chapter 15: monopoly - university of minnesota...
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Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Econ 1023 Introduction to Economics: Micro
Chapter 15: Monopoly
Instructor: Hiroki WatanabeSpring 2013
Watanabe Econ 4935 15 Monopoly 1 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
1 Monopolistic Market
2 Monopolistic Pricing
3 Inefficiency of Monopoly
4 Price Discrimination
5 Public Policy
6 Summary
Watanabe Econ 4935 15 Monopoly 2 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
1 Monopolistic MarketQuestionsWhy Monopolies AriesNatural Monopoly
2 Monopolistic Pricing
3 Inefficiency of Monopoly
4 Price Discrimination
5 Public Policy
6 Summary
Watanabe Econ 4935 15 Monopoly 3 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Questions
Question 1.1 (Agenda for Chpt 13-17)1 Where does the supply curve come from?2 What do firms do?3 How does the market structure affect the firms’
decision making?
1 Chpt 13: Preparation2 Chpt 14: Deriving the supply curve, perfect
competition3 Chpt 15: Monopoly4 Chpt 17: Oligopoly5 Chpt 16(?): Monopolistic competition
Watanabe Econ 4935 15 Monopoly 4 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Why Monopolies Aries
Definition 1.2 (Monopolist)
is a firm that is the sole seller of a product without closesubstitutes.
Price setter.Major cause: barriers to entry.
Watanabe Econ 4935 15 Monopoly 5 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Why Monopolies Aries
Barriers to entry:1 Government regulation2 Monopoly resources3 The production process
Watanabe Econ 4935 15 Monopoly 6 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Why Monopolies Aries
1 Government regulationGovernment gives a single firm the exclusive rightto produce some good or serviceGovernment-created monopoliesPatent and copyright lawsE.g., new drugs, postal services (legal fiat)
Watanabe Econ 4935 15 Monopoly 7 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Why Monopolies Aries
2 Monopoly resourcesA key resource required for production is owned bya single firm.E.g., DeBeers, toll highway
Watanabe Econ 4935 15 Monopoly 8 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Why Monopolies Aries
3 The production processA single firm can produce output at a lower totalcost than can a larger number of producers.E.g., local utility companies
Watanabe Econ 4935 15 Monopoly 9 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Natural Monopoly
Definition 1.3 (Natuaral Monopoly)
is a monopoly that arises because a single firm cansupply a good or service to an entire market at asmaller cost than could two or more firms.
Increasing returns to scale in a relevant region.
Watanabe Econ 4935 15 Monopoly 10 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Natural Monopoly
Example 1.4 (Natural Monopoly and IRS)
Suppose production function takes the form
ƒ () = 2.
To produce y = 4, which economy produces withfewer inputs?
1 Jack and Dotcom splitting the production.2 Jack producing all.
Watanabe Econ 4935 15 Monopoly 11 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Natural Monopoly
0 1.4142 2 2.82840
2
4
Che
esec
akes
y [s
lices
]
Number of Chefs xC [persons]
y=fJ(xC)
y=fD(xC)
0 1.4142 2 2.82840
2
4
Che
esec
akes
y [s
lices
]
Number of Chefs xC [persons]
Watanabe Econ 4935 15 Monopoly 12 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Natural Monopoly
1 Split: JC =p2, DC =
p2. 2
p2 chefs in total.
2 Single firm: JC = 2(< 2p2).
Watanabe Econ 4935 15 Monopoly 13 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Natural Monopoly
In natural monopoly,The average number of chefs you need to bake aslice decreases as y increases.Accordingly, the average total cost decreaseswith y.
Watanabe Econ 4935 15 Monopoly 14 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Natural Monopoly
0 1 2 3 40
0.5
1
1.5
2
2.5
3
3.5
4
Cheesecakes y [slices]
Cos
ts [$
]
TC(y)ATC(y)Co−ProductionSingle−Firm Production
0 1 2 3 40
0.5
1
1.5
2
2.5
3
3.5
4
Cheesecakes y [slices]
Cos
ts [$
]
Watanabe Econ 4935 15 Monopoly 15 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
1 Monopolistic Market
2 Monopolistic PricingMonopolist vs Competitive FirmMonopolistic PricingMR(y) ,MWTP(y)
3 Inefficiency of Monopoly
4 Price Discrimination
5 Public Policy
6 Summary
Watanabe Econ 4935 15 Monopoly 16 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolist vs Competitive Firm
Monopolists face a different demand curve thancompetitive firms do.Optimal pricing rule for competitive firms (c.f.
Proposition 2.2 in Ch 14):
MR(y∗)(= p) = MC(y∗).
Watanabe Econ 4935 15 Monopoly 17 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolist vs Competitive Firm
Does the same pricing rule (p = MC(y)) still apply toa monopolist?
Example 2.1 (Monopolistic Pricing)
Listen to Marketplace Clip .
Watanabe Econ 4935 15 Monopoly 18 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolist vs Competitive Firm
0 20 40 60 80 1000
2
4
6
8
10
Cheesecakes y [slices]
MC
, MW
TP
[$]
MC(y)Demand the Firm Faces
0 20 40 60 80 1000
2
4
6
8
10
Cheesecakes y [slices]
MC
, MW
TP
[$]
Watanabe Econ 4935 15 Monopoly 19 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolist vs Competitive Firm
0 20 40 60 80 1000
2
4
6
8
10
Cheesecakes y [slices]
MC
, MW
TP
[$]
MC(y)Demand the Firm Faces
0 20 40 60 80 1000
2
4
6
8
10
Cheesecakes y [slices]
MC
, MW
TP
[$]
Watanabe Econ 4935 15 Monopoly 20 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolist vs Competitive Firm
1 Monopoly1 price setter2 sole producer3 faces downward sloping demand.
2 Competitive firm1 price taker2 lots of infinitesimally small producers3 faces flat demand curve
Watanabe Econ 4935 15 Monopoly 21 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
Definition 2.2 (Competitive Frim’s PMP)
maxyπ(y) = py − TC(y).
Definition 2.3 (Monopolist’s PMP)
maxyπ(y) = MWTP(y)y − TC(y).
Total revenue is not linear for a monopolist.Recall Ch 5 Elasticity:
1 State lawmakers: Increase in revenue because theycan collect larger tax from each tourist.
2 Bill Connors: Reduction in revenue becauseincreased tax reduces the number of tourists.
Watanabe Econ 4935 15 Monopoly 22 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
Example 2.4 (Preview)
Metrolink’s total cost function is given by
TC(y) = y2 + 1,
where y is the # of passengers.Inverse demand for the train service is
MWTP(y) = −y + 12.
1 Competitive firms’ profit: π(y) = 6y − TC(y).2 Monopolist’s profit: π(y) = (−y + 12)y − TC(y).
Watanabe Econ 4935 15 Monopoly 23 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
0 2 4 6 8 100
5
10
15
20
25
30
35
40
Passengers y [people]
TC
, MW
TP
, TR
, π [$
]
TC(y)MWTP(y)TR(y)π(y)
0 2 4 6 8 100
5
10
15
20
25
30
35
40
Passengers y [people]
TC
, MW
TP
, TR
, π [$
]
Watanabe Econ 4935 15 Monopoly 24 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
0 2 4 6 8 100
5
10
15
20
25
30
35
40
Passengers y [people]
TC
, MW
TP
, TR
, π [$
]
TC(y)MWTP(y)TR(y)π(y)
0 2 4 6 8 100
5
10
15
20
25
30
35
40
Passengers y [people]
TC
, MW
TP
, TR
, π [$
]
Watanabe Econ 4935 15 Monopoly 25 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
Different from perfect competition: Total revenue isnot linear.Similar to perfect competition: At the optimal level,additional increase in revenue (MR) is cancelled byadditional decrease in total cost (TC) of the equalsize.
Watanabe Econ 4935 15 Monopoly 26 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
How do monopolists find the optimal output levely∗?
Watanabe Econ 4935 15 Monopoly 27 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
Instead of plugging in random y’s in π(y), we ask:If Jack sells one more slice, does it increasehis profit?
1 If it does, go ahead.2 If it decreases the profit, downsize.3 If it doesn’t change, then that’s the y he’s looking
for.
Watanabe Econ 4935 15 Monopoly 28 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
Change in profit from an additional unit sold hastwo sources:
1 MR(y): additional revenue that the additional unitbrings in (just p in a perfectly competitive market,but not anymore here)
Breaks further down into two components (next slide)2 MC(y): additional cost that the additional unit
inflicts (varies with y)
Watanabe Econ 4935 15 Monopoly 29 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolistic Pricing
Monopolists still follow Proposition 2.2 in Ch 14:
Proposition 2.5 (Finding the Optimal ProductionScale)
The output level y∗ that maximizes Jack’s profitsatisfies:
MR(y) = MC(y).
except that MR(y) does not coincide with MWTP(y)anymore.
Watanabe Econ 4935 15 Monopoly 30 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
Two effects by producing one more y:1 ☹ : If Metrolink carries one more passenger, it will
cost them ΔTC(y)Δy = MC(y).
2 ☺ : If Metrolink carries one more passenger, theyget
MR(y) = quantity effect︸ ︷︷ ︸
>0
+ price effect︸ ︷︷ ︸
<0
Watanabe Econ 4935 15 Monopoly 31 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
Break down the marginal effect of quantity changeover the total revenue:
1 Price-change effect (Bill Connors)☹: the marginal revenue lost by reduced price: haveto sell everything for a dollar less.ΔMWTP(y)
Δy y
2 Quantity-change effect (State lawmakers)☺: the marginal revenue gained by increased output:can sell one more slice.MWTP(y)
1
1Note Metrolink can’t increase output and price at the sametime. Also note that the problem Metrolink faces is PMP, not totalrevenue maximization.
Watanabe Econ 4935 15 Monopoly 32 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
The additional profit is
Δπ(y)Δy = MR(y) − MC(y)
= MWTP(y) + ΔMWTP(y)Δy − MC(y).
At y∗ π(y) does not increase nor decrease
i.e., Δπ(y)Δy = 0.
MR(y∗) = MC(y∗).So, set p = MR(y∗)?
Watanabe Econ 4935 15 Monopoly 33 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
Example 2.6 (Finding the Price)
Metrolink’s marginal revenue (additional revenuefrom one more passenger):
MR(y) = −2y + 12.
Their marginal cost:
MC(y) = 2y
a
aYou’re not responsible for deriving two equations above.
At the optimal level, MR offsets MC:
MR(y) = MC(y).
y∗ = 3.Watanabe Econ 4935 15 Monopoly 34 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
7
8
9
10
11
12
Passengers y [people]
MW
TP
, MR
, MC
[$]
MWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
7
8
9
10
11
12
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 35 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
The most common mistake:p∗ = MR(y∗ = 3) = 6.If they charge p = 6, demand is 6 rather than 3.Setting MR(y) = MC(y) finds the optimalquantity but not the optimal price.Price corresponds to y∗ = 3 is MWTP(y = 3) = 9.NOT 6. (what is the point of selling tickets for $6when you can sell them for $9 anyway?).
Watanabe Econ 4935 15 Monopoly 36 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
Another common mistake: (y, p) = (4,8) istempting,where marginal cost meets marginal willingness topay.Why does Metrolink choose (y, p) = (3,6) instead?(y, p) = (4,8) ignores Bill Connors’ effect. Confirm:
π(y = 4) = 32 − 17 = 15.π(y∗ = 3) = 27 − 10 = 17(> 15).
Watanabe Econ 4935 15 Monopoly 37 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
Exercise 2.7 (Monopolistic Pricing)
Find Metrolink’s profit maximizing service level (y∗) andcorresponding price (p∗) for the following:
Inverse demand: MWTP(y) = − 12y + 6 withMR(y) = −y + 6.MC(y) = 2.
Steps:1 Use MR(y) = MC(y) to find y∗.2 Plug y∗ in MWTP(y) to find p∗.
Watanabe Econ 4935 15 Monopoly 38 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
MR(y) ,MWTP(y)
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
MWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 39 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
1 Monopolistic Market
2 Monopolistic Pricing
3 Inefficiency of MonopolyEfficiency Loss due to Monopolistic Pricing
4 Price Discrimination
5 Public Policy
6 Summary
Watanabe Econ 4935 15 Monopoly 40 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
A monopolist sets p higher than their marginal cost.In perfect competition, p is exactly = MC(y).Monopoly sounds good for a producer and bad forconsumers.What is total surplus (social economic welfare)?The allocation is efficient if it achieves themaximum possible social economic welfare.
Watanabe Econ 4935 15 Monopoly 41 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
The first fundamental theorem: When RP(y) meetsMWTP(y), the market outcome is efficient.Monopoly: RP(y) is lower than MWTP(y), i.e., theset price > MC(y).Is a monopolistic market still efficient?
Watanabe Econ 4935 15 Monopoly 42 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
7
8
9
10
11
12
Passengers y [people]
MW
TP
, MR
, MC
[$]
CSPSMWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
7
8
9
10
11
12
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 43 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
7
8
9
10
11
12
Passengers y [people]
MW
TP
, MR
, MC
[$]
CSPSMWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 80
1
2
3
4
5
6
7
8
9
10
11
12
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 44 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
Due to the price-change effect, the monopolist stopproduceing before y reaches the pointMC(y) = MWTP(y) but rather MC(y) = MR(y).Reduced total surplus as a result.Creates deadweight loss.
Watanabe Econ 4935 15 Monopoly 45 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
Exercise 3.1 (Finding DWL)
For MWTP(y) = −12 y + 6, MR(y) = −y + 6 and MC(y) = 2,find passengers’ surplus, Metrolink’s surplus anddeadweight loss.
Watanabe Econ 4935 15 Monopoly 46 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
CSMWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 47 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
CSPSMWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 48 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Efficiency Loss due to Monopolistic Pricing
What can we do about the deadweight loss?1 price discrimination2 government fixes (public policy)
Watanabe Econ 4935 15 Monopoly 49 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
1 Monopolistic Market
2 Monopolistic Pricing
3 Inefficiency of Monopoly
4 Price DiscriminationPrice Discrimination
5 Public Policy
6 Summary
Watanabe Econ 4935 15 Monopoly 50 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
Does a monopolist really charge the uniform price?
Watanabe Econ 4935 15 Monopoly 51 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
Watanabe Econ 4935 15 Monopoly 52 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
Definition 4.1 (Price Discrimination)is the business practice of selling the same good atdifferent prices to different customers.
Doesn’t sound fair but it can eliminate the DWL.
Watanabe Econ 4935 15 Monopoly 53 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
Perfect price discrimination:Charge each customer a different priceCharge exactly his or her willingness to pay.The monopolist gets the entire surplus (Profit)No deadweight loss.
How?
Watanabe Econ 4935 15 Monopoly 54 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
Example 4.2 (Perfect Price Discrimination)
Metrolink hasInverse demand: MWTP(y) = − 12y + 6 withMR(y) = −y + 6.MC(y) = 2.
If Metrolink sets the price as p(y) = MWTP(y), what istheir surplus?
Watanabe Econ 4935 15 Monopoly 55 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
CSMWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 56 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
CSPSMWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 57 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
PSMWTP(y)MR(y)MC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
[$]
Watanabe Econ 4935 15 Monopoly 58 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
Why don’t they stop producing at y = 4?
Watanabe Econ 4935 15 Monopoly 59 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Discrimination
Examples of price discriminationMovie ticketsAirline pricesDiscount couponsFinancial aidQuantity discounts
Watanabe Econ 4935 15 Monopoly 60 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
1 Monopolistic Market
2 Monopolistic Pricing
3 Inefficiency of Monopoly
4 Price Discrimination
5 Public PolicyTypes of RegulationsAntitrust LawsPublic OwnershipPrice Regulation
6 SummaryWatanabe Econ 4935 15 Monopoly 61 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Types of Regulations
1 Antitrust laws2 Public Ownership3 Price regulation
Watanabe Econ 4935 15 Monopoly 62 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Antitrust Laws
Increasing competition with antitrust lawsSherman Antitrust Act, 1890Clayton Antitrust Act, 1914Prevent mergersBreak up companiesPrevent companies from coordinating their activitiesto make markets less competitive
Watanabe Econ 4935 15 Monopoly 63 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Public Ownership
Private ownersMaximize producer surplus
Public owners (government)Maximize total surplusWeak incentive to minimize costPossible efficiency loss due to inefficient production
Watanabe Econ 4935 15 Monopoly 64 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
Why don’t we simply ask the firm to produce moreand set the price down to p = MC(y)?We can, but problematic for natural monopoly.
Watanabe Econ 4935 15 Monopoly 65 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
Example 5.1 (Marginal Cost Pricing)
Consider the following environment:
MWTP(y) = −.5y + 6MR(y) = −y + 6TC(y) = 2y + 6MC(y) = 2.
What happens to the monopolist if the governmentimposes marginal cost pricing?
Watanabe Econ 4935 15 Monopoly 66 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
Ask Metrolink to serve y = 8 at p = 2.The total surplus will be maximized.
Watanabe Econ 4935 15 Monopoly 67 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
CSMWTP(y)MR(y)MC(y)ATC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
Watanabe Econ 4935 15 Monopoly 68 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
But then Metrolink will stop its operation in the longrun.Then the whole total surplus will be gone.
Watanabe Econ 4935 15 Monopoly 69 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
−πMWTP(y)MR(y)MC(y)ATC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
Watanabe Econ 4935 15 Monopoly 70 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
Unfortunately, this result is inevitable.Natural monopoly happens when the firm isoperating in the region where the ATC is decreasing.
Watanabe Econ 4935 15 Monopoly 71 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
Note that Metrolink does not have to stop itsoperation if there were no government intervention.
Watanabe Econ 4935 15 Monopoly 72 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
π (Long Run)MWTP(y)MR(y)MC(y)ATC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
Watanabe Econ 4935 15 Monopoly 73 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
1 We don’t want monopolistic pricing (inflictsDWL).
2 We want to but can’t impose marginal costpricing (eliminates DWL but the firm exitseventually).
3 Second best solution: average cost pricing.
Watanabe Econ 4935 15 Monopoly 74 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
If we impose the price where MWTP(y) = ATC(y),y increases, andπ(y) won’t be negative.DWL still exists but not worse than monopolisticpricing.
Watanabe Econ 4935 15 Monopoly 75 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
DWLAverted DWLMWTP(y)MR(y)MC(y)ATC(y)
0 1 2 3 4 5 6 7 8 9 100
1
2
3
4
5
6
Passengers y [people]
MW
TP
, MR
, MC
, AT
C [$
]
Watanabe Econ 4935 15 Monopoly 76 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
y CS PS TS π(y) DWL
Laissez-Faire 4 4 8 12 2 4MC Pricing 8 16 0 16 -6 0AC Pricing 6 9 6 15 0 1
Watanabe Econ 4935 15 Monopoly 77 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
Discussion 5.2 (Average-Cost Pricing)
Is average cost pricing implementable?
1 Can a government force average cost pricing?2 What’s the long-term effect?
Watanabe Econ 4935 15 Monopoly 78 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Price Regulation
1 Who would tell the true average cost?2 What’s worse, in the long term, Metrolink won’t get
motivated to reduce its cost (no innovation occurs).
Watanabe Econ 4935 15 Monopoly 79 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
1 Monopolistic Market
2 Monopolistic Pricing
3 Inefficiency of Monopoly
4 Price Discrimination
5 Public Policy
6 Summary
Watanabe Econ 4935 15 Monopoly 80 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Monopolist’s pricing ruleEfficiency lossPrice discriminationPrice regulation
Watanabe Econ 4935 15 Monopoly 81 / 83
Notes
Notes
Notes
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Airline du Jour
Today’s color theme is provided by courtesy of Alitalia
Watanabe Econ 4935 15 Monopoly 82 / 83
Monopolistic Market Monopolistic Pricing Inefficiency Price Discrimination Public Policy
Index
antitrust laws, 63average cost pricing, 74barriers to entry, 6deadweight loss, 45increasing returns to scale,10marginal cost, 29marginal cost pricing, 66,74marginal revenue, 29monopolist, 5monopolistic pricing, 74
natural monopoly, 10, 65perfect pricediscrimination, 54price effect, 31price setter, 5price-change effect, 32profit maximizationproblem, 22public ownership, 64quantity effect, 31quantity-change effect, 32
Watanabe Econ 4935 15 Monopoly 83 / 83
Notes
Notes
Notes