Monopoly

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.title[
# Monopoly
]
.subtitle[
## Chapter 15
]
.author[
### Hussain Hadah
]
.date[
### University of Houston | 19 April 2022
]

---

# Table of contents

1. [Introduction](#intro)

2. [How does a firm become a monopoly?](#sec1)

3. [How Monopolies Make Production and Pricing Decisions](#sec2)

4. [The Welfare Cost of Monopolies](#sec3)

5. [Price Discrimination](#sec4)

6. [Public Policy toward Monopolies](#sec5)

7. [Problems and Applications](#sec6)
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# Introduction

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# What is a monopoly?

- All of us right now are on a PC and we are all probably either using a Microsoft or Apple OS

- When these companies designed their OS, they got copyright from the government

- Copyrights gives a company the exclusive right to make and sell their products and services

- Apple and Microsoft have a <span style="color:red;"> _monopoly_</span> in the markets for iOS and Windows

--
- So far we've only studied models of competitive markets

- These models are not suitable for a monopolistic market

- In a competitive market, there are many buyers and sellers that no one buyer or seller can influence the price--- _price takers_

- In a monopolistic market, the firm has the power to influence the market price--- _price makers_

---
# Introduction (cont.)
- In a competitive market, a firm chooses the quantity to produce by setting the `$MC = P = MR$`

- In a monopolistic market, the firm charges a price higher than the MC

--
- Firms in monopolistic and competitive markets want to maximize profit

- The self-interested producers in a competitive market will lead to the best outcome for everyone

- The self-interested producers in a monopolistic market will lead to an outcome that is often not in the best interest of society

--
- The government can intervene by breaking up monopolies or preventing a firm from acquiring more market power, which will lead to a better outcome

- An example of this is the breakup of Standard Oil in 1911 by the US Supreme Court
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# How does a firm become a monopoly?

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# Why monopolies Arise?

- A firm is a <span style="color:red;"> _monopoly_</span> if it is the sole seller of its product and if its product doesn't have any close substitutes

- The main reason why monopolies arise is the _barriers to entry_

- A monopoly will always be the sole seller of a good or service if no other firm can enter the market

--
#### The three reasons behind barriers to entry:

--
##### 1. _Monopoly resources_: A key resource required for production is owned by a single firm

--
##### 2. _Government regulation_: The government gives a single firm the exclusive right to produce some good or service

--
##### 3. _The production process_: A single firm can produce output at a lower cost than can a larger number of firms

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# Monopoly Resources

- The simplest way for a firm to control a market is if it owns a key resource

--
##### Example: water supply in a small town

- If 12 residents in the town have working wells, then the model of a competitive market can explain the behavior of firms

- If there's only one supplier of water because they own the only water source, then the owner will hold monopoly power

--
### A classical example of a monopoly from owning key resources is DeBeers. The company owned 80% of all diamond supply

--
- It is rarely the case that a monopoly will arise as a result of owning a key resource

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# Government-Created Monopolies

- In many cases, a company will hold monopolistic power because the government gave it the exclusive right to sell some goods or services

--
- Examples of this are patents and copyrights

--
- When a pharmaceutical company discovers a new drug, it'll patent

- The patent gives the company the exclusive right to produce and sell a drug

--
- When a novelist writes a book, they can also copyright their book

--
- Both the pharmaceutical company and the novelist will charge higher prices than would've been the case in a competitive market

- But, by allowing the pharmaceutical company to profit off of drugs and the novelist off of writing, the patent laws encourage the company and the novelist to produce more drugs and novels

--
- The costs of patent laws are higher prices to consumers

- The benefits are the increased incentives to produce

---
# Natural Monopolies

- An industry is a <span style="color:red;"> _natural monopoly_</span> when a single firm can supply a good or service to the entire market at a lower cost than could two or more firms

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# Natural Monopolies (cont.)

- An example of a natural monopoly is a social media company

- Once the company invested in writing the code and buying servers, it will not incur more costs from more users

--
- A natural monopoly is not concerned with new entrants to the market

- A market with a natural monopoly is unattractive to enter because the new firm cannot achieve the same low costs that the monopoly enjoys

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# How Monopolies Make Production and Pricing Decisions

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# Monopoly vs Competition

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# A Monopoly's Revenue

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# A Monopoly's MR and Price

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# Profit Maximization

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# A Monopoly's Profit

$$
`\begin{equation}
\text{Profit } = (P - ATC) \times Q
\end{equation}`
$$

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# Summary

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## Why doesn't a monopoly have a supply curve?

### A monopoly is a _price maker_, so it's not meaningful to ask how much does a monopoly produce at any given price because it doesn't take the price as given
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# The Welfare Cost of Monopolies

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# Efficient level of output

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# The Deadweight Loss

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# The Monopoly’s Profit: A Social Cost?

- A monopoly firm does earn a profit under its market power.

- The firm's profit is not necessarily a problem for society

- The welfare in a market includes both producers and consumers

- One extra dollar paid by the consumer is an extra dollar received by the producer

- Total surplus equals the sum of consumer and producer surplus, this transfer from consumers to the owners of the monopoly does not affect the market’s total surplus

- So a monopoly's profit is not a social problem

--
- The problem is that a monopoly firm produces and sells a quantity of output below the level that maximizes total surplus

- The deadweight loss measures how much the economic pie shrinks

--
- If a firm is paying lobbyists to keep monopoly power

- The amount paid to lobbyists and the DWL is both a social loss that results in a reduced output

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# Price Discrimination

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# Definition

### <span style="color:red;"> _Price discrimination_</span> is the practice when a firm sells the same good to different consumers for different prices, even when the cost of producing the good is the same

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# A Parable about Pricing

- To understand why a monopolist would price discriminate, let’s consider an example

- Imagine that you are the president of a Publishing Company

- Your best-selling author has just written a new novel

- To keep things simple, let’s imagine that you pay the author a flat $2 million for the exclusive rights to publish the book

- Let’s also assume that the cost of printing the book is zero

- Your profit is the revenue from sales minus $2 million

- Given these assumptions, how would you, as president, decide the book’s price?

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- The book attracts two types of readers: 100,000 die-hard fans who would pay $30, and 400,000 less enthusiastic readers who will pay up to \$5

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# A Parable about Pricing (cont.)

- There are two prices to consider: 30 and 5

- At $30, you sell 100,000 copies and you make 1 million dollars in profit

- At $5, you sell 500,000 copies and you make \$500,000 in profit

- If it charges $30, then 400,000 consumers aren't buying the book, which causes DWL

--
- Let's assume that the two types of readers are in two separate markets: 400,000 American readers and 100,000 Australian readers

- Now, you can charge two different prices in the two markets

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# The Moral of the Story

1. Price discrimination is a rational strategy for a profit-maximizing monopolist

2. Price discrimination requires the ability to separate customers according to their willingness to pay

3. Price discrimination can raise economic welfare

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# The Analytics of Price Discrimination

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# Examples of Price Discrimination

#### 1. Movie Tickets: different prices for seniors and children

#### 2. Airline Prices: Most airlines charge a lower price for a round-trip ticket between two cities if the traveler stays over a Saturday night. They do this to separate leisure travelers from business travelers

#### 3. Discount Coupons

#### 4. Financial Aid

#### 5. Quantity Discounts
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# Public Policy toward Monopolies

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# Four ways to intervene

### 1. By trying to make monopolized industries more competitive

- Using antitrust laws and blocking horizontal and vertical mergers

### 2. By regulating the behavior of the monopolies

- The government can impose a price equals to a firm's MC

### 3. By turning some private monopolies into public enterprises

- In the United States, the government runs the Postal Service

### 4. By doing nothing at all
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# Problems and Applications

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# Question 1

##### A publisher faces the following demand schedule for the next novel from one of its popular authors:

##### The author is paid 2 million to write the book, and the marginal cost of publishing the book is a constant

##### Compute total revenue, total cost, and profit at each quantity. What quantity would a profit-maximizing publisher choose? What price would it charge?

##### Compute marginal revenue. (Recall that MR=ΔTR/ΔQ.) How does marginal revenue compare to the price? Is this a competetive market? Explain.

---
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# Question 1

##### A publisher faces the following demand schedule for the next novel from one of its popular authors:

##### The author is paid 2 million to write the book, and the marginal cost of publishing the book is a constant

##### Compute total revenue, total cost, and profit at each quantity. What quantity would a profit-maximizing publisher choose? What price would it charge?

##### Compute marginal revenue. (Recall that MR=ΔTR/ΔQ.) How does marginal revenue compare to the price? Is this a competetive market? Explain.

---
# Question 1

##### Graph the marginal-revenue, marginal-cost, and demand curves. At what quantity do the marginal-revenue and marginal-cost curves cross? What does this signify? Where is the DWL?

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# Question 1

#### If the author were paid $3 million instead of $2 million to write the book, how would this affect the publisher’s decision regarding what price to charge? Explain.

##### If the author were paid $3 million instead of $2 million, the publisher would not change the price, because there would be no change in marginal cost or marginal revenue. The only thing that would be affected would be the firm’s profit, which would fall.

#### Suppose the publisher was not profit-maximizing but was concerned with maximizing economic efficiency. What price would it charge for the book? How much profit would it make at this price?

##### To maximize economic efficiency, the publisher would set the price at $10 per book, because that is the marginal cost of the book. At that price, the publisher would have negative profits equal to the amount paid to the author.

---
# Question 2

#### A small town is served by many competing supermarkets, which have the same constant marginal cost.

##### Using a diagram of the market for groceries, show the consumer surplus, producer surplus, and total surplus.

##### Now suppose that the independent supermarkets combine into one chain. Using a new diagram, show the new consumer surplus, producer surplus, and total surplus. Relative to the competitive market, what is the transfer from consumers to producers? What is the deadweight loss?

---
# Question 3

##### Johnny Rockabilly has just finished recording his latest CD. His record company’s marketing department determines that the demand for the CD is as follows:

##### The company can produce the CD with no fixed cost and a variable cost of $5 per CD.

##### Find total revenue for quantity equal to 10,000, 20,000, and so on. What is the marginal revenue for each 10,000 increase in the quantity sold?

##### If you were Johnny’s agent, what recording fee would you advise Johnny to demand from the record company? Why?

---
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# Question 3

##### Johnny Rockabilly has just finished recording his latest CD. His record company’s marketing department determines that the demand for the CD is as follows:

##### The company can produce the CD with no fixed cost and a variable cost of $5 per CD.

##### Find total revenue for quantity equal to 10,000, 20,000, and so on. What is the marginal revenue for each 10,000 increase in the quantity sold?

##### What quantity of CDs would maximize profit? What would the price be? What would the profit be?

##### If you were Johnny’s agent, what recording fee would you advise Johnny to demand from the record company? Why?

---
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# Question 3

##### Johnny Rockabilly has just finished recording his latest CD. His record company’s marketing department determines that the demand for the CD is as follows:

##### The company can produce the CD with no fixed cost and a variable cost of $5 per CD.

##### If you were Johnny’s agent, what recording fee would you advise Johnny to demand from the record company? Why?

##### As Johnny's agent, you should recommend that he demand $550,000 from them, so he receives all of the profit (rather than the record company). The firm would still choose to produce 50,000 CDs because their marginal cost would not change.