Section 01: Monopolies

Monopoly

Monopolies space on the other end of the continuum from pure competition. A syndicate consists the one firm the produces a unique product or company with no near substitutes. Entry into the industry is blocked, which offers the firm sector power (i.e., the strength to progressive price over marginal cost). Historically, pure monopolies space rare and often brief lived because the reason for their visibility (usually clogged entry) is somehow weakened. Because that example, patents expire, new resources are regularly discovered, and new technologies allow brand-new competitors right into the market. Us will increase on these sources of syndicate power later. That will also become clear that firms have actually an motivation to shot to get a monopoly. Researching the attributes and behavior of a syndicate is a useful reference point particularly when looking in ~ the other industry structures.

As an interesting side note, when there is only one seller in a market, it is called a monopoly, yet when over there is only one buyer in the market, it is referred to as a monopsony. We will save our discussion on monopsonies until near the finish of the course.

A monopoly determines not only the amount to produce but also the price it will charge. The demand curve the firm deals with is the market demand curve. For this reason if it desires to offer more, that must lower the price. Does a monopoly have an incentive to advertise? since the for sure is additionally the market need curve, it has actually one hundreds percent that the market share; however, monopolies may advertise come increase in its entirety market demand or to improve goodwill or windy relations.

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Barriers to Entry

Recall from our conversation of perfect competition that once firms room able to attain economic profits, various other firms/entrepreneurs room attracted to the industry and entry will happen until economic profits are decreased to zero. Yet if over there is a barrier, entrance by profit-seeking this firm does no happen and economic profits deserve to persist. There are a range of different barriers that may allow a firm come exercise industry power (which really just method that a for sure can set price above marginal cost and extract positive profits). Obstacles to entry encompass the following 5 barriers.

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1. Legal Barriers

Governments often control essential solutions in a city such as water, sewer, and also garbage. If all family members are compelled to have 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. Manage of essential Inputs

Another obstacle to entrance can take place when firms room able to own or manage the vital inputs or resources, and as a result, lock may be able to control the market. In the early 1900’s, standard Oil’s regulate of the oil refining and also transportation was partly responsible because that the i of antitrust law which mentions regulations about monopolies and also monopolizing practices. In the 1940s the government accused Aluminum Co. That America of being a syndicate by managing the mineral bauxite, crucial input for making aluminum. De Beers’ regulate of unstable diamonds enabled it to manage and collection diamond prices.

References:

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

3. Network Externalities

Network externalities may likewise create barriers to entry. A hopeful network externality occurs as soon as the value of having actually or using an object increases together others usage the item. A phone call or fax machine, for example, becomes much more useful once others have phones or fax machines. If the industry is dominated by a specific product or brand, e.g., a computer operating device or details software, a network externality exists so users don’t desire to change products or brands. So the externality creates a barrier for various other firms to enter with a competing product.

4. Economic climates of Scale

In particular industries herbal monopolies exist wherein the long run average cost curve proceeds to decline in the relative region of demand. Consequently, one certain is may be to produce enough because that the market at a reduced per unit price than would be the instance if two firms mutual the market. In this case, hopeful profits have the right to exist, yet entrants cannot go into to record some of this profits because sharing the market method they have actually to enter at a smaller range of operation and also thus face higher average costs. The transmission of electrical energy is an example of a herbal monopoly.

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5. Strategy Behavior

Firms might undertake other strategic actions come discourage potential competitors from beginning the industry through pricing or manufacturing decisions. For example, a tiny town may have actually only one gas terminal that sets price a little lower 보다 the monopoly price (i.e., that does no act together a pure monopolist) in order to keep revenues low enough to deter others from start the market. Alternatively, a certain may develop a facility larger than required as a danger that it will boost production if various other firms attempt to get in the market. This strategic actions produce a obstacle to entry.

While no a true monopoly, Toy’s ‘R’ Us faced antitrust comes to for accused threatening the it would not offer manufacturers’ products unless they resolved the price of those items when marketed to competing discount stores.

Reference:

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

A single Price Monopolist

Unlike that company in pure compete that just decide the quantity to produce, monopolists must identify both the quantity and price. But these space not independent choices. Due to the fact that a monopolist encounters a downward sloping need curve, she must reduced the price if she desires to sell an ext goods (recall that the regulation of demand states the this inverse relationship exists in between price and quantity demanded). Provided that the monopolist have to charge the same price to all consumer (i.e. She cannot price discriminate), then to market more, she must charge a lower price, not just on the last good she desires to sell, yet on all of the product that she might have marketed at the greater price. This has vital implications for marginal revenue. It method that marginal revenue falls at twice the price of the demand curve (i.e. The slope is twice as steep). This might ideal be seen through an example. Stop assume that a monopolist have the right to sell 1 barrel the oil for $80 or 2 barrels because that $79 each. To offer two barrels, price should drop through $1. However MR because that the second one is adjust in TR split by change in quantity or (158 – 80) / (2-1) = $78. Therefore MR fell by $2 ($80-78) – twice the price as price!!

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

The extra mile for the mathematically lean students:

For those wanting to view mathematically why the marginal revenue curve is double as steep together the demand curve, right here is the math. Stop assume need is ns = 10-2Q. In our example, the slope of the need curve is -2. Complete Revenue i beg your pardon is equal to price times quantity equates to (10-2Q)Q = 10Q-2Q2. Making use of this equation we can evaluate the change in total revenue together Q changes. For example, let’s look in ~ the change in complete revenue as quantity changes from 3 to 4. Once Q amounts to 3, the full revenue is 4 and when Q equates to 4, the total revenue is 8. A readjust in full revenue of 4 dollars together Q boosts by one suggests a slope of -4 i m sorry is twice the slope of demand. Because that those that have had actually calculus, take the first derivative that 10Q-2Q2 to gain the marginal revenue the 10 – 4Q, which provides a slope of -4.

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Determining Price and Quantity

Profit maximization for a syndicate charging a solitary price will take place where marginal revenue is same to marginal cost. That is essential to note that this provides the benefit maximizing quantity however the price is figured out by going as much as the demand curve. That is, the price is acquired based ~ above what consumers space willing to pay because that that quantity level i beg your pardon is established by the need curve.

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Profits for the monopolist are obtained by calculating full revenue (TR) minus full cost (TC). TR=optimal price * optimal quantity (the an unified area that the blue and also grey crate in the figure). Acquisition the average total cost time the profit maximizing quantity offers the total cost. In the brief run, a syndicate may earn brief run profits or losses, yet unlike this firm in pure competition that have actually zero financial profits in the long run, monopolies have the right to maintain long run profits. If long run revenues are negative, the firm would certainly leave the industry and also the great would no longer be produced, since the syndicate was the just firm in the industry.

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Recall from our conversation on elasticities that along a linear need curve, over there is an elastic and also inelastic portion. In the elastic portion, lower prices increases complete revenue, and also in the inelastic part total revenue drops as price decreases. Total revenue is maximized at unit elasticity which occurs wherein marginal revenue is zero.

This provides for vital observation. Because we would expect marginal expense to be positive and a monopolist choose to create where MR=MC, we deserve to conclude the a monopolist would only develop in the elastic region of the demand curve.

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Practice

1. Determine the benefit maximizing quantity and also price for a single priced monopolist. Is the monopolist creating in the elastic region of the need curve at the point?

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Answer

Following the decision rule of producing where the marginal revenue equates to the marginal cost, we have the right to determine that developing six units and also charging a price of $550 will maximize profits. At the 6th unit, our marginal revenue is 175 and also the marginal expense is 140. At seven units the marginal price would exceed the marginal revenue. In looking in ~ the pillar on the far right, we verify the this is the amount that maximizes profits. At six units of output, the mid-point elasticity in between five and six systems is 1.42, i beg your pardon is elastic.

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

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Comparing come Pure Competition

Recall that purely compete firms create where MC is same to price and also that sector supply is obtained by horizontally including the MC curve of the that company in one industry. In equilibrium, the industry supply curve (the sum of the MC curves) crosses the demand curve. If the syndicate was come act in the very same fashion, the would produce where that MC curve the cross the need curve (just favor the sum of the MC curves overcome the demand curve in pure compete – only it is the sum of one curve). So in compare the outcome because that pure vain to the of monopolywe see that a solitary price monopolist will produce less than the completely competitive market and 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 creating where the price is same to the marginal cost. Through restricting output and also raising price, the single price monopolist catches a section of the consumer surplus. Due to the fact that output is restricted, a part of both the consumer and producer surplus is lost. This lose of financial surplus is recognized as deadweight loss, that neither the consumer nor the producer enjoy.

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

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Monopolies will frequently pursue rent seek activities safety time or money on activities that room not pertained to the production of the an excellent or organization but plan to rise the industry power and also profitability that the firm. Because that example, major soft drink companies, such together Coke or Pepsi, will sell millions to a college or stadion if castle are permitted to it is in the single soft drink vendor. Likewise athletic undertake firms may offer a university payments or discounts if castle are allowed to it is in the sole merchant of apparel. These expenditures space not regarded the manufacturing of the great or service but offer them a monopoly in the respective markets.

Legal cartel theory suggests that some industries may look for to be regulated or desire the regulation continues, so that the number of firms is minimal and the present firms have the right to act choose a monopoly. Regulation such as limiting the number of firms or people in a sector (e.g., medical school, state liquor licenses, or taxi cabs in new York City) may be done with “good intentions,” however they approve existing firms more market power which leader to higher prices and also a lower quantity supplied.

Section 02: Price Discrimination

Price Discrimination

If rather of charging each consumer the exact same price, a firm can price discriminate, which way charging different prices to various consumers based upon your willingness come pay, just how would they behave? What would be forced for a for sure to be able to price discriminate?

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

These might seem like challenging or i can not qualify conditions. But in fact, price discrimination deserve to be discovered in a selection of sectors including auto sales, movie and also airline tickets, utilities and phone rates. Also student discounts room a form of price discrimination.

First level or Perfect Price Discrimination

There room three different levels or levels of price discrimination. This levels are connected to how well the monopolist deserve to identify separation, personal, instance willingness to pay and also segment the sector accordingly.

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very first degree or perfect price discrimination is once a for sure charges each consumer their preferably willingness come pay, i m sorry is reflect by the need curve. As in other cases, the is optimal because that the certain to choose its calculation at the suggest where MR=MC. Yet if a firm can charge each human being his/her best willingness to pay, then mr = price as discovered on the need curve. For this reason it would certainly be willing to market its assets up come the point where the MC curve crosses the demand curve, i.e. Wherein MC = price = MR.This means that not just will the firm would be ready to sell more units than it did as a solitary priced monopolist, but it will additionally be allocatively efficient since price equals marginal expense at the last unit. However, each customer is now paying her maximum willingness to pay, and also therefore receives no customer surplus. For this reason although the output level is allocatively efficient and the exact same as perfect competition would obtain, the distribution of financial surplus is quite different – the for sure extracts every one of the surplus!

Since a firm may be unable to evaluate each consumer maximum willingness-to-pay and also the cost of gathering that details may it is in prohibitive, an initial degree price differentiate is often daunting /impossible to implement. The regulation profession is perhaps the finest example that perfect price distinguish – their market for a “free consultation” is design to obtain information top top willingness and capability to pay. Some other instances of attempts at perfect price discrimination would be a vehicle salesman that tries come 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 can not perfectly identify and segment consumer based upon individual willingness come pay, there still might be a method to extract some (but less) consumer surplus to rise profits. 2nd degree price discrimination (to be debated later) and third degree price discrimination can be work under the appropriate conditions. Third degree price discrimination might be employed as soon as the firm cannot identify individual demands, however can identify teams of consumer that have comparable demands and can segment them based upon some conveniently identifiable characteristic such as age, time that purchase, residency, or location. Climate the monopolist charges different prices come the various groups based upon their relative elasticities of demand. The much more inelastic the demand, the higher the price. This kind of price differentiate is many common. Being able to segment the market, into groups that have various elasticities, permits the firm to charge various prices and increase all at once profitability. Recall that the firm must be able to prevent the resale that the good for price discrimination to work. This is why we often see third degree price differentiate in the company sector, wherein the nature that the product or organization makes the resale the the good to an additional segment that the market an overwhelming or impossible. Right here are a couple of examples of third degree price discrimination.

Movie theaters regularly charge different prices based upon the time the consumption and age. The elasticity of need for those attending a matinee is more elastic 보다 those during primetime, for this reason a lower price is charged because that the matinee. Young youngsters and an elderly citizens have various elasticities of demand than young adults, which allow the theaters come price accordingly.

Airlines likewise price discriminate. Those purchasing ticket at least two main in advance typically acquire a reduced price than people purchasing tickets just a day or two before the flight. The distance and destination that the flight also make a difference since there room fewer substitutes if one is flying to say Hawaii verses one more city in ~ the state.

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

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

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Second degree Price Discrimination

Second level price discrimination is applied when the monopolist knows that there are two or more groups of consumers with different willingness come pay, yet she cannot identify which consumers belong to every group. If we make things an easy and assume that there space two groups, a high demand group (H) and a low demand group (L), climate ideally, she’d choose to charge a high price come the H group and also a low price come the l group. But if the she go this, consumer in the H group will claim to it is in from the together group and everyone will acquire the low price. 2nd degree price differentiate or block pricing charges different prices come different consumer groups based upon the amount consumed. The is, the certain knows that the H consumers are willing to acquisition a greater quantity 보다 the L consumers at the very same price. Therefore, that will set a price for the L group that extracts every one of their customer surplus for a little quantity level (say $2 for a parcel of 4 rolls of toilet paper), yet this would leave H consumers through some customer surplus due to the fact that they have actually a higher demand. To obtain at the very least some that that consumer surplus from them, the monopolist set a greater price because that a bigger package that targets H consumer (say $3.50 for a package of 8 rolfes of toilet paper). The volume discount urges the H consumers to to buy the larger package and also also allows the firm to extract much more of their consumer surplus, because they gain them come buy a bigger quantity (otherwise castle would just buy the 4 roll package). Unequal perfect price discrimination that extracts all of the consumer surplus, in 2nd degree price discrimination, the high need group quiet keeps some.

Two-Part Tariff

There space a variety of pricing methods that perform not seem like price discrimination, yet in reality are! One is worthy that note:the two-part tariff. The two-part tariff charges individuals an upfront member fee then likewise charges lock a per usage fee. Under the appropriate conditions, the two-part tariff provides perfect price discrimination possible. For example, part golf urbanbreathnyc.com and health clubs fee an annual membership fees in addition to the per usage fee because that each ring of golf or workout. If the marginal price of providing a round of golf is ten dollars, then the golf society charges a ten disagreement per usage fee and the golfer decides to play 25 ring of golf every year. If there to be no membership fee the area listed below the need curve and above the price would certainly be customer surplus, however, by charging a membership fee equal to the area of consumer surplus (recall the area that a triangle is .5*base*height or .5*25*60 = $750), the golf club is may be to convert the customer surplus into extr revenue because that the firm. This is the course, first degree or perfect price differentiate if the member fee different by consumer based ~ above willingness to pay. Alternatively, if the for sure can’t determine individual demands, however knows the needs for various groups, it can still use two-part tariffs to acquire the second degree price discrimination outcome. One of two people way, the for sure extracts some of the customer surplus as additional profits.

Another example of a two-part tariff would certainly be a cell phone agency that dues a monthly dues in addition to a per minute charge. Although other pricing strategies exist, girlfriend should be able to understand the impetus for why that company would want to price discriminate.

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Section 03: Antitrust and Regulation

Performance and Structure

Monopolies and also firms that collude to act favor monopolies, mitigate competition and create inefficiencies in the market. We have actually seen that single priced monopolists room neither allocatively effective (price amounts to marginal expense at the last unit produced) nor productively reliable (producing in ~ the lowest mean cost). Consequently, the joined States government has passed certain laws the restrict monopolies.

Government can evaluate a market based on 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 actions of the firms and the result prices and efficiencies. Need to a monopoly exist, the government can pursue a selection of options:

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

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Whenever firms become large in size or large relative to your industry, policy-makers identify that this firms are much more able to pursue monopoly-type conduct and obtain inefficient sector outcomes. In ~ the very same time, expansion of a firm, together we have seen, allows it to record economies of scale and also scope. Therefore when huge firms merge, the benefits need to be measured against the potential for effectiveness losses. There are three basic types the mergers. A horizontal merger is the merger or consolidation of 2 or an ext producers that the exact same product or service. For example, if a flour mill buys one more flour mill. Vertical mergers take place when that company at different stages of production of a product merge. For example, a flour mill the buys a wheat farm would be an example of an upstream upright merger (upstream method input-supplying), if the flour mill purchase a bakery would be an example of a downstream vertical merger (downstream way output-using). Conglomerate mergers take place when the merging firms produce unrelated products, such as a flour mill to buy a computer company. Conglomerate closing may permit a firm economic climates of scope or to diversify. Historically, number of 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 minimize the strength of that company that managed a huge percentage that a market. It made the illegal to get involved in activities in that result in the “restraint trade or commerce”, such together price fixing, and activities which monopolize or effort to monopolize. This legislation targeted firms such as the conventional Oil agency which to be monopolizing the refining and distribution the the petroleum. However, this an effective law to be vague in many respects and subsequent legislations were passed to an ext explicitly outline activities that to be illegal.

The Federal profession Commission act of 1914, empowered the Federal trade Commission (FTC) to protect against or avoid unfair techniques of competition and also unfair or deceptive action in or influence commerce. This particular day the FTC and the department of Justice’s antitrust division have the responsibility to inspection firms because that antitrust behavior.

The Clayton action 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 not justified by price differences. The purchase of a competitor’s stock and having interlocking directories, where the individuals are serving on both board of directors, are likewise illegal if they reduce competition. The Clayton Act additionally prohibits tie-in sales, where the acquisition of one product is a condition of revenue for another product. Later, the Celler-Kefauver act of 1950 closed loopholes in the Clayton action by restricting providers from the purchase of the physical assets that competitors. When horizontal mergers to be scrutinized under the Sherman Antitrust Act, vertical and also conglomerate mergers can be clogged under the Celler-Kefauver plot 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 an industry has a organic monopoly, a solitary firm is able to develop at a reduced per unit cost contrasted to having multiple firms in the industry. Thus, governments commonly opt come regulate rather of break up organic monopolies. An electric generating company, for instance has high fixed costs and the marginal expense of running strength to one more house is very low.

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An control not controlled single-priced syndicate would maximize revenues where marginal revenue equates to marginal cost, creating Qm and charging price, Pm. Together the federal government steps in to manage a market, what price need to they allow a monopolist come charge?

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Economically reliable or social Optimum Price

The financially efficient or social optimum price would occur where price equates to marginal cost, making the industry allocatively efficient. However, since the average full cost is decreasing in the region of demand, and also marginal cost intersects average expense at the minimum, marginal price will be below the average price in the relevant range of demand. If regulators force a monopoly to price in ~ this point, wherein price equals marginal cost, they would force the monopoly to incur a loss or an unfavorable economic profits, i beg your pardon would at some point force the monopoly out of business. Due to the fact that the syndicate is the only producer, government could subsidize the syndicate for this losses such that they earn a common return, yet this is frequently politically difficult.

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Fair Return or Average cost Pricing

Alternatively the government can force the syndicate to develop where price equals average total cost, leaving the firm a zero economic profit. Thus the for sure will continue to be in the industry since it is covering all chance costs. As demonstrated in ours graph, the price is less than the of the unregulated monopoly but greater than the economically efficient price. The limit of this plan is that firms have actually no inspiration to manage costs. If expenses rise, they have the right to simply petition the federal government for price increases. Yet if the firm enhances productivity and also pursues expense cutting measures, the government would force them to reduced prices. For this reason local utility companies may have actually newer equipment and also vehicles simply because of this perverse incentive.