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Imperfect Competition: Monopoly

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Imperfect Competition: Monopoly Imperfect Competition: Monopoly New Topic: Monopoly Q: What is a monopoly? A monopoly is a firm that faces a downward sloping demand, and has a choice about what price to charge – an increase in price doesn’t send most or all of the customers away to rivals. A Monopolistic Market consists of a single seller facing many buyers. Monopoly Q: What are examples of monopolies? There is one producer of aircraft carriers, but there few pure monopolies in the world - US postal mail faces competition from Fed-ex - Microsoft faces competition from Apple or Linux - Google faces competition from Yahoo and Bing - Facebook faces competition from Twitter, IG, Google+ But many firms have some market power- can increase prices above marginal costs for a long period of time, without driving away consumers. Monopoly’s problem 3 Example: A monopolist faces demand given by p(q) 12 q There are no variable costs and all fixed costs are sunk. How many units should the monopoly produce and what price should it charge? By increasing quantity from 2 units to 5 units, the monopolist reduces the price from $10 to $7. The revenue gained is area III, the revenue lost is area I. The slope of the demand curve determines the optimal quantity and price. Monopoly’s problem 4 The monopoly faces a downward sloping demand curve and chooses both prices and quantity to maximize profits. We let the monopoly choose quantity q and the demand determine the price p(q) because it is more convenient. TR(q) p(q) MR [ p(q)q] q p(q) q q q • The monopoly’s chooses q to maximize profit: max (q) TR(q) TC(q) p(q)q TC(q) q The FONC gives: Marginal revenue 5 TR(q) p(q) The marginal revenue MR(q) p(q) q q q p Key property: The marginal revenue is below the demand curve: MR(q) p(q) Example: demand is p(q) =12-q. What are TR(q) and MR(q)? D q MR Example 1 6 Suppose that demand and marginal cost are linear: p ( q ) a bq MC(q) cq where a,b,c>0 are constants. What is the monopolist’s optimal quantity and price? TR(q) qp(q) aq bq2 MR(q) a 2bq MC(q) MR(q) cq a 2bq a q c 2b a p a b( ) c 2b Monopoly and consumer surplus 7 Relationship between the monopoly's price and the perfectly competitive price that maximizes consumer surplus, pcs. p Consumer surplus is the area between the demand curve and the market price. pm MC The monopoly charges a higher price, and produces less units. What is the surplus (welfare) D cost of the monopolist to MR consumers? pcs q qm qcs Monopoly and total surplus 8 Consumer surplus is the area between the demand curve and the market p price. Producer surplus is the area between the marginal cost curve and the p MC m market price. p c The sum of these measures total (market) surplus. D MR Is total surplus maximized at quantity q q ? At q ? At q ? How is p called? qm qc qcs m cs c c Loss in surplus: dead weight loss 9 Relationship between the monopoly's price and the perfectly competitive price pc (that maximizes total surplus). p The monopoly charges a higher Dead weight loss MC pm price, and produces less units than a competitive market. pc What is the social welfare cost of the monopolist? D MR Dead weight loss: the area q between the maximum total surplus qm qc possible and the surplus created by the monopoly. Dead weight loss 10 Relationship between the monopoly's price and the perfectly competitive price pc (that maximizes total surplus). p Key Property: Dead weight loss The “distance” from price pc is negatively pm MC related to how much demand reacts to price changes (which is shown by how flat pc the demand curve is). The flatter (more elastic) is the demand D curve, the smaller is the difference between MR q pc and the monopoly price pm. qm qc The steeper (more inelastic) is the demand curve, the larger is the difference. Dead weight loss 11 Relationship between the monopoly's price and the perfectly competitive price pc (that maximizes total surplus). p Key Property: Dead weight loss The “distance” from price p is negatively pm MC c related to how much demand reacts to price changes (which is shown by how flat p c the demand curve is). The flatter (more elastic) is the demand D MR curve, the smaller is the deadweight loss. q q qm c The steeper (more inelastic) is the demand curve, the larger is the deadweight loss. Monopoly Q: Why do monopolies arise? 1. Government provision- for example patents, copyright laws, rights for satellite communication in certain countries, taxi permits 2. Large Economies of Scale – average cost of a single firm serving the entire market is lower than two firms. Happens when there are large fixed costs. For example: telephone lines, electricity generation (before the 80s) 3. Control of an essential input that cannot be replicated- For example, Coca-cola’s recipe, Google’s algorithm Definition: A market is a natural monopoly if the total cost incurred by a single firm producing output is less than the combined total cost of two or more firms producing this same level of output among them. Examples- Happens when there are high fixed costs. Electricity plants, Satellite companies .
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