1 monopoly 2 four basic market structures u perfectly competitive: many firms, identical products,...
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Four Basic Market Structures Perfectly Competitive: many firms, identical
products, free entry and exit, full and symmetric info Monopoly: single firm, no close substitutes, barriers
to entry, full and symmetric info Oligopoly: several firms, similar products, degree of
product differentiation varies depending upon the market, might be barriers, full and symmetric info
Monopolistic competition: many firms, similar products, slightly differentiated products, free entry and exit, full and symmetric info
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Competitive Market
This is the classic “textbook” market structure.
Firms in a competitive market all make a product that is perfectly substitutable: all demanders are equally satisfied with any supplier’s product.
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Monopoly
The single seller makes a product that has no “good” substitute.
Other firms may be able to produce the good or service but choose not to enter the market or are barred from it.
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Oligopoly
A few sellers make products that are good, but not perfect, substitutes.
Consumers can be induced to change suppliers but have only a limited number of choices.
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Monopolistic Competition
The market has many firms but each supplier’s product is differentiated.
Consumers can be induced to change brands but they have brand preferences.
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Question
What is the market structure for each of these products or firms: competitive, monopoly, oligopoly, monopolistic competition?– The Campus Store
– Kinko’s
– Pepperidge Farm’s Whole Wheat Bread
– PowerMac computer
– Windows computer
– NYSEG (electricity utility)
– Morton salt
– AT&T long distance
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Answer The Campus Store: most products competitive, textbooks
oligopoly, but location is very important. Kinko’s: monopolistic competition (differentiated service) Pepperidge Farm’s Whole Wheat Bread: competition or
monopolistic competition (slightly differentiated recipes) PowerMac computer and clones: monopoly, under license. Windows computer: monopolistic competition (differentiated
features) NYSEG (electricity utility): monopoly Morton salt: competitive AT&T long distance: oligopoly
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Sources of Monopoly Entry Barriers
Natural monopoly: the most efficient scale of production is so large, relative to market demand, that a single firm dominates the market.
Patents, copyrights, licenses, franchises: government protection of a firm’s right to produce a unique product.
Economic and/or legal restrictions, strategies or situations that make entry more difficult for new competitors than for the existing monopoly firm.
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Natural Monopolies Goods and services whose delivery requires the
construction of a physical network (wires, pipes, etc..) In such industries (local phone service, water,
sewage removal, electricity, gas) the physical networks display decreasing marginal cost over essentially all quantities.
Thus, average total cost is always declining and the minimum efficient scale is much larger than the size of the market.
Natural monopolies are often regulated: they cannot charge a higher price without government approval.
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Patents: Are There “Good” Monopolies?
Consider the protease inhibitor Crixivan from Merck.
A very effective AIDS therapy. Development costs were more than one
billion dollars. Annual revenue now from treating around
90,000 patients is $500,000,000.
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What is a “Good” Monopoly?
Why is Merck given a monopoly? The granting of a patent on the drug
Crixivan guarantees that Merck can earn monopoly profits on its sale.
These monopoly profits provide the incentive to invest in the research and development required to create the new drug.
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“Good” Monopolies
The granting of patent protection (legal monopoly) gives firms a strong incentive to invest in new product development.
Would firms make the R&D investments if they could not protect them through patents and trade secrets?
Probably not because competitors could steal the design at a fraction of the cost after the product is brought to market.
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“Other” Monopolies - Good? Bad?
Input Ownership– DeBeer’s and diamonds
Industry Secret or Know-how– IBM and mainframes?
Strategic Behavior– buy ‘em up– blow’ em up– let’s make a deal– Microsoft and operating systems?
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Caveats
monopoly does not => big big does not => monopoly monopoly does not => absolute and unlimited
control over price monopoly does not => must have economic
profit short run profit does not => monopoly power monopoly does not => badly behaved firm
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Classic Simple Monopoly
Polar extreme from perfect competition. Monopolist is a “price maker.” Cost curves are pretty much the same
(except in the case of natural monopoly).
The big change from before is in the demand side of the profit function.
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The Simple Monopolist The simple monopolist abides by the “law of one
price.” Everyone pays the same market price for all units purchased.
A monopolist faces the declining market demand curve for its product and simultaneously chooses price and quantity.
Now P>MR (before P=MR) because the simple monopolist must lower the price on all preceding units to sell an additional unit.
A monopolist has no “supply curve.”
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The Simple Monopolist: Rules for Profit Maximization
Suppose we are in the short run. Rules for profit maximization are the same as
before. If XSM maximizes profit, then
– MR(XSM ) = MC(XSM )» very important note: for a simple monopolist
P>MR at all positive levels of X.
– XSM is a max and not a min. – at XSM it’s worth operating.
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Simple Monopoly Economic profits equal
total revenue minus total costs.
Marginal revenue is the rate of change of total revenue (just like marginal cost is the rate of change of total cost) as quantity increases.
Economic profits are maximized when marginal revenue equals marginal costs
Monopoly Selling in a Single Market at a Single Price
Quantity
Market Demand
PriceTotal Costs
Marginal Cost
(midpoint formula)
Average Total Cost
Total Revenue
Marginal Revenue (midpoint formula)
Economic Profits
0 100.00 800 0.00 -80010 95.00 1,500 82.50 150.00 950.00 90.00 -55020 90.00 2,450 65.00 122.50 1,800.00 80.00 -65030 85.00 2,800 42.50 93.33 2,550.00 70.00 -25040 80.00 3,300 32.50 82.50 3,200.00 60.00 -10050 75.00 3,450 20.50 69.00 3,750.00 50.00 30060 70.00 3,710 18.50 61.83 4,200.00 40.00 49070 65.00 3,820 9.50 54.57 4,550.00 30.00 73080 60.00 3,900 9.00 48.75 4,800.00 20.00 90090 55.00 4,000 10.00 44.44 4,950.00 10.00 950
100 50.00 4,100 12.50 41.00 5,000.00 0.00 900110 45.00 4,250 17.50 38.64 4,950.00 -10.00 700120 40.00 4,450 20.00 37.08 4,800.00 -20.00 350130 35.00 4,650 25.00 35.77 4,550.00 -30.00 -100140 30.00 4,950 30.00 35.36 4,200.00 -40.00 -750150 25.00 5,250 35.00 35.00 3,750.00 -50.00 -1,500160 20.00 5,650 45.00 35.31 3,200.00 -60.00 -2,450170 15.00 6,150 60.00 36.18 2,550.00 -70.00 -3,600180 10.00 6,850 75.00 38.06 1,800.00 -80.00 -5,050190 5.00 7,650 100.00 40.26 950.00 -90.00 -6,700200 0.00 8,850 44.25 0.00 -8,850
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Graphical Display of Monopolist’s Solution
The monopolist sets marginal revenue equal to marginal cost at MR=MC=$10.
The optimal quantity is thus 90 units, which implies a market price of $55/unit.
The monopoly profits (light blue in the graph) are the difference between price ($55) and average total cost ($44.44) times the number of units sold.
Notice that our monopolist is a “natural monopoly” the average total costs decline over the entire relevant range of production and the minimum efficient scale (150) is bigger than the entire market.
Notice that if our monopolist operated at the competitive equilibrium (Price=MC=$30, Quantity=140), the firm would make a loss (ATC>Price).
Natural Monopolist's Market
-40.00
-30.00
-20.00
-10.00
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
100.00
0 10 20 30 40 50 60 70 80 90 100
110
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140
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Quantity
Do
llars
/un
it
Market Demand Price
Exact Marginal Revenue
Marginal Cost
Average Total Cost
Monopoly Profits
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Implications of the Monopolist’s Profit Maximum
Price will exceed the competitive price. Quantity will be less than the competitive quantity. The monopolist sells the output at a price greater than marginal
costs but the monopoly price can be above or below average total costs. Thus, the monopolist need not always make a profit. In the long run, of course, unprofitable monopolists will either stop production or raise the price further above marginal cost until it covers average total costs.
The monopolist will always try to operate on the elastic portion of the demand curve because when the elasticity of demand is greater than -1 (inelastic, between 0 and 1 in absolute value), marginal revenue is negative and, necessarily, less than marginal cost.
Since there is no entry to consider monopolists can have persistent long run economic profit.
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Simple Monopoly- Performance
Efficiency:– Is the monopoly equilibrium Pareto Efficient?
That is, at XSM is net social surplus maximized? Does $MB=$MC at XSM?
– Is the monopolist productively efficient? Does the monopolist operate at minimum efficient scale?
Equity: – Is the outcome of monopoly fair? Equitable?
Just?
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Simple Monopoly- Performance Answers
The simple monopoly equilibrium is not Pareto Efficient. – The simple monopolist creates “dead-weight-loss.”– At XSM, $MB>$MC . Recall: $MR=$MC at XSM while
$PSM>$MR at all X. So $PSM>$MC. Since $P=$MB, then $MB>$MC.
The simple monopolist may or may not be productively efficient.
Compared to the competitive equilibrium, there is a transfer of surplus from consumers to producers.
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Price Discriminating Monopolists
A monopolist might be able to charge different prices for different units sold and enhance its profits. – charge different people different prices– charge the same person different prices for different units
price discrimination– charging different prices for different units with no cost basis– charging the same price for different units when there are
cost differences
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Requirements for Price Discrimination
Some amount of monopoly power. An ability to prevent resale. Detailed information about who is buying
what unit and what demanders are willing to pay.
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Believe It Or Not What would you do to prevent resale??? when: 1940’s market: plastic molding powder
– industrial users: .85/pound– denture manufacturers: $22/pound
firm: Rohm and Haas problem: resale from industrial users to
denture manufacturers solution: rumor you are mixing arsenic in the
powder sold to industrial users!
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Two classic forms of Price Discrimination Perfect or First Degree Price Discrimination
– charge a different price for each unit sold– the most extreme form of price discrimination
Third Degree Price Discrimination– segment market and then charge a different price in each
market– exploit the observation that at the simple monopoly price
the own price elasticity of demand differs across the defined segmented markets
Price discrimination comes in many other “flavors”
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Question
The data on your handout show the demand curves for movie tickets of adults and seniors. The market described has only one movie theatre.– Find the best single price.– If the movie theater can charge separate
prices for adults and seniors, what are the best two prices?
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Two Prices are Better than One for Movie Tickets
The best single price in this market is $7.50/ticket, which makes economic profits of $4,225 (blue entries). Set marginal cost = marginal revenue with the single price.
The price discriminating monopolist can make more economic profits by charging adults $8.50 (yellow entries) and seniors $6.50 (green entries). Set marginal cost = marginal revenue separately for each market.
Price Discrimination in the Movie Theatre Market
Price per ticket
Quantity adult movie tickets
Quantity senior movie tickets
Total Demand
for Tickets
Single Price Total Revenue
Single Price
Marginal Revenue
Adult Total
Revenue
Adult Price
Marginal Revenue
Senior Total Revenue
Senior Price
Marginal Revenue
Marginal Cost
Single Price
Economic Profits
12.00 200 0 200 2,400 2,400 0 1.00 2,20011.50 225 25 250 2,875 9.00 2,588 7.00 288 11.00 1.00 2,62511.00 250 50 300 3,300 8.00 2,750 6.00 550 10.00 1.00 3,00010.50 275 75 350 3,675 7.00 2,888 5.00 788 9.00 1.00 3,32510.00 300 100 400 4,000 6.00 3,000 4.00 1,000 8.00 1.00 3,6009.50 325 125 450 4,275 5.00 3,088 3.00 1,188 7.00 1.00 3,8259.00 350 150 500 4,500 4.00 3,150 2.00 1,350 6.00 1.00 4,0008.50 375 175 550 4,675 3.00 3,188 1.00 1,488 5.00 1.00 4,1258.00 400 200 600 4,800 2.00 3,200 0.00 1,600 4.00 1.00 4,2007.50 425 225 650 4,875 1.00 3,188 -1.00 1,688 3.00 1.00 4,2257.00 450 250 700 4,900 0.00 3,150 -2.00 1,750 2.00 1.00 4,2006.50 475 275 750 4,875 -1.00 3,088 -3.00 1,788 1.00 1.00 4,1256.00 500 300 800 4,800 -2.00 3,000 -4.00 1,800 0.00 1.00 4,0005.50 525 325 850 4,675 -3.00 2,888 -5.00 1,788 -1.00 1.00 3,8255.00 550 350 900 4,500 -4.00 2,750 -6.00 1,750 -2.00 1.00 3,6004.50 575 375 950 4,275 -5.00 2,588 -7.00 1,688 -3.00 1.00 3,3254.00 600 400 1,000 4,000 -6.00 2,400 -8.00 1,600 -4.00 1.00 3,0003.50 625 425 1,050 3,675 -7.00 2,188 -9.00 1,488 -5.00 1.00 2,6253.00 650 450 1,100 3,300 -8.00 1,950 -10.00 1,350 -6.00 1.00 2,2002.50 675 475 1,150 2,875 -9.00 1,688 -11.00 1,188 -7.00 1.00 1,7252.00 700 500 1,200 2,400 1,400 1,000 1.00 1,200
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Summary of Price Discrimination Example
Calculating economic profits separately for the two markets (adult and senior) shows that the total is greater than with the best single price.
Taking advantage of different elasticities of demand.
Profit Maximum with 2 PricesEconomic profits adult market 2,813Economic profits senior market 1,513Total with price discrimination 4,325Total without price discrimination 4,225
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Believe It Or Not when: early 1990’s market: contact lenses firm: Bausch & Lomb Lenses:
– Optima @ $70/pair - wash and keep 1 year– Medalist @ $15/pair - wash and keep 2 months– SeeQuence 2 @ $8/pair - wash and keep 2 weeks– Occasions @ $3/pair - daily and disposable each day
Guess what?
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Believe It Or Not They were all the same lenses! Just packaged differently! What would you pay for a year?
– Optima = $70/pair - wash and keep 1 year– Medalist = $15x6=$90 (last 2 months)– SeeQuence 2 = $8x26=$208 (last 2 weeks)– Occasions = $3x365 = $1095
What would I do? Buy the Occasions and wash and wear until my eyes hurt.
Class action suits were eventually settled.
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First Degree Price Discrimination The monopolist charges the demand price for each
unit sold. In this case the market demand curve becomes the
monopolist’s marginal revenue curve. The monopolist sets MR=MC to get XFDPD. The monopolist charges a different price for each
unit according to the demand curve. Performance: XFDPD is Pareto Efficient and all the net
social surplus goes to the monopolist as producer surplus. Consumer surplus = $0!
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Should the Government Regulate Monopolies?
Essentially all monopolies are regulated. Natural monopolies are regulated by price
commissions that determine the rates the monopolies may charge.
Patent, copyright and license protections are a form of ex ante regulation: firms that follow the rules for establishing the validity of their innovations receive the protection of the patent, copyright or license.
Should the government do more? Good question.