copyright © 2010, All rights reserved eStudy.us Market Structure – A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry and exit Monopoly one firm with market power unique product (no close substitutes) impossible entry and exit price maker (monopoly company sets the price) Monopoly firm demand curve is downward sloping (must discount to sale more)

copyright © 2010, All rights reserved eStudy.us Barriers to Entry and Exit Legal barriers – Licenses – Patents and copyrights – Public franchises – Tariffs, quotas and other trade restrictions Strategic barriers – Predatory pricing – Marketing (product differentiation) Structural barriers – Economies of scale (Natural monopoly) – Vertical integration – Control of essential resources (technologies / commodities) – Brand loyalty Monopoly

copyright © 2010, All rights reserved eStudy.us QP $ $19 $17 $15 $13 $11 $9 $7 $5 $3 TR $0 $19 $34 $45 $52 $55 $54 $49 $40 $27 MR ---- $19 $15 $11 $7 $3 - $1 - $5 - $9 - $13 D MR Revenue with Market Power

copyright © 2010, All rights reserved eStudy.us TFC $10 TVC $0 $4 $7 $11 $18 $28 $47 $74 $112 $162 TC $10 $14 $17 $21 $28 $38 $57 $84 $122 $172 MC ---- $4 $3 $4 $7 $10 $19 $27 $38 $50 AFC $10 $5 $3.33 $2.50 $2.00 $1.67 $1.43 $1.25 $1.11 AVC $0 $4.00 $3.50 $3.67 $4.50 $5.60 $7.83 $10.57 $14.00 $18.00 ATC $10.00 $14.00 $8.50 $7.00 $7.60 $9.50 $12.00 $15.25 $19.11 $17 Profit -$10 $5 $17 $24 -$3 -$35 -$82 -$145 QP $ $19 $17 $15 $13 $11 $9 $7 $5 $3 TR $0 $19 $34 $45 $52 $55 $54 $49 $40 $27 MR ---- $19 $15 $11 $7 $3 - $1 - $5 - $9 - $13 Short-run Equilibrium

copyright © 2010, All rights reserved eStudy.us Profit maximization – When MR > MC – increase production – When MR < MC – decrease production – When MR = MC – Maximum profit Produce quantity where MR = MC Intersection of the marginal-revenue curve and the marginal-cost curve Short-run Equilibrium

copyright © 2010, All rights reserved eStudy.us MC MR D MR = MC Profit Max: Short-run Equilibrium

copyright © 2010, All rights reserved eStudy.us MC D MR $13.00 $4.50 Revenue Total Cost TVC TFC $52 $18 $10 $28 Profit$24 When Q=4 $7.00 Short-run Equilibrium P ATC AVC

copyright © 2010, All rights reserved eStudy.us Natural Monopoly – Infinite economics of scale leading to a single company having lowest cost Water service Sewer service Power service Trash service Should a municipality own these services? Is trash collection a natural monopoly? National law allows for natural monopoly so long firms surrender pricing power Regulation: should try to price near perfect competition (P = MC) rather than (P > MC) Regulators generally do a poor job protecting society interest. Case: Power service in Lubbock, TX and San Diego, CA Natural Monopoly $ Q AC

copyright © 2010, All rights reserved eStudy.us MC D monopoly MR AC $ Q Long Run View D perfect competition P pc PmPm QmQm Q pc P m > P pc and Q m < Q pc Monopoly allocates resources inefficiently

copyright © 2010, All rights reserved eStudy.us Monopoly produces quantity where MC = MR – which produces less than the socially efficient quantity of output – charges a Price > Marginal Cost – which creates a deadweight loss (triangle between the demand curve and marginal cost curve) Inefficiency of monopoly

copyright © 2010, All rights reserved eStudy.us Inefficiency of monopoly $ Monopoly charges a price above marginal cost and not all consumers who value the good at more than its cost Quantity produced and sold by a monopoly is below the socially efficient level Deadweight loss is represented by the area of the triangle between the demand curve (which reflects the value of the good to consumers) and the marginal-cost curve (which reflects the costs of the monopoly producer) Quantity0 Demand Marginal Revenue Q monopoly Marginal Cost P monopoly Q efficient Deadweight Loss

copyright © 2010, All rights reserved eStudy.us Price Discrimination Sell the same good at different prices to different customers Price Discrimination is a rational strategy to increase profit Requires the ability to separate customers according to their willingness to pay Certain market forces can prevent firms from price discriminating Arbitrage – buy a good in one market, sell it in other market at a higher price Charge each customer a price closer to his or her willingness to pay Sell more than is possible with a single price

copyright © 2010, All rights reserved eStudy.us Can raise economic welfare by eliminating the inefficiency of monopoly pricing More consumers get the good Higher producer surplus (higher profit) Price Discrimination Without price discrimination Single price > MC Consumer surplus Producer surplus (Profit) Deadweight loss Perfect price discrimination Charge each customer a different price Exactly his or her willingness to pay Monopolist - gets the entire surplus (Profit) No deadweight loss

copyright © 2010, All rights reserved eStudy.us Price Panel (a) shows a monopolist that charges the same price to all customers. Total surplus in this market equals the sum of profit (producer surplus) and consumer surplus. Panel (b) shows a monopolist that can perfectly price discriminate. Because consumer surplus equals zero, total surplus now equals the firm’s profit. Comparing these two panels, you can see that perfect price discrimination raises profit, raises total surplus, and lowers consumer surplus. Quantity0 (a) Monopolist with Single Price Price Quantity 0 (b) Monopolist with Perfect Price Discrimination Profit Consumer surplus Deadweight loss Monopoly price Quantity sold Marginal revenue Demand Marginal cost Quantity sold Profit Demand Marginal cost Price Discrimination

copyright © 2010, All rights reserved eStudy.us Examples of price discrimination – Movie tickets – Airline prices – Discount coupons – Financial aid – Quantity discounts Price Discrimination

copyright © 2010, All rights reserved eStudy.us Antitrust and Monopoly Increasing competition with antitrust laws – Sherman Antitrust Act, 1890 Reduce the market power of trusts – Clayton Antitrust Act, 1914 Strengthened government’s powers Authorized private lawsuits – Prevent mergers – Break up companies – Prevent companies from coordinating their activities to make markets less competitive Public Policy

copyright © 2010, All rights reserved eStudy.us Regulation and Monopoly – Regulate the behavior of monopolists Price – Common in case of natural monopolies – Marginal Cost pricing May be less than ATC No incentive to reduce costs Public Policy $ Quantity 0 ATC Loss ATC D MC Regulated price

copyright © 2010, All rights reserved eStudy.us Ownership and Monopoly – Private owners Incentive to minimize costs (maximize profit) – Public owners (government owned) If government does a bad job Losers are the customers and taxpayers Public Policy

copyright © 2010, All rights reserved eStudy.us Competition vs. Monopoly Comparison CompetitionMonopoly Similarities Goal of firms Rule for maximizing Can earn economic profits in short run? Differences Number of firms Marginal revenue Price Produces welfare-maximizing level of output? Entry in long run? Can earn economic profits in long run? Price discrimination possible? Maximize profits MR = MC Yes Many MR = P P = MC Yes No Maximize profits MR = MC Yes One MR < P P > MC No Yes Summary