Monolistic Competition

redrmyeprtal33

Chapter15.pdf

Home >Business & Finance homework help >Economics homework help >Monolistic Competition

PowerPoint Slides prepared by: V. Andreea CHIRITESCU Eastern Illinois University

N. GREGORY MANKIW

PRINCIPLES OF

ECONOMICS Eight Edition

Monopoly CHAPTER

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Why Monopolies Arise

•  Market power – Alters the relationship between a firm’s

costs and the selling price •  Monopoly

– Charges a price that exceeds marginal cost

– A high price reduces the quantity purchased

– Outcome: often not the best for society 2

Why Monopolies Arise

•  Governments – Can sometimes improve market outcome

•  Monopoly – Firm that is the sole seller of a product

without close substitutes – Price maker – Cause: barriers to entry

3 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Why Monopolies Arise

•  Barriers to entry – A monopoly remains the only seller in the

market •  Because other firms cannot enter the market

and compete with it 1.  Monopoly resources 2.  Government regulation 3.  The production process

4 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Why Monopolies Arise

•  Monopoly resources – A key resource required for

production is owned by a single firm

– Higher price

5 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

“Rather than a monopoly, we like to consider ourselves ‘the only game in town.’”

Why Monopolies Arise

•  Government regulation – Government gives a single firm the

exclusive right to produce some good or service

– Government-created monopolies •  Patent and copyright laws •  Higher prices •  Higher profits

6 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Why Monopolies Arise

•  Natural monopoly – A single firm can supply a good or service

to an entire market •  At a smaller cost than could two or more firms

– Economies of scale over the relevant range of output

– Club goods •  Excludable but not rival in consumption

7 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 1 Economies of Scale as a Cause of Monopoly

When a firm’s average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a result, a single firm can produce any given amount at the lowest cost.

8 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Costs

Quantity of output 0

Average total cost

Production and Pricing Decisions •  Monopoly

– Price maker – Sole producer – Downward sloping demand: the market

demand curve •  Competitive firm

– Price taker – One producer of many – Demand is a horizontal line (Price)

Figure 2 Demand Curves for Competitive and Monopoly Firms

Because competitive firms are price takers, they face horizontal demand curves, as in panel (a). Because a monopoly firm is the sole producer in its market, it faces the downward-sloping market demand curve, as in panel (b). As a result, the monopoly has to accept a lower price if it wants to sell more output.

10 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Price

Quantity of output 0

(a) A Competitive Firm’s Demand Curve

Price

Quantity of output 0

(b) A Monopolist’s Demand Curve

Demand

Production and Pricing Decisions •  A monopoly’s total revenue

– Total revenue = price times quantity •  A monopoly’s average revenue

– Revenue per unit sold – Total revenue divided by quantity – Always equals the price

11 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Production and Pricing Decisions •  A monopoly’s marginal revenue

– Revenue per each additional unit of output •  Change in total revenue when output

increases by 1 unit – MR < P

•  Downward-sloping demand •  To increase the amount sold, a monopoly firm

must lower the price it charges to all customers

– Can be negative 12

Table 1 A Monopoly’s Total, Average, and Marginal Revenue

13 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Production and Pricing Decisions •  Increase in quantity sold

– Output effect •  Q is higher: increase total revenue

– Price effect •  P is lower: decrease total revenue

•  Because MR < P – Marginal-revenue curve is below the

demand curve

14 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 3 Demand and Marginal-Revenue Curves for a Monopoly

The demand curve shows how the quantity sold affects the price of the good. The marginal-revenue curve shows how the firm’s revenue changes when the quantity increases by 1 unit. Because the price on all units sold must fall if the monopoly increases production, marginal revenue is less than the price.

15 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Price

2 1

-1 -2 -3

5 4 3

6 7 8 9

10 $11

-4

Quantity of water

0 1 2 3 4 5 6 7 8

Demand (average revenue)

Marginal revenue

Production and Pricing Decisions •  Profit maximization

– If MR > MC: increase production – If MC > MR: produce less – Maximize profit

•  Produce quantity where MR=MC •  Intersection of the marginal-revenue curve

and the marginal-cost curve •  Price: on the demand curve

16 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 4 Profit Maximization for a Monopoly

A monopoly maximizes profit by choosing the quantity at which marginal revenue equals marginal cost (point A). It then uses the demand curve to find the price that will induce consumers to buy that quantity (point B).

17 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Costs and

Revenue

Quantity 0

Average total cost

Demand

Marginal revenue

Marginal cost

QMAX

B Monopoly price

1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity . . .

2. . . . and then the demand curve shows the price consistent with this quantity.

Q1 Q2

Production and Pricing Decisions •  Profit maximization

– Perfect competition: P=MR=MC •  Price equals marginal cost

– Monopoly: P>MR=MC •  Price exceeds marginal cost

•  A monopoly’s profit – Profit = TR – TC = (P – ATC) ˣ Q

18 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 5 The Monopolist’s Profit

The area of the box BCDE equals the profit of the monopoly firm. The height of the box (BC) is price minus average total cost, which equals profit per unit sold. The width of the box (DC) is the number of units sold.

19 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Costs and

Revenue

Quantity 0

Demand

B E

Marginal revenue

QMAX

Average total cost

Marginal cost

Monopoly price

Monopoly profit

Average total cost

Monopoly Drugs versus Generic Drugs

•  Market for pharmaceutical drugs – New drug, patent laws, monopoly

•  Produce Q where MR=MC •  P>MC

– Generic drugs: competitive market •  Produce Q where MR=MC •  And P=MC

•  Price of the competitively produced generic drug – Below the monopolist’s price

20 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 6 The Market for Drugs

When a patent gives a firm a monopoly over the sale of a drug, the firm charges the monopoly price, which is well above the marginal cost of making the drug. When the patent on a drug runs out, new firms enter the market, making it more competitive. As a result, the price falls from the monopoly price to marginal cost.

21 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Costs and

Revenue

Quantity 0

Demand Marginal revenue

Monopoly quantity

Price during

patent life

Marginal cost Price after patent

expires

Competitive quantity

The Welfare Cost of Monopolies

•  Total surplus – Economic well-being of buyers and sellers

in a market – Sum of consumer surplus and producer

surplus •  Consumer surplus

– Consumers’ willingness to pay for a good – Minus the amount they actually pay for it

22 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

The Welfare Cost of Monopolies

•  Producer surplus – Amount producers receive for a good – Minus their costs of producing it

•  Benevolent planner: maximize total surplus – Socially efficient outcome – Produce quantity where

•  Marginal cost curve intersects demand curve – Charge P=MC

23 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 7 The Efficient Level of Output

A benevolent social planner maximizes total surplus in the market by choosing the level of output where the demand curve and marginal-cost curve intersect. Below this level, the value of the good to the marginal buyer (as reflected in the demand curve) exceeds the marginal cost of making the good. Above this level, the value to the marginal buyer is less than marginal cost.

24 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Costs and

Revenue

Quantity 0

Demand (value to buyers)

Efficient quantity

Marginal cost

Value to buyers

Cost to monopolist

Value to buyers is greater than cost to sellers

Value to buyers is less than cost to sellers

The Welfare Cost of Monopolies

•  Monopoly – Produce quantity where MC = MR – Produces less than the socially efficient

quantity of output – Charge P > MC – Deadweight loss

•  Triangle between the demand curve and MC curve

25 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 8 The Inefficiency of Monopoly

Because a monopoly charges a price above marginal cost, not all consumers who value the good at more than its cost buy it. Thus, the quantity produced and sold by a monopoly is below the socially efficient level. The deadweight loss is represented by the area of the triangle between the demand curve (which reflects the value of the good to consumers) and the marginal-cost curve (which reflects the costs of the monopoly producer).

26 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Costs and Revenue

Quantity 0

Demand

Marginal revenue

Monopoly quantity

Marginal cost

Monopoly price

Efficient quantity

Deadweight loss

The Welfare Cost of Monopolies

•  The monopoly’s profit: a social cost? – Monopoly - higher profit

•  Not a reduction of economic welfare – Bigger producer surplus – Smaller consumer surplus

•  Not a social problem – Social loss = Deadweight loss

•  From the inefficiently low quantity of output

27 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Price Discrimination

•  Price discrimination – Business practice – Sell the same good at different prices to

different customers – Rational strategy to increase profit – Requires the ability to separate customers

according to their willingness to pay – Can raise economic welfare

28 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Price Discrimination

•  Perfect price discrimination – Charge each customer a different price

•  Exactly his or her willingness to pay – Monopoly firm gets the entire surplus

(Profit) – No deadweight loss

29 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Price Discrimination

•  Without price discrimination – Single price > MC – Consumer surplus – Producer surplus (Profit) – Deadweight loss

30 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 9 Welfare with and without Price Discrimination

Panel (a) shows a monopoly that charges the same price to all customers. Total surplus in this market equals the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopoly that can perfectly price discriminate. Because consumer surplus equals zero, total surplus now equals the firm’s profit. Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus, and lowers consumer surplus.

31 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Price

Quantity 0

(a) Monopolist with Single Price Price

Quantity 0

(b) Monopolist with Perfect Price Discrimination

Profit

Consumer surplus

Deadweight loss Monopoly

price

Quantity sold

Marginal revenue

Demand

Marginal cost

Quantity sold

Profit

Demand

Marginal cost

Price Discrimination

•  Examples of price discrimination – Movie tickets

•  Lower price for children and seniors – Airline prices

•  Lower price for round-trip with Saturday night stay

32 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

“Would it bother you to hear how little I paid for this Alight?”

Price Discrimination

•  Examples of price discrimination – Discount coupons

•  Not all customers are willing to spend time to clip coupons

– Financial aid •  High tuition and need-based financial aid •  Willingness to pay

– Quantity discounts •  Customer pays a higher price for the first unit

bought than for the last unit bought 33

Public Policy Toward Monopolies

1.  Increasing competition with antitrust laws – Sherman Antitrust Act, 1890 – Clayton Antitrust Act, 1914 – Prevent mergers – Break up companies – Prevent companies from coordinating their activities to make markets less competitive

34 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

“But if we do merge with Amalgamated, we’ll have enough resources to Aight the anti-trust violation caused by the merger.”

ASK THE EXPERTS

35 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Airline Mergers

“If regulators had not approved mergers in the past decade between major networked airlines, travelers would be better off today.”

Public Policy Toward Monopolies

2.  Regulation – Regulate the behavior of monopolists

•  Price – Common in case of natural monopolies – Marginal-cost pricing

•  May be less than ATC •  No incentive to reduce costs

36 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Figure 10 Marginal-Cost Pricing for a Natural Monopoly

Because a natural monopoly has declining average total cost, marginal cost is less than average total cost. Therefore, if regulators require a natural monopoly to charge a price equal to marginal cost, price will be below average total cost, and the monopoly will lose money.

37 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

Price

Quantity 0

Average total cost

Loss

Average total cost

Demand

Marginal cost Regulated price

Public Policy Toward Monopolies

3.  Public ownership – How the ownership of the firm affects the

costs of production – Private owners

•  Incentive to minimize costs – Public owners (government)

•  If it does a bad job, losers are the customers and taxpayers

Public Policy Toward Monopolies

4.  Do nothing – Some economists argue that it is often

best for the government not to try to remedy the inefficiencies of monopoly pricing

– Determining the proper role of the government in the economy requires judgments about politics as well as economics

Table 2 Competition versus Monopoly: A Summary Comparison

40 © 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.