3rd Test Covers: Lectures (pdf): Public Goods (Oct. 28). Parson Mills Cost Curves (Nov 6). Competitive Markets (Nov 11). TaxifromHell (Nov 13). Monopoly (Nov 18). Aplia Assignments Runners and Investment Fund Managers Consumer Choices Involving Choc, Cig and Wine The Sumner Strawberry Farm Peruvian Guano Monopoly

Monopoly

salt

A firm is a monopoly if

1) It is the only seller of the good or service.

2) There are no close substitutes.

3) There are barriers to entry of competitors.

electricityinhalers

Monopoly

Ghandi’s March to the Sea

Monopoly

Why do Monopolies arise?

1) Governments create and protect them.Ghandi gathers salt at the end of his march to the sea, 1930

1882 Salt Act: Indians were forced to purchase salt from the British monopoly despite the fact that salt was freely available to those living on the coast

a) Exclusive Licenses

State Liquor Stores

Monopoly

Why do Monopolies arise?

1) Governments create and protect them.

b) Patents, Trademarks and Copyrights

Flixotide—A CFC-free inhaler patented by gsk

Monopoly

Why do Monopolies arise? 2) Natural Monopolies

PE

In the mid-1890s, Samuel Insull (SI) took over a power station in Chicago, one of about 20 power stations that served a tiny fraction of the city.

Chicago Market for Electricity (E), 1895

QE

ATCSI

Monopoly

Why do Monopolies arise? 2) Natural Monopolies

PE

At the end of the 19th Century, Samuel Insull (SI) took over a power station, one of about 20 power stations that served a tiny fraction of the city.

Chicago Market for Electricity (E), 1895

QE

ATCSI

D

ATC~20th plant

P1895

Q1895

Monopoly

Why do Monopolies arise? 2) Natural Monopolies

PEChicago Market for Electricity (E), 1900

QE

ATCSI

D

ATC~20th plant

P1900

Q1900

ATCHarrison St Station

In the late 1890s, Insull built the largest power plant in the world, the Harrison Street Station. To keep it running at near full tilt, he slashed prices, making electricity much more affordable.

Insull’s single plant could supply electricity to Chicago at a smaller cost than could the 20 smaller plants

Monopoly

Why do Monopolies arise? 3) Ownership of Key Resource

19th Century Peruvian

Guano

D

Q

Western Digital Memory Modules

Perfectly Competitive firms are price-takers

A firm loses all its customers if it P

Monopolies are Price-Makers, Competitive Firms are Price-Takers

D

Q

P

Monopolists are price-makers

can P

all its customers and not lose

CFC-Free Inhalers

P

Government will ban CFC propelled inhalers beginning in 2009

Guano-Bearing Regions of the Peruvian Coast

Peruvian Guano Monopoly

excrement of fish-eating birds

highly valued 19th century fertilizer, especially in Southern US

Large deposits on the Lobos and Chincha islands

Entire C

oastline of Peru

Lobos

Chincha Peruvian government authorized a single firm to sell guano

Odious stuff—miners were often convicts and Chinese laborers

Demand for Peruvian Guano (PG), 1850

0

10

20

30

40

50

60

70

80

90

100

0 50 100 150 200 250 300 350 400 450 500

Suppose the demand in 1850 for Peruvian guano was:

D

PPG

QPG

($ per ton)

(thou. of tons per year)

90

80

70

0

50

100

0

4,000,000

7,000,000

$80

$60

60

50

40

150

200

250

9,000,000

10,000,000

10,000,000

$20

$0

30

20

300

350

9,000,000

7,000,000

−$20

− $40

10

0

400

450

4,000,000

0

Price($/ton)

Q(1,000 tons)

TR($)

MR($)

$40

− $60

− $80

mid-pt of Q

25

75

125

175

225

275

325

375

425

Market for Peruvian Guano (PG), 1850

0

10

20

30

40

50

60

70

80

90

100

0 50 100 150 200 250 300 350 400 450 500

(thou. of tons per year)

MR

QPG

D

PPG($ per ton) $80

$60

$20

$0

MR($)

$40

mid-pt of Q

25

75

125

175

225

Two Effects on TR when the Monopoly Q

1) output effect—more Q is sold, so TR .

2) price effect—price , so TR .

If the monopoly wants to Q, it must lower P of all tons sold, which is why MR < P

wheelbarrow

group of guano miners

Pier

Buildings

Production of Peruvian Guano

Fixed Inputs—pier, railroad, wheelbarrows, housing and the island. Suppose TFC=$2 million per year.

Variable Inputs—labor. Suppose MC=$10 per thou. tons at Q

Market for Peruvian Guano (PG), 1850

0

10

20

30

40

50

60

70

80

90

100

0 50 100 150 200 250 300 350 400 450 500

D

PPG

QPG

($ per ton)

(thou. of tons per year)

MRMC=AVC

AFC (Q = 25,000) = ——— = —————— =TFC

Q

$2,000,000

25,000$80

$26.7

$11.4

$8.9

AFC ($)

$16

Q

25,000

75,000

125,000

175,000

225,000

$90

$36.7

$21.4

$18.9

ATC($)

$26

$6.2

$5.3

$7.3275,000

325,000

375,000

$16.2

$15.3

$17.3

ATC

= $80

Market for Peruvian Guano (PG), 1850

0

10

20

30

40

50

60

70

80

90

100

0 50 100 150 200 250 300 350 400 450 500

PPG

QPG

($ per ton)

(thou. of tons per year)

MR DMC=AVC

ATC

Does the Peruvian guano monopoly want to produce the Q=150,000th ton of guano?

MR(Q=100)

MC(Q=100)

Δ econ π (from just Q=150) =$20 > 0

Hence, the Peruvian guano monopoly wants to continue to produce as long as MR > MC.

QπMax=QM

PM

ATC

AVC

MC

PInhaler

($)

QM

PM≈30

To find QM & PM: (1) find intersection of MR & MC, (2) go down to horizontal axis to find QM and (3) go up to the demand curve and over to the vertical axis to find PM.

(1)

(2)

(3)

(3)

MR D

Quantity of CFC-Free Inhalers

Pharmacist Larry Cowan says that “the new [CFC-free inhaler is] going to cost around $30, where the previous [ones] cost around $10."

“Lifelong asthma sufferer Suzan Steblein said the price jump could

be troubling for many patients, but rescue inhalers are so vital that they'll have little choice but to pay.”

—Washington Post, 5/23/06

The Guano Monopoly’s Profits, 1850

0

10

20

30

40

50

60

70

80

90

100

0 50 100 150 200 250 300 350 400 450 500

PPG

QPG

($ per ton)

(thou. of tons per year)

MR DMC=AVC

ATC

QM

PM

A

B ATC(QM)

Total Revenue = PM* QM

Height of rectangle A+B

Base of rectangle A+B

= area A+B

= area BTotal Cost = ATC(QM) * QM

Econ π = TR − TC = area A

The Inefficiency of the Guano Monopoly, 1850

0

10

20

30

40

50

60

70

80

90

100

0 50 100 150 200 250 300 350 400 450 500

PPG

QPG

($ per ton)

(thou. of tons / yr)

MRDMC=AVC

ATC

QM Q*

PM

DWL

Benefit of QM to Q* to consumers

= WTP= area under D =

Opp cost of producing QM to Q*

= area under MC =

The deadweight loss of not producing these tons of guano equals the excess of the benefits over costs

Monopoly Q Efficient Q