Monopoly

The Monopoly Model

Sellers are price makers Sellers do not behave strategically Entry into the industry is completely blocked Buyers are price takers

Market Structure
Many buyers ONE seller No close substitutes for the firms product Well informed buyers Blocked entry to the market

How does Monopoly Arise?

Control over critical inputs Economies of scale and scope

Intellectual Property Rights

Regulation

The Profit-maximising Monopolist

Monopolist faces the industry demand curve

Profit max. conditions imply that MR = MC and MR cuts MC in its rising part (as slope of MR < slope of MC)
How do we get this MR curve of the monopolist? Whats the AR curve of the monopolist?

Marginal Revenue
Output per Price per Total Rev Marginal month unit (Rs.) (Rs) Rev (Rs) 0 40 0 1 35 35 35 2 30 60 25 3 25 75 15 4 20 80 5 5 15 75 -5 6 10 60 -15

Marginal revenue falls as output sold increases Marginal revenue is less than price (AR) After TR is max, MR becomes negative

Demand & MR Curves

50 40 30

20
Rs

10 0 -10 -20 Output per month 0 2 4 6

D
8

MR

TR = pq = f(q) * q,

where p = f(q) is demand curve

AR = pq/q = p = f(q) = demand curve MR = p (1 1/|e|)

Monopoly Equilibrium
Rs MC
P

AC

Monopoly Profit

D
Q

MR

Qty

When will the monopolist shut down?

In the short run, the monopolist can earn profit, make losses or just break even It will continue to operate (i.e. min. losses) as long as p exceeds AVC at the optimum level of output, i.e. p* < SAVC
P, R, C MC SAC SAVC P*

AR Q* Q MR

Short Run & Long Run ?

In the long run the firm is on its long run cost curves No entry of new firms takes place, so economic profit can exist in the long run Hence in long run also, the monopolist chooses output as in short run, i.e. at MR = LMC and sets the price from the cor. Demand curve But the monopolist stops producing if he incurs losses in the long run

Whats the supply curve of a monopolist?

A monopolist does not have a supply curve He chooses output and then price corresponding to that output from the demand curve So, supply curve does not exist for a monopolist

Measurement of Monopoly Power

Price Elasticity of demand: the degree of market power is inversely related to e. Fewer the substitutes, less is e, greater the firms market power Lerner Index: LI = (P MC) / P where P is the price the monopolist sets
o o o o Under perfect competition, P = MC, hence LI = 0 Under monopoly P > MC (as P> MR = MC), LI >0 Higher LI, higher is market power LI is inversely related to price elasticity of demand

Cross price elasticity: A high positive cross pelasticity implies existence of close substitutes, hence lower market power

Monopoly v Competition: Social cost of monopoly

Consider a perfectly competitive industry under constant returns to scale (implying horizontal long run supply curve of the industry) Suppose this industry is now converted into monopoly with same demand and cost curves The monopoly will charge a higher price and produce less output There will be a redistribution of income from consumers to the monopolist and A welfare loss due to less efficient resource use called deadweight loss

Monopoly v Competition
Rs
Deadweight loss of monopoly

PM
Monopoly profit

PC

LAC = LMC

D = AR
Q
M

QC

Qty

MR

Public Policy Toward Monopoly

Patent Policy
o Allow temporary monopoly power to encourage innovation

Anti-Monopoly (Antitrust) Policy

o Conduct Remedies regulate firm behaviour o Structural Remedies introduce/maintain competition (where possible)

Regulation of existing monopolies

In India, we had MRTP Act Competition Act 2002 and CCI

Natural Monopoly
Economies of scale are extensive in relation to the size of the market Hence, a single firm can produce the total industry output at less cost than any greater number of firms LAC curve might be falling over entire range of market demand or the MES is achieved at a very high level of output

Multiplant Monopolist
The monopolist operates more than one plant Sup, there are two plants described by two different cost structures TC1 and TC2 Hence the total cost will be TC = TC1 and TC2 From this we get MC = MC1 + MC2 The monopolist then equates MC with MR to decide the total output to be produced Then he would equate the MR with individual MCs to decide how much to produce in the two respective plants Hence, profit max. choice will occur at MR = MC1 = MC2

Multiplant Monopolist
Plant 1 MC1 Plant 2 MC2 Multiplant Monopolist MC

P*

DD MR
Q1*

Q1

Q2*

Q2

Total Q

Price Discrimination
Price discrimination occurs when a firm charges different prices to different customers for reasons other than differences in costs Price-discriminating monopoly does not discriminate based on prejudice, stereotypes, or ill-will toward any person or group
o Rather, it divides its customers into different categories based on their willingness to pay for good

Conditions for Price Discrimination

To successfully price discriminate, three conditions must be satisfied
o The firm must have some degree of market power facing a downward sloping demand curve o Firm must be able to separate consumers into two or more groups (e.g. by age, sex, region etc.) o Firm must be able to prevent arbitrage (i.e. prevent low-price customers from reselling to high-price customers)

Price Discrimination
Basic model: a monopolist charges:
A. Same price for all units. B. Same price to all customers.

Changing one or both of these is called Price Discrimination. Can one profit from this?
o 1st degree is different prices for different consumers and different units (both A and B are changed)[doctor charging different fees to different patients and for
different consultations]

o 2nd degree is different prices for different units (A changed). [ journal subscription rates different for 1 yr, 2 yr etc.] o 3rd degree is different prices to different consumers (B changed)[ journal subscription rates different for
individuals and libraries]

3rd-degree price discrimination

There are two markets where resale is not possible between them Hence two demand curves D1 and D2 Hence, he has MR1 and MR2 He obtains MR = MR1 + MR2 Monopolist produces in a single plant For profit max, he equates MR = MC How much he sells in market 1 and market 2 is determined by equating MR1 = MR2 = MC

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Price Discrimination
Market 1 Market 2 Monopolist
MC

P1 P2 D

MR1 D1 Q1 Q2

MR2

D2 Q

MR

Monopolist will set higher price in the market where price elasticity of demand is low In this case it is Market 1

2nd Degree Price Discrimination

All consumers face same price menu Actual price paid depends on consumers preferences or type Usually used when consumers cannot be distinguished ex ante Consumers self-select themselves for different schemes Ex: Quantity discount Journal subscriptions for 1 year, 2 years etc. Pricing of cinema hall tickets by time of day or day of the week

2nd degree Price Discrimination

Aryan values 1 umbrella at 100 rupees and has no need for another umbrella. Varun values 1 umbrella at 110 rupees and also values 2 umbrellas at 150 (together). They each want to maximize the difference between their value and the price they pay. What is the maximum a monopolist with zero marginal cost could make charging the same price per umbrella? What is the max it could make charging a price for 1 and a special for two together? o Hint: what would happen if they charge 100 for one and 150 for two?
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1st-Degree Price Discrimination

Different prices for both consumers and units. To do this properly, a monopolist must have strong information on: o Consumers preferences o Who is who 1st degree captures the whole consumer surplus. 1st degree is efficient. Its also called perfect price discrimination Difficult to implement in reality
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Examples of Price Discrimination.

Book publisher having different prices for different country editions of a book How about paperbacks Publisher charging libraries a higher rate to libraries than to individuals. Frequent Flyer Programs First Class Train tickets Entry Fee Packages at Amusement Parks

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Monopoly Pricing
Dumping (international price discrimination) Two-part Tariff (another practice to extract consumer surplus) Tying and Bundling Discrimination over time (durable good monopoly/ peak-load and off-load pricing)

Dumping
Charging of lower price abroad than at home for the same commodity due to higher price elasticity of demand in the foreign country
Its like third degree price discrimination to increase profits

Persistent, Predatory and Sporadic Dumping

Two-Part Tariffs
Definition: A two-part tariff a lump sum fee, F (for the right to purchase a product)plus a per unit fee, r (as the price for each unit of product they purchase) Example: The sports center charges a fee to join and then a per usage fee; or Fee at Nicco Park; telephone charges etc.

Charge a price per unit that equals marginal cost plus a fixed fee equal to the consumer surplus each consumer receives at this per unit price.

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Example: Surplus Extraction w/ Two-Part Tariff Optimal two-part tariff:

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(1) maximize surplus by r =2. (2) set F=surplus=72.

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Why?

72

2
10

12 14

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Tying and Bundling

A consumer can buy one good only by purchasing another good as well
Polaroid film with polaroid camera Bundling is a special case of Tying where two or more commodities are sold in the situation where customers have different tastes but the monopolist cannot price discriminate E.g. Buffet at restaurants; Pure and Mixed bundling

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Bundling
Pure bundling occurs when a firm sells two or more products only in a bundle and not individually Mixed bundling means commodities are available both in bundles and individually By bundling products, the monopolist increase profits by extracting more consumer surplus

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Bundling
Two types of people: o A values $120 for Word, $100 for Excel. o B values $80 for a Word, $120 for Excel. Microsoft has zero marginal cost. If Microsoft charges separately for each program, it should price both the products at $ 80 for Word and $ 100 for Excel so that each consumer can buy both the products. It can make a profit of $80 x 2 + $100 x 2 = $ 360 They could package both together (and stop selling it individually) at the price of $ 200. This will make a total profit of $200 x 2 = $ 400. But he still could not extract the entire consumer surplus, i.e. $220 + 200 = $420.

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Caselet 1
Chalchitra Cinema is the only movie theater in Sunderbans. The nearest rival movie theater the Chhayachitra, is 35 miles away. Thus Chalchitra Cinema possesses a degree of market power. Despite having market power, it is currently suffering losses. In a conversation with the owner of the Chalchitra Cinema, manager of the movie theater made the following suggestions: Since Chalchitra is a local monopoly, we should just increase ticket prices until we make enough profit. Is it a correct strategy? Comment.

Caselet 2
Interior Style is a monopolist in its state in interior designing. With more consciousness among the higher middle class people these days, the company faces an increase in demand recently. Graphically illustrate the impact of an increase in demand on price and quantity under monopoly.