Economics 1: Spring 2012 Monopoly
J. Bradford DeLong, Lanwei Wang, and a cast of thousands...
March 12, 2012
Let’s Start with a Business…
• Brie L. and Johnny D. start a business—Stranger Tides Pirate BouIque, say… – They rent 100 storefronts at $105000/day – They can sell up to 1000 items of pirate gear at a cost of $3/item
from each storefont—that is a total of 100000 items/day – Beyond that, their costs go up: they can’t find things and have to
hire people to paw through merchandise, etc—beyond 1000 items, their marginal cost is $3 + (Q-‐100000)/10000, where Q is the total number of items they sell…
• Suppose that there is nobody else selling: they are a monopoly
• Demand for the firm’s products is: – Q = 25000 x (10 – P)
Ladies and Gentlemen, to your iClickers…
• And the firm’s supply curve – A. Will start at $105000—a]er all, you have to pay for that upfront rental, so you have to charge $105000 for your first sale
– B. Will start at $3 and be flat. – C. Will start at $3 and then smoothly rise to $5 and beyond.
– D. Will be flat at $5. – E. We don’t have enough informaIon
Supply and Marginal Cost
Monopoly in the Short Run
Ladies and Gentlemen, to your iClickers…
• How much will the Stranger Tides Pirate BouIque sell? – A. As much as it can at its efficient marginal cost of $3: 100000 units
– B. Enough to make the firm supply curve intersect the demand-‐for-‐the-‐firm’s-‐products curve: 121430
– C. The same as under perfect compeIIon: 800000.
– D. None of the above
Monopoly: Marginal Cost and Revenue
Ladies and Gentlemen, to your iClickers…
• So the Stranger Tides Pirate BouIque will sell 87500 units a day in the short run. What price will it charge in the short run? – A. Its cost: $3. – B. Where there is demand for 87500 units: $6.50 – C. Where supply intersects demand: $5.14 – D. The perfect-‐compeIIon equilibrium price: $4 – E. None of the above
Monopoly: Marginal Cost and Revenue
Ladies and Gentlemen, to your iClickers…
• How much profit does the Stranger Tides Pirate BouIque make in the short run? – A. $6.50 x 87500 = $568750 – B. $5 x 87500 = $437500 – C. ($6.50 -‐ $3) x 87500 -‐ $1050 = $201250 – D. ($6.50 -‐ $3) x 87500 = $301250 – E. $6.50 x 87500 -‐ $105000 = $468750
Ladies and Gentlemen, to your iClickers…
• So what will happen next? – A. New compeItors will enter and Stranger Tides will lose its monopoly
– B. Stranger Tides will expand to lower its costs. – C. Stranger Tides will contract to raise its prices. – D. We can’t tell. Any of a number of things might happen
Monopoly in the Long Run
Ladies and Gentlemen, to your iClickers…
• Suppose it maintains its monopoly. What will Stranger Tides do in the long run? – A. ConInue to produce 87,500 and sell at $6.50. – B. Its costs if it produces 87,500 are $3 x 87,500 + $1050 x 100 =
$367500. If it rented fewer storefronts—88 rather than 100—it could save money as its total costs would only be $354,900. It will do so.
– C. Its short-‐term marginal cost is $3 but its long-‐term marginal cost is $4. Marginal revenue intersects long-‐term marginal cost at not 87,500 but 75,000: it will rent 75 storefronts and produce 75,000 at a cost of $304,800
– D. It will expand in order to make compeItors scared of entering the market.
– E. We cannot tell what will happen.
Monopoly in the Long Run
Ladies and Gentlemen, to your iClickers…
• Suppose it maintains its monopoly. How much money will Stranger Tides make in the long run? – A. 87,500 x ($6.50-‐$4) = $218,750. – B. 87,500 x ($7 -‐ $4) = $262500 – C. 75,000 x ($7 -‐ $4) = $225000 – D. 75000 x $7 – 75000 x $3 – 75 x $1050 = $221,250
– E. 68000 x ($7 -‐ $3) + 7000 x ($7-‐$3.50) – 68 x $1050 = $225000
Monopoly in the Long Run
EvaluaIng Monopoly
• One firm – Demand: Q = 25000(10 – P)
• Consumer surplus: – Average consumer surplus: ($10-‐$7)/2 = $1.75 – Number of consumers: 75000 – Total consumer surplus: $131,250
• Producer surplus: – 75000 x ($7 -‐ $4) = $225,000
EvaluaIng Monopoly II
• Suppose we had the same industry demand curve – Industry Demand: Q = 25000(10 – P)
• But suppose we had perfect compeIIon – Industry Supply: P = 4, with each firm producing 1100
• Welfare: – We would have 150,000 customers – We would have average consumer surplus of $3/customer
– We would have $450,000 of consumer surplus in the long run
– We would sIll have $0 producer surplus
Here the Comparison Is Valid
• No differences in tastes and preferences • We have – $450,000 in consumer surplus – vs. – $131,250 in consumer surplus plus $225,000 in producer surplus
• That difference is not chopped liver… • How do we count producer surplus for a monopolist? Is it a good thing?
How Would You Regulate a Monopoly?
• Break-‐up via anItrust policies? • Regulate via expert commissions? – Quota requirements?
– Rate regulaIon?
How Monopolies Die
• AnItrust enforcement • Nibbling away by a compeIIve fringe
• InsItuIonal sclerosis • DisrupIve innovaIons
How Monopolies Are Born
• Predatory pricing? • Collusion, cartels, and mergers?
• Cost advantages – Via economies of scale
• How acquired? – Via superior technology
• How acquired? • The next generaIon’s monopoly profits are the incenIve for this generaIon’s research and innovaIon
Remaining Topics • April 16: Aggregate Supply, the
Phillips Curve, and • April 18: Long-‐Run Economic
Growth and the Government Budget
• April 23: The Global Savings Glut, the Housing Bubble, the Financial Crisis, and the Recession
• April 25: Policies to Stem the Recession, the Jobless Recovery, the European Financial Crisis
• April 30: Review • May 7: Final Exam
• March 7: MonopolisIc compeIIon
• March 12: Monopoly • March 14: Oligopoly and
strategy • March 19: The labor market • March 21: Economic inequality • April 2: 2nd midterm • April 4: What Macroeconomics
Is • April 9: Aggregate Demand and
Supply • April 11: Shi]ing the Aggregate
Demand Curve