Monopoly A Price Searcher Model

Monopoly  Pure monopolist has no close substitutes  Sherman Act (1890) “anti-trust” law Section 1: Every contract, combination…or conspiracy, in restraint of trade…is declared to be illegal" Section 2: "Every person who shall monopolize, or attempt to monopolize…shall be deemed guilty of a felony” John Sherman

Relevant Market  Product Market DuPont (1956)  Cellophane  Flexible wrapping paper Alcoa (1945)  Primary aluminum  All aluminum Flexible Wrapping Paper 20% Cellophane 75% Aluminum Foil Butcher Paper Newspaper All Aluminum 33% Primary 90% Secondary Imported Learned Hand

Global Relevant Market  Geographic Market Local Regional National Global Local Regional National

Barriers to Entry  Economies of Scale “natural monopoly”  Control over key inputs Alcoa--bauxite DeBeers  GE Superabrasives (Diamond Innovations) LRAC Quantity $

…more barriers to entry  Government restrictions Patents  20 year duration Copyrights  Life of artist plus 70 years Licenses  Occupational licenses: doctors, lawyers, accountants, engineers  For what purpose: Public health or private interest? Franchises  Taxi medallions: 12,779  $336,000 per medallion Number of Patents Issued per year in US

Source: The New York City Taxicab Fact Book, Schaller Consulting, March Available at

Profit Maximizing Behavior Assume that Monopolist charges single price to all buyers π = TR – TC π = P(Q)*Q – TC MR = ∆TR/ ∆Q $ $40 $ D TR = $20,000 TR = $21,000 MR = ∆TR / ∆Q = [∆Q*P - ∆P*Q] / ∆Q Loss Gain MR = [6000 – 5000]/200 = $1000 / 200 MR = $5 MR < P Quantity MR

A single-price monopoly can sell 2 units for $8.50 per unit. In order to sell 3 units, the price must be $8.00 per unit. The marginal revenue from selling the third unit is a)$6.00 b)$7.00 c)$8.00 d)$8.50 e)$24.00 a)$6.00 b)$7.00 c)$8.00 d)$8.50 e)$

MR, P, and Elasticity MR = P [ 1 – 1/E ] MR = ∆TR / ∆Q = [∆Q*P - ∆P*Q] / ∆Q

a)$9 b)$8 c)$7 d)$6 e)$5 f)$4 a)$9 b)$8 c)$7 d)$6 e)$5 f)$4 The table below shows the quantity demanded at different prices. If this is the demand curve faced by a monopoly with constant marginal costs of $2, what price should the monopoly set to maximize profit? PriceQuantity $100 $91 $82 $73 $64 $55 $

Profit Maximization  π-max rule: Set output where MR = MC Set price off of demand curve $ $20 $ D Quantity MR MC ATC TR = P*Q = ($30)(700) = $21,000 TC = ATC*Q = ($20)(700) = $14,000 π = TR - TC = $ 7,000

a)$9 b)$8 c)$7 d)$6 e)$5 f)$4 a)$9 b)$8 c)$7 d)$6 e)$5 f)$4 The table below shows the quantity demanded at different prices. If this is the demand curve faced by a monopoly with constant marginal costs of $2, what price should the monopoly set to maximize profit? PriceQuantity $100 $91 $82 $73 $64 $55 $

 π-max rule: Set output where MR = MC Set price off of demand curve  How will monopolist react to: an increase in marginal cost? an increase in fixed cost? an increase in demand? $ $20 $ D Quantity MR MC ATC Profit Maximization

a)the firm is producing the profit maximizing output. b)the firm could increase its profit by increasing its price c)the firm could increase its profit by decreasing its output. d)the firm could increase its profit by decreasing its price a)the firm is producing the profit maximizing output. b)the firm could increase its profit by increasing its price c)the firm could increase its profit by decreasing its output. d)the firm could increase its profit by decreasing its price Assume that at the current output level, a monopolist is earning positive economic profit, has a marginal revenue of $7, and a marginal cost of $4. Which of the following is an accurate conclusion with regard to the monopolist's profit?

Welfare Comparison: PC vs. Monop  Perfect Competition: P C, Q C  Monopoly: P M, Q M $ D Quantity MR MC = ATC QcQc QMQM PMPM PCPC A B C PCMonop CS PS Social Welfare DWL A+B+C --- A B A+B C

What is the deadweight loss due to monopoly power in the diagram below? $ D Quantity MR MC = ATC a)$800 b)$400 c)$200 d)$100 a)$800 b)$400 c)$200 d)$

Price Discrimination  Definition: price differentials that do not reflect cost differentials  Motivation: to increase profits by capturing more consumer surplus  Necessary Conditions Market Power  Downward sloping demand curve Segment the market  Demographics  Usage rates Prevent resale  Movie theatres  Röhm-Haas: plastic molding compound Industrial: $0.85/lb Dentists: $22/lb Arsenic ?

Types of Price Discrimination  First Degree Charge each buyer their WTP Captures all CS and DWL  Second Degree Quantity discounts  Third Degree Set prices based on price elasticity Movie Theatre  MR A = MR K = MC $ D Quantity MR QcQc QMQM PMPM PCPC MC MC = $4 E A = 2 E K = 5 MR A = P A [1 – 1/E A ] MR A = MC P A [1 – 1/2] = 4P A = $8 Charge higher price to more inelastic group P K = $5

a)Price for men = $20; Price for women = $20 b)Price for men = $25; Price for women = $30 c)Price for men = $30; Price for women = $25 d)Price for men = $60; Price for women = $4 e)Impossible to determine from the information provided. a)Price for men = $20; Price for women = $20 b)Price for men = $25; Price for women = $30 c)Price for men = $30; Price for women = $25 d)Price for men = $60; Price for women = $4 e)Impossible to determine from the information provided. A monopolist has divided its market into two segments according to gender. The elasticity of demand for the product by men is equal to 3. The elasticity of demand for the product by women is equal to 5. If the marginal cost of selling the product to each segment is a constant $20 per unit, what price should the monopolist charge each segment?

Monopoly Advisor FirmPMRTRQTCMCATCAVCDecision A B5.9059,00010,00047, C , , D , , E , , Remain at the current output level. 2.Increase output. 3.Reduce output. 4.Shut down. 5.Go back and recalculate your figures because the ones supplied can’t possibly be right. Recommendations: