Chapter 25. Introduction. Learning Objectives. Monopoly

Transcription

1 Chapter 25 Monopoly Introduction The Ambassador Bridge separating Detroit, Michigan from Windsor, Ontario is owned by a private company. Clearly, this is a firm that owns a resource with few close substitutes. How does a firm in this situation, known as a monopoly, determine the price to charge for its product? Copyright 2008 Pearson Addison Wesley. All rights reserved Learning Objectives Identify situations that can give rise to monopoly Describe the demand and marginal revenue conditions a monopolist faces Discuss how a monopolist determines how much output to produce and what price to charge Evaluate the profits earned by a monopolist Understand price discrimination Explain the social cost of monopolies Copyright 2008 Pearson Addison Wesley. All rights reserved

2 Chapter Outline Definition of a Monopolist Barriers to Entry The Demand Curve a Monopolist Faces Elasticity and Monopoly Cost and Monopoly Profit Maximization Calculating Monopoly Profit On Making Higher Profits: Price Discrimination The Social Cost of Monopolies Copyright 2008 Pearson Addison Wesley. All rights reserved Did You Know That... A monopoly can arise whenever sellers are given exclusive rights to distribute a good? A law intended to help New York wineries creates a situation called monopoly? Copyright 2008 Pearson Addison Wesley. All rights reserved Definition of a Monopolist Monopolist A single supplier of a good or service for which there is no close substitute The monopolist therefore constitutes the entire industry. Copyright 2008 Pearson Addison Wesley. All rights reserved

3 Barriers to Entry Question How does a firm obtain monopoly power? Answers Barriers to entry that allow the firm to make long-run economic profits Barriers to entry are restrictions on who can start as well as stay in business. Copyright 2008 Pearson Addison Wesley. All rights reserved Barriers to Entry (cont'd) Barriers to entry include Ownership of resources without close substitutes Economies of scale Legal or governmental restrictions Copyright 2008 Pearson Addison Wesley. All rights reserved Barriers to Entry (cont'd) Ownership of resources without close substitutes The Aluminum Company of America (ALCOA) at one time owned most of of the world s bauxite. Copyright 2008 Pearson Addison Wesley. All rights reserved

4 Barriers to Entry (cont'd) Economies of scale Low unit costs and prices drive out rivals. The largest firm can produce at the lowest average total cost. Copyright 2008 Pearson Addison Wesley. All rights reserved Barriers to Entry (cont'd) Natural Monopoly A monopoly that arises from the peculiar production characteristics in an industry It usually arises when there are large economies of scale One firm can produce at a lower average cost than can be achieved by multiple firms Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 25-1 The Cost Curves That Might Lead to a Natural Monopoly Copyright 2008 Pearson Addison Wesley. All rights reserved

5 Barriers to Entry (cont'd) Legal or governmental restrictions Licenses, franchises, and certificates of convenience Examples include Electrical utilities Radio and television broadcasting Copyright 2008 Pearson Addison Wesley. All rights reserved International Policy Example: Malaysia s Drug-Labeling Monopoly Sellers of drugs and medical products are required to affix holographic labels providing information on usage. To obtain these labels, sellers have only one choice. They must buy the labels from a company called Mediharta. This company is the only label manufacturer that Malaysia s Registrar of Companies has approved to produce holographic labels. Copyright 2008 Pearson Addison Wesley. All rights reserved Barriers to Entry (cont'd) Legal or governmental restrictions Patents Intellectual property Tariffs Taxes on imported goods Regulation Safety and quality Copyright 2008 Pearson Addison Wesley. All rights reserved

6 Barriers to Entry (cont'd) Cartels An association of producers in an industry that agree to set common prices and output quotas to prevent competition Copyright 2008 Pearson Addison Wesley. All rights reserved The Demand Curve a Monopolist Faces The monopolist faces the industry demand curve because the monopolist is the entire industry. Copyright 2008 Pearson Addison Wesley. All rights reserved The Demand Curve a Monopolist Faces (cont'd) Recall that under perfect competition Firm faces perfectly elastic demand curve, it is a price taker The forces of supply and demand establish the price per unit Marginal revenue, average revenue, and price are all the same Copyright 2008 Pearson Addison Wesley. All rights reserved

7 The Demand Curve a Monopolist Faces (cont'd) Perfect competition versus monopoly The perfect competitor doesn t have to worry about lowering price to sell more. In a purely competitive situation, the firm accounts for a small part of the market. It can sell its entire output, whatever that may be, at the same price. Copyright 2008 Pearson Addison Wesley. All rights reserved The Demand Curve a Monopolist Faces (cont'd) Perfect competition versus monopoly The more the monopolist wants to sell, the lower the price it has to charge on the last unit sold. To sell the last unit, the monopolist has to lower the price because it is facing a downward sloping demand curve. Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 25-2 Demand Curves for the Perfect Competitor and the Monopolist Copyright 2008 Pearson Addison Wesley. All rights reserved

8 The Demand Curve a Monopolist Faces (cont'd) Monopoly Single seller Faces entire industry demand Must lower price to sell more Not all units sold for same price (MR < P) Perfect Competition Many sellers Faces perfectly elastic demand Must produce more to sell more All units sold for same price (P = MR) Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 25-3 Marginal Revenue: Always Less Than Price Copyright 2008 Pearson Addison Wesley. All rights reserved Elasticity and Monopoly The monopolist faces a downwardsloping demand curve, and cannot charge any price. A common misconception Thus, depending on the price charged a different quantity will be demanded. Copyright 2008 Pearson Addison Wesley. All rights reserved

9 Elasticity and Monopoly (cont'd) Question If a monopoly raises price, what will happen to quantity demanded? Hint Remember how consumers respond to a change in price. Copyright 2008 Pearson Addison Wesley. All rights reserved Elasticity and Monopoly (cont'd) Recall Monopolist is a single seller of a well-defined good or service with no close substitute. Think of some imperfect substitutes. The demand curve slopes downward because individuals compare marginal satisfaction to cost. Copyright 2008 Pearson Addison Wesley. All rights reserved Elasticity and Monopoly (cont'd) After all, consumers have limited incomes and unlimited wants. Copyright 2008 Pearson Addison Wesley. All rights reserved

10 Cost and Monopoly Profit Maximization We assume profit maximization is the goal of the pure monopolist, just as it is for the prefect competitor. Copyright 2008 Pearson Addison Wesley. All rights reserved Cost and Monopoly Profit Maximization (cont'd) Perfect competitor has only to decide on the profit-maximizing output rate because price is given. The perfect competitor is a price taker. For the pure monopolist, we must seek a profit-maximizing price output combination. The monopolist is a price searcher. Copyright 2008 Pearson Addison Wesley. All rights reserved Cost and Monopoly Profit Maximization (cont'd) Price Searcher A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve Copyright 2008 Pearson Addison Wesley. All rights reserved

11 Cost and Monopoly Profit Maximization (cont'd) We can determine the profit-maximizing price-output combination with either of two equivalent approaches. By looking at total revenues and total costs or by looking at marginal revenues and marginal costs Copyright 2008 Pearson Addison Wesley. All rights reserved Cost and Monopoly Profit Maximization (cont'd) Total revenues-total costs approach Maximize the positive difference between total revenues and total costs Marginal revenue-marginal cost approach Profit maximization will also occur where marginal revenue equals marginal cost. Copyright 2008 Pearson Addison Wesley. All rights reserved Cost and Monopoly Profit Maximization (cont'd) Question Why produce where marginal revenue equals marginal cost? Answer This is where the greatest positive difference between total revenue and total cost occurs. Copyright 2008 Pearson Addison Wesley. All rights reserved

12 Figure 25-4 Monopoly Costs, Revenues, and Profits, Panel (a) Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 25-4 Monopoly Costs, Revenues, and Profits, Panels (b) and (c) Copyright 2008 Pearson Addison Wesley. All rights reserved Cost and Monopoly Profit Maximization (cont'd) Producing past where MR = MC Incremental cost exceeds incremental revenue Producing less than where MR = MC Monopolist not maximizing profits here either Copyright 2008 Pearson Addison Wesley. All rights reserved

13 Figure 25-5 Maximizing Profits Copyright 2008 Pearson Addison Wesley. All rights reserved Calculating Monopoly Profit Monopoly profit is given by the shaded area, which is equal to total revenues (P Q) minus total costs (ATC Q). Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 25-6 Monopoly Profit Copyright 2008 Pearson Addison Wesley. All rights reserved

14 Calculating Monopoly Profit (cont'd) No guarantee of profit The term monopoly conjures up the notion of a greedy firm ripping off the public. If ATC is everywhere above AR, or demand No price-output combination allows the monopolist to cover costs Copyright 2008 Pearson Addison Wesley. All rights reserved Figure 25-7 Monopolies: Not Always Profitable Copyright 2008 Pearson Addison Wesley. All rights reserved On Making Higher Profits: Price Discrimination Price Discrimination Selling a given product at more than one price, with the difference being unrelated to differences in cost Copyright 2008 Pearson Addison Wesley. All rights reserved

15 On Making Higher Profits: Price Discrimination (cont'd) Price Differentiation Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers Copyright 2008 Pearson Addison Wesley. All rights reserved On Making Higher Profits: Price Discrimination (cont'd) Necessary conditions for price discrimination 1. The firm must face a downward-sloping demand curve. 2. The firm must be able to readily (and cheaply) identify buyers or groups of buyers with predictably different elasticities of demand. 3. The firm must be able to prevent resale of the product or service. Copyright 2008 Pearson Addison Wesley. All rights reserved Example: Why Students Pay Different Prices to Attend College Out-of-pocket tuition rates for any two college students can differ by considerable amounts. The reason is that colleges offer students diverse financial aid packages depending on their financial need. The college determines prices that families are most likely to pay, so that it can engage in price discrimination. Copyright 2008 Pearson Addison Wesley. All rights reserved

16 Figure 25-8 Toward Perfect Price Discrimination in College Tuition Rates Copyright 2008 Pearson Addison Wesley. All rights reserved The Social Cost of Monopolies Comparing monopoly with perfect competition Let s assume a monopolist comes in and buys up every single perfect competitor. Notice the monopolist produces a smaller quantity and sells at a higher price. Copyright 2008 Pearson Addison Wesley. All rights reserved The Social Cost of Monopolies (cont'd) Comparing monopoly with perfect competition Monopolists raise the price and restrict production compared to a perfectly competitive situation. Consumers pay a price that exceeds the marginal cost of production and resources are misallocated in such a situation. Copyright 2008 Pearson Addison Wesley. All rights reserved

17 Figure 25-9 The Effects of Monopolizing an Industry Copyright 2008 Pearson Addison Wesley. All rights reserved Issues and Applications: For This Monopoly Location is the Key A resource with literally few close substitutes is the Ambassador Bridge. Price searching for the profit-maximizing toll rates have boosted profits. Total revenues in excess of $60 million have been generated per year. Estimates of the market value of the bridge value it in excess of half a billion dollars. Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Why a monopoly can occur Barriers to entry Demand and marginal revenue conditions faced by a monopolist Because the monopolist constitutes the entire industry, it faces the entire market demand curve. Marginal revenue is less than price. Copyright 2008 Pearson Addison Wesley. All rights reserved

18 Summary Discussion of Learning Objectives (cont'd) How a monopolist determines how much output to produce and what price to charge Seeks to maximize its economic profits Produces where marginal revenue equals marginal cost Charges maximum price for the amount of output where MR = MC Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) A monopolist s profits Profit earned by monopolist is equal to the difference between the price it charges and its average production cost times the amount of output it produces and sells. Monopolist typically earns positive economic profits. Copyright 2008 Pearson Addison Wesley. All rights reserved Summary Discussion of Learning Objectives (cont'd) Price discrimination Selling at more than one price with the price differences being unrelated to differences in production costs. Monopolist sells some of its output at higher prices to consumers with less elastic demand. Copyright 2008 Pearson Addison Wesley. All rights reserved

19 Summary Discussion of Learning Objectives (cont'd) Social cost of monopolies Price exceeds marginal cost. The price is higher and output is lower for a monopolist as compared to a perfectly competitive industry. Copyright 2008 Pearson Addison Wesley. All rights reserved End of Chapter 25 Monopoly 19