Pure Monopoly

1. 22 Pure Monopoly

2. Chapter Objectives • Characteristics of Pure Monopoly • How Pure Monopoly Sets Profit Maximizing Output and Price • The Economic Effects of Monopoly • Why A Monopolist May Wish to Charge Different Prices in Different Markets

3. O 22.1 Characteristics • Single Seller • No Close Substitutes • “Price Maker” – controls total QS and thus controls price • Blocked Entry • Nonprice Competition • Examples • Regulated Monopolies • Near-Monopolies • Western Union-Frisbee-De Beers • Dual Objectives of Study – studying monopoly also helps understand monopolistic competition and oligopoly

4. Barriers to Entry • Economies of Scale – if economies of scale exists over a long range of output, only a single producer can satisfy consumer demand at least cost • Ex. Entrance into industries such as steel, auto manufacturing… • Legal Barriers to Entry • Patents – exclusive right of inventor to use his/her invention • Ex. Pharmaceuticals, IBM, GE • Licenses • Ex. Taxicab drivers, radio and tv stations • Ownership or Control of Essential Resources • Ex. Inco owning 90% world’s nickel reserves • Pricing and Other Strategic Barriers to Entry

5. Monopoly Demand Three assumptions made: • Monopoly Status is Secure • No Governmental Regulation • Firm is a Single-Price Monopolist – it charges the same price for all units of output (No Price Discrimination)

6. Monopoly Demand • Difference b/w monopoly and pure competition lies on demand side of market • Demand curve for monopolist is the market demand curve since the single seller is the industry • Since market demand is not perfectly elastic, monopolists demand curve is downsloping • No need for side-by-side curves; firm and industry are one and the same

7. 3 Implications of Downward-sloping Demand Curve • 1. MR is less than P • 2. Monopolist is price maker • 3. Monopolist sets prices in the elastic region of demand

8. Implication #1:MR is less than price • MR is less than price (AR) for every level of output except the first unit • Why? • The lower price applies not only to the extra units of output but also to all prior units of output • See p.428 Figure 22.3

9. Implication #2: The Monopolist is a Price Maker • All imperfect competitors face downward-sloping demand curves and are price makers • When a monopolist chooses the volume of output to produce, they are indirectly determining the price they will charge • Through control of output, monopolists can “make the price”

10. Implication #3: The Monopolist Sets Price in the Elastic Region of Demand • Total revenue test reveals that when demand is elastic, a dec. in P will increase TR and vice versa • A monopolist will never choose a price quantity combo that will decrease TR (MR is negative) • To get into inelastic region, monopolist must lower P and increase output • Less TR and higher TC yield lower profit

11. $142 132 122 112 102 92 82 1 2 3 4 5 6 0 Price and Marginal Revenue Marginal Revenue is Less Than Price • A Monopolist is • Selling 3 Units at • $142 • To Sell More (4), • Price Must Be • Lowered to $132 • All Customers • Must Pay the Same • Price • TR Increases $132 • Minus $30 (3x$10) Loss = $30 D Gain = $132

12. $142 132 122 112 102 92 82 1 2 3 4 5 6 0 Price and Marginal Revenue Marginal Revenue is Less Than Price • A Monopolist is • Selling 3 Units at • $142 • To Sell More (4), • Price Must Be • Lowered to $132 • All Customers • Must Pay the Same • Price • TR Increases $132 • Minus $30 (3x$10) • $102 Becomes a • Point on the MR • Curve • Try Other Prices to • Determine Other • MR Points Loss = $30 D Gain = $132 MR The Constructed Marginal Revenue Curve Must Always Be Less Than the Price

13. ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] ] Monopoly Revenue and Costs Revenue and Cost Data of a Pure Monopolist Cost Data Revenue Data (2) Price (Average Revenue) (3) Total Revenue (1) X (2) (1) Quantity Of Output (4) Marginal Revenue (5) Average Total Cost (6) Total Cost (1) X (5) (7) Marginal Cost (8) Profit (+) or Loss (-) 0 1 2 3 4 5 6 7 8 9 10 $172 162 152 142 132 122 112 102 92 82 72 $0 162 304 426 528 610 672 714 736 738 720 $100 190 270 340 400 470 550 640 750 880 1030 $-100 -28 +34 +86 +128 +140 +122 +74 -14 -142 -310 $90 80 70 60 70 80 90 110 130 150 $162 142 122 102 82 62 42 22 2 -18 $190.00 135.00 113.33 100.00 94.00 91.67 91.43 93.75 97.78 103.00 Can you See Profit Maximization?

14. $200 150 Price 100 50 0 2 2 4 4 6 6 8 8 10 10 12 12 14 14 16 16 18 18 $750 500 Total Revenue 250 0 Monopoly Revenue and Costs Demand and Marginal Revenue Curves Elastic Inelastic Demand, Marginal Revenue, and Total Revenue for a Pure Monopolist D MR Total-Revenue Curve TR

15. W 22.1 G 22.1 Monopoly Revenue and Costs • Monopolist is a Price Maker • Sets Price in the Elastic Region • Output and Price Determination • Cost Data • MR = MC Rule • No Supply Curve

16. Output and Price Determination • At what price-quantity combo will a profit-maximizing monopolist choose to operate? • Cost data: same cost data as used in Ch.20-21 • produce output where MR=MC • How to find price? • Draw a vertical line from MR=MC up to Demand curve to find profit-maximizing price

17. 3 Steps for Maximizing Profit in Pure Monopoly • 1. Determine profit-maximizing output where MR=MC • 2. Determine profit-maximizing price by drawing a vertical line upward from the output in Step 1 to the demand curve • 3. Determine profit: TR-TC or profit per unit by P-ATC x quantity

18. $200 175 150 125 Price, Costs, and Revenue 100 75 50 25 1 2 3 4 5 6 7 8 9 10 Quantity Profit Maximization By A Pure Monopolist MC Pm=$122 Economic Profit ATC D A=$94 MR=MC MR 0

19. No Monopoly Supply Curve • The pure monopolist has no S. curve • There is no unique relationship b/w price and QS • Since monopolist does not equate P to MC, it is possible to have different prices for the same output

20. Misconceptions Concerning Monopoly Pricing • Not the Highest Price • Total, Not Unit, Profit • Possibility of Losses

21. Not Highest Price • Since monopolist can manipulate P and Q, there is a misconception that it will charge the highest P possible • Monopolist seeks maximum total profit, NOT maximum price

22. Total, Not Unit, Profit • Monopolist seeks to maximize total profit, not unit profit • Ex. See Table 22.1

23. Possibility of Losses by Monopolist • Likelihood of economic profit is greater for pure monopolist than pure competitor • In LR, pure competitor will only have normal profit, economic profit can persist by monopolist since there will be no entrance of new firms • Pure monopoly does not guarantee profit. Profit can be affected by changes in demand and changing cost curves • If D curve (price) is lower than ATC, firm experiences losses

24. Price, Costs, and Revenue Quantity Loss Minimization By A Pure Monopolist MC ATC A Loss Pm AVC V D MR=MC MR 0 Qm

25. Economic Effects of Monopoly • Price, Output and Efficiency • Since the firm IS the industry, market and individual demand are same for monopolist • Monopoly yields neither productive nor allocative efficiency • Price exceeds min ATC, price is higher than MC • An efficiency loss occurs (total economic surplus is not maximized)

26. Economic Effects of Monopoly Price, Output, and Efficiency Pure Monopoly Purely Competitive Market S=MC MC b Pm P=MC= Minimum ATC c Pc Pc a D D MR Qc Qm Qc Pure Competition is Efficient Monopoly Price is Greater Than MC And Is Therefore Inefficient

27. Economic Effects of Monopoly Price, Output, and Efficiency • Income Transfer • Cost Complications • Economies of Scale • Simultaneous Consumption • Network Effects

28. Income Transfer • Monopoly transfers income from consumers to stockholders who own the monopoly • Monopolies benefit at the expense of consumers who overpay for the products

29. Cost Complications • Pure monopoly will charge higher P, produce less output, and allocate resources less efficiently than a purely competitive firm • In reality, costs may differ for monopolistic producers • Why? • 1. economies of scale • 2. X-inefficiency • 3. need for monopoly-preserving expenditures • 4. the “very long run” perspective

30. Economies of Scale • Due to extensive economies of scale, an industry of one or two firms may produce at lower ATC than industry of several firms • Ex. natural monopoly • Simultaneous consumption – ability of a product to satisfy large # consumers at same time • Network effects – increases in the value of products to each user as the total number of users rises (Ex. Internet, cell phones)

31. X-Inefficiency • Occurs when a firm produces output at higher than lowest possible cost of producing it • Result of “bad management” of firm • Lack of pressure from competition

32. O 22.3 X ATCX Average Total Cost Average Total Costs ATC1 X’ ATCX’ ATC2 Q1 Q2 Quantity Economic Effects of Monopoly • X-Inefficiency • Rent-Seeking Expenditures • Rent-Seeking Behavior • Technological Advance • Assessment and Policy Options

33. Rent-Seeking Expenditures and Technological Advance • Rent-Seeking behavior – any activity designed to transfer income or wealth to a firm at someone else’s expense • Firm may go to great expense to acquire or maintain right to monopoly • Technological advance – general view of economists that monopolist will not be technologically progressive

34. GLOBAL PERSPECTIVE Economic Effects of Monopoly Representative Highly Competitive Foreign Multinational Corporations Main Products Company (Country) Chemicals Gasoline Tires Computers Food Products Wireless Phones Gasoline Electronics Electronics Automobiles Food Products Bayer (Germany) BP Amoco (United Kingdom Michelin (France) NEC (Japan) Nestlé (Switzerland) Nokia (Finland) Royal Dutch/Shell (Netherlands) Royal Philips (Netherlands) Sony (Japan) Toyota (Japan) Unilever (Netherlands) Source: Fortune.com

35. O 22.4 Price Discrimination • The practice of selling a specific product at more than one price when the price differences are not justified by cost differences • Three Forms • Charging Each Customer the Maximum They Are Willing to Pay • Charging Each Customer One Price For The First Set of Units Purchased and a Lower Price for Subsequent Units • Charging Some Customers One Price and a Different Price for Other Customers

36. W 22.1 Price Discrimination • Conditions • Monopoly Power – some ability to control output and price • Market Segregation – firm must be able to classify buyers based on willingness to pay for product • No Resale • Examples of Price Discrimination • Airfares – fares for business travelers vs. vacationers • Electric Utilities • Theaters & Golf Courses – vary prices by price and age of consumers • See p.438 for graphical analysis

37. Regulated Monopoly • Natural Monopolies – subject to rate regulation • Rate Regulation • Socially Optimum Price – price that achieves allocative efficiency P = MC • Fair Return Price – if socially optimal price leads to loss for firm, regulatory agencies may establish fair-return price P = ATC

38. Price and Costs (Dollars) 0 Quantity Regulated Monopoly Dilemma of Regulation Monopoly Price Pm Fair-Return Price Socially Optimal Price f Pf a ATC Pr r MC D MR b Qm Qf Qr

39. De Beers Diamonds Are Monopolies Forever? Last Word • 66 Year Policy of Monopolizing the Diamond Trade • Mid-2000 Abandoned Monopoly Efforts • Decline in Number of Select Dealers and Cutters • Classic Monopoly Behavior • Pricing • Single-Channel Marketing

40. De Beers Diamonds Are Monopolies Forever? Last Word • End of an Era • New Diamond Discoveries-Angola, Canada • Australian Producer Withdrew • Bad Press and Public Perception Over Civil Strife Financing Role • Becoming Cartel of Specialized High-End Diamonds • Monopoly Didn’t Last Forever!