Professional Documents
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Chapter 08 5th Edn Revised by JH
Chapter 08 5th Edn Revised by JH
500
Price & Marginal Revenue
400
350
MR falls by $32 per unit
300
(double!)
250
So MR [always] has double
200 the slope!
0 1 2 3 4 5 6 7 8 9
Output demanded
Now let’s include the average cost and marginal cost
curves to find the price & output which maximises
monopoly profits in the long run.
400
300 P
MR
200 AC
MC
100
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
output
500
400
340
300 P
MR
200 AC
MC
100
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
output
The monopolist can make this profit
500 in the long-run because no new
competitors can enter the market to
“steal away” demand.
400
340
300 P
TOTAL PROFIT $1300
MR
210
200 AC
MC
100
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
output
A firm with monopoly-power may discover that it
can make even larger profits by segmenting its
consumers.
That is, by identifying distinct sub-groups of
potential customers who have different purchasing
capacities, and then charging them different
prices for the same product.
This is called price discrimination.
Adult $20.50 Student $17.00
Senior $14.50
20
Marginal
15 cost
10
Adult
5 Marginal Demand
revenue
0
0 100 200 300 400 500 600
45 Price too high
$0 revenue from students. for [poor]
40
students.
35
30
25
20 Student
Demand Marginal
15 cost
10
Adult
5 Marginal Demand
revenue
0
0 100 200 300 400 500 600
45 The cinema
40 Now: $17 x 300 = $5100 charges a
revenue from students. special
35 ‘student’ price.
30 $7500(adult) +
$5100(student) = $12600
25
20 Student
Demand Marginal
15 cost
10 Marginal
revenue
5
0
0 100 200 300 400 500 600
There are many ways a business can try to ensure
and protect its monopoly profits.
All these methods aim at keeping or driving other
businesses out who could “steal” some of its
customers.
That is, the business erects
barriers to entry to
potential rivals.
Warning! Some of these methods are illegal under the
Competition and Consumer Act 2010.
• Complements: to fully
enjoy a product,
customers have to buy a
complementary product.
• Substitute proliferation: Wrigley
300 P
MR
200 AC
MC
100
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
output
This tends to Breakeven
500
be the fate of P=AC
400 small
businesses
300 P
MR
200 AC
MC
100
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
output
What about a situation where barriers to entry are
moderately successful or where there is only enough
consumer demand to sustain a few businesses?
This is called an oligopolistic market.
o A few businesses dominate the market.
o E.g. 10 or fewer firms supply 50% or more of a national
market.
Australia has more oligopolistic markets than most developed
countries because of our relatively small population.
Industry Number Market share
Cars top 5 53%
Banks top 4 80%
Life insurance top 4 70%
Instant coffee top 3 88%
Supermarkets top 5 99%
Cola top 2 99%
Who are the industry leaders?
Because there are only a few rivals, the
behaviour of rivals can have a big effect on
demand (and thus revenue) for a particular
business’s product.
E.g. if your rivals decrease their prices, or launch
big advertising campaigns, you might loose many,
many customers, and thus lots of revenue.
• Collusion: when firms act jointly (more nearly as they
would if they were a monopolist) to increase overall
profits.
• Cartel: a group of producers with an agreement to
collude in setting prices and output.
• Game theory (to model collusion): theory designed to
understand strategic choices, that is, to understand
how people or organisations behave when they expect
their actions to influence the behaviour of others.
Thus, each business has to pay
close attention to how rivals
behave, and then react in a
rational way to maximise
profits (or minimise losses).
Like playing checkers or chess.
Game theory is about such
strategic decision-making.
My partner in crime might…
Rat: 5y Rat: 1y
Silent: 10y Silent: 2y
“Rational” to always rat out my partner in crime!
But if my partner is also rational, he will also rat me out!
If we had both been “irrational” and stayed silent…wah!
Exemplified by The Prisoner’s Dilemma
44
Same when roles reversed, so…
Low P: $2m
Your options
Low P
High P: $0m
Your
rivals
might Low P: $6m
High P
charge… High P: $4m
Same when roles reversed, so…
Advertise: $4m
Drumstick’s
Advertise
options
Don’t: $1m
Cornetto
might… Advertise: $8m
Not
Don’t: $5m
Price war example
•If everyone had agreed to charge “High P”, then all would
have made $4m profit each (instead only on $2m).
Advertising war example
•If Cornetto & Drumstick had agreed to “Not advertise”, then
both would have made $5m profit (instead of only $4m).
This makes for a perverse incentive against competing…
• The ongoing pursuit of restrictive and entry
deterrence practices are also a typical characteristic
of the behaviour of firms in an oligopolistic market
• Firms engage in a number of restrictive practices to
limit competition
• Many restrictive practices are aimed at the
wholesalers and retailers who sell a producer’s
goods – called ‘Vertical restrictions’, where as price
fixing is called ‘Horizontal restrictions’.
• Another way to reduce competition — to
prevent other firms from entering the market
• Intended to limit the number of firms — the
fewer the firms, presumably the weaker the
competitive pressure.
• E.g. Natural barriers to entry, predatory pricing,
building more production facilities than needed
i.e. ‘excess capacity’
Bid rigging: rivals communicate before lodging their bids and
agree among themselves who will win and at what price.
Market sharing: rivals agree to divide customers between
them.
Price fixing: rivals agree on a pricing structure rather than
competing against each other.
Price signalling: rivals disclose future price changes to each
other for the purpose of lessening competition.
Collective bargaining & boycott: rivals act as a block to
“blackmail” lower prices from suppliers.
When businesses collude, they ideally seek to maximise
the group’s profits – not any single individual firm’s
profits.
When this occurs, the legally separate businesses,
economically speaking, resemble a single firm.
In that case, one can treat the industry as if it were a
monopoly.
But does collusion happen in real life? You betcha.
“People of the same trade
seldom meet together, even
for merriment and
diversion, but [when they
do,] the conversation ends
in a conspiracy against the
public, or in some
contrivance to raise prices.”
52