powerpoint to accompany chapter 8 monopoly markets
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Chapter 8
Monopoly Markets
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Learning Objectives
1. Define monopoly.
2. Explain the four main reasons why monopolies arise.
3. Explain how a monopoly determines price and output.
4. Use a graph to illustrate how a monopoly affects economic surplus.
5. Discuss government policies towards a monopoly.
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Austar rules the regions
Australian Pay TV industry is dominated by three players: Foxtel, Optus TV and Austar. Austar is the sole provider of Pay TV in rural Australia, i.e.: one of a few firms in Australia enjoying the benefits of being a monopoly.
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Monopoly: The only seller of a good or service that does not have a close substitute.
LEARNING OBJECTIVE 1
Is any firm ever really a monopoly?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
The End of the Singapore Education Bonanza
At one time, Perth universities earned large profits by exporting education to Singapore. However, many new rivals entered the industry, and now the large profits initially earned are a thing of the past.
MAKING THE CONNECTION8.1
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Monopolies emerge due to a lack of competition created by barriers to entry.
The four main reasons for high barriers to entry are:
1. Government blocks the entry of more than one firm into a market.
2. One firm has control of a key resource material necessary to produce a good.
LEARNING OBJECTIVE 2
Where do monopolies come from?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
3. There are important network externalities in supplying the good or service.
4. Economies of scale are so large that one firm has a natural monopoly.
LEARNING OBJECTIVE 2
Where do monopolies come from?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
LEARNING OBJECTIVE 2
1. Government blocks entry in two main ways:
i. By granting a patent or copyright to an individual or firm, which gives the exclusive right to produce a product or service for a period of time.
ii. By granting a firm a public franchise, which makes it the exclusive legal provider of a good or service.
Where do monopolies come from?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
2. Another way for a firm to become a monopoly is by controlling a key resource.
This happens infrequently because most resources are widely available from a variety of suppliers.
LEARNING OBJECTIVE 2
Where do monopolies come from?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Are Diamond (Profits) Forever? The De Beers Diamond Monopoly
De Beers promoted the sentimental value of diamonds as a way to maintain its position in the diamond market.
MAKING THE CONNECTION8.2
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
3. Network externalities: These exist when the usefulness of a product increases with the number of consumers who use it.
Network externalities can set off a virtuous cycle: if a firm can attract enough customers initially, it can then attract more customers, which attracts even more customers, and so on.
LEARNING OBJECTIVE 2
Where do monopolies come from?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
4. Natural monopoly: A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms.
LEARNING OBJECTIVE 2
Where do monopolies come from?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price and cost
Quantity
Demand
0
0.06
0.04
30 billion
ATC
15 billion
Average total cost for a natural monopoly: Figure 8.1
B
A
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Like every other firm, a monopoly maximises profit at the output when marginal revenue equals marginal cost (MR=MC).
However, the difference is that a monopoly’s demand curve is the same as the demand curve for the product (downward sloping).
LEARNING OBJECTIVE 3
How does a monopoly choose price and output?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Monopoly is a price maker. It does not face a horizontal demand curve.
In fact, both its demand curve and marginal revenue curve are downward-sloping; and
the marginal revenue curve is positioned below its demand curve.
LEARNING OBJECTIVE 3
How does a monopoly choose price and output?
Calculating a monopoly’s revenue: Figure 8.2
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price and revenue
Quantity
Demand = average revenue
Marginal revenue
0
To sell more, the price must be lowered. The marginal
revenue curve will be below the demand curve.
Profit-maximising quantity and price for a monopolist: Figure 8.3a
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price and cost
Quantity
Demand
MR
0
MC$60
42
6
27
Profit-maximising quantity
Profit-maximising
priceB
A
Profits for a monopolist: Figure 8.3b
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price and cost
Quantity
Demand
MR
0
MC$60
42
6
30
Profit-maximising quantity
Profit-maximising
priceB
A
ATC
Profit
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Finding profit-maximising price and output for a monopolist
Suppose that Telstra has a monopoly for telephone lines in Armidale, NSW. The table on the next slide provides Telstra’s hypothetical demand and cost per month for telephone line rentals.
Fill in the missing values in the table.
If Telstra wants to maximise profits what price should it charge and how many line rentals per month should it sell? How much profit will it make? Briefly explain.
Suppose the local government imposes $8 per month tax on telephone line rental providers. Now what price should Telstra charge, how many line rentals should it sell and what will its profit be?
LEARNING OBJECTIVE 3
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Finding profit-maximising price and output for a monopolist
LEARNING OBJECTIVE 3
PRICE QUANTITYTOTAL
REVENUE
MARGINAL REVENUE
(MR = ΔTR/ΔQ)TOTAL COST
MARGINALCOST
(MC = ΔTC/ΔQ)
$30 10 $290
29 11 308
28 12 324
27 13 339
26 14 355
25 15 373
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Solving the problem:
STEP 1: Review the section ‘Profit maximisation for a monopolist’.
LEARNING OBJECTIVE 3
PRICE QUANTITYTOTAL
REVENUE
MARGINAL REVENUE
(MR = ΔTR/ΔQ)TOTAL COST
MARGINALCOST
(MC = ΔTC/ΔQ)
$30 10 $300 –$29
0 –
29 11 319 19 308 $18
28 12 336 17 324 16
27 13 351 15 339 15
26 14 364 13 355 16
25 15 375 11 373 18
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
STEP 2: Determine profit-maximising quantity and price to answer question 2.
MC=MR is at the output of 13 line rentals per month. Price is equal to $27 at that output. Telstra's profit is the difference between total revenue and total cost: profit = $351-$339=$12 per month.
STEP 3: To answer question 3 make an adjustment in calculation to incorporate the tax impact.
This tax is a fixed cost to Telstra because it is a flat $8, no matter how many line rentals it sells. Since there is no impact on Telstra’s marginal revenue or marginal cost, the profit-maximising level of output has not changed. Telstra will continue to sell 13 line rentals per month at a price of $27, but profits will fall by the amount of the tax from $12 to $4 per month.
LEARNING OBJECTIVE 3
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
We know that equilibrium in a perfectly competitive market results in the greatest amount of economic surplus, or total benefit to society, from the production of a good or service.
However, a monopoly will produce less and charge a higher price than would a perfectly competitive industry producing the same good.
LEARNING OBJECTIVE 4
Does monopoly reduce economic efficiency?
(b) Monopoly
0
(a) Perfect competition
Quantity
Supply
Demand
Pc
Demand
What happens if a perfectly competitive industry becomes a monopoly? Figure 8.4
1. If the industry becomes a monopoly, the supply curve becomes the monopolist’s marginal cost curve.
Qc
Price and
cost per unit
Quantity0 Qc
Pc
If the industry is perfectly competitive, the intersection of the demand and supply curves determines equilibrium price and quantity.
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price and
cost per unit
Pm
Qm
MC
MR
2. The monopolist reduces output to the level where MR = MC, …
3. …and charges a higher price.
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
LEARNING OBJECTIVE 4
The effects of monopoly can be summarised as follows:
1. Monopoly causes a reduction in consumer surplus.
2. Monopoly causes an increase in producer surplus.
3. Monopoly causes a deadweight loss, which represents a reduction in economic efficiency; (allocative inefficiency occurs).
Does monopoly reduce economic efficiency?
The inefficiency of a monopoly: Figure 8.5
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price and cost
Quantity
DemandMR
0
MC
PM
PC
Qc
MCM
Transfer of consumer surplus to monopoly
BA
Qm
C
Deadweight loss from a monopoly
(B + C)
Marginal cost of the
last unit produced by
the monopoly
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Market power and technological change
Market power: The ability of a firm to charge a price greater than marginal cost.
The introduction of new products requires firms to spend funds on research and development. Because firms with market power are more likely to earn economic profits, they are also more likely to introduce new products.
LEARNING OBJECTIVE 4
Does monopoly reduce economic efficiency?
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Collusion: An agreement among firms to charge the same price, or to otherwise not compete.
In Australia, trade practices laws are used to deal with monopolies, collusion and other forms of anti-competitive behaviour.
The laws usually make it illegal for large firms with market power to collude, and firms wishing to merge or take over another firm must apply for permission to do so.
LEARNING OBJECTIVE 5
Government policy toward monopoly
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
In Australia, competitive behaviour is monitored by the Australian Competition and Consumer Commission (ACCC).
The major regulatory law regarding trade practices is the Trade Practices Act 1974. It covers the following key areas:
Anti-competitive agreements, such as price fixing.
Exclusive dealing, such as (i) market sharing arrangements; and (ii) third line forcing.
LEARNING OBJECTIVE 5
Government policy toward monopoly
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Misuse of market power, such as predatory pricing.
Boycotts, such as an agreement between some suppliers and purchasers not to supply to, or purchase from, a particular firm or competitor.
Resale price maintenance.
Unconscionable and misleading conduct, such as deceiving people into signing contracts that they do not understand.
Product safety and reliability.
LEARNING OBJECTIVE 5
Government policy toward monopoly
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Anti-competitive behaviour in the cardboard box industry
Collusion between cardboard box producers raised the prices of many products for consumers.
MAKING THE CONNECTION8.3
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Horizontal merger: A merger between firms in the same industry.
Vertical merger: A merger between firms at different stages of production of a good.
Mergers: The trade-off between market power and efficiency
Sometimes a merged firm is more efficient and has lower costs, and other times it does not.
The ACCC has the task to evaluate each individual case.
LEARNING OBJECTIVE 5
Government policy toward monopoly
A merger that makes consumers better off: Figure 8.6
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price
Quantity
DemandMR0
MC before the merger
PM
PC
Qc
PMergeMerger with efficiency
gains
Qm
Merger with no efficiency
gains
MC after the merger
QMerge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Regulating natural monopolies:
In Australia, state regulatory commissions normally set the prices for natural monopolies.
The question is what the set price should be equal to?
Common options are: Price = Marginal cost
Price = Average total cost.
Two-part pricing.
LEARNING OBJECTIVE 5
Government policy toward monopoly
Regulating a natural monopoly: Figure 8.7
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price and cost
Quantity
Demand
MR
0
MCPM
PR
QR
PE
Monopoly price
Regulated price
Efficient price
ATC
QEQM
Profit
Loss
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
An Inside LookMonopoly in the Pay TV industry: The C7 case
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
An Inside LookFigure 1: A profitable Pay TV company with a monopoly in a local market
Insert Figure 1 from page 245, as large as possible
while retaining clarity
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
An Inside LookFigure 2: An expanded market increases firm profit
Insert Figure 2 from page 245, as large as possible
while retaining clarity
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Collusion
Copyright
Horizontal merger
Market power
Monopoly
Natural monopoly
Network externalities
Patent
Public franchise
Vertical merger
Key Terms
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
The common argument circulated by the Australian media that petrol prices are high because of, among other things, collusion between large petrol distributors.
Do you think this might be the case?
If so, why has the ACCC not taken decisive action to counteract it?
Find the report of the ACCC inquiry into the price of unleaded petrol published 18 December 2007 at:
http://www.accc.gov.au
Get Thinking!
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Price discrimination: Charging different customers different prices for the same product when the price differences are not due to differences in production costs.
APPENDIX
Price discrimination
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
There are three requirements for successful price discrimination:
• A firm must possess a market power.
• The firm must know what different consumers are willing to pay
• The firm must be able to divide (segment) the market for the product.
APPENDIX
Price discrimination
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
APPENDIX
Price discrimination by a cinema
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Airlines: The kings of price discrimination
• Business travellers - more price inelastic
• Holiday travellers - more price elastic
• Economy, business and first class
• Day and time
• Season
Yield management: continually adjusting prices to take into account fluctuations in demand
APPENDIX
Price discrimination
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Perfect price discrimination: This occurs when each consumer has to pay a price equal to the consumer’s maximum willingness to pay (no consumer surplus).
Two key outcomes of price discrimination are:
• Firm profits increase
• Consumer surplus decreases
APPENDIX
Price discrimination
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
APPENDIX
Perfect price discrimination
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q1. In which of the following situations can a firm be considered a monopoly?
a. When a firm is surrounded by other firms that produce close substitutes.
b. When a firm can ignore the actions of all other firms.
c. When a firm uses other firms’ prices in order to price its products.
d. When barriers to entry are eliminated.
Check Your Knowledge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q1. In which of the following situations can a firm be considered a monopoly?
a. When a firm is surrounded by other firms that produce close substitutes.
b. When a firm can ignore the actions of all other firms.
c. When a firm uses other firms’ prices in order to price its products.
d. When barriers to entry are eliminated.
Check Your Knowledge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q2. If cost conditions are such that competition leads to higher costs and higher prices, how should the market in question be characterised?
a. As a perfectly competitive market.
b. As a monopolistically competitive market.
c. As an oligopoly.
d. As a natural monopoly.
Check Your Knowledge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q2. If cost conditions are such that competition leads to higher costs and higher prices, how should the market in question be characterised?
a. As a perfectly competitive market.
b. As a monopolistically competitive market.
c. As an oligopoly.
d. As a natural monopoly.
Check Your Knowledge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q3. Refer to the figure below. How much is the amount of profit when the firm serves six subscribers per month?
a. (42 – 27) x 6
b. (42 – 30) x 6
c. (30 – 27) x 6
d. $42.
Check Your Knowledge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q3. Refer to the figure below. How much is the amount of profit when the firm serves six subscribers per month?
a. (42 – 27) x 6
b. (42 – 30) x 6
c. (30 – 27) x 6
d. $42.
Check Your Knowledge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q4. Refer to the figure below. Which area shows the reduction in consumer surplus from the existence of monopoly?
a. Area A.
b. Area B + C.
c. Area A + B.
d. None of the areas
indicated on the graph.
Check Your Knowledge
Hubbard, Garnett, Lewis and O’Brien: Essentials of Economics © 2010 Pearson Australia
Q4. Refer to the figure below. Which area shows the reduction in consumer surplus from the existence of monopoly?
a. Area A.
b. Area B + C.
c. Area A + B.
d. None of the areas
indicated on the graph.
Check Your Knowledge
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