Econ 201 1st Edition Lecture 15Outline of Last Lecture I. Perfect CompetitionII. Production and ProfitsIII. Marginal RevenueIV. ProfitabilityOutline of Current LectureI. MonopoliesII. Barriers to EntryIII. Maximizing ProfitIV. Preventing MonopoliesV. Price DiscriminationCurrent LectureChapter 13: Monopoly-Four principal models of market structure:- perfect competition- monopoly- oligopoly- monopolistic competition-An industry is known as a monopoly- Only one firm (Monopolist)- Barriers to entry- no close substitutesWhy Do Monopolies Exist?-Profits will not persist in the long run in the perfect competitive market, because of free entry-A monopoly market can protect their profit from sharing with new firms, because of a barrier for new firms to entryBarriers to Entry-Barriers to entry are essential for monopolies. They generate profit for the monopolist in the short run and long run.-Five ways to make a barrier exist:1. control of natural resources or inputs.2. increasing returns to scale.3. technological superiority.4. Network ExternalityThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.5. government-made barriers, including patents and copyrights.1. Control of a Scarce Resource or Input: If De Beers owned nearly all of the diamond mines in the world,it would have a monopoly in diamond production.2. Increasing Returns to Scale- A natural monopoly exists when increasing returns to scale (economies of scale) provide a large cost advantage to a single firm.- This means the average cost is lower as output increases (fixed cost spreads)- For example: Local natural gas company (National Grid plc, RI )3. Technological Superiority: A firm that maintains a consistent technological advantage over potential competitors can establish itself as a monopolist.4. Network Externality:- Network externality: the value of a good or service to an individual increasing as more others use the same good or service.- When a network externality exists, the firm with the largest network of customers using it product has an advantage in attracting new customers- This allow the firm to become a monopolist.5. Government-Made Barrier- A patent gives an inventor a temporary monopoly in the use or sale of an invention.- A copyright gives the creator of a literary or artistic work sole rights to profit from that work.How a Monopolist Maximizes Profit-All firms face the same rule: Profit is maximized at the Q where MR = MC.-MR = ∆TR/ ∆Q.-MR is below the demand curve-An increase in production by a monopolist has two opposing effects on revenue:- A quantity effect: One more unit is sold, increasing total revenue by the price at which the unit issold.- A price effect: To sell the last unit, the monopolist must cut the market price on all units sold. This decreases total revenue.-As long as the monopoly has strong barriers to entry, profit will stay.-Profit maximization consists of two steps:1.Choosing a quantityRule: Choose Q where MR = MC.2.Choosing a price Choose the highest price you can get away with, which is the highest price consumers will pay for that quantity.-Rule: Once you’ve picked your quantity, follow the graph to the demand curve, which shows youhow much consumers will pay.Preventing Monopoly:-Monopoly profit comes at consumers’ expense:When a monopoly raises prices and lowers Q, consumer surplus falls and deadweight loss is created.-To avoid deadweight loss, government policy attempts to prevent monopoly behavior.-The government policies used to prevent or eliminate monopolies are known as antitrust policy.Dealing with Natural Monopoly-Natural monopolies are a different story: They bring lower costs but there’s no guarantee the firm will voluntarily pass along its cost savings to consumers.-What can public policy do about this? Two common answers:- Public (government) ownership But publicly owned companies are often poorly run.- Price regulation: A price ceiling imposed on a monopolist does not create shortages if it is not settoo low.Price Discrimination-Monopolist increases its profit by discriminating prices- single-price monopolist: The firm offers its product to all consumers at the same price.- price discrimination: The monopolistic firm charges different prices to different consumers for the same good.-MR = MC to maximize the monopolistic profit in a single market-What if the monopolist sell to more than one market, each with its own demand curve?- E.g., senior citizens and young people, business travelers and leisure travelers.-If your consumers have low price elasticity, charge them more!Perfect Price Discrimination-When perfect price discrimination can be employed, a firm will charge each customer a different price, the maximum price each is willingness to pay.-Under perfect price discrimination, the firm captures all consumer surplus as profit.-Bargaining at the flea market: Perfect price discrimination.Price Discrimination-There is no deadweight loss, because all mutually beneficial transactions are exploited.-There is zero consumer surplus: The entire surplus is captured by the monopolist in the form of profit.-Common techniques for price discrimination:- Advance purchase restrictionso Prices are lower for those who purchase well in advanceo Separate people who are likely to shop for better prices from those who won’t- Volume discountso Prices are lower if you buy a large quantityo Separate people who want to buy a large quantity so are likely to be more sensitive to price from those who don’t- Two-part tariffso A consumer plays a flat fee upfronto Then pay a per-unit fee on each item purchaseso Works like a volume