Monopoly

# Monopoly
## Week 6
### Krisna Gupta
### 15 March 2021 (updated: 2021-03-15)

---

## Recap on last week

- We've learned various types of costs

- Two different levels of `$Q$`:
  - cost minimizing when `$MC=ATC$`
  - profit maximizing when `$MC=MR$`

- We've learned the condition in perfect market:
  - `$P$` is independent of producer's decision
  - hence: `$MR=P$`

---

## Today

- Entry and exit

- What happens when the market is a monopoly

- Price discrimination

---

# Entry & Exit

---

## Entry & Exit

- To construct the overall supply curve, we need to look at what Liv would do in different price setting.

- We have different level of Q. Time to learn different types of prices for supplier.

- Two types of Prices:
  - **Break-even price** = minimum ATC
  - **Shut-down price** = minimum AVC

---

## Break-even and Shut-down

- **Break even price** is the price level where Liv is operating at the lowest profit.
  - She might not want to produce at a loss.

- If price goes below break-even price, shutting down may not be necessary.

- In the short-run, fixed cost must still be paid regardless of Q produced. It's better to produce to cover some of the fixed cost.

- **Shut-down price** is the price level where Liv can still cover her variable cost, and have something left to cover a fraction of the fix cost.

---

### Liv's Cost Structure Again

---

### Break-even & loss

.pull-left[.s[
<table>
 <thead>
  <tr>
   <th style="text-align:center;"> Q </th>
   <th style="text-align:center;"> MC </th>
   <th style="text-align:center;"> AVC </th>
   <th style="text-align:center;"> ATC </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> NaN </td>
   <td style="text-align:center;"> Inf </td>
  </tr>
  <tr>
   <td style="text-align:center;background-color: grey !important;"> 1 </td>
   <td style="text-align:center;background-color: grey !important;"> 12 </td>
   <td style="text-align:center;background-color: grey !important;"> 12 </td>
   <td style="text-align:center;background-color: grey !important;"> 120.00 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 2 </td>
   <td style="text-align:center;"> 36 </td>
   <td style="text-align:center;"> 24 </td>
   <td style="text-align:center;"> 78.00 </td>
  </tr>
  <tr>
   <td style="text-align:center;background-color: blue !important;"> 3 </td>
   <td style="text-align:center;background-color: blue !important;"> 60 </td>
   <td style="text-align:center;background-color: blue !important;"> 36 </td>
   <td style="text-align:center;background-color: blue !important;"> 72.00 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 4 </td>
   <td style="text-align:center;"> 84 </td>
   <td style="text-align:center;"> 48 </td>
   <td style="text-align:center;"> 75.00 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 5 </td>
   <td style="text-align:center;"> 108 </td>
   <td style="text-align:center;"> 60 </td>
   <td style="text-align:center;"> 81.60 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 6 </td>
   <td style="text-align:center;"> 132 </td>
   <td style="text-align:center;"> 72 </td>
   <td style="text-align:center;"> 90.00 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 7 </td>
   <td style="text-align:center;"> 156 </td>
   <td style="text-align:center;"> 84 </td>
   <td style="text-align:center;"> 99.43 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 8 </td>
   <td style="text-align:center;"> 180 </td>
   <td style="text-align:center;"> 96 </td>
   <td style="text-align:center;"> 109.50 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 9 </td>
   <td style="text-align:center;"> 204 </td>
   <td style="text-align:center;"> 108 </td>
   <td style="text-align:center;"> 120.00 </td>
  </tr>
  <tr>
   <td style="text-align:center;"> 10 </td>
   <td style="text-align:center;"> 228 </td>
   <td style="text-align:center;"> 120 </td>
   <td style="text-align:center;"> 130.80 </td>
  </tr>
</tbody>
</table>
]]

- Below $72, Liv is operating at a loss.

- Above $12, Liv still manage to retain some of the fixed cost.
]
---

## Up the industrial curve

- Different producer may have different cost structure.

- Marginal cost is important because it determine lowest ATC (the break-even price) and profit.
  - MC is essentially the supply curve.
  
- When price below break-even price, firms only exit in the long run.
  - still produce while lowering fixed cost.

- When price below shut-down price, firms exit immediately.

---

### Profit max in perfect market

![](week6_files/figure-html/p0-1.png)

---

### Long run profit in a perfect market

![](week6_files/figure-html/p1-1.png)
.s[If an Industry is profitable, more firms will enter the market, push supply curve to the right. This push market price down]]

![](week6_files/figure-html/p2-1.png)
.s[The firm now has to operate on a lower MR. In the long run, the number of firms will be just enough to sustain and no more profit left for entrant]]

---

### Long run profit in a perfect market

![](week6_files/figure-html/p3-1.png)
]

- Overall market will have a straight line supply curve, where MC=ATC

- note that PS=0 (zero pure profit for producer)
]

---

## Perfect competition characteristics

- Entry & exit is important for a perfect market characteristics.

- An industry which have low shut-down price and break-even price tend to be more competitive.
  - When these prices are low, more entrepreneurs can join in.
  
- Low cost of entry and exit ensures a smooth adjustment of market.

---

---

## Perfect competition

- The cost of entry and exit is very relative and a little bit hard to judge whether it's "low" or "high".

- Second characteristic is **many producers with small market share**

- **Market share** is a measure on how much a firm gain revenue from a market.

- Even when there are many producers, it is not competitive if the market is dominated by small number of sellers.

---

## Perfect competition

- When a market consists of many sellers, market won't react too much when there is only one or two firms enter and exit.

- When a _warteg_ is closed, nobody cares.

- When a Electric Vehicle (EC) investor come in, it will be a headline.

---

### Smartphone Market share in Indonesia

<div id="mobile_vendor-ID-yearly-2019-2019" width="600" height="400" style="width:600px; height: 400px;"></div><p>Source: <a href="https://gs.statcounter.com/vendor-market-share/mobile/indonesia/#yearly-2019-2019-bar">StatCounter Global Stats - Device Vendor Market Share</a></p><script type="text/javascript" src="https://www.statcounter.com/js/fusioncharts.js"></script><script type="text/javascript" src="https://gs.statcounter.com/chart.php?mobile_vendor-ID-yearly-2019-2019&chartWidth=600"></script>

---

### Global car market

<a href="https://www.statista.com/statistics/316786/global-market-share-of-the-leading-automakers/" rel="nofollow"><img src="https://www.statista.com/graphic/1/316786/global-market-share-of-the-leading-automakers.jpg" alt="Statistic: Global automotive market share in 2019, by brand | Statista" style="width: 100%; height: auto !important; max-width:1000px;-ms-interpolation-mode: bicubic;"/></a><br />Find more statistics at  <a href="https://www.statista.com" rel="nofollow">Statista</a>

---

---

## High market share

- When a market is dominated by small number of players, we say the market is **concentrated**.

- Market concentration may be caused by a highly efficient firms:
  - very low cost.
  - superior quality at similar price.

- It can also be caused by some characteristics special to the product.
  - compatibility of complement
  - exclusive content
  
???

compatibility of complement: OS, electric charging for electric cars,
exclusive content: netflix vs prime, console wars, etc

---

## Standardized product

- Market tends to be more competitive when the product from a firm is undistinguished from other firm.
  - buyers don't care from which firm they purchase their goods.
  - firm have less control over price.
  
- In general, firms who wish to capture more market have two strategies:
  - **lower cost**.
  - **product differentiation**.

---

# Monopoly

---

## Deviation from perfect competition

- So far we have seen the importance of a perfect market:
  - producer is a price taker.

- We have seen that supply curve is essentially the marginal cost, which derives from the cost function.

- Cost C(Q) is a positive function of Q.
  - meaning, more Q leads to higher C(Q)
  
---

## Deviation from perfect market
  
- but price is independent.
  - `$\text{profit}=Q*P$` which is a linear function.
  - Marginal Revenue (MR) = price.
  - firms compete by lowering C
  
- **Product differentiation** may provide a firm to control their own price to some extent.

- When a firm can control price, price is no longer independent of firms' decision

- `$MR=MC$` still hold, but with control over price, a firm can now **choose their MR**

---

## Deviation from perfect market

- To see how this happens, we use **monopoly** as our first deviation from the perfect market.

- Monopoly is the other extreme of a perfect market.
  - most markets are somewhere in between.
  
- As usual, learning how the extreme works often easier and intuitive.

---

## Market structure

From extremely strong market power to no market power:

| type | differentated <br> product? | no. of <br> producers | example |
| --- | --- | --- | --- |
| Monopoly &nbsp; | not aplicable | &nbsp; 1 &nbsp; | electricity |
| Oligopoly &nbsp; | can be both | &nbsp; few &nbsp; | Internet Service|
| Monopolistic competition &nbsp; | &nbsp; &nbsp; &nbsp; yes | &nbsp; many &nbsp; | Smartphone |
| Perfect competition &nbsp; | &nbsp;&nbsp;&nbsp; no &nbsp; | &nbsp; many &nbsp; | fried rice |

---

# Side note: What's a market?

Sometimes it is hard to define market. A Carrefour vs KPPU case is famous for [debate about market definition](https://www.eastasiaforum.org/2009/09/10/is-there-a-carrefour-monopoly-in-indonesian-retailing/): Did Carrefour compete against only wholesale like supermarket and hypermarket retailing, or also mini-markets and traditional markets?

---

# Side note: What's a market?

How broad the definition of market should be? Smartphone is another excellent example. **Samsung galaxy Note series** can be argued to operate in a **differentiated smartphone market** thanks to its exclusive feature called S-pen. However, in the **low-end smartphone market**, it has little to no difference with other cheap smartphone, hence closer to a **perfect market**.

---

## Monopoly

- A producer is a **monopolist** if it is the **only** supplier of a good that has no **close substitute**.

- An industry is a **monopoly** when it runs by a monopolist.

- Monopoly operates by changing its production output and captures as much **Producer Surplus** as it could.

- Normally, more producer would want to enter the market. Why they could not?
  
---

## Why do monopolies exist

Generally, there are 5 reasons why monopolies (or oligopolies) exist

1. Control over scarce resource and input.

1. Increasing returns to scale industry.

1. Technological superiority.

1. Network externality.

1. Government-created barrier.

---

## Control over scarce resource and input

De Beers is famous for having control over diamond. Indofood who controls flour production have a huge advantage in the instant noodle market.

---

## Increasing returns to scale

When an industry have a very big fixed cost, a firm in that industry needs huge market share to maximize **spread effect**. Building internet infrastructure is expensive (tower, cable, etc) and a huge commitment.

A monopoly created and sustained by increasing returns to scale is called a **natural monopoly**.

---

## Technological superiority

- Intel managed to dominate the semi-conductor market thanks to its technological superiority over its competitor.
  
- However, technology can be researched and (to some extent) stolen.

- This makes technological superioriy less important compared to other reasons.

- Do not mixed tech superiority with network effect.

---

## Network effect

- An industry has **network effect** when the value of a product and service in that industry depends on how much users it has

- Network effect is very prominent in industries related to tech: Social media, Online games, Ride-sharing etc

- Google's search algorithm might not be superior, but it has much larger data thanks to the amount of users of its service, browser and android phone.

- Some said MacOS is better than Windows. But most developers make windows based apps.

---

## Government-Created Barrier

- The most important legally created monopoly these days maybe come from **patents** and **copyrights**.

- Patents and copyrights are important to provide incentives (at least temporary) for people to create and innovate.

- as soon as the patents and copyrights are over, it moves closer to a perfect market.

- Could lead to a missed opportunity, however.

- We also have Bulog, Pertamina and PLN.

---

## How monopolist maximize profit

- A firm operates in the perfect market face a flat demand curve
  - this is because price is independent
  
- However, monopolist face a market demand curve instead of an individual demand curve.

- Monopolist maximize profit by setting `$MR=MC$`, but they have control over their `$MR$`

---

## How monopolist maximize profit

.pull-left[
![](week6_files/figure-html/grafik1-1.png)
.s[An individual producer face a straight line because its Q has no impact on P]]

.pull-right[
![](week6_files/figure-html/grafik2-1.png)
.s[A monopolist face the whole market, hence its demand curve is equals to the market demand curve.]]

---

### Profit max in perfect market

![](week6_files/figure-html/pc1-1.png)
---

### Profit max in perfect market (short run)

![](week6_files/figure-html/pc2-1.png)
---

### Monopolist individual demand curve = the whole market demand curve

![](week6_files/figure-html/pc3-1.png)

---

### Monopolist decision making

![](week6_files/figure-html/pc5-1.png)

---

## Monopolist decision making

- Last week: Liv's MR = P because no matter how much she sell, price stays $100

- For monopolist, when they produce more, price goes down, while producing less increases price.

- increasing price decreases quantity bought (**Quantity effect**), while increasing margin per item sold (**price effect**)
  - remember tax revenue?
  
---

## Monopolist decision making

- Monopolist finds these the balance btween quantity effect and price effect by setting:

$$ MR = MC $$

- The profit-maximizing price is called **monopoly price**, while the profit-maximizing quantity is called **monopoly quantity**.

- Since there's no firm can join in, cost won't be reduced (very close) to zero at all.

---

## Why monopoly is bad

.pull-left[
![](week6_files/figure-html/p4-1.png)
.s[In the perfect market, the whole triangle is CS, where PS=0. Monopoly transfers some of this surplus to]]

![](week6_files/figure-html/p5-1.png)
.s[producer. Monopoly increases P and reduces Q, CS=A, PS=B, and DWL=C (loss transferred to no one)]]

---

## Dealing with monopoly

- Many countries try to reduce monopoly (and oligopoly) by fine and avoiding a merger.
  - Depends, some natural monopoly is hard to dealt with.

- In Indonesia, the most prominent institution combating monopoly and oligopoly is [KPPU]()(Komisi Pengawas Persaingan Usaha)
  - Telco, airfare, food industries, among other cases.
  
- There are few ways a government generally try to deal with monopoly
  
---

## Dealing with monopoly

1. Public ownership, like Pertamina, PLN, Bulog and PT. KAI.

1. Price ceiling / floor. This can be useful when market is not perfect. For example, A minimum wage can be useful when employers are too powerful.

In general, it is really hard to deal with monopoly because there's a trade off.

- Drug patent leads to monopoly, but important to incentivies innovation.

---

# Price Discrimination

---

## Why price discriminate

- When a monopolist charge one price, it lost a chance to profit from people who can't afford that price.

- If there is a way to charge different price to different types of customer, monopolist can capture more surplus.

- This practice is called **price discrimination**.

---

![](week6_files/figure-html/pd1-1.png)

---

![](week6_files/figure-html/pd2-1.png)

---

## Price discriminiation

- Obviously, people won't buy the more expensive ones if the product are the same.

- Some common techniques:
  - Advance purchase restrictions: early bird airfare tickets
  - Volume discount: less per unit cost if you buy bulk. eg: [short, tall, grande, venti](https://www.eater.com/2011/1/17/6701687/starbucks-to-launch-a-31-oz-big-gulp-of-coffee-the-trenta).
  - Two part tariff: you pay a flat rate to enter, but pay per-unit cost to upgrade.
  - Student price.
  - Time price: Gojek is expensive when rains, hotelroom rent price during holiday season.
  
---

## Price discrimination

- Interestingly, price discrimination is less bad compared to single price monopoly.

- Price discriminiation reduces DWL, adding a little bit of consumer surplus and producer surplus.

- Still less ideal compared to a lower-single-price monopoly, let alone a perfect market

- Price level from best to worst:

`$$P^* > P_{m2} > P_{m1} + P_{m2} > P_{m1}$$`

---

# Next week

Next week we are going to learn other deviations from the market.

Oligopoly and externalities are the two most prominent market failure.