Section 01: Monopolies

Monopoly

Monopolies are on the other finish of the continuum indigenous pure competition. A monopoly consists the one firm the produces a distinctive product or business with no close substitutes. Entry into the sector is blocked, which provides the firm industry power (i.e., the power to advanced price above marginal cost). Historically, pure monopolies room rare and also often quick lived because the factor for their existence (usually blocked entry) is somehow weakened. For example, patents expire, brand-new resources are regularly discovered, and new technologies allow new competitors right into the market. We will expand on these sources of syndicate power later. It will likewise become clear the firms have actually an impetus to shot to gain a monopoly. Researching the attributes and behavior that a syndicate is a beneficial reference point specifically when looking at the other sector structures.

As an exciting side note, when there is only one seller in a market, it is dubbed a monopoly, however when over there is only one the person who lives in the market, the is called a monopsony. We will save our conversation on monopsonies until close to the end of the course.

A syndicate determines not only the quantity to create but additionally the price it will charge. The need curve the firm deals with is the market demand curve. Hence if it wants to market more, that must reduced the price. Go a monopoly have an catalyst to advertise? due to the fact that the firm is likewise the market demand curve, it has actually one hundreds percent the the industry share; however, monopolies may advertise come increase overall market need or to boost goodwill or publicly relations.

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Barriers come Entry

Recall native our discussion of perfect compete that once firms are able to attain economic profits, various other firms/entrepreneurs are attracted to the industry and also entry will occur until economic profits are reduced to zero. Yet if over there is a barrier, entrance by profit-seeking firms does not happen and economic profits have the right to persist. There room a range of different obstacles that may allow a firm to exercise sector power (which yes, really just means that a firm can set price over marginal cost and extract confident profits). Obstacles to entry encompass the following five barriers.

You are watching: An unregulated natural monopolist would produce to the point at which:

1. Legitimate Barriers

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

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2. Control of essential Inputs

Another obstacle to entry can take place when firms space able to very own or manage the necessary inputs or resources, and as a result, lock may have the ability to control the market. In the at an early stage 1900’s, conventional Oil’s regulate of the oil refining and also transportation was partially responsible because that the passage of antitrust regulation which states regulations concerning monopolies and also monopolizing practices. In the 1940s the federal government accused Aluminum Co. The America of gift a syndicate by controlling the mineral bauxite, crucial input because that making aluminum. De Beers’ manage of unstable diamonds permitted it to regulate and set 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 actually or using an object increases together others usage the item. A phone or fax machine, for example, becomes an ext useful once others have actually phones or fax machines. If the industry is conquered by a specific product or brand, e.g., a computer operating mechanism or specific software, a network externality exists so individuals don’t want to readjust products or brands. For this reason the externality create a obstacle for various other firms to enter with a competing product.

4. Economies of Scale

In specific industries herbal monopolies exist whereby the long run average expense curve proceeds to decrease in the relative an ar of demand. Consequently, one certain is maybe to create enough for the sector at a reduced per unit cost than would certainly be the instance if 2 firms common the market. In this case, hopeful profits deserve to exist, yet entrants cannot go into to record some of these profits due to the fact that sharing the market way they have actually to enter at a smaller range of operation and thus face greater average costs. The transmission of power is an instance of a herbal monopoly.

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5. Strategy Behavior

Firms may undertake other strategic actions to discourage potential competitors from entering the market through pricing or manufacturing decisions. For example, a tiny town may have actually only one gas terminal that sets price a tiny lower than the syndicate price (i.e., it does not act as a pure monopolist) in order come keep revenues low enough to deter others from beginning the market. Alternatively, a for sure may construct a facility larger than necessary as a risk that the will boost production if other firms effort to go into the market. These strategic actions develop a obstacle to entry.

While no a true monopoly, Toy’s ‘R’ Us faced antitrust concerns for accused threatening the it would certainly not offer manufacturers’ goods unless they solved the price the those products when offered to completing discount stores.

Reference:

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

A single Price Monopolist

Unlike firms in pure vain that only decide the amount to produce, monopolists must identify both the quantity and price. But these room not independent choices. Due to the fact that a monopolist deals with a downward sloping need curve, she must reduced the price if she wants to sell much more goods (recall the the regulation of demand states the this inverse partnership exists between price and also quantity demanded). Provided that the monopolist should charge the same price to all consumer (i.e. She can not price discriminate), climate to market more, she must charge a lower price, not only on the last an excellent she desires to sell, however on all of the product the she could have offered at the higher price. This has vital implications for marginal revenue. It means that marginal revenue drops at double the rate of the need curve (i.e. The slope is double as steep). This might best be seen v an example. Stop assume the a monopolist have the right to sell 1 barrel the oil because that $80 or 2 barrels for $79 each. To offer two barrels, price should drop by $1. However MR because that the 2nd one is adjust in TR divided by readjust in amount or (158 – 80) / (2-1) = $78. So MR dropped by $2 ($80-78) – double the price as price!!

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

The extra mile because that the mathematically inclined students:

For those wanting to watch mathematically why the marginal revenue curve is double as steep as the demand curve, here is the math. Stop assume need is ns = 10-2Q. In our example, the steep of the need curve is -2. Total Revenue which is same to price times quantity equals (10-2Q)Q = 10Q-2Q2. Using this equation we have the right to evaluate the readjust in full revenue together Q changes. Because that example, let’s look at the change in full revenue as quantity transforms from 3 come 4. As soon as Q amounts to 3, the full revenue is 4 and when Q equates to 4, the complete revenue is 8. A change in total revenue that 4 dollars together Q rises by one means a steep of -4 which is twice the slope of demand. For those that have had calculus, take the first derivative the 10Q-2Q2 to obtain the marginal revenue of 10 – 4Q, which gives a slope of -4.

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Determining Price and also Quantity

Profit maximization for a syndicate charging a solitary price will occur where marginal revenue is equal to marginal cost. That is vital to note that this offers the benefit maximizing quantity but the price is identified by going as much as the need curve. That is, the price is obtained based upon what consumers are willing to pay because that that quantity level which is established by the demand curve.

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Profits because that the monopolist are acquired by calculating full revenue (TR) minus full cost (TC). TR=optimal price * optimal quantity (the combined area that the blue and grey crate in the figure). Acquisition the average full cost times the profit maximizing quantity gives the complete cost. In the short run, a syndicate may earn brief run profits or losses, yet unlike firms in pure vain that have zero economic profits in the long run, monopolies deserve to maintain long run profits. If long run profits are negative, the firm would certainly leave the industry and the great would no longer be produced, since the monopoly was the only firm in the industry.

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Recall from our discussion on elasticities that follow me a linear need curve, there is an elastic and inelastic portion. In the elastic portion, reduced prices increases complete revenue, and also in the inelastic portion total revenue falls as price decreases. Full revenue is maximized in ~ unit elasticity i m sorry occurs whereby marginal revenue is zero.

This offers for critical observation. Due to the fact that we would suppose marginal price to be positive and a monopolist chooses to create where MR=MC, we have the right to conclude that a monopolist would certainly only produce in the elastic an ar of the need curve.

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Practice

1. Recognize the benefit maximizing quantity and also price for a single priced monopolist. Is the monopolist developing in the elastic an ar of the need curve at the point?

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Answer

Following the decision preeminence of creating where the marginal revenue equals the marginal cost, we deserve to determine that producing six units and also charging a price the $550 will certainly maximize profits. At the 6th unit, our marginal revenue is 175 and also the marginal cost is 140. At seven units the marginal price would exceed the marginal revenue. In looking at the column on the far right, us verify the this is the amount that maximizes profits. At six units the output, the mid-point elasticity in between five and also six units is 1.42, i beg your pardon is elastic.

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At six units the marginal revenue is still better 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 that purely competitive firms produce where MC is same to price and that market supply is obtained by horizontally including the MC curve of the firms in one industry. In equilibrium, the industry supply curve (the amount of the MC curves) the cross the need curve. If the syndicate was to act in the exact same fashion, that would produce where the MC curve the cross the need curve (just prefer the sum of the MC curves overcome the need curve in pure compete – just it is the sum of one curve). So in compare the outcome because that pure compete to the of monopolywe see that a solitary price monopolist will create less 보다 the completely competitive market and also charge and higher price.

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In pure competition, economic surplus i beg your pardon is consumer plus producer surplus, is maximized. The market is allocatively efficient developing where the price is same to the marginal cost. By restricting output and also raising price, the solitary price monopolist catches a portion of the customer surplus. Since output is restricted, a portion of both the consumer and also producer surplus is lost. This ns of economic surplus is well-known as deadweight loss, that neither the customer nor the producer enjoy.

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A monopolist might or may not be productively efficient; it depends on even if it is it is producing at a allude where ATC is in ~ the minimum point. Abundant efficiency method least-cost and this occurs wherein ATC is in ~ its minimum point. In general, monopolies room not productively efficient. Monopolies may additionally suffer indigenous what is called x-inefficiency. X-inefficiency arises when expenses creep up as result of lack of compete and/or actions pursued by the monopolist to defend its syndicate position. These syndicate protecting actions are likewise called rent-seeking activities.

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Monopolies will regularly pursue rent seeking activities spending time or money on tasks that room not regarded the production of the an excellent or organization but plan to boost the industry power and also profitability of the firm. Because that example, significant soft drink companies, such as Coke or Pepsi, will market millions come a college or stadium if they are permitted to be the single soft drink vendor. Likewise athletic stay firms might offer a college payments or discounts if they are allowed to it is in the sole merchant of apparel. These expenditures are not related to the production of the great or company but provide them a monopoly in the particular markets.

Legal cartel theory suggests that some sectors may seek to be regulation or desire the regulation continues, so that the variety of firms is minimal and the currently firms can act favor a monopoly. Regulation such as limiting the number of firms or people in a industry (e.g., clinical school, state liquor licenses, or taxi cabs in brand-new York City) might be done v “good intentions,” however they approve existing firms much more market strength which leads to greater prices and a reduced quantity supplied.

Section 02: Price Discrimination

Price Discrimination

If rather of charging each customer the same price, a firm can price discriminate, which method charging different prices to different consumers based upon their willingness come pay, how would lock behave? What would certainly be compelled for a certain to be able to price discriminate?

Certain conditions must organize in order for a firm come charge various prices because that the exact same product. First, a firm have to be maybe to set the price (i.e. The must have actually some sector power). Second, the firm must have the ability to segment the industry into teams based top top either your willingness to salary or their various elasticities the demand. Third, the firm must have the ability to prevent resale of the item from one market segment come another.

These might seem like difficult or unlikely conditions. However in fact, price discrimination have the right to be discovered in a range of sectors including auto sales, movie and also airline tickets, utilities and also phone rates. Even student discounts space a type of price discrimination.

First degree or Perfect Price Discrimination

There room three different levels or level of price discrimination. This levels are associated to how well the monopolist deserve to identify individual willingness come pay and segment the market accordingly.

See more: This Striped Egg Has A Warm Glow, Sinii Krai Dragon

an initial degree or perfect price discrimination is once a certain charges each consumer their preferably willingness come pay, which is reflect by the demand curve. Together in other cases, it is optimal for the for sure to pick its calculation at the suggest where MR=MC. Yet if a firm can charge each person his/her preferably willingness to pay, then mr = price as uncovered on the demand curve. For this reason it would certainly be ready to sell its products up come the suggest where the MC curve crosses the demand curve, i.e. Where MC = price = MR.This means that not just will the firm would certainly be willing to sell more units 보다 it did as a single priced monopolist, but it will additionally be allocatively efficient since price equates to marginal cost at the critical unit. However, each consumer is now paying her maximum willingness come pay, and also therefore receives no customer surplus. So although the output level is allocatively efficient and also the very same as perfect competition would certainly obtain, the distribution of economic surplus is quite various – the firm extracts every one of the surplus!

Since a firm might be unable to assess each consumers maximum willingness-to-pay and also the cost of collection that details may be prohibitive, very first degree price discrimination is often complicated /impossible come implement. The legislation profession is perhaps the finest example the perfect price differentiate – their market for a “free consultation” is draft to obtain information top top willingness and capability to pay. Some other examples of attempts in ~ perfect price discrimination would certainly be a car salesman that tries to assess each consumer’s preferably willingness-to-pay and also charges accordingly. Auctions also shot to reach every consumer’s best price.

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Third level Price Discrimination

When a monopolist cannot perfectly identify and segment consumer based upon individual willingness to pay, over there still may be a method to extract part (but less) consumer surplus to boost profits. 2nd degree price distinguish (to be discussed later) and 3rd degree price discrimination can be employed under the best conditions. Third degree price discrimination might be employed once the certain cannot identify individual demands, yet can identify groups of consumers that have similar demands and can segment lock based upon some easily identifiable characteristics such together age, time that purchase, residency, or location. Climate the monopolist charges various prices come the various groups based upon their loved one elasticities that demand. The more inelastic the demand, the greater the price. This type of price discrimination is most common. Being able to segment the market, into groups that have various elasticities, permits the firm to charge different prices and also increase overall profitability. Recall the the certain must have the ability to prevent the resale of the good for price discrimination to work. This is why we regularly see 3rd degree price distinguish in the business sector, whereby the nature the the product or organization makes the resale that the great to one more segment that the market challenging or impossible. Right here are a few examples of 3rd degree price discrimination.

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

Airlines additionally price discriminate. Those purchasing tickets at the very least two mainly in advance typically obtain a lower price than people purchasing tickets only a work or two prior to the flight. The distance and also destination the the flight likewise make a difference because there space fewer substitutes if one is flying to say Hawaii verses one more city in ~ the state.

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

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

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Second degree Price Discrimination

Second degree price discrimination is implemented when the monopolist knows that there are two or more groups of consumers with different willingness to pay, however she cannot identify which consumers belong to every group. If us make things an easy and assume the there space two groups, a high demand group (H) and also a low need group (L), climate ideally, she’d favor to fee a high price come the H group and also a short price to the l group. But if the she go this, consumers in the H group will insurance claim to be from the together group and also everyone will gain the low price. 2nd degree price differentiate or block pricing charges different prices come different customer groups based upon the amount consumed. The is, the for sure knows the the H consumers space willing to purchase a higher quantity than the L consumers at the exact same price. Therefore, it will set a price because that the L team that extracts all of their customer surplus for a small quantity level (say $2 because that a parcel of 4 rolls of restroom paper), yet this would leave H consumers v some customer surplus because they have a greater demand. To acquire at the very least some the that customer surplus indigenous them, the monopolist to adjust a higher price for a bigger package the targets H consumers (say $3.50 because that a package of 8 rolls of toilet paper). The volume discount motivates the H consumers to to buy the larger package and also also allows the firm come extract more of their customer surplus, due to the fact that they obtain them come buy a larger quantity (otherwise they would only buy the 4 roll package). Unequal perfect price discrimination that extracts every one of the customer surplus, in second degree price discrimination, the high need group tho keeps some.

Two-Part Tariff

There room a number of pricing techniques that execute not seem choose price discrimination, but in truth are! One is worthy of note:the two-part tariff. The two-part tariff charges people an upfront membership fee then also charges them a per use fee. Under the appropriate conditions, the two-part tariff provides perfect price differentiate possible. Because that example, part golf stillproud.org and also health clubs fee an annual membership fees in enhancement to the per usage fee because that each ring of golf or workout. If the marginal expense of providing a round of golf is ten dollars, then the golf society charges a ten dollar per use fee and the golfer decides to play 25 rounds of golf per year. If there to be no membership fee the area listed below the need curve and over the price would be customer surplus, however, by charging a membership fee equal to the area of customer surplus (recall the area the a triangle is .5*base*height or .5*25*60 = $750), the golf society is able to transform the consumer surplus into added revenue because that the firm. This is the course, first degree or perfect price distinguish if the membership fee different by customer based upon willingness to pay. Alternatively, if the firm can’t determine individual demands, but knows the needs for different groups, it might still use two-part tariffs to obtain the second degree price discrimination outcome. One of two people way, the for sure extracts several of the customer surplus as additional profits.

Another example of a two-part tariff would be a cabinet phone firm that charges a monthly dues in addition to a per minute charge. Although other pricing methods exist, friend should be able to understand the inspiration for why firms would desire to price discriminate.

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Section 03: Antitrust and also Regulation

Performance and Structure

Monopolies and firms that collude to act like monopolies, mitigate competition and also create inefficiencies in the market. We have actually seen that solitary priced monopolists room neither allocatively effective (price equals marginal price at the critical unit produced) nor productively effective (producing in ~ the lowest typical cost). Consequently, the unified States federal government has passed certain laws the restrict monopolies.

Government deserve to evaluate a market based upon the structure the the market, i.e., the number of firms in the industry and also the obstacles to entry, or through the market’s performance or conduct, i.e., the actions of the firms and the resulting prices and also efficiencies. Must a monopoly exist, the government can seek a variety of options:

(1) break up the monopoly under antitrust laws; (2) regulate the monopoly; or (3) ignore the monopoly, if castle anticipate the the monopoly will be short lived or have negligible impact.

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Whenever firms become huge in dimension or large relative to your industry, policy-makers identify that these firms are more able to pursue monopoly-type conduct and obtain inefficient industry outcomes. In ~ the exact same time, growth of a firm, as we have actually seen, allows it to catch economies that scale and scope. For this reason when big firms merge, the benefits have to be measured against the potential for effectiveness losses. There are three simple types of mergers. A horizontal merger is the mergers or consolidation of 2 or more producers that the exact same product or service. For example, if a flour mill buys an additional flour mill. Vertical mergers occur when this firm at different stages of production of a product merge. Because that example, a flour mill the buys a wheat farm would be an instance of one upstream upright merger (upstream way input-supplying), if the flour mill purchase a bakery would be an instance of a downstream vertical merger (downstream means output-using). Conglomerate mergers occur when the merger firms create unrelated products, such together a flour mill to buy a computer system company. Conglomerate closing may enable a firm economies of border or to diversify. Historically, numerous tobacco companies have actually purchased food companies, such together Kraft, to aid them diversify and also improve their public image.

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Antitrust Legislation

In 1890, the Sherman Antitrust Act to be passed to mitigate the power of firms that regulated a big percentage of a market. It made it illegal to get involved in activities in that result in the “restraint trade or commerce”, such as price fixing, and activities which monopolize or effort to monopolize. This regulation targeted this firm such as the traditional Oil company which to be monopolizing the refining and also distribution the the petroleum. However, this powerful law to be vague in plenty of respects and subsequent regulations were passed to much more explicitly outline tasks that to be illegal.

The Federal profession Commission act of 1914, empowered the Federal trade Commission (FTC) to stop or stop unfair techniques of competition and unfair or deceptive plot in or affect commerce. Now the FTC and also the room of Justice’s antitrust division have the duty to inspection firms for antitrust behavior.

The Clayton act of 1914, strengthened the Sherman Antitrust Act, make illegal price discrimination of “commodities of choose grade and quality” when it is reduces competition and also is not justified by price differences. The purchase of a competitor’s stock and having interlocking directories, whereby the individuals are offer on both board of directors, are also illegal if they minimize competition. The Clayton Act likewise prohibits tie-in sales, wherein the acquisition of one product is a problem of sale for another product. Later, the Celler-Kefauver act of 1950 close up door loopholes in the Clayton action by restricting suppliers from the acquisition of the physical assets of competitors. If horizontal mergers were scrutinized under the Sherman Antitrust Act, vertical and conglomerate mergers might be clogged under the Celler-Kefauver plot 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 an industry has actually a organic monopoly, a single firm is maybe to produce at a reduced per unit cost compared to having multiple that company in the industry. Thus, governments commonly opt come regulate instead of break up organic monopolies. An electric generating company, for instance has high fixed costs and the marginal price of running strength to one an ext house is really low.

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An unregulated single-priced monopoly would maximize revenues where marginal revenue equals marginal cost, creating Qm and charging price, Pm. Together the federal government steps in to regulate a market, what price have to they enable a monopolist come charge?

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Economically effective or social Optimum Price

The economically efficient or society optimum price would take place where price equates to marginal cost, making the market allocatively efficient. However, because the average total cost is decreasing in the region of demand, and marginal price intersects average expense at the minimum, marginal expense will be below the average price in the relevant range of demand. If regulators force a syndicate to price in ~ this point, wherein price amounts to marginal cost, they would pressure the syndicate to incur a loss or an unfavorable economic profits, i m sorry would ultimately force the monopoly out the business. Because the syndicate is the just producer, government can subsidize the monopoly for these losses such that they earn a common return, yet this is regularly politically difficult.

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Fair Return or Average cost Pricing

Alternatively the government can force the monopoly to create where price amounts to average total cost, leave the certain a zero financial profit. Thus the certain will remain in the industry since it is covering all opportunity costs. As demonstrated in our graph, the price is much less than that of the unregulated syndicate but higher than the financially efficient price. The border of this plan is that firms have no motivation to control costs. If expenses rise, they deserve to simply petition the federal government for price increases. But if the firm enhances productivity and also pursues expense cutting measures, the federal government would force them to reduced prices. Thus local utility suppliers may have actually newer equipment and also vehicles simply because of this perverse incentive.