Chapter 8. MonopolyChapter 8. MonopolyChapter 8. MonopolyChapter 8. Monopoly

• How?

• Firm behavior

• Monopoly vs. Competition

• Price Discrimination

• Policy

• How?

• Firm behavior

• Monopoly vs. Competition

• Price Discrimination

• Policy

What makes a monopoly?What makes a monopoly?What makes a monopoly?What makes a monopoly?

• single supplier of good firm supply = market supply firm demand = market demand

• single supplier of good firm supply = market supply firm demand = market demand

How does it happen?How does it happen?How does it happen?How does it happen?

1. no close substitutes

• otherwise, makers of substitutes are competition

• example: electricity

1. no close substitutes

• otherwise, makers of substitutes are competition

• example: electricity

2. barriers to entry2. barriers to entry2. barriers to entry2. barriers to entry

• hard (impossible)

for new competitors to enter market

• barriers are natural legal

• hard (impossible)

for new competitors to enter market

• barriers are natural legal

natural monopolynatural monopolynatural monopolynatural monopoly

• high fixed costs

• large economies of scale

• one firm meets market demand,

with lowest cost

• high fixed costs

• large economies of scale

• one firm meets market demand,

with lowest cost

examplesexamplesexamplesexamples

• distribution of water electricity natural gas

• distribution of water electricity natural gas

legal monopolylegal monopolylegal monopolylegal monopoly

• firm owns most of natural resource

• firm has exclusive license, patent, copyright

• firm owns most of natural resource

• firm has exclusive license, patent, copyright

examplesexamplesexamplesexamples

• DeBeers & diamonds

• Bayer & Cipro

• Microsoft & Powerpoint

• DeBeers & diamonds

• Bayer & Cipro

• Microsoft & Powerpoint

monopolist & pricesmonopolist & pricesmonopolist & pricesmonopolist & prices

• power to set prices price maker

• charge single price to everyone

• set prices for different groups/units price discrimination

• power to set prices price maker

• charge single price to everyone

• set prices for different groups/units price discrimination

Monopoly behaviorMonopoly behaviorMonopoly behaviorMonopoly behavior

• single price case

• same rule: choose Q where MR = MC

BUT

• different outcome

• single price case

• same rule: choose Q where MR = MC

BUT

• different outcome

P & MRP & MRP & MRP & MR• for monopoly,

MR < P

• why? increase Q

-- additional revenue-- but at lower P

(demand slopes down)

• for monopoly, MR < P

• why? increase Q

-- additional revenue-- but at lower P

(demand slopes down)

P

Q

D

$7

$6

5 6

TR = $7 x 5 = $35

TR = $6 x 6 = $36 MR = $1from 5 to 6

MR & DMR & DMR & DMR & DP, MR

Q

DMR

profit maximizingprofit maximizingprofit maximizingprofit maximizing

• choose Q where MR = MC

• charge highest P possible using demand curve

• profit

= (P - ATC)(Q)

• choose Q where MR = MC

• charge highest P possible using demand curve

• profit

= (P - ATC)(Q)

P, MR

Q

DMR

MC

Q*

P*

P, MR

Q

DMR

MC

Q*

P*ATC

economic profit

13.3 Monopoly vs. Competition13.3 Monopoly vs. Competition13.3 Monopoly vs. Competition13.3 Monopoly vs. Competition

• monopoly smaller output higher price

• monopoly smaller output higher price

P, MR

Q

DMR

MC

Qm

PmPc

Qc

Pm > Pc

Qm < Qc

Is monopoly efficient?Is monopoly efficient?Is monopoly efficient?Is monopoly efficient?

• No

• output too low Marginal benefit > MC deadweight loss

• No

• output too low Marginal benefit > MC deadweight loss

P, MR

Q

D

S=MC

competitioncompetitioncompetitioncompetition

Pc

Qc

consumersurplus

producersurplus

monopolymonopolymonopolymonopoly

P, MR

Q

DMR

MC

Qm

Pm

consumersurplus

producersurplus

deadweight loss

Price DiscriminationPrice DiscriminationPrice DiscriminationPrice Discrimination

• charge each buyer higher price possible convert consumer surplus to

economic profit

• must identify & separate buyers prevent reselling

• charge each buyer higher price possible convert consumer surplus to

economic profit

• must identify & separate buyers prevent reselling

How?How?How?How?

• charge different prices to groups of buyers

• groups have different willingness to pay

• charge different prices to groups of buyers

• groups have different willingness to pay

example: airlinesexample: airlinesexample: airlinesexample: airlines

• separate business, tourist travelers businesses have less elastic

demand, will pay more

• last minute, refundable tickets have higher price

• separate business, tourist travelers businesses have less elastic

demand, will pay more

• last minute, refundable tickets have higher price

• get consumer surplus from business travelers

• still have low fairs for tourism

• get consumer surplus from business travelers

• still have low fairs for tourism

Example: textbooks Example: textbooks Example: textbooks Example: textbooks

• NYT 10/21/2003

• Textbooks in U.S. cost twice as much as European editions

• Students ordering overseas Internet makes reselling easier,

price discrimination tougher

• NYT 10/21/2003

• Textbooks in U.S. cost twice as much as European editions

• Students ordering overseas Internet makes reselling easier,

price discrimination tougher

other price discriminationother price discriminationother price discriminationother price discrimination

• charge differently for different units

• example 1 pizza, $10 2 pizzas, $14

• people value 1st pizza more

• MC of 2nd pizza to same house small

• charge differently for different units

• example 1 pizza, $10 2 pizzas, $14

• people value 1st pizza more

• MC of 2nd pizza to same house small

Monopoly & policyMonopoly & policyMonopoly & policyMonopoly & policy

• some monopolies are regulated Niagara Mohawk

• some are illegal AT&T (split in 1982) Microsoft?

• some are created drug patents

• some monopolies are regulated Niagara Mohawk

• some are illegal AT&T (split in 1982) Microsoft?

• some are created drug patents

why allow monopolies?why allow monopolies?why allow monopolies?why allow monopolies?

• inefficient deadweight loss

• but there are gains economies of scale

-- natural monopolies

-- utilities

• inefficient deadweight loss

• but there are gains economies of scale

-- natural monopolies

-- utilities

• innovation drug patents reward research copyrights reward creativity

• innovation drug patents reward research copyrights reward creativity

summary: monopolysummary: monopolysummary: monopolysummary: monopoly

• unique good, barrier to entry

• choose Q where MR = MC but MR < P

• Qm lower, Pm higher than competition inefficient

• may use price discrimination

• unique good, barrier to entry

• choose Q where MR = MC but MR < P

• Qm lower, Pm higher than competition inefficient

• may use price discrimination