1. Ch. 12: Monopoly  Causes of monopoly  Monopoly pricing and output determination  Performance and efficiency of single-price monopoly and competition  Price discrimination  Regulation of monopoly

2. Market Power Market power –the ability to influence the market price, by influencing the total quantity offered for sale. –greater when there are fewer close substitutes and demand is more inelastic Monopoly –A firm that produces a good or service for which no close substitute exists –One supplier that is protected from competition by a barrier preventing the entry of new firms.

3. Causes of monopoly Legal monopoly –Patents Inventions protected from copying, usually 20 years. –Copyrights Musical and literary works protected from copying. –Public franchise –Zoning –Licensing –Why do we create legal monopolies? Sole Ownership of Key Input Natural Monopoly – Scale economies

4. An example of a natural monopoly Demand and Cost for Electrical Production Figure 1

5. 1. Total cost if one firm produces 3,000 GW would be 1.$100 2.$100,000 3.$300,000 4.$1,200,00

6. 2. Total profit for 1 firm producing 3,000 and selling at $100 per GW would be 1.$0 2.$100 3.$100,000 4.-$100,000

7. 3. Total cost for each of 3 firms producing 1,000 and selling at $100 per GW would be 1.$400 2.$100,000 3.$300,00 4.$400,000

8. 4. Total profit for each of 3 firms producing 1,000 GW and selling at $100 per GW would be: 1.-$300 2.-$300,000 3.$0 4.$100,000

9. What will eventually happen if one large firm produces 3000 and competed with any small firm that produces 1000? 1.The small firm will lose the competition. 2.The large firm will lose the competition. 3.Neither firm can survive 4.Both firms will survive

10. Natural Monopoly Natural monopoly occurs when –there are scale economies – when LATC is dropping below the demand curve –One large firm can produce at a lower cost per unit than many small firms.

11. Monopoly Price-Setting Single-price monopoly –sells each unit of its output for the same price to all its customers. Price discriminating monopoly –Sells different units of a good or service for different prices. –Many firms price discriminate, but not all of them are monopoly firms.

12. A Single-Price Monopoly’s Output and Price Decision  Price and Marginal Revenue A monopoly is a price setter, not a price taker. Demand curve for the monopoly’s output is the market demand curve. TR = P * Q MR = increase in TR from selling one more unit For a single-price monopoly, MR < P

13. A Single-Price Monopoly’s Output and Price Decision PQTRMR 414 326 236 144 060 MR<P MR falls at twice the rate as price. Demand is inelastic when MR is negative Demand is elastic when MR is positive

14. If demand is inelastic, a fall in price brings a decrease in total revenue and marginal revenue is negative.

15. –The firm produces the output at which MR = MC and sets the price to sell that quantity. –Never produce an output at which demand is inelastic (i.e. where MR<0).

16. Figure 2

17. At what price is demand unit elastic? 1.$10 2.$20 3.$25 4.$30

18. At a price of $10, demand is ______ because marginal revenue will be ______ 1.Elastic; positive. 2.Elastic; negative 3.Inelastic; positive 4.Inelastic; negative.

19. The profit maximizing price is _____ and the profit maximizing output is ____. 1.Elastic; positive. 2.Elastic; negative 3.Inelastic; positive 4.Inelastic; negative.

20. The profit maximizing firm will have a profit of 1.$0 2.$200 3.$400 4.$600

21. Single-Price Monopoly vs. Competition

22. –Because marginal revenue is less than price at each output level for a monopoly, Q M < Q C P M > P C. –Compared to perfect competition, monopoly restricts output and charges a higher price. Single-Price Monopoly vs. Competition

23. Compared to perfect competition a.Consumer surplus b.Producer surplus c.Deadweight loss

24. Single-Price Monopoly and Competition Compared Rent Seeking –May reallocate benefits of monopoly –any attempt to capture consumer surplus, producer surplus, or economic profit. –Rent seeking is not confined to monopoly. Forms of rent seeking –Political activities –Auctions of monopoly rights –Licenses

25. Price Discrimination –Price discrimination is the practice of selling different units of a good or service for different prices. –To be able to price discriminate, a monopoly must: Identify and separate different buyer types Sell a product that cannot be resold Price differences that arise from cost differences are not price discrimination.

26. Price Discrimination Examples of price discrimination –Quantity discounts quantity discounts that reflect lower costs at higher volumes are not price discrimination. –Among groups of buyers. Business versus vacation travelers. Senior citizen discounts. –Time of purchase Weekend vs. weekday activities. Day vs. night phone rates.

27. Price Discrimination  Single price monopolist would charge $1200 and sell 8,000 trips to maximize profits.  Price discriminating monopolist would charge different price for each trip to convert consumer surplus into its own revenue.

28. Price Discrimination Perfect price discrimination extracts the entire potential consumer surplus and converts it to economic profit. –Demand curve becomes MR curve.

29. Price Discrimination Output increases to the quantity at which price equals marginal cost Economic profit increases above that earned by a single-price monopoly. Deadweight loss is eliminated

30. Price discrimination and elasticity If a firm has constant MC and markets with different elasticity of demand, where should it charge the higher price? D MR D MC

31. Pepsi has information about customer purchases of products and wants to decide who to send coupons for Pepsi. Based on principles of profit maximization, it should send coupons to the customers who: 1.Have the most price elastic demand 2.Have the least price elastic demand. 3.Purchase the most Pepsi. 4.Purchase the least Pepsi.

32. A gas company sells its products in two cities. It owns the only gas station within 20 miles of Alton. It has one of 6 gas stations in Lemars. Based on this, the price elasticity of demand for gasoline should be greater in _____ and gas prices should be higher in ______. 1.Alton; Alton 2.Alton; Lemars 3.Lemars; Alton 4.Lemars; Lemars

33. Efficiency and Rent Seeking with P Discrim. The more perfectly a monopoly can price discriminate, the closer q gets to the competitive output (P = MC) the more efficient is the outcome (less DW loss) –But this outcome differs from the outcome of perfect competition in two ways: firm captures the entire consumer surplus. increase in economic profit attracts even more rent- seeking activity that leads to an inefficient use of resources.

34. Monopoly Policy Issues Gains from Monopoly –A single-price monopoly creates inefficiency (DWL). –A price discriminating monopoly captures consumer surplus and converts it into producer surplus and economic profit (equity). –The possibility of monopoly profits encourages rent-seeking, which wastes resources. –But monopoly can bring benefits.

35. Monopoly Policy Issues Product innovation –Patents and copyrights provide protection from competition and let the monopoly enjoy the profits stemming from innovation for a longer period of time. Economies of scale and scope –Lower cost with one large producer than many small producers.

36. Regulating Natural Monopoly Different types of regulations: MC pricing - socially efficient - economic losses - subsidies or allow price discrimination? AC pricing –not socially efficient –zero economic profit