Section 01: Monopolies

Monopoly

Monopolies space on the other end of the continuum indigenous pure competition. A monopoly consists that one firm the produces a distinct product or business with no near substitutes. Entry right into the market is blocked, which offers the firm sector power (i.e., the strength to raise price over marginal cost). Historically, pure monopolies are rare and often quick lived since the factor for their visibility (usually blocked entry) is somehow weakened. Because that example, patents expire, new resources are often discovered, and new technologies allow new competitors into the market. Us will increase on these sources of syndicate power later. It will additionally become clear the firms have actually an motivation to try to acquire a monopoly. Examining the attributes and also behavior of a monopoly is a valuable reference point an especially when looking at the other sector structures.

As an interesting side note, when there is just one seller in a market, that is referred to as a monopoly, however when there is only one the person who lives in the market, it is called a monopsony. We will conserve our discussion on monopsonies until near the finish of the course.

A syndicate determines not only the quantity to produce but additionally the price it will charge. The demand curve the firm encounters is the market need curve. Thus if it wants to sell more, the must reduced the price. Go a monopoly have an incentive to advertise? since the certain is additionally the market need curve, it has actually one hundreds percent the the sector share; however, monopolies might advertise come increase as whole market need or to boost goodwill or public relations.

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Barriers come Entry

Recall from our discussion of perfect competition that once firms space able to acquire economic profits, various other firms/entrepreneurs space attracted come the industry and entry will occur until financial profits are decreased to zero. Yet if there is a barrier, entry by profit-seeking this firm does not happen and also economic profits can persist. There room a variety of different obstacles that may enable a firm come exercise industry power (which yes, really just method that a certain can set price over marginal cost and extract hopeful profits). Barriers to entry encompass the following 5 barriers.

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1. Legitimate Barriers

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

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2. Regulate of necessary Inputs

Another obstacle to entrance can occur when firms room able to very own or regulate the essential inputs or resources, and also as a result, castle may be able to control the market. In the at an early stage 1900’s, standard Oil’s manage of the oil refining and transportation was partly responsible because that the i of antitrust legislation which specifies regulations regarding monopolies and also monopolizing practices. In the 1940s the federal government accused Aluminum Co. The America of being a monopoly by controlling the mineral bauxite, an essential input because that making aluminum. De Beers’ manage of turbulent diamonds enabled it to regulate and collection diamond prices.

References:

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

3. Network Externalities

Network externalities may likewise create obstacles to entry. A hopeful network externality occurs once the worth of having or using things increases together others usage the item. A phone or fax machine, for example, becomes more useful once others have phones or fax machines. If the sector is dominated by a certain product or brand, e.g., a computer operating device or certain software, a network externality exist so users don’t desire to readjust products or brands. Therefore the externality creates a barrier for various other firms to enter with a competing product.

4. Economies of Scale

In details industries herbal monopolies exist whereby the lengthy run average expense curve proceeds to decrease in the relative an ar of demand. Consequently, one for sure is maybe to create enough because that the industry at a reduced per unit cost than would certainly be the case if 2 firms common the market. In this case, positive profits deserve to exist, yet entrants cannot get in to catch some of these profits because sharing the market method they have to get in at a smaller scale of operation and also thus face higher average costs. The transmission of power is an example of a herbal monopoly.

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5. Strategy Behavior

Firms might undertake other strategic actions to discourage potential competitors from entering the sector through pricing or production decisions. Because that example, a tiny town may have actually only one gas terminal that sets prices a small lower 보다 the syndicate price (i.e., that does no act as a pure monopolist) in order to keep earnings low enough to deter others from entering the market. Alternatively, a for sure may build a facility larger than essential as a danger that that will increase production if other firms attempt to get in the market. These strategic actions develop a obstacle to entry.

While not a true monopoly, Toy’s ‘R’ Us challenged antitrust involves for allegedly threatening the it would certainly not offer manufacturers’ goods unless they solved the price of those goods when marketed to competing discount stores.

Reference:

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

A solitary Price Monopolist

Unlike that company in pure competition that just decide the quantity to produce, monopolists must identify both the quantity and price. However these are not live independence choices. Since a monopolist deals with a bottom sloping demand curve, she must reduced the price if she wants to sell more goods (recall the the legislation of demand states the this inverse relationship exists between price and also quantity demanded). Given that the monopolist must charge the same price come all consumers (i.e. She cannot price discriminate), then to market more, she have to charge a lower price, not just on the last great she desires to sell, but on all of the product the she could have sold at the greater price. This has crucial implications for marginal revenue. It way that marginal revenue falls at twice the rate of the need curve (i.e. The steep is double as steep). This might best be seen with an example. Let’s assume the a monopolist deserve to sell 1 barrel of oil because that $80 or 2 barrels for $79 each. To sell two barrels, price need to drop by $1. However MR for the second one is change in TR divided by change in amount or (158 – 80) / (2-1) = $78. For this reason MR dropped by $2 ($80-78) – double the rate as price!!

The marginal revenue curve because that a single priced monopolist will always be twice as steep as the need curve. Because the need curve mirrors the price and the marginal revenue curve is below the need curve, the price is no much longer equal to the marginal revenue together it remained in pure competition.

The extra mile because that the mathematically skinny students:

For those wanting to view mathematically why the marginal revenue curve is twice as steep together the demand curve, below is the math. Stop assume demand is ns = 10-2Q. In our example, the slope of the demand curve is -2. Full Revenue i beg your pardon is same to price times quantity equals (10-2Q)Q = 10Q-2Q2. Making use of this equation we deserve to evaluate the adjust in total revenue as Q changes. For example, let’s look in ~ the adjust in full revenue together quantity alters from 3 to 4. Once Q equals 3, the complete revenue is 4 and also when Q equals 4, the complete revenue is 8. A adjust in full revenue that 4 dollars together Q increases by one implies a slope of -4 i beg your pardon is double the slope of demand. Because that those who have had calculus, take the first derivative of 10Q-2Q2 to acquire the marginal revenue the 10 – 4Q, which offers a steep of -4.

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Determining Price and Quantity

Profit maximization because that a syndicate charging a solitary price will occur where marginal revenue is same to marginal cost. The is crucial to keep in mind that this provides the profit maximizing quantity but the price is identified by going up to the need curve. That is, the price is acquired based top top what consumers space willing come pay for that quantity level i m sorry is figured out by the demand curve.

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Profits for the monopolist are derived by calculating full revenue (TR) minus full cost (TC). TR=optimal price * optimal amount (the an unified area the the blue and also grey boxes in the figure). Taking the average full cost time the profit maximizing quantity gives the complete cost. In the quick run, a monopoly may earn short run revenues or losses, yet unlike firms in pure compete that have zero financial profits in the lengthy run, monopolies deserve to maintain lengthy run profits. If lengthy run profits are negative, the firm would leave the industry and also the an excellent would no longer be produced, due to the fact that the syndicate was the only firm in the industry.

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Recall native our discussion on elasticities that along a linear demand curve, there is an elastic and inelastic portion. In the elastic portion, reduced prices increases total revenue, and in the inelastic portion total revenue falls as price decreases. Full revenue is maximized in ~ unit elasticity i beg your pardon occurs wherein marginal revenue is zero.

This offers for an essential observation. Since we would intend marginal expense to it is in positive and also a monopolist chooses to develop where MR=MC, we can conclude the a monopolist would certainly only create in the elastic an ar of the demand curve.

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Practice

1. Identify the benefit maximizing quantity and also price for a single priced monopolist. Is the monopolist producing in the elastic an ar of the demand curve at that point?

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Answer

Following the decision dominance of producing where the marginal revenue equates to the marginal cost, we deserve to determine that developing six units and also charging a price the $550 will maximize profits. At the sixth unit, ours marginal revenue is 175 and the marginal price is 140. At seven units the marginal cost would exceed the marginal revenue. In looking at the shaft on the far right, we verify that this is the quantity that maximizes profits. At 6 units the output, the mid-point elasticity in between five and six units is 1.42, i beg your pardon is elastic.

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At 6 units the marginal revenue is still better than the marginal cost, but due to the fact that it is less at the seventh unit six units maximizes profits.

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Comparing to Pure Competition

Recall the purely compete firms develop where MC is same to price and also that market supply is acquired by horizontally adding the MC curve of the that company in one industry. In equilibrium, the market supply curve (the sum of the MC curves) crosses the demand curve. If the monopoly was to act in the same fashion, that would create where that is MC curve crosses the need curve (just prefer the sum of the MC curves cross the need curve in pure vain – only it is the amount of one curve). Therefore in comparing the outcome because that pure vain to the of monopolywe view that a solitary price monopolist will develop less than the purely competitive market and also charge and higher price.

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In pure competition, financial surplus which is consumer plus producer surplus, is maximized. The market is allocatively efficient developing where the price is equal to the marginal cost. By restricting output and raising price, the solitary price monopolist catches a portion of the customer surplus. Due to the fact that output is restricted, a part of both the consumer and also producer surplus is lost. This loss of financial surplus is well-known 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 even if it is it is creating at a allude where ATC is in ~ the minimum point. Productive efficiency means least-cost and this occurs whereby ATC is in ~ its minimum point. In general, monopolies are not productively efficient. Monopolies may also suffer from what is called x-inefficiency. X-inefficiency occurs when prices creep up as result of lack of vain and/or actions gone after by the monopolist to safeguard its syndicate position. These syndicate protecting plot are likewise called rent-seeking activities.

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Monopolies will often pursue rent seeking activities spending time or money on activities that room not related to the manufacturing of the good or business but plan to boost the sector power and also profitability of the firm. For example, significant soft drink companies, such as Coke or Pepsi, will market millions come a university or stadium if lock are enabled to be the single soft drink vendor. An in similar way athletic stay firms might offer a college payments or discounts if castle are permitted to be the sole merchant of apparel. These expenditures room not concerned the manufacturing of the great or business but provide them a syndicate in the particular markets.

Legal cartel theory argues that some markets may look for to be regulated or desire that regulation continues, so the the number of firms is minimal and the currently firms can act favor a monopoly. Regulation such as limiting the variety of firms or individuals in a sector (e.g., medical school, state liquor licenses, or taxi cabs in new York City) might be done v “good intentions,” however they provide existing firms much more market strength which leads to greater prices and also a lower quantity supplied.

Section 02: Price Discrimination

Price Discrimination

If rather of charging each customer the exact same price, a firm could price discriminate, which means charging various prices to different consumers based upon their willingness come pay, exactly how would lock behave? What would be required for a firm to be able to price discriminate?

Certain problems must hold in order for a firm to charge different prices because that the exact same product. First, a firm must be may be to collection the price (i.e. It must have some market power). Second, the firm must be able to segment the sector into teams based ~ above either your willingness to pay or their different elasticities of demand. Third, the certain must be able to prevent resale the the item native one industry segment come another.

These may seem like daunting or unlikely conditions. However in fact, price discrimination have the right to be found in a range of sectors including automobile sales, movie and also airline tickets, utilities and also phone rates. Also student discounts are a form of price discrimination.

First level or Perfect Price Discrimination

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

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an initial degree or perfect price discrimination is when a for sure charges each consumer their maximum willingness come pay, which is reflected by the need curve. Together in other cases, the is optimal because that the firm to pick its output at the allude where MR=MC. But if a firm deserve to charge each human his/her maximum willingness come pay, then mr = price as found on the demand curve. For this reason it would be willing to market its assets up to the point where the MC curve the cross the demand curve, i.e. Where MC = price = MR.This way that not only will the firm would certainly be ready to sell much more units than it did as a solitary priced monopolist, however it will likewise be allocatively efficient because price amounts to marginal cost at the last unit. However, each customer is now paying she maximum willingness come pay, and therefore receive no customer surplus. For this reason although the output level is allocatively efficient and the same as perfect competition would certainly obtain, the distribution of financial surplus is quite various – the firm extracts every one of the surplus!

Since a firm might be can not to assess each consumer maximum willingness-to-pay and also the cost of collection that information may it is in prohibitive, an initial degree price differentiate is often an overwhelming /impossible come implement. The legislation profession is maybe the best example of perfect price distinguish – their sell for a “free consultation” is draft to achieve information on willingness and capability to pay. Some other instances of attempts at perfect price discrimination would be a auto salesman that tries to assess each consumer’s preferably willingness-to-pay and charges accordingly. Auctions also try to reach each consumer’s best price.

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Third degree Price Discrimination

When a monopolist cannot perfectly identify and segment consumer based upon individual willingness come pay, over there still might be a means to extract some (but less) consumer surplus to rise profits. 2nd degree price discrimination (to be disputed later) and third degree price discrimination can be employed under the right conditions. Third level price discrimination might be employed as soon as the for sure cannot determine individual demands, however can identify groups of consumers that have similar demands and can segment castle based top top some quickly identifiable characteristics such as age, time of purchase, residency, or location. Climate the monopolist charges different prices come the various groups based upon their loved one elasticities that demand. The more inelastic the demand, the higher the price. This type of price distinguish is most common. Gift able come segment the market, into groups that have different elasticities, enables the firm to charge various prices and increase in its entirety profitability. Recall the the firm must be able to prevent the resale the the good for price discrimination to work. This is why we often see 3rd degree price differentiate in the organization sector, wherein the nature the the product or service makes the resale the the great to an additional segment that the market challenging or impossible. Below are a few examples of third degree price discrimination.

Movie theaters often charge different prices based upon the time that consumption and also age. The elasticity of need for those attending a matinee is more elastic than those during primetime, therefore a reduced price is charged for the matinee. Young youngsters and senior citizens have various elasticities of demand than young adults, which permit the theaters to price accordingly.

Airlines likewise price discriminate. Those purchasing tickets at least two main in breakthrough typically get a reduced price than individuals purchasing tickets only a job or two before the flight. The distance and also destination that the flight likewise make a difference due to the fact that there are fewer substitutes if one is paris to to speak Hawaii verses another city within the state.

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

Some template parks, such together Disneyland and Disney World, offer occupants of California and Florida different prices than non-state residents.

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Second level Price Discrimination

Second level price discrimination is implemented when the monopolist knows that there room two or much more groups of consumers with various willingness to pay, yet she cannot identify which consumer belong to each group. If we make things simple and assume that there space two groups, a high demand group (H) and also a low need group (L), then ideally, she’d choose to charge a high price come the H group and a short price to the l group. But if the she go this, consumers in the H team will case to it is in from the together group and everyone will get the low price. 2nd degree price differentiate or block pricing charges various prices come different consumer groups based on the quantity consumed. That is, the firm knows the the H consumers space willing to acquisition a higher quantity 보다 the L consumer at the same price. Therefore, that will set a price because that the L team that extracts all of their consumer surplus for a small quantity level (say $2 because that a package of 4 rolfes of toilet paper), yet this would certainly leave H consumers with some customer surplus since they have actually a greater demand. To get at least some that that consumer surplus from them, the monopolist to adjust a higher price because that a larger package that targets H consumer (say $3.50 because that a parcel of 8 rolfes of toilet paper). The volume discount motivates the H consumers to buy the larger package and also enables the firm to extract an ext of their customer surplus, because they obtain them to buy a bigger quantity (otherwise lock would just buy the 4 roll package). Unequal perfect price discrimination the extracts all of the consumer surplus, in 2nd degree price discrimination, the high demand group tho keeps some.

Two-Part Tariff

There are a variety of pricing tactics that perform not seem favor price discrimination, yet in reality are! One is worthy of note:the two-part tariff. The two-part tariff charges individuals an upfront membership fee then likewise charges castle a per usage fee. Under the best conditions, the two-part tariff renders perfect price discrimination possible. Because that example, part golf naipublishers.com and also health clubs fee an annual membership fees in enhancement to the per use fee because that each round of golf or workout. If the marginal price of offering a ring of golf is ten dollars, then the golf club charges a ten dissension per use fee and also the golfer decides to play 25 rounds of golf every year. If there to be no membership fee the area below the need curve and above the price would be customer surplus, however, by charging a member fee same to the area of consumer surplus (recall the area of a triangle is .5*base*height or .5*25*60 = $750), the golf club is may be to transform the customer surplus into additional revenue because that the firm. This is of course, an initial degree or perfect price distinguish if the membership fee different by consumer based ~ above willingness to pay. Alternatively, if the firm can’t determine individual demands, but knows the needs for various groups, it can still usage two-part tariffs to obtain the 2nd degree price differentiate outcome. One of two people way, the certain extracts several of the consumer surplus as extr profits.

Another example of a two-part tariff would be a cabinet phone company that dues a monthly dues in enhancement to a every minute charge. Although other pricing strategies exist, you should have the ability to understand the impetus for why firms 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 favor monopolies, minimize competition and create inefficiencies in the market. We have seen that solitary priced monopolists space neither allocatively reliable (price equates to marginal price at the critical unit produced) no one productively reliable (producing at the lowest typical cost). Consequently, the unified States government has passed certain laws that restrict monopolies.

Government deserve to evaluate a market based upon the structure the the market, i.e., the variety of firms in the industry and also the barriers to entry, or through the market’s performance or conduct, i.e., the behavior of the firms and also the resulting prices and efficiencies. Should a syndicate exist, the federal government can seek a variety of options:

(1) break up the syndicate under antitrust laws; (2) control the monopoly; or (3) overlook the monopoly, if castle anticipate that the monopoly will be quick lived or have negligible impact.

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

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Antitrust Legislation

In 1890, the Sherman Antitrust Act was passed to alleviate the strength of that company that regulated a large percentage the a market. That made it illegal to take part in tasks in that an outcome in the “restraint trade or commerce”, such together price fixing, and activities which monopolize or effort to monopolize. This regulation targeted firms such as the conventional Oil firm which was monopolizing the refining and also distribution that the petroleum. However, this powerful law was vague in many respects and subsequent laws were happen to more explicitly outline activities that were illegal.

The Federal trade Commission action of 1914, empowered the Federal profession Commission (FTC) to prevent or protect against unfair methods of competition and unfair or deceptive acts in or affecting commerce. Now the FTC and the room of Justice’s antitrust division have the obligation to investigate firms for antitrust behavior.

The Clayton act of 1914, strengthened the Sherman Antitrust Act, do illegal price discrimination of “commodities of like grade and also quality” when it is to reduce competition and also is no justified by expense differences. The purchase of a competitor’s stock and having interlocking directories, wherein the people are offer on both plank of directors, are also illegal if they minimize competition. The Clayton Act additionally prohibits tie-in sales, whereby the purchase of one product is a condition of revenue for an additional product. Later, the Celler-Kefauver plot of 1950 close up door loopholes in the Clayton action by restricting providers from the purchase of the physics assets that competitors. When horizontal mergers were scrutinized under the Sherman Antitrust Act, vertical and also conglomerate mergers might be blocked under the Celler-Kefauver act if they could 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 actually a herbal monopoly, a solitary firm is may be to produce at a reduced per unit cost compared to having multiple this firm in the industry. Thus, governments typically opt come regulate rather of breaking up organic monopolies. An electrical generating company, for example has high solved costs and also the marginal price of running strength to one much more house is very low.

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An unregulated single-priced monopoly would maximize revenues where marginal revenue equates to marginal cost, producing Qm and also charging price, Pm. Together the government steps in to manage a market, what price should they enable a monopolist come charge?

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Economically reliable or society Optimum Price

The economically efficient or social optimum price would happen where price equals marginal cost, make the industry allocatively efficient. However, since the average total cost is declining in the region of demand, and also marginal expense intersects average price at the minimum, marginal price will be listed below the average cost in the relevant selection of demand. If regulators force a syndicate to price in ~ this point, where price equals marginal cost, they would pressure the monopoly to incur a lose or an unfavorable economic profits, which would eventually force the monopoly out that business. Due to the fact that the syndicate is the just producer, government can subsidize the syndicate for this losses such that they knife a regular return, however this is often politically difficult.

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Fair Return or Average expense Pricing

Alternatively the government can force the monopoly to produce where price equals average complete cost, leaving the for sure a zero financial profit. Thus the for sure will continue to be in the industry due to the fact that it is covering all chance costs. Together demonstrated in ours graph, the price is much less than the of the unregulated syndicate but higher than the economically efficient price. The border of this policy is the firms have no motivation to control costs. If expenses rise, they deserve to simply petition the government for price increases. But if the firm improves productivity and also pursues price cutting measures, the federal government would pressure them to lower prices. Thus local utility service providers may have newer equipment and vehicles simply due to this perverse incentive.