ECON 308
Week 7.1
Monopoly & Monopoly Pricing
(Chapter 7)
Market structure
• What is a market?
• All firms and individuals willing and able to
buy or sell a particular product
• What is market structure?
• Defined by attributes of the market
environment
Demand Facing the Firm
$P
$P
D1
$P
D2
Q


Q
$P
D3
D4
Q
Increasing degrees of Competition
Increasing degrees of Market Power
Q


Market structure
the archetypes
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•
•
•
Monopoly
Oligopoly
Monopolistic competition
Perfect competition
Perfect competition
characteristics
•
•
•
•
Many buyers and sellers
Product homogeneity
Low cost and accurate information
Free entry and exit
• Best regarded as a benchmark
Price Taker Firm Demand Curve
$P
$P
Market
D
Firm
S
Pe
Pe
D=MR
S
D
Qe
Q/T
Qe
Q/T
Firm supply
• Short run
– Marginal cost curve above average
variable cost
– P* = SRMC
• Long run
– Long-run marginal cost curve
above long-run average cost
Long-Run Industry Equilibrium
$P
$P
Market
D
Firm
MC
S
ATC
Pe
Pe
D
S
D
Qe
Q/T
Qe
Q/T
Monopoly
• Strong barriers to entry  single
supplier
• Profit maximization
– faces market demand and sets MR=MC
• Unexploited gains from trade
Sources of Market Power:
Barriers to entry
Incumbent reactions
Incumbent advantages
•
•
•
•
• Precommitment
contracts
• Licenses and patents
• Learning-curve effects
• Pioneering brand
advantages
Specific assets
Economies of scale
Excess capacity
Reputation effects
$Price
Demand Facing the Firm
Demand
$10
9
8
7
6
5
4
3
2
1
D
1
2
3
4
5
6
7
8
Qty/T
Total Revenue
$Price
Demand
$10
9
8
7
6
5
4
3
2
1
D
1
2
3
4
5
6
7
Qty/T
Marginal Revenue =Additional Revenue
$Price
Demand
$10
9
8
7
6
5
4
3
2
1
D
1
2
3
4
5
6
7
Qty/T
Derivation of Marginal Revenue
Price
Quantity
$ 10.00
$ 9.00
$ 8.00
$ 7.00
$ 6.00
$ 5.00
$ 4.00
$ 3.00
$ 2.00
1
2
3
4
5
6
7
8
9
Total
Revenue
$ 10.00
$ 18.00
$ 24.00
$ 28.00
$ 30.00
$ 30.00
$ 28.00
$ 24.00
$ 18.00
Marginal
Revenue
$ 8.00
$ 6.00
$ 4.00
$ 2.00
$ 0
- $ 2.00
- $ 4.00
- $ 6.00
Marginal Revenue
$Price
Demand
D
MR
Qty/T
Marginal Revenue & Elasticity
$Price
Ed > 1
Ed = 1
Ed < 1
Demand
MR
Qty/T
Monopoly Output
$Price
Demand
MC
Pm
Mc
D
MR
Qm
Qty/T
Market Power: No Close Substitutes
$Price
MC
Demand
Pm
Mc
D
MR
Qm
Qty/T
Market Power: Few Close Substitutes
$Price
MC
Demand
Pm
Mc
D
MR
Qm
Qty/T
Market Power: Many Close Substitutes
$Price
Demand
MC
Pm
D
Mc
MR
Qm
Qty/T
No Market Power: Many Identical Substitutes
$Price
MC
Demand
P = MR
P = Mc
Qm
Qty/T
Monopoly Profit?
Demand
MC
Pm
AC
Profit
D
MR
Qm
Qty/T
Monopoly After Entry of Competition
$ Price
Demand
MC
AC
Pm
D
MR
Qm
Qty/T
Efficiency Loss ?
Demand
MC
Pm
Mc
MR
Qm
D
Qty/T
Sources of Monopoly Power
Barriers to Entry
• Absolute Cost Advantage: Unique access to
production technique or an essential input.
• Natural Monopoly: Economies of Scale
• Product differentiation
• Regulatory Barriers: Patents, copyrights,
franchise, license.
Price Discrimination
• Charging different prices for different units
sold.
• Allows firms to increase sales and capture
more of consumer surplus.
Monopoly Pricing: Single Price
$ Price
Demand
Pm
Potential Efficiency loss
Marginal Cost
MR
Qm
Qty/T
First Degree: Charging different
customers different prices.
• Auction
• College scholarships
First Degree: Different Prices for different buyers
$ Price
Demand
Scholarship Amount
Tuition
Marginal Cost
MR
Qm
Qty/T
First Degree: Charging different
customers different prices.
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•
•
•
•
•
•
Auction
College scholarships
IBM Punch Cards
Polariod Camera, Film
Ink Jet Printers, Cartridges
Swiffer, pads
Glllette Razor, Blades
Second Degree: (Quantity Forcing)
• Offering a schedule of prices to all buyers, which
successively lowers the price for additional units,
purchased (Moving down each buyers individual
demand)
• Tires: Buy 3, get 4th free.
• Soft Drinks:Product prices,
– medium16 oz. $ 1.09, .07/oz.
– large: 22 oz. $ 1.19, extra 6 oz. @ .02/oz.
– extra large:32 oz. $1.29, extra 10 oz. @ .01/ oz.
• Two Part Tariff: Entry Fee plus per unit
– Costco: Membership & Price
Third Degree: Charging different prices to different
groups according to different elasticity of Demand.
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•
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Grocery coupons
Prescription drugs in different countries.
Doctors medical services
Newly released unique products
Movies: Children, Seniors, Middle; Matinee
Mail Order Catalogues: Old vs. New Customer
Freeway Adjacent Restaurant
Brand name mixers on Holiday Sale
Mattresses: Match any advertised price
Menu
Necessary Conditions for Successful
Price Discrimination
• Ability to identify and separate buyers by
elasticity of demand.
• Collect different prices from the different
buyers
• Prevent Resale