reducing a firm’s production doesn’t seem good.

Example: Piped Water ● Developing a pipeline bringing

Water to everyone’s house is Very expensive at first.

● Once the pipeline exists: ○ Moving water is cheap.

● Can another firm enter? ○ It’s going to be really hard. ○ Fixed Costs are super high. ○ When someone is already

Providing water, how can you Realistically get your costs low Enough to compete?

Barriers to Entry: Something that prevents other firms from entering the industry

● Technological Superiority ○ Intel -- microprocessors

● These tend to not last. ○ Other companies learn to compete. ○ People tend to figure out how use technology.

■ Americans use to travel to Britain and Sneakily study their manufacturing Processes.

○ Also, less obviously bad (in my opinion).

Barriers to Entry Something that prevents other firms from entering the industry

1. Network Externalities a. Value of a good increases when more people use it. b. Example: Facebook

i. My backpack isn’t much more valuable if lots of people Also own it.

ii. Facebook’s value is heavily dependent upon whether Or not other people use it.

iii. Can another social media really jump in an compete? 1. Yes… but it’s going to be difficult.

Barriers to Entry Government Barriers to Entry

Patents = temporary monopoly in the use or sale of an invention

Copyrights= sole rights to profit from a literary or artistic work

No Patent → little reward to creating new products

Monopolies are basically the polar opposite of Perfect Competition-- How does this change things?

● In Both Monopoly and Perfect Competition, Industry Demand is downward sloping.

● In Perfect Competition, the individual firm demand is perfectly elastic. ● In Monopoly, the individual firm demand is the Industry Demand.

Perfect Competition

Monopoly

Tons of Firms 1 Firm

Free Entry and Exit Barriers to Entry

Firms can’t influence price

Firm can charge whatever they want

When Demand isn’t perfectly elastic, MR isn’t P.

Change in TR = Price Effect + Quantity Effect Suppose we are selling 6 units. We Want to sell the 7th one. We need to lower the price from $3 to $2 the price to make this happen.

QE = $2 PE = - $6

TR changes from $18 to $14.

The price of the 7th unit is $2. But its MR is -$4.

Basically, the price is often not the same as MR.

Why was MR the same as Price in Perfect Competition? Because an individual firm has a perfectly elastic demand curve. They don’t need to lower their prices to sell more.

For the market (or the monopolist) to sell more, the price needs to be lower-- for the standard reasons given earlier. Lowering prices will:

1. Increase the amount of people with WTP > P 2. Make people substitute towards the lower priced good. 3. Increase how much of the good people can afford.

Another way to think about it... If a monopolist raises price, Qd goes down a bit.

If a perfectly competitive firm raises their prices, Qd goes to 0.

Elasticity tends to vary across the demand curve

At higher prices, demand tends to be Elastic.

At lower prices, demand tends to be Inelastic.

High Price → More Elastic. Low Price → Less Elastic * = average, for this slide

Elasticity → (Change in Q/Q* )/(Change in P/P*)

= (P*/Q*)(Change in Q/Change in P) = (P*/Q*)/Slope

High P, lower Q → Elasticity is high → Raising Prices Decreases TR

Low P, High Q → Elasticity is lower → Raising Prices increases TR

At low quantities the percent change in quantity tends to be relatively large.

At high quantities, the percent change in quantity tends to be relatively small.,

Elasticity and Demand 1. A firm is going to want to supply at an elastic portion of a curve.

a. Isn’t it ideal to supply an inelastic good? Inelastic goods generally don’t have close substitutes-- couldn’t a monopolist really overcharge people and make money?

b. In a sense yes, but as long as demand is inelastic they could sell less and increase revenue by charging higher prices.

How the Monopolist Maximizes Profit Continue producing as long as Marginal Revenue >= Marginal Cost!

It’s the same rule. The same logic still applies.

KEY DIFFERENCE: MR is NOT Price!

To sell more, the monopolist must lower their price-- the additional revenue they gain is not the price.

Monopoly: Table Format

Q P MC MR TR TC ATC Profit

0 14 -- 10

1 12 1

2 10 3

3 8 5

4 6 7

5 4 8

1. Note: Monopolies don’t have Supply Curves! There is not a clear cause and Effect relationship between Price and Quantity.

2. They are price makers. a. It’s not meaningful to ask “what quantity will

They sell at any price?” since they make their Quantity and price decisions simultaneously.

b. It’s confusing. The quantity they supply at Any given price is dependent upon Demand.

Inefficiency Price they sell at: P* Quantity they sell at: Q*

CS = Below D and above P* up to Q* (1)

PS = Above MC and below P* up to Q* (2)

DWL: Area below D and above MC, but After Q*. (3)

Now we’ll do a bit of comparison with Perfect Competition.

● Simplifying things a bit… ○ Constant MC ○ No Fixed cost ○ ATC = AVC = MC ○ → Flat MC = Flat ATC

In perfect competition:

P = MC = ATC

Consumers get all the surplus.

In Monopoly: MR = MC

→ Profits.

→ Less CS

→ DWL

How to deal with this: 1. Case 1: Natural Monopoly

a. Increasing Returns to Scale---> Having one company produce everything results in really low LRATC. That seems good, production is pretty cheap.

b. These monopolies shouldn’t be broken up probably. But what do we do about the high prices? i. Regulation

1. Set Prices 2. Concern: Does the government know what the ideal price is?

ii. Public Ownership 1. Have the government run the firm 2. Government might set prices in an efficient manner. 3. Concerns: Corruption, Low-Quality and High Cost

2. Case 2: Other Types a. Break em up! → Antitrust Laws

Price Discrimination: Definitions Single-Price Monopolist: offers product at same prices to all consumers Price Discrimination: Charging different prices to different consumers for the same good.

If people vary in their willingness to pay-- why not charge people more?

In perfect competition, if I was willing to supply a good to someone at a lower price, I couldn’t get away with charging more than that → a competitor would stop me.

Now, I can charge more if I want → no one to stop me.

Airline Business Travelers → High WTP Leisure Travelers → Low WTP

100 Leisure Travelers with WTP at $150. 100 Business Travelers with WTP at $500.

Price Options: More than 500: No one buys. 150 to 500: Only Business Travelers Buy 0 to 150: Only Leisure Travelers Buy

Cost = $100

Options > 500 → No $ → Bad.

Charge $500. → Profit = 100(500 -100) = 40,000

Charge $150 → Profit = 200(150-100) = 10,000

Maximize profit by charging $500

Price Discrimination: Charge $150 until one week before. Then charge $500

(500-100)100 + 100(150-100) = 40,000 + 5,000 = $45,000

Airlines Airlines do a ton of price discrimination → getting low WTP to buy by charging less and charging people with high WTP more. How do they do this?

Want to charge business travelers more because we can charge them more.

Want to charge leisure travelers less because they wouldn’t buy it otherwise.

Business Travelers → High WTP

Leisure Travelers → Low WTP

● Round trips → Leisure → lower prices ● Early or Very Late Notice → Leisure Low Prices

Other Examples of Price Discrimination

During the day movies are cheaper.

Early Bird Food Specials

Disneyland Tickets are cheaper for locals

Black Friday type sales

Amazon varying prices by zip code

Requirements for Price Discrimination ● Different elasticities

○ If they value the product the same, there’s no point in charging them different prices ○ If raising prices for everyone is worthwhile, then raise prices→ don’t price discriminate. ○ But if raising prices helps (increases profit) from certain groups but not others… discriminate.

● No resale ○ They can’t sell to each other. ○ Otherwise the low WTP will buy lots of it and sell to the other group.

■ Examples: Having ID at gate for flying prevents this.

Others

● Needs to be legal.

Perfect Price Discrimination ● Charge everyone their WTP. ● Monopolist gets all surplus ● No DWL! It’s efficient!

Discrimination reduces DWL!

This is why we don’t care As much about this, as long As it doesn’t seem horrible.

Should we be concerned? ● It’s debated. ● In my opinion, probably. But it varies by situation. ● People like Robert Reich suggest that market power is a really big problem.

○ Prices are raised and the poor are harmed. ○ Profits go to rich executives. ○ Firms get away with bad practices.

● Economic inequality is arguably greatly driven by market power. ○ Many people suggest that increasing competition is crucial to improving quality

of life for the poor and the middle class.

Should we be concerned? ● Others, like Thomas Sowell, suggest you should often basically leave these markets alone.

Arguments for this include: i. Barriers to Entry don’t last or aren’t effective.

1. Many so-called Monopolists end up getting competed out of business. ii. Most “monopolies” aren’t even monopolies, given that there are many competitors. iii. The idea of a monopoly is too subjectively defined. Firms making goods with close

substitutes too often get added into the monopoly category. 1. Is Whole Foods a monopoly?