While a competitive firm is a price taker, a monopoly firm is a price maker. A firm is considered a monopoly if...

Transcription

1 Monopoly

2 Cause of monopoly

3 While a competitive firm is a price taker, a monopoly firm is a price maker. A firm is considered a monopoly if... it is the sole seller of its product. its product does not have close substitutes there are significant barriers to enter the market.

4 Microsoft has the market power for Windows operating system. The market price charged by each legal copy of the Windows operating system exceeds the mariginal costs of production. Why the price is not even higher? Because people wouldn t buy Although monopolies can control prices of their good, their profits are not unlimited!

5 The fundamental cause of monopoly is barriers to entry. Barriers to entry have three sources: Ownership of a key resource. The government gives a single firm the exclusive right to produce some good. Costs of production make a single producer more efficient than a large number of producers.

6 Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason. Nowadays, resources are owned by many people. Many goods are traded internationally and the scope of their markets is worldwide.

7 Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.

8 An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. A natural monopoly arises when there are economies of scale over the relevant range of output.

10 Monopoly versus Competition Monopoly Is the sole producer Faces a downward-sloping demand curve Is a price maker Reduces price to increase sales Competitive Firm Is one of many producers Faces a horizontal demand curve Is a price taker Sells as much or as little at the same price

12 The company was founded in 1888 by Cecil Rhodes: in 1871, he found a 83.5 carat diamond on Kimberley, South Africa he invested the profits into buying up small mining operators In 1888, he founded De Beers, as a result of merge He was the sole owner of all diamond mining operations in South Africa.

13 In 1889, Rhodes got an agreement with the London-based Diamond Syndicate, which agreed to purchase a fixed quantity of diamonds at an agreed price. in 1902, De Beers controlled 90% of the world's diamond production.

14 the only way to increase the value of diamonds is to make them scarce, that is to reduce production. E. Oppenheimer (later chair of the company) It controlled prices by: purchasing and stockpiling diamonds produced by other manufacturers convincing independent producers to join its single channel monopoly flooding the market with diamonds similar to those of producers who refused to join the cartel.

15 The end of the monopoly: In 2000, producers in Russia, Canada and Australia decided to distribute diamonds outside of the De Beers channel. Rising awareness of blood diamonds that forced De Beers to limit sales to its own mined products. De Beers market share fell from 90% in the 1980s to less than 40% in 2012.

16 Is a Microsoft truly the monopolist? Large market share Behavior Limits the access to documentation, which enables developing of competitive software Sell jointly Internet Explorer with an operating system Exclusionary agreements

17 Microsoft: Settled anti-trust litigation in the U.S. in 2001 Fined 493 million euros by the European Commission in 2004 Fined 1.35 Billion USD in 2008 for noncompliance with the 2004 rule. Is the Microsoft truly the monopolist or very strong competitor?

18 Polish mail (Poczta Polska) Deutsche Telekom: former state monopoly, still partially state owned, currently monopolizes high-speed VDSL broadband network Warsaw underground

19 Decision process

20 Total Revenue Average Revenue Marginal Revenue TR AR TR Q Q P Q P Q MR TR Q 1 1/ E P P Q

22 A Monopoly s Marginal Revenue A monopolist s marginal revenue is always less than the price of its good. The demand curve is downward sloping. When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.

23 A Monopoly s Marginal Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P Q). The output effect more output is sold, so Q is higher. The price effect price falls, so P is lower.

25 A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity.

26 Copyright 2004 South-Western Costs and Revenue Monopoly price and then the demand curve shows the price consistent with this quantity. B 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity... A Average total cost Marginal cost Demand Marginal revenue 0 Q Q MAX Q Quantity

27 Comparing Monopoly and Competition For a competitive firm, price equals marginal cost. P = MR = MC For a monopoly firm, price exceeds marginal cost. P > MR = MC

28 Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) Q Profit = (P - ATC) Q

30 The monopolist will receive economic profits as long as price is greater than average total cost.

31 Two type of market structures observed: Monopoly: patent laws give the monopoly on sale drugs for some time Competition: when the patent runs out, any firm may produce and sell the drug During the life of the patent the price is above the marginal cost When the patent runs out, new firms enter the market and the price falls

33 Suppose, a company is a monopolist and faces the downward sloping demand curve P D 100 2Q The company has the following cost structure TC 10 40Q Q How much will the firm produce? At what cost and price? What are the firm profits? 2

34 Consumer and producer surplus

35 Welfare economics is the study of how the allocation of resources affects economic wellbeing. Buyers and sellers receive benefits from taking part in the market. The equilibrium in a market maximizes the total welfare of buyers and sellers.

36 Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product.

37 Consumer surplus measures economic welfare from the buyer s side. Producer surplus measures economic welfare from the seller s side.

38 Willingness to pay is the maximum amount that a buyer will pay for a good. It measures how much the buyer values the good or service.

39 Consumer surplus is the buyer s willingness to pay for a good minus the amount the buyer actually pays for it.

41 The market demand curve depicts the various quantities that buyers would be willing and able to purchase at different prices.

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43 Copyright 2003 Southwestern/Thomson Learning Price of Album $100 John s willingness to pay 80 Paul s willingness to pay 70 George s willingness to pay 50 Ringo s willingness to pay Demand Quantity of Albums

46 The area below the demand curve and above the price measures the consumer surplus in the market.

48 Copyright 2003 Southwestern/Thomson Learning (b) Consumer Surplus at Price P Price A P 1 Initial consumer surplus B C Consumer surplus to new consumers P 2 D Additional consumer surplus to initial consumers E F Demand 0 Q 1 Q 2 Quantity

49 Consumer surplus, the amount that buyers are willing to pay for a good minus the amount they actually pay for it, measures the benefit that buyers receive from a good as the buyers themselves perceive it.

50 Producer surplus is the amount a seller is paid for a good minus the seller s cost. It measures the benefit to sellers participating in a market.

52 Just as consumer surplus is related to the demand curve, producer surplus is closely related to the supply curve.

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55 The area below the price and above the supply curve measures the producer surplus in a market.

57 Price of House Painting $ Total producer surplus ($500) (b) Price = $800 Supply Georgia s producer surplus ($200) Grandma s producer surplus ($300) Quantity of Houses Painted Copyright 2003 Southwestern/Thomson Learning

59 Copyright 2003 Southwestern/Thomson Learning (b) Producer Surplus at Price P Price Additional producer surplus to initial producers Supply P 2 D E F P 1 B Initial producer surplus C Producer surplus to new producers A 0 Q 1 Q 2 Quantity

60 Consumer surplus and producer surplus may be used to address the following question: Is the allocation of resources determined by free markets in any way desirable?

61 Consumer Surplus = Value to buyers Amount paid by buyers and Producer Surplus = Amount received by sellers Cost to sellers

62 Total surplus = Consumer surplus + Producer surplus or Total surplus = Value to buyers Cost to sellers

63 Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society.

64 In addition to market efficiency, a social planner might also care about equity the fairness of the distribution of well-being among the various buyers and sellers.

66 Three Insights Concerning Market Outcomes Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. Free markets allocate the demand for goods to the sellers who can produce them at least cost. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.

67 Because the equilibrium outcome in a competitive market is an efficient allocation of resources, the social planner can leave the market outcome as he/she finds it.

68 Market Power If a market system is not perfectly competitive, market power may result. Market power can cause markets to be inefficient because it keeps price and quantity from the equilibrium of supply and demand.

69 Deadweight loss

70 In contrast to a competitive firm, the monopoly charges a price above the marginal cost. From the standpoint of consumers, this high price makes monopoly undesirable. However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable.

71 Copyright 2004 South-Western Price Marginal cost Value to buyers Cost to monopolist Cost to monopolist Value to buyers Demand (value to buyers) 0 Quantity Value to buyers is greater than cost to seller. Efficient quantity Value to buyers is less than cost to seller.

72 Deadweight loss: is the total surplus lost due to monopoly pricing Because a monopoly sets its price above marginal cost, it places a wedge between the consumer s willingness to pay and the producer s cost. This wedge causes the quantity sold to fall short of the social optimum.

74 The Inefficiency of Monopoly The monopolist produces less than the socially efficient quantity of output. Some consumers would buy the good in a competitive market but will not buy under monopolistic pricing

75 The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax. The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit. The deadweight loss is however not a result of the monopoly profit monopoly profits are not a social problem

76 Government responds to the problem of monopoly in one of four ways. Making monopolized industries more competitive. Regulating the behavior of monopolies. Turning some private monopolies into public enterprises. Doing nothing at all.

77 Antitrust laws are a collection of statutes aimed at curbing monopoly power. Antitrust laws give government various ways to promote competition. They allow government to prevent mergers. They allow government to break up companies. They prevent companies from performing activities that make markets less competitive.

78 Prevent mergers: Microsoft and Intuit in Breaks up companies: Polish railways (PKP) were divided into a set of smaller companies (2001) AT&T telecommunications company was divided into 8 smaller companies (1984) Prevents companies from performing activities that make markets less competitive.

79 Government may regulate the prices that the monopoly charges. The allocation of resources will be efficient if price is set to equal marginal cost. When the company is a natural monopoly than it has a decreasing average cost then AC<MC The firm will exit the market (suffers losses)

81 In practice, regulators will allow monopolists to keep some of the benefits from lower costs in the form of higher profit, a practice that requires some departure from marginal-cost pricing. Examples: Electricity prices Gas prices

82 Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself. Examples: Railway trucks Postal Services

83 Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies.

84 Lets consider the previous example with a company characterized by P D 100 2Q TC 10 40Q Q What is the efficient scale of production? What is the deadweight loss? Suppose, the company profits are transferred to consumers. Does it change the deadweight loss? 2

85 Examples and effects on the deadweight loss.

86 Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.

87 Suppose, we run a Publishing company that has a monopoly for selling a novel No printing costs Fixed cost to the author: $2 million for exclusive rights to publish Demand Price Sale Income Profits 30$ $ Decision: set the price $30

88 Deadweight loss: potential readers do not buy the book Suppose, the two types of customers lives in two countries: Europa (willing to pay $30) US (wiling to pay $5) When it charges two different prices, the company can have $ profit Country Price Sale Income EU 30$ US 5$

89 Price discrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power. Perfect Price Discrimination Perfect price discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.

90 The price discrimination is a rational behavior of a monopolist Increase the profits It requires separation of consumers according to their willingness to pay No arbitrage Price discrimination can rise the economic welfare (reduces the deadweight loss)

93 Examples of Price Discrimination Movie tickets Airline prices Discount coupons Quantity discounts

94 How prevalent are the problems of monopolies? Monopolies are common. Most firms have some control over their prices because of differentiated products. Firms with substantial monopoly power are rare. Few goods are truly unique.

95 A monopoly is a firm that is the sole seller in its market. It faces a downward-sloping demand curve for its product. A monopoly s marginal revenue is always below the price of its good.

96 Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost.

97 A monopolist s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. A monopoly causes deadweight losses similar to the deadweight losses caused by taxes.

98 Policymakers can respond to the inefficiencies of monopoly behavior with antitrust laws, regulation of prices, or by turning the monopoly into a government-run enterprise. If the market failure is deemed small, policymakers may decide to do nothing at all.

99 Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. Price discrimination can raise economic welfare and lessen deadweight losses.