Market Power at Work: Computer Market Revisited

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1 Monopolies Part II Competition is always a good thing. It forces us to do our best. A monopoly renders people complacent and satisfied with mediocrity. Nancy Pearcey

2 Market Power at Work: Computer Market Revisited For comparison purposes, Universal is not taking advantage of economies of scale. Economies of scale reductions in minimum average costs that come about through increases in the size (scale) of plants and equipment

3 The Production Decision Like any producer, Universal wants to produce at the rate that maximizes profits. Universal faces a production decision concerning its many plants. Production decision the selection of the short-run rate of output (with existing plant and equipment)

4 The Production Decision A monopolist can foresee the impact of increased production on market price. A monopolist prevents production increases by coordinating the production decisions of its plants.

5 Marginal Revenue Each Universal plant faces a downward-sloping demand curve so that the marginal revenue no longer equals price. Only firms that confront a horizontal demand curve equate marginal cost and price.

6 Reduced Output The typical Universal plant will produce fewer computers than would be produced by a typical perfectly competitive firm.

7 The Monopoly Price The intersection of the marginal revenue and marginal cost curves establishes the profit-maximization rate of output. The demand curve tells us how much consumers are willing to pay for that output.

8 Price (per computer) Price (per computer) Charts: Initial Conditions in the Monopolized Computer Market $ W C Monopoly outcome Competitive $1200 outcome 1000 Average total cost A Competitive market supply X M B Demand curve facing single plant Market demand Marginal cost Marginal revenue of single plant Quantity (computers per month) 0 24,000 Quantity (computers per month)

9 Monopoly Profits Total profit equals average profit per unit times the number of units produced. Profit per unit = price average total cost Profit per unit = p ATC Total profits = profit per unit X quantity Total profits = (p ATC) X q

10 Monopoly Profits A monopoly receives larger profits than a comparable competitive industry by reducing the quantity supplied and pushing prices up.

11 Price (per computer) Chart: Monopoly Profits: The Typical Universal Plant $ W C Marginal cost Average total cost Profit K M B Demand curve facing single plant Marginal revenue of single plant Quantity (computers per month)

12 Price (per computer) Chart: Monopoly Profits: The Entire Company Monopolist's equilibrium $ R Monopoly profit A MC Competitive short-run equilibrium ATC T U V X Competitive long-run equilibrium 0 q M q C Market demand MR Quantity (computers per month)

13 Barriers to Entry High barriers to entry prevent profithungry entrepreneurs from entering the market to compete monopoly profits away. Monopoly profits persist as long as barriers to entry prevent competitors from entering the market.

14 A Comparative Perspective on Market Power Outcomes differ under competitive and monopoly conditions.

15 Competitive Industry High prices and profits signal consumers demand for more output. The high profits attract new suppliers. Production and supplies expand. Prices slide down the market demand curve.

16 Competitive Industry A new equilibrium is established. Price equals marginal cost at all times. Throughout the process, there is great pressure to reduce costs or improve product quality.

17 Monopoly Industry High prices and profits signal consumers demand for more output. Barriers to entry are erected to exclude potential competition. Production and supplies are constrained. Prices don t move down the market demand curve.

18 Monopoly Industry No new equilibrium is established. Price exceeds marginal cost at all times. There is no squeeze on profits and thus no pressure to reduce costs or improve product quality.

19 Monopoly Industry Because monopoly markets do not tend towards marginal cost pricing, consumers do not get the mix of output that delivers the most utility from available resources. Marginal cost pricing the offer (supply) of goods at prices equal to their marginal cost

20 Political Power A firm with considerable market power is likely to have significant political power as well.

21 The Limits to Power Monopolists only have absolute control of the quantity of output supplied to the market. Monopolists must still contend with the market demand curve.

22 The Limits to Power The greater the price elasticity of demand, the more a monopolist will be frustrated in its attempts to establish both high prices and high volume. Price elasticity of demand the percentage change in quantity demanded divided by the percentage change in price

23 Price Chart: Competition vs Monopoly P A Consumer surplus S Perfect Competition P C D 0 Q C Quantity

24 Price Chart: Competition vs Monopoly P A P M Consumer surplus Deadweight loss to consumer S =MC Deadweight loss Impose Monopoly P C Monopoly s gain MR Deadweight loss to supplier D 0 Q M Quantity Q C

25 How Does a Monopoly Change When Price Discrimination is Possible? Price discrimination - selling a good or service at a number of different prices To be able to price discriminate, a monopoly must Identify and separate different buyer types. Sell a product that cannot be resold.

26 Price Discrimination Consumer surplus Price discrimination attempts to capture even more consumer surplus than a single-price monopoly does.

27 Price Discrimination Discriminating among units of a good charging buyers different prices on each good bought (ex. bulk buying discounts) Discriminating among individuals Some people value additional units differently (business travelers vs. tourists).

28 Continued in Monopolies Part III

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