Monopoly 12-1

Drawing on Chapter 12 Graphics copyright © 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Overview Monopoly Setting a Single Price and Output Definition Sources Profit Maximization Setting a Single Price and Output The Short Run Adjustments In The Long Run Price Discrimination The Social Perspective Efficiency Losses Public Policy Toward Natural Monopoly 12-3

Figure 12.11: A Monopolist who Should Shut Down in the Short-Run 12-4

A Monopolist Has No Supply Curve The monopolist is a price maker. When demand shifts, elasticity at a given price may either increase or decrease, and vice-versa. So there is no unique correspondence between the monopolist’s price and quantity produced. Monopoly has a supply rule, which is to equate marginal revenue and marginal cost. 12-5

Figure 12.12: Long-Run Equilibrium for a Profit-Maximizing Monopolist In the long run, a profit-maximizing monopolist still sets Q=Q* where MR=MC, but taking into account adjustments in all inputs, not just short run variable inputs, along LMC. At Q* that coincides with SMC for the corresponding level of FC that minimizes ATC (at ATC*Q*= LACQ*) given Q=Q*. Note that there is still positive economic profit. 12-6

Price Discrimination Charging different prices to different buyers and/or for different units bought. Examples Volume discounts Senior citizen discounts Coupons ? 12-7

Price Discrimination Third-degree: prices differ only across buyers in separate markets Second-degree: each buyer chooses from the same structure of multiple prices across different numbers of units First-degree: different price for every unit bought Distinction between types in order of degree to which not only prices differ across units, but also to which monopolist captures consumer surplus. Let’s examine them more closely, starting with third-degree. 12-8

Figure 12.13: The Profit-Maximizing Monopolist Who Sells Two Markets 12-9

Figure 12.14: A Monopolist with a Perfectly Elastic Foreign Market Especially a few decades ago, when there were greater government-created barriers to international trade, it was fairly common for small economies to have a monopoly producer of a good with a government license or economies of scale, as well as a strongly protected national market. In a few cases, those monopolists also exported to foreign markets which were large and integrated enough to have a high degree of competition. Even today, with freer international trade, this story applies to a significant degree to producers in relatively protected markets. Again Form the horizontal sum of MRs, asking the question: for each additional unit produced, in which market should this be sold, for a higher MR? Find Q* where combined MR=MC. Find corresponding Qi* and Pi* 12-10

Figure 12.15: Perfect Price Discrimination 12-11

Figure 12.16: The Perfectly Discriminating Monopolist Doesn’t the shaded area plus the ATC curve look like a smiling cartoon face? You’d be happy, too, if you wanted profit and got all the consumer surplus! It illustrates the idea common to second-degree that the monopolist can charge some buyers with higher willingness to pay more without losing the buyers that aren’t willing to pay that much, and continue to serve the lower willingness-to-pay buyers without “undercharging” the higher willingness-to-pay buyers. 12-12

Figure 12.17: Second-Degree Price Discrimination 12-13

Figure 12.18: A Perfect Hurdle A common example of this is creating a “hurdle” over which some, but not all, buyers will be willing to jump in order to get a lower price. The hurdle creates costs for buyers which are either not the same for all buyers or which some buyers are more willing to pay than others. To which of our previous examples does this apply? 12-14

The Efficiency Loss From Monopoly Deadweight loss from monopoly: the loss of efficiency (consumer surplus + producer surplus) due to the presence of a monopoly. None if price discriminating perfectly. 12-15

Figure 12.19: The Welfare Loss from a Single-Price Monopoly 12-16

Public Policy Toward Natural Monopoly State ownership and management State regulation Exclusive contracting Vigorous enforcement of antitrust laws A laissez-faire policy 12-17

Figure 12.20: A Natural Monopoly 12-18

State Ownership And Management Subsidization for greater allocative efficiency? X-inefficiency? Or less than private? Better quality assurance, or not? 12-19

State Regulation Of Private Monopolies Public Utilities Usually rate of return guaranteed Erring on the high side, Incentives to overinvest Possible cross-subsidization 12-20

Figure 12.21: Cross-Subsidization to Boost Total Output 12-21

Exclusive Contracting for Natural Monopoly Detailed contracts, competitive bidding? Theory Evidence Hard to specify every detail of quality 12-22

Antitrust and Laissez Faire Sherman (1890) and Clayton (1914) Acts HHI or other index, specification of market Economies of scale vs. competition Innovation and entry 12-23

Figure 12.22: The Efficiency Losses from Single-Price and Two-Price Monopoly 12-24

Figure 12.23: Does Monopoly Suppress Innovation? 12-25