Section 01: Monopolies

Monopoly

Monopolies room on the other finish of the continuum native pure competition. A monopoly consists that one firm that produces a distinct product or business with no nearby substitutes. Entry right into the industry is blocked, which offers the firm sector power (i.e., the power to progressive price over marginal cost). Historically, pure monopolies space rare and also often quick lived because the reason for their visibility (usually clogged entry) is in which method weakened. For example, patents expire, brand-new resources are frequently discovered, and brand-new technologies allow brand-new competitors into the market. We will increase on these resources of monopoly power later. That will also become clear that firms have actually an motivation to try to acquire a monopoly. Examining the attributes and behavior of a monopoly is a useful reference point an especially when looking in ~ the other sector structures.

As an amazing side note, once there is just one seller in a market, that is called a monopoly, but when over there is only one buyer in the market, it is dubbed a monopsony. Us will save our conversation on monopsonies until near the end of the course.

A syndicate determines not just the quantity to create but also the price it will charge. The need curve the firm encounters is the market need curve. For this reason if it wants to market more, it must reduced the price. Go a syndicate have an incentive to advertise? since the certain is also the market need curve, it has actually one hundreds percent the the sector share; however, monopolies might advertise to increase in its entirety market need or to enhance goodwill or public relations.

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Barriers come Entry

Recall from our discussion of perfect vain that when firms are able to acquire economic profits, other firms/entrepreneurs room attracted come the industry and also entry will occur until financial profits are lessened to zero. Yet if over there is a barrier, entry by profit-seeking firms does no happen and economic profits deserve to persist. There room a variety of different barriers that may enable a firm come exercise market power (which yes, really just way that a for sure can set price above marginal cost and also extract optimistic profits). Barriers to entry encompass the following five barriers.

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1. Legal Barriers

Governments often control essential services in a city such together water, sewer, and also garbage. If all families are forced to have actually garbage service and the federal government grants the contract to one firm, that firm would have actually a monopoly.

Reference:

2. Regulate of essential Inputs

Another barrier to entry can happen when firms space able to very own or control the vital inputs or resources, and also as a result, castle may have the ability to control the market. In the beforehand 1900’s, typical Oil’s control of the oil refining and also transportation was partly responsible for the i of antitrust regulation which mentions regulations concerning monopolies and also monopolizing practices. In the 1940s the federal government accused Aluminum Co. That America of gift a monopoly by managing the mineral bauxite, crucial input because that making aluminum. De Beers’ regulate of rough diamonds allowed it to manage and collection diamond prices.

References:

http://www.time.com/time/magazine/article/0,9171,764369,00.html

3. Network Externalities

Network externalities may also create obstacles to entry. A confident network externality occurs as soon as the value of having or using an object increases together others usage the item. A phone or fax machine, for example, becomes much more useful once others have phones or fax machines. If the industry is overcame by a particular product or brand, e.g., a computer operating system or details software, a network externality exists so individuals don’t want to adjust products or brands. Therefore the externality creates a obstacle for various other firms to get in with a contending product.

4. Economic situations of Scale

In specific industries herbal monopolies exist wherein the lengthy run average price curve proceeds to decline in the relative region of demand. Consequently, one for sure is able to develop enough because that the industry at a lower per unit price than would certainly be the case if 2 firms common the market. In this case, hopeful profits have the right to exist, yet entrants cannot get in to record some of this profits since sharing the market method they have to get in at a smaller scale of operation and also thus face greater average costs. The infection of electrical power is an example of a organic monopoly.

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5. Strategic Behavior

Firms may undertake various other strategic actions come discourage potential competitors from entering the sector through pricing or production decisions. For example, a tiny town may have actually only one gas terminal that sets prices a small lower than the monopoly price (i.e., that does not act as a pure monopolist) in order to keep revenues low sufficient to deter others from start the market. Alternatively, a firm may develop a facility bigger than needed as a hazard that it will increase production if other firms attempt to get in the market. These strategic actions produce a obstacle to entry.

While no a true monopoly, Toy’s ‘R’ Us challenged antitrust pertains to for allegedly threatening the it would certainly not offer manufacturers’ goods unless they solved the price that those items when marketed to competing discount stores.

Reference:

http://online.wsj.com/article/SB125573656435491057.html

A solitary Price Monopolist

Unlike this firm in pure competition that only decide the amount to produce, monopolists must recognize both the quantity and price. But these room not live independence choices. Since a monopolist deals with a downward sloping need curve, she must lower the price if she wants to sell much more goods (recall that the legislation of need states that this inverse partnership exists between price and quantity demanded). Given that the monopolist have to charge the very same price come all consumers (i.e. She can not price discriminate), climate to market more, she should charge a lower price, not just on the last an excellent she wants to sell, but on every one of the product that she can have sold at the greater price. This has essential implications for marginal revenue. It method that marginal revenue falls at twice the rate of the need curve (i.e. The steep is double as steep). This might ideal be seen v an example. Stop assume the a monopolist have the right to sell 1 barrel that oil because that $80 or 2 barrels for $79 each. To sell two barrels, price have to drop by $1. But MR because that the 2nd one is readjust in TR split by adjust in amount or (158 – 80) / (2-1) = $78. For this reason MR fell by $2 ($80-78) – double the rate as price!!

The marginal revenue curve for a solitary priced monopolist will always be double as steep together the demand curve. Due to the fact that the need curve shows the price and the marginal revenue curve is below the need curve, the price is no much longer equal come the marginal revenue as it was in pure competition.

The extra mile for the mathematically inclined students:

For those wanting to watch mathematically why the marginal revenue curve is double as steep as the need curve, below is the math. Let’s assume need is ns = 10-2Q. In our example, the slope of the need curve is -2. Full Revenue which is same to price times quantity equals (10-2Q)Q = 10Q-2Q2. Utilizing this equation we can evaluate the readjust in total revenue as Q changes. Because that example, stop look at the change in complete revenue as quantity alters from 3 to 4. As soon as Q equates to 3, the total revenue is 4 and when Q amounts to 4, the full revenue is 8. A readjust in full revenue the 4 dollars together Q increases by one means a steep of -4 i m sorry is double the steep of demand. Because that those that have had calculus, take it the very first derivative that 10Q-2Q2 to obtain the marginal revenue of 10 – 4Q, which offers a slope of -4.

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Determining Price and also Quantity

Profit maximization because that a monopoly charging a solitary price will take place where marginal revenue is equal to marginal cost. The is important to note that this provides the benefit maximizing quantity yet the price is determined by going up to the need curve. That is, the price is acquired based top top what consumers are willing come pay because that that amount level i beg your pardon is figured out by the demand curve.

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Profits because that the monopolist are obtained by calculating total revenue (TR) minus complete cost (TC). TR=optimal price * optimal quantity (the an unified area of the blue and also grey boxes in the figure). Taking the average total cost time the profit maximizing quantity offers the full cost. In the quick run, a monopoly may earn quick run earnings or losses, however unlike this firm in pure compete that have actually zero financial profits in the lengthy run, monopolies deserve to maintain long run profits. If lengthy run profits are negative, the firm would certainly leave the industry and the an excellent would no longer be produced, since the monopoly was the only firm in the industry.

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Recall native our conversation on elasticities that follow me a linear need curve, there is an elastic and inelastic portion. In the elastic portion, lower prices increases full revenue, and in the inelastic part total revenue drops as price decreases. Total revenue is maximized at unit elasticity which occurs whereby marginal revenue is zero.

This gives for vital observation. Due to the fact that we would expect marginal cost to be positive and also a monopolist chooses to develop where MR=MC, we have the right to conclude that a monopolist would only produce in the elastic an ar of the need curve.

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Practice

1. Recognize the profit maximizing quantity and price for a solitary priced monopolist. Is the monopolist producing in the elastic an ar of the need curve at that point?

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Answer

Following the decision dominance of creating where the marginal revenue equates to the marginal cost, we have the right to determine that producing six units and also charging a price the $550 will certainly maximize profits. At the sixth unit, our marginal revenue is 175 and the marginal cost is 140. At seven units the marginal cost would exceed the marginal revenue. In looking at the shaft on the much right, us verify that this is the amount that maximizes profits. At six units the output, the mid-point elasticity between five and also six units is 1.42, which is elastic.

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At 6 units the marginal revenue is still greater than the marginal cost, but since it is much less at the saturday unit six units maximizes profits.

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Comparing to Pure Competition

Recall the purely compete firms produce where MC is same to price and also that market supply is obtained by horizontally adding the MC curves of the firms in one industry. In equilibrium, the market supply curve (the sum of the MC curves) the cross the need curve. If the syndicate was to act in the exact same fashion, that would develop where that MC curve the cross the need curve (just favor the amount of the MC curves cross the demand curve in pure compete – only it is the amount of one curve). So in compare the outcome because that pure vain to that of monopolywe view that a single price monopolist will develop less than the purely competitive market and also charge and higher price.

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In pure competition, economic surplus i m sorry is customer plus producer surplus, is maximized. The sector is allocatively efficient developing where the price is same to the marginal cost. By restricting output and raising price, the solitary price monopolist captures a section of the customer surplus. Since output is restricted, a part of both the consumer and producer surplus is lost. This loss of financial surplus is recognized as deadweight loss, that neither the customer nor the producer enjoy.

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A monopolist may or might not it is in productively efficient; it counts on whether it is developing at a allude where ATC is in ~ the minimum point. Fertile efficiency means least-cost and also this occurs where ATC is at its minimum point. In general, monopolies space not productively efficient. Monopolies may also suffer indigenous what is called x-inefficiency. X-inefficiency occurs when expenses creep up because of lack of compete and/or actions gone after by the monopolist to defend its monopoly position. These monopoly protecting actions are likewise called rent-seeking activities.

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Monopolies will often pursue rent seek activities security time or money on activities that are not related to the production of the good or company but plan to boost the sector power and also profitability that the firm. Because that example, significant soft drink companies, such as Coke or Pepsi, will offer millions come a university or stadium if castle are permitted to be the sole soft drink vendor. An in similar way athletic undertake firms may offer a college payments or discounts if lock are enabled to be the sole vendor of apparel. This expenditures space not pertained to the manufacturing of the great or organization but provide them a monopoly in the corresponding markets.

Legal cartel theory suggests that some industries may look for to be regulation or desire the regulation continues, so the the number of firms is minimal and the existing firms deserve to act prefer a monopoly. Regulation such as limiting the variety of firms or people in a sector (e.g., clinical school, state liquor licenses, or taxi cabs in brand-new York City) might be done v “good intentions,” however they provide existing firms much more market strength which leads to higher prices and also a lower quantity supplied.

Section 02: Price Discrimination

Price Discrimination

If rather of charging each consumer the very same price, a firm could price discriminate, which way charging different prices to different consumers based upon their willingness to pay, exactly how would lock behave? What would certainly be forced for a firm to have the ability to price discriminate?

Certain problems must organize in order because that a firm to charge various prices for the exact same product. First, a firm have to be maybe to set the price (i.e. That must have actually some market power). Second, the for sure must be able to segment the market into groups based ~ above either their willingness to pay or their different elasticities that demand. Third, the for sure must have the ability to prevent resale the the item indigenous one industry segment to another.

These might seem like challenging or i can not qualify conditions. Yet in fact, price discrimination can be discovered in a variety of sectors including car sales, movie and also airline tickets, utilities and also phone rates. Also student discounts are a type of price discrimination.

First level or Perfect Price Discrimination

There space three different degrees or levels of price discrimination. These levels are related to how well the monopolist deserve to identify separation, personal, instance willingness come pay and segment the market accordingly.

See more: Getting Freaky: Can You Get Pregnant From A Toilet Seat Get Me Pregnant?

an initial degree or perfect price discrimination is when a for sure charges each consumer their best willingness come pay, i beg your pardon is reflect by the demand curve. As in various other cases, that is optimal for the certain to choose its calculation at the suggest where MR=MC. Yet if a firm can charge each human being his/her preferably willingness to pay, then grandfather = price as uncovered on the demand curve. So it would be ready to offer its products up to the allude where the MC curve crosses the demand curve, i.e. Where MC = price = MR.This method that not only will the firm would be willing to sell much more units 보다 it did as a single priced monopolist, however it will also be allocatively efficient because price equals marginal cost at the last unit. However, each consumer is currently paying her maximum willingness to pay, and also therefore receive no customer surplus. So although the output level is allocatively efficient and the same as perfect competition would certainly obtain, the circulation of financial surplus is quite different – the firm extracts every one of the surplus!

Since a firm might be can not to assess each consumers maximum willingness-to-pay and also the expense of collection that information may be prohibitive, an initial degree price distinguish is often daunting /impossible come implement. The regulation profession is maybe the best example the perfect price discrimination – their offer for a “free consultation” is designed to acquire information top top willingness and capability to pay. Part other instances of attempts in ~ perfect price discrimination would certainly be a car salesman that tries come assess each consumer’s preferably willingness-to-pay and charges accordingly. Auctions also shot to reach each consumer’s maximum price.

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Third degree Price Discrimination

When a monopolist can not perfectly identify and segment consumer based upon individual willingness come pay, over there still might be a method to extract some (but less) customer surplus to increase profits. Second degree price discrimination (to be disputed later) and 3rd degree price discrimination can be employed under the appropriate conditions. Third degree price discrimination may be employed when the certain cannot identify individual demands, but can identify teams of consumers that have comparable demands and can segment them based top top some conveniently identifiable characteristics such as age, time the purchase, residency, or location. Climate the monopolist charges different prices to the different groups based on their family member elasticities the demand. The much more inelastic the demand, the greater the price. This type of price differentiate is many common. Being able come segment the market, into groups that have different elasticities, enables the firm come charge various prices and also increase as whole profitability. Recall the the for sure must be able to prevent the resale that the great for price discrimination come work. This is why we frequently see third degree price differentiate in the organization sector, whereby the nature of the product or organization makes the resale of the an excellent to another segment of the market challenging or impossible. Below are a few examples of 3rd degree price discrimination.

Movie theaters often charge different prices based on the time the consumption and also age. The elasticity of demand for those attending a matinee is more elastic 보다 those during primetime, therefore a lower price is charged because that the matinee. Young kids and an elderly citizens have different elasticities of demand than young adults, which permit the theaters come price accordingly.

Airlines additionally price discriminate. Those purchasing ticket at the very least two main in advancement typically gain a reduced price than individuals purchasing tickets only a day or two prior to the flight. The distance and also destination that the flight additionally make a difference because there space fewer substitutes if one is paris to speak Hawaii verses another city within the state.

Gas stations within the exact same city frequently price discriminate charging a higher price in ~ stations situated close come the interstate or ~ above the main roads.

Some layout parks, such as Disneyland and also Disney World, offer citizens of California and Florida different prices than non-state residents.

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Second degree Price Discrimination

Second level price discrimination is imposed when the monopolist knows the there space two or an ext groups of consumer with various willingness come pay, yet she cannot determine which consumer belong to each group. If we make things basic and assume the there are two groups, a high demand group (H) and a low demand group (L), climate ideally, she’d like to fee a high price come the H group and also a low price come the together group. Yet if the she does this, consumers in the H team will case to be from the l group and also everyone will obtain the short price. 2nd degree price distinguish or block pricing charges different prices to different consumer groups based on the amount consumed. The is, the for sure knows the the H consumers are willing to acquisition a greater quantity 보다 the L consumer at the same price. Therefore, it will collection a price because that the L group that extracts every one of their customer surplus because that a tiny quantity level (say $2 for a parcel of 4 rolfes of toilet paper), however this would leave H consumers v some customer surplus due to the fact that they have a higher demand. To gain at the very least some the that customer surplus native them, the monopolist sets a greater price for a larger package the targets H consumers (say $3.50 because that a package of 8 roll of restroom paper). The volume discount motivates the H consumer to purchase the larger package and also also enables the firm to extract more of their consumer surplus, because they gain them come buy a larger quantity (otherwise lock would just buy the 4 role package). Unequal perfect price discrimination the extracts every one of the consumer surplus, in second degree price discrimination, the high demand group quiet keeps some.

Two-Part Tariff

There space a number of pricing methods that perform not seem prefer price discrimination, however in truth are! One is worthy that note:the two-part tariff. The two-part tariff charges individuals an upfront membership fee then also charges them a per use fee. Under the best conditions, the two-part tariff renders perfect price differentiate possible. Because that example, part golf bromheads.tv and also health clubs fee an yearly membership fees in enhancement to the per use fee for each ring of golf or workout. If the marginal price of giving a ring of golf is ten dollars, climate the golf club charges a ten dollar per usage fee and the golfer decides come play 25 ring of golf per year. If there to be no member fee the area below the demand curve and above the price would certainly be consumer surplus, however, through charging a member fee equal to the area of customer surplus (recall the area of a triangle is .5*base*height or .5*25*60 = $750), the golf society is may be to convert the consumer surplus into additional revenue for the firm. This is the course, an initial degree or perfect price differentiate if the membership fee differs by consumer based ~ above willingness to pay. Alternatively, if the firm can’t recognize individual demands, however knows the demands for various groups, it could still usage two-part tariffs to acquire the second degree price differentiate outcome. One of two people way, the for sure extracts some of the consumer surplus as additional profits.

Another instance of a two-part tariff would certainly be a cell phone company that dues a monthly fee in enhancement to a every minute charge. Although various other pricing techniques exist, girlfriend should have the ability to understand the catalyst for why this firm would want to price discriminate.

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Section 03: Antitrust and also Regulation

Performance and Structure

Monopolies and also firms that collude come act like monopolies, reduce competition and also create inefficiencies in the market. We have actually seen that single priced monopolists are neither allocatively efficient (price equals marginal price at the critical unit produced) nor productively reliable (producing in ~ the lowest mean cost). Consequently, the united States government has passed certain laws that restrict monopolies.

Government deserve to evaluate a market based on the structure the the market, i.e., the number of firms in the industry and the obstacles to entry, or through the market’s performance or conduct, i.e., the behavior of the firms and also the result prices and efficiencies. Need to a syndicate exist, the government can go after a variety of options:

(1) rest up the syndicate under antitrust laws; (2) manage the monopoly; or (3) disregard the monopoly, if castle anticipate that the monopoly will be brief lived or have negligible impact.

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Whenever this firm become huge in dimension or huge relative to your industry, policy-makers identify that this firms are an ext able to go after monopoly-type conduct and obtain inefficient market outcomes. At the very same time, development of a firm, as we have seen, permits it to capture economies the scale and also scope. So when huge firms merge, the benefits need to be measured versus the potential for effectiveness losses. There space three basic types of mergers. A horizontal merger is the mergers or consolidation of 2 or more producers that the very same product or service. Because that example, if a flour mill buys another flour mill. Vertical mergers happen when firms at various stages of production of a product merge. For example, a flour mill the buys a wheat farm would certainly be an example of one upstream upright merger (upstream way input-supplying), while the flour mill buying a bakery would be an instance of a downstream vertical merger (downstream way output-using). Conglomerate mergers happen when the merging firms develop unrelated products, such as a flour mill to buy a computer company. Conglomerate merger may permit a firm economies of border or come diversify. Historically, number of tobacco companies have purchased food companies, such together Kraft, to aid them diversify and improve their public image.

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Antitrust Legislation

In 1890, the Sherman Antitrust Act was passed to mitigate the strength of this firm that controlled a huge percentage of a market. That made the illegal to participate in activities in that an outcome in the “restraint trade or commerce”, such together price fixing, and activities which monopolize or effort to monopolize. This law targeted firms such as the typical Oil company which to be monopolizing the refining and distribution that the petroleum. However, this an effective law to be vague in countless respects and subsequent legislations were happen to much more explicitly outline tasks that to be illegal.

The Federal profession Commission act of 1914, empowered the Federal trade Commission (FTC) to avoid or prevent unfair approaches of competition and also unfair or deceptive plot in or affect commerce. This particular day the FTC and the room of Justice’s antitrust department have the responsibility to investigate firms because that antitrust behavior.

The Clayton act of 1914, strengthened the Sherman Antitrust Act, make illegal price differentiate of “commodities of prefer grade and also quality” as soon as it is to reduce competition and also is not justified by price differences. The purchase of a competitor’s stock and having interlocking directories, whereby the people are serving on both plank of directors, are likewise illegal if they minimize competition. The Clayton Act likewise prohibits tie-in sales, wherein the acquisition of one product is a condition of sale for another product. Later, the Celler-Kefauver action of 1950 close up door loopholes in the Clayton action by restricting suppliers from the acquisition of the physical assets the competitors. While horizontal mergers to be scrutinized under the Sherman Antitrust Act, vertical and conglomerate mergers can be blocked under the Celler-Kefauver action if they can reduced competition.

References:

http://www.stolaf.edu/people/becker/antitrust/statutes/clayton.html

http://www.stolaf.edu/people/becker/antitrust/statutes/ftc.html

Natural Monopolies

If one industry has a organic monopoly, a solitary firm is may be to create at a reduced per unit cost compared to having multiple this firm in the industry. Thus, governments frequently opt to regulate instead of breaking up organic monopolies. An electrical generating company, for instance has high fixed costs and the marginal cost of running strength to one an ext house is very low.

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An unregulated single-priced syndicate would maximize profits where marginal revenue equates to marginal cost, creating Qm and charging price, Pm. As the federal government steps in to control a market, what price need to they enable a monopolist come charge?

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Economically effective or social Optimum Price

The economically efficient or social optimum price would happen where price amounts to marginal cost, making the market allocatively efficient. However, due to the fact that the average complete cost is declining in the an ar of demand, and marginal cost intersects average price at the minimum, marginal cost will be below the average expense in the relevant variety of demand. If regulators pressure a monopoly to price in ~ this point, where price amounts to marginal cost, castle would pressure the syndicate to incur a ns or an adverse economic profits, which would ultimately force the monopoly out the business. Since the monopoly is the just producer, government might subsidize the syndicate for this losses such the they knife a regular return, yet this is regularly politically difficult.

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Fair Return or Average expense Pricing

Alternatively the government might force the syndicate to create where price amounts to average full cost, leaving the firm a zero financial profit. Hence the firm will continue to be in the industry since it is extending all possibility costs. Together demonstrated in ours graph, the price is less than that of the unregulated monopoly but higher than the financially efficient price. The limit of this policy is that firms have actually no catalyst to manage costs. If prices rise, they can simply petition the federal government for price increases. But if the firm enhances productivity and pursues cost cutting measures, the government would force them to lower prices. Hence local utility providers may have newer equipment and also vehicles simply because of this perverse incentive.