1. Monopoly, Market Power, and Economies of Scale Today: Introduction of situations in which the Invisible Hand breaks down

2. Up until now… …we have typically analyzed markets with no control over market price Each firm was a price taker, since it only produced a very small fraction of quantity supplied in the market

3. Many sellers vs. one seller Many sellers No control over price One seller, also known as a monopolist Complete control over price (sort of)

4. Sort of? Recall that demand curves are downward-sloping Each time price increases, fewer people are willing to pay the price to purchase the good The monopolist can control price, but must face the consequences that price determines quantity sold

5. MB in a competitive vs. monopolistic environment Competitive environment MB is price, since price does not depend on quantity supplied by an individual firm Monopolistic environment We will see that MB decreases as quantity supplied increases

6. What happens to the monopolist when it sells another unit? Each time another unit is sold, price of the good decreases We will go through a simple example, shown to the right, to determine MR for the monopolist PQ 40 31 22 13 00

7. Marginal revenue How much additional is received by selling one more unit of the good? We must first calculate TR Notice that for Q > 1, MR < P PQTRMR 400 3 313 1 224 133 -3 040

8. Market inefficiencies of monopoly Decreasing marginal revenue creates inefficiencies in the market We will talk about this more in the next lecture

9. And now, onto the big question of the day? How Do Firms Gain Market Power? Exclusive control over important inputs Patents and copyrights Government licenses or franchises Economies of scale  Natural monopoly Networks

10. Exclusive control over important inputs If a company controls a significant portion of the important inputs to a product, it can have significant influence on price

11. Exclusive control over important inputs Example: De Beers Rough diamond explorer Around 40% of world diamond production by value Sales and marketing through the Diamond Trading Company This company sells almost half of the world’s rough diamonds by value (Information from http://en.wikipedia.org/wiki/De_Beers, checked Feb. 3, 2008)

12. De Beers Such large control over the market makes De Beers able to act similarly to a monopolist Marketing of diamond jewelry does not have to be brand specific "A Diamond is Forever" attempts to prevent old jewelry from entering the market De Beers does have some control over world prices

13. Patents and copyrights Patents and copyrights prohibit others from copying private work and discoveries Example: Copying songs and movies that are copyrighted are typically prohibited by law

14. Government licenses or franchises Government owned property often allows exclusive operation of the property for various uses This is to prevent competition that could deteriorate a natural destination

15. Government licenses or franchises Example: Yosemite National Park Limited parking Tasteful hotels Most of the park is undeveloped Most of park development is in only 7 square miles Park is 1,200 square miles Vernal Fall

16. Economies of scale Some technologies are such that as the quantity produced increases, ATC decreases for all reasonable quantities produced This is due to increasing returns to scale This happens when ALL inputs double and production MORE THAN doubles Often happens with large fixed costs and nearly-linear variable costs

17. Example where a single firm could gain market power When a firm gains market control with economies of scale, it is called a natural monopoly There are problems with natural monopolies if left uncontrolled Deal with this later Price ($) Quantity D ATC

18. Network economies What do the following products have in common? Skype Sony IVE Microsoft's MSN Messenger Ojo

19. Network economies They are all trying to become the leader in video calling programs This technology has improved since the PicturePhone was unveiled in 1964

20. Monopoly inefficiency As we will see, monopolies typically produce quantities that are less than efficient This leads to positive economic profits

21. Controlling monopolies Laws have been passed to control monopoly profits Regulation typically tries to set economic profit to be about zero This sometimes makes regulated stocks a relatively safe investment

22. Controlling monopolies Why are monopolies typically regulated? We will analyze this in the next lecture In the absence of regulation, a monopoly will usually produce a quantity that is below the optimal amount in order to make positive economic profits Monopolies can increase efficiency by price discrimination However, the monopolist sometimes benefits more than consumers do