1.8 Monopoly/Price Discrimination Flashcards
What is a monopoly and what are the causes? How is it graphed?
Single firm can serve entire market - assume consumers are price takers, but now market served by monopoly and high barriers to entry into market
Causes: cost advantages of single firm/government intervention
Cost advantage:
- Superior technology or organisation
- Exclusive control over input
- Natural monopoly - AC curves always downward sloping (usually utility companies such as gas, electricity and water)
Graphed on page 23
How do governments intervene in markets with monopolies
- Government monopolies exist - the corporation is the sole provider of a particular good and competition prohibited by law e.g. postage systems, railroads, public utilities, etc.
Patents:
Temporary monopolies granted to encourage innovation usually in pharmaceuticals
How to monopolies profit maximise?
They make the output and shutdown decisions
Only shutdown if revenues are lower than the variable costs
Output decision:
Profit max when MR = MC
Difference to perfect competition is that MR is not equal to P for a monopolists. Monopolists sell the entire market quantity
What is the market demand curve for monopolists
Profit maximising behaviour determined by the market demand curve:
Only supplier, doesnt consider competitors
Constrained by demand
Chooses point on demand curve which maximises profits - either sets price or quantity - both approaches yield same result
(PAGE 23)
Since the monopoly is the industry there is no distinction between firms
What are some of the implications of the monopolistic demand curve?
- Increasing q by one unit yields extra revenue of P2 x 1 area, but price must lower to p2, losing revenue on the first Q units
- Monopolists extra/marginal revenue from selling an additional unit < price, p2
(some tekky maths on page 23 explaining stuff)
Basically that MR = p(Q)(1+1/PED)
Implies:
- Monopolist never on inelastic part of demand curve
- If demand inelastic, MR is negative because MR = p(Q)(1+1/PED)
- MC never negative (otherwise total cost would go down when more is produced)
Thus, MR < MC on inelastic part of demand curve and monopolist could increase profits by producing less
When quantity falls, revenues rise, costs go down so profits rise
Illustrate the different effects at different inelasticities of the demand curve?
on page 24 mf
Suppose that p(Q) = 24 - Q
R(Q) = p(Q) x Q = 24Q - Q^2
AR(Q) = p(Q) = 24Q - Q
MR(Q) = dR(Q)/dQ = 24 - 2Q
This means the MR curve is twice as steep as the AR (demand) curve
- Monopolists as a result do not operate below the mid point of demand
Find the profit maximising quantity of C(Q) = 12 + Q^2 from the previous example then draw the finished graph
MC(Q) = 2Q
MC = MR
2Q = 24-Q so Q* = 6
the profit max price = p(Q*) = 24-6=18
At p* and q* profits are:
p* x Q* - C(Q*) = (18x6) - 12 - 6^2 = 60
ALTERNATIVE:
Since AC = 12/Q + Q
AC* = 12/6 + 6 = 8
Profit = Q* x (p* - AC(Q*)) = 6x(18-8) = 60
Graph on page 24
How do monopolies affect economic welfare?
Monopolies operate where p > MC
Implies they could increase welfare by increasing output. If they wanted to maximise welfare they could produce where P = MC
Since a perfectly competitve firm produces here this is called the perfectly competitive outcome
For monopolies, however, output is lower and prices are higher so welfare is lower
How are monopolies regulated?
- Deregulation and trade liberalisation
- COmpetitoion policy
- CMA in charge of enforcing anticompetitive laws
Structural remedies: try to alter industry structure:
- Blocking mergers
- Force companies to restructure
- Break up companies
Remedies not always feasible - highly complex, costly and not always desirable
Conduct remedies: intervention to restrict behaviour without changing underlying market strucutre
- Prevent price fixing and cartels
For natural monopolies, directly intervene in price setting process of firm
Regulated demand:
- Set price ceiling at competitive price
- Demand curve flat is price restriction binding - also changes MR curve and MC intersects at competitive equilibrium
- This replicates the competitive market outcome, eliminates deadweight loss
What are the problems of price regulation
- Limited information and AR and MC curves, hard to calculate
- Monopolies must be allowed to make at least 0 profits - for a natural monopoly, setting p = MC will cause firms to shut down
Regulatory capture:
- Monopolists have better information about demand and costs neede to be involved in regulation; not same incentives as regulator
- Regulators too closely aligned with firms if it benefits them
What are the conditions for price discrimination
Firms price discriminate because it can increase profits:
- Charge higher prices to customers willing to pay more than uniform monopoly rate (different elasticity)
- Can sell to people not willing to pay as much
To price discriminate, 3 conditions must be met
- Market power to charge above market price
- Can identify and separate consumers who are willing to pay more/less (elasticity)
- Must be able to prevent reselling from those who pay less and those who pay more
What is first degree price discrimination?
- Charge exact price to maximum they are willing to pay, no consumer surplus
- Firm profit increased by absorbing consumer surplus, all becomes producer surplus
This is called the reservation value. This means the firms MR is its demand curve
- Firms do not sell past the point where MC > MR
On a diagram, this means price is set at the y intercept of the demand curve which is a mazza
- There is also technically no deadweight loss, so is efficient in maximising welfare
Why is first degree price discrimination rare?
- Firms dont have perfect information
- Cost of gathering data to high
- Advances in technolgies making it easier
- Relevant because most efficient form of discrimination, provides benchmark against which to compare the other types.
What is second degree - show is graphically:
Price discrimination through bulk buying - may be multiple people
Block pricing: charge one price for first few units, different prices for subsequent blocks
Similar results to perfect discrimination, producer surplus is up, CS down compared to sinlge price monopolist
Welfare up compared to single price monopolist
- Approahces perfect PD when more and more blocks are added, but better information is needed
Graphee on page 24
Third degree pric ediscimination
Firms know which groups have higher prices
Creates third degree
- ALl indiviudlas in group pay same price but prices varie
- Groups based on exogenous characteristics
E.g. age discounts, location discounts etc
