UBEA 1013: ECONOMICS 1 CHAPTER 6: MARKET STRUCTURE: MONOPOLY 6.1 Characteristic 6.2 Short-run...

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UBEA 1013: ECONOMICS

CHAPTER 6: CHAPTER 6: MARKET STRUCTURE: MONOPOLYMARKET STRUCTURE: MONOPOLY

6.1 Characteristic

6.2 Short-run Decision: Profit Maximization

6.3 Short-run Decision: Minimizing Loss

6.4 Long-run Profit Maximization & Misconception

6.5 Social Cost of Monopoly

6.6 Natural Monopoly

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Monopolies:

the firm almost totally dominated the market with its competitor hardly provide competition or their products are hardly substitutable.

E.g. included collusion or cartel: Organization of Petroleum Exporting Countries (OPEC), DeBeer, Microsoft, Tenaga Nasional.

What is monopoly or can be considered a monopoly?

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i. One firm: Firm supply is equal to the whole market/industry supply.

ii. No close substitute : Unique product with no competition.

iii. Price maker : Monopoly can influence either the market price or quantity supplied. Constraint by demand behavior of consumers.

iv. Barriers to entry : Heavy restrictions or barriers. Barrier to entry is legal or natural constraints that protect a firm from potential competitors.

Market power: “One firm”, “no close substitute” & “barriers to entry” give market power to monopoly (to be a “price maker”).

(i) monopolist can choose a price -- consumers choose how much they wish to buy at that price

(ii) monopolist can choose the quantity, letting the consumers to decide what price they will pay for that quantity

6.1 Characteristic

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a. Government franchises, or firms that become monopolies by virtue of a government directive;

b. Patents, copyrights or barriers that grant the exclusive use of the patented product or process to the inventor;

c. Economies of scale and other cost advantages enjoyed by industries that have large capital requirements. A large initial investment, or the need to embark in an expensive advertising campaign, deter would-be entrants to the industry;

d. Ownership of a scarce factor of production: If production requires a particular input, and one firm owns the entire supply of that input, that firm will control the industry.

Further on the forth assumption, barriers to entry include:

6.1 Characteristic6.1 Characteristic

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Figure 6.1: Monopolist’s Demand, MR & TR Curve

6.1 Characteristic6.1 Characteristic

Monopolist’s marginal revenue is below the demand.

The MR curve shows the change in TR. TR is maximum when marginal revenue equals zero.

The MR is twice as steep as the demand curve.

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If MR < MC, it would pay for the firm to decrease output as the saving in cost would be

bigger than loss in revenue

If the MR > MC, additional revenue will more than additional cost, thus it would be better

off for the firm to increase output

The only point where the firm has no incentive to change output is where the MR = MC

[ Optimization condition for monopoly = perfect competition ]

((Only that in perfect competition: P = MR))

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• The profit-maximizing level of output (Qm) occurs where MR = MC.

• Notice that the outcome is different from that of perfect competition. Here, the price ($4.00) is more than the average total cost ($3.00), and the monopolist earns positive economic profit of ($4 - $3 = $1) per unit.

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If average revenue less than average total cost, a firm suffer losses.

Despite having market power, the monopolist still constraint to either setting the price or output only, not both.

Therefore, monopolist is also subject to the three profit-maximization situation as in perfect competition structure that is incurring economic profit, economic loss or breakeven situations.

6.3 Short-run Decision: Minimizing Loss

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If the operating profit is negative (TR < TVC), the monopoly suffers operating losses that push total losses above fixed costs.

So, it is better to shut down.

Summary:TR > TVC: Decision = Keep operating (in short term)TR < TVC: Decision = Shut down

Those decisions is known as minimizing losses.

6.3 Minimizing loss6.3 Minimizing loss

<<< Same as perfect competition structure >>>

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Figure 6.2: Profit Maximization Situations

6.3 Minimizing loss6.3 Minimizing loss

(a) Economic profit (b) Economic loss

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6.4 Long-run Profit Maximization & Misconception

True Misconception

Monopolist CAN earn positive economic profit in the long run.

Monopolist ALWAYS earn positive economic profit in the long run.

Monopolist seek to maximize PROFIT.

Monopolist seek to maximize PRICE.

Monopolist has BOTH good and bad to the market/society.

Monopolist ALWAYS bad to the market/society.

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6.5 Social Cost of Monopoly

There are three type of social cost of monopoly as follow:

a) Deadweight loss as result of not producing at price equal to marginal cost like in perfect competitive market structure;

b) Rent-seeking behavior to preserve positive profits; and

c) Price discrimination behavior that transfer income or surplus from consumers to the monopolist.

To be continue next week …..

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A) Deadweight lossFrom consumer surplus to monopoly surplus

From consumer surplus to nobody

From producer surplus to nobody

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B) Rent Seeking

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C) Price Discrimination

Definition:Charging different prices to different buyers or different prices on different units sold is called price discrimination.

First-degree price discrimination

Second-degree price discrimination

Third-degree price discrimination

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The monopolist sells different units of output for different prices and these prices may differ person to person.


Perfect price discrimination – each unit of output is sold at the maximum price that individual (consumer) is willing to pay for it

What happen to consumer surplus?????

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Need information on the maximum each consumer willing to pay.

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The monopolist sells at different price per unit of output, depending on how much a consumer buys

Second-degree price discrimination

Non-linear pricing.

NO need information on the maximum each consumer willing to pay. ONLY to construct “price-quantity” package.

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The monopolist sells to different group of consumer with different price but every unit of product sold to a given group is sold at same price

Third-degree price discrimination

Most common.

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Products are sell in bundle.

Other types of discrimination: Bundling

Table 6.1: Bundling and Willingness to Pay

Type of consumerType of consumer Word Processor Word Processor (WP)(WP)

SpreadsheetSpreadsheet (Sp)(Sp)

TotalTotalReveRevenuenue

Type AType A $200$200 $150$150

Type BType B $150$150 $200$200

ScenarioScenario:: Total sales Total sales (WP)(WP)

Total sales (Sp)Total sales (Sp)

(i) Individual price (WP $150, Sp (i) Individual price (WP $150, Sp $150)$150)

2*$150 = $3002*$150 = $300 2*$150 = $3002*$150 = $300 $600$600

(ii) Individual price (WP $200, Sp (ii) Individual price (WP $200, Sp $200)$200)

1*$200 = $2001*$200 = $200 1*$200 = $2001*$200 = $200 $400$400

(iii) Individual price (WP $150, Sp (iii) Individual price (WP $150, Sp $200)$200)

2*$150 = $3002*$150 = $300 1*$200 = $2001*$200 = $200 $500$500

(iv) Individual price (WP $200, Sp (iv) Individual price (WP $200, Sp $150)$150)

1*$200 = $2001*$200 = $200 2*$150 = $3002*$150 = $300 $500$500

(v) Bundle price ($350)(v) Bundle price ($350) 2*$350 = $7002*$350 = $700

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Two kind of pricing for two related product: e.g.a) Entrance and ride priceb) Camera and films pricec) Razor price & blade price

Other types of discrimination: Two-Part Tariff

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6.6 Natural Monopoly

A natural monopoly is an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

End

UBEA 1013: ECONOMICS 1 CHAPTER 6: MARKET STRUCTURE: MONOPOLY 6.1 Characteristic 6.2 Short-run...

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