Econ Final Exam (last two chapters)

When does a monopoly experience a loss?

-A monopolist will earn a loss if the AC is above the demand curve

Regulating monopolies

-Today, the most commonly used approach to regulating monopoly pricing is to impose a price ceiling, called a price cap. -A government can eliminate the deadweight loss of monopoly by imposing a price cap equal to the price that would prevail in a competitive market.

Cost-Based Monopoly

Certain cost structures may facilitate the creation of a monopoly. -One possibility is that a firm may have substantially lower costs than potential rivals. -A second possibility is that the firms in an industry have cost functions such that one firm can produce any given output at a lower cost than two or more firms can.

Monopoly profits

Profit is TR-TC which is the box between average cost and price up to the quantity produced.

Marginal revenue for a monopoly

For a monopoly: P depends on the quantity sold P(Q) = inverse demand -Total Revenue is then TR= P(Q)xQ -MR=P'(Q)Q+P(Q) P'(Q)<0 (the law of demand) Therefore MR<P(Q) "marginal revenue is less than price" -marginal revenue is above price

Nonoptimal price regulation

If the government sets the price ceiling at a nonoptimal level, a deadweight loss results.

Market failure (from monopoly)

Inefficient production or consumption, often because a price exceeds marginal cost -The market failure from a monopoly occurs because its price is greater than its marginal cost. -This economic inefficiency creates a rationale for governments to intervene.

Bundling

Selling multiple goods or services for a single price -Bundling allows firms that can't directly price discriminate to charge customers different prices. Whether either type of bundling is profitable depends on customers' tastes and the ability to prevent resale.

Price markup (Lerner index) depends on the elasticity of demand

They're inversely related -More elastic, the less the price markup is, the less the lerner index is -More inelastic, the more the price markup is, the more the lerner index is

The monopoly set its price...

above marginal cost to maximize profit -Consumers buy less at this high monopoly price than they would at the competitive price, which equals marginal cost.

Unlike perfect competition, which achieves economic efficiency by maximizing welfare, a profit-maximizing monopoly is...

economically inefficient because it wastes potential surplus, resulting in a deadweight loss, DWL.

A single-price monopoly takes...

less consumer surplus from consumers than a perfectly price-discriminating monopoly.

market power (monopoly power)

the ability of a firm to charge a price above marginal cost and earn a positive profit. -ability to raise price without losing a large quantity of sales.

reservation price

the maximum amount a person would be willing to pay for a unit of output.

Monopolies cause deadweight loss because

they produce too little output

nonlinear price discrimination

when it charges a different price for large quantities than for small quantities, so that the price paid varies according to the quantity purchased. -price consumers pay is based on the quantity! -second degree price discrimination

To find Marginal revenue...

-Just look at the inverse demand function and double the slope

Relationship between elasticity and DWL

-More elastic, less DWL -More inelastic, more DWL

Mixed bundling

-The firm offers consumers the choice of buying the goods separately or as a bundle. -A restaurant may offer the soup and sandwich special as well as sell each item separately.

This table illustrates that not all monopolies can set high prices. -A monopoly that faces a horizontal, perfectly elastic demand curve sets its price equal to its marginal cost—just like a price-taking, competitive firm. -If this monopoly were to raise its price, it would lose all its sales, so it maximizes its profit by setting its price equal to its marginal cost.

-The more elastic the demand curve at the optimum, the less a monopoly can raise its price without losing sales. -All else the same, the more close substitutes for the monopoly's good, the more elastic is the demand curve at the optimum.

Monopolies deal with marginal revenue

A firm's marginal revenue, MR, is the change in its revenue from selling one more unit. -A firm's marginal revenue curve depends on its demand curve. -Although the marginal revenue curve is horizontal for a competitive firm, it is downward sloping for a monopoly.

Shutdown decision for monopoly (SR AND LR)

A monopoly shuts down to avoid making a loss in the short run if its price is below its average variable cost at its profit-maximizing (or loss-minimizing) quantity In the long run, the monopoly shuts down if the price is less than its average cost. -If AC<price, firm makes a profit

Two-Part Pricing with Identical Customers

-If the monopoly sets its price, p, equal to its constant marginal cost of 10, total surplus is maximized. The firm breaks even on each unit sold and has no producer surplus and no profit. -However, if the firm also charges a lump-sum access fee of 2,450, it captures this 2,450 as its producer surplus or its profit per customer, and leaves Valerie with no consumer surplus. *The firm maximizes its profit by setting its price equal to its marginal cost and charging an access fee that captures the entire potential consumer surplus. -If the firm were to charge a price above its marginal cost of 10, it would sell fewer units and make a smaller profit.

Increasing competition is an alternative to regulation as a means of reducing the harms of monopoly

-You can quickly reduce the monopoly's market power by allowing other firms to enter -As new firms enter the market, the former monopoly must lower its price to compete, so welfare rises

Governments often fail to regulate monopolies optimally for at least three reasons.

1) Due to limited information about the demand and marginal cost curves, governments may set a price ceiling above or below the competitive level. 2) Regulation may be ineffective when regulators are captured: influenced by the firms they regulate. 3) Because regulators generally cannot subsidize the monopoly, they may be unable to set the price as low as they want because the firm may shut down.

Types of Price Discrimination

1) Perfect price discrimination (first-degree price discrimination) 2) Nonlinear price discrimination (second-degree price discrimination) 3) Group price discrimination (third-degree price discrimination)

monopoly behavior

Goal: Maximize Profits Profits = Total Revenue-Total Cost Rule for Max Profits: sell additional units as long as the increase in revenue from the added unit exceeds the cost of producing an added unit (I.e. MR=MC)

We now examine the factors that determine how much above its marginal cost a monopoly sets its price.

Size doesn't matter. Rather, a monopoly marks up its price more over its marginal cost, the less sensitive consumers are to price: the less elastic is the demand curve.

Bundling sales are most advantageous to the seller when

-the demands for the two goods are negatively correlated -bundling is not good if the demand for the two goods are positively correlated! *as long as reservation prices are positively correlated, pure bundling cannot increase the profit.

Two forms of tie-in sales

1) requirement tie-in sale 2) bundling.

To find MR with nonlinear

-Find total revenue P(Q)*Q -Find the derivative of total revenue to find MR

monopoly vs. perfectly competitive firm

-Monopoly will select quantity where MR=MC -Perfectly Competitive firm will select quantity where P=MC Compared to a perfectly competitive firm, a monopolist sells less output at a higher price

To get rid of DWL

-Put a price ceiling where MC=D *price ceiling will increase output -subsidize

Government creation of monopolies

-By preventing other firms from entering a market, governments create monopolies. Barriers to entry -Sometimes governments own and manage monopolies, forbidding other firms from entering. Patent -an exclusive right granted to the inventor to sell a new and useful product, process, substance, or design for a fixed period. -This right allows the patent holder to be the exclusive seller or user of the new invention. -Patents often give rise to monopoly, but not always. -Why, then, do governments grant patent monopolies? The main reason is to encourage inventive activity—less innovation would occur if successful inventors did not receive a patent monopoly.

A firm with market power can earn a higher profit using nonuniform pricing than by setting a uniform price for two reasons.

1) First, the firm captures some, or all, of the single-price consumer surplus. 2) Second, the firm converts at least some of the single-price deadweight loss into profit by charging a price below the uniform price to some customers who would not purchase at the single-price level. *A monopoly that uses nonuniform pricing can lower the price to these otherwise excluded consumers without lowering the price to consumers who are willing to pay higher prices.

Monopoly

the only supplier of a good that has no close substitute -A monopoly can set its price—it is not a price taker like a competitive firm.

Monopoly graph looks like...

-A monopoly's output is the market output, and the demand curve a monopoly faces is the market demand curve. -Because the market demand curve is downward sloping, the monopoly (unlike a competitive firm) doesn't lose all its sales if it raises its price.

Two-part tariff

charges a customer one fee for the right to buy the good and an additional fee for each unit purchased. ex. costco

tie-in-sale

customers can purchase one product only if they agree to buy another product as well. One example is bundling, where several products are sold together as a package.

Marginal revenue curve

the monopoly's marginal revenue curve lies below the demand curve at every positive quantity. -The marginal revenue curve is a straight line that starts at the same point on the vertical (price) axis as the demand curve but has twice the slope of the demand curve, so the marginal revenue curve hits the horizontal (quantity) axis at half the quantity as the demand curve

Causes of monopoly

1) Costs 2) Government action

Cost advantages

-If a low-cost firm profitably sells at a price so low that other potential competitors with higher costs would lose money, no other firms enter the market. Thus, the low-cost firm is a monopoly. -A firm can have a cost advantage over potential rivals for several reasons. It may have a superior technology or a better way of organizing production. -Another example is that the firm controls an essential facility: a scarce resource that a rival needs to use to survive.

What happens as a profit-maximizing monopoly faces more elastic demand?

It has to lower its price.

-More elastic, lower market power -Less elastic, higher market power

Low market power: -More elastic -highly competitive firm -a lot of substitutes -A rise in the price causes a sharp decrease in demand High market power -less elastic -Few close substitutes -As price rises, demand doesn't drop as much Perfect competiton -Horizontal, perfectly elastic demand -

Summary of perfect price discrimination

Under perfect price​ discrimination, the same quantity is produced as would be produced by a competitive​ market, and the last unit of output sells for the marginal​ cost; thus, perfect price discrimination is efficient. By selling each unit of its output to the customer who values it the most at the maximum price that person is willing to​ pay, the reservation​ price, the perfectly​ price-discriminating monopoly captures all possible consumer surplus. All the social gain from the extra output goes to the perfectly​ price-discriminating firm.

Causes of monopoly (class ppt) -In competitive markets, profit leads to entry of new firms (increased competition), but in monopoly markets, barriers to entry exist

(1) Government: Patents, Copyright, Trademark, Trade Secret Protection (2) Government: Favors, Exclusive Rights, Regulation (3) Natural: Exclusive Access to Resources (4) Natural: Economies of Scale (lower unit cost from producing large quantities)

Which Firms Can Price Discriminate

1) First, a firm must have market power. -A monopoly, an oligopoly firm, or a monopolistically competitive firm might be able to price discriminate. However, a perfectly competitive firm cannot price discriminate because it is a price taker! 2) Second, for a firm to profitably discriminate, groups of consumers or individual consumers must have demand curves that differ, and the firm must be able to identify how its consumers' demand curves differ. 3) Third, a firm must be able to prevent or limit resale. -Price discrimination doesn't work if resale is easy because the firm would be able to make only low-price sales. *Biggest obstacle

Two-step analysis to determine the output level that maximizes their profit

-First, the firm determines the output, Q*, at which it makes the highest possible profit—the output at which its marginal revenue equals its marginal cost. -Second, the firm decides whether to produce Q* or shut down.

Welfare Effects of Group Price Discrimination

-Group price discrimination results in inefficient production and consumption. As a result, welfare under group price discrimination is lower than that under competition or perfect price discrimination. -However, welfare may be lower or higher with group price discrimination than with a single-price monopoly.

The degree to which the monopoly raises its price above its marginal cost depends on the shape of the demand curve at the profit-maximizing quantity.

-If the monopoly faces a highly elastic—nearly flat—demand curve at the profit-maximizing quantity, it loses substantial sales if it raises its price by even a small amount. -Conversely, if the demand curve is not very elastic (relatively steep) at that quantity, the monopoly loses fewer sales from raising its price by the same amount.

Effects of a shift in the demand curve

-In a competitive market, the effect of a shift in demand on a competitive firm's output depends only on the shape of the marginal cost curve -In contrast, the effect of a shift in demand on a monopoly's output depends on the shapes of both the marginal cost curve and the demand curve.

Pure bundling

-In pure bundling, a firm only sells the goods together. -For example, a restaurant may offer a soup and sandwich special but not allow customers to purchase the soup or the sandwich separately. -Whether pure bundling increases the firm's profit depends on the reservation prices.

Different elasticities, different DWL

-More inelastic, more DWL -More elastic, less DWL

Group price discrimination (more info)

-Most firms have no practical way to estimate the reservation price for each of their customers and to charge each customer a different price. However, many of these firms know which groups of customers are likely to have higher reservation prices on average than others. -Consumer groups may differ by age (such as adults and children), by location (such as by country), or in other ways. All units of the good sold to customers within a group are sold at a single price.

Perfect Price Discrimination Is Efficient but Harms Some Consumers

-Perfect price discrimination maximizes total surplus, but the entire surplus goes to the firm

Preventing Resale

-Resale is difficult or impossible for most services and when transaction costs are high. -Similarly, a firm can prevent resale by vertically integrating: participating in more than one successive stage of the production and distribution chain for a good or service. -Governments frequently aid price discrimination by preventing resale.

When will a monopoly face a relatively elastic demand curve and hence have little market power?

-The elasticity of demand of the market demand curve depends on consumers' tastes and options. -The more consumers want a good—the more willing they are to pay "virtually anything" for it—the less elastic is the demand curve. (1) better substitutes for the firm's product are introduced (2) more firms enter the market selling the same product (3) firms that provide the same service locate closer to this firm.

Unlike a competitive firm, a monopoly can adjust its price, so it has a choice of setting its price or its quantity to maximize its profit.

-The monopoly is constrained by the market demand curve. Because the demand curve slopes down, the monopoly faces a trade-off between a higher price and a lower quantity or a lower price and a higher quantity. -The monopoly chooses the point on the demand curve that maximizes its profit. Unfortunately for the monopoly, it cannot set both its quantity and its price. -If the monopoly sets its price, the demand curve determines how much output it sells. If the monopoly picks an output level, the demand curve determines the price. -Because the monopoly wants to operate at the price and output at which its profit is maximized, it chooses the same profit-maximizing solution whether it sets the price or output. -In the rest of this chapter, we assume that the monopoly sets quantity.

The perfect price discrimination solution differs from the competitive equilibrium in two important ways.

1) First, in the competitive equilibrium, everyone is charged where P=MC. In the perfect price discrimination optimum, only the last unit is sold at that price. Customers buy the other units at their reservation prices, which are greater than P=MC 2) Second, consumers receive some consumer surplus under competition. A perfectly price-discriminating monopoly captures all the surplus or potential gains from trade. -Total surplus is the same in competition and in perfect price discrimination (perfect price discrimination doesn't reduce efficiency) -But, there is no CS in ppd. Consumers are much better off in competition

Group price discrimination

-a firm charges each group of customers a different price, but it does not charge different prices within the group. -The price that a firm charges a consumer depends on that consumer's membership in a particular group. Thus, not all customers pay different prices—the firm sets different prices only for a few groups of customers. -Because group price discrimination is the most common type of price discrimination, the phrase price discrimination is often used to mean group price discrimination. ~students, seniors, children -third degree price discrimination

Perfect price discrimination

-a firm sells each unit at the maximum amount any customer is willing to pay for it. (Sells each unit at the reservation price) -It captures all possible consumer surplus -Perfect price discrimination is rare because firms do not have perfect information about their customers. -it is the most efficient form of price discrimination -A perfectly price-discriminating monopoly's marginal revenue is the same as its price. -the firm's marginal revenue curve is its demand curve. -like any profit-maximizing firm, a perfectly price-discriminating firm produces where its marginal revenue curve intersects its marginal cost curve. -No DWL, no CS 1st degree everything is turned into profit

Lerner Index

-a measure of a firm's markup, or its level of market power -the ratio of the difference between price and marginal cost to the price -The greater the difference between price and marginal cost, the larger the Lerner Index and the greater the monopoly's ability to set price above marginal cost. -This measure is zero for a competitive firm because a competitive firm cannot raise its price above its marginal cost. (P-MC)/P If the firm is maximizing its profit, we can express the Lerner Index in terms of the elasticity of demand (P-MC)/P=-1/e

Requirement tie-in sale

-customers who buy one product from a firm are required to make all their purchases of another product from that firm. -Some firms sell durable machines such as copiers under the condition that customers buy copier services and supplies from them in the future. -This requirement allows the firm to identify heavier users and charge them more per unit. -Heavier users are less elastic and thus can be charged more

nonlinear price discrimination (more info)

-firms may know that most customers are willing to pay more for the first unit than for successive units. -Such a firm can price discriminate by letting the price each customer pays vary with the number of units the customer buys. -Although the price varies with quantity, each customer faces the same nonlinear pricing schedule.

Natural monopoly

-if one firm can produce the total output of the market at lower cost than several firms could. -A firm can be a natural monopoly even if it does not have a cost advantage over rivals because average cost is lower if only one firm operates. -If all potential firms have the same strictly declining average cost curve, this market is a natural monopoly -In an industry with a natural monopoly cost structure, having only one firm produce is the lowest cost way to produce any given output level.

Price discrimination

-where a firm charges various consumers different prices for a good. -charging consumers different prices for the same good based on individual consumer characteristics, membership in an identifiable subgroup of consumers, or on the quantity consumers purchase -Firms that set a single price use an intermediate price between people who are willing to pay a lot and people who are not. -A price-discriminating firm that varies its prices across customers avoids this trade-off. 1) First, a price-discriminating firm charges a higher price to customers who are willing to pay more than the uniform price, capturing some or all of their consumer surplus 2) Second, a price-discriminating firm sells to some people who were not willing to pay as much as the uniform price. -lower prices for students or seniors

When a firm practices perfect price​ discrimination, it

A. produces the same quantity as would be produced by a competitive market. B. charges each consumer her reservation price. C. takes all consumer surplus from consumers. D. captures all the social gain.

When the marginal revenue is positive, demand is elastic If the firm raises the price in the elastic range of demand, total revenue will increase When demand is unit elastic, marginal revenue = 1 When the total revenue is increasing, demand is elastic The absolute value of the price elasticity of demand increases as you move down the demand curve

T F F T F

Block pricing (nonlinear pricing)

They charge one price per unit for the first few units (a block) purchased and a different price per unit for subsequent blocks. -Gas, electric, water, and other utility companies commonly use declining-block or increasing-block pricing. -The firm uses declining-block prices to maximize its profit. -The more block prices that a firm can set, the closer the firm gets to perfect price discrimination, where it captures all the potential consumer surplus, and its profit or producer surplus equals total surplus. -Moreover, because the last unit sells at a price equal to marginal cost, total surplus is maximized and society suffers no deadweight loss. -consumers are worse off with block pricing because they have less surplus

Two-Part Pricing with Nonidentical Consumers

Thus, the monopoly charges Valerie a lump-sum access fee of 2,450 and Neal an access fee of 4,050, so that the customers receive no consumer surplus. -Charing where p=mc and setting an access fee that is equal to each customer's potential consumer surplus. (price discrimination) If the monopoly cannot charge its customers different prices, it sets its price greater than MC

Nonuniform pricing

where a firm charges consumers different prices for the same product or charges a single customer a price that depends on the number of units the customer buys. -a monopoly can increase its profit if it uses nonuniform pricing! price discrimination, two-part pricing, and tie-in sales.

Social cost of monopoly

•A monopolist sells at a higher price and lower quantity than a competitive market. •Consumer surplus is lower. •Producer surplus (profit) is higher. •There is a Dead Weight Loss because the increase in PS< decrease in CS.

What is Marginal Revenue?

•MR = additional revenue from selling 1 more unit of output (incremental/rate of change) •Calculate by taking the change in revenue over some interval and divide by the change in quantity over that interval. •MR is less than the price of the last unit sold.