Monopoly

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Lecture 9

• Monopoly

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Pure Monopoly

• A monopolized market has a single seller.
• The monopolists demand curve is the (downward
  sloping) market demand curve.
• So the monopolist can alter the market price by
  adjusting its output level.

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Pure Monopoly
/output unit
Higher output q causes alower market price, p(q).
p(q)
Output Level, q
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Why Monopolies?

• What causes monopolies?
• Government intervention

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Why Monopolies?

• What causes monopolies?
• government intervention
• a patent e.g. a new drug

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Why Monopolies?

• What causes monopolies?
• government intervention
• a patent e.g. a new drug
• sole ownership of a resource e.g. a toll highway

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Why Monopolies?

• What causes monopolies?
• government intervention
• a patent e.g. a new drug
• sole ownership of a resource e.g. a toll highway
• formation of a cartel e.g. OPEC

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Why Monopolies?

• What causes monopolies?
• government intervention
• a patent e.g. a new drug
• sole ownership of a resource e.g. a toll highway
• formation of a cartel e.g. OPEC
• large economies of scale e.g. local utility
  companies.

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Pure Monopoly

• Suppose that the monopolist seeks to maximize its
  economic profit,
• What output level q maximizes profit?

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TR,TC
TC
TR
q
p
? max
q
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p
q
MR,MC
MC
MR
q
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Markup pricing
/output unit
p(q)
p(q)
MC(q)
q
q
MR(q)
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The Inefficiency of Monopoly
/output unit
The efficient output levelqe satisfies p(q)
MC(q).
p(q)
MC(q)
p(qe)
q
qe
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The Inefficiency of Monopoly
/output unit
The efficient output levelqe satisfies p(q)
MC(q).
p(q)
CS
MC(q)
p(qe)
q
qe
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The Inefficiency of Monopoly
/output unit
The efficient output levelqe satisfies p(q)
MC(q).
p(q)
CS
MC(q)
p(qe)
PS
q
qe
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The Inefficiency of Monopoly
/output unit
p(q)
p(q)
MC(q)
q
q
MR(q)
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The Inefficiency of Monopoly
/output unit
p(q)
CS
p(q)
MC(q)
q
q
MR(q)
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The Inefficiency of Monopoly
/output unit
p(q)
CS
p(q)
MC(q)
PS
q
q
MR(q)
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The Inefficiency of Monopoly
The monopolist produces less than the efficient
quantity, making the market price exceed the
efficient market price.
/output unit
p(q)
p(q)
MC(q)
DWL
p(qe)
q
q
qe
MR(q)
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Natural Monopoly

• A natural monopoly arises when the firms
  technology has economies-of-scale large enough
  for it to supply the whole market at a lower
  average total production cost than is possible
  with more than one firm in the market.

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Natural Monopoly
/output unit
ATC(q)
p(q)
MC(q)
q
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Natural Monopoly
/output unit
ATC(q)
p(q)
p(q)
MC(q)
q
q
MR(q)
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Entry Deterrence by a Natural Monopoly

• A natural monopoly deters entry by threatening
  predatory pricing against an entrant.
• A predatory price is a low price set by the
  incumbent firm when an entrant appears, causing
  the entrants economic profits to be negative and
  inducing its exit.

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Entry Deterrence by a Natural Monopoly

• E.g. suppose an entrant initially captures
  one-quarter of the market, leaving the incumbent
  firm the other three-quarters.

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Entry Deterrence by a Natural Monopoly
/output unit
ATC(q)
p(q), total demand DI DE
DE
DI
MC(q)
q
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Entry Deterrence by a Natural Monopoly
/output unit
An entrant can undercut theincumbents price
p(q) but ...
ATC(q)
p(q), total demand DI DE
DE
p(q)
DI
pE
MC(q)
q
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Entry Deterrence by a Natural Monopoly
/output unit
An entrant can undercut theincumbents price
p(q) but
ATC(q)
p(q), total demand DI DE
the incumbent can then lower its price as
far as pI, forcing
the entrant
to exit.
DE
p(q)
DI
pE
pI
MC(q)
q
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Inefficiency of a Natural Monopolist

• Like any profit-maximizing monopolist, the
  natural monopolist causes a deadweight loss.

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Inefficiency of a Natural Monopoly
/output unit
ATC(q)
p(q)
p(q)
MC(q)
q
q
MR(q)
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Inefficiency of a Natural Monopoly
/output unit
ATC(q)
Profit-max MR(q) MC(q) Efficiency p MC(q)
p(q)
p(q)
MC(q)
p(qe)
q
qe
q
MR(q)
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Inefficiency of a Natural Monopoly
/output unit
ATC(q)
Profit-max MR(q) MC(q) Efficiency p MC(q)
p(q)
p(q)
DWL
MC(q)
p(qe)
q
qe
q
MR(q)
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Regulating a Natural Monopoly

• Why not command that a natural monopoly produce
  the efficient amount of output?
• Then the deadweight loss will be zero, wont it?

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Regulating a Natural Monopoly
/output unit
At the efficient outputlevel qe, ATC(qe) gt p(qe)
ATC(q)
p(q)
MC(q)
ATC(qe)
p(qe)
qe
q
MR(q)
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Regulating a Natural Monopoly
/output unit
At the efficient outputlevel qe, ATC(qe) gt
p(qe)so the firm makes aneconomic loss.
ATC(q)
p(q)
MC(q)
ATC(qe)
Economic loss
p(qe)
qe
q
MR(q)
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Regulating a Natural Monopoly

• So a natural monopoly cannot be forced to use
  marginal cost pricing. Doing so makes the firm
  exit, destroying both the market and any
  gains-to-trade.
• Regulatory schemes can induce the natural
  monopolist to produce the efficient output level
  without exiting.

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How Should a Monopoly Price?

• So far a monopoly has been thought of as a firm
  which has to sell its product at the same price
  to every customer. This is uniform pricing.
• Can price-discrimination earn a monopoly higher
  profits?

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Types of Price Discrimination

• 1st-degree Each output unit is sold at a
  different price. Prices may differ across
  buyers.
• 3rd-degree Price paid by buyers in a given group
  is the same for all units purchased. But price
  may differ across buyer groups.E.g., senior
  citizen and student discounts vs. no discounts
  for middle-aged persons.

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First-degree Price Discrimination

• Each output unit is sold at a different price.
  Price may differ across buyers.
• It requires that the monopolist can discover the
  buyer with the highest valuation of its product,
  the buyer with the next highest valuation, and so
  on.

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First-degree Price Discrimination
/output unit
Sell the th unit for
MC(q)
p(q)
q
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First-degree Price Discrimination
/output unit
Sell the th unit for Later onsell
the th unit for
MC(q)
p(q)
q
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First-degree Price Discrimination
/output unit
Sell the th unit for Later onsell
the th unit for Finally
sell the th unit for marginal
cost,
MC(q)
p(q)
q
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First-degree Price Discrimination
The gains to the monopoliston these trades
areand zero.
/output unit
MC(q)
p(q)
q
The consumers gains are zero.
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Third-degree Price Discrimination

• Price paid by buyers in a given group is the same
  for all units purchased. But price may differ
  across buyer groups.

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Third-degree Price Discrimination

• A monopolist manipulates market price by altering
  the quantity of product supplied to that market.
• So the question What discriminatory prices will
  the monopolist set, one for each group? is
  really the question How many units of product
  will the monopolist supply to each group?

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Third-degree Price Discrimination

• Two markets, 1 and 2.
• q1 is the quantity supplied to market 1. Market
  1s inverse demand function is p1(q1).
• q2 is the quantity supplied to market 2. Market
  2s inverse demand function is p2(q2).
• The monopolists profit is the sum of profits in
  both markets. What quantities sold maximize this
  profit?

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Third-degree Price Discrimination
Market 1
Market 2
p1(q1)
p2(q2)
p1(q1)
p2(q2)
MC
MC
q1
q2
q1
q2
MR1(q1)
MR2(q2)
MR1(q1) MR2(q2) MC, p1(q1)?p2(q2)