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Chapter 10

Chapter 10 Monopoly, Cartels, and Price Discrimination.docx

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McGill University
Economics (Arts)
ECON 208
Mayssun El- Attar Vilalta

Chapter 10 Monopoly, Cartels, and Price Discrimination 10.1 A Single-Price Monopolist Revenue Concepts for a Monopolist  Everything in chapter 7 = applies to all market structures  Monopolist is a sole producer of the product that it sells, so the demand curve it faces is the market demand curve for that product, which dhows the total quantity that buyers want to purchase at each price and the quantity that the monopolist will be able to sell at each price  Unlike a perfectly competitive firm, a monopolist faces a negatively sloped demand curve  Sales can be increased only if price is reduced, and price can be ^ only if sales are reduced Average Revenue  TR = p x Q when the monopolist charges the same price for all units sold  AR = TR/Q = (p x Q)/Q = p average revenue  Since the demand curve shows the price of the product, the D curve = the avg revenue curve Marginal Revenue  The revenue resulting from the sale of one more unit of the product  Since –vely sloped, monopolist must reduce price it charges on all units to sell an extra unit. BUT by reducing the price on all previous units, the firm loses some revenue, so the price received for the extra unit sold is not the firms MR. MR = price – lost revenue.  The monopolist’s marginal revenue is less than the price at which it sells its output. Thus the monopolist’s MR curve is below its demand curve  As price declines, the quantity sold ^, MR = ΔTR/ΔQ  Two opposing forces that are present whenever the monopolist considers changing its price: o Reduction in price – units that the firm is already selling bring in less money at the new lower price than at the original higher price = (loss in revenue = amount of price reduction x number of units already being sold) o New units are sold, which adds to revenue = (gain in revenue = number of new units sold x price at which they’re sold) o Net change in total revenues is the difference between these two amounts  MR is always 1) when MR is +ve and inelastic (ɳ<1) when MR is –ve. ɳ declines as go down the D curve. A profit-maximizing monopolist will always produce on the elastic portion of its D curve, where MR is +ve Short-Run Profit Maximization  Rule 1: The firm shouldn’t produce at all unless price (average revenue) exceeds average variable cost (p>AVC) 1  Rule 2: If the firm does produce, it should produce a level of output such that marginal revenue equals marginal cost (MR = MC = profit maximizing level)  Monopolist – MR=MC = determines the firms profit-maximizing quantity; but the price charged to consumers is then determined by the D curve  Even when the firm is choosing its quantity to maximize its profits, the size of those profits depends on the position of the ATC curve. so can earn –ve or 0 profits  Nothing guarantees that a monopolist will make positive profits in the short run, but if it suffers persistent losses, it will eventually go out of business. No Supply Curve for a Monopolist  In perfect competiton, each firm is a price taker and its supply curve is given by its own MC curve. there is a unique relationship between market price and quantity supplied by any single firm: an increase in the market price leads to an increase in quantity supplied. (NOT IN MONOP)  A monopolist does not have a supply curve because it is not a price taker; it chooses its profit- maximizing price-quantity combination from among the possible combinations on the market demand curve.  Monopolist has a marginal cost curve, but it doesn’t face a given market price. It chooses the price-quantity combo on the market demand curve that maximizes its profits. Firm and Industry  The monopolist is the industry.  SR profit-maximizing positiong of the firm is the SR eq. of the industry Competition and Monopoly Compared (230)  Perfectly competitive industry, eq. determined by intersection of industry demand and supply curves (supply curves = the sum of the individual firms’ marginal cost curves, therefore, eq. output is price = marginal cost)  Monopolist, eq. output is such that price>marginal cost. The gap between price and marginal cost implies the level of output in a monopolized industry is < the level of output that would be produced if the industry were instead made up of many price-taking firms (with the same cost structure)  A perfectly competitive industry produces a level of output such that price equals marginal cost. A monopolist produces a lower level of output, with price exceeding marginal cost.  Market efficiency: amount of economic surplus generated in the market  monopolist decisions are profitable for the firm by lead to an inefficient outcome for society as a whole; since price> marginal cost, greater benefit for society if more units of the good were produced since the marginal value to society of extra units (as reflected by price) exceeds the marginal cost of producing the extra units. More economic surplus if monopolist ^ outputs; but the profit-maximizing decision to restrict output below the competitive level creates a loss of economic surplus for society (deadweight loss) = market unefficiency  A monopolist restricts output below the competitive level and thus reduces the amount of economic surplus generated in the market. The monopolist therefore creates an inefficient market outcome. Entry Barriers and Long-Run Equilibrium  If monopoly is suffering losses in SR, it will continue to operate as long as it can cover its variable costs. In LR, it will leave the industry unless it can find a scale of operations at which its full opportunity costs can be covered.  If monopoly profits are to persist in the long run, the entry of new firms into the industry must prevented; if new firms enter in order to earn more than the opportunity cost of their capital, the firm is no longer a monopoly. The former monopolist will now have to compete with the 2 new firms and will capture only part of the overall market demand instead of facing the whole market demand curve.  Entry barrier: any barrier to the entry of new firms into an industry. An entry barrier may be natural or created Natural Entry Barriers  Natural barriers arise due to economies of scale.  When the LRAC curve is –vely sloped over a large range of output, big firms have significantly lower ATCs than smaller firms  Minimum efficient scale (MES) is the smallest-size firm that can reap all the economies of large- scale production. It occurs at the level of output at which the firm’s LRAC curve reaches a min.  Natural Monopoly: an industry characterized by economies of scale sufficiently large that only one firm can cover its costs while producing at its minimum efficient scale (electricity transmission; setup cost – the cost to the new firm of entering the market, developing its products, and establishing such things as its brand image and its dealer network may be so large that entry would be unprofitable) Created Entry Barriers  Created by conscious govt action.  Patent laws – prevent entry by conferring on the patent holder the sole legal right to produce a particular product for a specific period of time  Firm may also be granted charter/franchise that prohibits competition by law. (Canada post)  Regulation/licensing of firms severely restricts entry  Other barriers can be created by the firm/firms already in the market (organized crime – operation outside the law makes available an array of illegal but potent barriers to new entrants. But law-abiding firms must use legal tactics to try to ^ new entrant’s setup costs like threat of price cutting – designed to impose unsustainable losses on a new entrant – to heavy brand-name advertising) The Significance of Entry Barriers  No entry barriers and profits cant persist in the LR since there is freedom of entry and exit in perfect competition; in a monopoly profits can persist in the LR whenever there are effective entry barriers  In competitive industries, profits attract entry, and entry erodes profits. In monopolized industries, positive profits can persist as long as there are effective entry barriers The Very Long Run and Creative Destruction  Very LR = technology changes = entry barriers = monopoly that succeeds in preventing the entry of new firms capable of producing its products will sooner/later find its barriers circumvented by innovations.  A firm may be able to develop a new production process that circumvents a patent upon which a monopolist relies to bar the entry of competing firms.  A firm may compete by producing a somewhat different product satisfying the same need as the monopolists product (UPS vs. Canada post)  A firm may get around a natural monopoly by inventing a technology that produces at a low minimum efficient scale (MES) and allows it to enter the industry and still cover its full costs. (cell phone provider vs. land-line. – don’t need to establish expensive network of wires)  A monopolist’s entry barriers are often circumvented by the innovation of production processes and the development of new goods and services. Such innovation explains why monopolies rarely persist over long periods, except those that are protected through government charter or regulation. 3  Joseph Schumpeter – entry barriers not a serious obstacle in very LR; argued that SR profits of a monopoly provide a strong incentive for others, through their own innovations and product development, to try to usurp some of these profits for themselves….development of similar products; creative destruction: the replacement of one product by another, which reflects the new firms abilities to circumvent entry barriers that would otherwise permit monopolists to earn profits in the LR. Since CD thrives on innovation, monopoly profits are a major incentive to economic growth; today, his theory can extend to any market structure that allows profits to exist in LR (oligopolies) 10.2 Cartels as Monopolies  Monopoly can also arise when many firms in an industry agree to cooperate with one another, eliminating competition among themselves = band together and behave as a single seller to maximize joint profits = Cartel: an organization of producers who agree to act as a single seller in order to maximize joint profits  Restrict output and elevate price: considerable market power  OPEC – global market cartel supported by national govts; DTC – restricted diamond outputs to keep prices from falling  ^ in both, the
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