Lecture 6B - Monopolies
Why does a government grant monopoly rights to firms, if it creates a deadweight loss?
- This is usully done if the firm operates in a natural monopoly >> Such that it is more efficient that only one company produces the product.
Given the example (photo), does the monopoly decide to produce, and if so what is the profit?
1. Determine profit maximising output level; when MR=MC, q =6. 2. Shut down decision: - SHORT-RUN: AVC = 6 < Price =18, at the profit maximing output, so the firm decides to produce. - LONG-RUN: AC=8 < P=18, so the monopoly makes a positive profit. Profit at q=6; Profit = (Price-AC)*quantity = (18- 8)*6 =10
What factors determine the shape of the demand curve, and therefore the extend of the monopoly´s market power?
A monopoly has little market power if the demand curve it faces is relatively elastic. Utiltimatley the elasticity of demand of the market demand curve DEPENDS ON CONSUMER´S TASTES AND OPTIONS. >> The more consumers want good - the more willing they are to pay "virtually anything" for it - the less elastic is the demand curve. Ceteris Paribus, the demand curve a firm faces (not neccearily a monopoly), becomes more elastic as: 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.
Define Monopoly
A monopoly is the only supplier of a good for which there is no close substitute.
Define Natural Monopoly
A situation in which one firm can produce the total output of the market at lower cost than several firms could together. With a natural monopoly, it is more efficient to have only one firm produce than more firms.
Define antitrust policy
Aka "competition laws" Limiting monopoly market power Antitrust refers to government policy to REGULATE or BREAK UP monopolies in order to PROMOTE FREE COMPETITION and attain the BENEFITS that such competition can provide to the economy and to society as a whole. Government policies that try to: 1. prevent anti-competitive pricing (monopolies trying to eliminate competition) 2. low quantities 3. deadweight loss from emerging and dominating markets
How do firms maximise their revenue?
All firms, including competitive firms and monopolies, maximize their profits by setting marginal revenue equal to marginal cost.
How does a monopoly maximize profits? What are the 2 ways a monopoly can reach profit maximization?
Any firm maximizes its profit by operating where its marginal revenue equals its marginal cost MR=MC. 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 (A competitive firm sets its quantity to maximize profit because it cannot affect market price.)
In the diagram, why does the firm profit maximize when q=6?
At q=6, MC = MR. AT SMALLER QUANTITIES, the monopoly´s marginal revenue is greater than its marginal cost, so its marginal profit is positive. >> By increasing its output, it lowers its profit. Similarly, at quantities greater than 6 units, the monopoly's marginal cost is greater than its marginal revenue, so it can increase its profit by reducing its output.
Why do governments often grant monopoly rights to public utility providers?
Believing that they are natural monopolies, governments frequently grant monopoly rights to public utilities to provide essential goods or services such as water, gas, electric power, or mail delivery
SUMMARY What are the 2 general ways monopolies form? 1. What are the cost advantages that create a monopoly? 2. What are the government actions that create monopolies?
COST ADVANTAGES: - A firm may be a monopoly if: 1. It controls a key input, 2. has superior knowledge about producing or distributing a good, 3. has substantial economies of scale 4. Positive network externality GOVERNMENT ACTIONS - Governments may establish government-owned and operated monopolies. -They may also create private monopolies by establishing barriers to entry that prevent other firms from competing.
What general factor determines the shape of the monopoly´s demand curve, and the degree to which the monopoly can raise its cost above the MC?
Consumer elasticity. If the monopoly faces a HIGHLY ELASTIC - NEARLY FLAT - DEMAND CURVE at the profit maximixing quantity, it would lose substantial sales if it raise its price by even a small amount. If the monopoly faces a RELATIVELY INELSTAIC DEMAND (steep)at the profit maximizing quantity, the monopoly would loose fewe sales from raising its price by the same amount.
Is first degree price discrimination practical?
Doesn't happen in real life (only theoreticaly), because monopolies don't know how much each consumer is willing to pay. - This makes this form of price discrimination the most difficult to adopt. So they use other degrees (2nd and 3rd) to do it, which are less than perfect price discrimination.
What are the ways governments encourage competition?
Encouraging competition is an alternative to regulation as a means of reducing the harms (Deadweight loss) of monopolies. ALLOWING COMPETITIORS TO ENTER MARKET: When a government has created a monopoly by preventing entry, it 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. ALLOWING IMPORTS (reducing/removing barriers that protect domestic monopolies): A government may end a ban on imports so that a domestic monopoly faces competition from foreign firms. >> If costs for the domestic firm are the same as costs for the foreign firms and there are many foreign firms, the former monopoly becomes just one of many competitive firms. As the market becomes competitive, consumers pay the competitive price, and the deadweight loss of monopoly is eliminated.
Can the market efficiency be restored in a monopolistic market?
THEORETICALLY it is possible to restore, by PERFECT/ 1st DEGREE PRICE DISCRIMINATION. In practice it is NOT possible.
What is the formula for the marginal revenu curve of a monopoly?
For a monopoly to increase its output by ΔQ, the monopoly lowers its price per unit by Δp/ΔQ, which is the slope of the demand curve. By lowering its price, the monopoly loses (Δp/ΔQ)xQ on the units it originally sold at the higher price (area C), but it earns an additional p on the extra output it now sells (area B). Thus, the monopoly's marginal revenue is MR = p + (Δp/ΔQ)*Q
Discuss the marginal revenue curve for all linear (down-wards sloping) demand curves
For all linear demand curves the relationship between the marginal revenue and demand curve is the same: 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. Forexample: the demand curve has a slope of -1 and hits the horizontal axis at 24 units, while the marginal revenue curve has a slope of -2 and hits the horizontal axis at 12 units.
Discuss licences to operate as a way of creating a monopoly. Give an example.
Frequently, firms need government licenses to operate. If governments make it difficult for new firms to obtain licenses, the first firm may maintain its monopoly. EXAMPLE: Until recently, many U.S. cities required that new hospitals or other inpatient facilities demonstrate the need for a new facility to obtain a certificate of need, which allowed them to enter the market.
Discuss the second step of the profit maximizing process. How does a monopoly choose whether to shut-down or operate at the determined profit maximising output level?
IN THE LONG-RUN a monopoly shuts down to avoid making a loss if the optimal price (price at profit maximising output level) is below its average cost. Price<Average cost IN THE SHORT-RUN a monopoly shuts down if the optimal price is less than its average VARIABLE costs.
How does the ratio of price to marginal cost vary as the elasticity of demand changes?
INELASTIC DEMAND (e.g. -1.01): >> The monopoly's profit-maximizing price is many times higher than its marginal cost ELASTIC DEMAND: As the elasticity of demand becomes perfectly elastic (approaches negative infinity), the ratio of price to marginal cost shrinks to p/MC=1, such that the monopoly charges a price equal to its MC (like a perfectly competitive firm).
In the given example, calculate the difference between the price the monopoly sets and its marginal cost.
In this example, the elasticity of demand is ε = 3 at the monopoly optimum where Q = 6. As a result, the ratio of price to marginal cost is p/MC = 1/[1 + 1/(3)] = 1.5, or p = 1.5MC. Thus, the profitmaximizing price, $18, in panel a is 1.5 times the marginal cost of $12
Lecture Outline: 1. Sources of Market Power 2. The Monopolist's Problem 3. Introducing games 4. Oligopoly 5. Monopolistic Competition
Lecture Outline: 1. Sources of Market Power 2. The Monopolist's Problem 3. Introducing games 4. Oligopoly 5. Monopolistic Competition
SUMMARY How does a monopoly maximize profits?
Like any firm, a monopoly—a single seller—maximizes its profit by setting its output so that its marginal revenue equals its marginal cost. The monopoly makes a positive profit if its average cost is less than the price at the profit-maximizing output
Explain, using the formula for a monopoly´s maringal reenu, why a monopoly´s marginal revenue is smaller than the price.
MR = p + (Δp/ΔQ)*Q Because the slope of the monopoly's inverse demand curve, is negative, the last term ((Δp/ΔQ)*Q) is negative. The equation therefore confirms that confirms that the price is greater than the marginal revenue, which equals p plus a negative term.
What factor determines how much market power a monopoly has?
Market power is measured by how much above the marginal cost, a monopoly sets its price. The SHAPE OF THE DEMAND CURVE at profit maximizing point determines the monpoly´s market power strength.
SUMMARY What is market power, and what is the extent of market power dependent on?
Market power is the ability of a firm to charge a price above marginal cost and earn a positive profit. The more elastic the demand the monopoly faces at the quantity at which it maximizes its profit, the closer its price to its marginal cost, the competitive level.
What is the necessary precondition for first degree price discrimination?
Market power: The ability of a firm to charge a price above marginal cost and earn a positive profit. If the firm does not have market power, it must charge consumers the marginal cost, and so is unable to charge them the maximum price individual consumers are willing to pay.
What types of firms have market power?
Monopolies
Compare monopolies to perfect competition.
Monopolies are INEFFICIENT, relative to perfect competition (where community surplus is maximized - it is the GOLDEN STANDARD). PRICE SETTER VS PRICE TAKER: A monopoly can set its price (because no competitors and no close substitutes)—it is not a price taker like a competitive firm. MARKET OUTPUT & MARKET DEMAND CURVE: 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. As a consequence, the monopoly sets its price above marginal cost to maximize its profit. Consumers buy less at this high monopoly price than they would at the competitive price, which equals marginal cost. >> Therefore COMMUNITY SURPLUS is not maximised (but sometimes society benefits from researh and high investment). MR=MC but PRICE IS HIGHER than these. And thus PROFITS in the long run are GREATER THAN ZERO.
Do all monopolies profit maximize by setting high prices (higher than its marginal costs)?
No. The extent to which a monopoly can mark up its set price from its marginal costs, depends on the ELASTICITY of the DEMAND CURVE. When a monopoly faces a PERFECTLY ELASTIC demand curve (horizontal), it must set its PRICE QUAL TO ITS MARGINAL COST >> Just like price-taking of a 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 ELATIC THE DEMAND CURVE, THE LESS A MONOPOLY CAN RAISE ITS PRICE WITHOUT LOSING SALES. When a monopoly faces an INELASTIC demand curve, it can set its price higher than the marginal price.
Can a monopoly set both its price and quantity sold?
No. The monopoly sets on, and the other is determined by the demand curve. 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.
Graphically represent the different in community surplus for a perfect competition firm and a monopoly
PERFECT COMPETITION: - Producers have no surplus, because they are selling at the minimum price they are willing to accept (MC=MR=p). - On the other hand consumer surplus is maximized, as the goods are sold at the minimum price - While producer surplus is not existent, consumer surplus is maximized, and so community surplus is maximised. MONOPOLY: - Consumer surplus is smaller, because price is set higher (p>MC=MR). - Consumer surplus of area DWL is lost, while area PS is given to producers, who now have a producer surplus at the greater price. - While producers gain surplus, the overall community surplus is smaller than in a competitive market, because DWL is lost. Thus a monopoly IS CONSIDERED INEFFICIENT, in comparison to the perfect competition GOLDEN STANDARD.
In what market structure is welfare maximised and when is it not maximized?
Perfect Competition: - GOLDER STANDARD - Consumer surplus is maximized because goods are sold at the lowest possible price, price=MC=MR=price- gold standard. Monopoly: - By setting its price aboveits marginal cost, a monopoly causes consumers to buy less than the competitive level of the good, so deadweight loss to society occurs.
What is first degree/perfect price discrimination? How does first degree price discrimination restore market efficiency in a monopoly?
Perfect price discrimination occurs when a firm sells each unit at the MAXIMUM AMOUNT ANY CUSTOMER IS WILLING TO PAY for it, so prices differ across customers, and a given customer may pay more for some units than for others. In effect the monopoly captures all available consumer surplus for itself (consumer surplus = 0, as it is "taken" by the firm). Community surplus is maximized, as the dead weight loss is eliminated (the firm is willing to sell at the point where MC=demand as well) and effficiency restored. - This extracts all the consumer surplus and earns the firms the HIGHEST POSSIBLE PROFITS. - Some consumers benefit others don't (depending on what the consumer is willing to pay, those willing to pay more, loose becaue they end up paying more).
Define price disciriminaiton and list the 3 possible types
Price discrimination is the practice of CHARGING A DIFFERENT PRICE for THE SAME GOOD OR SERVICE. There are three types of price discrimination: - first-degree, - second-degree, - third-degree price discrimination
In the given graph, at which point is the monopoly profit maximising?
Profit maximization occurs when MR = MC; MP=0. MR = MC, at q=6 and p= 18.
Given the following demand curve, marginal cost curve, marginal revenue curve and cost curve, what is the profit maximizing point? Does the firm shut-down at that point? And does the firm make a profit? p = 24 -Q MR = 24 -Q MC = 2Q C(Q) = Q^2 + 24
Profit maximization occurs when MR= MC MR = 24-Q = 2Q = MC Solving for q, we find that Q = 6. Substituting Q=6 into the demand function we find that the profit-maximizing price is p = 24 - Q = 24 - 6 = 18. When Q=6 and p=18, the AVC (= Q^2/Q=Q) is 6, which is less than the price (18), so the firm does not shut down. The average cost is AC (C(Q)/Q) = (6 + 12/6) = 8,which is less than the price, so the firm makes a profit.
In the diagram, what is the profit maximizing price?
Profit maximization occurs when MR=MC At Q=500, p = 3.50 >> profit maximizing price.
What affects the point at which profits are maximized for monopolys?
Profit maximization occurs when MR=MC From this it can be concluded that 2 factors effect the monopoly optimum: 1.) Shifts in the demand curve (affect the MR curve) 2.)Shifts in cost curves (affect the MC curve) This is because monopolies do NOT have a supply curve.
Given that the following revenue curve, what is marginal revenue curve? Demand curve; p = 24 -Q
Profit maximization; MR = MC 1. Derive MR curve: General formula: MR= p + (Δp/ΔQ)*Q Substitute in values: Form demand curve, p = 24. Use the demand curve to calculate how much the price consumers are willing to pay falls if quantity increases by one unit. From the demand function the price consumers are willing to pay falls $1 if quantity increases by one unit, so the slope of the inverse demand curve is Δp/ΔQ = 1 Subsitute values into MR function. MR = p + (Δp/ΔQ)* Q = (24 - Q) + (-1)Q = 24 - 2Q. Therefore MR = 24 -Q
Why is the profit-maxizing quantity smaller than the revenue-maximizing quantity?
The REVENUE CURVE reaches its maximum Q=12, where the slope of the revenue curve, the marginal revenue, is zero. >> This is the revenue maximing point, as this is the point at which the difference between the demand curve (price) and MR is the greatest. The PROFIT CURVE reaches its maximum at Q=6, where marginal revenue equals marginal cost. Because marginal cost is positive, marginal revenu must be positive where profit is maximized. Because the marginal revenue curve has a negative slope, marginal revenue is more positive at a smaller quantity than where its equals zero. Thus, the profit curve must reach a maximum at a smaller quantity 6, than the revenue curve, 12.
A firm with a patent monopoly sets a high price that results in deadweight loss. Why, then, do governments grant patent monopolies?
The main reason is that inventive activity would fall if there were no patent monopolies or other INCENTIVES to inventors. The costs of developing a new drug or new computer chip are often hundreds of millions or even billions of dollars. If anyone could copy a new drug or chip and compete with the inventor, few individuals or firms would undertake costly research. Thus, the government is explicitly trading off the LONF-RUN BENEFITS of ADDITIONAL INVESNTIONS against the SHORTER-TERM HARMS of monopoly pricing during the period of patent protection.
How does the marginal revenue of a monopoly and perfect competition firm differ?
The marginal revenue of a monopoly differs from that of a competitive firm because the monopoly faces a DOWN-WARD SLOPING DEMAND CURVE, whil the competitive firm faces a HORIONTAL DEMAND CURVE. MR = ΔR/Δq.
What is the trade-off monopolys face when profit maximizing?
The monopoly is constrained by the market demand curve. Because the demand curve slopes downward, 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.
What is third degree price discrimination/multimarket price discirmination?
Third degree price discrimination occurs when a firm charges different groups of customers (segments) different prices, but charges a given customer the same price for every unit of output sold. Typically, not all customers pay different prices—the firm sets different prices only for a few groups of customers. Because this last type of discrimination is the MOST COMMON, the phrase price discrimination is often used to mean multimarket price discrimination.
When does a natural monopoly occur?
This occurs when firms have ECONOMIES OF SCALE AT ALL LEVELS OF OUTPUT, and so its AVERAGE COST CURVE FALLS as output increases (fixed costs are spread over more units, so average costs fall, while marginal costs remain the same). IF ALL POTENTIAL FIRMS HAVE THE SAME STRICTLY DECLINING AVERAGE COST CURVE, THIS MARKET HAS A NATURAL MONOPOLY. It is more efficient for one company to produce all the output, and so higher quantity, as average costs are lower at higher quantities. If the two firms divided total production in any other way, their cost of production would still exceed the cost of a single firm (as the following solved problem shows). The reason is that the marginal cost per unit is the same no matter how many firms produce, but each additional firm adds a fixed cost, which raises the cost of producing a given quantity. If only one firm provides water, the cost of building a second plant and a second set of pipes is avoided.
Discuss the first step of the profit maximizing process. How does a monopoly choose the output at which it maximizes profits?
To determine the profit maximising output of a monopoly, the firm must use: 1. its linear demand curve 2. its marginal revenu curve and 3. linear marginal cost curve. > The firm maximises its profits when MR= MC. > This is also where marginal profit is 0 (MR = MR-MC)
Today, what is a common example of monopolies seen across almost all countries?
Today, nearly every country grants a patent—an exclusive right to sell that lasts for a limited period of time—to an inventor of a new product, process, substance, or design.
What are the two general reasons/causes of a monopolized market? SOURCES OF BARRIERS TO ENTRY.
Two key reasons: 1. A firm has a COST ADVANATGE over other firms: >>> If a low-cost firm profitably sells at a price so low that other potential competitors with higher costs would make losses, no other firm enters the market. Sources of cost advantages include: - Control of key resources - Economies of scale -Superior technology/production processes - Network externalities 2. A government created monopoly
How can you calculate the degree to which a monopoly can raise its price above the marginal cost, using the demand curve elasticity?
We can derive the relationship between market power and the elasticity of demand at the profit-maximizing quantity using: MR = p(1 + 1/ε) = MC By rearranging: p/MC = 1/(1 + (1/ε)) The ratio shows that the ratio of the price to marginal cost depands ONLY on the ELASTICITY OF DEMAND AT THE PROFIT-MAXIMIZING QUANTITY.
Discuss how Xerox´s monopoly changed as its demand curve changed in shape?
When Xerox started selling its plain-paper copier, no other firm sold a close substitute. >> Other companies' machines produced copies on special slimy paper that yellowed quickly. As other firms developed plain-paper copiers, the demand curve that Xerox faced became more elastic, and shifted downwards. Thus Xerox had to lower its set price, closer to its marginal costs point (the mark-up was lowered)
When is deadweight loss greatest in a monopoly market? What is the shape of the demand curve?
When the demand curve faced by the monopoly is inelastic, such that price can be set significantly higher than the monopoly´s marginal costs. >> In effect, consumer surplus loss is greater, and hence community surplus/welfare loss is greater.
How do you determine a monopoly´s profit maximising output mathematically?
You need to know: 1. The DEMAND CURVE (p = 24 -Q) >>> From the demand curve, you derive the MR CURVE (MR= p + (Δp/ΔQ)*Q) 2. COST CURVE >> From the cost curve, you derive the MC curve >>> Then you equate the MC equation to the MR equation (point at which MP = O, and profit is maximised), to identify the profit maximising output point.
What is the 2 step approach used by all firms to determine the level that maximizes their profit?
1. First, the firm determines the ouput, Q*, at which it makes the highest pssible profite - the output at which its marginal revenu equals its marginal cost. 2. Second the firm decideds whether to produce Q* or shut down.
List examples of antitrust policies
1. OPTIMAL PRICE REGULATION: In some markets, the government can eliminate the deadweight loss of a monopoly by requiring that it charge no more than the competitive price (price ceiling where p=MC) 2. BREAKING UP MONOPOLIES, such as what happened with Alcoa, the past aluminum metal company. 3. ENCOURAGING COMPEITION
Define 1. Consumer surplus 2. Producer surplus 3. Welfare
1. The difference in price between what the consumer is willing to pay and what the consumer actually pays 2. The difference in price between what the producer is willing to take and what the producer actually takes 3. Welfare is defined as the sum of consumer surplus, CS, and producer surplus.
How do governments create monopolies?
1.) Governments own and manage monopolies. e.g postal services and hospitals (However many state-owned monopolies have been privatized in recent years) 2.) Frequently however, governments create monopolies by PREVENTING COMPETING FIRMS from entering a market. --> By making it difficult for new firms to obtain a LICENSE TO OPERATE --> By granting a firm MONOPOLY RIGHTS --> By AUCTIONING RIGHTS TO BE A MONOPOLY
Derive the marginal revenue curve when the monopoly faces the linear inverse demand function, p = 24 - Q, How does the slope of the marginal revenue curve compare to the slope of the inverse demand curve?
1.) Use the demand curve to calculate how much the price consumers are willing to pay falls if quantity increases by one unit. According to the inverse demand function, the price consumers are willing to pay falls $1 if quantity increases by one unit, so the slope of the inverse demand curve is Δp/ΔQ = 1 2.) Use the demand function equation, and the general marginal revenue equation to derive the marginal revenue function. We obtain the marginal revenue function for this monopoly by substituting into the general marginal revenue equation the slope of the inverse demand function, and replacing p with the demand function. MR = p + (Δp/ΔQ)*Q = (24 - Q) + (1)Q = 24 - 2Q Thus, the slope of this marginal revenue curve is ΔMR/ΔQ = 2, so the marginal revenue curve is twice as steeply sloped as is the demand curve.
List the 3 ways governments typically prevent competiting firms from entering a market (effectivly creating a monopoly)
1.)By making it difficult for new firms to obtain a LICENSE TO OPERATE 2.) By granting a firm MONOPOLY RIGHTS (including patents) 3.) By AUCTIONING RIGHTS TO BE A MONOPOLY
Does the maringal revenue curve of competitive firms and monopolies lie above, below, or on their demand curves?
A MONOPOLY´S marginal revenue curve lies below its demand curve at any positive quantity because its demand curve is downward sloping. A COMPETITIVE FIRM´S marginal revenu lies on its demand curve at any positive quantity, because its demand curve is horizontal.
Define deadweight loss/ allocative inefficiency
A deadweight loss is a COST TO SOCIETY (fall in total surplus) created by MARKET INEFFICIENCY. Markets are inefficient when supply and demand are OUT OF/NOT IN EQUILIBIRUM, and thus the price for a good is not set to where the supply and demand curves intersect. A situation of a "BROKEN INVISIBLE" hand.
What is marginal revenue dependent on?
A firm's marginal revenue curve depends on its demand curve. A firm's demand curve shows the price, p, it receives for selling a given quantity, q. The price is the average revenue the firm receives, so a firm's revenue is R = pq.
Define marginal revenue
A firm's marginal revenue, MR, is the change in its revenue from selling one more unit. MR = ΔR/Δq.
Define patent
A form of monopoly rights granted by the government "An exclusive right granted to the inventor to sell a new and useful product, process, substance, or design for a fixed period of time".
SUMMARY What government actions reduce monopolys´ market power?
A government can eliminate the welfare harm of a monopoly by forcing the firm to set its price at the competitive level. >> If the government sets the price at a different level or otherwise regulates nonoptimally, welfare at the regulated monopoly optimum is lower than in the competitive equilibrium. A government can eliminate or reduce the harms of monopoly by allowing or facilitating entry/ENCOURAGING COMPETITION.
Discuss the marginal revenue of monopolies
A monopoly faces a downward-sloping market demand curve, as in panel b of Figure 11.1. (We've called the number of units of output a firm sells q and the output of all the firms in a market, or market output, Q. Because a monopoly is the only firm in the market, there is no distinction between q and Q, so we use Q to describe both the firm's and the market's output.) The monopoly, which is initially selling Q units at p1, can sell one extra unit only if the price falls to p2. The monopoly's initial revenue, p1xQ, is R1 = A+C. When it sells the extra unit, its revenue, p2x(Q+1), is R2=A+B. Thus its marginal revenu is ΔR = R2 - R1 = (A + B) - (A + C) = B - C. The monopoly sells the extra unit of output at the new price, so its extra revenue is B = p2 x 1 = p2. The monopoly loses the difference between the new price and the original price, Δp = (p2 - p1), on the Q units it originally sold: C = ΔpxQ. Thus, the monopoly's marginal revenue, B - C = p2 - C, is less than the price it charges by an amount equal to area C.
Given that the following cost curve, what is the average variable cost and average cost? Cost curve: C(Q) = Q^2 + 12
Average variable cost; Variable costs = Q^2 Therefoere, average vaible costs = Q^2/Q = Q, which is a straight line. Average costs = (Q^2 + 12)/Q = Q + 12/Q, which is U-shaped
SUMMARY Discuss the welfare effect of a monopoly
Because a monopoly's price is above its marginal cost, too little output is produced, and society suffers a deadweight loss. The monopoly makes higher profit than it would if it acted as a price taker. Consumers are worse off, buying less output at a higher price.
A firm that delivers Q units of water to households has a total cost of C(Q) = mQ + F. If any entrant would have the same cost, does this market have a natural monopoly?
Both firms face the same strictly declining cost curves.
What is the difference between a shift in demand for a perfectly competive firm and a monopoly?
COMPETITIVE FIRM: A shift in demand causes the equilibrium to move along the supply curve (the horizontal sum of the marginal cost curves of all the competitive firms). BECAUSE THE COMPETITIVE EQUILIBRIUM LIES ON THE SUPPLY CURVE, EACH QUANTITY CORRESPONDS TO ONLY ONE POSSIBLE PRICE. MONOPOLY: A shift in demand causes the monopoly optimum to change; the monopoly quantity stays the same, but the price rises. THUS, A SHIFT IN DEMAND DOES NOT MAP OUT A UNIQUE RELATIONSHIP BETWEEN PRICE AND QUANTITIY IN A MONOPOLISED MARKET.
Discuss MONOPOLY RIGHTS as a way of creating a monopoly.
Government grants of monopoly rights have been common for public utilities. Instead of running a public utility itself, a government gives a private company the monopoly rights to operate the utility. A government may capture some of the monopoly profits by charging a high rent to the monopoly. Governments around the world have privatized many state-owned monopolies in the past several decades. By selling its monopolies to private firms, a government can capture the value of future monopoly earnings today. However, for political or other reasons, governments frequently sell at a lower price that does not capture all future profits.
What are the 3 problems with optimal price regulation?
Governments often fail to regulate monopolies optimally for at least three reasons. 1. LIMITED INFORMAITON Due to limited information about the demand and marginal cost curves, governments may set a price ceiling above or below the competitive level. 2. REGULATORS ARE CAPTURED: Regulation may be ineffective when regulators are captured: influenced by the firms they regulate. - Typically, this influence is more subtle than an outright bribe. >> Many American regulators worked in the industry before they became regulators and hence are sympathetic to those firms. >> Some regulators, relying on industry experts for their information, may be misled or at least heavily influenced by the industry. **** Arguing that these influences are inherent, some economists contend that price and other types of regulation are unlikely to result in efficiency.***** 3. MONOPOLIES UNABLE TO OPERATE WHEN P=MC: 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. - In a natural monopoly where the average cost curve is strictly above the marginal cost curve, if the regulator sets the price equal to the marginal cost so as to eliminate deadweight loss, the firm cannot afford to operate. If the regulators cannot subsidize the firm, they must raise the price to a level where the firm at least breaks even.
What are sources of cost advantages that can lead to a monopoly?
If a lowcost firm profitably sells at a price so low that other potential competitors with higher costs would make losses, no other firm enters the market. A firm can have a cost advantage over potential rivals for a number of reasons: 1. Control over ESSENTIAL RESOURCES: a scarse resource that a rival needs to use to survive. E.g. a firm that owns the only quarry in a region is the only firm that can profitably sell gravel to local construction firms. 2. SUPERIOR TECHNOLOGY or better PRODUCTION ORGANIZATION: e.g. Henry Ford´s assembly lines and standardization enabled him to sell cars cheaper until he was copied. 3. ECONOMIES OF SCALE 4. POSITIVE NETWORK EXTERNALITIES: A good has a network externality if one person's demand depends on the consumption of a good by others. If a good has a positive network externality, its value to a consumer grows as the number of units sold increases. When a new firm enters a market, the positive network externality of other firms, represents a barrier to entry. >> Because of the need for a CRITICAL MASS of customers in a market with a positive network externality, we frequently see only one large firm surviving, e.g. FACEBOOK taking over msn.
What are the problems if the government sets the price of a monopoly product at a non-optimal level?
If the government sets the price ceiling at a nonoptimal level, a DEADWEIGHT LOSS RESULTS. 1. The governmnet sets the price below the optimal level. >>> If it sets the price BELOW THE FIRM´S MINIMUM AVERAGE COST, the firm shuts down, so the deadweight loss equals the sum of the consumer plus producer surplus under optimal regulation. >>> If the government sets the price ceiling BELOW THE OPTIMALLY REGULATED PRICE BUT HIGHER THAN FIRMS MINIMUM AVERAGE COSTS, the firm does not shut down and consumers who are lucky enough to buy the good benefit because they can buy it at a lower price than they could with optimal regulation. As we show in the following solved problem, there is a deadweight loss because less output is sold than with optimal regulation.
Explain the loss in community surplus as a result of the monopoly, using the given diagram.
If the monopoly were to act like a competitive market, it would sell 8 units (where demand intersects marginal cost) at price of 16. >> At this quantity, consumer surplus is area A+B-C and producer surplus is D+E. If the firm acts like a monopoly, it would sell 6 units (where MC=MR) at a price of 18. At this quantity consumer surplus is only A. - Part of the consumer surplus, B, goes to the monopoly, but the rest C IS LOST. - By charging the monopoly price of 18 instead of 16, the monopoly recieves 2€ more per unit and extra profit of area B. - The monopoly loses area E, however, because it sells less than the competitive output. - Consequently the monopolies producer surplus increases by B-E. We know that the producer surplus INCREASES, because the monopoly had the option of producing at the ocmpetitive level and chose not to do so. The DEADWEIGHT LOSS is lower than competitive welfare. The deadweight loss of monopoly is -C-E, which represents the CONSUMER SURPLUS AND PRODUCER SURPLUS LOST BECAUSE LESS THAN THE COMPETITIVE OUTPUT IS PRODUCED.
What does the effect of a shift in demand, on a (monpolistic) compeitive firms´s output, depend on?
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. The marginal cost curve is the firms supply curve (above the minim average variable cost) The shape of the demand curve does NOT affect output - because it always faces a horizontal demand curve at the market price. Thus, if you know a competitive firm's marginal cost curve, you can predict how much that firm will produce at any given market price
Does society benefit from monopolies?
In a monopoly situation, society/community surplus is not maximised, because price is higher than MR=MC, thus consumer surplus is lost. However, sometimes monopolies are good for society, expecially when there are HIGH FIXED COSTS, like pharma, where there are very high R&D costs. In these cases the FIRMS, unless it is allowed to be a monopoly, NOT WILLING TO INVEST in the high fixed costs.
Discuss the relationship between the marginal revenue and price for monopolies and competitive firms
In general, the relationship between the marginal revenue and demand curves depends on the shape of the demand curve. The competitive firm in panel a does not lose an area C from selling an extra unit because its demand curve is horizontal. It is the downward slope of the MONOPOLY´S demand curve that causes its MARGINAL REVENUE TO BE LESS THAN ITS PRICE.
SUMMARY What is a natural market power?
In markets with substantial economies of scale, the single seller is called a natural monopoly because total production costs would rise if more than one firm produced the good.
Where is first degree of price discrimination seen? Give an example.
In some cultures, bargaining for goods and services, i.e., first degree price discrimination is the norm. In others, first degree discrimination is much less prevalent and consumers are more used to prices which are not negotiable. The aim of first degree price discrimination is for the firm to appropriate the entire consumer surplus
Given that the following cost curve, what is marginal cost curve? Cost curve: C(Q) = Q^2 + 12
In the function C(Q) = Q^2 + 12, Q^2 = monopolys variable cost 12 = monopoly´s fixed costs Marginal cost, is the cost of producing one extra unit. This is equal to the slop of the cost curve. Thus you find the derivative of the cost curve, to get the marginal cost curve. Therefore, MC = 2Q
When did Monopolies first arise?
Monopolies have been common since ancient times. In the fifth century B.C., the Greek philosopher Thales gained control of most of the olive presses during a year of exceptionally productive harvests
What is second degree price discrimination/quantitiy discrimination?
Second-degree price discrimination occurs when a firm charges a different price for large quantities than for small quantities but all customers who buy a given quantity pay the same price
Discuss how the US Postal Service (USPS) monopoly changed as its demand curve changed in shape?
The U.S. Postal Service (USPS) had a monopoly in FIRST-CLASS MAIL SERVICE and OVERNIGHT DELIVERY. 1. FIRST CLASS MAIL SERVICES: - Today, phone calls, faxes, and e-mail are excellent substitutes for many types of first-class mail. 2. OVER NIGHT DELIVERY: - The USPS had a monopoly in overnight delivery services until 1979. - Now FedEx, United Parcel Service, and many other firms compete with the USPS in providing overnight deliveries. Because of this new competition, the USPS's share of business fell from 77% in 1988 to 59% in 1996, and its overnight-mail market fell to 4%. First-class mail declined 22% from 1998 to 2007. Over time the demand curves the USPS faces for first-class mail and overnight service have SHIFTED DOWNWARD AND BECOME MORE ELASTIC.
Define market power
The ability of a firm to charge a price above marginal cost and earn a positive profit
How do you know if the price regulation is optimal?
The answer is that this regulated outcome is the same as would occur if this market were competitive, where welfare is maximized ==> The "GOLDEN STANDARD".
Discuss the marginal revenue of competitive firms
The competitive firm faces a horizontal demand curve at the market price, p1. Because its demand curve is horizontal, the competitive firm can sell another unit of output without dropping its price. As a result, the marginal revenue it receives from selling the last unit of output is the (constant) market price. Initially, the competitive firm sells q units of output at the market price of p1, so its revenue, R1, is area A, which is a rectangle that is p1xR1. If the firm sells one more unit, its revenue is R2 =A+B, where area B is p1x1=p1. The competitive firm´s marginal revenue equals the market price: ΔR = R2 - R1 = (A + B) - A = B = p1. p1 because, if a firm sells one more unit Δq = 1, its marginal revenue is MR = ΔR.
In a monopoly, what causes the deadweight loss?
The deadweight loss is due to the gap between price and marginal cost at the monopoly output (in comparison to the competitve output level).
What is the demand curve dependent on?
The demand curve is dependent on the price elasticities of the firms consumers. The consumers of COMPETITIVE firms have perfectly elastic demand curves, as a change in price leads to them stopping their purchase of the firm goods, and instead purchase from the MANY compeititors (subsitutes) of the market. >> HORIZONTAL DEMAND CURVE The consumers of a MONOPOLY have a less elastic demand curve, because they do not have alternatives (no competitors or substitutes). Thus a change in price leads to a less than proportionate decrease in demand.
Give examples of firms whose demand curve have become more elastic due to factors increasing elasticity?
The demand curves for Xerox, the U.S. Postal Service, and McDonald's have become more elastic in recent decades for these three reasons: 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. As the demand curves become more elastic, the monopoly has to LOWER ITS PRICE.
What is the monopolists problem?
The down-ward sloping demand curve of monopoles. In perfect competition, if you increase price, demand drops to zero. In a monopoly, if oyu increase priced, demand decreases. So how should you maximize profits? • If you increase price from 4 to 5, quantitiy demanded falls from 400 to 200. • Price effect = the change in revenue from change in price • Quantity effect = the change in quantity from change in price • Does the price effect outweigh the demand effect?
What does the effect of a shift in demand, on a monpoly´s output, depend on?
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. Unlike a competitive firm, a monopoly does not have a supply curve. Knowing the monopoly's marginal cost curve is not enough for us to predict how much a monopoly will sell at any given price. Unlike a competitive firm, A MONOPOLY DOES NOT HAVE A SUPPLY CURVE. Knowing the monopoly's marginal cost curve and demand curve is not enough for us to predict how much a monopoly will sell at any given price. We also need to know the shape of the MR curve.
How does perfect price discrimination restore market efficiency in a monopoly market?
The same quantity is produced as would be produced by a competitive market and that the last unit of output sells for the marginal cost, we demonstrate that perfect price discrimination is efficient
Is it usually assumed that the monopoly sets its price of quantity?
Usually assumed that the monopoly chooses its quantity (similar to a competitive firm).