MONOPOLY

IMBA NCCU
Managerial Economics
Jack Wu
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
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

SOURCES OF MARKET POWER
 unique resources
 human
 natural
 intellectual property
 patent
 Copyright
 economies of scale / scope
 product differentiation
 government regulation
 MONOPOLY: MARGINAL REVENUE AND
PRICE

250

infra-marginal
units
150
Price ($ per unit)

130
demand (marginal benefit)

70
marginal revenue
50

0.4 0.8 1.2 1.4 1.6 2

-50
Quantity (Million units a year)
REVENUE, COST, AND PROFIT
Total Marginal Total Marginal
Price Revenue Revenue Cost ($) Cost Profit
($) Sales ($) ($) ($) ($)
200 0.0 0 50 -50
190 0.2 38 190 52 10 -40
180 0.4 72 170 56 20 16
170 0.6 102 150 62 30 40
160 0.8 128 130 70 40 58
150 1.0 150 110 80 50 70
140 1.2 168 90 92 60 76
130 1.4 182 70 106 70 76
120 1.6 192 50 122 80 70
110 1.8 198 30 140 90 58
100 2.0 200 10 160 100 40
90 2.2 198 -10 182 110 16
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.
OPERATING SCALE:
PROFIT MAXIMUM
MONOPOLY: PROFIT MAXIMUM, III
 contribution margin = total revenue less variable cost
 profit-maximizing scale: selling additional unit does not
change the contribution margin
DEMAND CHANGE
Find new scale where marginal revenue = marginal cost
 should change price

 new scale and price depend on both new demand and

costs
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
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?
ADVERTISING
 benefit of advertising -- increment in contribution
margin
 advertising elasticity = % increase in demand from 1%
increase in advertising
ADVERTISING: PROFIT MAXIMUM
Profit-maximizing advertising/sales = incremental margin
x advertising elasticity
• incremental margin = (price - MC)
PROZAC: ADVERTISING
Competition from generics would
 reduce incremental margin

 raise advertising elasticity

COKE VS PEPSI, NOV. 1999
 Coke
 raised prices by 7%
 increased advertising and other marketing

 Pepsi
 raisedprice by 6.9%
 what about advertising?
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)
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

 ADVERTISING

Industry/Company Curr. Sales Advertg Ratio

IBM USD 89,131 1,406 1.6%

Anheuser Busch USD 15,036 850 5.7%
Fosters AUD 3,972 380 9.6%
Microsoft USD 32,187 1,060 3.3%

General Mills USD 11,244 477.0 4.2%

Kellogg USD 10,177 858.0 8.4%
SAP EUR 7,025 162 2.3%
Unilever EUR 39,672 4,999 12.6%
Units: millions
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
R&D SALES RATIOS (2005)

Company Units Sales Rev R&D exp R&D/sales

(million)
General USD 11,244 168 1.5%
Mills
Kellogg USD 10,177 181 1.8%
Unilever EUR 39,672 953 2.4%
IBM USD 91,134 5,842 6.4%
Microsoft USD 39,788 6,184 15.5%
SAP EUR 8,512 1,089 12.8%
 MARKET STRUCTURE, I
(a) Perfect (b) Monopoly
Competition
demand

demand 60
Price (Cents per unit)

Price (Cents per unit)

marginal
30 30
supply cost

marginal revenue

0 300 0 150

Quantity (Million units a year) Quantity (Million units a year)

MARKET STRUCTURE, II
Relative to competitive market, monopoly
 sets higher price

 produces less

 earns higher profit

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
MONOPSONY
 buyer with market power restricts purchases to depress
price
 trades off

 marginal expenditure
 marginal benefit
 MONOPSONY SCALE

marginal expenditure

400
Price ($ per ton)

supply
350

273
marginal benefit

0 6 8

Quantity (Thousand tons a year)