Micro Ch 12

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Chapter 12 Monopoly

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12 Monopoly

Chapter Outline

12.1 Introducing a New Market Structure12.2 Sources of Market Power12.3 The Monopolist’s Problem12.4 Choosing the Optimal Quantity and Price12.5 The “Broken” Invisible Hand: The Cost of Monopoly12.6 Restoring Efficiency12.7 Government Policy toward Monopoly

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12 Monopoly

Key Ideas

1. Monopoly represents an extreme marketstructure with a single seller.2. Monopolies arise both naturally andthrough government protection.3. Monopolists are price-makers and

produce at the point where marginal revenue equals marginal cost.

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12 Monopoly

Key Ideas

4. The monopolist maximizes profits by producing a lower quantity and charging a higher price than perfectly competitive sellers. By doing so, deadweight loss results.

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12 Monopoly

Key Ideas

5. Efficiency can be established in a monopoly through first-degree price discrimination or government intervention.

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12 Monopoly

Evidence-Based Economics Example:

Can a monopoly ever be good for society?

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Price makersSellers that can set the price of a good

Market powerThe ability to set the price

MonopolyOne seller of a good or service with no close

substitutes

12.1 Introducing a New Market Structure

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12.1 Introducing a New Market Structure

Exhibit 12.1 Two Market Structures

12.2 Sources of Market Power

Barriers to entry

Circumstances that prevent potential competitors from entering the market

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12.2 Sources of Market Power

Types of barriers to entry

1. Legal market power2. Natural market power• Control of key resources• Economies of scale

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12.2 Sources of Market PowerLegal Market Power

1. Legal market power

Patent ®Government-granted permission to be the sole producer and seller of a good

Copyright ©Government-granted rights to the creator of literary or artistic work

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2. Natural market power

Natural market powerWhen a single firm obtains market power through barriers to entry created by the firm itself

12.2 Sources of Market PowerNatural Market Power

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Control of key resources

Key resourcesAre essential for the production of a good or service

12.2 Sources of Market PowerNatural Market Power

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Examples:

• Alcoa controlling bauxite, used in production of aluminum

• Professional sports teams controlling talent

• De Beers’ control of diamond production

12.2 Sources of Market PowerNatural Market Power

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Network externalitiesWhen a product’s value increases as more consumers use it

Examples:• eBay• Facebook• Angie’s List

12.2 Sources of Market PowerNatural Market Power

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Economies of scale

Natural monopolyEmerges because it enjoys economies of

scale over a very large range of output

12.2 Sources of Market PowerNatural Market Power

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Exhibit 12.2 Average Total Cost and Marginal Cost for a Natural Monopoly

12.2 Sources of Market PowerNatural Market Power

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Both monopolist and perfect competitor

• Produce an output using a production process and inputs

• Incur production costs

12.3 The Monopolist’s Problem

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Can a monopolist charge any

price it wants to?

12.3 The Monopolist’s Problem

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12.3 The Monopolist’s Problem

Exhibit 12.3 Perfectly Competitive Firms and Monopolies Face Different Demand Curves

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Exhibit 12.4 The Market Demand Curve for Claritin

12.3 The Monopolist’s ProblemRevenue Curves

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12.3 The Monopolist’s ProblemRevenue Curves

Exhibit 12.5 Revenues and Costs for Claritin at Different Levels of Output

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Example: Assume this monopolist is selling 200 units at a price of $5 each and wants to increase the quantity it sells to 400 units. It has to lower the price to $4 to do so.

Good News Bad NewsSelling 200 more units Charging $1 less onat $4 each = $800 200 units it was

selling before = -$200

12.3 The Monopolist’s ProblemRevenue Curves

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12.3 The Monopolist’s ProblemRevenue Curves

Exhibit 12.6 The Quantity Effect and the Price Effect on Revenues for Claritin

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12.3 The Monopolist’s ProblemRevenue Curves

Exhibit 12.7 Relationship among Price, Marginal Revenue, and Total Revenue

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12.4 Choosing the Optimal Quantity and PriceProducing the Optimal Quantity

Exhibit 12.8 Marginal Revenue and Marginal Cost for Claritin

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12.4 Choosing the Optimal Quantity and PriceSetting the Optimal Price

Exhibit 12.9 Choosing the Profit-Maximizing Price for Claritin

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12.4 Choosing the Optimal Quantity and PriceHow a Monopolist Calculates Profits

Profit = Total revenue – total cost Total revenue = P x Q Total cost = ATC x Q

Profit = (P x Q) – (ATC x Q) = Q (P – ATC)

Profit = 500M($3.50 - $1.02) = $1,240,000,000

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12.4 Choosing the Optimal Quantity and PriceHow a Monopolist Calculates Profits

Exhibit 12.10 Computing Profits for a Monopolist

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12.4 Choosing the Optimal Quantity and PriceDoes a Monopoly Have a Supply Curve?

A supply curve answers the question:

If the price is $x, how many units does the firm want to produce?

A monopolist is not a price taker, but a price maker; therefore, the supply relationship does not exist.

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12.5 The “Broken” Invisible Hand: The Cost of Monopoly

The “Broken” Invisible Hand

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12.5 The “Broken” Invisible Hand: The Cost of Monopoly

Exhibit 12.11 Surplus Allocations: Perfect Competition Versus Monopoly

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12.6 Restoring Efficiency

Exhibit 12.11 Surplus Allocations: Perfect Competition Versus Monopoly

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12.6 Restoring EfficiencyThree Degrees of Price Discrimination

Why do firms offer mail-in (or online) rebates instead of just discounting the price up front?

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Price discrimination

Charging different customers different prices for the same good or service when there are no cost differences

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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Three degrees of price discrimination

1. First-degree (perfect)2. Second-degree3. Third-degree

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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First-degree (perfect) price discrimination

When each consumer is charged the maximum he/she is willing to pay

Examples: buying a car, eBay

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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12.6 Restoring EfficiencyThree Degrees of Price Discrimination

Exhibit 12.13 Surplus Allocations For a Monopoly: With and Without Perfect Price Discrimination

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Second-degree price discriminationConsumers are charged different prices

based on the characteristics of the purchase

Examples: when firms sell blocks of product at a lower price than advertised—last-minute hotel rooms; utility company pricing for commercial vs. residential usage

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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Third-degree price discrimination

Consumers are charged different prices based on the characteristics of the customer or location

Examples: senior citizen discounts, student discounts, theater matinee discounts

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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Why create different markets?

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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What if firms don’t know what someone’s willingness to pay (elasticity) is?

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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Have you ever…?

gone to a Black Friday sale?

bought a hardcover book?

stood in line for new technology?

12.6 Restoring EfficiencyThree Degrees of Price Discrimination

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12.6 Restoring EfficiencyThree Degrees of Price Discrimination

Why do firms offer mail-in (or online) rebates instead of just discounting the price up front?

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12.7 Government Policy toward Monopoly

Antitrust policy

Government policies that try to prevent anti-competitive pricing, low quantities, and deadweight loss from emerging and dominating markets

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Sherman Act (1890)

Prohibited restraint of trade— monopoly markets

Recent application: Microsoft

12.7 Government Policy toward Monopoly

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Microsoft accused of restraint of trade• Monopolizing market• Bundling Windows operating system

with Internet Explorer browser• Keeping competitors from obtaining

large market share

12.7 Government Policy toward Monopoly

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Ruling

• Microsoft was not broken up into two separate firms (one for operating system and one for applications)

• But it had to change marketing practices and make it easier for other browsers to work with Windows

12.7 Government Policy toward Monopoly

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12.7 Government Policy toward MonopolyPrice Regulation

Efficient (socially optimal) pricePrice is equal to marginal cost

Fair-returns pricePrice is equal to average total cost

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12.7 Government Policy toward MonopolyPrice Regulation

Exhibit 12.11 Surplus Allocations: Perfect Competition Versus Monopoly

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12 Monopoly

Evidence-Based Economics Example:

Can a monopoly ever be good for society?