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Economics (359)
ECON 101 (172)
Chapter 10

# Chapter 10 - Monopoly, Cartels & Price Discrimination.docx

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School
University of British Columbia
Department
Economics
Course
ECON 101
Professor
Robert Gateman
Semester
Winter

Description
10.1 Single-Price Monopolist 10-06-2012 Revenue Concepts for a Monopolist  Same cost concepts for all firs in all market structures  Monopolist – sole producer o Demand curve for industry = demand curve for that firm  Unlike a perfectly competitive firm, a monopolist faces a negatively sloped demand curve.  Tradeoff: price it charges vs. quantity it sells o Sales can be increased only if price is reduced  Average revenue = price  Marginal revenue falls twice as fast as demand o Must reduce price that it charges on all units in order to sell an extra unit o Marginal revenue = price minus lost revenue (from having to lower the price) o Marginal revenue from extra unit is less than the price that it receives  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.  Two opposing forces present whenever the monopolist considers changing its price o Loss in revenue – When it lowers price to sell an extra unit, the revenue from the first n units is lower at the new lower price = price reduction * number of units o Gain in revenue – New units sold add to revenue = new units sold * price o Net change in total revenue – difference between these two amounts  Marginal revenue is always less tha price  Perfectly competitive firm – price taker – sell all it wants at the given market price  Monopolist – negatively sloped demand curve – must reduce price to increase sales  TR rises (MR +) as price falls, reaching a maximum. As price continues to fall, TR falls (MR -)  Demand is elastic when MR is positive Demand is inelastic when MR is negative  Elasticity decreases as you move down the demand curve  Monopolist will always produce on the elastic portion of the demand curve (MR +) Short-Run Profit Maximization  Rule 1: Should not produce at all unless price (average revenue) exceeds average variable cost  Rule 2: Produce a level of output such that marginal revenue equals marginal cost  Profit maximizing quantity – MR = MC, price charged to the consumers is determined by the demand curve  Profit maximizing monopolist need not be making positive profits o Size of profits depends on the position of the ATC curve  Nothing guarantees that a monopolist will make positive profits in the short tun, but if it suffers persistent losses, it will eventually go out of business. No Supply Curve for a Monopolist o 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. o Monopolist does not face a given market price; chooses the price-quantity combination Firm and Industry o Monopolist IS the industry Competition and Monopoly Compared o PC – Eq is determined by the intersection of the industry demand and supply curves  Eq output – where price = marginal cost o Monopolist – Eq output – price is greater than marginal cost  Gap between price and MC  level of output of monopolist < level of output if it were made up of many price-taking firms o 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.  Society would benefit from having those units produced; therefore, monopolist creates a deadweight social loss  inefficient (lost economic surplus) o 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  Losses and profits provide incentives for exit and entry  Losses in short run  continue to operate as long as its covering its variable costs  Losses in long run  leave the industry unless it can find a scale of operations at which its opportunity costs are covered  Profits – other firms will enter the industry and try to earn more then the OC of capital  firm will cease to be a monopoly  compete with new firms  If monopoly profits are to persist in the long run, the entry of new firms into the industry must be prevented. Natural Entry Barriers o Arise as a result of economies of scale o When LRAC curve is negatively sloped over a large range of output, big firms have significantly lower ATC than small firms o Any potential entrant would have unit costs higher than those of the existing firm and could not compete o Natural monopoly – industry’s demand conditions allow no more than one firm to cover its costs while producing at its MES o Setup cost – cost to the new firm of entering the market, developing its products, and establishing its brand Created Entry Barriers o Conscious government action – ex. patent laws o Patent laws – sole legal right to produce a particular product for a specified period of time o Charters or franchise – prohibits competition by law o Government sanctioned monopoly o Regulation/licensing of firms o Threat of force or sabotage can deter entry – ex. organized crime, price cutting, heavy brand-name advertising Significance of Entry Barriers o Profits can persist in the long run whenever there are effective barriers to entry o 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  Technological changes  New ways of producing old products, new products created to satisfy new and familiar wants  Concept of entry barriers  entry barriers will eventually be circumvented by innovations o New production process that circumvent a patent o Different product satisfying the same need  Get around a natural monopoly by inventing a technology that produces at a low MES  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.  Joseph Schumpeter – “entry barriers were not a serious obstacle in the very long run”, short- run profits of a monopoly provide a strong incentive for others o Creative destruction – replacement of one product by another (circumvent entry barriers; existence of monopoly profits is a major incentive to economic growth) 10.2 Cartels as Monopolies 10-06-2012 Cartel  Many firms in an industry to agree to cooperate with one another, eliminating competition among themselves  Behave as if they were a single seller, objective of maximizing their joint profits  Agree to restrict their total output to maximize their joint profits  Successful policies aimed at preventing the creation of domestic cartels o Operate in global markets and are supported by national governments ex. OPEC  Problems: enforcing the agreement among its members  Ex. De
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