Chapter 10: Monopoly, Cartels, and Price Discrimination Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 10.1A Single-Price Monopolist 1.explain why marginal revenue is less than price for a profit-maximizing monopolist. 2.understand how entry barriers can allow monopolists to maintain positive profits in the long run. 10.2Cartels as Monopolies 3.describe why firms would form a cartel to restrict industry output and how this would increase their profits. 10.3Price Discrimination 4.explain how some firms can increase their profits through price discrimination. Copyright © 2014 Pearson Canada Inc. 2 Chapter 10, Slide

Monopoly a market in which a single firm (the monopolist) is the sole producer protected from new competitors by barriers to entry Barriers to Entry obstacles that make it difficult for new participants to enter a market 10-3 © 2012 McGraw-Hill Ryerson Limited LO1 Monopoly

1.technical barriers such as sole ownership of a resource 2.legal barriers such as public franchise, licences, patents, and copyrights 3.economic barriers caused by economies of scale 10-4 © 2012 McGraw-Hill Ryerson Limited LO1 Barriers to Entry

Self-Test 10-5 © 2012 McGraw-Hill Ryerson Limited Entry into the following industries is very difficult. What type of barrier to entry is involved? a)Computer operating systems b)Commercial aircraft manufacturing c)West coast wild salmon fishing LO1

able to set price rather than having to accept the market-determined price can set either price or quantity sold, but not both since the monopolist is the industry, it faces the market demand for the product demand is a downward-sloping curve must decrease the price in order to sell more 10-6 © 2012 McGraw-Hill Ryerson Limited LO1 Monopoly

10.1A Single-Price Monopolist Revenue Concepts for a Monopolist A monopolist faces a negatively sloped demand curve. If the monopolist charges the same price for all units sold, its total revenue (TR) is: TR = p x Q 7 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Revenue Concepts for a Monopolist Average revenue (AR) is total revenue divided by quantity: AR = TR/Q = (p x Q)/Q = p Marginal revenue (MR) is the revenue resulting from the sale of an additional unit of production: MR =  TR/  Q The monopolist must reduce the price to increase its sales— therefore the MR curve is below the demand curve. 8 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Fig A Monopolist's Average and Marginal Revenue 9 Copyright © 2014 Pearson Canada Inc. Average and Marginal Revenue CurvesComputing Average and Marginal Revenue Chapter 10, Slide

Short-Run Profit Maximization The profit-maximizing level of output is where MC = MR. A profit-maximizing monopolist has p > MC. The size of fixed costs determine whether a monopolist earns positive economic profits. 10 Copyright © 2014 Pearson Canada Inc. Fig Short-Run Profit Maximization for a Monopolist Chapter 10, Slide

Short-Run Profit Maximization Unlike a competitive firm, the monopolist does not have a supply curve because it chooses its price. Can we compare the monopoly outcome to the competitive outcome? In a perfectly competitive industry price equals MC. But a monopolist produces at a lower level of output, with price exceeding MC. 11 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Fig The Inefficiency of Monopoly 12 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Entry Barriers and Long-Run Equilibrium Despite incentives to enter, effective entry barriers allow monopoly profits to persist in the long run. Entry barriers are of two types: "natural" – such as economies of scale "created" – by advertising campaigns, or – by government regulation 13 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Monopolies charge higher prices than perfectly competitive firms. Monopolies produce lower outputs than perfectly competitive firms and these outputs are below economic capacity. Monopolies, unlike perfectly competitive firms, may make economic profits in the short run and in the long run © 2012 McGraw-Hill Ryerson Limited LO4 Perfect Competition v Monopoly

The Very Long Run and Creative Destruction In the very long run, technological changes and innovations can circumvent effective entry barriers. Joseph Schumpeter defended monopoly on the basis that the pursuit of monopoly profits provides incentives to innovate. Schumpeter called the replacement of one monopolist by another through innovation the process of creative destruction. 15 Copyright © 2014 Pearson Canada Inc. APPLYING ECONOMIC CONCEPTS 10-1 Entry Barriers for Irish Pubs During the Booming 1990s Chapter 10, Slide

16 Copyright © 2014 Pearson Canada Inc. Joseph Schumpeter (1882–1950) "What we have to accept is that [monopoly] has come to be the most powerful engine of progress and in particular of the long-run expansion of total output not only in spite of, but to a considerable extent through, this strategy [of creating monopolies], which looks so restrictive when viewed in the individual case and from the individual point of time." Chapter 10, Slide

10.2Cartels as Monopolies Several firms in an industry may form a cartel to maximize joint profits. The Effects of Cartelization Cartelization will reduce output and raise price from the perfectly competitive levels. 17 Copyright © 2014 Pearson Canada Inc. Fig. 10-4The Effect of Cartelizing a Competitive Industry Chapter 10, Slide

Problems that Cartels Face Cartels tend to be unstable because members have an incentive to cheat. 18 Copyright © 2014 Pearson Canada Inc. Fig. 10-5A Cartel Member's Incentive to Cheat Chapter 10, Slide

Problems that Cartels Face Any one firm within the cartel has an incentive to cheat. But if all firms cheat, the price will fall back toward the competitive level, and joint profits will not be maximized. Enforcing output restrictions and preventing entry are difficult. Thus, cartels rarely last for long. 19 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

10.3Price Discrimination A producer practices price discriminates by charging different prices for different units of its product for reasons not associated with differences in cost. Central to this is that different consumers value the product by different amounts. Any firm facing a downward-sloping demand curve can increase profits if it is able to price discriminate. Copyright © 2014 Pearson Canada Inc. 20 Chapter 10, Slide

When Is Price Discrimination Possible? 1.When firms have market power. 2.When consumers differ in their valuations of the product. 3.When firms can prevent arbitrage. 21 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Different Forms of Price Discrimination Price Discrimination Among Units of Output A firm captures consumer surplus by charging different prices for different units sold. "Perfect" price discrimination transfers all consumer surplus to the seller. 22 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Fig Price Discrimination Among Units of Output 23 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

Fig. 10-7A Numerical Example of Profitable Price Discrimination Profit maximization requires that MR be equalized across the two segments.  price is higher in the segment with less elastic demand. 24 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide

The Consequences of Price Discrimination Price discrimination increases firms' profits (otherwise they wouldn't do it!). For price discrimination by the unit, firms will often increase their output and overall efficiency will increase. The effect on consumers is unclear—they may lose consumer surplus, but they could also gain surplus (if output increases as a result). 25 Copyright © 2014 Pearson Canada Inc. Chapter 10, Slide