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