Section12 Flashcards
What defines a monopoly?
Monopoly: A firm that is the sole seller of a product without close substitutes. It has market power, the ability to raise prices without losing all sales to rivals.
What are the main causes of a monopoly?
AC and MC do cross!
- Ownership of a key resource (e.g., DeBeers with diamonds).
- Government-created monopolies through patents and copyrights.
AC and MC do not cross!
- Natural monopolies: A single firm supplies at lower cost due to economies of scale.
What is a natural monopoly?
A natural monopoly occurs when a single firm can supply the market more efficiently than multiple firms due to economies of scale. Example: water distribution with high fixed costs for infrastructure.
AC and MC do not cross!
How does a monopolist’s production and pricing differ from a competitive firm?
Monopolist:
- Sole producer.
- Faces a downward-sloping demand curve.
- Price maker: Reduces price to increase sales.
Competitive firm:
- One of many producers.
- Faces a horizontal demand curve.
- Price taker: Sells at the market price.
- Sells as much or as little at the
same price
does the monopolist really reduce prices?
What are the effects on revenue when a monopolist increases output?
Revenue effects:
- Output effect: More output sold, so Q increases.
- Price effect: Price decreases, so P falls.
The impact on total revenue depends on price elasticity of demand.
Demand = average revenue
How does a monopoly set its profit-maximizing output and price?
A monopoly maximizes profit where marginal revenue (MR) = marginal cost (MC).
slope TR = slope TC
MR = first derivative TR function
MC = first derivative TC function
The optimal price is determined using the demand curve at the profit-maximizing output.
What is the welfare cost of a monopoly?
Monopolies charge a price above marginal cost, creating a wedge between consumer willingness to pay and producer cost. This results in lower quantities sold than the social optimum, leading to inefficiency.
What is price discrimination?
Selling the same good at different prices to different customers based on their willingness to pay (e.g., discounts for students or seniors).
What conditions are necessary for price discrimination?
- Ability to separate customers by willingness to pay.
- Prevention of arbitrage (resale at different prices).
How can monopolies be regulated?
Regulatory Solutions:
P = AC (Second-best) = P₂
The firm is forced to price at average cost, ensuring zero economic profit but still covering costs.
This can be achieved by setting a maximum return on equity.
P = MC (First-best) = P₁
Leads to economic efficiency (allocative efficiency), but the firm incurs a loss since P₁ < AC.
In natural monopolies, ATC is always above MC because of high fixed costs!!!
-> Two-Part Tariff Solution (optimal solution):
A solution to avoid losses while achieving efficiency is to charge a fixed tariff (a lump sum fee) in addition to the marginal cost pricing.
The company sets a fixed charge to cover the losses and a variable tariff to cover the marginal cost.
This pricing model ensures efficient allocation of resources while keeping the firm financially viable. -> fixed tariff + variable tariff
example: Electricity and Water Services: Consumers pay a fixed monthly fee plus a variable charge per unit used. Telecommunications: Subscription-based plans where users pay a base fee plus per-minute/data charges.
Barriers to Entry
The fundamental cause of monopoly is the presence of barriers to entry.
Barrier to entry: anything which prevents a firm from entering a market or industry.
Main sources for barriers to entry:
1. A key resource is owned by a single firm.
2. The government gives a single firm the exclusive right to produce some good or service.
3. Natural Monopolies: Costs of production make a single producer more efficient than a large number of producers (economies of scale).
Patent and copyrigh
Patents give the company the exclusive right to manufacture and sell the product for a fixed number of years – often 20 years
Copyright- “the right of an individual or organization to own things they create in the same way as a physical object to prevent others from
copying or reproducing the same”
Why patent and copyright laws? To provide incentives to firms to
invest in R&D activities ➔ innovations ➔ new products and benefits not only for the firms but also for the society
Paper
municipal utilities
Ein Municipal Utility ist ein kommunales Versorgungsunternehmen, das wesentliche Dienstleistungen wie Strom, Gas, Wasser, Abwasser, Fernwärme und öffentlichen Nahverkehr für eine Stadt oder Gemeinde bereitstellt. In Deutschland sind diese als Stadtwerke bekannt.
- Both papers investigate economies of scale in Swiss municipal utilities (electricity and gas).
- They highlight inefficiencies in utility sizes, suggesting potential cost reductions through consolidation.
- Franchised monopolies and restructuring might improve efficiency.
- Higher customer density affects optimal firm size differently across industries.
These studies provide valuable insights for policymakers and regulators in the utility sector, focusing on cost efficiency and optimal market structures.
Marginal Revenue (MR)
- is the change in total revenue that results from a change in
output by one unit (can be both positive and negative) - first derivative of the total revenue function
MR is always lower than AR (or price) in imperfect competition because to sell more, the firm must lower prices for all units.
Demand = AR = P = Zahl - aQ
MR = Zahl - bQ
TR = Zahl*Q - Q^2
a<b: AR ist flacher als MR
For a competitive firm:
𝑷 = 𝑴𝑹 = 𝑴𝑪
For a monopoly firm:
𝑷 > 𝑴𝑹 = 𝑴𝑪
Price Discrimination: 3 lessons about price discrimination
- It is a rational strategy for profit-maximizing monopolist.
- It requires the ability to separate customers according to their WTP, e.g.
by geography, age, income, time of use (peak time/off-peak time), etc. - It can raise economic welfare compared to a situation where a monopolist only charges a single price! Wedge of dead weight loss gets smaller!
➢ The increase in total welfare is due to higher producer surplus which translates to higher profit for the monopolist.
