1. IMBA NCCU Managerial Economics Jack Wu
Monopoly
IMBA NCCU
Managerial Economics
Jack Wu

2. MARKET Pure (Perfect) competition – least freedom in pricing
Monopolistic competition
Medical clinic
Oligopoly
Hospital
anti-virus software, microcomputer operating system
Monopoly – single supplier of good or a service with no close substitute: most freedom in pricing
[IP] 08mono-ap-wo.ppt

3. 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 buyers

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

5. 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)

6. REVENUE, COST, AND PROFIT

7. Monopoly: Profit Maximum, I
Operate at scale where
marginal revenue = marginal cost
Justification:
If marginal revenue > marginal cost, sell more and increase profit.
If marginal revenue < marginal cost, sell less and increase profit.

8. Operating Scale: Profit Maximum

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

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

11. 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

12. 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?

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

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

15. PROZAC: ADVERTISING Competition from generics would
reduce incremental margin
raise advertising elasticity

16. 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?

17. 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)

18. 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

19. Advertising IBM USD 89,131 1,406 1.6% Anheuser Busch 15,036 850 5.7%
Industry/Company
Curr.
Sales
Advertg
Ratio
IBM
USD
89,131
1,406
1.6%
Anheuser Busch
15,036
850
5.7%
Fosters
AUD
3,972
380
9.6%
Microsoft
32,187
1,060
3.3%
General Mills
11,244
477.0
4.2%
Kellogg
10,177
858.0
8.4%
SAP
EUR
7,025
162
2.3%
Unilever
39,672
4,999
12.6%
Units: millions *
The book, p.210

20. Research and Development
The profit maximizing R&D/sales ratio is the incremental margin percentage x the R&D elasticity of demand
R&D/sales should be raised if price is higher, marginal cost is lower, or if the R&D elasticity is higher

21. R&D Sales Ratios (2005) Company Units (million) Sales Rev R&D exp
General Mills
USD
11,244
168
1.5%
Kellogg
10,177
181
1.8%
Unilever
EUR
39,672
953
2.4%
IBM
91,134
5,842
6.4%
Microsoft
39,788
6,184
15.5%
SAP
8,512
1,089
12.8%

22. MARKET STRUCTURE, I (a) Perfect Competition (b) Monopoly demand demand60
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)

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

24. 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

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

26. MONOPSONY SCALE marginal expenditure supply Price ($ per ton)
400
supply
350
Price ($ per ton)
273
marginal benefit 6 8
Quantity (Thousand tons a year)