Monopoly, Price Discrimination & Monopolistic Competition

Question 1

Monopoly definition

Answer 1

Only supplier for a good where there is no close substitute.

Question 2

Reasons for monopoly (3)

Answer 2

Barriers to entry
E.o.S
E.o.Scope (natural monopolies - inefficient to have multiple firms)

Question 3

Main characteristic of monopoly

Answer 3

Price setter - choose any price and quantity to supply at.

Question 4

Revenue for monopoly

Answer 4

P(y) x y

Question 5

Profit maximisation problem for monopoly (look at slides)\

What is the final expression we get.

Answer 5

Max p(y)y - c(y)

F.O.C use chain rule

The first 2 terms represent MR, last means MC which we can rearrange to get MC=MR

Question 6

We wanna see how PED links to MR.

First recall PED formula

Answer 6

ε = p/y x dy/dp

Question 7

So how can we rewrite MR to include ε

Answer 7

MR = y dp(y)/dy +p(y)

Where y dp(y)/dy = p(y)/ε (PED)

SO
MR = p(y)/ε + p(y)
Then factorise to take p(y) out
p(y) (1 + 1/ε)

Question 8

So MR=MC(y)= p(y) (1-1/ε)

From this we can rearrange to find the profit maximising price.

Answer 8

p(y) = MC(y) / (1-1/ε)

Monopolies set P>MC

Question 9

What does markup pricing price suggest

Answer 9

Price is a markup over marginal cost which depends on PED.

E.g If PED (ε) high/elastic, price will be only slightly above normal price. Inelastic = greater price

Question 10

2 cases of the markup pricing rule: explain their PED & where they would price at.

1. Competitive firm
2. Monopolist

Answer 10

1. Competitive firm faces perfectly elasticity, so demand is horizontal. So ε is infinite, so denominator (1-1/ε) is so small we just assume the denominator is 1.

From this, we can see p(y)=MC(y) in a competitive market

2. A monopoist faces a downward sloping curve, so ε is finite (we also assume ε>1). So price is set above MC, with a markup of 1-/1ε

So a monopolist operates at a quantity where MC=MR, and sets a price > MC (since using the markup pricing rule shows us this)

Question 11

Monopoly with linear demand

Answer 11

p(y) = a - by

PM problem
Max (a-by)y - c(y)

So F.O.C using product rule
a - 2by = MR

Which is twice as steep as demand curve (-2by) with same intercept (a)

Question 12

From this we can find the PM output and price

Answer 12

Y* = a - dc(y)/dy
/
2b

Sub this into Y from the original linear expression
p= a-by

Question 13

Draw diagram that compares monopoly and a competitive market. (Pg 5)

What is a flaw of monopoly

Answer 13

Not pareto efficient - producing less output than desired.

People are willing to pay PC or more to buy the good, but it is not supplied, since the monopolist would have to reduce the price paid for all customers, reducing the monopolists profit. So there is a deadweight loss.

Question 14

Show the difference in CS and PS and deadweight losses in monopoly vs competitive market.

Answer 14

Deadweight loss adds up the difference between what consumers are willling to pay, and the cost of supplying the units which are not produced by the monopolist.

Question 15

So this shows why a monopoly is bad (not Pareto efficient)

But when may a competitive market not be possible (2)

Answer 15

If there is a natural monopoly with increasing returns across full range of output , meaning AC is always falling, so one firm produces at a lower AC than multiple firms combined. (downward sloping)

If minimum efficient scale is high relative to demand.

Question 16

Natural monopoly characteristics

Answer 16

High fixed costs
Low MC (we assume 0)

Question 17

Natural monopoly diagram: where does it produce

Answer 17

Producers where MR=MC=0.
remember we assume 0 marginal costs so MR=0.

Question 18

So if there were multiple firms each producing a small quantity, AC would be very high.

More efficient for one firm. However, the price the monopoly sets may be undesireable.

What can be done? (2)

Answer 18

Government could run the natural monopoly, supply at a loss, break even, or earn a profit, but will probably set a price below pm (monopolists price)

Regulate private supply - limit price to be under pm but at least to break even (=AC) or slightly higher (>AC)

Question 19

Second reason why a competitive market may not exist: Minimum efficient scale high relative demand

What is the MES?

Answer 19

The lowest level of output where all E.O.S exploited
i.e lowest point on AC curve.

Question 20

Case 2: Where MES is high relative to demand (pg10)

Answer 20

Cannot produce at pMC (competitive market price P=MC) since AC>P so making a loss.

So unable to reach MES to exploit all E.O.S so firm could instead produce at MC=MR where P>AC

This shows us that for a competitive market to exist, we need MES small.

Question 21

Price discrimination

Answer 21

Charging different prices for different consumers

Question 22

3 types of price discrimination

Answer 22

1st 2nd 3rd degree

Question 23

First degree

Answer 23

Seller charges a different price for any unit to any consumer

E.g no standardised price.

Question 24

Second degree price discrimination

Answer 24

Every consumer who buys a certain quantity pays the same price (bulk buying discounts)

Question 25

Third degree price discrimination

Answer 25

Different prices according to their characteristics (e.g student vs non-student tickets)

Question 26

First degree price discrimination: how much does the monopolist receive?

Answer 26

Monopolist receives the consumers valuation for every unit they sell. (They sell for the reservation price of the consumer- the maximum they are willing to pay)

Question 27

What does the demand curve look like (pg12)

Answer 27

Treat it as a series of consumers valuations of the good, starting with the highest valuation and work down (downward sloping).

So monopolists under first degree PD receives this valuation (reservation price)

Question 28

Monopolists supply for first degree price discrimination

How much do they supply

Answer 28

As long as amount they receive is>= costs
P=MC

Which is the competitive output!
(Remember demand curve AR=P so P=MC)

Question 29

Graph to show this supply, and what is the key point.

Answer 29

Monopolist exploits the full consumer surplus. So it is all producer surplus since no CS anymore (consumers pay their max price)

Question 30

What efficiency do we achieve, and evaluation (pg12)

Answer 30

Pareto efficiency (monopolist supplies the competitive output level P=MC)

Eval:
Distribution of welfare unequal: all goes to the producer. Consumer has no surplus since they pay their reservation price.

Question 31

Is first degree discrimination realistic

Answer 31

No, requires strong information needed to achieve this outcome. (E.g to understand consumers valuations to extract their full surplus)

Question 32

Third degree price discrimination assumption

Answer 32

Resale by consumers is not possible.

Question 33

Structure:
Group 1 has demand D1(p1) and group 2 D2(p2)

We turn into inverse demand curves to get p1(y1) p2(y2)

Cost of producing output is c(y1+y2_

What is the PM problem?

Answer 33

Max p₁(y₁)y₁ + p₂(y₂)y₂ - c(y₁+y₂)

Question 34

First order conditions for this PM problem equation

Answer 34

Max profit for group 1: MR₁ - MC₁ = 0

Max profit group 2: MR₂ - MC₂ = 0

Question 35

Then recall our MC formula as a function of PED.

Answer 35

MC(y) = p(y) (1 - 1/ε)

We apply this to both groups with same marginal cost
MC(y) = p₁(y₁) (1-1/ε₁) = p₂(y₂)(1-1/ε₂)

Assume group 1 has lower elasticity ε₁<ε₂
So 1-1/ε₁ < 1-1/ε₂

This means p₁(y₁) >p₂(y₂).
Makes sense as lower elasiticty, less responsive to a change in price and so monopolist charges them more!

Question 36

Maths example pg 41

Question 37

Draw/explain diagrams for 3rd degree price discrimination (pg15)

Answer 37

First 2 diagrams are with price discrimination.

Together, it is more profitable to sell at different prices.
Different MC=MRs

3rd diagram shows if we had a single price for all consumers. It has 2 slopes to represent the change in slopes and the slope change starts at the different intercept level

Question 38

Monopolistic competition - main characteristics

2. Where does it produce?

Answer 38

Free entry/exit so profits are driven down to 0.
Differentiated products

2. MC=MR

Question 39

What does product differentiation mean for a firm, and the demand curve?

Answer 39

A firm does not instantly lose all its sales if it raises its price.

Loses sales but some are willing to pay the higher price while others move to another product.

As a result the demand curve is more elastic (flat)

Question 40

How is an indiviudal firms demand curve affected by more firms entering th emarket

Answer 40

Demand curve shifts inward as each firm now has a smaller share.

Curve becomes more elastic (flatter) , since more options.

Question 41

How to show demand curve for a high number of firms vs low diagramatically

Answer 41

Demand curve when higher no. of firms will be flatter and lower (shift inward since smaller market share now)

Question 42

SR vs Long run equilibrium for monopolistic competition

Answer 42

SR - firms may earn positive profits (wont lose all sales due to product differentiation)

LR - firms will enter due to the profit, and thus compete profit away.

Question 43

Draw monopolistic comp diagram for SR vs LR

Answer 43

IN LR AC=AR

Question 44

Efficiency and welfare - MONOPOLISTIC COMPETITION BETTER THAN COMPETITIVE MARKET?

Yes and no

Answer 44

No, as firm does not operate at lowest point of AC curve.
Higher price and lower quantity supplied.

Yes - product differentiation exists