ECON 308 Week 7 1 Monopoly Monopoly Pricing

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 D 1 $P D 2 Q Q $P D 3 D 4 Q Increasing degrees of Competition Increasing degrees of Market Power Q

Market structure the archetypes • • 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

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

Monopoly • Strong barriers to entry single supplier • Profit maximization – faces market demand 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 $ 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 MR Demand Qty/T

Monopoly Output $Price Demand MC Pm Mc D MR Qm Qty/T

Market Power: No Close Substitutes $Price MC Demand Pm Mc MR Qm D 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: Degree Different Prices for different buyers $ Price Demand Scholarship Amount Tuition Marginal Cost MR Qm Qty/T

First Degree: Charging different customers different prices. • • 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 4 th free. • Soft Drinks: Product prices, – medium 16 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. • • • 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