Chapter 25 Monopolies

FOUR MARKET MODELS

Name The Product Obey your Thirst Sprite Is it in you Gatorade Two for me, none for you Twix Hungry, why wait? Snickers Give me a break Kit Kat Like a good neighbor… State Farm My heart to yours Pillsbury Name The Product

Name The Product There is no wrong way to eat a Reese’s I’m love’n it McDonalds Once you pop you can’t stop Pringles Choosy mothers choose _______. Jiff You can do it, we can help. Home Depot Zoom, zoom, zoom Mazda What is in your wallet? Capital One Name The Product

Name The Product It just keeps going and going and going… Energizer Bet ya can’t eat just one. Lays Potato Chips Double your pleasure, double your fun Doublemint Gum Have it your way Burger King Don’t leave home without it. American Express The quicker picker upper. Bounty Name The Product

5 Characteristics of a Monopoly 1. Single Seller One Firm controls the vast majority of a market The Firm IS the Industry 2. Unique good with no close substitutes 3. “Price Maker” The firm can manipulate the price by changing the quantity it produces (ie. shifting the supply curve to the left). Ex: California electric companies

5 Characteristics of a Monopoly 4. High Barriers to Entry New firms CANNOT enter market No immediate competitors Firm can make profit in the long-run 5. Some “Nonprice” Competition Despite having no close competitors, monopolies still advertise their products in an effort to increase demand.

Copyright © 2008 Pearson Addison Wesley. All rights reserved. Barriers to Entry Question How does a firm obtain monopoly power? Answers Barriers to entry that allow the firm to make long-run economic profits Barriers to entry are restrictions on who can start as well as stay in business. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Four Origins of Monopolies Geography is the Barrier to Entry Ex: Nowhere gas stations, De Beers Diamonds, Cable TV, -Location or control of resources limits competition and leads to one supplier. 2. The Government is the Barrier to Entry Ex: Water Company, Firefighters, The Army, Pharmaceutical drugs, rubix cubes… -Government allows monopoly for public benefits or to stimulate innovation. -The government issues patents to protect inventors and forbids others from using their invention. (They last 20 years)

Four Origins of Monopolies 3. Technology or Common Use is the Barrier to Entry Ex: Microsoft, Intel, Frisbee, Band-Aid… -Patents and widespread availability of certain products lead to only one major firm controlling a market. 4. Mass Production and Low Costs are Barriers to Entry Ex: Electric Companies If there were three competing electric companies they would have higher costs. Having only one electric company keeps prices low Natural Monopoly- It is NATURAL for only one firm to produce because they can produce at the lowest cost.

International Policy Example: Malaysia’s Drug-Labeling Monopoly Sellers of drugs and medical products are required to affix holographic labels providing information on usage. To obtain these labels, sellers have only one choice. They must buy the labels from a company called Mediharta. This company is the only label manufacturer that Malaysia’s Registrar of Companies has approved to produce holographic labels. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Barriers to Entry (cont'd) Legal or governmental restrictions Patents Intellectual property Tariffs Taxes on imported goods Regulation Safety and quality Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Barriers to Entry (cont'd) Cartels An association of producers in an industry that agree to set common prices and output quotas to prevent competition Copyright © 2008 Pearson Addison Wesley. All rights reserved.

The Demand Curve a Monopolist Faces The monopolist faces the industry demand curve because the monopolist is the entire industry. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

The Demand Curve a Monopolist Faces (cont'd) Recall that under perfect competition Firm faces perfectly elastic demand curve, it is a price taker The forces of supply and demand establish the price per unit Marginal revenue, average revenue, and price are all the same Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Comparing Monopoly and Perfect Competition Single seller Faces entire industry demand Must lower price to sell more Not all units sold for same price Many sellers Faces perfectly elastic demand Must produce more to sell more All units sold for same price (P = MR) Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Elasticity and Monopoly The monopolist faces a downward-sloping demand curve, and cannot charge any price. Thus, depending on the price charged a different quantity will be demanded. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Cost and Monopoly Profit Maximization We assume profit maximization is the goal of the pure monopolist, just as it is for the prefect competitor. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Cost and Monopoly Profit Maximization (cont'd) Perfect competitor has only to decide on the profit-maximizing output rate because price is given. For the pure monopolist, we must seek a profit-maximizing price output combination. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Cost and Monopoly Profit Maximization (cont'd) Price Searcher A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Cost and Monopoly Profit Maximization (cont'd) We can determine the profit-maximizing price-output combination with either of two equivalent approaches. By looking at total revenues and total costs or by looking at marginal revenues and marginal costs. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Cost and Monopoly Profit Maximization (cont'd) Total revenues-total costs approach Maximize the positive difference between total revenues and total costs Marginal revenue-marginal cost approach Profit maximization will also occur where marginal revenue equals marginal cost. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

When graphing monopolies… Only one graph because the firm IS the industry. The cost curves are the same The MR= MC rule still applies Shut down rule still applies

THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE! The Main Difference Monopolies (and all Imperfectly competitive firms) have downward sloping demand curve. Which means, to sell more a firm must lower its price. This changes MR… THE MARGINAL REVENUE DOESN’T EQUAL THE PRICE!

This is what a monopoly looks like when graphed…always! MC ATC Costs (dollars) D MR Quantity

Remember…Perfect Competition $20 15 10 5 MC MR=P 14 ATC Cost and Revenue AVC 6 1 2 3 4 5 6 7 8 9 10

Calculating Monopoly Profit Monopoly profit is given by the shaded area, which is equal to total revenues (P  Q) minus total costs (ATC  Q). Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Figure 25-6 Monopoly Profit Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Calculating Monopoly Profit (cont'd) No guarantee of profit The term monopoly conjures up the notion of a greedy firm ripping off the public…Not always true! Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Figure 25-7 Monopolies: Not Always Profitable Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Price, costs, and revenue Conclusion: A monopolists produces where MR=MC, buts charges the price consumer are willing to pay identified by the demand curve. Q 200 175 150 125 100 75 50 25 0 1 2 3 4 5 6 7 8 9 10 Price, costs, and revenue $9 8 7 6 5 4 3 2 MC ATC D MR

Calculating Marginal Revenue

Calculate TR and Marginal Revenue Quantity Price TR MR $16 1 15 2 14 3 13 4 12 5 11 6 10 7 9 8

Calculate TR and Marginal Revenue Quantity Price TR MR $16 1 15 2 14 28 3 13 39 4 12 48 5 11 55 6 10 60 7 9 63 8 64

Calculate TR and Marginal Revenue Quantity Price TR MR $16 - 1 15 2 14 28 13 3 39 11 4 12 48 9 5 55 7 6 10 60 63 8 64 -1 -3

On Making Higher Profits: Price Discrimination Selling a given product at more than one price, with the difference being unrelated to differences in cost Senior discounts Military discounts Student discounts Copyright © 2008 Pearson Addison Wesley. All rights reserved.

On Making Higher Profits: Price Discrimination (cont'd) Price Differentiation Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers Copyright © 2008 Pearson Addison Wesley. All rights reserved.

The Social Cost of Monopolies Comparing monopoly with perfect competition Let’s assume a monopolist comes in and buys up every single perfect competitor. Notice the monopolist produces a smaller quantity and sells at a higher price. Monopolists raise the price and restrict production compared to a perfectly competitive situation. Consumers pay a price that exceeds the marginal cost of production and resources are misallocated in such a situation. Copyright © 2008 Pearson Addison Wesley. All rights reserved.

Because there is little external pressure to be efficient Monopolies are inefficient because they… Charge a higher price Don’t produce enough No allocative efficiency Produce at higher costs No productive efficiency Have little incentive to innovate Why? Because there is little external pressure to be efficient

Regulating Monopolies

Rate Regulation in the form of price ceilings Why Regulate? Since monopolies are inefficient if unregulated, the government seeks to make them efficient How do they regulate? Rate Regulation in the form of price ceilings

End of Chapter 25 Monopoly