Lectures_1-2_monopoly

Natural monopoly

IAntitrust regulation – breakup of monopolies

IWhat if optimal …rm size (minimum e¢ ciency scale) is large compared to market size (where the market size is given by

D(minAC ))

I Especially if operating under increasing returns

I At most one …rm …ts in the market

p

I Monopoly is to remain intact

I But should be regulated!

21

Unregulated natural monopoly

IMonopoly maximizes pro…ts - sets q such that

MR(q) = MC (q)

IGets a positive pro…t if p(q) > AC (q)

IDeadweight loss (price>MC!)

22

Marginal cost pricing

I Optimal regulated price=MC

I No deadweight loss

I But monopoly incurs a loss (p < AC!)

IThis is not sustainable in long-run – monopoly will go out of business

23

Solution

IGive the (natural) monopoly a lump-sum subsidy (+ price cap)

IOR

IAverage cost pricing

ITo assure fair income distribution, do not allow monopoly appropriate too much of consumer surplus

IRegulate at average price

ISo that consumers pay (long-run) AC

24

Monopoly (cont.)

I Is monopoly bad?

IDWL compared to competitive solution

IPrice distortions

ICost distortions (weaker incentives to innovate?)

IRent-seeking to maintain monopoly power

I Are there any bene…ts to a monopoly?

Ioperated the natural monopoly market (which otherwise would not be served)

Iincentives for innovation if monopoly status can be maintained (promise of pro…ts)

25

Monopolistic price discrimination

I Ine¢ ciency of monopoly:

IWants to charge price>MC

IBut if charges higher prices to some customers, loses some other (whose willingness to pay is only slightly above MC)

IWhat if can charge di¤erent prices to di¤erent customers?

IOr, better yet, charge di¤erent prices to di¤erent customers for di¤erent units of output

26

Degrees of monopolistic price discrimination

I First – perfect

I Which one? Depends on information and on costs of resale

27

Perfect price discrimination

ICan charge di¤erent prices to di¤erent people for di¤erent units

IKnows exactly the tastes of each consumer (!)

ICharge marginal willingness to pay for each unit

IProduce as long as P>MC

I Hence no deadweight loss

IFirst price discrimination is socially e¢ cient!

IBUT Monopoly appropriates all surplus

p

Monopoly profit

MC

D

28

3rd degree price discrimination

IMonopolist serving m markets

IEach market gets own price, no re-sale btw markets

I FOCs

m

Pi (qi ) + qi Pi0(qi ) = C 0(å qi )

i =1

I or equivalently

Pi Ci0(Q) = 1

Pi #i

IHigher prices in less elastic markets

INotice that costs of production do not need to be separable!

I But often it is assumed that MC are constant and the same in each market

29

3rd degree price discrimination

MC

30