1、Monopoly and Dominant Firms Chapter 11 Monopoly conjures images of huge profits,great wealth,and indiscriminate power,labeled robber barons.But some monopolies are not very profitable Others dominate their industry Still others are regulated by State Public Service or Utility Commissions,and may hav
2、e very low rates of return on invested capital.Regulated monopolies are known as utilities.2005 South-Western Publishing Sources of Market Power for a Monopolist Legal restrictions-copyrights&patents.Control of critical resources creates market power.Government-authorized franchises,such as provided
3、 to cable TV companies.Economies of size allow larger firms to produce at lower cost than smaller firms.Brand loyalty and extensive advertising makes entry highly expensive.Increasing returns in network-based businesses-compatibilities increase market penetration.What Went Wrong With Apple?Apple tri
4、ed to pursue increasing returns by trying to be the industry standard Tried to protect is graphical interface code(GIC)from infringement Lead to Apple being less compatible with software being developed Microsoft recognized and became the industry standard Monopoly is a single seller where entry is
5、prohibited and there are no close substitutes1.FIRM=INDUSTRY2.MR PQDP=100-Q6059 40 41TR1=6040=2400TR2=5941=2419So.MR =19 where MR P19An Unregulated MonopolyDMR3.At output where MR=MC,profit is maximizedMCPMQMProof:Max =TR TCFind where d/dQ=0 d/dQ=dTR/dQ-dTC/dQ=0 MR MC=0So:MR=MC4.Charge highest price
6、 that the market will bear,PMMARGINAL REVENUE is twice as steep as a linear demand curveIf P=a-bQ,then TR=aQ-bQ2 so MR=a-2bQThis is twice as steepIf we use a linear demand curve:Find the monopoly quantity if:P=100-Q,and where MC=20.Answer this by starting where MR=MC TR=PQ=100Q-Q2 MR=100-2Q=20 80=2Q
7、 QM=40 Find Monopoly Price:PM=100-40=60The highest price that the market will bear.A MONOPOLY PROBLEM P 1+1/EP =MCMarginal RevenueAs EP goes to negative infinity,MR approaches PThe Importance of Price Elasticity of Demand for a MonopolyMONOPOLY has MR=MCTR=QP(Q)dTR/dQ=MR=P+(dP/dQ)Q=P 1+(dP/dQ)(Q/P)=
8、P 1+1/EP Optimal Markups The optimal markup can be found using this same formula.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 is where-4/(-4+1)=1.333.If the price elasticity is infinite,the mark
9、up is zero.This occurs in competition.If EP=-3&MC =100Whats PM?Find the Monopoly Price in these Problems P 1+1/(-3)=100 P 2/3 =100So,P=$150.If EP=-5,then optimal monopoly price falls to$125.The more elastic is the demand,the closer is price to MC.ANSWERA Monopoly Pricing Problem Regression results f
10、or Lands End Womens light-weight coats:Log Q=-.4-1.7 Log P+1.2 Log Y (3.2)(4.5)Let MC of imported womens light-weight coats be$19.50.Find the Monopoly Price for a Lands End light-weight coats.ANSWER:P(1+1/EP)=MC P(1+1/(-1.7)=19.50 P=$47.36Limit Pricing An established firm considers the possibility o
11、f new entrants with distaste.Suppose a new entrant would have a U-shaped average cost curves.Suppose also that the established firm has created some brand loyalty,such that entrants must under-price them to take away their customers.ACThe potential competitor(PC)has no demand at limit price PL as DP
12、C is below ACPC PLACPCDIIItimeProfit ProfileWhich profit profile(I or II)represents monopoly pricing?Would a stockholder prefer profile I or II?ACestablishedQDPCRegulated Monopolies Electric Power Companies Natural Gas Companies Communication Companies Often,Water Companies All are examples of regul
13、ated companies They are all“naturally monopolistic”as they all have significant declining cost curves.Suppose we examine railroads before regulation as an example of a nature monopoly.Natural Monopolies Declining Cost Industries economies in distribution economies of scale Without Regulation they fa
14、ce Cyclical Competition with prices gyrating between PM and PC.railroad history includes periods of huge profits then bankruptciesACMCDEMANDMRQM P M PR=ACPC=MCQR QCSolutions to the Problem of Natural Monopolies PREVENT ENTRY,set P=MC and subsidize.subsidies require some form of taxation,which will t
15、end to distort work effort.subsidies to AMTRAK NATIONALIZE,prevent entry,set price typically low governments find changing price a highly political event once popular solution in Europe REGULATE,prevent entry,&set P=AC common in US for local telephone,electricity,water FRANCHISE through a bidding wa
16、r,likely P=AC Cable T.V.concessions at various stadiumsPeak Load Pricing Examples:Long Distance Calls,Electrical Prices,Seasonally Pricing at Amusement Parks Conditions Not Storable Same Facilities Demand VariationPeak and Off-Peak DemandWhat price should we charge for peak and off-peak users?Off Pe
17、ak DemandPeak Load DemandpricePpPoQ0 QPGeneral Solution P(peak)=variable costs+capital costs P(off-peak)=variable costs only Some argue that off-peak users benefit from capacity Electrical Case:Less chance of a brown out Amusement Park:Off peak users enjoy more space Then off-peak users should pay for some part of the capacity
