Today

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Today

• Entry the monopolist
• Price discrimination the monopolist

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Entry and the Monopolist

• Why dont others enter?

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Barriers to Entry

• Ordinarily, we expect that profits will attract
  entry to a market.
• This might make it hard to remain a monopolist.
• Expect to see a monopoly only when there are some
  kind of barriers to entry.
• We will discuss four types of barriers to entry.

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1. Economies of scale natural monopoly
P
If another firm produced less than 10,000 units,
it would have higher AC and could be undercut in
price. If it entered producing 10,000 units, then
price would be driven down below AC for both
firms.
MC
p
LRATC
D
Q
9,000
10,000
13,000
20,000
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Natural Monopoly

• Demand is low enough that there is only room for
  one firm producing at minimum average cost.
• OR Economies of scale are so strong that LRAC are
  decreasing up to a very large quantity (relative
  to demand).
• Public utilities are often natural monopolies.

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Regulation of Natural Monopoly

• Governments often create a legal monopoly to
  provide goods that are natural monopolies.
• This makes it illegal to compete against the
  provider.
• Governments then regulate the monopoly to force
  it to act more like a price taker.
• Many public utilities are regulated.

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2. Large Set-up Costs

• Referring to large sunk costs of entry.
• Includes developing product, advertising, setting
  up operations.
• Potential entrants may be reluctant to bear these
  costs if they are not sure they will be able to
  break even.
• Examples
• Virgin cola wide-body airplane production

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3. Patent Laws or Trade Secrets

• It may be illegal or impossible to duplicate the
  product.
• Secret formula for Coke
• spiral ham-cutting machine
• Polaroid cameras

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Social Cost/Benefits of Patents

• Costs Creates a monopoly, which harms
  consumers.
• Benefits Provides an incentive to do RD so as
  to earn monopoly profits for a while. Otherwise,
  maybe no innovation.
• They are crudely balanced by giving patents for
  17 years only.

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4. Legal Barriers

• Perhaps a legal monopoly (see regulation of
  natural monopolies, above).
• Licensing requirements, such as in medicine or
  law.

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Price Discrimination and the Monopolist
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Type 2 Price Discrimination

• When a seller approximates selling the units of a
  good for what they are worth to consumers.
• The ice cream problem, when you set up quantity
  discounts.

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Profit Maximization and Price Discrimination

• The profit-maximizing rule (choose Q where MR
  MC) applies only to one price situations.
• If a monopolist is able to price discriminate,
  this will allow him to do better.

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Price Discrimination on Graph
If the monopolist must charge only one price,
what will he do?
P
MC
D
MR
Q
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Price Discrimination on Graph
How much is his Producers Surplus?
P
MC
PM
D
MR
Q
QM
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Price Discrimination on Graph
Can he increase it by offering different prices
on different units?
P
MC
PM
D
MR
Q
QM
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Price Discrimination on Graph
How are consumers affected by this?
P
MC
PM
D
MR
Q
QM
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Type 3 Price Discrimination

• When different types of consumers have different
  price elasticities of demand, a seller can try to
  charge different prices depending on who buys.
• Must have a way of identifying the high-value
  consumers from the others.
• Must be able to prevent re-sale.

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Example Air Travel

• Business v. leisure travelers
• Who has more elastic demand?
• How can the types be identified?
• How is re-sale prevented?

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Example Movie ticket prices

• Matinee v. evening viewers
• Adult v. kid
• Who has more elastic demand?
• How can the types be identified?
• How is re-sale prevented?

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Type 1 Price Discrimination

• When a seller sells each unit of a good for what
  it is worth to each consumers.
• Called perfect price discrimination.
• In this situation, the monopolist does provide
  the allocatively efficient level of output.

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Perfect Price Discrimination
Each unit sells for a different price. The
efficient quantity is provided. Sum of PS CS is
maximized (but CS 0). No deadweight loss.
P
MC
PM
D
MR
Q
QM
QE
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Coming Up

• Monopolistic competition oligopoly
• Group Work Exercise related to monopolies

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Instructions

• For each product or market, identify a way that
  price discrimination is used.
• Which type (I, II, or III) is it?
• Are any devices needed to prevent re-sale or
  separate types of consumers?

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Products or Markets

• Kings Dominion (and other amusement parks).
  Think beyond adult v. child ticket prices.
• Hotel rooms in Florida
• Flea markets
• Legal and medical services
• Cheerios cereal