Topic 4: Microeconomics Review: Monopoly

Transcription

1 Topic 4: Microeconomics Review: Monopoly EC 3322 Semester I 2008/2009 Yohanes E. Riyanto EC 3322 (Industrial Organization I) 1

2 Monopoly A irm is a monopoly i it is the only supplier o a product or which there is no close substitute. A monopoly can set price without being araid o being undercut by its rivals. Since the irm is a price-setter, it aces a downward-sloping market demand it can raise its price above marginal cost. A monopoly sets its output to maximize its proit (just like a competitive irm) since demand is downward sloping the more it sells, the lower the price will be. A competitive irm individual demand curve is horizontal the price does not all i it expands quantity. A irm s behavior and government regulation inluence the irm s ability to become and remain a monopoly. Yohanes E. Riyanto EC 3322 (Industrial Organization I) 2

3 Monopoly p ($) revenue loss I B>A, then selling one more unit will increase revenues. ( 1) MR = p q + p q p 0 p 1 A revenue gains B q 0 q 0 +1 q Yohanes E. Riyanto EC 3322 (Industrial Organization I) 3

4 Monopoly (Proit Maximization) $ MR MC q* q r π π ( q) ( q) = p( q) q c( q) π q p q c q = q+ p( q) = 0 q q q p q c q q+ p( q) = q q c(q) MR R(q)=p(q)q q MC 2 π q MR MC s.o.c. = < 0 2 q q q Yohanes E. Riyanto EC 3322 (Industrial Organization I) 4

5 Monopoly (Marginal Revenue) ( p( q) q) p( q) MR = = q + p q q q MR < p q slope o the demand ( < 0) Thus, MR is always smaller than the demand. I p q = a bq slope o the demand ( < 0) p q MR = q + p( q) = bq + a bq = a 2bq q p q =0 then q= a/ b MR = 0 then q = a / 2b Yohanes E. Riyanto EC 3322 (Industrial Organization I) 5

6 Monopoly p ($) p m monopoly proit dead weight loss The ability o the monopoly to charge price above MC depends on the demand curve elasticity o the demand. p pq MR = p + q = p 1+ q qp 1 qp MR = p 1 + with ε = ε pq p c MR a 2b p(q) a b MC q Yohanes E. Riyanto EC 3322 (Industrial Organization I) 6

7 1 MR = p 1+ ε MR >0 i the demand curve is elastic (ε<-1). MR<0 i the demand curve is inelastic (-1<ε<0). Monopoly We can write the proit max condition (MR=MC) as: 1 MR = p 1 + and MR = MC ε 1 p MC 1 p 1 + = MC = ε p ε The let hand side is the price-cost margin the indicator or market power also known as Lerner Index. The monopoly price is close to MC (competitive price) when the demand is very elastic, and it increasingly exceeds MC when the demand becomes less elastic. p MC 1 i ε = 2 then = p = 2MC p 2 p MC 1 i ε = 100 then = p = 1.01MC p 100 Yohanes E. Riyanto EC 3322 (Industrial Organization I) 7

8 Monopoly Thus, when the demand is inelastic (-1<ε<0), it is not possible to meet the proit maximizing condition p MC 1 i ε = 1/ 2 then = p 1/2 thus p = MC, which is not possible. Hence, a monopoly never operates on the inelastic portion o the demand curve. I it is the case it can increase proit by raising its price until it operates in the elastic portion o the demand curve. Monopoly (Dead Weight Loss) Monopoly brings about dead weight loss (DWL) the triangle area the size o the DWL varies with the demand elasticity as the demand becomes more inelastic, DWL increases. Yohanes E. Riyanto EC 3322 (Industrial Organization I) 8

9 Monopoly (Dead Weight Loss) p ($) When price increases, the monopoly proit increases to A+B, but DWL also increases to C+D DWL D = ( )( ) = B A 50 D C MR DWL C + D= ( )( ) = MC p(q) q So monopoly is always bad? Beneits R&D (patent) Yohanes E. Riyanto EC 3322 (Industrial Organization I) 9

10 Monopoly (Natural Monopoly) A natural monopoly arises when the irm s technology has economies-oscale large enough or it to supply the whole market at a lower average total production cost than is possible with more than one irm in the market. < c q c q1 c q2... c qn with n irms p ($) p(q) p m 0 q* MR AC MC q Yohanes E. Riyanto EC 3322 (Industrial Organization I) 10

11 Dominant Firm with a Competitive Fringe What happen to monopoly i there are entry by higher-cost irms? What happens i a lower-cost irm enters a market with many price-taking irms? A Dominant irm (price setter) vs. several small competitive irms (price takers) Intel vs. other smaller producers o microprocessors. Why some irms may be dominant than others: Dominant irms may have lower costs (more eicient) than ringe irms. Dominant irms may have a superior product due to reputation or advertising. A group o irms may collude and collectively act as a dominant irm cartel. Whether or not a dominant irm can exercise ull market power in the longrun depends on the number o irms that can enter the market and how are their relative production costs. Yohanes E. Riyanto EC 3322 (Industrial Organization I) 11

12 Dominant Firm with a Competitive Fringe Source: Yohanes E. Riyanto EC 3322 (Industrial Organization I) 12

13 Dominant Firm with a Competitive Fringe source: Hitwise and Yohanes E. Riyanto EC 3322 (Industrial Organization I) 13

14 Dominant Firm with a Competitive Fringe Yohanes E. Riyanto EC 3322 (Industrial Organization I) 14

15 Dominant Firm with a Competitive Fringe The No-Entry Model A dominant irm and a competitive ringe, in which no additional ringe irms can enter the market. Assumptions: There is one large dominant irm with lower production costs than other irms. All irms except the dominant irm is price takers. The dominant irm knows the market demand curve and can predict how much outputs the competitive ringe will produce.. All irms produce homogeneous product. The dominant irm must consider the reaction o the comp. ringe to its action with comp. ringe it will make lower proit than the ull monopoly proit the presence o ringe hurt the dominant irm and beneits consumers. Yohanes E. Riyanto EC 3322 (Industrial Organization I) 15

16 Dominant Firm with a Competitive Fringe $ Supply curve o comp. ringe MC AC S(p(q))=nq (p(q)) $ Residual Demand D d (p(q))=d(p(q))-s(p(q)) * p * p MC d AC d p p p p * p MR d MC d* market demand D(p(q)) q Q Competitive Fringe q,q Q d Q Q Q* d Mkt Quantity Q Yohanes E. Riyanto EC 3322 (Industrial Organization I) 16

17 Dominant Firm with a Competitive Fringe The Model with Entry I unlimited entry is possible, a dominant irm cannot set as high a price as it can i entry is limited (prevented). We retain all assumptions except that we now allow an unlimited entry by competitive ringe irms. The ringe irms cannot make proits in the LR either break-even or exit. I ringe irms lood into a market when there are proit opportunities, the dominant irm cannot charge a price above the min. AC o a ringe irm the dominant irm earns positive proit, ringe irms break even. Yohanes E. Riyanto EC 3322 (Industrial Organization I) 17

18 Dominant Firm with a Competitive Fringe $ $ MC d p S(p(q)) p * p D d (p(q))=mr d MC d* market demand D(p(q)) Competitive Fringe q,q Q d Q Q Q* d Mkt Quantity Q Yohanes E. Riyanto EC 3322 (Industrial Organization I) 18

19 Dominant Firm with a Competitive Fringe Mathematical Analysis ( q ) ( q ) Total costs o a ringe irm C C AC o a ringe irm AC = MC o a ringe irm Proit a ringe irm Recall a ringe irm is a price taker can sell as much as it wants at the going price but it cannot inluence the price p=constant. 2 2 q C ( q ) ' ( ) q MC = = C q π = pq C q Max π = pq C q First order condition or max, π q ' 0 ' = p C q = p= C q Second order condition or max, q π q " " = C q < C q > 0 thus 0 Yohanes E. Riyanto EC 3322 (Industrial Organization I) 19

20 Dominant Firm with a Competitive Fringe Mathematical Analysis Note Thus, Q = nq ; and Q = Q + Q d = ( + d) pq pq Q Totally dierentiating the.o.c. ' ( + d) = ( ) p nq Q C q " '. + '. d =. p n dq p dq C dq Rearranging: p' < 0 dq > 0 = < 0 " dqd np ' C < 0 > 0 < 0 Thus, as Q d increases, q will all. The dominant irm will solve: Π = pq + Q( Q) Q - C( Q) d d d d d d Yohanes E. Riyanto EC 3322 (Industrial Organization I) 20

21 Dominant Firm with a Competitive Fringe Mathematical Analysis Π = pq + Q( Q) Q - C( Q) d d d d d d Π dq d 1.o.c. = ( + ) + '( + ) 1 + p Qd Q Qd p Qd Q Qd Qd Cd( Qd) = 0 Qd dqd Recall that: dq p' dq np' = and Q = nq thus = dq np C dq np C " " d ' d ' " C dq np' < " " dq = + = > d np' C C + n p' This ratio is positive and can be veriied to be smaller than 1 (given that p <0). Q I Q = 0, thus = 0 Q d Π d = 1 pq ( d) + p' ( Qd) Qd Cd( Qd) = 0 monopoly proit condition Q d < 0 < 0 Yohanes E. Riyanto EC 3322 (Industrial Organization I) 21

22 Antitrust Policy on Monopolization Recall monopoly power creates ineiciencies (DWL), although there maybe some beneits (economies o scale-eiciency and R&D) as well. Exercise o monopoly power is usually subjected to antitrust policy. Examples: AT&T (1982) and Microsot (2002) AT&T AT&T was a holding company controlling 22 local distribution telephone companies, Bell Long Lines Division, Western Electric, and Bell Labs. Its control on the telecommunication industry was the result o a combination o government regulation, vertical integration and aggressive competitive practices. The complaints AT&T monopolized the industry by adopting strategies; 1) keeping out independent equipment manuacturers rom AT&T markets by solely purchasing all equipments rom AT&T s subsidiary, Western Electric and 2) preventing competition by not giving access to independent carriers rom interconnecting with the AT&T systems. US Justice Dept ordered AT&T to be broken up into allowed to keep Western Electric, Long Lines and Bell Labs but must divest its 22 local operating companies. Yohanes E. Riyanto EC 3322 (Industrial Organization I) 22

23 Antitrust Policy on Monopolization Microsot In 1998, the US Dept. o Justice iled an antitrust action against Microsot with allegation that Microsot had abused and exercised monopoly power in the market or PC operating systems. Windows has 90% market share. Microsot tied its browser (Internet Explorer) with Windows such that it restricted the market or competing browsers. Microsot argued that Windows and IE are inextricably linked and the browser is an integral part o the operating system. In June 2000, DC judge Thomas Penield Jackson ruled that Microsot was a monopolist in the market or Intel-compatible PC operating systems. It should be broken up into 2 companies, i.e. one to produce the OS and one to produce other sotware. Upon appeal, the court airmed the previous inding o Microsot s monopolization but overturned the ruling that Microsot should be broken-up. In Dec 2002, the US Dept. o Justice reached a inal settlement agreement with Microsot restricts some o Microsot s actions and establishing monitoring system to ensure compliance, in addition o monetary damages. Yohanes E. Riyanto EC 3322 (Industrial Organization I) 23