Monopoly

and

Dominant

FirmsChapter

11"Monopoly"

conjures

images

of

hugeprofits,great

wealth,

and

indiscriminate

power,labeled

robber

barons.But

some

monopolies

are

not

very

profitableOthers

dominate

their

industryStill

others

are

regulated

by

State

Public

Service

orUtility

Commissions,

and

may

have

very

lowratesof

return

on

invested

capital.Regulated

monopolies

are

known

as

utilities.

2005South-Western

PublishingSources

of

Market

Power

for

a

MonopolistLegal

restrictions

--

copyrights

&

patents.Control

of

critical

resources

creates

marketpower.Government-authorized

franchises,

such

asprovided

to

cable

TVcompanies.Economies

of

size

allow

larger

firms

to

produce

atlower

cost

than

smallerfirms.Brand

loyalty

and

extensive

advertisingmakes

entry

highlyexpensive.Increasing

returns

in

network-basedbusinesses

-

compatibilities

increase

marketpenetration.What

Went

WrongWith

Apple?Apple

tried

to

pursue

increasing

returns

bytrying

to

be

the

industry

standardTried

to

protect

is

graphical

interface

code(GIC)

from

infringementLead

to

Apple

being

less

compatiblewithsoftware

being

developedMicrosoft

recognized

and

became

theindustry

standardMonopoly

is

a

singlesellerQDP

=

100

-

Q605940

41where

entry

is

prohibited

andthere

are

no

closesubstitutesFIRM

=INDUSTRYMR

<

PTR1

=

60?40

=2400TR2

=

59?41

=

2419So.

MR =

19where

MR

<

P19An

Unregulated

MonopolyDMR3. At

output

where

MR

=

MC,profit

is

maximizedMCPMQMProof:

Max

=TR–TCFind

where

d

/dQ

=

0d

/dQ

=

dTR/dQ

-

dTC/dQ

=

0MR

–MC

=

0So: MR

=

MC4. Charge

highest

pricethat

the

market

will

bear,

PMMARGINAL

REVENUE

is

twice

assteepas

a

linear

demand

curveIf P

=

a

-

b?Q,

thenTR

=

aQ

-

bQ2soMR

=

a

-

2b?QThis

is

twice

as

steepIf

we

use

a

linear

demand

curve:?

QM

=40Find

Monopoly

Price:?

PM

=

100-40=60The

highest

pricethat

the

market

willbear.A

MONOPOLY

PROBLEMFind

the

monopoly

quantity

if:

P

=

100

-

Q,and

where

MC

=

20.Answer

this

by

starting

where

MR

=

MC?

TR

=

P?Q

=

100?Q-Q2?

MR

=

100

-

2?Q

=

20?

80=

2?QP

[1

+

1/

EP

]

=

MCMarginal

RevenueMR

approaches

PThe

Importance

of

Price

Elasticity

ofDemand

for

a

MonopolyMONOPOLY

has

MR

=

MCTR

=Q?P(Q)dTR/dQ

=

MR

=

P

+

(dP/dQ)Q

=

P

[

1

+

(dP/dQ)(Q/P)

]=

P[

1+

1/

EP

]As

EP

goes

tonegative

infinity,Optimal

MarkupsThe

optimal

markup

can

be

found

using

this

sameformula. P

=[ED

/(

ED+1)]?MC.The

optimal

markup

m

is:

(1+m)

=

[ED

/(

ED+1)]For

example,

if

ED

=

-3,

the

markup

is

50%,

since

=[-3/(

-3+1)]

=

1.5.If

ED

=

-4,

the

markup

is

33.3%,

since

his

iswhere[-4/(

-4+1)]

=

1.333.If

the

price

elasticity

is

infinite,

the

markup

is

zero.This

occurs

in

competition.If

EP

=-

3&

MC =

100What’s

PM?Find

the

Monopoly

Price

in

theseProblemsP[

1+ 1/(

-3)]=

100P[

2/3]

=

100So,

P

=$150.If EP

=

-5,

thenoptimalmonopoly

price

falls

to$125.The

more

elasticis

thedemand,

the

closer

isprice

to

MC.ANSWERA

Monopoly

Pricing

ProblemRegression

results

for

Land’s

EndWomen’slight-weight

coats:Log

Q

=

-.4-1.7

LogP

+

1.2Log

Y(3.2) (4.5)Let

MC

of

importedwomen’slight-weightcoats

be$19.50.Find

the

Monopoly

Price

for

a

Land’s

Endlight-weight

coats.ANSWER: P(

1+ 1/EP

)

=

MC?

P

(1+ 1/(-1.7))=19.50?

P

=

$47.36Limit

PricingAn

established

firm

considers

thepossibility

of

new

entrants

withdistaste.Suppose

a

new

entrant

would

have

a

U-shaped

average

cost

curves.Suppose

also

that

the

established

firm

hascreated

somebrand

loyalty,

such

thatentrants

must

under-price

them

to

takeaway

their

customers.ACThe

potential

competitor

(PC)

has

no

demand

atlimit

price

PL

as

DPC

is

belowACPCPLACPCDIIItimeProfit

ProfileWhich

profit

profile

(I

or

II)

represents

monopoly

pricing?Would

a

stockholder

prefer

profile

I

or

II?ACestablishedQDPCRegulated

MonopoliesElectric

Power

CompaniesNatural

Gas

CompaniesCommunication

CompaniesOften,

Water

Companies?

All

are

examples

of

regulatedcompanies?

They

are

all

“naturally

monopolistic”

as

they

allhave

significant

declining

cost

curves.?

Suppose

we

examine

railroads

before

regulationas

an

example

of

a

naturemonopoly.Natural

MonopoliesDeclining

CostIndustries?

economies

indistribution?

economies

ofscaleWithout

Regulationthey

face

Cyclical

Competitionwithprices

gyratingbetween

PM

and

PC.?

railroad

history

includesperiods

of

huge

profitsthenbankruptciesACMCDEMANDQMPMRP =

ACPC

=

MCQR

QCMRSolutions

to

theProblem

of

Natural

MonopoliesPREVENT

ENTRY,

setP

=

MCandsubsidize.?

subsidies

require

some

form

oftaxation,

which

will

tend

to

distortwork

effort.?

subsidies

to

AMTRAKNATIONALIZE,

prevent

entry,set

price

typically

low?

governments

find

changing

price

ahighly

politicalevent?

once

popular

solution

in

EuropeREGULATE,

prevententry,

&

set

P

=

AC?

common

in

US

for

localtelephone,

electricity,waterFRANCHISE

througha

bidding

war,

likelyP

=

AC?

CableT.V.?

concessions

at

variousstadiumsPeak

Load

PricingExamples: