CHAPTER 11: MONOPOLY MORE ON FIRM STRUCTURE

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CHAPTER 11 MONOPOLYMORE ON FIRM STRUCTURE
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STUDY OBJECTIVES

• IDENTIFY ASSUMPTIONS UNDERLYING MONOPOLY
  THEORY OR STRUCTURE
• DETERMINE BOTH FIRM AND MARKET EQUILIBRIUMS
• EXAM. AFFECTS OF CHANGES IN SUPPLY AND
  DEMAND
• EXAM. PRICE DISCRIMINATION MODELS AND AFFECTS

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MONOPOLY

• ITS STRUCTURE IS COMPLETELY OPPOSITE TO
  STRUCTURE FOR P.C.
• OUTCOMES ARE VERY DIFFERENT

MANY FIRMS
ONE
FIRM HOMOGENOUS PRODUCT/ SERVICE
HETEROGENEOUS FREEDOM
OF ENTRY EXIT
BARRIERS
RELEVANT INFORMATION
LACK OF INFO
FARMS SMALL COMPT. STORES
T.V. CABLE CO.
PU R E MONOPOLISTIC
OLIGOPOLY MONOPOLY COMPETITION
COMPETITION
-------I M P E R F E C T C O M P E T I T I O N
- - - - - -
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Short-Run Equilibrium Conditions (and Abbreviated
Models) for the Firm
Imperfect Competition
Perfect Competition
Pure Competition
Monopolistic Competition
Oligopoly
Monopoly
ATUC
ATUC
ATUC
P
P
P
P
P
ATUC
ATUC
Q
Q
Q
Q
Q
(1) Freedom from external control (2)
Free entry exit (3) Many buyers and
sellers (4) No one seller affects
price (5) No product differ-
entiation (6) Perfect rationality
(Economic Man) (7) Perfect mobility (8)
Perfect information
(1) Freedom from external control (2)
Free entry exit (3) Many buy and
sell (4) No one seller affects
price (5) No product differentiation
(1) Freedom from external control (2)
Free entry exit (3) Many buy and
sell (4) Individual seller affects
price (5) Differentiation possible
(1) Watchful control (2) Difficult entry
exit (3) FEW buy or sell (4) Price
affected (5) Differentiation possible
(1) Severe control (2) Entry precluded (3)
ONE buy or sell (4) Price affected (5)
Product one-of -a-kind
THESE FIRMS ARE POWERLESS
THESE FIRMS ARE POWERFULL
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MONOPOLY STRUCTURE

• 1. ONE SELLER AND MANY BUYERS
• 2. HETEROGENOUS GOOD
• 3. BARRIERS TO ENTRY
• 4. INCOMPLETE INFORMATION

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BARRIERS TO ENTRY

• LEGAL BARRIERS
• FRANCHISES, PATENTS, GOVERNMENT LICENSES
  CREATE BARRIERS
• 1. A PUBLIC FRANCHISE -- GOVERNMENT
  PROVIDES RIGHT TO FIRM TO PROVIDE GOOD OR
  SERVICE EXCLUDES OTHER FIRMS

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PUBLIC FRANCHISE

• EXAMPLES
• U.S. POSTAL SERVICE
• RADIO T.V. STATIONS
• MEDICAL PROFESSION
• ALL HAVE GOVERNMENT SANCTION WHICH
  ELIMINATES COMPETITION

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ENTRY BARRIERS CONT

• 1. PUBLIC FRANCHISES
• 2. PATENTS - A DOCUMENT GRANTING
  MONOPOLY RIGHTS TO USE, SELL, PRODUCE
  GOODS OR SERVICES THAT WERE CREATED BY AN
  INVENTION OR IDEA
• GENERATES ECONOMIC PROFITS INCENTIVE
  FACTOR TO TAKE RISK
• 17 YEARS

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ENTRY BARRIERS CONT

• 1. PUBLIC FRANCHISES, 2. PATENTS
• 3. REGULATED MONOPOLY - A RIGHT PROVIDED
  TO A FIRM TO BE THE SOLE PRODUCER OF A
  GOOD OR SERVICE BECAUSE OF ECONOMIES OF
  SCALE
• PUBLIC UTILITIES
• ELECTRIC, TELEPHONE, T.V. CABLE,
• TECH. BREAKS DOWN

LRAC
O U T P U T
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ENTRY BARRIERS CONT

• 1. PUBLIC FRANCHISES, 2. PATENTS,
• 3. REGULATED MONOPOLIES
• 4. CONTROL RESOURCES - FIRM OWNS ALL
  RIGHTS TO RESOURCES TO MAKE PRODUCT OR
  SERVICE
• ALUMINUM COMPANY OF AMERICA
• DEBEERS COMPANY OF SOUTH AFRICA WHICH
  CONTROLS DIAMONDS

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ENTRY BARRIERS CONT

• 1. PUBLIC FRANCHISES, 2. PATENTS,
• 3. REGULATED MONOPOLY,
• 4. CONTROL RESOURCES
• 5. PRODUCT DIFFERENATION -- PRODUCTION OF
  HETEROGENEOUS PRODUCT OR SERVICE
• IN MONOPOLY, ONLY ONE TYPE OF GOOD
  OR SERVICE
• NOT TRUE FOR OTHER MARKET STRUCTURES

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MONOPOLIST PRICE SEARCHER

• BECAUSE OF MARKET STRUCTURE, MONOPOLIST IS
  PRICE SEARCHER
• PRICE SEARCHER -- A SELLER HAS SOME
  ABILITY TO CONTROL OR SET PRICES --
  DEFINITION OF IMPERFECT COMPETITION
• IN CONTRAST, THE STRUCTURE FOR THE P.C.
  FIRM CAUSED THESE FIRMS TO BE PRICE TAKERS

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PRICE TAKERS VS. PRICE SEARCHERS

• DEMAND OR A.R. M. R. CURVES
• P.C. CAN SELL ALL IT WANTS AT PRICE
• I.C. (MONOPOLIST) MUST SELL MORE AT A LOWER
  PRICE

P
DEMAND, A.R. M.R.
DEMAND OR A.R.
M.R.
Q for MONOPOLIST (I.C.)
Q for P.C.
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PRICE TAKER VS. PRICE SEARCHER

• P.T. (P.C. STRUCTURE) A.R. M.R.
• P. S. (MONOPOLISTS) A.R. gt M.R.
• MUST SELL MORE AT A LOWER PRICE

T.R. IF OUTPUT OR PRICE 0
O P A.R. M.R. T.R. 1 10 10
10 10 2 9 9 8
18 3 8 8 6 24 4
7 7 4 28 5 6 6
2 30 6 5 5 -5
25

T.R.
30 MAX T.R.
M.R. A.R.
Q
OUTPUT
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M.R. ELASTICITY

• INELASTIC DEMAND - Ed lt 1 OR 1 DECREASE
  IN PRICE IS MATCHED BY LESS THAN 1 INCREASE
  IN QUANTITY, T.R. DECLINES (M.R. IS
  NEGATIVE)
• P 2.00 Q 10 T.R. 20 M.R. 20
• P1 1.00 Q 15 T.R. 15 M.R. -5
• ELASTIC DEMAND - Ed gt 1 OR 1 DECREASE IN
  PRICE IS OFFSET BY MORE THAN 1 INCREASE IN
  QUANTITY, T.R. INCREASES (M.R. IS
  POSITIVE)

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M.R. AND ELASTICITY

• UNIT ELASTICITY -- Ed 1.0 OR A 1 DECREASE
  IN P IS MATCHED BY A 1 INCREASE IN QUANTITY
  , T.R. IS CONSTANT AND (M.R. (0) ZERO)
• WORK EXAMPLES FOR ELASTIC UNIT BY CHANGING
  Q. FROM PRIOR SLIDE

ELASTIC
UNIT
INELASTIC
T.R.
UNIT E.
INELASTIC
M.R.

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MAX. PROFIT OR MIN. LOSSES FOR MONOPOLY

• MAX. PROFIT BY MAKING MC MR
• IN S.R., BEHAVIOR OF FIRM AND ITS SUPPLY
  CURVE INFLUENCE BY PRODUCTION FUNCTIONS
  LAW OF DIMINISHING RETURNS
• BY MANAGING MC CURVE (FIRM SUPPLY CURVE)
  CAN INFLUENCE MARKET PRICE PAID BY BUYER

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THREE OUTCOMES FOR MONOPOLIST

• NORMAL P. ECONOMIC LOSSES
• PROFIT

MC MC
AC
AC
MC A.C AR MR
AVC
E.P.
P
NP TP
MR AR MR
AR
0
0 0
Q
Q
Q
Q U A N T I T Y
LOSS
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SHUTDOWN CASE FOR MONOPOLY

• MONOPOLY WILL SHUT DOWN IF AR IS NOT AT
  LEAST AVC OR IS AT LEAST PAYING SOME
  AFC AND ALL AVC

mc atc avc
C D E
TR OQEP TVC 0QDB TC OQCA SHUT DOWN SINCE
TR lt TVC, or AR lt AVC
A B P 0
Q
E
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MONOPOLY SOCIAL LOSSES

• OPTIMUM CONDITIONS IN P.C. STRUCTURE
• P AR MR ATC MC EARNING NORMAL PROFITS
  OPT. OUTPUT
• NON OPTIMUM CONDITION FOR MONOP.
• P AR gt MR MC P AR gt ATC THUS ECONOMIC
  PROFITS EARNS , SMALLER QUANTITY THEN OPT.
  PRODUCED, ATC NOT AT MIN.

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MONOPOLY SOCIAL LOSSES

• GRAPHIC

MC
MC ATC

ATC
P 0
0
AR MR D
P P
LOWEST POINT ON ATC
LOWEST POINT ON ATC CURVE
MR AR
Q
Q Q1
PURE COMP.
MONOPOLY MONOPOLY, ATC gt at Q gt ATC at Q1
, OUTPUT REDUCED BY QQ1, PRICE INCREASED FROM
P to P.
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MONOPOLY SOCIAL LOSSES

• WELFARE COST AND RENT SEEKING AS SOCIAL COSTS
  OF MONOPOLY

P R I C E
W E L F A R E C O S T T R I A N G L E
Pm
C A
M C A T C
Pc
B
M R A R or D
0 Q Q
Q U A N T I T Y
M O N O P O L Y P R O F I T
VALUE TO BUYERS TO INCREASE OUTPUT
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MONOPOLY SOCIAL LOSSES

• BECAUSE OF COMPETITION, GROUPS OR
  INDIVIDUALS WILL ATTEMPT TO CAPTURE MONOPOLY
  PROFITS FROM MONOPOLISTS -- RESOURCES ARE
  USED TO CAPTURE RENTS FOR EITHER THE
  EXISTING MONOPOLISTS OR FOR THOSE DESIRING
  TO BE THE MONOPOLISTS NOT TO PRODUCE
  GOODS -
• SOCIAL WASTE -- MON. PROFITS MIS-USE OF
  RESOURCES

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PRICE DISCRIMINATION

• PRICE DISCRIMINATION IS A PRACTICE WHERE THE
  SELLER CHARGES DIFFERENT PRICES FOR GOODS AND
  PRICE DIFFERENCE DOES NOT REFLECT COST
  DIFFERENCE
• THREE LEVELS OF PRICE DISCRIMINATION
• PERFECT OR FIRST DEGREE
• SECOND DEGREE
• THIRD DEGREE

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FIRST DEGREE PRICE DISCRIMINATION

• FIRST DEGREE - OCCURS WHEN SELLER CHARGES
  THE HIGHEST PRICE EACH CONSUMER WILL PAY
  FOR GOOD RATHER THAN GO WITH OUT (CAPTURES
  ALL SURPLUS)

CHARGES P1 FOR Q1 (FIRST UNIT) AND P2 FOR
Q2 (SECOND UNIT) ETC.
P1 P2 0 Q1 Q2
BUYER SUR.
P
SELLER SUR
Q
PURE COMP.
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SECOND DEGREE PRICE DISCRIMINATION

• SECOND DEGREE- SELLER CHARGES A HIGHER PRICE
  FOR ONE SET OF QUANTITY, A LOWER PRICE
  FOR THE NEXT SET OF QUANTITY, ETC
• FIRST 10 UNITS FOR 10
• SECOND 10 FOR 8
• DOES NOT CAPTURE ALL SURPLUS

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THIRD DEGREE PRICE DISCRIMINATION

• SELLER CHARGES DIFFERENT PRICES IN DIFFERENT
  MARKETS OR CHARGES A DIFFERENT SEGMENT OF
  THE BUYING POPULATION DIFFERENT PRICES
• DUE TO DIFFERENT ELASTICITIES OF DEMAND
  - LOWER PRICE FOR MORE ELASTIC HIGHER
  PRICE FOR MORE INELASTIC
• UTILITY COMPANIES

A
Pi Pe 0 Qi Qe
B
T R
0QIAPI 0QeBPe
Di De
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CONDITIONS FOR PRICE DISCRIMINATION

• 1. SELLER MUST HAVE SOME CONTROL
  OVER PRICE - OPERATING IN IMPERFECT
  COMPETITION
• 2. SELLER MUST BE ABLE TO DISTINGUISH
  AMONG CUSTOMERS WHO ARE WILLING TO PAY
  DIFFERENT PRICES - IN SOME CASES
  DIFFERENT ELASTICITY OF DEMAND AMONG BUYERS
• 3. PREVENT RESALE OR ARBITRAGE

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ARBITRAGE

• BUYING A GOOD IN ONE MARKET AT A LOW PRICE
  AND SELLING GOOD IN SECOND AT HIGHER
• IN COMPETITIVE MARKETS, ARBITRAGE IS USED TO
  MAINTAIN PRICE EQUILIBRIUM ACROSS SPACE AND
  TIME