Chapter 9: Monopoly and Imperfect Definition: Competition total revenue = total amount received A. Total revenue and marginal revenue from selling product
Definition: Definition: total revenue = total amount received marginal revenue = amount received from selling product from selling one more unit of product P = price of product Q = number of units sold PQ = total revenue
Firm with downward-sloping Definition: demand curve marginal revenue = amount received from selling one more unit of product Demand for firm's product 17 16 15 ∆(PQ) d(PQ) 14 or 13
∆Q dQ (P) Price 12 11 10 012345 Quantity (Q)
1 Example: Firm with downward- Example: Firm with downward- sloping demand curve sloping demand curve Q P Q P TR
Demand for firm's product 1 16 Demand for firm's product 1 16 16 17 17 16 16 15 15 14 2 15 14 2 15 30 13 13
Price (P) 12 Price (P) 12 11 11 10 10 012345 3 14 012345 3 14 42 Quantity (Q) Quantity (Q) 4 13 4 13 52
Example: Firm with downward- Example: Firm with downward- sloping demand curve sloping demand curve Q P TR MR Demand for firm's product Marginal revenue 17 17 16 16 15 15 14 14
Demand for firm's product 13 (MR) 13 1 16 16 16 (P) Price 12 12 11 11 17 10 revenue Marginal 10 16 012345 012345 15 Quantity (Q) Quantity (Q) 14 2 15 30 14 13
Price (P) 12 11 Q P TR MR Note: MR < P 10 3 14 42 12 012345 1 16 16 16 Quantity (Q) Reason: more quantity 2 15 30 14 4 13 52 10 means lower price 3 14 42 12 4 13 52 10
Special case: linear demand curve Special case: linear demand curve
Demand for firm’s product: P = a - bQ
P Demand curve: slope = -b P = a + bQ a is the intercept Intercept = a -b is the slope
Q
2 P = a+ bQ total revenue: Marginal revenue: PQ = (a - bQ)Q a − 2bQ = aQ - bQ2 This is equation of a line where marginalrevenue: a is the intercept −2b is the slope d(PQ) = a -2 bQ dQ
Chapter 9: Monopoly and Imperfect Competition
Demand for firm’s product: P = a - bQ A. Total revenue and marginal revenue
P Demand curve: slope = -b B. Marginal revenue for a perfectly competitive firm
Marginal revenue curve: slope = -2b Intercept = a
Q
Extreme case: Firm with perfectly Extreme case: Firm with perfectly elastic demand curve elastic demand curve Q P TR MR Demand for firm's product
15 Demand for firm's product 1 10 13 15 13 11 11 2 10 9
9 Price (P)
Price (P) Price 7 7 5 012343 10 5 Quantity (Q) 01234 Quantity (Q) 4 10
3 Extreme case: Firm with perfectly Extreme case: Firm with perfectly elastic demand curve elastic demand curve Q P TR MR Q P TR MR
Demand for firm's product 1 10 10 Demand for firm's product 1 10 10 10 15 15 13 13 11 2 10 20 11 2 10 20 10 9 9 Price (P) Price (P) 7 7 5 5 012343 10 30 012343 10 30 10 Quantity (Q) Quantity (Q) 4 10 40 4 10 40 10
Conclusion: if demand is perfectly elastic, Question: but don’t demand curves always then MR = P slope down (i.e., always less than perfectly elastic)? If demand is less than perfectly elastic, then MR < P Answer: yes, but it’s a question of degree
Key issue: how much of market does each firm control?
Chapter 9: Monopoly and Imperfect Competition A. Total revenue and marginal revenue Consider entire U.S. market for tomatoes B. Marginal revenue for a perfectly competitive firm • More than 5 million tons C. The difference between individual firm’s produced each year demand curve and market demand curve • Sell wholesale for about $50/ton
4 Consider entire U.S. market for tomatoes • More than five million tons produced each year • Sell wholesale around $50/ton Consider individual tomato farm • Suppose demand has elasticity of -1 • Produces 1,000 tons per year • Means 10% increase in U.S. production (500,000 more tons) would lower price by 10% (from $50 to $45)
Comparison of industry-wide demand curve with individual producer’s demand curve Consider individual tomato farm • Produces 1,000 tons per year Industry-wide demand curve Individual farm's demand curve
• 10% increase in one farm’s production is 65 65 55 55 100 tons 45 45 35 35 25 25 • This is 1/50,000 = 0.002 % of U.S. market 15 15 Price ($ per ton) per ($ Price Price ($ per ton) per ($ Price 5 5 • U.S. price would drop 0.002% (from 35790 500 1000 1500 2000 2500 Quantity (millions of tons) Quantity (tons) $50/ton to $49.99/ton)
Example: earth is approximately flat Perfect competition: firm for all practical purposes ignores any potential effect of its actions on the market price • Represent as: perfectly elastic demand curve • Justification: this firm is a very small part of the total market
5 Comparison of industry-wide and individual producer’s demand curve when there is a monopoly • Imperfect competition: firm takes into account the effect of its actions on price Industry-wide demand curve Individual firm's demand curve
• Monopoly: firm is the only seller in the 65 65 55 55 entire market 45 45 35 35 25 25 15 15 Price ($ per ton) Price ($ per ton) 5 5 35793579 Quantity (millions of tons) Quantity (millions of tons)
Chapter 9: Monopoly and Imperfect Competition A. Total revenue and marginal revenue B. Marginal revenue for a perfectly competitive firm C. The difference between individual firm’s demand curve and market demand curve D. Total cost and marginal cost
Definition: total cost total expensesfirm would Q Total cost incur in order to produce quantityQ 1 4 marginalcost additionalcost of 2 10 producingone more unit 3 18 4 28 Δ(TC) d(TC) 5 40 or ΔQ dQ 6 54
6 Chapter 9: Monopoly and Imperfect Competition Q Total cost Marginal cost A. Total revenue and marginal revenue 1 4 4 B. Marginal revenue for a perfectly 2 10 6 competitive firm C. The difference between individual firm’s 3 18 8 demand curve and market demand curve 4 28 10 D. Total cost and marginal cost 5 40 12 E. Profit maximization 6 54 14
First method of proof: calculus Proposition: any firm maximizes profit by TR total revenue setting marginal revenue equal to marginal cost TC total cost TR − TC profit Firm maximizes profit by finding derivative of profit with respect to Q and setting it to zero
dTR − TC 0 dQ Second method of proof: intuition requires dTR dTC Suppose the firm wasn’t following our dQ dQ advice, and operated at a level where MR > MC or marginal revenue marginal cost
7 Then if it produced one more unit: Or, suppose instead the firm wasn’t • its revenues would go up by MR following our advice, and operated at a • its costs would go up by MC level where MR < MC • if MR > MC, its revenues would go up by more than its costs if it produced one more unit • Conclusion: if MR > MC, firm can increase profits by producing one more unit
Then if it produced one less unit: Combined implication: firm is only • its revenues would go down by MR (bad) maximizing profits if it sets MR = MC • its costs would go down by MC (good) • if MR < MC, its cost savings more than make up for lost revenue • Conclusion: if MR < MC, firm can increase profits by producing one less unit
Any firm will try to set MR = MC Any firm will try to set MR = MC • For a perfectly competitive firm, MR = P • For an imperfectly competitive firm or • Therefore, a perfectly competitive firm will monopolist, MR < P set P = MC • Therefore, an imperfectly competitive firm • That is, it will choose a level of production will set MC < P at which the marginal cost of producing • That is, it will choose a level of production one more unit is equal to the price at which the marginal cost of producing one more unit is less than the price
8 Chapter 9: Monopoly and Imperfect Supply decisions for farm 1 Competition E. Profit maximization If P = 10, farm 1 F. Price and output under perfect produces 1 unit Marginal Cost for farm 1 competition If P = 12, farm 1 16 produces 2 units 14
12 If P = 14, farm 1 Price (P) 10 produces 3 units 8 012345 Quantity (Q)
Supply decisions for farm 2
If P = 10, farm 2 Suppose there are 100 different farms like produces 2 units farm 1 and 100 farms like farm 2 Marginal Cost for farm 2 If P = 12, farm 2 If P = 10, type 1 farms produce 1 unit each 16 produces 4 units 14 (100 total), type 2 farms produce 2 units 12 If P = 14, farm 2
Price (P) each (200 units total) 10 produces 6 units 8 02468 So if P = 10, all farms together produce 300 Quantity (Q) units
If P = 12, type 1 farms produce 2 units each If P = 10, all farms (200 total), type 2 farms produce 4 units together produce 300 each (400 units total) units Supply curve for entire industry If P = 12, all farms 16 So if P = 12, all farms together produce 600 14 together produce 600 12
units Price (P) units 10
8 If P = 14, all farms 0 500 1000 together produce 900 Quantity) units
9 Supply curve for MC for type 1 MC for type 2 whole industry Conclusion: under perfect competition, MC1 industry-wide supply curve is horizontal MC2 supply
summation of each firm’s individual PPP marginal cost curve
Q1 Q2 Q total = 100 x Q1 + 100 x Q2
Market equilibrium under perfect Chapter 9: Monopoly and Imperfect competition Competition E. Profit maximization
P Industry-wide demand curve F. Price and output under perfect competition G. Price and output under monopoly Industry-wide supply curve
Equilibrium price
Q Equilibrium quantity
Suppose now that a single company buys up all the farms. John D. Rockefeller set out to acquire all oil production and refining operations in the 1870’s
10 If company wants to produce 300 units, cheapest way is 1 unit from each of type 1 If one single company farms and 2 units from each of type 2 controlled all these farms farms, what would the (If it produced a second unit from a type 1 marginal cost curve for the company look farm or a third unit from a type 2 farm, like? would cost more than $10 to produce)
Marginal cost curve MC for type 1 MC for type 2 for monopoly This means that the marginal cost of MC1 producing 300th unit is $10 MC2
To produce 600 units, should produce 2 PPP units on each type 1 farm and 4 units on each type 2 So marginal cost of producing 600th unit is Q1 Q2 Q total = $12 100 x Q1 + 100 x Q2
Conclusion: the marginal cost curve for the But rather than face a relatively flat demand megafirm is the horizontal summation of curve, monopolist would operate on the the individual marginal cost curves for scale of the entire market demand each individual farm In other words, the marginal cost curve for the monopolist is the same as the industry-wide supply curve under perfect competition
11 Monopolist will choose Q so that MR = MC
Demand for firm’s product: P = a - bQ
P Demand curve: slope = -b P MC
Marginal revenue curve: slope = -2b Intercept = a
MR demand
Q Q1 Q
Firm chooses level of output given by Q1
Chapter 9: Monopoly and Imperfect Firm will charge highest price it can Competition E. Profit maximization Firm chooses price given by P1 P F. Price and output under perfect MC competition P1 G. Price and output under monopoly H. Comparison of perfect competition with
MR demand monopoly
Q1 Q
Firm chooses level of output given by Q1
Monopolist chooses (Q1,P1) Monopolist chooses (Q1,P1) Perfect competition results in (Q2,P2) Perfect competition results in (Q2,P2) Price Price P MC Q1 < Q2 Marginal supply P1 P1 cost P2 P1 > P2 P2
MR demand MR demand demand
Q1 Quantity Q2 Quantity Q1 Q2 Q
12 Chapter 9: Monopoly and Imperfect Comparison of industry-wide demand curve Competition with individual producer’s demand curve E. Profit maximization Industry-wide demand curve Individual farm's demand curve 65 65 55 55 MR = MC 45 45 35 35 25 25 F. Price and output under perfect competition 15 15 Price ($ per ton) per ($ Price ton) per ($ Price 5 5 P 3579 0 500 1000 1500 2000 2500 Industry-wide demand curve Quantity (millions of tons) Quantity (tons)
Industry-wide supply curve The earth is flat
Equilibrium price
Q Equilibrium quantity
Chapter 9: Monopoly and Imperfect Competition
E. Profit maximization Monopolist chooses (Q1,P1) Perfect competition results in (Q2,P2) F. Price and output under perfect Price Price competition Marginal supply G. Price and output under monopoly P1 cost H. Comparison of perfect competition with P2 monopoly MR demand demand
Q1 Quantity Q2 Quantity
Consumers worse off under monopoly
Conclusion: monopoly results in a higher Consumer surplus under monopoly Consumer surplus under perfect comp price and less output being produced
Marginal supply P1 cost
P2
MR demand demand
Q1 Q2
13 Firms better off under monopoly Society worse off under monopoly
Producer surplus under monopoly Producer surplus under perfect comp Total surplus under monopoly Total surplus under perfect comp
Marginal supply Marginal supply P1 cost P1 cost
P2 P2
MR demand demand MR demand demand
Q1 Q2 Q1 Q2
Society worse off under monopoly
Deadweight loss under monopoly Total surplus under perfect comp
Marginal supply P1 cost P2 Adam Smith (1776): An individual producer “neither intends to promote the MR demand demand public interest, nor knows how much he is promoting it ...
Q1 Q2 [but is] led by an invisible hand to promote an end which was no part of his intention.”
Why “invisible hand” works under perfect If marginal benefit to consumer (price) were competition: greater than marginal cost of production, Marginal cost to firm from producing one society would be better off producing one more unit = resources that must be more unit. surrendered to produce the good Under perfect competition, marginal benefit Marginal benefit to customer from producing to consumer (price) is set equal to one more unit is the price they’re willing to marginal cost, and so social surplus is pay maximized.
14 Deadweight loss represents goods that should be produced but aren’t
Under monopoly, price (marginal benefit to Deadweight loss under monopoly Total surplus under perfect comp consumer of getting more goods) is greater than marginal cost to society of producing one more unit. Marginal supply P1 cost
Deadweight loss results when these desired P2 goods don’t get produced.
MR demand demand
Q1 Q2
Chapter 9: Monopoly and Imperfect Competition E. Profit maximization Up to this point, we assumed that F. Price and output under perfect monopolist had to charge all customers competition the same price G. Price and output under monopoly Price discrimination: monopolist has the H. Comparison of perfect competition with power to charge different people different monopoly prices for the same product I. Price discrimination
Demand for coke curve Demand for coke curve
$2.50 $2.50
$2.00 $2.00
$1.50 $1.50 Sell to this person $1.00 $1.00 for $2.00
Price ($ per can) $0.50 Price ($ per can) $0.50
$0.00 $0.00 050100150 050100150 Number willing to buy Number willing to buy
15 Demand for coke curve
“Perfect price discrimination”: monopolist $2.50 can charge each customer the maximal $2.00 amount that customer is willing to pay $1.50 Sell to this person Under perfect price discrimination, marginal $1.00 for $2.00 Sell to this person revenue would be the price for 50 cents
Price ($ per can) per ($ Price $0.50
$0.00 050100150 Number willing to buy
Monopolist that can discriminate Consumers have zero surplus perfectly under perfect price discrimination
Consumer surplus under Monopolist chooses to produce Q1 Consumer surplus under usual monopoly perfect price discrimination P Charges this customer price Pa Pa MC Marginal Marginal Pb Charges this customer price Pb P1 cost cost
demand = marginal revenue MR demand Demand = MR Q1 Q Q1 Q2
Value of benefit to firm of price Firm is better off under perfect discrimination exceeds loss to price discrimination consumers Producer surplus under Producer surplus under Total surplus under Total surplus under usual monopoly perfect price discrimination usual monopoly perfect price discrimination
Marginal Marginal Marginal Marginal P1 cost cost P1 cost cost
MR demand Demand = MR MR demand Demand = MR
Q1 Q2 Q1 Q2
16 There is no deadweight social loss from perfect price discrimination
Total surplus under Total surplus under Price discrimination is hard to implement: perfect competition perfect price discrimination (1) It’s against the law
supply marginal cost
P1
demand Demand = MR
Q1 Q2
Clayton Act of 1914: Price discrimination is hard to implement: “It shall be unlawful for any person engaged in (1) It’s against the law commerce, in the course (2) All customers will try to buy at the of such commerce, either directly or indirectly, to lowest price discriminate in price (3) Firm doesn’t know each customer’s between different purchasers of maximal price commodities of like grade (4) Firm must be able to prevent resale and quality”
Many firms find ways to (2) Sales and implement partial promotions price discrimination You could buy coke at anyway: Ralph’s for: (1) Each passenger on $3.33 a 12-pack on this flight may have Jan 13 (3 for $9.99) paid a different price $3.00 for 6-pack on Jan 13 (2 for $6.00) $3.00 for 12-pack on Jan 10
17 (3) Discounts for • Problem set 2: due week of Jan 23-27 seniors, students, • pages 247-248, probs #2 a-b-c, #5, #6, children, … #7 a-e, #9 a-e
Chapter 9: Monopoly and Imperfect Competition First exam will be Thursday Feb 2 in class H. Comparison of perfect competition with Exam will only cover Chapters 7, 9 &10 monopoly Exam will have some multiple choice, some • Monopoly makes consumers worse off fill in the blank • Monopoly makes producers better off Discussion sections that meet Feb 2 after • Monopoly is inefficient the exam won’t meet Discussion sections that meet Jan 30-Feb 2 before the exam will meet
Chapter 9: Monopoly and Imperfect Chapter 9: Monopoly and Imperfect Competition Competition H. Comparison of perfect competition with H. Comparison of perfect competition with monopoly monopoly I. Price discrimination I. Price discrimination • Consumers worse off under price J. Natural monopoly discrimination than usual monopoly • Firm better off under price discrimination than usual monopoly • Perfect price discrimination is efficient
18 We also assumed that each individual firm’s marginal cost curve sloped up, so that industry-wide supply curve was the horizontal sum of all the individual MC curves We motivated our Supply curve for discussion by MC for type 1 MC for type 2 whole industry supposing that the industry started out as MC1 MC2 supply perfectly competitive and one company PPP bought up all the firms
Q1 Q2 Q total = 100 x Q1 + 100 x Q2
The assumption of increasing average costs Definition: (also called decreasing returns to scale) is An industry in which an increase in the natural in some industries (e.g. agriculture) quantity produced leads to a decrease in but not in others (e.g., petroleum refining) average cost per unit is called a “natural monopoly”
This property is sometimes referred to as “increasing returns to scale”
Example: to refine Suppose you build an oil refinery for $2 petroleum products, billion. there is an enormous fixed cost (build Each year you will have to pay interest on refinery) but the debt, taxes, maintenance, insurance, thereafter marginal etc. of say $200 million. cost of additional This $200 million per year is a fixed cost you production is roughly pay even if you produce nothing. constant up to the capacity of the plant
19 Quantity Fixed Marginal Total Average (gals/yr) cost cost cost cost 0 $200 M For each gallon of gasoline you refine, you’ll need to buy more crude oil, pay for more 100 M $200 M labor, energy, … Suppose this marginal cost of producing 200 M $200 M each additional gallon of gasoline is $1 per gallon. 300 M $200 M
400 M $200 M
Quantity Fixed Marginal Total Average Quantity Fixed Marginal Total Average (gals/yr) cost cost cost cost (gals/yr) cost cost cost cost 0 $200 M $1/gal 0 $200 M $1/gal $200 M
100 M $200 M $1/gal 100 M $200 M $1/gal $300 M
200 M $200 M $1/gal 200 M $200 M $1/gal $400 M
300 M $200 M $1/gal 300 M $200 M $1/gal $500 M
400 M $200 M $1/gal 400 M $200 M $1/gal $600 M
Quantity Fixed Marginal Total Average (gals/yr) cost cost cost cost Marginal and average cost 0 $200 M $1/gal $200 M 3.5
3 100 M $200 M $1/gal $300 M $3/gal 2.5
2 MC 200 M $200 M $1/gal $400 M $2/gal AC
$/gallon 1.5
1 300 M $200 M $1/gal $500 M $1.67/gl 0.5
0 400 M $200 M $1/gal $600 M $1.50/gl 0 100 200 300 400 500 Millions of gallons
20 Total cost is area of rectangle
3.5 Total cost of producing Note that if the perfect competition condition 200 M gals/year is 3 (200 M gals) x ($2/gal) (P = MC) held in this industry, the firm = $400 M 2.5 would make a loss 2 MC AC
$/gallon 1.5
1 AC = TC/Q TC = AC x Q 0.5
0 0 100 200 300 400 500 Millions of gallons
Price and output decisions for Firm would make a loss if P = MC natural monopoly
Total revenues if firm produces Total costs if firm produces Q1 and sells for price P1 = MC Q1 $ per unit $/unit $/unit Firm chooses to produce at output = Q1
AC1 AC AC
P1 MC MC AC MC
MR demand Quantity Q1 Quantity Q1 Q1 Quantity
Price and output decisions for Price and output decisions for natural monopoly natural monopoly
$ per unit $ per unit
Firm chooses to charge price P1 Firm’s revenues are P1 x Q1 P1 P1
AC AC MC MC
MR demand MR demand
Q1 Quantity Q1 Quantity
21 Price and output decisions for Price and output decisions for natural monopoly natural monopoly
$ per unit $ per unit
Firm’s total costs are AC1 x Q1 P1 Firm’s total profits are this area AC1 AC1 AC AC MC MC
MR demand MR demand
Q1 Quantity Q1 Quantity
Even a monopolist can Chapter 9: Monopoly and Imperfect still make a loss Competition
Produces Q1 H. Comparison of perfect competition with $ per unit Charges price P1 monopoly Average cost AC1 AC1 Firm’s losses are this area I. Price discrimination P1 AC J. Natural monopoly
MC K. Where do monopolies come from? 1. Cartels or producer co-operatives MR demand
Q1 Quantity
Definition: Obstacles to running a cartel: A cartel is a group of producers who agree (1) They’re illegal in the United States to restrict output in order to raise the price
22 Sherman Antitrust Act (1890): Sherman Antitrust Act (1890): “Every contract, combination in the form of trust or “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign commerce among the several States, or with foreign nations, is declared to be illegal. Every person who shall nations, is declared to be illegal. Every person who shall make any contract or engage in any combination or make any contract or engage in any combination or conspiracy hereby declared to be illegal shall be deemed conspiracy hereby declared to be illegal shall be deemed guilty of a felony, and, on conviction thereof, shall be guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $10,000,000 if a punished by fine not exceeding $10,000,000 if a corporation, or, if any other person, $350,000, or by corporation, or, if any other person, $350,000, or by imprisonment not exceeding three years, or by both said imprisonment not exceeding three years, or by both said punishments, in the discretion of the court.” punishments, in the discretion of the court.” Amended to: $100 M and 10 years under H.R. 1086 (signed into law June 2004)
OPEC: Organization of Petroleum Exporting Countries
Prosecution of cartels is taken seriously.
Obstacles to running a cartel : Example: consider a cartel consisting of 10 (1) They’re illegal in the United States. countries each producing 2 million barrels (2) Each member of a cartel has an of oil per day. incentive to cheat on their agreement. Marginal cost of production: • Physical cost of added production • Opportunity cost (oil may be worth more next year)
23 Suppose total marginal cost is $20/barrel Then the marginal revenue for OPEC as a and current price is $41/barrel whole from producing another million Suppose further that if OPEC increased barrels per day is: production 1 million barrels per day, price would fall from $41/barrel to $40/barrel $40/b x 1 M b/day - $1/b x 20 M b/day = $20 M /day
Marginal cost we supposed was $20/b, so However, suppose one country (say Kuwait) additional cost of producing extra 1 M by itself could produce an extra 1 M b/day b/day is $20 M without the other countries finding out Conclusion: MR = MC = $20 M So for these figures, OPEC would currently be maximizing the collective profit of all its members
Kuwait’s marginal revenue: Most international cartels throughout history $40/b x 1 M b/day - $1/b x 2 M b/day have fallen apart after a short period from = $38 M /day these forces. Kuwait’s marginal cost: $20 M/day So Kuwait would make an extra $18 M each day by “cheating” on the rest of the cartel
24 But what about OPEC? Actual figures: Many economists believe that OPEC in fact OPEC produces 30 M bl/day is not operating as a cartel, but is just a Saudi Arabia alone produces 9 M bl/day collection of countries each acting in its OPEC = Saudi Arabia own interests.
Chapter 9: Monopoly and Imperfect Competition K. Where does monopoly or oligopoly Problems with merging to create monopoly: come from? (1) The merger can be challenged by 1. Cartels or producer co-operatives U.S. Department of Justice or Problems: illegal in U.S. and incentive to Federal Trade Commission cheat 2. Mergers or acquisitions
Celler-Kefauver amendment to Clayton Act • 1997: FTC blocked merger of Office Depot (1950): with Staples Prohibits mergers or acquisitions that would • 2000: U.S. Department of Justice blocked reduce competition merger of WorldCom and Sprint • 1999: FTC approved the merger of Mobil and Exxon
25 Marginal cost curve MC for type 1 MC for type 2 for monopoly Problems with merging to create monopoly: MC1 MC2 (1) The merger can be challenged by P1 P1 U.S. Department of Justice or MC1 MC1 MC1 Federal Trade Commission demand (2) If you act as a monopoly, new MR
competitors will appear Q1 Q2 Q total = 100 x Q1 + 100 x Q2
There is strong incentive for new firms to enter market
A Tomato Farm Is Not Hard To Start A tomato farm is not that hard to start
Chapter 9: Monopoly and Imperfect Competition Conclusion: a successful monopoly or K. Where does monopoly or oligopoly oligopoly requires barriers to new entry come from? 1. Cartels or producer co-operatives 2. Mergers or acquisitions 3. High fixed costs and barriers to entry
26 Increasing returns to scale only hold up to Example: there are 159 the efficient scale of the plant refineries in the U.S. today However, there were 263 refineries in the U.S. in 1982 No new refineries built in last quarter century and 100 shut down Reason: difficulties in getting new sites approved
The kind of gasoline that can be legally sold varies from county to county Conclusion: environmental regulation can raise substantial barriers to entry and has made the U.S. gasoline industry substantially less competitive over the last 25 years
Chapter 9: Monopoly and Imperfect Competition K. Where does monopoly or oligopoly come from? 1. Cartels or producer co-operatives 2. Mergers or acquisitions Yosemite Concession Services 3. High fixed costs and barriers to entry 4. Explicit government restrictions a. Government licenses or franchises
27 Chapter 9: Monopoly and Imperfect Competition K. Where does monopoly or oligopoly come from? 4. Explicit government restrictions Permits to operate a. Government licenses or a taxi franchises b. Patents and copyrights
Reason for copyright or patent: Before book was written, made a guess that There were big fixed costs in creating would sell 10,000 copies book (say, $300,000) Marginal cost of writing one more book: Before book was written, “fixed costs” $300,000 “fixed cost” weren’t fixed. + 10,000 books x $20 “marginal cost” per book = $500,000
Marginal revenue from one more book: Patents and copyright: 10,000 books x $60/book Government intentionally creates a legal = $600,000 monopoly for creator of original work in Based on this market expectation, looked order to provide incentive for the work to like a good deal have been created in the first place But if price only covered the marginal production cost of $20/book, book would never have been written
28 Lipitor (lowers cholesterol) Downloading music from the web • 100 pills (20 milligrams) cost $290 in U.S. Marginal cost is nearly zero • cost $201 in Canada • Pfizer spent $7.5 billion on research this “If I had to pay I wouldn’t buy it, so what’s the year harm?”
Suppose you’d pay 50 cents for a recording Problem: if everybody could do this, what • If you were charged $1.00, wouldn’t buy it would be incentive to have produced • This would be example of deadweight loss music in the first place? from monopoly Issue: from the point of view of policy, are “fixed costs” really fixed? Practical solution: patents and copyrights don’t last forever
Chapter 9: Monopoly and Imperfect Competition K. Where does monopoly or oligopoly • 63% of the world’s come from? known oil reserves are in the Middle East 4. Explicit government restrictions • 23% of the world total 5. Exclusive control over important are in Saudi Arabia inputs alone
29 Much of the gasoline Ability to exercise monopoly control limited delivered to San by close substitutes Diego comes through a single pipeline E.g., gasoline can be shipped from L.A. to owned by Kemper San Diego by truck at extra cost over Morgan pipeline
Chapter 9: Monopoly and Imperfect Competition K. Where does monopoly or oligopoly Network economies: users receive benefits come from? when they all are using the same product 4. Explicit government restrictions 5. Exclusive control over important inputs 6. Network economies
First exam will be Thursday Feb 2 in class Exam will only cover Chapters 7, 9 & 10
DIRECTIONS: No calculators, books, or notes of any kind are allowed. All papers and notebooks must remain closed and on the floor at all times throughout the exam, and students are not allowed to leave the examination room until finished. Answer all questions in the Example: computer space provided with the exam. 105 points are possible on this operating system exam. HINTS: Feel free to use either of the following formulas if you find them useful. Area of a triangle = (1/2) (base) (height) Here again, potential Area of a trapezoid = (1/2) (base1 + base2) (height) substitutes limit ability PART I: MULTIPLE CHOICE—circle the correct answer (4 points each, 72 points total) to exercise monopoly PART II: FILL IN THE BLANK (33 points total)—credit for correct power answer only (no partial credit) For sample problems see problem sets 1 and 2.
30 Reminders of study resources: • Lecture slides available from class web page • Your text book and its study questions • Copies of old exams from class web page • AS Lecture notes available for sale in Old Student Center in Revelle College
31