Section 8 Flashcards
Pure Monopoly
Single Seller
No close substitutes
Price maker
Blocked Entry
Near Monopoly
A single firm has the bulk of sales, like Intel with 80% of the chip market.
Geographic Monopolies
Monopoly in a geographic area like in a town.
Barriers to Entry (Monopolist)
- Economies of scale (long-run ATC declines)
- Legal barriers to entry (patents, licenses)
- Ownership or control of essential resources
- Pricing and other strategic barriers to entry (price undercutting, etc.)
- Network externalities - one item demands the use of another item.
Natural Monopoly
Market demand curve intersects the long-run ATC curve at any point where average total costs are declining.
Demand Curve (Monopolist)
Company demand is the industry demand.
Demand curve is downward sloping
Three implications:
- Marginal revenue is less than price
- Monopolist is the price maker
- Sets prices in the elastic region of demand
Marginal Revenue is Less Than Price (Monopolist)
Can increase sales only by charging a lower price. Must charge all customers the same price.
Since each unit made drops the price on the demand curve total revenue increases at a diminishing rate. Also MR curve lies below the demand curve.
MR falls twice as fast as demand.
Marginal revenue is positive while total revenue is increasing. when TR maxes then marginal revenue is zero. TR diminishing is a negative MR.
Price Maker (Monopolist)
Those with downsloping demand curves are price makers
Sets Prices in the Elastic Region of Demand (Monopolist)
When elastic, a decline in price will increase total revenue.
When inelastic, a decline in price will reduce total revenue.
Determining Output (Monopolist)
MR = MC
Determining Price (Monopolist)
Follow quantity curve up to demand curve
Creates supplier surplus.
Seeks highest total revenue, not highest unit price.
Supply Curve (Monopolist)
No supply curve for a monopolist. No unique relationship between price and quantity since MC is less then price.
Profit Guarantee (Monopolist)
Can have losses since can’t guarantee demand or increasing production costs.
Productive Efficiency (Monopolist)
May be productive efficient if producing at minimum ATC, but since marginal revenue is less then price and price exceed minimum ATC.
Allocative Efficiency (Monopolist)
Not allocative efficient since marginal benefit exceeds marginal cost since demand curve lies above supply.
Private Tax
Transfer of income from consumers to monopolist since they charge more then minimum ATC.
Cost Differences (Monopolist)
- Economie of scale
- x-inefficiency
- Monopoly preserving expenditures
- Technological advance (generally not as progressive) - New technologies can destroy monopolies.
X-Inefficiency
Produces higher then necessary. Mostly due to inefficient management.
Rent-Seeking Expenditures
Transfer income to someone else. Seeks to keep their monopoly.
Price Discrimination (defined for Monopolists)
Increase profits by charging more to some buyers.
- Charge each customer the max they are willing to pay
- One price for the first set, then lower prices for subsequent units
- Charging some customers one price and others another price
Conditions for Price Discrimination (Monopolist)
Is possible when these conditions are met:
- Has a monopoly
- Market segmentation is possible
- Resale of products is not possible
Rate Regulation
When competition is not possible the government might regulate prices.
Locally regulated monopolies are called public utilities.
Socially Optimal Price (Monopolist)
P = MC
AKA Economically Efficient. Allocatively Efficient since it is where the demand curve intersects with the marginal cost curve.
ATC is not covered, price is to low.
Need to offer subsidy or take a loss.
Fair-Return Price (Monopolist)
P = ATC
AKA Average Cost Pricing - Equal to normal profit.
Pushes firms to not watch their costs, cost overrun is common.
Oligopoly
- Few large producers
- Homogeneous or differentiated products (differentiated will engage in heavy advertising and non-price competition)
- Control over price but mutual interdependence
- High entry barriers
Some have come about by mergers
Largest 4 firms control 40% of the market
Shortcomings of an Oligopoly
- Localized Markets - Can be local due to transportation costs
- Interindustry Competition - substitute products might not be accounted for
- World Trade - imports can be ignored when looking at oligopolies
- Dominant Firms - Herfindahl index will show how firms rank in market power.
Game Theory
Patterning behavior according to the actions and expected reactions of rivals.
Mutual Interdependence
If a firm can increase their profits and influence their rivals by changing their pricing strategies.
Collusion
Cooperation with rivals to control price and supply
Cause of Oligopoly Models
- Diversity of oligopolies - (tight is where two of three firms control a market, loose is where six or seven firms shre 70-80% of the market)
- Compliance of Interdependence - You can’t determine your own demand and revenue since you don’t know what your rivals will do. (prices are inflexible)
Three Oligopoly Models
- Kinked-Demand theory
- Cartels and other collusion
- Price Leadership Model (tactic)
Kinked-Demand Theory
Non-collusinv oligopoly
Can match changes of rivals or ignore price changes. Can lead to price wars.
If they drop their price, you drop yours, if they raise, you leave yours alone.
Get a gap in the demand curve at the point of the price change. Since you combine the elastic and inelastic curves together.
If one firm rises their price it becomes elastic, a decrease would be inelastic
Cartels and Other Collusion
Agree on price and production quantity.
Cartel is a group of producers who have a formal agreement on what each member will produce.
Obstacles to Collusion
- Demand and cost differences - each company can have different costs
- Number of firms - more can be difficult
- Cheating - secret price cutting, etc.
- Recession - cut prices to avoid losses
- Potential Entry - Good profits can lead to new entrants.
- Legal obstacles - Illegal in some places, anti-trust.
Price Leadership Model
Dominate firm sets the price and others follow. Can lead to price wars.
Three tactics:
- Infrequent price changes
- Communicate through the industry, like speeches
- Limit Pricing - won’t choose a price that maximizes short-run profits to keep competitors out
Oligopoly and Advertising
Two reasons:
- Harder to duplicate product development and advertising (can obtain long-term economies of scale for sales)
- Can have higher profits for these areas
Productive Efficiency (Oligopoly)
Unlikely to occur
Allocative Efficiency (Oligopoly)
Unlikely to occur
Oligopoly Popularity
Less then a monopoly, with three exceptions:
- Increased foreign competition can break down collusion
- Limit pricing - when prices are low to keep competitors out, this can help society
- Technical advance - They will push for advances to help beat their competitors
Collusion Types
- Explicit - Direct communication
- Implicit - Coordinate without direct communication
- Non-collusion - mutual interdependence - must be aware of what the others are doing
- Contestable - Work together to keep others out
