Topic 8: Monopolies Flashcards
<p>What are the assumptions in monopolies</p>
<ol> <li>There is only ONE firm – but many buyers</li> <li>There are prohibitive barriers to entry for potential entrants</li> <li>Resource mobility and market information may be influenced by the monopolist</li> <li>The monopolist aims to maximise profits</li> <li>There are no close substitutes for this product.</li></ol>
<p>How do monopolies arise?</p>
<ul> <li>probably the single most important characteristic of monopoly is the barriers to entry condition. These barriers can take a number of forms:</li></ul>
<ol> <li>Government blocks the entry of more than one firm into a market</li></ol>
<ul> <li>patents and copyright incentives – a patent is a legal barrier to entry that conveys to its holder the exclusive right to supply a product for a certain period of time</li> <li>granting a public franchise (exclusive provider)</li></ul>
<ol> <li>One firm has control of a key resource material necessary to produce a good</li></ol>
<ul> <li>occurs when a firm controls some non-reproducible resource critical to production</li></ul>
<ol> <li>There are important network externalities in supplying the good or service</li></ol>
<ul> <li>getting a ‘critical scale’ of users makes entry difficult for other firms − e.g. Windows operating system, Facebook</li></ul>
<ol> <li>Economies of scale are so large that one firm has a natural monopoly</li></ol>
<ul> <li>when a single firm experiences substantial economies of scale (a single firm can satisfy the market at a lower average cost per unit) e.g. gas and electricity, NBN Co</li> <li>reliant on infrastructure</li></ul>
<p>Describe revenue in monopolies</p>
<ul> <li>because the monopolist supplies the entire market, the market demand curve is also the demand curve faced by the monopolist this has implications for revenue: in perfect competition firms were price takers (so MR curve horizontal). this is not so for the monopolist.</li> <li>if the monopolist wishes to ↑ production, it must lower its price not just for the additional units, but for all units. <ul> <li>a gain in revenue from selling more output</li> <li>a loss of revenue from selling each unit at a lower price.</li> </ul> </li> <li>marginal revenue is the extra revenue from selling one more unit of output, in perfect competition this was the same as price, but not here.</li></ul>
<h2>Economic profit</h2>
<ul> <li>cost curves for monopolist are the same as in perfect competition;</li> <li>profit-maximising rule is also the same: MR = MC</li> <li>but it is MR we look at, not price, do π-max level of output occurs at Q*</li> <li>although MR=MC is profit max, consumers pay P*</li> <li>once π-max Q has been found, read up to the demand curve to determine price charged to consumers</li> <li>the amount of economic profit is also calculated in same way as perfect competition: [P*-ATC*] x Q*</li> <li>in the long run: <ul> <li>because of barriers to entry, the distinction between the long and short run for a monopolist is not as relevant – monopolists can enjoy positive economic profits indefinitely</li> <li>it is not true, however, to say that a monopolist can charge ‘whatever they like’. Monopolists are constrained by the demand for their product, as well as their costs</li> </ul> </li></ul>
<p>Are monopolies economically efficient?</p>
<ul> <li>equilibrium in perfect competition is where P=MC</li> <li>equilibrium in monopoly is where MR=MC</li> <li>Consumer surplus: Perfect comp = A + B + C Monopoly = A [consumers lose B + C] <ul> <li>Can see that consumers lose under a monopoly compared to perfect competition. Prices are higher (PM > PPC), and output lower (QM < QPC)</li> </ul> </li> <li>Producer surplus: Perfect comp = E + D Monopoly = E + B [producers lose D < gain of B] – greater positive profits in short run and long run <ul> <li>Producers have a net gain, because Area B (captured from consumers) is greater than the loss from Area D.</li> <li>there is a deadweight loss from a monopoly: DWL = C + D, by restricting output, the MB to consumers (at PM) is > the MC. Society would benefit from the monopolist producing additional units, but they won’t because they gain more by keeping output at QM</li> </ul> </li></ul>
<p>Are monopolies productively/allocatively efficient?</p>
<ul> <li>productive efficiency: the monopolist, because it is insulated from competition, has no need to produce at min ATC. Therefore produces to the left of min ATC at ATC1.</li> <li>allocative efficiency: P>MC/MB>MC consumers value last unit at Pm and want more resources devoted towards it</li></ul>
<p>Are monopolies dynamically efficient?</p>
<ul> <li>generally not an economically efficient market structure but there are potentially dynamic elements where over time, the monopoly can adopt the most efficient productive techniques</li> <li>rationale: technological change over time promotes ‘creative gales of destruction’ – blowing out old inefficient industries and bringing in new dynamic industries</li> <li>argument for monopolies being dynamically efficient due to heavy investment in research and development <ol> <li>Only extremely large firms have the ability to undertake very expensive R&D – in competitive markets, smaller firms w potentially not the capacity to undertake this</li> <li>Given the role of technological innovation in modern economies, this private expenditure on R&D allows for more innovation than would be possible from the public sector alone (universities for example).</li> </ol> </li></ul>
<p>What are reasons for giving patents?</p>
<ul> <li>the patent is a ‘reward’ for undertaking research and development: <ul> <li>allows the producer to recoup their investment (and then make further investments).</li> </ul> </li> <li>physical production costs are usually very low: <ul> <li>so if no patent protection were given it would be impossible to recoup this investment.</li> </ul> </li> <li>example: in 2001, the patent on the world’s most popular antidepressant, Prozac, expired. Before the patent expired, one pill sold for around $2.40, and earned its producer, Eli Lilly, around $2.7 billion per year. Within a few weeks, prices had fallen from $2.40 (for Prozac) down to $0.32 for its generic counterpart. Eli Lilly’s earnings fell 22%, and its market share went from 100% down to 30% within six months <ul> <li>in short run, no incentive to undertake research and development due to extremely high costs, high price allows for this</li> </ul> </li></ul>
<p>What is price discrimination and what are the conditions for it to occur?</p>
<p><em>def.</em>: increasing profit by selling the same good at different prices to different consumers for reasons unrelated to cost</p>
<p>Conditions for price discrimination</p>
<ol> <li>Firm must have some degree of market power (does not have to be a monopolist though)</li> <li>Consumers must have different elasticities of demand</li> <li>The firm must be able to identify these different elasticities and be able to charge accordingly</li> <li>Re-sale by consumers is not possible.</li></ol>
<p>Describe first degree price discrimination</p>
<ul> <li>market demand curve shows the maximum price consumers are willing to pay for each unit of output</li> <li>firms would love to be able to charge each consumer this maximum willingness to pay - they would be able to convert every dollar of consumer surplus into producer surplus, and hence increase revenue (and profit)</li> <li>assume ATC is constant and assume different prices are changed (to match different consumers’ MB)</li> <li>allocatively efficient, because the marginal cost of the last unit produced is equal to the price they charged for that unit. • i.e. there is no DWL.</li> <li>not a reason for giving monopolists more market power, because:</li></ul>
<p>1. First degree price discrimination is very rare</p>
<p>2. Consumer surplus is still zero – equity issue</p>
<p>3. There is no reason why firms will be productively efficient.</p>
<p>Describe second degree price discrimination</p>
<ul> <li>much more common in economies</li> <li>consumers ‘self-select’ themselves as having a particular ED - the firm will offer a range of different pricing schemes and consumers will select which one they want</li> <li>examples: <ul> <li>airline tickets – MC is essentially 0, demand is more elastic when booking in advanced (leading to lower price offered)</li> <li>phone contracts</li> <li>supermarkets: home brand – trying to get as far down on the demand curve as they can (maximising profit), discount coupons and discounts to bulk buyers</li> </ul> </li></ul>
<p>Third degree</p>
<p>Describe third degree price discrimination</p>
<ul> <li>the difference to 2nd degree is here there is generally no choice.</li> <li>different types of consumers are ‘lumped together’ as having the same elasticity – over time have figured out general elasticity of group, can do more than one elasticities</li> <li>examples: movie tickets – you’re either a student / pensioner / adult or you’re not; bus and train tickets – same principle as above;</li></ul>
<p>Describe imperfect price discrimination</p>
<ul> <li>assume constant (same) marginal costs for both segments, and the firm can divide the market into two broad segments</li> <li>Π max is calculated in the normal way for each segment (MR=MC)</li> <li>can see that the consumers in the inelastic market pay more (P1) than those in the elastic segment (PE).</li> <li>importance of ‘no re-sale’: – If re-sale possible, then people would buy in the elastic market and sell it for more in the inelastic market. This would raise the price in the elastic segment (↑ demand) and lower it in the inelastic segment (supply ↑)</li></ul>
<p>What are the implications from price discrimination?</p>
<ol> <li>Good for firms: firms can earn higher profits than if they didn’t price discriminate (that’s why they do it!)</li> <li>Bad for buyers in total <ul> <li>using price discrimination, different prices are charged to different buyers, and prices span higher and lower than the one price which would be charged if price discrimination was not possible</li> <li>this means that some are worse off because they now enjoy less consumer surplus, but some buyers (with the highest price elasticity or lowest ability/willingness to pay) are now able to procure the good/service whereas they would otherwise be priced out of the market</li> </ul> </li></ol>
<p>nonetheless, the total consumer surplus will always be lower with price discrimination than without.</p>
