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Firm decision in monopoly
The reason for monopoly Price strategy
Short-run decision Long-run decision
Warfare loss in monopoly the Theory of Contestable Markets
Why to be monopoly
Resources monopoly: ALCOA (aluminum); DeBeers (diamond)
Natural monopoly: it is efficient for one firm to supply the whole market.
Government-authorized franchise: only one firm is approved by government.
Competition lead to monopoly Patent or copyright
Monopolist: price decision
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P
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MRD
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MR D
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P
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Would Monopolist be in loss?
Super profit lossBreak even
Long-run decision in monopoly
Monopolist maximizes profit by choosing to produce output where MR = LMC, as long as P LAC Will exit industry if P < LAC Monopolist will adjust plant size to the optimal
levelOptimal plant is where the short-run average
cost curve is tangent to the long-run average cost at the profit-maximizing output level
MR
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1P
1AC
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P
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LMC
LAC
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Monopolist’s decision in long-run
LACLMC
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P
MRD
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Monopolist will loss in long-run?
Optimal markup, contribution margin and gross profit margin.
Optimal markup MR=MC MR=P(1+1/Ep);so P=MC*Ep/(Ep+1)
Contribution margin: P-MC Contribution margin percentage: (P-
MC)/P
Gross profit margin: P-MC-FC
the Theory of Contestable Markets
In 1982, William ． Baumol set up this theory.
a perfectly contestable market would have no barriers to entry or exit. Contestable markets are characterized by "hit and run" competition; if a firm in a contestable market raises its prices much beyond the average price level of the market, and thus begins to earn excess profits, potential rivals will enter the market, hoping to exploit the price level for easy profit. When the original incumbent firm(s) respond by returning prices to levels consistent with normal profits, the new firms will exit. Because of this, even a single-firm market can show highly competitive behavior.
Entry of new firms into a market erodes market power of existing firms by increasing the number of substitutes
A firm can possess a high degree of market power only when strong barriers to entry exist Conditions that make it difficult for new
firms to enter a market in which economic profits are being earned
Barriers to Entry
Common Entry Barriers
Economies of scale When long-run average cost declines
over a wide range of output relative to demand for the product, there may not be room for another large producer to enter market
Product differentiation Barriers created by government
Licenses, exclusive franchises
Essential input barriers One firm controls a crucial input in the
production process
Brand loyalties Strong customer allegiance to existing
firms may keep new firms from finding enough buyers to make entry worthwhile
Common Entry Barriers
Consumer lock-in Potential entrants can be deterred if they
believe high switching costs will keep them from inducing many consumers to change brands
Network externalities Occur when benefit or utility of a product
increases as more consumers buy & use it Make it difficult for new firms to enter
markets where firms have established a large base or network of buyers
Common Entry Barriers
Monopoly profit and limit pricing
A limit price is the price set by a monopolist to discourage entry into a market, and is illegal in many countries.
When MR=MC, monopolist may earn short-run profit maximization, that would inducing new entries. Monopolist falls its price to discourage entry, that may reduce its shout-rum profit but would gain more in long-run.
E.g: price strategy of Galanz
The sale of Galanz’s microwave (sales volume):
1993:10000 ; 1994:100000; 1995:250000,market share 25.1%(Xianhua
24.8%); 1996:600000,market share 34.7% ； 1997:1250000, market share 49.6% ； sales
profit rate 11% 1998:3150000(export),2130000(demestic),mar
ket share 61.43%,sales profit rate 9% 1999,price falled and reduce sales profit rate to
6%.
limit pricing
limit pricing
Short-runShort-run
Long-runLong-run
Natural monopoly and price regulation
A natural monopoly by contrast is a condition on the cost-technology of an industry whereby it is most efficient (involving the lowest long-run average cost) for production to be concentrated in a single form.
Examples: power grid companies, gas companies, electric power companies
price discrimination
Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider Doctors or lawyers charge for different fee
for the same service. Power plant differents its price to firm and
individual. Restaurant charges different price for old
and young person.
First-Degree (Perfect) Price Discrimination Every unit is sold for the maximum
price each consumer is willing to pay Allows the firm to capture entire consumer
surplus
Difficulties Requires precise knowledge about every
buyer’s demand for the good Seller must negotiate a different price for
every unit sold to every buyer
First-Degree (Perfect) Price Discrimination (Figure 14.2)
Second-Degree Price Discrimination
Lower prices are offered for larger quantities and buyers can self-select the price by choosing how much to buy
When the same consumer buys more than one unit of a good or service at a time, the marginal value placed on additional units declines as more units are consumed
Declining block pricingOffers quantity discounts over successive discrete blocks of quantities purchased
Block Pricing with Five Blocks
D
Two-part pricingCharges buyers a fixed access charge (A) to purchase as many units as they wish for a constant fee (f) per unitTotal expenditure (TE) for q units is:
TE A fq
Third-Degree Price Discrimination
If a firm sells in two markets, 1 & 2; ask for different price for each market.
How to allocate output?Allocate output (sales) so MR1 = MR2
Optimal total output is that for which MRT = MC
For profit-maximization, allocate sales of total output so that
MRT = MC = MR1 = MR2
Why choose price discrimination?
Different Demand elasticity? Different cost? Different time?
