Chapter 22 Monopoly How Firm behavior

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Chapter 22. Monopoly • How? • Firm behavior • Monopoly vs. Competition • Price Discrimination • Policy

What makes a monopoly? • single supplier of good § firm supply = market supply § firm demand = market demand

How does it happen? 1. no close substitutes • otherwise, makers of substitutes are competition • example: electricity

2. barriers to entry • hard (impossible) • for new competitors to enter market barriers are § natural § legal

natural monopoly • high fixed costs • large economies of scale • one firm meets market demand, with lowest cost

examples • distribution of § water § electricity § natural gas

legal monopoly • firm owns most of natural resource • firm has exclusive license, patent, copyright

examples • De. Beers & diamonds • Bayer & Cipro • Microsoft & Powerpoint

monopolist & prices • power to set prices • • § price maker charge single price to everyone set prices for different groups/units § price discrimination

Monopoly behavior • single price case • same rule: • § choose Q where MR = MC BUT different outcome

P & MR • for monopoly, • § MR < P why? § increase Q -- additional revenue -- but at lower P (demand slopes down)

TR = $7 x 5 = $35 P TR = $6 x 6 = $36 $7 MR = $1 from 5 to 6 $6 D 5 6 Q

MR & D P, MR D MR Q

profit maximizing • choose Q where MR = MC • charge highest P possible • § using demand curve profit = (P - ATC)(Q)

P, MR MC P* D MR Q* Q

economic profit P, MR MC P* ATC D MR Q* Q

13. 3 Monopoly vs. Competition • monopoly § smaller output § higher price

P, MR MC Pm > Pc Qm < Qc Pm Pc D MR Qm Qc Q

Is monopoly efficient? • No • output too low § Marginal benefit > MC § deadweight loss

competition P, MR consumer surplus S=MC Pc D producer surplus Qc Q

monopoly P, MR consumer surplus Pm MC deadweight loss D MR producer surplus Qm Q

Price Discrimination • charge each buyer higher price • possible § convert consumer surplus to economic profit must § identify & separate buyers § prevent reselling

How? • charge different prices to groups of • buyers groups have different willingness to pay

example: airlines • separate business, tourist travelers • § businesses have less elastic demand, will pay more last minute, refundable tickets have higher price

• get consumer surplus from business • travelers still have low fairs for tourism

Example: textbooks • NYT 10/21/2003 • Textbooks in U. S. cost twice as • much as European editions Students ordering overseas § Internet makes reselling easier, price discrimination tougher

other price discrimination • charge differently for different units • example • • § 1 pizza, $10 § 2 pizzas, $14 people value 1 st pizza more MC of 2 nd pizza to same house small

Monopoly & policy • some monopolies are regulated • • § Niagara Mohawk some are illegal § AT&T (split in 1982) § Microsoft? some are created § drug patents

why allow monopolies? • inefficient • § deadweight loss but there are gains § economies of scale -- natural monopolies -- utilities

• innovation § drug patents reward research § copyrights reward creativity

summary: monopoly • unique good, barrier to entry • choose Q where MR = MC • • § but MR < P Qm lower, Pm higher than competition § inefficient may use price discrimination

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