Professional Documents
Culture Documents
Topics to be Discussed
Monopoly and Monopoly Power
Sources of Monopoly Power
The Social Costs of Monopoly Power
Capturing Consumer Surplus
Price Discrimination
Two part tariff, peak load pricing,
bundling, intertemporal pricing
P
D
P
S
Individual Firm
LMC
P0
P0
Q0
2005 Pearson Education, Inc.
LRAC
D = MR = P
q0
Q
4
Monopoly
Monopoly
1.
2.
3.
4.
Monopoly
The monopolist is the supply-side of the
market and has complete control over
the amount offered for sale.
Monopolist controls price but must
consider consumer demand
Profits will be maximized at the level of
output where marginal revenue equals
marginal cost.
2005 Pearson Education, Inc.
P=6-Q
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10
7
6
5
Average Revenue (Demand)
4
3
2
1
Marginal
Revenue
7 Output
11
Monopoly
Observations
1. To increase sales the price must fall
2. MR < P
3. Compared to perfect competition
No change in price to change sales
MR = P
12
13
14
MC
P1
P*
AC
P2
Lost
profit
D = AR
MR
Q1
2005 Pearson Education, Inc.
Q*
Q2
Lost
profit
Quantity
15
Monopoly: An Example
Cost C (Q ) 50 Q 2
C
MC
2Q
Q
Demand : P (Q ) 40 Q
R(Q ) P (Q )Q 40Q Q 2
R
MR
40 2Q
Q
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16
Monopoly: An Example
MC MR
2Q 40 2Q
4Q 40
P (Q ) 40 Q
P (Q ) 40 10
P (Q ) 30
Q 10
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17
Monopoly: An Example
By setting marginal revenue equal to
marginal cost, we verified that profit is
maximized at P = $30 and Q = 10.
This can be seen graphically by plotting
cost, revenue and profit
Profit is initially negative when produce little
or no output
Profit increase and q increase, maximized at
Q*=10
2005 Pearson Education, Inc.
18
r'
400
R
When profits are
maximized, slope of
rr and cc are equal:
MR=MC
300
c
200
r
Profits
150
100
50
0
c
5
10
15
20 Quantity
19
40
Profit = (P - AC) x Q
= ($30 - $15)(10) =
$150
MC
P=30
AC
Profit
20
AR
AC=15
10
MR
0
10
15
20
Quantity
20
Monopoly
Monopoly pricing compared to perfect
competition pricing:
Monopoly
P
> MC
Price is larger than MC by an amount that
depends inversely on the elasticity of demand
Perfect
Competition
= MC
Demand is perfectly elastic so P=MC
21
Monopoly
If demand is very elastic, there is little
benefit to being a monopolist
The larger the elasticity, the closer to a
perfectly competitive market
Notice a monopolist will never produce a
quantity in the inelastic portion of
demand curve
In inelastic portion, can increase revenue by
decreasing quantity and increasing price
22
Shifts in Demand
In perfect competition, the market supply
curve is determined by marginal cost.
For a monopoly, output is determined by
marginal cost and the shape of the
demand curve.
There
23
Shifts in Demand
Shifts in demand do not trace out price
and quantity changes corresponding to a
supply curve
Shifts in demand lead to
Changes in price with no change in output
Changes in output with no change in price
Changes in both price and quantity
24
Shifts in Demand
$/Q
MC
P1
P2
Shift in
demand leads
to change in
price but same
quantity
D2
D1
MR2
MR1
Q1= Q2
Quantity
25
Shifts in Demand
$/Q
MC
P1 = P 2
D2
Shift in
demand leads
to change in
quantity but
same price
MR2
D1
MR1
Q1
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Q2
Quantity
26
Monopoly
Shifts in demand usually cause a change
in both price and quantity.
Example show how monopolistic market
differs from perfectly competitive market
Competitive market supplies specific
quantity a every price
This relationship does not exist for a
monopolistic market
27
Monopoly Power
Pure monopoly is rare.
However, a market with several firms,
each facing a downward sloping demand
curve will produce so that price exceeds
marginal cost.
Firms often product similar goods that
have some differences thereby
differentiating themselves from other
firms
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28
29
$/Q
At a market price
of $1.50, elasticity of
demand is -1.5.
2.00
2.00
1.60
1.50
MCA
1.50
1.40
DA
Market
Demand
1.00
MRA
1.00
10,000
20,000
30,000
Quantity
3,000
5,000
7,000
QA
Chapter 10
31
The
L is expressed in terms of Ed
= (P - MC)/P = -1/Ed
Ed
32
Monopoly Power
Monopoly power, however, does not
guarantee profits.
Profit depends on average cost relative
to price.
One firm may have more monopoly
power, but lower profits due to high
average costs
33
MC
P
1 1 Ed
34
$/Q
P*
MC
MC
P*
P*-MC
P*-MC
MR
D
MR
Q*
Quantity
Q*
Quantity
1.11( MC )
1 1 .1 0.9
5. Prices set about 10 - 11% above MC.
36
1.25(MC )
1 1 5 0.8
5. Prices set about 25% above MC.
37
38
39
40
41
Number of Firms
The monopoly power of a firm falls as the
number of firms increases all else equal
More important are the number of firms with
significant market share
Market is highly concentrated if only a few
firms account for most of the sales
42
43
44
45
Pm
A
MC
Because of the
higher price,
consumers lose
A+B and
producer gains
A-C.
PC
AR=D
MR
Qm
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QC
Quantity
46
Externality
When one
persons actions
imposes a cost or
benefit on the
well-being of a
bystander.
Externalities
usually result in
market failure.
2005 Pearson Education, Inc.
2) Negative: an external
cost is imposed on
someone. (examples: exhaust
from autos, barking dogs, noise
from airplanes)
Externalities
Externalities cause markets to
allocate resources inefficiently.
This happens through:
1) CONSUMPTION: consuming a good
results in externality.
2) PRODUCTION: producing a good
results in externality.
2005 Pearson Education, Inc.
Externalities
50
Introduction
Pricing without market power (perfect
competition) is determined by market
supply and demand.
The individual producer must be able to
forecast the market and then concentrate
on managing production (cost) to
maximize profits.
Chapter 11
52
Introduction
Pricing with market power (imperfect
competition) requires the individual
producer to know much more about the
characteristics of demand as well as
manage production.
Chapter 11
53
Chapter 11
54
P1
P*
P2
MC
PC
Q*
2005 Pearson Education, Inc.
MR
Chapter 11
Quantity
55
Chapter 11
56
Price Discrimination
First Degree Price Discrimination
Charge a separate price to each customer: the
maximum or reservation price they are willing to pay.
Area
between MR and MC
Chapter 11
57
Price Discrimination
If the firm can perfectly price
discriminate, each consumer is charged
exactly what they are willing to pay.
MR curve is not longer part of output
decision
Incremental revenue is exactly the price at
which each unit is sold the demand curve
Additional profit from producing and selling
an incremental unit is now the difference
between demand and marginal cost
2005 Pearson Education, Inc.
Chapter 11
58
MC
P*
PC
D = AR
MR
Q*
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Q**
Chapter 11
Quantity
59
Chapter 11
60
Chapter 11
61
First-Degree Price
Discrimination in Practice
Six prices exist resulting
in higher profits. With a single price
P*4, there are fewer consumers.
$/Q
P1
P2
P3
MC
P*4
Discriminating up to
P6 (competitive price)
will increase profits
P5
P6
Q*
2005 Pearson Education, Inc.
MR
Chapter 11
Quantity
62
Second-Degree Price
Discrimination
In some markets, consumers purchase
many units of a good over time
Demand for that good declines with
increased consumption
Electricity,
63
Second-Degree Price
Discrimination
Quantity discounts are an example of
second-degree price discrimination
Ex: Buying in bulk like at Sams Club
64
Without discrimination: P
= P0 and Q = Q0. With
second-degree
discrimination there are
three blocks with prices
P1, P2, & P3.
P1
P0
P2
AC
MC
P3
D
MR
Q1
1st Block
2005 Pearson Education, Inc.
Q0
2nd Block
Q2
Q3
Quantity
3rd Block
65
66
Price Discrimination
Third Degree Price Discrimination
Most common type of price
discrimination.
Examples: airlines, premium v. non-premium
liquor, discounts to students and senior
citizens, frozen v. canned vegetables.
Chapter 9
67
68
Chapter 11
69
Third-Degree Price
Discrimination
Algebraically
P1: price first group
P2: price second group
C(QT) = total cost of producing output
Q T = Q1 + Q 2
Profit: = P1Q1 + P2Q2 - C(QT)
Chapter 11
70
Third-Degree Price
Discrimination
First group of consumers:
MR1= MC
Chapter 11
71
Third-Degree Price
Discrimination
Determining relative prices
Thinking of relative prices that should be
charged to each group of consumers and
relating them to price elasticities of demand
may be easier.
MR P 1 1 Ed
Then : MR1 P1 (1 1 E1 ) MR2 P2 (1 1 E2 )
E1 and E2 elasticites of demand for each group
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72
D2 = AR2
MRT
MR2
MR1
2005 Pearson Education, Inc.
D1 = AR1
Quantity
73
MC = MR1 at Q1 and P1
P1
QT: MC = MRT
Group 1: more inelastic
Group 2: more elastic
MR1 = MR2 = MCT
QT control MC
MC
P2
D2 = AR2
MCT
MRT
MR2
D1 = AR1
MR1
Q1
Q2
Chapter 11
QT
Quantity
74
75
$/Q
MC
P*
D2
MC=MR1
=MR2
MR2
MR1
D1
Q*
Quantity
76
77
Intertemporal Price
Discrimination
Once this market has yielded a
maximum profit, firms lower the price to
appeal to a general market with a more
elastic demand.
This can be seen graphically looking at
two different groups of consumers one
willing to buy right now and one willing to
wait.
78
Intertemporal Price
Discrimination
$/Q
P1
P2
D2 = AR2
AC = MC
MR1
Q1
2005 Pearson Education, Inc.
MR2
D1 = AR1
Q2
Quantity
79
80
Peak-Load Pricing
Objective is to increase efficiency by
charging customers close to marginal
cost
Increased MR and MC would indicate a
higher price.
Total surplus is higher because charging
close to MC
Can measure efficiency gain from peak-load
pricing
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81
Peak-Load Pricing
With third-degree price discrimination,
the MR for all markets was equal
MR is not equal for each market because
one market does not impact the other
market with peak-load pricing.
Price and sales in each market are
independent
Ex: electricity, movie theaters
82
Peak-Load Pricing
$/Q
MC
P1
D1 = AR1
P2
MR1
D2 = AR2
MR2
Q2
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Q1
Quantity
83
Bundling
When film company leased Gone with
the Wind it required theaters to also
lease Getting Gerties Garter.
Why would a company do this?
Company must be able to increase revenue.
We can see the reservation prices for each
theater and movie.
84
85
86
P*
MC
D
Quantity
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