Page 5 - Microeconomics

MONOPOLY (continued)
MONOPOLY PROFIT PRICE DISCRIMINATION MONOPOLISTIC COMPETITION
MAXIMIZATION CHARGING CONSUMERS DIFFERENT PRICES • CHARACTERISTICS:
• PRODUCTION: The monopolist expands FOR THE SAME PRODUCT. 1. Large number of buyers and sellers
production to Q*, until the revenue from the last • REQUIREMENTS: 2. Imperfect information; price maker
marginal unit (marginal revenue) equals the 1. Seller must be a monopolist or have considerable 3. Low barriers to entry
cost of producing it (marginal cost). monopoly power. 4. Differentiated products (such as different brands
• PRICE: Once a level of production is selected, 2. Sellers must be capable of dividing consumers into or levels of service); costs are higher due to
different classes, each class being charged a different
the demand curve gives the price (P*) that must price (market segmentation). expenditures to differentiate products (such as
advertising)
be charged to persuade consumers to buy what 3. Marginal costs of production for the different classes 5. Very elastic demand curve
is available. must be similar.
6. Short run behavior like a monopolist
• PROFIT: Production will continue in the short 4. Consumers charged a lower price must be incapable • IN THE LONG RUN:
run as long as the price exceeds the average of reselling to consumers in the higher priced class. 1. Competition ensures zero economic (normal)
variable cost. • FOR EACH CLASS OF CONSUMERS, THE profit in the long run. The demand curve will shift
1. If the price exceeds average variable cost MONOPOLIST SHOULD ALLOCATE OUTPUT to the left until P = ATC and economic profits will
(AVC) but is less than average total cost TO THE POINT WHERE the marginal revenues be zero.
(ATC), the monopolist will produce at a loss. from selling to each class are equal to the marginal 2. Price is greater than marginal cost so that the
2. If the price exceeds average total cost, the costs. consumer is willing to pay more than it costs to
monopolist will make a profit. 1. Price discrimination reduces consumer surplus. produce the good; no allocative efficiency.
3. In the long run, the monopolist can earn 2. Perfect price discrimination completely wipes out 3. Monopolistic competition does not operate
positive economic profits, but will shut down consumer surplus. at minimum average cost, so that productive
if it continues suffering losses. efficiency is not achieved either.
$ MC P $
MKT1 MKT2 MC
ATC
P* P
P 2
Profit ATC 1
P*
ATC* D
1 D
2
MR D=AR=P
Q* Production Q O Q
2
$ 1 Price Discrimination MR D Q
ATC 0 Q*
MC
NATURAL MONOPOLY OLIGOPOLY
ATC* • DEFINITION: A natural monopoly arises because • CHARACTERISTICS:
Loss a single firm can supply the market and its long run 1. Few sellers and many buyers
P* average costs (LRAC) are still falling when the limits 2. Close substitutes or differentiated products
of market demand are reached. EX: Public Utilities. 3. Imperfect information; price maker
Unregulated Profit 4. Barriers to entry are strong but not as strong as
$ in a monopoly; economies of scale make entry of
Loss at Socially
MR D=AR=P new firms very costly
P u Optimal Output Q 0 • OLIGOPOLY MODELS:
Q* Production
1. Pure Oligopoly:
MONOPOLY & EFFICIENCY a. Kinked demand curve
• THE MONOPOLIST IS NOT FORCED TO P r LRAC b. Competitors follow price cuts but not price
PRODUCE WHERE UNIT COSTS ARE increases
LOWEST (LACK OF COMPETITION). Thus, P 0 LRMC c. Gives rise to stable prices
productive efficiency may not be achieved. MR AR=D Kinked-Demand Curve
• THE MONOPOLIST PRODUCES WHERE Q Po
THE PRICE IS GREATER THAN THE Q u Q r Q 0 Rival Will Not Follow
MARGINAL COST. Hence, the consumer pays • UNREGULATED NATURAL MONOPOLY will Starting Price Increase
more for an extra unit of production than produce Q U (where MR = LRMC) at P U , making a Price
it costs society. Allocative efficiency is not profit. Rival Follows
achieved. 1. There is no incentive for the monopolist to lower Price Decrease
• MONOPOLISTS PRODUCE LESS AT price and lower costs because of lack of competition. Stable
A HIGHER PRICE THAN WOULD 2. The price will be raised to cover any cost increase. Range Demand
BE PRODUCED UNDER PERFECT 3. There is uncertainty about where the true cost and MR Curve
COMPETITION. Monopoly profit reduces demand curves lie. Starting Q Q
consumer welfare by charging consumers a • SOCIALLY OPTIMAL OUTPUT (Q O ): D = LRMC. 2. Collusion (EX: O.P.E.C.):
higher price. A reduction in production even Here, allocative efficiency is achieved (output is a. Firms collude to behave as a monopolist
further reduces their welfare; a “deadweight” produced up to the point where the cost of an extra unit b. Types of collusion:
loss to society is created. equals the price consumers are willing to pay for the
extra unit). At Q O , the price P O is less than LRAC and i. tacit – hidden
the monopolist realizes a loss. This requires a subsidy ii. overt
at least equal to the loss (which is most likely to occur 3. Price leadership: This oligopoly model is
P
M Deadweight Loss if the government owns the firm). composed of one dominant firm with few smaller
• PRIVATELY OWNED NATURAL MONOPOLIES firms called “fringe” firms. Firms allow one firm
ARE USUALLY REGULATED. The regulation to exercise leadership and the fringe follows.
allows the monopolist to charge P r and produce Q r , 4. Contestable markets: Oligopoly with low
P PC MR PC = where the price equals LRAC. This ensures a “fair” barriers to entry.
D PC = MC return to the monopolist (normal profits). • MEASUREMENTS OF MARKET POWER:
• PARTS OF A NATURAL MONOPOLY CAN BE 1. Four (4) Firm Concentration Ratio: Sum of
MR
M OPENED TO COMPETITION. EX: A monopoly the market shares of the top four firms in the
can be granted to the electric transmission system industry.
D (wires, etc.) even if more than one company can 2. Herfindahl-Hirschman Index: Sum of the squares
Q Q M of the market shares of all firms in an industry.
M PC produce the electricity to be generated.
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