Download Marginal Revenue and Monopoly: Implications for Output, Price, and Profit and more Schemes and Mind Maps Public Policy in PDF only on Docsity!
herbert.stocker@uibk.ac.at Herbert StockerMonopoly
Institute of International Studies University of Ramkhamhaeng
&
Department of Economics University of Innsbruck
Monopoly
A firm is considered a monopoly if.. .Definition
substitutes.its product does not have closeit is the sole seller of its product.
Repetition
Remember:
There are two kinds of restrictions:restrictions they face. Firms maximize their profits subject to the
Market restrictions. Technological restrictions.
Repetition
Remember:
markets.monopolies and firms on perfectly competitiveOnly market restrictions differ betweenoutput for the derivation of the cost function!Remember that we did not need the price ofThese are embedded in the cost function:competitive markets.monopolies and for firms on perfectly Technological restrictions are the same for
Monopoly & Perfect Competition
Perfect Competition:
Every supplier
and firms are price-takers!Therefore, marginal revenue is simply the price,output for the same price.perfectly elastic, he can sell every unit ofperceives demand for his own product as
Monopoly & Perfect Competition
Monopoly:
A Monopolist is the only supplier
revenue no longer equals price!marginal revenue of a monopoly, e.g. marginalThis has important implications for thelower price!want to sell more, they can do so only at aMonopolistic firms are price-seekers; if theyincreases price.demand for his product is falling when heproduct. Therefore he perceives that theand there are no close substitutes for his
Perfect Competition vs. Monopoly
P^ Perfect Competition:
Q
‘perceived’
Market Demand
demand Each producer perceives the
for
his
product
as
perfectly elastic.
Monopoly:
‘perceived’
Market Demand
P
Q
to Monopolist perceives demand
be
less
than
perfectly
elastic.
Total and Marginal Revenue
Example:
Q (^) = 6
P
Total
Marginal
Average
Price
Quantity
Revenue
Revenue
Revenue
P
Q
R
P
×
Q
MR
AR =
P
Marginal Revenue
Rearranging terms gives
MR
P
Q
×
P
Q
P
P
P Q
∆^
P
Q
P
P^ Q
P
Q
P
E
Q ,P ) = (^) P ( 1 (^) −
|E
Q ,P (^) | )
Marginal Revenue
specific way on the price elasticity of demand: Therefore, marginal revenue depends in a very
MR
R
Q
P
|E
Q ,P (^) | )
When demand is elastic (
|E
Q ,P (^) |
(^) 1) increasing
output will increase revenue (MR
When demand is inelastic (
|E
Q ,P (^) | (^) < (^) 1)
(MRincreasing output will decrease revenue
Output, Price Elasticity & Revenue
reduces output? What happens with monopolist’s revenue, when he
elastic
inelastic
E
(^) − 1
E
(^) −∞
E = 0
P
Q
bc
Q
bc
P
Elastic Demand:
Q
P
R
elastic
inelastic
E
(^) − 1
E
−∞
E = 0
P
Q
bc
Q
bc
Q Inelastic Demand:P ↓ ⇒
P
R
Monopoly
monopolist willWe can see from this simple analysis that a Example
(^) never
(^) produce a quantity in the
inelastic portion of the demand curve. Why?
a maximum!reducing the quantity, therefore this cannot beThis implies he could make higher profits byProducing less would lower cost.would increase revenue.If demand is inelastic a decrease of quantity
More generally...
Profit Maximization
costprofit is the difference between revenue and Monopolists like all firms maximize profit, and
R
C
For a maximum it must be true that
d π
dQ
MR︸︷︷︸dQdR
−
MC︸︷︷︸dQdC
Therefore profit maximization implies
MR = MC
This result is true for monopolists
(^) and
(^) for firms on
perfectly competitive markets!
Profit Maximization
demand is perfectly elastic, this implies MR = For a firm on a perfectly competitive market Perfect Competition
P
whereTherefore, profit maximizing firms choose output
MR =
P
= MC
Profit Maximization
For a monopolist marginal revenue is Monopoly
MR =
P
|E
Q ,P (^) | )
therefore a monopolist chooses output
(^) and price
where
MR =
P
|E
Q ,P (^) | ) = MC
perfect and imperfect competition! MR = MC holds generally, but MR is different for firms under
Monopoly: Profit Maximization
P
Q
D (P )
MR
AC MC
MC
MR ⇒ Profit Lost
MR
MC
Which
quantity
should
a monopolist
Whenproduce?
marginal
rev-
enue
is
higher
than
Whenshould produce more!marginal cost the firm
marginal
rev-
should produce less!marginal cost the firmenue is is smaller than
Monopoly
marginal costFor a monopoly, output is determined byis determined by marginal cost. In perfect competition, the market supply curve
(^) and
(^) the shape of the demand
market there is no supply curve for monopolisticSince supply depends on the demand curve,curve (demand elasticity).
both price and quantity.Shifts in demand usually cause a change in
Example
Monopoly
0 1 2 3 4 Profits of a monopolist: 0
P
Q
R
MR
C
MC
bc bc
Q
∗
P
∗
bc bc π bc ∗
Market demand:
(^) P (^) = 4
(^) − (^) Q
Revenue:
(^) R (^) = 4
Q (^) − (^) Q 2
Marginal revenue: MR = 4
(^) − (^2) Q
Cost:
(^) C (^) = 0
. 2 Q (^2)
Marginal cost: MC = 0
. 4 Q
Condition for profit maximum:
MR
= MC
(^4) − (^2) Q
= 0
. 4 Q
Q ∗ = 1
. 667
π ∗ = R ∗ −
(^) C (^) ∗ = 2^
. 833
Monopoly
0 1 2 3 4 Profits of a monopolist: 0
1
2
3
4
P
Q
R
MR
C
MC
bc bc
Q
∗
P
∗
bc bc π bc ∗
Q (^) = 4 (^) − (^) P
↔
P (^) = 4 (^) − (^) Q
R (^) = 4 Q (^) − (^) Q ,^2
MR = 4
(^) − (^2) Q
C (^) = 0
. 2 Q (^2)
MC = 0
. 4 Q
Q
P
R
MR
C
MC
π
-0.
-1.
-2.
-3.
-1.
-4.
-3.
Monopoly: Alternative Presentation
0 1 2 3 4 Profit with Total Cost: 0
P
Q
R
MR
C
MC
bc bc
Q
∗
P
∗
bc bc π bc ∗
π ∗ = (^) R ( Q ) (^) − (^) C (^) ( Q )
0 1 2 3 4 Profit with Average Cost: 0
1
2
3
4
P
Q
MR
MC
bc bc
Q ∗
P ∗
AC
bc
AC( Attention: Q ) = 0∗
.6 ˙ 3
MC(
Q ) = 0∗
.6 ˙ 6
π ∗
π ∗ = ( P (^) − (^) AC)
Q
Long-Run Profit Maximization
In the long run...
P produce output where MR = LMC, as long as Monopolist maximizes profit by choosing to (^) > (^) LAC
Will exit industry if
P
LAC!
level.Monopolist will adjust plant size to the optimal
Long-Run Profit Maximization
Optimal plant is where the short-run average cost curve is
tangent to the long-run average cost at the profit-maximizing
output level.
A General Rule for Pricing
Markup Pricing: Rule of Thumb
P
Q
D (P )
MR
AC MC
bc
Q
M∗ b b
P
M∗ (^) b
bc
Profits
π (^) = (
P
AC)
Q
are
highest
when
butMR = MC,
managers
often
don’t
know
their
marginal cost!
Markup Pricing: Rule of Thumb
P
Q
D (P )
MR
AC MC
Q
M∗ b b
P
M∗ (^) b
bc b c
Therefore,
managers
profits;This results in smallerwhere AC = MR.a proxy and producecost AC (or AVC) assometimes use average
but
the
loss
tic.demand is rather elas-might be small when
Market Power
produce so that price exceeds marginal cost!facing a downward sloping demand curve, willHowever, also a market with several firms, eachPure monopoly is rare.the closer to a perfectly competitive market.to being a monopolist; the larger the elasticity, If demand is very elastic, there is little benefit
Market Power
these cases.analysis in this chapter is also applicable inThis gives them (limited) market power. Thefrom other firms.differences, thereby differentiating themselvesoften produce similar goods that have some Firms on markets with imperfect competition
Market Power
demand it is facing is total market demand.Since the monopoly is the only supplier theis facing.determined by the elasticity of demand the firmFor a pure monopoly market power isprice higher than marginal cost. Monopoly power is determined by ability to set
completely by elasticity of market demand. Degree of monopoly power is determined
Market Power
power.higher, therefore the have much less marketsubstitutes elasticity of demand is usually much With more firms in the market offering close
demand for their own product is relevant!Attention: For Managers only the elasticity ofXXX is usually very elastic.inelastic, demand for eggs from a specific farmerEven if market demand for eggs should bemore elastic than the market elasticity. Demand for a firm’s product is usually (much)
Market Power
Remember:
Profit depends on average cost relative to price!lower profits due to high average costs.One firm may have more monopoly power butprofits. Monopoly power, however, does not guarantee
Measures of Market Power
marginal cost of production.difference between a firm’s product price and measure of market power that focuses on the Lerner Index:
L
P
P MC
|E
Q ,P (^) |
Under perfect competition, i.e. when
P
= MC,
L
When
L
(^) = 1 the market power is highest
possible.
Barriers to Entry
Economies of Scale and Mergers
industries (Can act as a barrier to entry in differentoperation.costs are associated with larger scale ofslopes downward or when lower production Exist when a firm’s long run average cost curve
MES)
media, and telecommunications.with economies of scale, e.g. technology,Mergers are particularly important in industries
Minimum Efficient Scale (MES)
indicator for technological market entry barriers. Average cost at half of the MES (1/2 MES) is a MES & Market Entries:
High
barriersentrymarket
AC
Q
bcbc
bc
MES
MES
(^2) MES 1
Low
barriersentrymarket
AC
Q
MES^ bc
bc
MES
(^2) MES 1
→ (^) important for intensity of competition, Mergers & Acquisitions,...
Barriers to Entry: Natural Monopolies
Natural Monopoly:
when a firm can supply a
systems, bridges,.. .Examples include tap water distributiongovernment.are therefore often regulated or run by theNatural monopolies cause market failure, andthe relevant range of output.output, i.e., average cost curve is falling overeconomies of scale over the relevant range ofA natural monopoly arises when there arecost than could two or more firms.good or service to an entire market at a smaller
Barriers to Entry
Barriers Created by the Government
a public good.new information that has the characteristics ofprotection arises because innovations representPatents and copyrights: The need for patentprofessionals). Licenses (e.g. for physicians and other
Because ofexclusion and is nonrival in consumption. Public goods: A good that has high costs of
(^) free riding
(^) behaviour public goods
would not be provided on free markets.
Barriers to Entry
Input Barriers
Barriers in financial capital marketsDeBeers). Control over raw materials (e.g. diamonds and
Smaller firms are perceived as riskier.Smaller firms need more collateral for loans. Larger firms can get lower interest rates.
Barriers to Entry
Creation of Brand Loyalties
becomes less elastic by these measures.Managers hope that demand for their productmaintain market power.strategy that managers use to create andadvertising and other marketing efforts is a The creation of brand loyalties through
Barriers to Entry
Consumer Lock-In and Switching Costs
costs strategies:Examples for consumer lock-in and switchingswitching costs strategies to gain market power.Managers often use consumer lock-in andswitching costs if they changed.types or brands and would incur substantial When consumers become locked into certain
Loyalty programs,.. .Search costsSpecialized suppliersBrand-specific trainingDurable purchases Contractual commitments
Barriers to Entry
Network Externalities
For example software systems.scale, in contrast to supply-side economies.Can be considered demand-side economies ofthe product.product depends on number of customers using Act as a barrier to entry because the value of a
Monopoy & Welfare
P
Q
MC
D
bc
P
C∗
Q
C∗
bc
MR
bc
P
M
Q
M Deadweight
Loss
Social Costs of Monopoly
Rent Seeking:is determined by the profit to be gained.The incentive to engage in monopoly practicesdeadweight loss. Social cost of monopoly is likely to exceed the
Firms may spend to gain
monopoly power
Building excess capacityAdvertising Lobbying
Public Policy Toward Monopolies
monopoly in one of four ways: Government responds to the problem of
public policies).deemed small compared to the imperfections ofDoing nothing at all (if the market failure isenterprises.Turning some private monopolies into publicRegulating the behavior of monopolies.competitive. Making monopolized industries more
Antitrust Laws
promote competition.Antitrust laws give government various ways toaimed at curbing monopoly power. Antitrust laws are a collection of statutes
that make markets less competitive.They prevent companies from performing activitiesThey allow government to break up companies. They allow government to prevent mergers.
Antitrust Issues
Antitrust legislation focuses for example on.. .compete.regulates how firms use their market power to Legislation limits market power of firms and
Mergers between firms that reduce competition.The use of tie-in sales and exclusive dealings. Price discrimination that lessens competition.
Antitrust Issues
Focus of the Horizontal Merger Guidelines:
power.efficiencies could offset increase in marketExtent to which any cost savings andsellers.Other factors influencing coordination amongNature and extent of entry into the market.price and output.Possibility that a merging firm might affectLevel of seller competition in that market. Definition of the relevant market.
Regulation
monopoly charges: Government may regulate the prices that the
in a loss!However, in natural monopolies this will resultprice is set to equal marginal cost.The allocation of resources will be efficient if
(When average cost (AC) fall marginal cost (MC)
must be lower than AC. Optimal pricing
(^) P (^) = MC would therefore
pricing.requires some departure from marginal-costthe form of higher profit, a practice thatkeep some of the benefits from lower costs in In practice, regulators will allow monopolists toresult in losses!)
Public Policy Toward Monopolies
Rather than regulating a
(^) natural monopoly
imperfections of public policies.failure is deemed small compared to theGovernment can do nothing at all if the marketthe government runs the Postal Service).can run the monopoly itself (e.g., sometimes that is run by a private firm, the government
