Module 7 Flashcards
What is a natural monopoly? (2 points)
a) Economies of scale are so large that one firm can supply the entire market at a lower average cost than two or more firms.
b) ATC curve is still declining at the point where it crosses the demand curve.
What is the narrow definition of a monopoly?
A firm is a monopoly if it can ignore the actions of all other firms.
What is the general definition of a monopoly?
- The firm is able to earn an economic profit in the long run
- A firm that is the only seller of a good or service for which there is not a close substitute
What are the 4 barriers to entry?
- Government (i.e. patents, public franchises)
- Key resource is controlled by one firm
- Network externalities
- Natural monopoly
How does a monopoly decide how much to produce at what price?
Q: where MR = MC
P: where Q hits the demand curve
What is price discrimination?
Charging different prices to different people for the same good or service when the price differences are not due to differences in cost.
What needs to be true in order to price discriminate?
- must have market power
- must be able to segment the market to prevent arbitrage
- customers must have different willingness to pay, and the firm must know this and the P to charge them
What is the Law of One Price
Basically that arbitrage will enforce a single price on the market.
What are industry terms for price discrimination?
Yield management
Price optimization
Dynamic pricing
What is perfect price discrimination?
When the monopoly can charge everyone exactly according to their willingness to pay.
Why are monopolies generally innefficient?
When monopolies cannot perfectly price discriminate, there’s a deadweight loss due to them not producing at their most efficient output. (they produce where MR = MC, not where MC = P)
Since perfect price discrimination makes monopolies produce at the efficient level, what’s the loss to society?
Consumers are worse off because the entire consumer surplus is taken by the monopoly.
When does a monopoly produce at MC = P
In perfect price discrimination.
What is price discrimination across time?
Charging a higher price when a product is first introduced and a lower price later.
Is price discrimination legal?
Basically if it increases or doesn’t affect competition, it’s OK, as long as the discrimination is not based on a protected trait such as race.
What is another term for perfect price discrimination?
First degree price discrimination.
What is second degree price discrimination?
done in blocks
What form of second degree price discrimination does Costco use?
Two-part tariffs.
Which were the first two anti-trust laws (USA & Canada)?
Competition Act - Canada - 1889
Sherman Act - USA - 1890
Which Canadian governing body deals with monopolies?
Competition Bureau of Canada
What are two important considerations when looking at whether a monopoly is good or not?
Definition of the market
Possible increases in economic efficiency
What are the three guidelines used to see if a monopoly should be broken up?
- Market definition - if all firms in that market increased price, would they make more or less $ (because there’s no close substitutes)
- Measure of concentration - Herfindahl-Hirschman Index
- Merger standards
What’s the Herfindahl-Hirschman Index?
An index of how concentrated a market is, and how concentrated it would be after a potential merger. Want to keep it below 2,500, changes themselves below 100. Sum of squares of all market shares (not just the merging firms).
How do we set a government price for a natural monopoly?
Must set at P (demand) = ATC.
Why can’t we force natural monopolies to produce and sell at the price where MC = MR?
For a natural monopoly, ATC will still be dropping when it crosses the demand curve, meaning that it hasn’t yet crossed MC, so P=MC will be below ATC, and so the firm will incur a loss.
What’s the rule of thumb for pricing?
(P-MC)/P = 1/E
where E is the price elasticity of demand
perfect competition: = 1/infinity
perfectly inelastic demand: = 1/0
How do we set price for a monopoly that isn’t a natural monopoly?
Since ATC is rising again, but below MC as it crosses D for a monopoly that isn’t a natural monopoly, we set P = MC = D.
Why is MR always below D for suppliers who are price-makers?
MR < D for suppliers who are price-makers because the output effect increases total revenue while the price effect lowers total revenue.
