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Chapter 10

Chapter 10- Monopoly, Cartel, and Price Discrimination.docx

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University of Toronto Mississauga
Kalina Staub

Chapter 10- Monopoly, Cartels, and Price Discrimination 10.1- A Single Price Monopolist  Monopoly- A market containing a single firm  Monopolist- A firm that is the only seller in a market Revenue Concepts for a Monopolist  Unlike a perfectly competitive firm, a monopolist faces a negatively sloped demand curve  Sales are increased only if price is reduced and price is increased only if sales are reduced  Average Revenue  TR= P x Q AR= TR/Q = P and Demand curve= AR curve  Marginal Revenue  Because demand curve is negatively sloped, the monopolist must reduce the price that it charges on all units in order to sell an extra unit but this implies that price received for extra unit sold is not the firm’s marginal revenue because by reducing the price on all previous units, the firm loses some revenue  MR= P – lost revenue  MR is less than the price at which it sells its output because the price must be reduced on all units in order to sell an additional unit, thus the monopolist’s MR curve is below its demand curve  MR= Change TR/ Change Q  Reduction of price- loss in revenue is the amount of the price reduction multiplied by the number of units already being sold and the gain in revenue is the number of new units sold multiplied by the price at which they are sold o Net change in total revenue is the difference between these two amounts  The value of elasticity declines steadily as we move down the demand curve  Profit maximizing monopolist will always produce on the elastic portion of its demand curve (where MR is positive) Short Run Profit Maximization  Recall rules about profit maximization: Rule 1: The firm should not produce at all unless price (average revenue) exceeds average variable cost Rule 2: If the firm does produce, it should produce a level of output such that marginal revenue equals marginal cost  Profit maximizing output is at Q* where MC=MR which equal demand curve  MR=MC and p > AVC (AVC must be below ATC)  Profits = rectangle box of p*, intersection of Demand, ATC=Q*, and c  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  For profit maximizing monopolist, price is greater than marginal cost  No supply curve for a monopolist  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  Has a marginal cost curve  Firm and Industry o No need for industry since monopolist= industry o Short run profit maximizing position of firm = short run equilibrium of industry o Inefficient of Monopoly: Level of output in monopolized industry is less than the level of output that would be produced if the industry were perfectly competitive  Competition and Monopoly Compared  Monopolist restricts output below the competitive level and thus reduces the amount of economic surplus generated in the market, therefore creates an inefficient market outcome (marginal revenue to society of extra units reflected by the price exceed marginal cost of producing the extra units) Entry Barriers and Long Run Equilibrium  If monopoly profits are to persists in the long run, the entry of new firms into the industry must be prevented otherwise the firm will no longer be a monopoly and will have to share profits  Entry Barrier- Any barrier to the entry of new firms into an industry, natural or created  Natural Entry Barriers  Result of economies of scale  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 o Ex. Electrical power transmission- cheaper to have only one set of power lines rather than more serving a given region o Ex. Setup cost- grown firm is able to compete effectively with existing monopolist but new firm with large setup costs cannot  Created Entry Barriers  Result of conscious government action o Ex. Patent laws, charter, franchise, etc o Ex. Canada Post has government sanctioned monopoly on delivery of first class mail  Result of firms already in the market  Illegal tactics or legal tactics: o Ex. Price cutting- designed to impost unsustainable losses on new entrant o Ex. Heavy brand name advertising The Very Long Run and Creative Destruction  Monopoly that succeeds in preventing the entry of new firms capable of producing its product will find its barriers circumvented by innovations through by:  Firm may be able to develop new production process that circumvents patent upon which monopolist relies to bar the entry of competing firms  Firm may compete by producing somewhat different product satisfying the same need as the monopolist’s product  Firm get around natural monopoly by inventing technology that produces at a low minimum efficient scale (MES) and allows it to enter the industry & still cover full costs  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  Creative Destruction- Replacement of one product by another; creative= rise of new products and destruction= demise of the existing products and perhaps the firms that produced them  Reflects new firms’ abilities to circumvent entry barriers that would otherwise permit monopolists to earn profits in the long rum  Because creative destruction thrives on innovation, the existence of monopoly profits is a major incentive to economic growth 10.2- Cartels as Monopolies  Cartel- An organization of producers who agree to act as a single seller in order to maximize joint profits  Policies prevent creation of domestic cartels but cartels that exist in global markets are supported by national governments  Examples: Petroleum Exporting Countries (crude oil), DeBeers (diamonds), and Canpotex (Canadian Potash Exports)  Difficulties cartels face:  Difficult to maintain controlling influence on the specific market  Problems enforcing the agreements among its members The Effects of Cartelization  Increase in total volume of their sales requires a reduction in price  To restrict industry output to the level that maximizes their joint profits (MC=MR)  The profit maximizing cartelization of a competitive industry will reduce output and raise price from the perfectly competitive levels  FIGURE 10-4 ON PAGE 239; Cartelization of a competitive industry can always increase that industry’s profits  Equilibrium for competitive industry occurs when S (MC) = D  If industry is cartelized, p
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