monopoly notes

8/12/2019 Monopoly Notes

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MONOPOLY + PRICE DISCRIMINATION

(DISPENSE +Capitoli 1-2-5-10 CABRAL + pp. 65-75 e 79-86 e 133-140 TIROLE)

(Riassunti delle parti dei libri non contenute nelle dispense)

CAPITOLO I CABRAL

Market Powerability to set prices above cost ( specifically above marginal cost)for the Chicago School no

market powerif there is free entry

Creating market power

legal protection from competition through patentsXerox and photocopies

firm strategy (free decoder for cable TVprice war, but the forerunner can maintain an advantage)

Maintaning market power

Predatory prices to keep entrants out of the market

(the opposite) Legal steps against predatory prices of entrants

Implications of Market Power

Transfer from Consumers to Producers

Inefficient Allocation of Resources

Consumers willing to pay more than the marginal cost, but less than the price are not considered

Inefficient Production (Attenzione Cabral dice che i monopoli non sono efficienti, le dispense dicono di

s: Mi sembra che Cabral intenda dynamic efficiency) Rent seeking When a company, organization or individual uses their resources to obtain an economic gain

from others without reciprocating any benefits back to society through wealth creation. Furthermore large

amount of resources are wasted

An example of rent-seeking is when a company lobbies the government for loan subsidies, grants or tariff

protection. These activities don't create any benefit for society, they just redistribute resources from the

taxpayers to the special-interest group

Roles of the government

Regulationprices under a regulators oversight

Antitrust policy (or competition policy) has a broader range of activities

prevent firms from takingactions that increase market power in a detrimental way

Industrial policy opposite: government tries to strengthen the market position of a firm or an

industry (eg: national firms)

Structure-Conduct-Performance Paradigm: starting from the structure (number of buyers and sellers,

product differentiation and examining the conduct of firms (prices, advertising etc.), one tries to estimate

how competitive the market is.


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RICAPITOLAZIONE CONCETTI BASE (CAPITOLO II CABRAL)

Demand curvedirect D(p) , inverse P(d)

Consumers surplusdifference between willingness to pay and price paid for all units

Price elasticiy dq pdp q

Costsaverage, marginal,fixed, variable, total

Competive markets

A perfectly competitive firm's supply curve Si(p)is that portion of its marginal cost curve that liesabove the minimum of the average variable cost curve. A perfectly competitive firm maximizes profit by

producing the quantity of output that equates price and marginal cost. As such, the firm moves along

it's marginal cost curve in response to alternative prices. Because the marginal cost curve is positively

sloped due to the law of diminishing marginal returns, the firm's supply curve is also positively sloped.

The short run market supply curveis given by 1

N

i

i

S p

where N is the fixed number of firms (inthe short run this number is fixed)

Because theequilibrium price level is the same for all firms in the long run, thelong-runmarket supply

curve is generally horizontal. This may change based on whether the industry has economies ordiseconomies of scale.

Costs and expenditures, opportunity costs and sunk costs

Economic costs differ from expenditures, because they include opportunity costs that do not correspond

to actual expenditures and exclude expenditures that correspond to sunk costs

Opportunity costs

Sunk costs

Fixed costs vs. sunk costs

Fixed costsdo not vary with the quantity of output produced. Sunk costsare unrecoverable costs. The two

concepts are independent of each other, but are usually related.

An example of a fixed cost that is not sunk: auto insurance paid monthly. It is fixed in that the amount paid does

not depend on miles driven per month (let's suppose this). But it is not sunk, as the insurance can be canceled any

time.

An example of a sunk cost that is not fixed: money you paid for three rolls of film on a final sale. As you cannot

return the film, the money is sunk. But it is obviously a variable cost.

Sunk costs are costs that have been incurred in the past, and are not relevant to the future, and not relevant to a

future decision. A decision has already been made, in the past, and that specific decision cannot be changed. A

new decision can be made regarding the past decision, but, that is a new decision. Sunk costs cannot be changed.

Sunk costs are never relevant to a future decision.
https://www.boundless.com/economics/definition/equilibrium-price/https://www.boundless.com/economics/definition/long-run/https://www.boundless.com/economics/definition/market/https://www.boundless.com/economics/definition/market/https://www.boundless.com/economics/definition/long-run/https://www.boundless.com/economics/definition/equilibrium-price/


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(CAPITOLO V CABRAL)

REGULATION OF MONOPOLIES

Monopoly with costs C=F+cq absent regulationPM> Pc Loss of efficiencyE

Profit= qM

(PM

-c)F =-F

If the regulation sets the price at c (compettiitive market price) the firm has a negative profit-F

If the regulator gives the firm a subsidy equal to F, it can do this only by increasing taxes elsewhere in

the economy and this can give rise to an inefficiency E >E. The discretion of the regulator to give

funds to the firmregulatory capture (expenses of the firm to capture the regulators

benevolence corruption) If the price is set equal to the average cost (average-cost-pricing ) the overall profit is zero (or in the

US rate-of-return regulationthe price is set so as to guarantee a fair return)

Natural monopolies for networks (Telefoni, elettricit, gas,etc)

One company has the network (upstream monopoly) and provides services (downstream

competition). The upstreammonopoly can try to exploit its position to avoid the entrance of new

firms

The firm has no incentive to reduce costs.

Low incentives even if there is an interval between

cost reduction and price settingprice cap for a

period long enoughhow long? typically 5 or 10

years


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Upstream monopolies can not carry out downstream activitiesBUT vertical integration

can increase efficiency

Efficient component pricing rule New entrants must be at least as efficient as the

vertically integrated company. Fix the fee afor using the network

Suppose the marginal cost for the integrated firm isc and the marginal cost of the entrant isCE.pis the price

The new entrant has a positive return only if p-a- CE>0

If a=p-c then p-a- CE= c - CE>0 entrant is more efficient than the integrated firm


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CABRAL Capitolo 10 + Tirole 133-140

PRICE DISCRIMINATION

First degree price discrimination

Trade-off between efficiency 1) and consumers welfare 2)

Trade-off between fairness 3) and making the good accessible to as many users as possible 4)

BUT

there cases in which total efficiency decreasesas a result of price discrimination ( price

discrimination costly)

there are cases in which the Pareto frontier is improved (bothfirm and consumers are better off)

First degree price discrimination is very difficult and rare (doctor in a small town knows how much each

customer can pay, airplanes are sold at different prices to different airlines (Boeing knows exactly how

much each is willing to pay)

2ndand 3rddegree price discrimination

Sellers can price-discriminate either based on observable buyer characteristics (3rddegree) or

by inducing buyers to self-select among different product offerings (2nd

degree)

3rddegree price discrimination

Let 1 2 , ., . , mp p p be theprices at m discriminated markets and

1 1 2 2 ,..,, m mD p D p D p the corresponding demand curves and 1

m

i i

i

q D p

the aggregate demand piis chosen so as to maximise

If only one price

Consumers surplus B Firms profit A Total SurplusA+B

If the firm could sell the good at different prices corresponding to each

consumers willingness to pay FIRST DEGREE DISCRIMINATION , it would

produce q=qDand would collect the whole surplus A+B+C

Differences:

1) Welfare increase (A+B+C)-(A+B)=C>0

2) Consumers are worse off from B0

3) Different consumers pay different prices

4) More consumers are served (willing to pay less than pM but more than c


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1 1 1

m m m

i i i i i i i i

i i i

p D p C q p D p C D p

1i

i i

dCp

dq

p

Welfare in case of 3rd

degree price discrimination

Consumers in high elasticity markets prefer discrimination, in low elasticity markets prefer a

uniform price

Let , , , ,i i i i i ip q S p p q S p be the prices, outputs and consumers surplus under

discrimination and price uniformity respectively. i i iq q q The welfare difference (discrimination-uniformity) is given by

1 1 1 1,

m m m m

i i i i i ii i i iW W S p p c q S p p c q

(*)

W is convex with respect to price(per quanto riguarda la parte con S(p)

S(p)=-D(p)S(p)=-D(p)>0 )

Se una funzione convessa '( ) ( ) ( )i i i i iS p S p S p p p and '( ) ( ) ( )i i i i i iS p S p S p p p

e poich 'i iS p D p dallequazione (*) seguono i due limiti superiori e inferiori

1

m

i i

i

W W p c q

and 1

m

i

i

W W p c q

Price discrimination reduces the welfare if1

m

i

i

q

(differenza di output complessivo) is zero (or

negative). If the price discrimination does not increase the output, it reduces the welfare.

Example:linear demand curves all markets are servedi i i i iq a b p a cb

Under discrimination the monopolist maximises

i i i ip c a b p / 2i i i ip a cb b / 2i i iq a cb

/ 2i i i

i i i

q a c b

If forced to set a uniform price the monopolist maximises

i ii i

p c a b p

/ 2i i ii i i

p a c b b

/ 2i i i

i i i

q a c b p

e quindi ii

q = ii

q cio non c un aumento di outputc una diminuzione di welfare


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2nd degree discrimination

Two-part tariff (da Wikipedia)

the price of a product or service is composed of two parts - a lump-sum fee as well as a per-unit charge(ATTENZIONE: su alcuni testi definita first degree (perch nel caso pi sempliceannulla il deadweight loss e

recupera tutto il consumers supply, su altri definita second degree, because it does not depend on the identity of

the buyer, but only on the quantity purchasedprevale questa seconda definizione)

The unit charge is above or equal to the marginal cost of production, and below or equal to the price the firm

would charge in a perfect monopoly F+cq

The price charged varies not due to different costs borne by the firm.credit cards which charge an annual

fee plus a per-transaction fee is a good example of a two-part tariff, a fixed fee charged by a car rental

company in addition to a per-kilometre fuel fee is not so good, because the fixed fee may reflect fixed costssuch as registration and insurance which the firm must recoup in this manner. This can make the

identification of two-part tariffs difficult.

The variable price c is set to pc(competitive price) =marginal cost so that the

maximum amount of q still profitable for the firm is sold. Output equal to

competitive market output.

The fixed cost is equal to A+B+C (deadweight loss + consumers surplus).

Setting F=A+B+C forces the consumer to buy qc. Suppose he buys a

reduced quantity qrthe price paid (A+B+C)+cqr would be greater than his

willingness(A+B+C)+cqr , because C>C

Single consumers demand

curve (willingness to pay)


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If there are n consumers with the same willingness to pay the firms strategy does not change. CS(n)=n*CS(1)

However, it is possible for the firm to earn even greater profits. Assume it sets the unit price equal to Pm, and

imposes a lump-sum fee equal to area A. Both consumers again remain in the market, except now the firm is

making a profit on each unit sold - total market profit from the sale of Qm units at price Pm is equal to area

CDE. Profit from the lump-sum fee is 2 x A = AB. Total profit is therefore area ABCDE.

Thus, by charging a higher per unit price and a lower lump-sum fee, the firm has generated area E more profit

than if it had charged a lower per-unit price and a higher lump-sum fee. Note that the firm is no longer producing

the allocatively efficient output, and there is a deadweight loss experienced by society equal to area F - this is a

result of the exercise of monopoly power.

Consumer X is left with no consumer surplus, while Consumer Y is left with area B.

Bundling

Bundling is packaging two or more products to gain a pricing advantage

Conditions necessary for bundling

Heterogeneous customers

Price discrimination is not possible

Demands must be negatively correlated

Examplefilm company leased Blockbuster, it required theaters to alsolease Failure

Blockbuster Failure

TheaterA $12,000 $3,000

Theater B $10,000 $4,000

Renting the movies separately would result in each theater paying the lowest reservation price for each

movie:

Maximum price Wind = $10,000

Maximum price Gertie = $3,000

Total Revenue = $26,000

If the movies are bundled:

Theater A will pay $15,000 for both

Theater B will pay $14,000 for both

If each were charged the lower of the two prices, total revenue will be $28,000

The movie company will gain more revenue ($2000) by bundling the movie

If the demand curve (willingness to pay) is different, the price structure

is different: EXAMPLE Y demand curve is twice X demand curve.

The firm cannot identify each consumer (2nddegree)

The firm would like to follow the same logic as before and charge a per-

unit price of Pc while imposing a lump sum fee equal to area ABCD - the

largest consumer surplus of the two consumers. In so doing, however,

the firm will be pricing consumer X out of the market, because the

lump-sum fee far exceeds his own consumer surplus of area AC.

Nevertheless, this would still yield profit equal ABCD from consumer Y.

A solution to pricing consumer X out of the market is toinstead charge alump-sum fee equal to area AC, and continue to charge Pc per unit.

Profit in this instance equals twice the area AC (two consumers):2 xAC. As it turns out, since consumer Y's demand is twice consumer X's,

ABCD = 2 x AC. The profit is the same and the producer is indifferent to

either of these pricing possibilities, although consumer Y is better off

this way since she gets consumer surplus BD.


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More profitable to bundle because relative valuation of two films are reversed

Demands are negatively correlated

A pays more for Blockbuster ($12,000) than B ($10,000)

B pays more for Failure ($4,000) than A ($3,000)

If the demands were positively correlated (Theater A would pay more for both films as shown) bundling

would not result in an increase in revenue, for instance

Blockbuster Failure

TheaterA $12,000 $4,000

Theater B $10,000 $3,000

If the movies are bundled:

Theater A will pay $16,000 for both

Theater B will pay $13,000 for both

If each were charged the lower of the two prices, total revenue will be $26,000, the same as by selling the

films separately

Versioning Second degree quality discrimination

Examples:

1st class/2nd class train tickets

Business class/economy class airfares

Hardcover/paperback books

Damaged goods

Principles

Offer versions tailored to the needs of different customersAccentuate the differences between the versions

Dimensions to Exploit

- Delay [book publishers, post services, stock quotes]

- User interface [Dialogweb, DataStar]

- Image resolution [Photodisk]

- Speed of operation [Mathematica]

- Capability [Kurzweil]

- Features and functions [Quicken]

- Customer support

It can occasionally reduce the overall welfare


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Intertemporal discrimination

A simple two period model due to Bulow (J. Political Economy, 1982):

- t = 1, 2.

- Good bought in period 1 lasts for two periods with no depreciation.- After period 2, it becomes obsolete.

- Assume production cost = 0.

- Monopolist and consumers have the discount factor 1/ (1 )r

- Demand for use of the good each period D(p)=1-p

Leasing

No link between periods.

Monopolist setspt so as

max (1 )t

t t

p

p p 1 2 1/ 2p p

The total discounted sum of profits is (1 )l 1 1 1

4 4 4

Selling with pre-commitment to not lower price in period 2:

Consumers who buy do so in period 1.

If quantity q is sold then the marginal consumer is one whose per period use value is (1 q) and so

the price charged must be:

p = (1+)(1 q)

The monopolist solves

max q(1 + )(1 q)

q

which yields, q1= 1/2 , p1= (1+)/2 and the total discounted sum of profits is (1 )1

4

Same market outcome as leasing.

Selling with no pre-commitment

If q1( 1) is the quantity of goods sold by the monopolist in period 1 and q2is the quantity of new goods

sold in period 2, then the price in period 2 must satisfy:

p2= 1(q1+ q2):


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So, for any q1, in period 2, the monopolist will set q2to maximize

[1 (q1+ q2)] q2

which yields: q2(q1) = (1 q1)/2= p2 and the profit in period 2 2 1 12( ) ( )1

1q q

4

Now, we go to period 1.

If monopolist sells q1 in period 1, then the marginal consumer (the lowest valuation consumer that buys) is

the one with utilization valuation equal to (1 q1).

The highest price at which he can sell q1 is a price p1(q1) such that this marginal consumer is indifferent

between buying the good in period 1 (and enjoying it for two periods) or waiting to buy it in period 2 at a

price p2(q1) and using it for one period:

(1 q1)(1 + ) p1(q1) = [(1 q1) p2(q1)] = (1 q1)/2

so that 1 1 1 1 12

( ) ( ) ( )p q q

The intertemporal discounted sum of profits by selling q1in period 1:

q1 p1(q1) + 2(q1)

and maximizing this yield

The total discounted sum of profits:

22

(1 )44

which is strictly less than (1 )1

4 , the total discounted sum of profits when the monopolist leases or sells

with pre-commitment to not lower prices.

Discounted Price

value of paid in

use in 2 period 1

periods

Discounted value

of use in period 2

only minus price

paid in period 2


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Durable goods, Coase conjecture and evading the Coase problem(a form of price discrimination)

Formal version of the Coase Conjecture:

Infinitely lived monopolist with unit cost of production c 0.

Assume there is a continuum of infinitely lived consumers with unit demand whose

valuation of the durable good (the infinite horizon discounted sum of use value) is

distributed on [c, )

Prices revised at points of time of interval > 0.

Discount factor: = er where r is the interest rate.

Conjecture:As 0, the intertemporal (discounted sum of) profit of the monopolist 0and all prices converge to c. In the limit, almost all trades take place at the initial instant.

Main arguments:

Continuum of consumers implies consumers are price taking.

They decide according to their expectation of future prices which they take as given.

Rational expectations equilibrium:

consumers anticipate the price path to be chosen by monopolist, take this as given

and buy accordingly;

given this buying behavior, there should no incentive for the monopolist to deviatefrom the price path at any point.

Incentive to wait is lower for higher valuation consumers.

For example, for a consumer whose infinite horizon value of using the good is v the gain

from buying today rather than tomorrow:

(v pt) (v pt+1) = (1)v pt+ pt+1 is increasing in v.

If consumer with a certain valuation buys today, all consumers with higher valuation must

have bought by the end of today.

For any fixed > 0, equilibrium price path is nonincreasing over time.

If price increases tomorrow, no one will buy tomorrow.

As becomes extremely small, buyers will wait even if the price declines very slightly and so

the price decline must be extremely small if you want some consumers to buy today rather

than wait.

As 0, if current p >> c, then people anticipate price decline in very near future and wait.

So p c.


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Mitigating factors of Coase conjecture:

- Leasing (see above)

- Pre-commitment (see above)

Make your commitment well known, thus putting your reputation on the line. Make a monetary contract with someone to increase the benefit of staying on course.

Software programs that block internet access for a predetermined period of time

Limited number of items with destruction of moulds (paintings, sculptures, etc.)

- Asymmetric Information: buyers may not know MC of seller.Low cost seller can pretend to be a high cost seller, charge a price equal to MC of high cost seller

and earn positive profit that is bounded away from zero (even if interval between price revisions are

close to zero).

- Inflow of new cohorts of buyersThe stock of consumers waiting to buy are on the average of lower valuation than new cohort.

Monopolist has incentive to not lower price too much and sell to higher valuation new consumers,

until the stock of old lower valuation consumers become large and at that point to have a big sale

which, in turn, reduces the stock of consumers sharply and then return to high prices again.

Price cycles.

- Planned Obsolescence:Reducing durability reduces the quantity of goods carried over and thus convinces buyers that the

price wont falltoo much.

Textbook producers frequently bring out new editions to kill used books.

- Money back guarantee- compensate consumers for all future price declines.Effectively, monopolist pre-commits to not cut price.Problems in enforcement (secret price cuts, quality improvement etc).


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monopoly notes

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