Chapter 10 Flashcards
What is total revenue for a monopolist?
TR = p x Q
What is average revenue for a monopolist?
AR = TR/Q (P x Q)/Q = P
- Since the demand curve shows the price of the product, it follows that the demand curve is also the monopolist’s average revenue curve.
What is marginal revenue for a monopolist?
MR = ΔTR/ΔQ
- Because of the downward sloping demand curve the monopolist must reduce the price that it charges on all units to sell an extra unit.
- So the price received for the extra unit sold is not the firm’s marginal revenue because by reducing the price on all previous units, the firm loses some revenue.
- Marginal revenue is equal to the price minus this lost revenue.
- So the marginal revenue resulting from the sale of an extra unit is less than the price that the monopolist receives for that unit.
- The monopolists MR curve lies below its demand curve.
Compare price in a perfectly competitive market and a monopoly.
- The level of output in a monopolized industry is less than the level of output that would be produced if the industry were perfectly competitive.
- For a perfectly competitive market, P = MC
- For a monopoly, P > MC
- In a monopoly, the marginal value to society of extra units, as reflected by the price, exceeds the marginal cost of producing the extra units.
Explain how a monopoly leads to market inefficiency.
- More economic surplus would be generated for society if the monopolist increased its level of output.
- The monopolist’s profit-maximizing decision to restrict output below the competitive level creates a loss of economic surplus for society - a deadweight loss.
What must happen for a monopoly to persist?
The entry of new firms must be prevented.
Describe creative destruction. [3]
- In the very long run, technological changes and innovations can circumvent effective entry barriers.
- Joseph Schumpeter (1883 - 1950) defended monopoly on the basis that the pursuit of monopoly profits provided incentives to innovate.
- He called the replacement of one monopolist by another through innovation the process of creative destruction.
Describe problems that cartels face.
- Cartels tend to be unstable.
- Any one firm within the cartel has an incentive to cheat.
- But if all firms cheat, the price falls back toward the competitive level, and joint profits will not be maximized.
- A successful cartel must also be able to prevent the entry of new producers.
- Successful cartels are often able to license the firms in the industry and to control entry by restricting the number of licenses.
What is price discrimination?
- The sale by one firm of different units of a product at two or more different prices for reasons not associated with difference in cost.
- If price differences reflect cost differences, they are not discriminatory.
- When price differences are based on different buyers’ valuations of the same product, they are discriminatory.
When is price discrimination possible? [3]
- Market power
- Different valuations of the product
- Prevent arbitrage.
What is price discrimination among units of output?
A firm captures consumer surplus by charging different prices for different units sold.
What is price discrimination among market segments?
Easier for firms to distinguish between different market segments than it is to detect an individual consumer’s willingness to pay for different units of that product.
Price discrimination among market segments is more common than price discrimination among units.
What is hurdle pricing?
Give an example.
- Hurdle pricing exists when firms create an obstacle that consumers must overcome to get a lower price.
- Consumers then assign themselves to the various market segments - those who don’t want to jump the hurdle and are willing to pay the high price, and those who choose to jump the hurdle to benefit from the low price.
- A familiar example is coupons for discounts at grocery stores.
What are the consequences of price discrimination? [3]
- For any given level of output, the most profitable system of discrimatory prices will always provide higher profits to the firm than the profit-maximizing single price.
- A monopolist that price discriminates among units will produce more output than will a single-price monopolist.
- If price discrimination leads the firm to increase total output, the total economic surplus generated in the market will increase, and the outcome will be more efficient.
What are the assumptions of a monopoly? [3]
There is no ‘competition’ in monopoly. Monopoly market structure has absolute market power.
- One seller; the firm is the industry
- Selling a unique good; monopoly sells an exclusive good
- Entry and exit are impossible; ‘barriers to entry’ are insurmountable.
Compare monopoly and perfect competition. [4]
Monopoly
- Single firm
- Unique good
- Entry & exit impossible
- “Price setter”
- Demand curve
- Downward sloping (both firm and industry)
Perfect competition
- Many many firms
- Homogenous goods
- Entry & exit easy
- “Price taker”
- Demand curve
- Horizontal (firm) and downward sloping (industry)
When will a monopolist produce?
Monopolist will produce where e ≥ 1; MR ≥ 0 (TR is increasing)
Summarize profit maximization for a monopoly. [3]
- e ≥ 1 (go left)
- P ≥ AVC (stay in business in SR)
- MR = MC (maximize total profits)
What are the conditions for price discrimination? [3]
-
Monopoly power (seller can charge different prices)
- Firms that are price takers cannot price discriminate
- Firm must have some market power
-
Consumer must value different units of same product differently (buyer willing to pay different prices = different elasticity)
- Same consumer
- Different consumer - firm must be able to segment the market
-
No arbitrage (buyer cannot defeat the seller’s objective)
- Arbitrage = consumers buy at low price and resell at higher price
- Low price reseller can capture all the price discriminating monopolist’s profits
