Price Discriminating Monopoly Lecture 24 Dr. Jennifer P. Wissink ©2018 John M. Abowd and Jennifer P. Wissink, all rights reserved. April 25, 2018

Long Run Profit Maximization with Simple Monopoly Pretty much the same story as in the short run, but, use correctly calculated long run cost information. Positive economic profit invites entry, but since there are barriers to entry positive economic profit can persist. Negative economic profit encourages exit, and if the monopolist can get out he will. Monopolist might make long run adjustments to changes in the economic environment.

Graphical Display of Simple Monopolist’s Long Run Profit Maximizing Solution (1) The monopolist sets marginal revenue equal to marginal cost. (1a) Then goes up to the demand curve to get the price. (2) Then makes sure he is at a max (and not a min). (3) Then makes sure it is worth operating in the long run. $ lrmc PSM Demand QSM Q mrSM

Long Run Simple Monopoly – Performance, Efficiency & Equity Recall Efficiency Definitions: The market equilibrium quantity is Pareto/Allocatively Efficient(AE) if net social surplus (NSS) in the market is maximized. Maximizing NSS implies MBsoc = MCsoc The firm’s quantity is productively efficient(pe) if it operates at the minimum point on its long run average total cost curve. So the efficiency questions are: Is the long run equilibrium quantity, QSM, with simple monopoly AE? A = Yes! B = No. C = Maybe yes, maybe no. Is the long run equilibrium quantity, QSM, pe?

Simple Monopoly Performance $ lrmc=$MCsociety PSM Demand=$MBsociety QSM QAE Q Qmes mrSM

Simple Monopoly Versus Perfect Competition Suppose we start with a market that is perfectly competitive and has 50 independent firms operating in the market for fedoras. Suppose one day Vito Corleone manages to buy out all 50 firms simultaneously and creates the monopoly, Fantastic Fedoras. Suppose nothing changes in the nature of the cost structures once the monopoly is set up. If this is the case, then the monopoly (multi-plant) marginal cost curve will look exactly like the former market short run supply curve. Note: The advantage to having a monopoly in this story is that is allows the monopolist (Vito) to totally control the number of hats that get put on the market for sale. Under conditions of perfect competition no one has any individual market power, so they all act as 50 independent price taking firms. Let’s compare the before and after.

Perfect Competition (PC) vs Simple Monopoly (SM) Before (PC) After (SM) Price Quantity Consumers' Surplus Producers’ Surplus Net Social Surplus MCsoc mcSM SRS MBsoc Demand mrSM

So: Are Monopolies Good? Bad? Ugly? Your Opinion A = Good! B = Bad. My Advice, It Depends.... What kind of monopoly is it? From whose point of view are we asking? How did the monopoly position come about? How is the monopoly position maintained? How does the monopoly behave?

So: Should the Government Regulate Monopolies? Essentially all monopolies are regulated, in some way or another. Natural monopolies are regulated by price commissions that determine the rates the monopolies may charge. Patent, copyright and license protections are a form of ex ante regulation: firms that follow the rules for establishing the validity of their innovations receive the protection of the patent, copyright or license. Should the government do more? Good question.

Ways the Government Can Regulate Monopolies – DO/KNOW THESE! How about a per unit tax on the output of the monopolist? What would that do? How about a per unit subsidy on the output of the monopolist? What would that do? How about a tax on the economic profit of the monopolist? What would that do? How about a binding price ceiling on the monopolist? What would that do? How about breaking up the monopoly? What would that do? How about taking away the patent? What would that do?

Placing a Per Unit Tax on the Simple Monopolist’s Output mc PSM Demand QSM mrSM

Placing a Price Ceiling on the Simple Monopolist mc PSM Demand QSM mrSM

How About Price Discriminating Monopolists? A monopolist might be able to charge different prices for different units sold and enhance its profits. charge different people different prices charge the same person different prices for different units Price Discrimination charging different prices for different units with no cost basis for the differential in price charging the same price for different units when there are cost differences

Three Requirements for Price Discrimination Some amount of monopoly power. An ability to prevent resale. Detailed information about who is buying what unit, and what that demander is willing to pay.

Believe It Or Not What would you do to prevent resale??? When: 1940’s Market: plastic molding powder industrial users: .85/pound denture manufacturers: $22/pound Firm: Rohm and Haas Problem: resale from industrial users to denture manufacturers was reducing profit Solution: rumor you are mixing arsenic in the powder sold to industrial users!