Today Entry the monopolist Price discrimination the monopolist

Today • Entry & the monopolist • Price discrimination & the monopolist

Entry and the Monopolist Why don’t others enter?

Barriers to Entry • Ordinarily, we expect that profits will attract entry to a market. • This might make it hard to remain a monopolist. • Expect to see a monopoly only when there are some kind of barriers to entry. • We will discuss four types of barriers to entry.

1. Economies of scale & natural monopoly P If another firm produced less than 10, 000 units, it would have higher AC and could be undercut in price. MC p* LRATC If it entered producing 10, 000 units, then price would be driven down below AC for both firms. D 20, 000 13, 000 10, 000 9, 000 Q

Natural Monopoly • Demand is low enough that there is only room for one firm producing at minimum average cost. • OR Economies of scale are so strong that LRAC are decreasing up to a very large quantity (relative to demand). • Public utilities are often natural monopolies.

Regulation of Natural Monopoly • Governments often create a legal monopoly to provide goods that are natural monopolies. • This makes it illegal to compete against the provider. • Governments then regulate the monopoly to force it to act more like a price taker. • Many public utilities are regulated.

2. Large Set-up Costs • Referring to large sunk costs of entry. • Includes developing product, advertising, setting up operations. • Potential entrants may be reluctant to bear these costs if they are not sure they will be able to break even. • Examples: • Virgin cola; wide-body airplane production

3. Patent Laws or Trade Secrets • It may be illegal or impossible to duplicate the product. • Secret formula for Coke • spiral ham-cutting machine • Polaroid cameras

Social Cost/Benefits of Patents • Costs: Creates a monopoly, which harms consumers. • Benefits: Provides an incentive to do R&D so as to earn monopoly profits for a while. Otherwise, maybe no innovation. • They are crudely balanced by giving patents for 17 years only.

4. Legal Barriers • Perhaps a legal monopoly (see regulation of natural monopolies, above). • Licensing requirements, such as in medicine or law.

Price Discrimination and the Monopolist

Type 2 Price Discrimination • When a seller approximates selling the units of a good for what they are worth to consumers. • The ice cream problem, when you set up quantity discounts.

Profit Maximization and Price Discrimination • The profit-maximizing rule (choose Q where MR = MC) applies only to “one price” situations. • If a monopolist is able to price discriminate, this will allow him to do better.

Price Discrimination on Graph P MC MR If the monopolist must charge only one price, what will he do? D Q

Price Discrimination on Graph P MC How much is his Producer’s Surplus? PM MR QM D Q

Price Discrimination on Graph P MC PM MR QM Can he increase it by offering different prices on different units? D Q

Price Discrimination on Graph P MC How are consumers affected by this? PM MR QM D Q

Type 3 Price Discrimination • When different types of consumers have different price elasticities of demand, a seller can try to charge different prices depending on who buys. • Must have a way of identifying the highvalue consumers from the others. • Must be able to prevent re-sale.

Example: Air Travel • Business v. leisure travelers • Who has more elastic demand? • How can the types be identified? • How is re-sale prevented?

Example: Movie ticket prices • Matinee v. evening viewers • Adult v. kid • Who has more elastic demand? • How can the types be identified? • How is re-sale prevented?

Type 1 Price Discrimination • When a seller sells each unit of a good for what it is worth to each consumers. • Called perfect price discrimination. • In this situation, the monopolist does provide the allocatively efficient level of output.

Perfect Price Discrimination P MC PM Each unit sells for a different price. The efficient quantity is provided. Sum of PS & CS is maximized (but CS = 0). No deadweight loss. MR QM QE D Q

Coming Up • Monopolistic competition & oligopoly • Group Work: Exercise related to monopolies

Instructions • For each product or market, identify a way that price discrimination is used. • Which type (I, II, or III) is it? • Are any devices needed to prevent re-sale or separate types of consumers?

Products or Markets • King’s Dominion (and other amusement • • parks). Think beyond adult v. child ticket prices. Hotel rooms in Florida Flea markets Legal and medical services Cheerios cereal