1. UBEA 1013: ECONOMICS 1 CHAPTER 6: MARKET STRUCTURE: MONOPOLY 6.1 Characteristic 6.2 Short-run Decision: Profit Maximization 6.3 Short-run Decision: Minimizing Loss 6.4 Long-run Profit Maximization & Misconception 6.5 Social Cost of Monopoly 6.6 Natural Monopoly

2. UBEA 1013: ECONOMICS 2 Monopolies:  the firm almost totally dominated the market with its competitor hardly provide competition or their products are hardly substitutable.  E.g. included collusion or cartel: Organization of Petroleum Exporting Countries (OPEC), DeBeer, Microsoft, Tenaga Nasional. What is monopoly or can be considered a monopoly?

3. UBEA 1013: ECONOMICS 3 i. One firm: Firm supply is equal to the whole market/industry supply. ii. No close substitute : Unique product with no competition. iii. Price maker : Monopoly can influence either the market price or quantity supplied. Constraint by demand behavior of consumers. iv. Barriers to entry : Heavy restrictions or barriers. Barrier to entry is legal or natural constraints that protect a firm from potential competitors. Market power: “One firm”, “no close substitute” & “barriers to entry” give market power to monopoly (to be a “price maker”). (i)monopolist can choose a price -- consumers choose how much they wish to buy at that price (ii)monopolist can choose the quantity, letting the consumers to decide what price they will pay for that quantity 6.1 Characteristic

4. UBEA 1013: ECONOMICS 4 a. Government franchises, or firms that become monopolies by virtue of a government directive; b. Patents, copyrights or barriers that grant the exclusive use of the patented product or process to the inventor; c. Economies of scale and other cost advantages enjoyed by industries that have large capital requirements. A large initial investment, or the need to embark in an expensive advertising campaign, deter would-be entrants to the industry; d. Ownership of a scarce factor of production: If production requires a particular input, and one firm owns the entire supply of that input, that firm will control the industry. Further on the forth assumption, barriers to entry include: 6.1 Characteristic

5. UBEA 1013: ECONOMICS 5 Figure 6.1: Monopolist’s Demand, MR & TR Curve 6.1 Characteristic  Monopolist’s marginal revenue is below the demand.  The MR curve shows the change in TR. TR is maximum when marginal revenue equals zero.  The MR is twice as steep as the demand curve.

6. UBEA 1013: ECONOMICS 6 6.2 Short-run Decision: Profit Maximization If MR < MC, it would pay for the firm to decrease output as the saving in cost would be bigger than loss in revenue If the MR > MC, additional revenue will more than additional cost, thus it would be better off for the firm to increase output The only point where the firm has no incentive to change output is where the MR = MC [ Optimization condition for monopoly = perfect competition ] ((Only that in perfect competition: P = MR))

7. UBEA 1013: ECONOMICS 7 6.2 Short-run Decision: Profit Maximization The profit-maximizing level of output (Q m ) occurs where MR = MC. Notice that the outcome is different from that of perfect competition. Here, the price ($4.00) is more than the average total cost ($3.00), and the monopolist earns positive economic profit of ($4 - $3 = $1) per unit.

8. UBEA 1013: ECONOMICS 8 If average revenue less than average total cost, a firm suffer losses. Despite having market power, the monopolist still constraint to either setting the price or output only, not both. Therefore, monopolist is also subject to the three profit- maximization situation as in perfect competition structure that is incurring economic profit, economic loss or breakeven situations. 6.3 Short-run Decision: Minimizing Loss

9. UBEA 1013: ECONOMICS 9 If the operating profit is negative (TR < TVC), the monopoly suffers operating losses that push total losses above fixed costs. So, it is better to shut down. Summary: TR > TVC: Decision = Keep operating (in short term) TR < TVC: Decision = Shut down Those decisions is known as minimizing losses. 6.3 Minimizing loss >>

10. UBEA 1013: ECONOMICS 10 Figure 6.2: Profit Maximization Situations 6.3 Minimizing loss (a) Economic profit (b) Economic loss

11. UBEA 1013: ECONOMICS 11 6.4 Long-run Profit Maximization & Misconception TrueMisconception Monopolist CAN earn positive economic profit in the long run. Monopolist ALWAYS earn positive economic profit in the long run. Monopolist seek to maximize PROFIT. Monopolist seek to maximize PRICE. Monopolist has BOTH good and bad to the market/society. Monopolist ALWAYS bad to the market/society.

12. UBEA 1013: ECONOMICS 12 6.5 Social Cost of Monopoly There are three type of social cost of monopoly as follow: a) Deadweight loss as result of not producing at price equal to marginal cost like in perfect competitive market structure; b) Rent-seeking behavior to preserve positive profits; and c) Price discrimination behavior that transfer income or surplus from consumers to the monopolist. To be continue next week …..

13. UBEA 1013: ECONOMICS 13 A) Deadweight loss From consumer surplus to monopoly surplus From consumer surplus to nobody From producer surplus to nobody

14. UBEA 1013: ECONOMICS 14 B) Rent Seeking

15. UBEA 1013: ECONOMICS 15 C) Price Discrimination Definition: Charging different prices to different buyers or different prices on different units sold is called price discrimination. First-degree price discrimination Second-degree price discrimination Third-degree price discrimination

16. UBEA 1013: ECONOMICS 16 The monopolist sells different units of output for different prices and these prices may differ person to person. First-degree price discrimination Perfect price discrimination – each unit of output is sold at the maximum price that individual (consumer) is willing to pay for it What happen to consumer surplus?????

17. UBEA 1013: ECONOMICS 17 First-degree price discrimination Need information on the maximum each consumer willing to pay.

18. UBEA 1013: ECONOMICS 18 The monopolist sells at different price per unit of output, depending on how much a consumer buys Second-degree price discrimination Non-linear pricing. NO need information on the maximum each consumer willing to pay. ONLY to construct “price- quantity” package.

19. UBEA 1013: ECONOMICS 19 The monopolist sells to different group of consumer with different price but every unit of product sold to a given group is sold at same price Third-degree price discrimination Most common.

20. UBEA 1013: ECONOMICS 20 Products are sell in bundle. Other types of discrimination: Bundling Table 6.1: Bundling and Willingness to Pay Type of consumer Word Processor (WP) Spreadsheet (Sp) (Sp)Total Reve nue Type A $200$150 Type B $150$200 Scenario: Total sales (WP) Total sales (Sp) (i) Individual price (WP $150, Sp $150) 2*$150 = $300 $600 (ii) Individual price (WP $200, Sp $200) 1*$200 = $200 $400 (iii) Individual price (WP $150, Sp $200) 2*$150 = $300 1*$200 = $200 $500 (iv) Individual price (WP $200, Sp $150) 1*$200 = $200 2*$150 = $300 $500 (v) Bundle price ($350) 2*$350 = $700

21. UBEA 1013: ECONOMICS 21 Two kind of pricing for two related product: e.g. a)Entrance and ride price b)Camera and films price c)Razor price & blade price Other types of discrimination: Two-Part Tariff

22. UBEA 1013: ECONOMICS 22 6.6 Natural Monopoly A natural monopoly is an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient. End