Download - Chapter 11A/24
CHAPTER 11A/24
MONOPOLYProf. Charles Fusi
11A/24-2Lecture by Prof. Charles Fusi
INTRODUCTION
In New York City, a taxicab requires a medallion as legal possession of a license to operate the taxi business.
Thus, the medallion constitutes a barrier to entry to New York City’s taxicab industry.
In this chapter, you will learn how governmentally imposed and other types of barriers to entry give rise to monopolies, or single-firm industries.
11A/24-3Lecture by Prof. Charles Fusi
LEARNING OBJECTIVES
Identify situations that can give rise to monopoly
Describe the demand and marginal revenue conditions a monopolist faces
Discuss how a monopolist determines how much output to produce and what price to charge
Evaluate the profits earned by a monopolist
Understand price discrimination
Explain the social cost of monopolies
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CHAPTER OUTLINE
Definition of a Monopolist Barriers to Entry The Demand Curve a Monopolist Face Elasticity and Monopoly Cost and Monopoly Profit Maximization Calculating Monopoly Profit On Making Higher Profits: Price
Discrimination The Social Cost of Monopolies
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DEFINITION OF A MONOPOLIST
Monopolist
A single supplier of a good or service for which there is no close substitute
The monopolist therefore constitutes the entire industry
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BARRIERS TO ENTRY
Question How does a firm obtain monopoly
power? Answer
Barriers to entry that allow the firm to make long-run economic profits
Barriers to entry are restrictions on who can start as well as stay in business.
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BARRIERS TO ENTRY (CONT'D)
Barriers to entry include:
Ownership of resources without close substitutes
Economies of scale
Legal or governmental restrictions
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BARRIERS TO ENTRY (CONT'D)
Ownership of resources without close substitutes
The Aluminum Company of America (ALCOA) at one time owned most of of the world’s bauxite
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BARRIERS TO ENTRY (CONT'D)
Economies of scale
Low unit costs and prices drive out rivals
The largest firm can produce at the lowest average total cost
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BARRIERS TO ENTRY (CONT'D)
Natural Monopoly A monopoly that arises from the peculiar
production characteristics in an industry
It usually arises when there are large economies of scale
One firm can produce at a lower average cost than can be achieved by multiple firms
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FIGURE 11A/24-1 THE COST CURVES THAT MIGHT LEAD TO A NATURAL MONOPOLY
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BARRIERS TO ENTRY (CONT'D)
Legal or governmental restrictions
Licenses, franchises, and certificates of convenience
Examples include Electrical utilities
Radio and television broadcasting
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BARRIERS TO ENTRY (CONT'D)
Legal or governmental restrictions Patents
Intellectual property
Tariffs Taxes on imported goods
Regulation Government enforcement of safety and
quality
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THE DEMAND CURVE A MONOPOLIST FACES
The monopolist faces the industry demand curve because the monopolist is the entire industry
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Recall that under perfect competition
Firm faces perfectly elastic demand curve, it is a price taker
The forces of supply and demand establish the price per unit
Marginal revenue, average revenue, and price are all the same
THE DEMAND CURVE A MONOPOLIST FACES (CONT'D)
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THE DEMAND CURVE A MONOPOLIST FACES (CONT'D)
Marginal revenue equals the change in total revenue due to a one-unit change in the quantity produced and sold
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THE DEMAND CURVE A MONOPOLIST FACES (CONT'D)
Perfect competition versus monopoly
The perfect competitor doesn’t have to worry about lowering price to sell more
In a purely competitive situation, the firm accounts for a small part of the market
It can sell its entire output, whatever that may be, at the same price
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THE DEMAND CURVE A MONOPOLIST FACES (CONT'D)
Perfect competition versus monopoly
The more the monopolist wants to sell, the lower the price it has to charge on the last unit sold
To sell the last unit, the monopolist has to lower the price because it is facing a downward sloping demand curve
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FIGURE 11A/24-2 DEMAND CURVES FOR THE PERFECT COMPETITOR AND THE MONOPOLIST
11A/24-20Lecture by Prof. Charles Fusi
Monopoly Perfect Competition
Single seller
Faces entire industry demand
Must lower price to sell more
Not all units sold for same price (MR < P)
Many sellers
Faces perfectly elastic demand
Must produce moreto sell more
All units sold for same price (P = MR)
THE DEMAND CURVE A MONOPOLIST FACES (CONT'D)
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FIGURE 11A/24-3 MARGINAL REVENUE: ALWAYS LESS THAN PRICE
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ELASTICITY AND MONOPOLY
The monopolist faces a downward-sloping demand curve (its average revenue curve)
That means that it cannot charge just any price with no changes in quantity (a common misconception) because, depending on the price charged, a different quantity will be demanded
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ELASTICITY AND MONOPOLY (CONT'D)
Question If a monopoly raises price, what will
happen to quantity demanded?
Hint Remember how consumers respond to a
change in price
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ELASTICITY AND MONOPOLY (CONT'D)
Recall
A monopolist is a single seller of a well-defined good or service with no close substitute
Think of some imperfect substitutes.
The demand curve slopes downward because individuals compare marginal satisfaction to cost
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ELASTICITY AND MONOPOLY (CONT'D)
After all, consumers have limited incomes and unlimited wants
The market demand curve, which the monopolist alone faces in this situation, slopes downward because individuals compare the marginal satisfaction they will receive to the cost of the commodity to be purchased
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COSTS AND MONOPOLY PROFIT MAXIMIZATION
We assume profit maximization is the goal of the pure monopolist, just as it is for the perfect competitor
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COSTS AND MONOPOLY PROFIT MAXIMIZATION (CONT'D)
Perfect competitor has only to decide on the profit-maximizing output rate because price is given The perfect competitor is a price taker
For the pure monopolist, we must seek a profit-maximizing price output combination The monopolist is a price searcher
11A/24-28Lecture by Prof. Charles Fusi
COSTS AND MONOPOLY PROFIT MAXIMIZATION (CONT'D)
Price Searcher
A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve
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COSTS AND MONOPOLY PROFIT MAXIMIZATION (CONT'D)
We can determine the profit-maximizing price-output combination with either of two equivalent approaches:
By looking at total revenues and total costs
or
By looking at marginal revenues and marginal costs
11A/24-30Lecture by Prof. Charles Fusi
COSTS AND MONOPOLY PROFIT MAXIMIZATION (CONT'D)
Total revenues-total costs approach Maximize the positive difference
between total revenues and total costs
Marginal revenue-marginal cost approach Profit maximization will also occur where
marginal revenue equals marginal cost
11A/24-31Lecture by Prof. Charles Fusi
COSTS AND MONOPOLY PROFIT MAXIMIZATION (CONT'D)
Question Why produce where marginal revenue
equals marginal cost?
Answer This is where the greatest positive
difference between total revenue and total cost occurs
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FIGURE 11A/24-4 MONOPOLY COSTS, REVENUES, AND PROFITS, PANEL (A)
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FIGURE 11A/24-4 MONOPOLY COSTS, REVENUES, AND PROFITS, PANELS (B) AND (C)
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COSTS AND MONOPOLY PROFIT MAXIMIZATION (CONT'D)
Producing past where MR = MC Result is that incremental cost will
exceed incremental revenue
Producing less than where MR = MC The monopolist is not maximizing profits
through this approach either
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FIGURE 11A/24-5 MAXIMIZING PROFITS
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COST AND MONOPOLY PROFIT MAXIMIZATION (CONT’D)
Real-World Informational Limitations Price searching by a less-than perfect
competitor is a process A monopolist can only estimate the
actual demand curve and make an educated guess when it sets its profit-maximizing profit
For the perfect competitor, price is given already by the intersection of market demand and supply
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CALCULATING MONOPOLY PROFIT
Monopoly profit is given by the shaded area in Figure 24-6, which is equal to total revenues (P Q) minus total costs (ATC Q)
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FIGURE 11A/24-6 MONOPOLY PROFIT
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CALCULATING MONOPOLY PROFIT (CONT'D)
No guarantee of profits
The term monopoly conjures up the notion of a greedy firm ripping off the public
If ATC is everywhere above AR, or demand
No price-output combination allows the monopolist to cover costs
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FIGURE 11A/24-7 MONOPOLIES: NOT ALWAYS PROFITABLE
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INTERNATIONAL EXAMPLE: A MEXICAN CEMENT MONOPOLY FINDS A WAY TO INCUR LOSSES
In Mexico, a single company, Cemex, accounts for almost 80 percent of the nation’s cement production and sales.
Thus, Cemex sells cement to Mexican consumers at almost twice the market price in the United States, where a number of firms make and sell cement.
Recently, Cemex has been incurring losses as a result of falling demand in 2008 and its debt costs from short-term loans that the company had borrowed during periods of expansion.
11A/24-42Lecture by Prof. Charles Fusi
ON MAKING HIGHER PROFITS: PRICE DISCRIMINATION
Price Discrimination
Selling a given product at more than one price, with the difference being unrelated to differences in cost
11A/24-43Lecture by Prof. Charles Fusi
ON MAKING HIGHER PROFITS: PRICE DISCRIMINATION (CONT'D)
Price Differentiation
Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers
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ON MAKING HIGHER PROFITS: PRICE DISCRIMINATION (CONT'D)
Necessary conditions for price discrimination
1. The firm must face a downward-sloping demand curve
2. The firm must be able to readily (and cheaply) identify buyers or groups of buyers with predictably different elasticities of demand
3. The firm must be able to prevent resale of the product or service
11A/24-45Lecture by Prof. Charles Fusi
EXAMPLE: WHY STUDENTS PAY DIFFERENT PRICES TO ATTEND COLLEGE
Out-of-pocket tuition rates for any two college students can differ by considerable amounts, even if the students happen to major in the same subjects and enroll in many of the same courses.
The reason for this is that colleges offer students diverse financial aid packages depending on their “financial need.”
To document their “need” for financial aid, students must provide detailed information about family income and wealth. This information helps the college determine the prices that different families are most likely to be willing and able to pay, so that it can engage in price discrimination.
11A/24-46Lecture by Prof. Charles Fusi
FIGURE 11A/24-8 TOWARD PERFECT PRICE DISCRIMINATION IN COLLEGE TUITION RATES
11A/24-47Lecture by Prof. Charles Fusi
THE SOCIAL COST OF MONOPOLIES
Comparing monopoly with perfect competition
Let’s assume a monopolist comes in and buys up every single perfect competitor
Notice the monopolist produces a smaller quantity and sells at a higher price
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THE SOCIAL COST OF MONOPOLIES (CONT'D)
Comparing monopoly with perfect competition
Monopolists raise the price and restrict production compared to a perfectly competitive situation
Consumers pay a price that exceeds the marginal cost of production and resources are misallocated in such a situation
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FIGURE 11A/24-9 THE EFFECTS OF MONOPOLIZING AN INDUSTRY
11A/24-50Lecture by Prof. Charles Fusi
YOU ARE THERE: A TEXAS VETERINARY BOARD WHITTLES DOWN VETS’ COMPETITION
The Texas Board of Veterinary Medical Examiners has determined that horse-teeth floaters, who provide basic dental services for horses, must be certified or else they must work under the supervision of a licensed veterinarian.
This way, many skilled horse-teeth floaters without a license will no longer able to compete with licensed veterinarians in the market for horse dental services.
11A/24-51Lecture by Prof. Charles Fusi
ISSUES & APPLICATIONS: THIS MEDALLION IS NOT SIMPLY A DECORATIVE PENDANT
The number of taxi medallions issued by New York City is controlled by the city’s Taxi and Limousine Commission.
The commission’s medallions serve as a barrier to entry in the taxicab market.
The medallions can be bought and sold, and the market clearing prices have generally risen since 2004, now exceeding $600,000 for individual owners and $800,000 for corporate owners.
11A/24-52Lecture by Prof. Charles Fusi
FIGURE 11A/24-10 MARKET PRICES OF NEW YORK CITY TAXI MEDALLIONS
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SUMMARY DISCUSSION OF LEARNING OBJECTIVES (CONT'D)
Why a monopoly can occur Barriers to entry
Demand and marginal revenue conditions faced by a monopolist Because the monopolist constitutes the
entire industry, it faces the entire market demand curve.
Marginal revenue is less than price.
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SUMMARY DISCUSSION OF LEARNING OBJECTIVES (CONT'D)
How a monopolist determines how much output to produce and what price to charge
Seeks to maximize its economic profits
Produces where marginal revenue equals marginal cost
Charges maximum price for the amount of output where MR = MC
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SUMMARY DISCUSSION OF LEARNING OBJECTIVES (CONT'D)
A monopolist’s profits
Profit earned by monopolist is equal to the difference between the price it charges and its average production cost times the amount of output it produces and sells.
Monopolist typically earns positive economic profits.
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SUMMARY DISCUSSION OF LEARNING OBJECTIVES (CONT'D)
Price discrimination
Selling at more than one price with the price differences being unrelated to differences in production costs.
Monopolist sells some of its output at higher prices to consumers with less elastic demand.
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SUMMARY DISCUSSION OF LEARNING OBJECTIVES (CONT'D)
Social cost of monopolies
Price exceeds marginal cost.
The price is higher and output is lower for a monopolist as compared to a perfectly competitive industry.
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APPENDIX G: CONSUMER SURPLUS IN A PERFECTLY COMPETITIVE MARKET
Given the market clearing price that prevails in the perfectly competitive market, consumer surplus is: the difference between the total amount
that consumers would have been willing to pay and the total amount that they actually pay
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FIGURE G-1 CONSUMER SURPLUS IN A PERFECTLY COMPETITIVE MARKET
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APPENDIX G: HOW SOCIETY LOSES FROM MONOPOLY
Deadweight Loss The portion of consumer surplus that no
one in society is able to obtain in a situation of monopoly
No one in society, not even the monopoly, can obtain this deadweight loss
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APPENDIX G: HOW SOCIETY LOSES FROM MONOPOLY (CONT’D)
As a result of monopoly, consumers are worse off in two ways: The monopoly profits that result constitute
a transfer of a portion of consumer surplus away from consumers to the monopolist
The failure of the monopoly to produce as many units as would have been produced under perfect competition eliminates consumer surplus that otherwise would have been a benefit to consumers
11A/24-62Lecture by Prof. Charles Fusi
FIGURE G-2 LOSSES GENERATED BY MONOPOLY