10. Monopoly - schneider.wiwi.uni-wuppertal.de · 10. Monopoly . Literature: Pindyck ......
Transcript of 10. Monopoly - schneider.wiwi.uni-wuppertal.de · 10. Monopoly . Literature: Pindyck ......
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 1 |
10. Monopoly
Literature: Pindyck and Rubinfeld, Chapter 10, 12
Varian, Chapter 24
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 2 |
Chapter Outline
• Monopoly
• Monopoly Power
• Sources of Monopoly Power
• The Social Costs of Monopoly Power
• Monopolistic Competition
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 3 |
Perfect Competition
• Review of perfect competition
– P = LMC = LAC.
– In the long-run, firms earn normal profit, i.e., zero economic
profit.
– Large number of buyers and sellers.
– Homogeneous products.
– Complete information.
– The firm is a price-taker.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 4 |
Perfect Competition
Q Q
P P Market Single Firm D S
Q0
P0 P0 D = LMC = P
q0
LAC LMC
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 5 |
Monopoly
• Monopoly
1) One seller – many buyers.
2) One product (no good substitutes).
3) Barriers for market entry.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 6 |
Monopoly
• The monopolist covers the supply side of the market and has
market power over the amount of goods produced.
• The profits are maximized when marginal cost is equal to
marginal revenue.
• Marginal revenue : Change in revenue resulting from a one-unit
increase in output.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 7 |
Monopoly
• Determining the marginal revenue
– The monopolist, being the only supplier in the market, uses
market demand to determine output and price.
– Consider a firm facing following demand curve:
P = 6 – Q.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 8 |
Total, Marginal, and Average Revenue
€6 0 €0 --- --- €5 1 €5 €5 €5 €4 2 €8 €3 €4 €3 3 €9 €1 €3 €2 4 €8 -€1 €2 €1 5 €5 -€3 €1
Total Marginal Average Price Quantity Revenue Revenue Revenue P Q R MR AR
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 9 |
Average and Marginal Revenue
Output 0
1
2
3
Price (€ per unit of output)
1 2 3 4 5 6 7
4
5
6
7
Average Revenue (demand)
Marginal Revenue
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 10 |
Monopoly
• Note that:
1) The price has to fall for sales to increase.
2) MR < P.
3) In comparison to perfect competition:
• No change in prices when sales change.
• MR = P.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 11 |
Monopoly
The Monopolist‘s Output Decision
• Profits are maximized at the production level where
MR = MC.
( ) ( ) ( )
/ 0Q R Q C Q
d dQ MR MCor MC MR
ππ
= −= − ==
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 12 |
Profits are Maximized when Marginal Revenue Equals Marginal Cost
• When switching to output levels below MR = MC, the
decrease in revenue is greater than the decrease in costs
(MR > MC).
• When switching to output levels above MR = MC, the
increase in cost is greater than the increase in revenue
(MR < MC).
The Monopolist‘s Output Decision
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 13 |
Profits are Maximized when Marginal Revenue Equals Marginal Cost
Lost Profits
P1
Q1
Lost Profits
MC
AC
Quantity
D = AR
MR
P*
Q*
P2
Q2
Price (€ per unit of output)
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 14 |
Monopoly
• An Example:
2( ) 50
2
Cost C Q QdCMC QdQ
= = +
= =
The Monopolist‘s Output Decision
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 15 |
Monopoly
( ) 40
2( ) ( ) 40
40 2
Demand P Q Q
R R Q P Q Q Q Q
MR Q
= = −
= = = −
= −
The Monopolist‘s Output Decision
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 16 |
Monopoly
40 2 210
When 10, 30.
MR MC or Q QQ
Q P
= − ==
= =
The Monopolist‘s Output Decision
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 17 |
Example of Profit Maximization
Quantity
€
0 5 10 15 20
100
150
200
300
400
50
R
Profits r
r'
c
c’
C
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 18 |
Example of Profit Maximization
Profit
AR
MR
MC
AC
Quantity
€/Q
0 5 10 15 20
10
20
30
40
15
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 19 |
Monopoly
A Rule of Thumb for Pricing
• We would like to convert the condition MC = MR into a
simple rule of thumb, which will be easier to apply in
practice.
• This can be demonstrated using the following steps:
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 20 |
( )( )
( )1.
2. d
dR d PQMRdQ dQ
dP Q dPMR P Q P PdQ P dQ
dQPE Q dP
= =
= + = +
=
A Rule of Thumb for Pricing
( )( ) 1
13.
d
d
Q dPP dQ E
MR P PE
=
= +
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 21 |
4. is maximized when MR MC
1 P P MCE
MC P1 (1 E )
d
d
π =
+ =
=+
A Rule of Thumb for Pricing
The price markup rate (as a percentage of price) is
equal to the reciprocal of the elasticity of demand!
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 22 |
( )
Assume the following is given: 4 9
9 9 €120.7511 4
dE MC
P
= − =
= = =+ −
An Example
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 23 |
Monopoly
Pricing in a Monopoly Compared to Pricing in Perfect
Competition
• Monopoly:
P > MC.
• Perfect competition:
P = MC.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 24 |
Monopoly
Pricing in a Monopoly Compared to Pricing in Perfect
Competition
• The more elastic the demand is, the closer the price is to
the marginal cost.
• If Ed is a large negative number, the price is closer to
marginal costs and vice versa.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 25 |
Example: Astra-Merck Prices Prilosec
• The drug, Prilosec, represented a new generation of
antiulcer medication.
• Price P = €3.50 /daily dose.
• MC = 30 to 40 cents/daily dose.
• is in the range of -1 to -1.2.
DE
The Monopolist‘s Output Decision
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 26 |
Astra-Merck Prices Prilosec
[ ] [ ]
( )
0.351 1 1 1 1.1
0.35 3.891 0.91 0.09
D
MCPE
MC Euro
= = =+ + −
= =+ −
•The price of €3.50 is almost equal to our rule of thumb for pricing.
The Monopolist‘s Output Decision
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 27 |
Monopoly
• The effect of a tax
– The monopolist can sometimes increase his price by more than
the amount of the tax (see chapter 9).
• Analyzing the effect of a tax:
– t = specific tax.
– MC = MC + t.
– MR = MC + t: optimal production decision.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 28 |
Effect of an Excise Tax on a Monopolist
Quantity
€/Q
MC D = AR
MR
Q0
P0 MC + tax
t
Q1
P1
P∆
Increase in P: P0 to P1 > tax
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 29 |
Effect of an Excise Tax on a Monopolist
• Question
– Suppose for example that Ed = -2.
– How much would the change in price be?
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 30 |
Effect of an Excise Tax on a Monopolist
• Answer
11
When 2 2
MC increases to MC2( ) 2 2
The price rises by twice the amount of the tax.
MCP
EdE P MCd
tP MC t MC t
=
+
= − → =
+= + = +
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 31 |
Monopoly Power
• Pure monopolies are rare.
• However, a market with many firms, all of whom are facing a
negative (downward sloping) demand function, can also produce
at a quantity where price exceeds marginal cost.
• Scenario:
– Four firms with the same market share of 5,000 units
produce 20,000 tooth-brushes for a price of €1.50 each.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 32 |
The Demand for Toothbrushes
Quantity 10,000
2.00
QA
€/Q €/Q
1.50
1.00
20,000 30,000 3,000 5,000 7,000
2.00
1.50
1.00
1.40
1.60
At a market price of €1.50, elasticity of market demand is -1.5.
Market Demand
The demand curve of firm A depends on the extent to which its product differs from others and how other firms compete.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 33 |
The Demand for Toothbrushes
At a market price of €1.50, elasticity of market demand is -1.5.
Quantity 10,000
2.00
QA
€/Q €/Q
1.50
1.00
20,000 30,000 3,000 5,000 7,000
2.00
1.50
1.00
1.40
1.60
DA
MRA
Market Demand
Firm A, however, has a much more elastic demand curve, DA, because of competition from other firms: Ed = -6. Still, firm A has some monopoly power: its profit-maximizing price is €1.50, which exceeds its marginal cost.
MCA
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 34 |
Monopoly Power
•Profit is not guaranteed by monopoly power.
•Profit depends on average cost in comparison to prices.
• Remember the rule of thumb for pricing:
• Pricing for a firm with market power:
If Ed is large, the mark-up rate is small.
If Ed is small, the mark-up rate is large.
( )1 1 d
MCPE
=+
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 35 |
Elasticity of Demand and Price Markup
€/Q €/Q
Quantity Quantity
AR
MR
MR AR
MC MC
Q* Q*
P*
P*
P* - MC
The more elastic the demand is, the less the price markup.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 36 |
Markup Pricing: Supermarkets to Designer Jeans
Supermarkets
( )
( )
1. Supermarket chain several supermarkets .2. Similar product.3. 10 for each supermarket.
4. 1.11( ).1 1/ 10 0.9
5. Price should be almost 10-11% above MC.
EdMC MCP MC
= −
= = =+ −
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 37 |
Markup Pricing: Supermarkets to Designer Jeans
Small Convenience Stores
( )
1. Higher prices than supermarkets.2. Customers are less price sensitive.3. 5.
4. 1.25( ).1 1 5 0.8
5. Prices should be almost 25% above MC.
dEMC MCP MC
= −
= = =+ −
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 38 |
Markup Pricing: Supermarkets to Designer Jeans
Designer Jeans
1. Ed = -2 to -3.
2. Prices should be 50 – 100% higher than
MC.
3. MC = €15 - €20/piece.
4. Wholesale price = €20 - €50.
5. How can you explain this price?
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 39 |
Sources of Monopoly Power
• What are the sources of monopoly power, and why do some
firms have more monopoly power than others?
• The monopoly power of a firm is determined through the
elasticity of demand.
• The elasticity of demand is determined by three factors:
1) The elasticity of market demand.
2) The number of firms in the market.
3) The interaction among firms.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 40 |
The Social Costs of Monopoly Power
• Monopoly power results in higher prices and lower quantities
being produced.
• However, does monopoly power make consumers and
producers better or worse off?
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 41 |
Deadweight Loss from Monopoly Power
B A
Lost Consumer Surplus
Deadweight Loss
Because of the higher price, consumers lose A + B and the producer gains A – C.
C
Quantity
AR
MR
MC
QC
PC
Pm
Qm
€/Q
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 42 |
The Social Costs of Monopoly Power
• Rent seeking: spending money in socially unproductive efforts to
acquire, maintain, or exercise monopoly power.
― Lobbying
― Advertising
― Creation of additional product capacities
• The incentive for the implementation of such monopoly power
depends on the targeted profits.
• The higher the rent transfer from consumer to monopoly, the
higher are the social costs of the monopoly.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 43 |
The Social Costs of Monopoly Power
• Price regulation
– Recall that price regulation in perfect competition leads to
welfare loss.
• Question:
– What happens in the case of a monopoly?
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 44 |
Price Regulations
MC Pm
Qm
AC
AR
MR
If left alone, a monopolist produces Qm and charges Pm.
€/Q
Quantity
If we decrease price to PC, Output increases to its maximum QC and we do not face welfare loss.
P2 = PC
Qc
Every price below P4 causes the firm to incur losses.
P4
P1
Q1
Marginal revenue curve when price is regulated to be no higher than P1.
P3
Q3 Q’3
If price decreases to P3, the output decreases. We then have a shortage of supply: Q’3 - Q3.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 45 |
The Social Cost of Monopoly Power
• Natural monopoly
– A firm that can produce the entire output of a market at a
cost lower than what it would be if there were several
firms.
Economies of scale may make it too costly for more
than a few firms to supply the entire market. In some cases, economies of scale may be so large that it is most efficient for a single firm—a natural monopoly—to supply the entire market.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 46 |
Regulating the Price of a Natural Monopoly
MC
AC
AR MR
€/Q
Quantity
Setting the price at Pr yields the largest possible output consistent with the firm’s remaining in business. Excess profit is zero.
Qr
Pr
PC
QC
If price were regulated to PC the firm would lose money and go out of business.
Pm
Qm
Without price regulation the producer produces Qm for a price of Pm .
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 47 |
Monopolistic Competition
• Characteristics
1) Many companies
2) Free market entry and exit
3) Differentiated products
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 48 |
Monopolistic Competition
• The degree of monopoly power depends on the extent of
differentiation.
• Examples for such common market structures:
– Toothpaste
– Soap
– Cold remedies (i.e. remedies for catching a cold)
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 49 |
Monopolistic Competition
• The assumptions for having monopolistic competition
– Two important assumptions
Differentiated goods that are highly substitutable but are not
perfect substitutes.
Free market entry and exit.
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 50 |
A Monopolistic Competitive Firm in the Short and Long Run
Quantity
€/Q
Quantity
€/Q MC
AC
MC
AC
DSR
MRSR
DLR
MRLR
QSR
PSR
QLR
PLR
Short Run Long Run
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 51 |
Deadweight Loss MC AC
€/Q
Quantity
€/Q
D = MR
QC
PC
MC AC
DLR
MRLR
QMC
P
Quantity
Perfect Competition Monopolistic Competition
Comparison of Competitive Equilibrium: Monopolistic and Perfect Competition
| 20.06.2017 | Prof. Dr. Kerstin Schneider| Chair of Public Economics and Business Taxation | Microeconomics| Chapter 10 Slide 52 |
Monopolistic Competition
• Monopolistic competition and economic efficiency
– If monopoly power exists (differentiation), a higher price will be
charged in the market in comparison to perfect competition. If
the price is lowered to the point where MC = D, the total rent
increases by the yellow triangle.
– Although, in the long-run economic profit is equal to zero, firms
still do not produce the cost minimizing quantity; rather, they
operate with excess capacity.