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Monopoly

How? Firm behavior Monopoly vs. Competition Price Discrimination Policy

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What makes a monopoly?

single supplier of good firm supply = market supply firm demand = market demand

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How does it happen?

1. no close substitutes otherwise, makers of substitutes are

competition example: electricity

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2. barriers to entry

hard (impossible)for new competitors to enter market

barriers are natural legal

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natural monopoly

high fixed costs large economies of scale one firm meets market demand,

with lowest cost

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examples

distribution of water electricity natural gas

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legal monopoly

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

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examples

DeBeers & diamonds Bayer & Cipro Microsoft & Powerpoint

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monopolist & prices

power to set prices price maker

charge single price to everyone set prices for different groups/units

price discrimination

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Monopoly behavior

single price case same rule:

choose Q where MR = MCBUT

different outcome

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P & MR for monopoly,

MR < P why?

increase Q-- additional revenue-- but at lower P

(demand slopes down)

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P

Q

D

$7

$6

5 6

TR = $7 x 5 = $35

TR = $6 x 6 = $36 MR = $1from 5 to 6

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MR & DP, MR

Q

DMR

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profit maximizing

choose Q where MR = MC charge highest P possible

using demand curve profit

= (P - ATC)(Q)

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P, MR

Q

DMR

MC

Q*

P*

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P, MR

Q

DMR

MC

Q*

P* ATC

economic profit

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13.3 Monopoly vs. Competition

monopoly smaller output higher price

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P, MR

Q

DMR

MC

Qm

PmPc

Qc

Pm > PcQm < Qc

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Is monopoly efficient?

No output too low

Marginal benefit > MC deadweight loss

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P, MR

Q

D

S=MC

competition

Pc

Qc

consumersurplus

producersurplus

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monopolyP, MR

Q

DMR

MC

Qm

Pm

consumersurplus

producersurplus

deadweight loss

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Price Discrimination

charge each buyer higher price possible convert consumer surplus to economic profit

must identify & separate buyers prevent reselling

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How?

charge different prices to groups of buyers groups have different willingness to pay

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example: airlines

separate business, tourist travelers businesses have less elastic demand, will pay

more last minute, refundable tickets have higher

price

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

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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

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other price discrimination

charge differently for different units example

1 pizza, $10 2 pizzas, $14

people value 1st pizza more MC of 2nd pizza to same house small

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Monopoly & policy some monopolies are regulated

Niagara Mohawk some are illegal

AT&T (split in 1982) Microsoft?

some are created drug patents

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why allow monopolies?

inefficient deadweight loss

but there are gains economies of scale

-- natural monopolies-- utilities

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innovation drug patents reward research copyrights reward creativity

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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