Micro Chapter 12
what is the trade-off monopolists face when changing prices? what is the reason for this trade-off?
- reason: *since demand curve is downward sloping* , a higher price charged means less quantity can be produced -downward sloping demand curve makes it impossible to sell large quantity at high price -monopoly cannot sell at a point above mkt demand curve -look at graph (B) on pg 290 to see difference between perf. competition demand curve and monopoly demand curve
relationship between marginal revenue (MR) and total revenue
-MR is downward sloping and total revenue is hill shaped (upside-down U) -when total rev. is rising, MR must be positive (still downward sloping but above x-axis) -when total rev. is falling, MR is negative (still downward sloping, below x-axis)
antitrust policy
-aims to regulate and prevent anticompetitive pricing, low quantities, and deadweight loss from emerging / dominating markets -reasoning: monopoly pricing is potentially detrimental to society and very costly for consumers -goal: to keep markets open and competitive
fair-returns price
-allows monopolists to charge a higher price, specifically a price set at the ATC -doesn't maximize surplus -produces deadweight loss -allows monopolist to make zero economic profits; therefore, the monopoly can stay in business w/o the government having to make up for incurred losses
why aren't FB, twitter, and eBay considered natural monopolies?
-although all 3 exhibit network externalities and such networks seem to present barriers to entry, they aren't natural monopolies b/c: 1. *natural monopolies* arise from economies of scale (firm's ATC curve decreases over important range of output) 2. *network externalities* arise from consumer benefits and have nothing to do w/ economies of scale
Sherman act
-beginning of the antitrust policy -prohibited any agreements or actions that would put restraints on trade- in essence, prohibiting firms from monopolizing markets -today, the US antitrust policy is still based on the Sherman Act
cost of smaller social surplus bc of monopoly
-cost: deadweight loss (the surplus that would exist in the competitive equilibrium but is lost in a monopoly)
invisible hand in perf. comp. firm
-creates harmony between individual & social interest -maximizes social surplus in the competitive equilibrium -even in markets composed of only self-interested people, the overall well-being of society is maximized
what is the point of the concept of patents / copyrights
-goods that are copyrighted (such as a best selling book) are often difficult / costly to produce, so without the increased incentive (being able to be the monopolist), the best selling book would never be made -no point in putting all the effort towards a book, piece of art, invention, etc. if someone else can just sell it too without putting in the work --> so patents / copyrights protect whoever made them
why can't government make up for losses incurred by monopolist?
-gov must raise this money through taxes, and gov taxes lead to deadweight loss
why is perf price discrimination difficult to achieve?
-hard to charge every consumer a unique price -challenging to know every consumer's willingness to pay
if the demand curve hits the x-axis for quantity at 1,200, where does MR hit the x-axis? why?
-hits it at 600 -for every linear demand curve, MR is twice as steep (hits x-axis at half the demand #) -slope of MR curve is twice as large as slope of demand curve
what happens with price increases? -think about both cases (Q effect dominating P effect and vice versa)
-if quantity effect dominates price effect (Q-P = ?) , total revenue decrease (Q - high P = neg rev) -if price effect dominates quantity effect (P-Q = ?), total revenue increases (high P - Q = pos rev) -depends on which way you're moving along demand curve (up or down ) -chart in the middle of page 292!!
profits in natural vs. legal monopolies
-large profits attract entrants in legal monopolies , but profits in natural monopolies are not as attractive bc potential entrants realize that they can't achieve low costs of the natural monopolist, bc on entry they likely will "split the market" and render much higher costs and lower profits for each seller
"robber barons" in the 1890s
-men such as John D. Rockefeller, Andrew Carnegie, and Cornelius Vanderbilt dominated certain industries and were often accused of using questionable methods and unfair practices -this is why and when the antitrust policy against monopolies started in the US
cost conditions effect on natural monopolies
-natural monopolies emerge when cost conditions characterize their industry -bc of them, natural monopolies worry less about potential market entrants than do legal monopolies
do patents / copyrights last forever
-no they're temporary and eventually the protected goods enter public domain -at this time other produces can distribute them
outcome of monopolists using perfect price discrimination
-not only maximize their own profits, but also maximize social surplus (aka it is *socially efficient*) -inequity in the allocation of surplus (buyers get no surplus and sellers get all) -Pareto-efficient equilibrium bc no one can be made better off without making someone else worse o ff -explained on graph pg 300
barriers to entry
-obstacles that prevent potential competitors from entering the market -protect the seller against competition -range from complete exclusion of market entrants to prevention of new firm from entering and competing equally
natural market power
-occurs when a firm obtains market power through barriers to entry created by the firm itself -consists of 2 main sources of monopoly power which are: 1. the monopolist owns or controls a *key resource* necessary for production 2. there are *economies of scale* in production over the relevant range of output
legal market power
-power a firm has when it obtains market power through barriers to entry created not by the firm itself but by the government -ex) barriers can be patents or copyrights
compared to competitive firms, monopolists ...
-produce less and charge more, thus making themselves better off with the potential of earning economic profits in both short and long run -make consumers worse off -decrease social surplus
why constant marginal cost curve?
-represents a good description of the cost structure of a firm more detailed explanation: -in instances where high fixed costs are typical for industries that spend lots of money on researching / developing products (like pharmaceutical companies) it makes sense for MC to be constant over large ranges of output, *because mass production of the product leads to each additional unit of production to have a constant addition cost per unit*
price-maker
-sellers that set price of a good
knowing the perfectly competitive sellers problem, what is the difference in the monopolist's problem?
-since monopolist is the sole market supplier, it faces the market demand curve (downward-sloping) as opposed to horizontal demand curve -unlike perf. comp. firm, the monopolist can increase price and not lose all of its business
for goods / services that have economies of scale over the relevant range of output, what might be efficient
-single firm may serve the entire market, because it can do so at a lower cost than any larger number of firms could
a monopoly
-the most extreme form of market power -an industry structure in which only one seller provides a good or service that has no close substitutes
perf. comp. seller's problem (maxing profits)
-to maximize profits, perfectly competitive firm expands production until MC = price, where price is determined by intersection of the demand and supply curves -also, MR for perfect comp. firm = price bc the firm faces a perfectly elastic demand curve (horizontal) - *at the market price* , the perf. comp. firm can sell as many units as it wishes, but if it charges more it'll lose all its business bc other sellers are selling it for cheaper (the mkt price) -and if it charges less it doesn't get as much revenue
when is it not efficient to set price to MC?
-when MC is lower than ATC at every level of quantity -setting price equal to MC would cause the firm's total revenue to be less than total cost, so firm will experience economic loss and exit industry
when is total revenue maximized?
-when MR is crossing the x-axis -also known as the point where additional unit of output causes MR to equal zero
natural monopolies arise bc....
...the economies of scale of a single market firm make it efficient to have only one provider of a good or service
4 steps in the production and pricing decisions facing the monopolist
1. expand Q until MC = MR 2. produce Q at that point 3. trace up to the demand curve 4. find P associated with Q
2 types of market power that arise from barriers to entry
1. legal market power 2. natural market power
how is the monopolist's problem similar to the perfectly competitive seller's problem
1. monopolist must understand how inputs combine to make outputs 2. monopolist must know the costs of production -all of the product and cost concepts learned in earlier chapters directly apply to monopolist's problem
when to stop increasing production in monopoly
MR = MC -intersection of these two curves gives max profit -if your MR is still above MC, keep producing more -differs from perf comp profit maximizing (MR = MC = P) bc monopolists are price-makers, not price-takers -read page 294 (Producing the Optimal Quantity) -look at graph on pg 295
what do monopolists lack
a supply curve (only have MR, MC, and demand curves) -in order to have a supply curve, a firm must be a price-taker -monopolists, aka price-makers, do not vary their production based on market price bc they set their own
how do laws such as copyright result in benefits for the monopolist? what is their effect on consumers?
advantage for sellers: monopolists can charge higher prices than would occur under perfect competition disadvantage for consumers: as a result, consumers are all worse off bc they pay higher prices for goods
copyright
an exclusive right granted by the government to the creator of a literary or artistic work ex) when someone copyrights a book they are given a government guarantee that no one else could print and sell the book without authors permission --refers to an artistic work or book (differs from patent)
ability of a company to control a market (or to gain market power) relies on...
barriers to entry
electricity example summed up:
consider electricity provided to a town: -if there were multiple providers in one town, each producer would have its high startup cost, which would then be costly for consumers -better option? one single provider provides to all, because even though that provider's initial startup fixed costs are still high, the more houses he provides electricity to, the more the cost is spread out (so consumers also end up paying less) -this shows economies of scale because as # of outputs (houses provided to) go up, the ATC (avg. total cost) of providing to each house goes down **in example we are assuming constant MC -since it's most efficient for one single firm to be providing to the whole market, a natural monopoly arises (there is no government regulation saying only one electricity provider can provide to these houses, it's just more efficient for everyone so it naturally arises)
second-degree price discrimination
consumers are charged different prices based on characteristics of their purchase, such as the quantity they purchase
first-degree: perfect price discrimination
consumers are charged the max price they are willing to pay
most basic way for a firm to develop market power
control the entire supply of key resources ex) renters are willing to pay more for a house with lake view. if only one house has this view, the owner of the house has great market power
what does it mean when price effect is smaller than quantity effect
demand is elastic over the range of demand curve
third-degree price discrimination
different groups of customers are charged dif prices based on their own attributes (such as age, gender, or location) ex) senior citizens and children get discounts on train tickets ex) sometimes car dealers base negotiating prices off gender or race of car buyer
what portion of demand curve does the monopolist set the price on
elastic portion (top half of a linear demand curve is elastic)
market power
gives firm the ability to set the price of a good
price effect
loss in revenues when customers originally paying your higher price are now paying your lower price
quantity effect
lower price allows you to sell more units
key resources
materials that are essential for the production of a good or service
how do the monopolists steps differ from steps of perfectly competitive firm?
monopolist: price is set at a level higher than MC set: P > MR = MC perf comp firm: price is equal to MC set: P = MR = MC major difference: firm in a competitive industry does not set its price (the market does), whereas monopolist sets price based on the mkt demand curve
monopolists MR depends on
negatively sloped demand curve that they face
network externalities
occur when a product's value increases as more consumers begin to use it ex) uber: as more riders join the network, more drivers will join too ex) facebook is more valuable than myspace bc more people use FB
price discrimination
occurs when firms charge different consumers different prices for the same good or service ex) you buy plane ticket home for $500, the frequent flyer next to you bought theirs for $350
what is a way someone can become the person running this natural monopoly (in previous example)? -give 3 examples of instances where natural monopolies occur
often times this person is the first supplier in their given market examples: providers of clean water, natural gas, electricity
long-run economic profits in perfectly competitive markets vs. monopoly
perf comp: long-run profits are zero monopoly: long-run profits remain Why? because there is no threat of entry from competitors (bc of barriers to entry), so no new entrants threaten to increase supply and push the price down to eliminate economic profits
go over restoring social efficiency (aka maximizing social surplus)
pg 298 and 299 explain it / how price discrimination comes about
calculating economic profits for a monopoly
profits = total revenue - total cost so profits = (P x Q) - (ATC x Q) so (after factoring Q) profits = (P - ATC) x Q
when the quantity effect and price effect happen, how do you calculate increase in total revenues ?
quantity effect - price effect = total change
efficient or socially optimal price
refers to a price set at marginal cost
in monopolies consumer surplus decreases and some of it is taken over by producer surplus. social surplus is CS + PS, so why isn't social surplus the same in monopolies as it is in perfect comp
social surplus decreases in monopolies bc not only does CS turn into PS but it also turns into deadweight loss
economies of scale occur when...
the average total cost (ATC) per unit of output decreases as total output increases -electricity example on page 288
both legal and natural monopolies have on thing in common: __________
the monopolist's problem
patent
the privilege granted to an individual or company by the government, which gives him or her the sole right to produce and sell a good --refers to an invention, discovery, idea (ex: medication)
what happens when price effect dominates quantity effect (with price decreases)
total revenues fall (bc price effect is negative and quantity effect is positive) (look at graph 12.6 on pg 292)
what happens when quantity effect dominates price effect
total revenues increase explanation: Q effect - P effect = change in rev larger # - smaller # = positive change
what can break the powerful result of the invisible hand? and why?
what: market power why: a firm that exercises market power causes a reallocation of resources toward itself, thereby sacrificing social surplus (happens in a monopoly) -bottom of pg 297 shows how it happens on a graph
is it possible for goods to feature both economies of scale *and* network effects?
yes ex) operating system software and telephone networks