Section 01: Monopolies

Monopoly

Monopolies are on the other finish of the continuum from pure competition. A monopoly is composed of one firm that produces a distinctive product or company via no close substitutes. Enattempt right into the sector is blocked, which gives the firm sector power (i.e., the power to raise price over marginal cost). Historically, pure monopolies are rare and also regularly short lived because the reason for their existence (typically blocked entry) is someexactly how weakened. For instance, patents expire, new resources are regularly discovered, and also brand-new technologies enable brand-new rivals right into the industry. We will certainly expand on these sources of monopoly power later. It will also come to be clear that firms have an motivation to try to obtain a syndicate. Studying the qualities and also behavior of a syndicate is a useful recommendation suggest specifically when looking at the various other industry frameworks.

As an exciting side note, once tright here is just one seller in a sector, it is dubbed a monopoly, yet when there is just one buyer in the industry, it is called a monopsony. We will conserve our discussion on monopsonies till near the end of the course.

A monopoly determines not only the amount to create however likewise the price it will charge. The demand curve the firm deals with is the industry demand also curve. Therefore if it desires to market more, it should reduced the price. Does a monopoly have an incentive to advertise? Since the firm is likewise the industry demand curve, it has one hundred percent of the market share; however, monopolies may advertise to boost overall sector demand also or to improve goodwill certainly or public relationships.

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Barriers to Entry

Recontact from our conversation of perfect competition that as soon as firms are able to acquire financial profits, other firms/entrepreneurs are attracted to the market and also enattempt will occur till financial earnings are decreased to zero. But if there is a obstacle, enattempt by profit-seeking firms does not happen and also financial revenues have the right to persist. Tright here are a variety of various obstacles that may permit a firm to exercise sector power (which really just suggests that a firm can set price above marginal cost and extract positive profits). Barriers to entry encompass the complying with 5 obstacles.

You are watching: For the monopoly firm that does not engage in perfect price discrimination,

1. Legal Barriers

Governments often control crucial solutions in a city such as water, sewer, and garbage. If all households are required to have actually garbage service and the federal government grants the contract to one firm, that firm would have a monopoly.

Reference:

2. Control of Necessary Inputs

Another obstacle to enattempt can happen once firms are able to own or control the vital inputs or resources, and also as an outcome, they might have the ability to manage the sector. In the at an early stage 1900’s, Standard Oil’s control of the oil refining and also transport was partly responsible for the passage of antitrust regulation which mentions regulations about monopolies and also monopolizing practices. In the 1940s the government accused Aluminum Co. of America of being a monopoly by controlling the mineral bauxite, an important input for making aluminum. De Beers’ control of rough diamonds enabled it to control and also set diamond prices.

References:

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

3. Netoccupational Externalities

Network-related externalities might additionally create obstacles to enattempt. A positive network-related externality occurs once the worth of having actually or using an object increases as others use the item. A phone or fax machine, for instance, becomes even more helpful once others have actually phones or fax devices. If the market is conquered by a details product or brand also, e.g., a computer operating device or particular software program, a network-related externality exists so customers don’t want to readjust products or brands. So the externality creates a barrier for other firms to enter through a completing product.

4. Economies of Scale

In specific markets natural monopolies exist where the long run average price curve continues to decline in the family member area of demand. Consequently, one firm is able to develop sufficient for the sector at a lower per unit expense than would be the case if 2 firms mutual the industry. In this situation, positive profits can exist, however entrants cannot enter to capture some of these revenues bereason sharing the industry suggests they have to enter at a smaller scale of operation and for this reason challenge better average prices. The transmission of electrical energy is an instance of a herbal monopoly.

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5. Strategic Behavior

Firms may undertake other strategic actions to discourage potential competitors from entering the sector via pricing or manufacturing decisions. For example, a little tvery own may have just one gas terminal that sets prices a little lower than the monopoly price (i.e., it does not act as a pure monopolist) in order to save revenues low sufficient to deter others from entering the sector. Additionally, a firm may build a facility larger than needed as a threat that it will rise manufacturing if other firms attempt to enter the industry. These strategic actions create a barrier to enattempt.

While not a true monopoly, Toy’s ‘R’ Us challenged antitrust comes to for allegedly threatening that it would certainly not sell manufacturers’ products unmuch less they fixed the price of those items as soon as marketed to contending discount stores.

Reference:

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

A Single Price Monopolist

Unfavor firms in pure competition that just decide the quantity to create, monopolists should identify both the quantity and also price. But these are not independent options. Due to the fact that a monopolist encounters a downward sloping demand also curve, she need to lower the price if she desires to sell even more goods (respeak to that the law of demand also claims that this inverse partnership exists between price and quantity demanded). Given that the monopolist should charge the very same price to all consumers (i.e. she cannot price discriminate), then to market more, she need to charge a reduced price, not only on the last great she wants to market, however on all of the product that she could have offered at the greater price. This has essential implications for marginal revenue. It implies that marginal revenue drops at twice the rate of the demand curve (i.e. the slope is twice as steep). This might best be seen via an instance. Let’s assume that a monopolist can market 1 barrel of oil for $80 or 2 barrels for $79 each. To offer two barrels, price have to drop by $1. But MR for the second one is adjust in TR separated by adjust in amount or (158 – 80) / (2-1) = $78. So MR dropped by $2 ($80-78) – twice the price as price!!

The marginal revenue curve for a single priced monopolist will certainly always be twice as steep as the demand curve. Because the demand also curve shows the price and also the marginal revenue curve is below the demand curve, the price is no longer equal to the marginal revenue as it was in pure competition.

The additional mile for the mathematically inclined students:

For those wanting to watch mathematically why the marginal revenue curve is twice as steep as the demand curve, below is the math. Let’s assume Demand also is P = 10-2Q. In our instance, the slope of the demand also curve is -2. Total Revenue which is equal to price times amount equates to (10-2Q)Q = 10Q-2Q2. Using this equation we deserve to evaluate the change in complete revenue as Q changes. For instance, let’s look at the change in total revenue as quantity transforms from 3 to 4. When Q equates to 3, the total revenue is 4 and also as soon as Q equals 4, the total revenue is 8. A readjust in full revenue of 4 dollars as Q boosts by one implies a slope of -4 which is twice the slope of demand also. For those that have had actually calculus, take the initially derivative of 10Q-2Q2 to acquire the marginal revenue of 10 – 4Q, which offers a slope of -4.

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Determining Price and Quantity

Profit maximization for a monopoly charging a single price will certainly happen where marginal revenue is equal to marginal expense. It is necessary to note that this provides the profit maximizing quantity however the price is established by going up to the demand curve. That is, the price is acquired based upon what consumers are willing to pay for that quantity level which is identified by the demand also curve.

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Profits for the monopolist are acquired by calculating total revenue (TR) minus complete cost (TC). TR=optimal price * optimal quantity (the combined area of the blue and grey boxes in the figure). Taking the average total expense times the profit maximizing amount gives the total price. In the brief run, a syndicate may earn brief run earnings or losses, however unprefer firms in pure competition that have actually zero economic earnings in the lengthy run, monopolies deserve to maintain long run revenues. If long run profits are negative, the firm would leave the market and the good would certainly no much longer be developed, because the monopoly was the only firm in the market.

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Recall from our discussion on elasticities that alengthy a linear demand also curve, tright here is an elastic and also inelastic percentage. In the elastic percent, lower prices boosts complete revenue, and in the inelastic percent complete revenue falls as price decreases. Total revenue is maximized at unit elasticity which occurs wbelow marginal revenue is zero.

This provides for a critical monitoring. Since we would certainly suppose marginal cost to be positive and also a monopolist chooses to develop where MR=MC, we can conclude that a monopolist would certainly only create in the elastic area of the demand also curve.

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Practice

1. Determine the profit maximizing quantity and price for a single priced monopolist. Is the monopolist creating in the elastic area of the demand also curve at that point?

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Answer

Following the decision ascendancy of creating wbelow the marginal revenue amounts to the marginal cost, we can identify that creating six units and also charging a price of $550 will maximize earnings. At the sixth unit, our marginal revenue is 175 and the marginal price is 140. At salso systems the marginal price would exceed the marginal revenue. In looking at the column on the far best, we verify that this is the amount that maximizes revenues. At six devices of output, the mid-suggest elasticity between five and also six systems is 1.42, which is elastic.

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At six units the marginal revenue is still better than the marginal expense, but considering that it is less at the seventh unit 6 devices maximizes earnings.

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Comparing to Pure Competition

Respeak to that pudepend competitive firms develop wbelow MC is equal to price and that sector supply is acquired by horizontally including the MC curves of the firms in an industry. In equilibrium, the sector supply curve (the amount of the MC curves) crosses the demand curve. If the monopoly wregarding act in the same fashion, it would produce wbelow its MC curve crosses the demand also curve (simply like the sum of the MC curves cross the demand curve in pure competition – just it is the amount of one curve). So in comparing the outcome for pure competition to that of monopolywe see that a single price monopolist will certainly produce less than the pudepend competitive sector and also charge and higher price.

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In pure competition, financial excess which is customer plus producer excess, is maximized. The market is allocatively effective developing wright here the price is equal to the marginal expense. By restricting output and also raising price, the single price monopolist captures a part of the customer excess. Because output is limited, a portion of both the consumer and also producer surplus is shed. This loss of financial surplus is recognized as deadweight loss, that neither the customer nor the producer reap.

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A monopolist might or might not be productively efficient; it depends on whether it is producing at a point where ATC is at the minimum point. Productive efficiency suggests least-cost and this occurs where ATC is at its minimum suggest. In basic, monopolies are not productively efficient. Monopolies might also experience from what is called x-inefficiency. X-inefficiency arises once costs creep up because of lack of competition and/or actions gone after by the monopolist to protect its monopoly position. These monopoly protecting actions are additionally dubbed rent-seeking activities.

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Monopolies will certainly often go after rent seeking activities spfinishing time or money on activities that are not related to the production of the good or business yet intended to rise the industry power and profitability of the firm. For example, significant soft drink providers, such as Coke or Pepsi, will certainly offer millions to a university or stadium if they are permitted to be the single soft drink vendor. Likewise athletic wear firms may sell a university payments or discounts if they are allowed to be the sole seller of apparel. These expenditures are not concerned the manufacturing of the excellent or business but give them a monopoly in the particular sectors.

Legal cartel theory argues that some sectors may look for to be regulated or desire that regulation proceeds, so that the number of firms is limited and also the existing firms have the right to act prefer a monopoly. Regulation such as limiting the number of firms or individuals in a sector (e.g., clinical college, state liquor licenses, or taxi cabs in New York City) may be done with “great intentions,” yet they approve existing firms even more market power which leads to better prices and also a reduced amount provided.

Section 02: Price Discrimination

Price Discrimination

If rather of charging each consumer the very same price, a firm might price discriminate, which implies charging different prices to different consumers based upon their willingness to pay, exactly how would they behave? What would certainly be required for a firm to be able to price discriminate?

Certain problems should organize in order for a firm to charge various prices for the same product. First, a firm need to have the ability to set the price (i.e. it should have some industry power). Second, the firm need to be able to segment the market into groups based upon either their willingness to pay or their various elasticities of demand also. Third, the firm need to have the ability to proccasion resale of the item from one industry segment to one more.

These might seem favor hard or unmost likely problems. But in fact, price discrimination deserve to be discovered in a range of sectors including automobile sales, movie and airline tickets, utilities and also phone prices. Even student discounts are a form of price discrimicountry.

First Degree or Perfect Price Discrimination

Tright here are 3 different degrees or levels of price discrimination. These levels are pertained to exactly how well the monopolist have the right to determine individual willingness to pay and also segment the industry accordingly.

See more: Question Why Do You Think We See Phases Of The Moon? ? Why Do We See Different Phases Of The Moon

First level or perfect price discrimination is once a firm charges each customer their maximum willingness to pay, which is reflected by the demand curve. As in other situations, it is optimal for the firm to choose its output at the point where MR=MC. But if a firm have the right to charge each perkid his/her maximum willingness to pay, then MR = price as uncovered on the demand curve. So it would be willing to sell its commodities as much as the suggest where the MC curve crosses the demand curve, i.e. wbelow MC = price = MR.This means that not just will the firm would be willing to sell even more devices than it did as a single priced monopolist, however it will certainly additionally be allocatively reliable because price amounts to marginal cost at the last unit. However before, each consumer is currently paying her maximum willingness to pay, and also therefore receives no customer surplus. So although the output level is allocatively efficient and also the same as perfect competition would obtain, the circulation of financial surplus is rather different – the firm extracts every one of the surplus!

Since a firm may be unable to assess each consumers maximum willingness-to-pay and also the cost of gathering that indevelopment might be prohibitive, initially degree price discrimicountry is frequently difficult /impossible to implement. The legislation profession is probably the best instance of perfect price discrimicountry – their market for a “cost-free consultation” is designed to achieve information on willingness and capability to pay. Some various other examples of attempts at perfect price discrimicountry would be a auto salesman that tries to assess each consumer’s maximum willingness-to-pay and charges as necessary. Auctions also attempt to reach each consumer’s maximum price.

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Third Degree Price Discrimination

When a monopolist cannot perfectly recognize and segment consumers based upon individual willingness to pay, tbelow still may be a way to extract some (yet less) customer surplus to increase revenues. 2nd level price discrimination (to be discussed later) and 3rd degree price discrimicountry could be employed under the appropriate conditions. Third degree price discrimination may be employed as soon as the firm cannot identify individual requirements, yet have the right to recognize groups of consumers that have actually similar requirements and also deserve to segment them based upon some easily identifiable characteristic such as age, time of purchase, residency, or location. Then the monopolist charges different prices to the different teams based upon their family member elasticities of demand also. The even more inelastic the demand, the greater the price. This type of price discrimicountry is the majority of widespread. Being able to segment the sector, into groups that have actually different elasticities, permits the firm to charge different prices and also increase overall profitcapability. Recall that the firm have to have the ability to proccasion the resale of the good for price discrimination to work-related. This is why we regularly see third level price discrimination in the service sector, wright here the nature of the product or service makes the resale of the excellent to one more segment of the sector hard or difficult. Here are a few examples of third degree price discrimination.

Movie theaters regularly charge various prices based on the time of usage and also age. The elasticity of demand also for those attfinishing a matinee is more elastic than those in the time of primetime, so a lower price is charged for the matinee. Young youngsters and also senior citizens have actually various elasticities of demand also than young adults, which enable the theaters to price accordingly.

Airlines likewise price discriminate. Those purchasing tickets at leastern 2 weeks in advancement frequently acquire a reduced price than people purchasing tickets only a day or two prior to the flight. The distance and also location of the flight additionally make a difference because tright here are fewer substitutes if one is flying to say Hawaii verses one more city within the state.

Gas stations within the same city regularly price discriminate charging a higher price at stations situated cshed to the interstate or on the primary roads.

Some template parks, such as Disneyland and also Disney World, market citizens of The golden state and Florida different prices than non-state occupants.

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Second Degree Price Discrimination

2nd degree price discrimination is implemented as soon as the monopolist knows that tright here are two or more groups of consumers via various willingness to pay, yet she cannot recognize which consumers belengthy to each team. If we make points easy and assume that tright here are 2 groups, a high demand group (H) and also a low demand also team (L), then ideally, she’d favor to charge a high price to the H team and a low price to the L team. But if the she does this, consumers in the H group will certainly claim to be from the L team and also everyone will certainly obtain the low price. Second degree price discrimination or block pricing charges different prices to different consumer teams based on the quantity consumed. That is, the firm knows that the H consumers are willing to purchase a greater quantity than the L consumers at the very same price. Thus, it will collection a price for the L team that extracts all of their customer excess for a little quantity level (say $2 for a package of 4 rolls of toilet paper), however this would leave H consumers with some customer excess because they have a higher demand also. To get at least some of that customer surplus from them, the monopolist sets a greater price for a larger package that targets H consumers (say $3.50 for a package of 8 rolls of toilet paper). The volume discount urges the H consumers to buy the larger package and likewise allows the firm to extract more of their customer excess, bereason they gain them to buy a larger amount (otherwise they would certainly only buy the 4 roll package). Unprefer perfect price discrimicountry that extracts all of the consumer excess, in second degree price discrimicountry, the high demand group still keeps some.

Two-Part Tariff

Tright here are a variety of pricing strategies that do not seem favor price discrimination, yet in reality are! One is worthy of note:the two-component tariff. The two-part tariff charges people an upfront membership fee then also charges them a per use fee. Under the right problems, the two-component tariff renders perfect price discrimicountry possible. For example, some golf slrfc.org and wellness clubs charge an yearly membership fee in enhancement to the per usage fee for each round of golf or workout. If the marginal price of offering a round of golf is ten dollars, then the golf club charges a ten dollar per usage fee and the golfer decides to play 25 rounds of golf per year. If tright here was no membership fee the location listed below the demand curve and also over the price would be consumer surplus, however, by charging a membership fee equal to the location of customer surplus (respeak to the area of a triangle is .5*base*height or .5*25*60 = $750), the golf club is able to transform the customer excess into additional revenue for the firm. This is of course, initially degree or perfect price discrimination if the membership fee differs by customer based upon willingness to pay. Conversely, if the firm can’t identify individual requirements, however knows the needs for different groups, it can still usage two-component tariffs to attain the second degree price discrimination outcome. Either way, the firm extracts some of the customer excess as added earnings.

Anvarious other example of a two-component tariff would certainly be a cell phone agency that charges a monthly fee in enhancement to a per minute charge. Although other pricing strategies exist, you need to have the ability to understand also the motivation for why firms would certainly want to price discriminate.

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Section 03: Antitrust and Regulation

Performance and also Structure

Monopolies and also firms that collude to act choose monopolies, reduce competition and also develop inefficiencies in the market. We have actually watched that single priced monopolists are neither allocatively effective (price equals marginal cost at the last unit produced) nor productively effective (producing at the lowest average cost). Consequently, the USA federal government has passed certain laws that restrict monopolies.

Government have the right to evaluate a sector based on the structure of the industry, i.e., the variety of firms in the industry and also the barriers to entry, or by the market’s performance or conduct, i.e., the behavior of the firms and the resulting prices and also efficiencies. Should a monopoly exist, the federal government can pursue a selection of options:

(1) break up the monopoly under antitrust laws; (2) manage the monopoly; or (3) neglect the monopoly, if they anticipate that the monopoly will be brief lived or have negligible affect.

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Whenever before firms become huge in size or big family member to their sector, policy-devices acknowledge that these firms are even more able to seek monopoly-type conduct and also obtain inefficient industry outcomes. At the very same time, growth of a firm, as we have actually viewed, permits it to capture economic climates of range and also scope. So as soon as big firms merge, the benefits need to be measured versus the potential for efficiency losses. Tbelow are three fundamental forms of mergers. A horizontal merger is the merger or consolidation of 2 or more producers of the same product or organization. For instance, if a flour mill buys an additional flour mill. Vertical mergers take place as soon as firms at various steras of production of a product merge. For example, a flour mill that buys a wwarmth farm would be an example of an upstream vertical merger (upstream suggests input-supplying), while the flour mill buying a bakery would be an instance of a downstream vertical merger (downstream implies output-using). Conglomeprice mergers occur when the merging firms produce unconnected commodities, such as a flour mill purchasing a computer system company. Conglomeprice mergers might enable a firm economies of scope or to diversify. Historically, numerous tobacco companies have purchased food companies, such as Kraft, to aid them diversify and also enhance their public picture.

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Antitrust Legislation

In 1890, the Sherguy Antitrust Act was passed to minimize the power of firms that regulated a large percentage of a sector. It made it illegal to participate in tasks in that cause the “restraint profession or commerce”, such as price resolving, and also activities which monopolize or attempt to monopolize. This law targeted firms such as the Standard Oil Company kind of which was monopolizing the refining and also distribution of the petroleum. However before, this effective regulation was vague in many kind of respects and also subsequent legislations were passed to even more clearly outline tasks that were illegal.

The Federal Trade Commission Act of 1914, empowered the Federal Trade Commission (FTC) to prevent or speak unfair methods of competition and also unfair or deceptive acts in or affecting business. Today the FTC and also the Department of Justice’s antitrust division have actually the duty to investigate firms for antitrust behavior.

The Clayton Act of 1914, strengthened the Shermale Antitrust Act, making illegal price discrimicountry of “commodities of choose grade and quality” once it is reduces competition and also is not justified by cost differences. The purchase of a competitor’s stock and having interlocking directories, wright here the individuals are serving on both board of directors, are likewise illegal if they reduce competition. The Clayton Act also prohibits tie-in sales, where the purchase of one product is a problem of sale for another product. Later, the Celler-Kefauver Act of 1950 closed loopholes in the Clayton Act by restricting service providers from the purchase of the physical assets of competitors. While horizontal mergers were scrutinized under the Sherguy Antitrust Act, vertical and conglomeprice mergers might be blocked under the Celler-Kefauver Act if they could diminished 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 an sector has actually a herbal monopoly, a solitary firm is able to create at a lower per unit expense compared to having actually multiple firms in the sector. Hence, governments generally opt to regulate instead of breaking up herbal monopolies. An electrical generating company, for example has high resolved prices and the marginal expense of running power to an additional home is incredibly low.

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An unregulated single-priced monopoly would maximize profits wbelow marginal revenue equates to marginal price, producing Qm and charging price, Pm. As the government procedures in to manage a industry, what price have to they enable a monopolist to charge?

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Economically Efficient or Social Optimum Price

The economically efficient or social optimum price would occur wbelow price amounts to marginal cost, making the sector allocatively efficient. However, considering that the average complete price is declining in the area of demand also, and also marginal price intersects average price at the minimum, marginal cost will certainly be below the average cost in the appropriate array of demand also. If regulators pressure a syndicate to price at this suggest, wbelow price equates to marginal price, they would force the monopoly to incur a loss or negative financial earnings, which would certainly eventually pressure the monopoly out of business. Because the monopoly is the just producer, federal government can subsidize the monopoly for these losses such that they earn a normal return, however this is frequently politically difficult.

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Fair Rerotate or Median Cost Pricing

Conversely the federal government could force the monopoly to develop wbelow price equates to average complete cost, leaving the firm a zero financial profit. Thus the firm will certainly reprimary in the market considering that it is extending all chance prices. As demonstrated in our graph, the price is less than that of the unregulated monopoly but better than the economically effective price. The drawago of this plan is that firms have actually no impetus to regulate expenses. If expenses increase, they have the right to simply petition the federal government for price boosts. But if the firm enhances efficiency and also pursues expense cutting procedures, the government would force them to reduced prices. Hence local utility service providers might have actually more recent devices and vehicles simply as a result of this perverse impetus.