9 Monopoly SLIDES CREATED BY ERIC CHIANG CHAPTER 9 SLIDE 1 Ikon Images / Getty Images CHAPTER 9 SLIDE 1

CHAPTER OBJECTIVES Describe the characteristics of a monopoly and market power. Describe the ways in which firms maximize market power using barriers to entry. Use monopoly market analysis to determine the equilibrium level of output and price for a monopoly. Describe the differences between monopoly and competition.  CHAPTER 9 SLIDE 2

CHAPTER OBJECTIVES Describe the different forms of price discrimination. Describe the different approaches to regulating a natural monopoly. Relate the history and purpose of antitrust legislation to monopoly analysis. Apply concentration ratios and the Herfindahl-Hirschman index to analyze the likelihood of regulation in a given market. Describe the conditions of a contestable market and its significance. CHAPTER 9 SLIDE 3

OKSANA DUBOSHINA | DREAMSTIME.COM MARKET POWER CHAPTER 9 SLIDE 4

Characteristics of monopoly include: MONOPOLY MARKETS Characteristics of monopoly include: one firm. no close substitutes for product. significant barriers to entry. potential long-run economic profit. substantial market power and control over price (monopolists are price makers). CHAPTER 9 SLIDE 5

Y R T N E BARRIERS TO SOURCES OF MARKET POWER CHAPTER 9 SLIDE 6 JEZPER | DREAMSTIME.COM Y R T N E SOURCES OF MARKET POWER CHAPTER 9 SLIDE 6

 CONTROL OF A KEY INPUT OF PRODUCTION CHAPTER 9 SLIDE 7 Charles Rex Arbogast / AP Images  CONTROL OF A KEY INPUT OF PRODUCTION CHAPTER 9 SLIDE 7

 ECONOMIES OF SCALE: LARGE FIXED COSTS CHAPTER 9 SLIDE 8 MOOD/BOARD/CORBIS  ECONOMIES OF SCALE: LARGE FIXED COSTS CHAPTER 9 SLIDE 8

 GOVERNMENT PROTECTION WITH PATENTS AND COPYRIGHTS CHAPTER 9 SLIDE 9 AP PHOTO/CHRIS PIZZELLO  GOVERNMENT PROTECTION WITH PATENTS AND COPYRIGHTS CHAPTER 9 SLIDE 9

PROFIT MAXIMIZATION Monopolies maximize profit the same way that competitive firms do, by using the profit-maximization rule: PROFIT IS MAXIMIZED AT THE QUANTITY AT WHICH MR = MC. CHAPTER 9 SLIDE 10

MARGINAL REVENUE = ΔTR / ΔQ MONOPOLY AND MARGINAL REVENUE A monopoly’s demand curve is the market demand curve. To sell more quantity, it must lower the price on all units. MARGINAL REVENUE = ΔTR / ΔQ EXAMPLE: P = $40, Q = 10; TR = $400 P = $38, Q = 11; TR = $418 MR of the 11th unit is $18. CHAPTER 9 SLIDE 11

MR < P FOR MONOPOLY COMPETITIVE MARKET MONOPOLY MR < P PRICE ($) LOSS OF $20 $40 MR = P 38 GAIN OF $38 Pc D 18 MR D 10 11 10 11 OUTPUT OUTPUT CHAPTER 9 SLIDE 12

Profit = (P − ATC) × quantity MONOPOLY PROFITS MC ATC 30 PROFITS Profit = (P − ATC) × quantity (30 − 20) × 50 = $500 PRICE AND COST 20 D MR 50 OUTPUT CHAPTER 9 SLIDE 13

FIVE STEPS TO MAXIMIZING PROFIT Step 1: Find MR = MC MC ATC Step 2: Find optimal Q 30 3 3 PROFITS 5 PRICE AND COST Step 3: Find optimal P 20 4 4 1 Step 4: Find ATC D MR Step 5: Find profit 2 50 OUTPUT CHAPTER 9 SLIDE 14

A MONOPOLY CAN HAVE LOSSES ATC MC Profit = (35 − 40) × 50 = −$250. Firm has negative profit. 40 LOSSES 35 PRICE AND COST D MR 50 OUTPUT CHAPTER 9 SLIDE 15

ETEIMAGING | DREAMSTIME.COM COSTS OF MONOPOLY CHAPTER 9 SLIDE 16

This creates inefficiency in the market known as deadweight loss. COMPARING MONOPOLY AND COMPETITION Under conditions of monopoly, the price will be higher and output will be lower than under conditions of competition. This creates inefficiency in the market known as deadweight loss. CHAPTER 9 SLIDE 17

MONOPOLY INEFFICIENCY COMPETITIVE MARKET MONOPOLY S S DEADWEIGHT LOSS PRICE ($) PRICE ($) PM Pc MR D D Qc QM OUTPUT OUTPUT CHAPTER 9 SLIDE 18

INEFFICIENCES OF MONOPOLY RENT SEEKING X-INEFFICIENCY COSTLY ACTIONS (SUCH AS LOBBYING) TAKEN TO AVOID OR LIMIT COMPETITION OCCURS WHEN MONOPOLIES SQUANDER (SUCH AS LAVISH RETREATS AND PERKS) CHAPTER 9 SLIDE 19

AJV123AJV/DREAMSTIME.COM HONG CHAN/DREAMSTIME.COM MONOPOLIES CREATE BENEFITS IN TERMS OF INNOVATION: NEW PRODUCTS AND TECHNOLOGIES CHAPTER 9 SLIDE 20

PRICE DIFFERENT PRICES DIFFERENT CUSTOMERS CHARGING TO DISCRIMINATION ROBBIVERTE | DREAMSTIME.COM PRICE DISCRIMINATION DIFFERENT PRICES DIFFERENT CUSTOMERS CHARGING TO CHAPTER 9 SLIDE 21

   TO PRICE DISCRIMINATE, FIRMS: CONDITIONS FOR PRICE DISCRIMINATION TO PRICE DISCRIMINATE, FIRMS: MUST HAVE SOME CONTROL OVER PRICE. MUST BE ABLE TO SEPARATE THE MARKET INTO GROUPS BASED ON ELASTICITIES OF DEMAND. MUST BE ABLE TO PREVENT ARBITRAGE.    CHAPTER 9 SLIDE 22

ERIC CHIANG TYPES OF PRICE DISCRIMINATION  CHAPTER 9 SLIDE 23

1ST DEGREE PRICE DISCRIMINATION FIRMS CAPTURE ALL OF CONSUMER SURPLUS BY CHARGING EACH CONSUMER HIS OR HER MAXIMIUM WILLINGNESS-TO-PAY. CHAPTER 9 SLIDE 24

FRANCIS DEAN/CORBIS 2ND DEGREE PRICE DISCRIMINATION CHARGING DIFFERENT PRICES BASED ON THE QUANTITY PURCHASED (E.G., BLOCK PRICING) CHAPTER 9 SLIDE 25

SECOND-DEGREE PRICE DISCRIMINATION Using multiple prices captures more consumer surplus. P0 ADDITIONAL PROFIT PM PROFITS FOR SINGLE MONOPOLIST P1 PRICE AND COST PC D MR 50 OUTPUT CHAPTER 9 SLIDE 26

ALPHASPIRIT | DREAMSTIME.COM 3RD DEGREE PRICE DISCRIMINATION: CHARGING DIFFERENT PRICES TO DIFFERENT GROUPS OF CONSUMERS WITH VARYING ELASTICITIES CHAPTER 9 SLIDE 27

NATURAL MONOPOLY: A MONOPOLY WITH LARGE ECONOMIES OF SCALE, OFTEN PROTECTED BY THE GOVERNMENT, SUCH AS THE U.S. POSTAL SERVICE ERIC CHIANG CHAPTER 9 SLIDE 28

REGULATING NATURAL MONOPOLIES A natural monopoly has significant economies of scale, such that one firm is more cost efficient than two or more. To prevent a natural monopolist from exploiting its market power, government uses regulation such as: Average cost pricing. rate of return regulation. price cap regulation. CHAPTER 9 SLIDE 29

AVERAGE COST PRICING RULE Natural monopolies are often forced to charge a price equal to ATC, which is more than the competitive price but less than the monopoly price. PM PRICE AND COST PR ATC PC MC D MR QM QR QC OUTPUT CHAPTER 9 SLIDE 30

REGULATION IN PRACTICE RATE OF RETURN PRICE CAPS MAXIMUM PRICES THAT FIRMS CAN CHARGE, ADJUSTED TO COST CONDITIONS PRICING THAT ALLOWS THE FIRM TO EARN A NORMAL RETURN ON INVESTMENT CHAPTER 9 SLIDE 31

ANTITRUST POLICY THE GOAL OF ANTITRUST POLICIES AND LAWS IS TO PRESERVE COMPETITION AND PREVENT MONOPOLIES WITH THEIR MAXIMUM MARKET POWER FROM ARISING IN THE FIRST PLACE. CHAPTER 9 SLIDE 32

GEORGE STIGLER (1911–1991) Contributed in the areas of industrial structure, market functioning, effects of regulation, and information theory. Won the Nobel Prize in Economics in 1982. CHAPTER 9 SLIDE 33

MAJOR ANTITRUST LAWS THE SHERMAN ACT (1890) THE CLAYTON ACT (1914) PROVIDES CRIMINAL PENALTIES FOR ATTEMPTS TO MONOPOLIZE THE CLAYTON ACT (1914) FORBIDS CONTRACTS AND OTHER ARRANGEMENTS THAT LIMIT COMPETITION THE FEDERAL TRADE COMMISSION ACT (1914) PROTECTS CONSUMERS FROM UNFAIR OR DECEPTIVE PRACTICES CHAPTER 9 SLIDE 34

MONOPOLY POWER INCREASES AS IT BECOMES MORE CONCENTRATED DEFINING THE RELEVANT MARKET MONOPOLY POWER INCREASES AS IT BECOMES MORE CONCENTRATED FOUR-FIRM CONCENTRATION RATIO IS THE SHARE OF INDUSTRY SALES ACCOUNTED BY THE FOUR LARGEST FIRMS. TERMINATOR3D | DREAMSTIME.COM COMPANY A CHAPTER 9 SLIDE 35

HERFINDAHL-HIRSCHMAN INDEX THE MAIN MEASURE OF MARKET CONCENTRATION USED TO EVALUATE MERGERS AND JUDGE MONOPOLY POWER HHI IS THE SUM OF THE SQUARES OF MARKET SHARE HELD BY EACH FIRM. HHI RANGES FROM 0 TO 10,000. CHAPTER 9 SLIDE 36

CATEGORIZING HHI RESULTS HHI < 1,500: INDUSTRY IS UNCONCENTRATED. 1,500 < HHI < 2,500: INDUSTRY IS MODERATELY CONCENTRATED. HHI > 2,500: INDUSTRY IS HIGHLY CONCENTRATED. CHAPTER 9 SLIDE 37

JAMES LEYNSE/CORBIS CONTESTABLE MARKETS: INDUSTRIES IN WHICH THE THREAT OF COMPETITION KEEPS PRICES LOW CHAPTER 9 SLIDE 38

KEY CONCEPTS Monopoly Average cost pricing rule Monopoly power Rate of return regulation Barriers to entry Price caps Economies of scale Antitrust law Rent seeking Concentration ratio X-inefficiency Herfindahl–Hirschman index Price discrimination Contestable market Perfect (first-degree) price discrimination Second-degree price discrimination Third-degree price discrimination Natural monopoly Marginal cost pricing rule CHAPTER 9 SLIDE 39

WHICH OF THE FOLLOWING IS NOT A MAJOR BARRIER TO ENTRY FOR A MONOPOLIST? CONTROL OVER A KEY INPUT A PATENT PROTECTION B ECONOMIES OF SCALE C Answer: E COPYRIGHT PROTECTION D PRODUCT DIFFERENTIATION E CHAPTER 9 SLIDE 40

ERIC CHIANG PRACTICE QUESTION WHAT IS THE MAIN CHARACTERISTIC THAT MAKES THE NATURAL GAS FOR VEHICLES INDUSTRY A NATURAL MONOPOLY? Answer: The natural gas industry has very large fixed costs with large economies of scale. This makes one firm more cost efficient than two firms. CHAPTER 9 SLIDE 41

IF SEAN CAN SELL 10 SKATEBOARDS AT $100 EACH OR 11 SKATEBOARDS AT $95 EACH, WHAT IS THE MARGINAL REVENUE OF THE 11TH SKAKEBOARD? $45 A $95 B Answer: A $100 C $1,045 D CHAPTER 9 SLIDE 42

PRACTICE QUESTION IMAGE SOURCE/GETTY IMAGES Answer: Shoppers who use coupons pay a lower price for the same products than shoppers who do not use coupons. This is an example of third degree price discrimination, which segments shoppers based on their willingness to spend time clipping coupons. WHEN A SHOPPER USES MANY COUPONS AT A GROCERY STORE, WHAT TYPE OF PRICE DISCRIMINATION IS TAKING PLACE, AND WHY? CHAPTER 9 SLIDE 43

IF AN INDUSTRY CONTAINS EIGHT FIRMS WITH MARKET SHARES OF 25, 18, 15, 12, 10, 10, 6, AND 4, WHAT IS THE FOUR-FIRM CONCENTRATION RATIO? 50 A 70 B Answer: B 100 C 1,318 D CHAPTER 9 SLIDE 44

9 END OF CHAPTER SLIDES CREATED BY ERIC CHIANG CHAPTER 9 SLIDE 45 Tshooter/Shutterstock; Anton Balazh/Shutterstock CHAPTER 9 SLIDE 45