Monopoly 4. Comparative statics: The effect of increasing costs. 5. - PDF document

Outline of Presentation 1. Definition of monopoly. Chapter 14: 2. Barriers to entry. 3. Theory of a single price monopoly. Monopoly 4. Comparative statics: The effect of increasing costs. 5. Monopoly and Welfare. Teemu Nyholm 6. Monopoly and Quality. 7. Price discrimination. 8. Why do natural monopolies exist? S ystems S ystems Analysis Laboratory Analysis Laboratory Session 1 - Student presentation Session 2 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 1 Seminar on Microeconomics - Fall 1998 / 2 1. Definition of monopoly 2. Barriers to Entry Definition: Dictionary: Barriers to entry protect a firm from the competition. The existence Exclusive control by one group of the means of producing or of monopolies is always based on some kind of barriers to entry. selling a commodity or service. Legal barriers to entry: law, license, patent. Economics: => Legal Monopoly. The amount of output a monopoly is selling responds continuously as a function of the price it charges. Natural barriers to entry: unique source of supply, economies of scale, economies of scope. • In a competitive markets a firm is a price-taker . => Natural Monopoly . • In monopolistic market a firm is a price-maker . S ystems S ystems Analysis Laboratory Analysis Laboratory Session 3 - Student presentation Session 4 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 3 Seminar on Microeconomics - Fall 1998 / 4 First order condition can be written using elasticity of demand 3. Theory of single price monopoly  +  ( ) 1 dc y =   Monopoly’s maximization problem: 1 p ( y ) ε  ( )  dy y Monopoly is choosing optimal output in order to maximize I Monopolist is producing such amount, that marginal profit. cost equals to marginal revenue. − max p ( y ) y c ( y ) II Monopolist is able to sell at a price level, that exceeds its y marginal costs. Thus monopoly price exceeds First and second order conditions: competitive-market-price and the amount produced is less. + − = III The difference between monopoly price and p ( y ) p ' ( y ) y c ' ( y ) 0 competitive-market-price depends on the commodity’s + − ≤ 2 p ' ( y ) p ' ' ( y ) y c ' ' ( y ) 0 elasticity of demand . S ystems S ystems Analysis Laboratory Analysis Laboratory Session 5 - Student presentation Session 6 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 5 Seminar on Microeconomics - Fall 1998 / 6

Linear example: 4. Comparative statics p The effect of a cost change on price: MC p* dp dp dy 1 = = > 0 yp ' ' ( y ) dc dy dc + 2 p ' ( y ) D Part of a monopoly’s cost increase is passed a long in the MR form of increased prices. y* y S ystems S ystems Analysis Laboratory Analysis Laboratory Session 7 - Student presentation Session 8 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 7 Seminar on Microeconomics - Fall 1998 / 8 5. Monopoly and Welfare 6. Monopoly and Quality Social objective function: Let q be product quality and let’s suppose that costs and utility depend on quality. Social objective function: = − W ( x ) max u ( x ) c ( x ) x = − W ( x , q ) u ( x , q ) c ( x , q ) Let x * be the level of monopoly output. Then Let ( x* , q*) be monopolist’s profit maximizing points. Then = − > W ' ( x *) u ' ' ( x *) x * 0 ∂ ∂ W ( x *, q *) p ( x *, q *) => x * does not maximize welfare. = − > * 0 x ∂ ∂ x x IV Monopolist produces too little output relative to ∂ ∂ ∂     W ( x *, q *) u ( x *, q *) p ( x *, q *) = −   * x the social optimum.   ∂ ∂ ∂     q q x * q S ystems S ystems Analysis Laboratory Analysis Laboratory Session 9 - Student presentation Session 10 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 9 Seminar on Microeconomics - Fall 1998 / 10 V If the derivative of average willingness to pay exceeds 7. Price discrimination the derivative of marginal willingness to pay for the quality change, so monopolist’s quality choice will not be optimal from the social viewpoint. Definition: Price discrimination is the practice of charging some customers a higher price than others for an identical good or of charging an individual customer higher price on a small purchase than on a large one. S ystems S ystems Analysis Laboratory Analysis Laboratory Session 11 - Student presentation Session 12 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 11 Seminar on Microeconomics - Fall 1998 / 12

VI If a firm is perfectly price discriminating, it will choose 7.1 First-degree price to produce a Pareto efficient level of output, that is the same level as a firm in the competitive markets would discrimination produce. A perfectly price discriminating firm gains all the surplus from the trade. In the perfect price discrimination the price charged for each unit is equal to the maximum willingness to pay for that unit. Monopolist’s maximizing problem, when perfectly price discriminating: − ≥ max r cx such that u ( x ) r . r , x Let (r*,x*) be the optimal price and amount combination. = Then from f.o.c: u ' ( x *) c = r * u ( x *) S ystems S ystems Analysis Laboratory Analysis Laboratory Session 13 - Student presentation Session 14 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 13 Seminar on Microeconomics - Fall 1998 / 14 Self-selection constraints: 7.2 Second-degree price Consumers choose ( x 1 , r 1 =p(x 1 ) x 1 ) and ( x 2 , r 2 =p(x 2 ) x 2 ). discrimination Because they want to consume amount x i and are willing to pay r 1 Second-degree price discrimination occurs when prices differ only depending on the number of commodities bought. It is − ≥ − ≥ u ( x ) r 0 and u ( x ) r 0 1 1 1 2 2 2 known as nonlinear pricing . And because they prefer their own consumption choice Let’s suppose two consumers with utility functions u 1 (x) and u 2 (x) for product x such that − ≥ − u ( x ) r u ( x ) r 1 1 1 1 2 2 − ≥ − u ( x ) r u ( x ) r . 2 2 2 2 1 1 > > u ( x ) u ( x ) and u ' ( x ) u ' ( x ) 1 2 1 2 Now monopolist’s optimization problem takes the form + − max r r cx -cx 1 2 1 2 such, that self - selection constraint s hold. S ystems S ystems Analysis Laboratory Analysis Laboratory Session 15 - Student presentation Session 16 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 15 Seminar on Microeconomics - Fall 1998 / 16 From the first order conditions 7.3 Third degree price = + − > u ' ( x ) c u ' ( x ) u ' ( x ) c 1 1 2 1 1 1 discrimination = ' ( ) u x c 2 2 VII If a firm is using nonlinear pricing, then the consumer with Third-degree price discrimination occurs when consumers are the highest demand pays marginal cost and others pays charged different prices, but each consumer faces a constant price more. Thus only the consumer with the highest demand for all units of output purchased. consumes socially efficient amount. Let’s suppose that a firm is price discriminating among two groups with different demand curves p 1 (x 1 ) and p 2 (x 2 ). Now the profit maximization problem takes the form + − − max p ( x ) x p ( x ) x cx cx 1 1 1 2 2 2 1 2 S ystems S ystems Analysis Laboratory Analysis Laboratory Session 17 - Student presentation Session 18 - Student presentation Helsinki University of Technology Helsinki University of Technology Seminar on Microeconomics - Fall 1998 / 17 Seminar on Microeconomics - Fall 1998 / 18