MBMC Monopoly and Other Forms of Imperfect Competition

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 2 Imperfect Competition Imperfectly Competitive Firms Have some control over price Price may be greater than the cost of production Long-run economic profits are possible

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 3 Imperfect Competition Perfect Competition An ideal market that maximizes economic surplus A situation that does not always exist

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 4 Imperfect Competition Imperfectly Competitive Markets Reduce economic surplus to varying degrees Are very common

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 5 Imperfect Competition Different Forms of Imperfect Competition Pure Monopoly (most inefficient)  The only supplier of a unique product with no close substitutes

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 6 Imperfect Competition Different Forms of Imperfect Competition Monopolistic Competition (closest to perfect competition)  A large number of firms that produce slightly differentiated products that are reasonably close substitutes for one another  Long-run adjustment to zero economic profits  Importance of differentiation

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 7 Imperfect Competition Different Forms of Imperfect Competition Oligopoly (more efficient than a monopoly)  Industry structure in which a small number of large firms produce products that are either close or perfect substitutes  Cost advantages from large size may prevent the long-run adjustment to zero economic profit  Undifferentiated and differentiated products

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 8 Imperfect Competition The Essential Difference Between Perfectly and Imperfectly Competitive Firms The perfectly competitive firm faces a perfectly elastic demand for its product. The imperfectly competitive firm faces a downward-sloping demand curve.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 9 Imperfect Competition In perfect competition: Supply and demand determine equilibrium price. The firm has no market power. At the equilibrium price, the firm sells all it wishes.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 10 Imperfect Competition With perfect competition: If the firm raises its price, sales will be zero. If the firm lowers its price, sales will not increase. The firm’s demand curve is the horizontal line at the market price.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 11 Imperfect Competition With imperfect competition: The firm has some control over price or some market power. The firm faces a downward sloping demand curve.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 12 The Demand Curves Facing Perfectly and Imperfectly Competitive Firms Quantity $/unit of output Quantity D Market price Price D Perfectly competitive firmImperfectly competitive firm

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 13 Five Sources of Market Power Market Power A firm’s ability to raise the price of a good without losing al its sales

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 14 Five Sources of Market Power Exclusive control over inputs Patents and Copyrights Government Licenses or Franchises Economies of Scale (Natural Monopolies) Network Economies

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 15 Economies of Scale and the Importance of Start-Up Costs Firms with large fixed costs and low variable costs: Have low marginal costs Average total cost declines sharply as output increases Economies of scale will exist

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 16 Economies of Scale and the Importance of Start-Up Costs Constant Returns to Scale A production process is said to have constant returns to scale if, when all inputs are changed by a given proportion, output changes by the same proportion.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 17 Economies of Scale and the Importance of Start-Up Costs Increasing Returns to Scale A production process is said to have increasing returns to scale if, when all inputs are changed by a given proportion, output changes by more than that proportion; also called economies of scale.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 18 Total and Average Total Costs for a Production Process with Economies of Scale Average cost ($/unit) Quantity Total cost ($/year) Quantity F Q0Q0 F + MQ 0 TC = F + MQ Total cost rises at a constant rate as output rises ATC = F/Q + M M Average costs decline and is always higher than marginal cost

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 19 Costs for Two Computer Game Producers (1) Nintendo Playstation Annual production1,000,000 1,200,000 Fixed cost$200,000 $200,000 Variable cost$800,000 $960,000 Total cost$1,000,000$1,160,000 Average total cost per game $1.00 $0.97 Observations Fixed costs are a relatively small share of total cost Cost/game is nearly the same

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 20 Costs for Two Computer Game Producers (2) Annual production1,000,000 1,200,000 Fixed cost$10,000,000 $10,000,000 Variable cost$200,000 $240,000 Total cost$10,200,000$10,240,000 Average total cost per game $10.20 $8.53 Nintendo Playstation Observations Fixed costs are a relatively large share of total cost Playstation has a $1.67 average cost advantage Playstation can lower prices, cover cost, and attract customers

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 21 Annual production500,000 1,700,000 Fixed cost$10,000,000 $10,000,000 Variable cost$100,000 $340,000 Total cost$10,100,000$10,340,000 Average total cost per game $20.20 $6.08 Costs for Two Computer Game Producers (3) Nintendo Playstation Shift of 500,000 units to Playstation Nintendo’s average cost increases to $20.20/unit Playstation average cost falls to $6.08 A large number of firms cannot survive when the cost differential is high

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 22 Economies of Scale and the Importance of Fixed Costs Fixed investment in research and development has been increasing as a share of production costs %80% %20% Cost of producing a computer Fixed CostVariable Cost SoftwareHardware

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 23 Economies of Scale and the Importance of Fixed Costs Economic Naturalist How big will Playstation’s unit cost advantage be if it sells 2,000,000 units per year, while Nintendo sells only 200,000?

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 24 Economies of Scale and the Importance of Fixed Costs Economic Naturalist Why does Intel sell the overwhelming majority of all microprocessors used in personal computers?

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 25 Profit Maximization for the Monopolist A price taker (perfect competition) and a price setter (imperfect competition) share two economic goals. They want: To maximize profits To select the output level that maximizes the difference between TR and TC, where MB= MC.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 26 Profit Maximization for the Monopolist For a producer MB = Marginal Revenue (MR) or a change in a firm’s total revenue that results from a one-unit change in output

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 27 Profit Maximization for the Monopolist Marginal Revenue for the Monopolist Perfect competition and monopolies  Both increase output when MR > MC.  Calculate MC the same way.  Do not have the same MR at a given price. oIn perfect competition: MR = P oIn monopoly: MR < P

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 28 The Monopolist’s Benefit from Selling an Additional Unit Price ($/unit) Quantity (units/week) D If P = $6, then TR = $6 x 2 = $12 If P = $5, then TR = $5 x 3 = $15 The MR of selling the 3 rd unit = $3 (15-12) For the 3 rd unit, MR = $3 < P = $5

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 29 Observations MR < P MR declines as quantity increases MR is the change between two quantities MR < P because price must be lowered to sell an additional unit PQTRMR 3 1 Marginal Revenue in Graphical Form

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 30 Price & marginal revenue ($/unit) Quantity (units/week) PQTRMR D Marginal Revenue in Graphical Form MR

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 31 The Marginal Revenue Curve for a Monopolist with a Straight-Line Demand Curve Price Quantity Observations The vertical intercept, a, is the same for MR and D The horizontal intercept for MR, Q 0 /2, is one half the demand intercept, Q 0. D Q0Q0 a Q 0 /2 a/2 MR

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 32 Profit Maximization for the Monopolist Profit Maximizing Decision Rule When MR > MC, output should be increased. When MR < MC, output should be reduced. Profits are maximized at the level of output for which MR = MC.

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 33 The Monopolist’s Profit- Maximizing Output Level Price ($/unit of output) Quantity (units/week) 6 D Marginal Cost 2 4 MR 8 Observations If P = $3 & Q = 12 MR < MC and output should be reduced Profits are maximized at 8 units where MR = MC P = $4 where quantity demanded = quantity supplied

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 34 Even a Monopolist May Suffer an Economic Loss Price ($/minute) Minutes (millions/day) Price ($/minute) Minutes (millions/day) ATC ATC Economic loss = $400,000/day Economic profit = $400,000/day D 0.05 MC MR D 0.05 MC MR Being a monopolist doesn’t guarantee an economic profit

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 35 D Marginal cost The socially optimal amount occurs where MC = 12 units The Demand and Marginal Cost Curves for a Monopolist Price ($/unit of output) Quantity (units/week) Why the Invisible Hand Breaks Down Under Monopoly

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide MR 8 The profit maximizing level of output of 8 units, where MR = MC, is less than the socially optimal output of 12 Between 8 and 12, MB to society > MC to society Cannot increase output because MR to the firms is less than MC The Demand and Marginal Cost Curves for a Monopolist Price ($/unit of output) Quantity (units/week) D Why the Invisible Hand Breaks Down Under Monopoly 3 Marginal cost

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide MR 8 Because MR < P, the monopoly produces less than the socially optimal amount The deadweight loss of the monopoly to society = (1/2)($2/unit)(4units/wk) = $4/wk. Deadweight loss The Demand and Marginal Cost Curves for a Monopolist Price ($/unit of output) Quantity (units/week) D Why the Invisible Hand Breaks Down Under Monopoly 3 Marginal cost

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 38 Why the Invisible Hand Breaks Down Under Monopoly Monopoly Profits are maximized where MR = MC. P > MR P > MC Deadweight loss Perfect Competition Profits are maximized where MR = MC. P = MR P = MC No deadweight loss

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 39 Difficulties in Reducing the Deadweight Loss of Monopolies Enforcing antitrust laws Patents, copyrights, and innovation Natural monopolies Why the Invisible Hand Breaks Down Under Monopoly

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 40 Price Discrimination The practice of charging different buyers different prices for essentially the same good or service Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 41 Examples of Price Discrimination Senior citizens and student discounts on movie tickets Supersaver discounts on air travel Rebate coupons Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 42 Economic Naturalist Why do many movie theaters offer discount tickets to students? Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 43 Example How many manuscripts should Carla edit? Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 44 Total and Marginal Revenue from Editing Reservation PriceTotal RevenueMarginal revenue Student($ per paper)($ per week)($ per paper) A4040 B3876 C36108 D34136 E32160 F30180 G28196 H

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 45 Example How many manuscripts should Carla edit?  Opportunity cost = $29  TR = P x Q, or for 4 papers, 4 x $34 = $136/wk  MR is the difference in TR from adding another student  If MR > MC: increase output Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 46 Example How many manuscripts should Carla edit?  Carla edits 3 papers oTC = 3 x $29 = $87 oTR = $108 oEconomic profit = $108 - $87 = $21/wk oAccounting profit = $108 Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 47 Example How many manuscripts should Carla edit?  Opportunity cost = $29  Must charge the same price  Reservation price > opportunity cost for student A to F  Socially efficient number is 6 oTR = 6 x $30 = $180 oTC = 6 x $29 = $174 oEconomic profit = $180- $174 = $6 oAccounting profit = $180 Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 48 Example If Carla can price discriminate, how many papers should she edit?  Assume Carla can charge each student the reservation price. Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 49 Using Discounts to Expand the Market Reservation Studentprice A40 B38 C36 D34 E32 F30 G28 H26 Carla would edit A to F TR = $40 + $38… = $210 TC = 6 x $29 = $174 Economic Profit = $210 - $174 = $36/wk Economic Profit is $30 more

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 50 Using Discounts to Expand the Market Perfectly Discriminating Monopolist Charging each buyer exactly their reservation price  Economic surplus is maximized  Consumer surplus is zero  Economic surplus = producer surplus

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 51 Limitations to Perfect Price Discrimination Seller will not know each buyer’s reservation price. Low price buyers could resell to other buyers at a higher price. Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 52 The Hurdle Method of Price Discrimination Profit-maximizing seller’s goal is to charge each buyer his/her reservation price. Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 53 The Hurdle Method of Price Discrimination There are two problems to implementing this pricing strategy.  Seller does not know the reservation prices  Seller must separate high and low price buyers The hurdle method of price discrimination is used to solve these problems. Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 54 The Hurdle Method of Price Discrimination The practice of offering a discount to all buyers who overcome some obstacle. Example  Offering a rebate to those who mail in a coupon Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 55 A Perfect Hurdle Separates buyers precisely according to their reservation prices What do you think? Is a perfect hurdle possible? Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 56 Question How much should Carla charge for editing if she uses a perfect hurdle? Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 57 Assume Carla offers a mail in rebate coupon Students with at least a $36 reservation price never use the coupon Students with a reservation price below $36 use the coupon Opportunity cost = $29 Discount coupon = $4 Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 58 Price Discrimination with a Perfect Hurdle Reservation PriceTotal RevenueMarginal revenue Student($ per paper)($ per week)($ per paper) A4040 B3876 C36108 D3434 E3264 F3090 G28112 H List Price Submarket Discount Price Submarket

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 59 Solution TR = (3)(36) + (2)(32) = $172 MC = ($5)($29) = $145 Economic Profit = $27/wk Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 60 Question Is price discrimination a bad thing?  The hurdle method raised economic surplus. Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 61 Producer Surplus Single price = 3( ) = $21/wk Discount price = 3( ) = $21/wk 2( ) = $6/wk $27/wk Calculating Economic Surplus Consumer SurplusReservation PriceActual PriceConsumer Surplus A$40$36$4 B$38$36$2 C$36$36$0 Both Single price & discount Without Discount $6 D$34$22$2 With Discount $8 Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 62 Economic Surplus Single price = $6 + $21 = $27/wk Discount price = $8 + $27 = $35/wk Calculating Economic Surplus Consumer SurplusReservation PriceActual PriceConsumer Surplus A$40$36$4 B$38$36$2 C$36$36$0 Both Single price & discount Without Discount $6 D$34$22$2 With Discount $8 Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 63 Question Is Carla’s discount rebate completely efficient? Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 64 Examples of Price Discrimination Temporary Sales Book publishers and paperback books Automobile producers offer various models Commercial air carriers Movie producers Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 65 Economic Naturalist Why might an appliance retailer instruct its clerks to hammer dents into the sides of its stoves and refrigerators? Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 66 Summary Single price monopolies are inefficient because P > MR. The hurdle method of price discrimination reduces the inefficiency. Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 67 Summary The more finely the seller can discriminate, the smaller the efficiency loss. Hurdles are not perfect, therefore, there will be some efficiency loss. Using Discounts to Expand the Market

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 68 Public Policy Toward Natural Monopoly Methods of Controlling Natural Monopolies State ownership and management  Weighing the benefit of marginal cost pricing versus the cost of less incentive for innovation

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 69 Public Policy Toward Natural Monopoly Methods of Controlling Natural Monopolies State regulation of private monopolies  Cost-plus regulation oHigh administrative cost oLess incentive for innovation oP does not equate to MC

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 70 Public Policy Toward Natural Monopoly Methods of Controlling Natural Monopolies Exclusive contracting for natural monopoly  Competition for the contract sets P = MC  Difficulty when fixed costs are high such as electric utilities

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 71 Public Policy Toward Natural Monopoly Methods of Controlling Natural Monopolies Vigorous enforcement of anti-trust laws  Helps prevent cartels  May prevent economies of scale

MBMC Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10: Monopoly and Other Forms of Imperfect Competition Slide 72 Public Policy Toward Natural Monopoly What do you think? Should we regulate natural monopolies?

MBMC End of Chapter End of Chapter