Managerial Economics Jack Wu Monopoly Managerial Economics Jack Wu

Market Power Definition: ability to influence price monopoly -- single supplier of good or a service with no close substitute oligopoly -- few suppliers monopsony -- single buyer oligopsony -- few suppliers

Sources of Market Power unique resources human natural intellectual property patent Copyright economies of scale / scope product differentiation government regulation

Monopoly: Marginal Revenue and Price 250 infra-marginal units 150 130 demand (marginal benefit) Price ($ per unit) 70 marginal revenue 50 0.4 0.8 1.2 1.4 1.6 2 -50 Quantity (Million units a year)

Revenue, Cost, and Profit

Monopoly: Profit Maximum, I Operate at scale where marginal revenue = marginal cost

Monopoly: Profit Maximum, II 250 demand (marginal benefit) 150 130 Price ($ per unit) 70 marginal revenue 50 marginal cost 0.4 0.8 1.2 1.4 1.6 2 -50 Quantity (Million units a year)

Monopoly: Profit Maximum, III contribution margin = total revenue less variable cost profit-maximizing scale: selling additional unit does not change the contribution margin

Demand Change Find new scale where marginal revenue = marginal cost should change price new scale and price depend on both new demand and costs

Prozac: Demand Reduction 250 200 Price ($ per unit) 150 marginal cost 100 original demand 50 new demand 0.4 0.8 1.2 1.6 2 new marginal revenue Quantity (Million units a year)

Cost Change Find new scale where marginal revenue = marginal cost change in MC --> should change price (but less than change in MC) change in fixed cost --> should not change price or scale

Reduction in Marginal Cost 200 demand 150 marginal revenue original marginal cost Price ($ per unit) 100 new marginal cost k 50 0.4 0.8 1.2 1.6 2 -50 Quantity (Million units a year)

3G Licensing “There’s good and bad in auctioning off spectrum … it may raise costs for telecoms providers” Anthony Wong, Director- General, OFTA, Hong Kong How does one-time license fee affect price and scale of operations?

Advertising benefit of advertising -- increment in contribution margin advertising elasticity = % increase in demand from 1% increase in advertising

Advertising: Profit Maximum Profit-maximizing advertising/sales = incremental margin x advertising elasticity incremental margin = (price - MC)

Prozac: Advertising Competition from generics would reduce incremental margin raise advertising elasticity

Coke vs Pepsi, Nov. 1999 Coke Pepsi raised prices by 7% increased advertising and other marketing Pepsi raised price by 6.9% what about advertising?

Answer Pepsi should increase advertising expenditure for two reasons: price increase --> increase in incremental margin; Pepsi’s increase in advertising will attract some marginal consumers -- those who are brand- switchers, relatively less loyal to Pepsi/Coke; so Coke’s demand will be more sensitive to advertising (higher advertising elasticity)

Dollar General “Our customer lives within three to five miles of the store, knows we’re there” cut advertising from 3.8% to 0.2% of revenue sales dropped but profit rose

Market Structure, I (a) Perfect Competition (b) Monopoly demand demand 60 Price (Cents per unit) Price (Cents per unit) marginal cost 30 30 supply marginal revenue 300 150 Quantity (Million units a year) Quantity (Million units a year)

Market Structure, II Relative to competitive market, monopoly sets higher price produces less earns higher profit

Competitiveness entry and exit barriers perfectly contestable market -- sellers can enter and exit at no cost Lerner Index (incremental margin percentage) -- measures the degree of actual and potential competition

Monopsony buyer with market power restricts purchases to depress price trades off marginal expenditure marginal benefit

Monopsony Scale marginal expenditure supply Price ($ per ton) 400 supply 350 Price ($ per ton) 273 marginal benefit 6 8 Quantity (Thousand tons a year)