Chapter 8. Monopoly How? Firm behavior Monopoly vs. Competition Price Discrimination Policy How? Firm behavior Monopoly vs. Competition Price Discrimination Policy

What makes a monopoly? single supplier of good  firm supply = market supply  firm demand = market demand single supplier of good  firm supply = market supply  firm demand = market demand

How does it happen? 1. no close substitutes otherwise, makers of substitutes are competition example: electricity 1. no close substitutes otherwise, makers of substitutes are competition example: electricity

2. barriers to entry hard (impossible) for new competitors to enter market barriers are  natural  legal hard (impossible) for new competitors to enter market barriers are  natural  legal

natural monopoly high fixed costs large economies of scale one firm meets market demand, with lowest cost high fixed costs large economies of scale one firm meets market demand, with lowest cost

examplesexamples distribution of  water  electricity  natural gas distribution of  water  electricity  natural gas

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

examplesexamples DeBeers & diamonds Bayer & Cipro Microsoft & Powerpoint DeBeers & diamonds Bayer & Cipro Microsoft & Powerpoint

monopolist & prices power to set prices  price maker charge single price to everyone set prices for different groups/units  price discrimination power to set prices  price maker charge single price to everyone set prices for different groups/units  price discrimination

Monopoly behavior single price case same rule:  choose Q where MR = MC BUT different outcome single price case same rule:  choose Q where MR = MC BUT different outcome

P & MR for monopoly,  MR < P why?  increase Q -- additional revenue -- but at lower P (demand slopes down) for monopoly,  MR < P why?  increase Q -- additional revenue -- but at lower P (demand slopes down)

P Q D $7 $6 5 6 TR = $7 x 5 = $35 TR = $6 x 6 = $36 MR = $1 from 5 to 6

MR & D P, MR Q D MR

profit maximizing choose Q where MR = MC charge highest P possible  using demand curve profit = (P - ATC)(Q) choose Q where MR = MC charge highest P possible  using demand curve profit = (P - ATC)(Q)

P, MR Q D MR MC Q* P*

P, MR Q D MR MC Q* P* ATC economic profit

13.3 Monopoly vs. Competition monopoly  smaller output  higher price monopoly  smaller output  higher price

P, MR Q D MR MC Qm Pm Pc Qc Pm > Pc Qm < Qc

Is monopoly efficient? No output too low  Marginal benefit > MC  deadweight loss No output too low  Marginal benefit > MC  deadweight loss

P, MR Q D S=MCcompetitioncompetition Pc Qc consumer surplus producer surplus

monopolymonopoly P, MR Q D MR MC Qm Pm consumer surplus producer surplus deadweight loss

Price Discrimination charge each buyer higher price possible  convert consumer surplus to economic profit must  identify & separate buyers  prevent reselling charge each buyer higher price possible  convert consumer surplus to economic profit must  identify & separate buyers  prevent reselling

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

example: airlines separate business, tourist travelers  businesses have less elastic demand, will pay more last minute, refundable tickets have higher price separate business, tourist travelers  businesses have less elastic demand, will pay more last minute, refundable tickets have higher price

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

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 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

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 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

Monopoly & policy some monopolies are regulated  Niagara Mohawk some are illegal  AT&T (split in 1982)  Microsoft? some are created  drug patents some monopolies are regulated  Niagara Mohawk some are illegal  AT&T (split in 1982)  Microsoft? some are created  drug patents

why allow monopolies? inefficient  deadweight loss but there are gains  economies of scale -- natural monopolies -- utilities inefficient  deadweight loss but there are gains  economies of scale -- natural monopolies -- utilities

innovation  drug patents reward research  copyrights reward creativity innovation  drug patents reward research  copyrights reward creativity

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 unique good, barrier to entry choose Q where MR = MC  but MR < P Qm lower, Pm higher than competition  inefficient may use price discrimination