Monopoly-and-All-That by akgame

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									Monopoly

   ECO 230
J.F. O’Connor
            Market Structure
• Perfect Competition
  – participants act as price takers and cannot by
    individual behavior affect market outcome
• Imperfect Competition
  – An individual firm has some degree of control
    over the price for its good
  – If it increases price, it does not lose all its
    customers
              Forms of Imperfect
                 Competition
• Monopoly
   – A firm that’s the only supplier of a unique product with
     no close substitutes
• Oligopolist
   – A firm that produces a product for which only a few
     rival firms produce close substitutes
• Monopolistically competitive firm
   – One of a large number of firms that produce slightly
     differentiated products that are reasonably close
     substitutes for one another
       Understanding Monopoly
•   Bases for monopoly
•   Profit maximization for a monopolist
•   Social efficiency of monopoly
•   Regulation of monopoly
•   Pricing strategies
          Bases for Monopoly
• Economies to scale relative to the size of the
  market
• Transmission and transportation networks
• Control of an input
• Patent
• Copyright
• Exclusive franchise from government
• Legal cartel
       Examples of Monopoly
• One grocery store, one bakery or a funeral
  home in a small town
• Telephone, electricity, water firm
• Alcoa, Picasso,
• Drugs, Roundup
• Stephen King
• Pepsi on campus
• Baseball
             Returns to Scale
• Constant returns to scale
  – When all inputs are changed by a given
    proportion and output changes by the same
    proportion
• Increasing returns to scale
  – When all inputs are changed by a given
    proportion and output changes by a higher
    proportion
  – Also know as Economies of Scale
           Economies of Scale
• With Economies of Scale
  – Average total cost of production falls as output
    increases
  – There are high start-up costs
  – There are low marginal costs
         Profit Maximization
• Key is to understand that under simple
  monopoly, where there is one price for all
  units, selling an additional unit requires
  lowering the price of all units sold.
  Therefore, marginal revenue (MB of selling
  another unit) is less than the price received
  for the unit. A monopolist faces the market
  demand curve.
         Profit Maximization
• AK Water Co. has a monopoly on the
  supply in a region
• Fixed cost is $20
• Average variable cost is $4 per unit and
  therefore, MC =$4
• Problem is to decide on the profit
  maximizing level of output
      Revenue,Cost, & Profit
P      un
 rice Q a tity    R ) V (Q
                 T (Q T C )    CT (Q   ro
                              F C ) P fit
   20       0       0     0   20    20    -20
   18       1      18     4   20    24     -6
   16       2      32     8   20    28      4
   14       3      42    12   20    32     10
   12       4      48    16   20    36     12
   10       5      50    20   20    40     10
    8       6      48    24   20    44      4
    6       7      42    28   20    48     -6
    4       8      32    32   20    52    -20
    2       9      18    36   20    56    -38
    0     1 0       0    40   20    60    -60
     Profit Maximizing Output
• Looking at the table, TR is price time
  quantity, TC is Total Variable Cost + FC,
  and Profit is TR – TC.
• At output of 4, profit is a maximum, $12.
• Total revenue and total cost are are graphed
  in the next slide. Profit at any given level of
  output is the vertical difference between the
  two, which is greatest at output of 4.
               Total Revenue and Cost
          60

                                                  TC
          50


          40

                                                  TR
 ollars




          30
D




          20


          10


          0
           0   1   2   3   4      5       6   7   8    9   10

                                un
                               Q a tity
           Marginal Analysis
• Instead of looking at total revenue and total
  cost, one can look at profit maximization in
  per unit terms.
• Compare addition to revenue (MR) with
  addition to cost (MC) from changing output.
            Per Unit Data
Q     R )
     A (Q    R )
            T (Q   M (Q
                    R )   M'R    V = C T (Q
                                A CM AC )
0     20     0            2 0     4
1     18     18    1 8    1 6     4    4 0
                                      2 .0
2     16     32    1 4    1 2     4    4 0
                                      1 .0
3     14     42    1 0     8      4    0 7
                                      1 .6
4     12     48     6      4      4     .0
                                       9 0
5     10     50     2      0      4     .0
                                       8 0
6     8      48     -2     -4     4     .3
                                       7 3
7     6      42     -6     -8     4     .8
                                       6 6
8     4      32    -10    -12     4     .5
                                       6 0
9     2      18    -14    -16     4     .2
                                       6 2
10    0      0     -18            4     .0
                                       6 0
         Average and Marginal Revenue
         20

         18
                   AR
         16
         14
         12

         10
                        MR
$/unit




         8
         6

         4
         2

         0
         -2

         -4
           0   1   2    3    4      5       6   7   8   9   10

                                 Quantity
                            Unit Curves
         20
         18
         16
                     T
                    AC
         14
         12
                                      AR
         10
$/unit




         8
         6
                    C V
                   M =A C
         4
         2
         0
         -2
                                               MR
         -4
           0   1     2      3   4      5       6    7   8   9   10

                                     un
                                    Q a tity
  Profit Maximizing Conditions
• Find the output at which
   marginal revenue = marginal cost
• On the demand curve, find the price at
  which the output can be sold.
• Check to see that P is greater than AVC
• Compute economic profit, [P-ATC(q)]q
           Some Comments
• Having a monopoly allows you to set price
  but not quantity. Buyers decide on quantity.
• A monopoly does not guarantee an
  economic profit or even covering of
  variable costs. Note that many patents have
  never been exercised.
• Some monopolists have positively sloped
  marginal cost curves (see text)
Social Inefficiency of Monopoly
• One condition for an efficient allocation of
  resources is that the valuation of the
  marginal unit to the consumer (price) equal
  the opportunity cost of producing it
  (marginal cost)
• Under monopoly, P> MR=MC. Hence the
  allocation is socially inefficient. In our
  example, the value of the marginal unit is
  $12 while the marginal cost is only $4.
  The Social Cost of Monopoly
• We can use our graph to measure the social
  cost or deadweight loss because of
  monopoly
• The socially efficient outcome is 8 units at a
  price of $4, Price = MC
• The social cost is the area under the demand
  curve from 4 to 8 units and above the MC,
  namely, .5(12-4)(8-4) = $16
          Measuring the Social Cost of
                  Monopoly
         20
         18
         16
                     T
                    AC
         14
         12
                                      AR
         10
$/unit




         8
         6
                    C V
                   M =A C
         4
         2
         0
         -2
                                               MR
         -4
           0   1     2      3   4      5       6    7   8   9   10

                                     un
                                    Q a tity
 Why Do We Grant Monopoly?
• To take advantage of economies of scale
• To encourage innovation in art, science, and
  literature
• In return for granting a monopoly that takes
  advantage of economies to scale, society
  reserves the right to regulate the price
  charged by the monopolist.
      Regulation of Monopoly
• Socially Efficient Regulation
  – Set a price ceiling at AR=MC and pay a lump-
    sum subsidy to the monopolist to ensure zero
    economic profit.
• Fair Rate of Return Regulation
  – Set a price ceiling where AR=ATC. This
    ensures zero economic profit but output is less
    than socially efficient. It may be close enough.
• Public Ownership
        Current Developments
• Electricity, natural gas, telephone, cable
• Airlines
• Privatization of state monopolies
         Price Discrimination
• A monopolist can sometimes increase profit
  by charging different prices to different
  customers or for different units.
• Charging different prices for the same good
  is called price discrimination.
• Price discrimination is illegal in the U.S.!
  Kinds of Price Discrimination
• Third degree – separate buyers into two or
  more markets. E.g. movie theaters, ailines
• Quantity discounts – electric utility
• Perfect or first degree price discrimination –
  charge the reservation price for each unit -
           Third Degree
• Firm produces a product with essentially
  zero marginal cost
• Two possible markets, one high priced, one
  low priced
                One Price
Market 1              Market 2
   Price   Quantity      Price   Quantity      TR

    40          0                               0
    35        500                           17500
    30       1000                           30000
    25       1500                           37500
    20       2000                           40000
    15       2500                           37500
    10       3000         10          0     30000
     5       3500          5       2000     27500
     0       4000          0       4000         0
• If the firm charges one price for all units, it
  will maximize total revenue, and in this
  case, profit by selling 2,000 units at $20 per
  unit.
• Note that it does not sell in the second
  market.
• If the buyers can be separated, it could sell
  another 2,000 in the second market at $5
  and add $10,000 to revenue and profit.

								
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