So a little bit
of housekeeping before we get started. First, I was online
at like 3 p.m. yesterday, and I noticed like 80
people hadn't started the homework yet. And
I assume it's because people do things last
minute, but I thought I'd send out a little
courtesy announcement to remind people it
was due last night. So everyone ended
up pretty much, pretty much
everyone ended up getting it done,
which is great. And just a
reminder, the next homework is
already out, and that's due Sunday
night as well. The big thing I guess to talk about is the exam. So once again, next
Monday, I've written up the exam now. And I
just want to talk about some of the differences
between this exam and the first one.
So the first exam was probably more calculation
heavy. You had the present value
calculations, elasticity calculations, supply
and demand calculations. If I recall correctly,
I think only one or two
questions require adding numbers
together in any way. It's going to be a
much more intuition, logic-based exam.
So to my engineering students in the
room, I apologise. But for everyone
else, probably a relatively good
thing. So think about the things
we discussed in the rationality and
utility lecture, the theory and the
intuition behind consumer optimisation as well.
So I'm not going to ask you for specific
numbers, but you should know the difference
between things like substitution and income
effects, etc. and it's something for
producer theory as well what else did I want
to say about that yeah not much really yeah
so a couple of other things I'll try and
get a practice exam out by Wednesday I'm not
going to add additional office hours this week
but if people want them email me there's
enough demand I will put them on I put the
same room before the exam between 5.30 and
7.30 on Monday so we just went over what
like review practice questions last time
But you can use that in any way you want. So
I'll be posted up there for a couple of hours.
Feel free to join. And yeah, that's
it about the exam. Does anyone have any
questions about it? Great. And the final thing
I want to mention is on Wednesday, 11.30
to 12.30, I do have this guest speaker
coming in for my Experimental Economics
class. We've booked a room three times
the size. So if anyone wants to tag
along, he's going to talk about his work
using experiments to understand what's going
on with artificial intelligence and
human interaction. He's great. He's a
good friend of mine. He's quirky. He's French,
hence he's quirky. So yeah, it will
be a good talk if anyone wants to
tag along. I'll put up the information
on Brightspace. All right, so we're
jumping to topics. We're going to
market structure. So in between cost
minimization and cost and this, in the textbook
there are two topics. I'm skipping those
topics for two reasons. One, we're already a
little bit far behind and this was my decision
to spend time talking about market failures
and also rationality and utility, which I
think was important. Also, I don't like
those two topics. I think they're relatively
boring. They're just very definition
-based things. So if you want to read
about that stuff, you can. But it's
literally like read and remember type stuff.
It's not like learning any type of intuition
or logic there. so we're going to speak
about market structure that's going to be
the plan for this week and then the week after
um we'll jump into to probably one class
of game theory i'm still considering cancelling
class on wednesday as well depending
on how this goes so you guys can have a
longer break um but i'll let you know about
that so from this topic and the next couple
of topics we're going to look at different
market structures and what this means for
for two related things first. How do firms
operate in these types of market structures?
How do they go about their decisions of deciding
what to produce and how to price it if
they are able to make pricey decisions? I
think most importantly, what this means for consumer welfare
in society. Some of these market
structures are better for society than
others. So the main one we're going to
talk about today is perfect competition.
This is our free market, as we've described
quite a few times so far this semester.
And today we're going to get started at
the end on this idea of monopoly. If you
remember, monopoly is one of our four market
failures, so we're finally going to
get into that today. Monopolies can
have pretty bad consequences for
society, so we'll talk about that later
on and also focus on the reasons
why on Wednesday. Then we're going to
talk about monopolistic competition, which
kind of sits in between monopoly and perfect
competition. And finally, we're not going
to discuss it in this lecture, but we're
going to talk about oligopoly or duopoly,
when there's like two firms that dominate
the market. The reason why we're not going to
talk about it in this lecture is, I guess,
for a couple of reasons. One, it's a
completely separate topic in the textbook, but
I'm actually not going straight to that
topic after this. I'm going to slice in the
topic on game theory. Because at the end
of the day, duopoly and oligopoly is game
theoretic, so I don't really want to teach
it before I give you a proper understanding
of game theory. It's all about
strategic decisions when other people can make
strategic decisions as well. whereas in perfect
competition there's no decision really
to make besides your what's in your own
interest and in monopoly you're not playing
against anyone else really it's just you're
making your own decisions as well that's how
they differ from oligopoly so what defines
perfectly competitive markets the first is
that there are many buyers and sellers
that are small relative to the market so what
this kind of means is there are no single
buyer or no single seller that can individually
determine prices in the market. Everyone
is what we call a price taker, not a
price maker. You look at the equilibrium
and that's the price you buy at or that's
the price you sell at. So think about,
actually I'll talk about the next one.
Each firm in the market produces a homogenous
or identical product. So imagine
going down to the farmer's market
in Lafayette on a Saturday once you know
it's a bit warmer, there's back on, there's
like 15 different like stores in it
all selling carrots. There's nothing really different between
the carrots. The prices are
probably going to be very similar
in that regard. There's nothing
really differentiating those products. They're homogenous or, as
we say, identical. Another example would
be there are many different stores on campus
and just around that sell sodas, so Coke and
Pepsi and yada, yada, yada. They all sell the
same things. There's no real difference
between them, so you can go to any of these
stores and buy them. Also, there are thousands
of people on campus, so not one individual
buying everything. So this is what we mean,
we have an identical product and many buyers
and many sellers. In a perfectly
competitive market, buyers and sellers all have
perfect information. If you remember, when
there isn't perfect information or asymmetric
information, think about our market for
lemons and cars, this means the market can
unravel and nothing gets solved. So information
is really important. There are no transaction
costs, so there's no frictions essentially.
and finally this is really important at
any time a new firm can come and enter the
market and any firm can exit the market there
are no barriers to entry or exit and as
you'll see when we discuss the monopoly there
are large barriers to entry which result in
a lack of competition so the implications
of these conditions and a perfectly competitive
market are twofold first the market
price is determined by our supply and demand
interaction so at equilibrium in supply
and demand that's how we get the price that
all firms face and all buyers face also
in the long run when there's perfect
competition every firm earns zero economic
profits zero economic profits before you start
thinking like that's weird why would any
firm want to earn zero profits don't prefer
to rely on profit. Economic profit is
not accounting profit. I've got some slides,
you know, kind of building on that later,
but just remember, economic profit takes
into account your implicit costs as well. Like,
you could be earning a $100,000 wage by
working a job rather than running a company.
So this is what's taken into account in
the economic profit. So we have our good
old supply and demand functions on the
left-hand side here. And as you can see
in our perfectly competitive market,
Where they intersect is where we get our
equilibrium quantity, and more importantly, our
equilibrium price. And what this means
is for any individual firm, we can
move to the right -hand side here, this
is the demand curve that they face, any
individual firm. So as you can see, they
can produce any amount of output, but they
have to sell at this price. They can't sell
at any other price. This is on the y-axis
here. so the thing to notice about this is
that the demand curve is horizontal so going
back to our lecture on elasticity if you
remember when the demand curve is vertical this
means it's perfectly inelastic that means
you can raise the price as much as you
want like our good old friend Martin Shevelli
did and demand won't change at all when
it's horizontal it's perfectly elastic. That
means any slight change in price is going
to completely shift everyone's behavior. So
what this is saying is because each individual
firm faces a fully elastic demand curve,
if you raise your prices above the market price
by even one cent, no one's going to
buy them. Your demand for your good is going
to fall to zero. So that makes every
single individual firm a price taker, not a
price maker. They have no control of the
price, if they try and change the price,
it's got to be back. So if you remember
from our last lecture, we defined the short
run as a period where at least
one of your inputs is fixed, usually
capital. Labor is something you can
change, but capital is fixed. There are
other things that could be fixed, like
land, etc. as well. In the long run, that's
when one of these variables, sorry I
should say, all these variables are no
longer fixed they're no longer fixed so you
can change everything and that's usually
like six months but by definitions when
nothing is fixed you can change them so to
maximize short run profits where one of these
variables are fixed managers must take
is given the fixed inputs fixed costs
and determine how much output to produce
by changing the variable inputs so
some costs are going to be fixed no matter
what you do So you should be focusing on
how much revenue you can get depending
on the changes in your variable costs
not your fixed costs So This is kind of what
it looks like so as you can see this is
the dollars and this is the quantity of
output by the firm and The revenue a firm
gets is just defined by this straight line
here because revenue is just price times quantity
remember at every point they choose to
produce they're facing the same price so if they
sell one unit they're going to get one
times price they sell two units they're going
to get two times price so every time an
extra bit of output is produced you're just
receiving an extra price in revenue hence why
this is a straight line and here you can
see you have this cubic cost function as per
usual we saw this in the previous lecture and
the maximizing output in terms of profit is
our good old marginal revenue equals
marginal cost marginal revenue equals marginal
cost and as you can see the slope of our
marginal revenue curve is constant all the time
it's just price p and the slope of our
marginal cost line will change at every point
on the graph it's just the tangential point
to this function so if we're at a it's going
to look something flat like that in between
a and e it's going to get a little bit steeper
and it keeps getting steeper and steeper
up until this point e where you can see
the marginal cost slope and the marginal revenue
slope are parallel once again what this
tells us is that when you produce
that next unit the marginal cost will
equal the marginal revenue, you
don't get any more problems. So that's
when you maximize. If you stop
production at A, when this is very flat,
you're essentially at a point where the
slope of the marginal revenue is greater
than the slope of the marginal cost, which
means you're making more revenue than
the cost to produce the next unit. If you
stop there, you're leaving money on the
table. And if you produce at this point B,
the tangent is going to be steeper than
the marginal revenue curve so your marginal
cost of the next unit will be higher than
the marginal revenue the next unit is
giving you a loss so you're overproducing
that's the idea there okay so as we just
said before the demand curve is going to be
our um what defines our marginal revenue because
it's just the price that we face and you
can just calculate this through a calculus
alternative as well revenue is price times
quantity the change in revenue given the
change in quantity just take the one out
the front reduce the power by one and you
end up with P so the marginal revenue in a
competitive market is always going to be the
price the price all right so profit
maximization under perfect competition so we know
firms maximize their profits when marginal
cost equals marginal revenue so you can see
we have our marginal cost curve here and
we have our marginal revenue curve here this
is where they intercept as a result this firm
should produce a q star where this dot
is and the way we calculate the profit of
the firm is how much they receive for each good
minus how much it costs on average to
produce each good that's the total profit so
we look at our average total cost curve so
the difference between the price we receive
and the average cost for each unit is this
vertical line here and we just multiply
that by how many units we produced so this
whole area here is the economic profits that
this firm receives so just one caveat over
the range in which the marginal cost is
increasing this is a caveat because um uh you could
have like a decreasing marginal cost as
as it is here so marginal cost is decreasing
up until a and then it starts increasing
so we could probably get the the same kind of
slope here but because marginal cost is
decreasing you want to keep producing until
you're at a point where it's increasing so
that's the one caveat there that's quite
important so here's a simple example a firm's
cost function is five plus q squared if the
firm sells output in a perfectly competitive
market and other firms in the industry sell
at a price of 20 bucks what price should the
manager of this firm charge what level
of output should be produced to maximize
profit and how much profit will be earned so a
simple question to start with what price should
the manager of this firm charge for one
you know they're good exactly everyone else
is charging 20 remember if you charge 20 or
one no one's going to buy from you so
you charge what the equilibrium price is or
the market price is which is given here so great
we've got that now we can figure out the
marginal cost and the marginal revenue we
can take the marginal cost from the cost
function here it's just the change in cost given
the change in quantity so we just take the
first derivative of that so we take the
two out the front here reduce the power by
one and the marginal cost is 2q remember
the marginal revenue is just a price it's just
a price so that's going to be 20. so our
marginal cost equals marginal revenue equals
20 equals 2q and that tells us this firm
should produce 10 units and then to figure out
their profit there's a couple of ways you
can do this you can figure out what the
average cost per unit is but you can also do it
this way in terms of the total cost as
well. So they sell 10 units at $20 each. So
this is their revenue minus their cost. And we
have the cost function here, 5 plus Q
squared. Q is 10. So we just plug that in and
we find that the answer is $95. That's the
maximum profit they can make. If they produce
more or less than 10, they're going to end
up with less profit. So, so far we've talked
about a situation when the firms are
maximizing their profit, but there's also
situations in the short one when firms are losing
money so they want to minimize their
losses the cool thing is it's the exact same
thing is the exact same picture it's just the
outcomes are slightly different okay so
once again every firm maximizes their profits
when the marginal cost equals the marginal
revenue so we have this point here at Q star
and the way we figure out the profit or the
loss is the difference between the average
total cost and the price so in this case
at q star the average total cost is above
the price so the distance between the two
is how much loss you're making per unit and
then you multiply it by the quantity sold
and you get your loss this minimizes losses
so a question for all of you to minimize
loss why is this firm producing at q star
rather than choosing not to produce anything
at all in this period. All losses, so yeah. I feel like a really
great intuition and it's something that like
Walmart will do all the time when a competitor
enters the industry, they'll price them
out of the market even though they're making
losses in the short run. That's not what's
going on here though. There's something else
going on here. Yeah? Okay, so you're
nearly there. You said the word I'm
looking for, fixed cost. What else
is on this graph that we haven't
talked about yet? sorry we're talking
about marginal revenue we're talking about
marginal cost we're talking about average
total cost there's one other thing here
yeah variable cost so remember fixed costs
are stuck no matter what you do the fixed costs
are gone so example being you started a
new month and you know your average total cost
is going to be above the revenue that you
can make but this could be because you're
locked into a $50 ,000 a month contract
in terms of your rent. So it doesn't matter
if you produce goods or if you go prolly in
the forest, you're $50 ,000 down no matter
what. So in terms of production in the short
run, the only thing you should care about is
your marginal benefit or marginal revenue
versus your marginal cost. So the thing the firm
cares about in making their outward decision
is, does selling the next good give me more
revenue then it costs to make the next good
so we don't take the fixed cost into account
so we only take our average variable cost
and as you can see at this price here it's
above our average variable cost so even
though overall we're making a loss in terms of what
we can control we're still making this
counterfactual profit counterfactual profit
so it's better for us to produce a cube rather
than reduce it zero and do something else
we're still making this in counterfactual
profit even though our overall accounting profit
is a loss does that make sense to everyone
great so ignore the sunk costs ignore the
fixed costs in the short run we're making these
decisions marginal benefit versus marginal
cost is what we always want to say however
as you can see in this situation the average
variable cost is also above the marginal revenue
when this intersects with marginal cost
so at Q star in this case both the average
total cost and average variable costs are
above so what we can see is the average
variable cost minus the price so this blue
line here this is our counterfactual loss if we
produce Q star compared to producing zero and
this is going to be our sunk cost loss we have
that no matter what but clearly by producing
q star compared to zero we also lose this
blue area this firm is going to shut down
in the short run they're not going to produce
anything they'll leave all their resources
idle there's no point creating anything
because if you produce q star you're worse off
than you would be if you produce zero so the
average variable cost at the point
where marginal cost equals
marginal revenue determines whether you
produce in the short run or you don't produce
in the short run. So this is an example
of a case where a firm would shut down and
this is going to be very loud so I'll turn
it down a little bit. I've been throwing this
turkey for a month. Sliced bread is toast. This is not happening. I know there
are concerns, but everything's fine. Delivery, best thing
since sliced bread. I know. America's best
thing. So I think that's a
very cute ad. You know my affinity
for The Office and Rainn Wilson
plays Dwight. I think that's a
great job there. But clearly the idea is
in the short run, they have all their
capital fixed. Like Little Caesars
just popped up. They're not making
any economic profits in the short run.
The average variable cost is going to
be, as you can see, above the marginal
revenue. So this firm will stop
producing shutdown, not employ any
labor, which is a variable cost. And
someone like, you know, Rainn Wilson
is off delivering pizzas, doing
something instead. So the key thing
to figure out if a firm will shut down
or not is if the marginal revenue is
above or below the average variable
cost at the point of intersection with
the marginal cost. so yeah that's exactly
what i just said there okay so yeah this
is the exact same thing here so if the the the
price is p0 or less then this firm will
produce sorry then this firm will not
produce and they'll shut down because let's say
here at p minus one whatever this is as
you can see where it intersects with marginal
cost the average variable cost will be
above it but here at P1, when it intersects
with marginal cost, P1 is above the average
variable cost. So we can look at the
intersection point where any price below will result
in shutdown and any price above will result
in positive profits. Yeah? What about the
instance where it sits on the intersection
point where the firm should produce
or not? Yeah, so zero economic profits they'll
choose to produce. Well, there's they're
indifferent, essentially. So, yes firms won't,
don't have an incentive to exit in that
situation. Ivan? yeah they'll continue
production when it's when it's above they're
making economic profits and when it's below
they're making economic losses and they'll
choose to shut down in the short run in the
short run the long run decision is slightly
different so knowing each individual firm's
supply curve or marginal cost in a perfectly
competitive market we've seen this with
demand curves we can figure out at a price how
much will be supplied in equilibrium so we
have the marginal cost of firm I so I
represents every possible firm in this market we
have 500 firms and as you can see when the
price is 10 all firms produce nothing so
there'll be no products supplied at equilibrium
when the price is $10 but at $12 based on
the marginal cost each firm will supply one
unit one unit so if every of the every firm
of the 500 has this supply curve and we
know at the price of $12 each firm will supply
one unit then at $12 with 500 firms will
be 500 units being supplied and this will
be our equilibrium here also if it was like
$11 then it would be what like this looks
like half a unit being supplied if you can
create half unit so this would result in like
250 and fifty units in the market so that's
how you can figure that out all right so
you know the long run so remember one of
the key features of competitive markets is
that firms can enter and exit at any time
there are no barriers to entry and this is
going to change the supply the output at
the same price so for example if we have all
these firms and one new firm enters the
market that means if we go back to the the
previous slide that instead of 500 units being
produced at $12 we're now going to have
501 units at $12 so what that essentially
means is there are more units being provided
at the same price so as a result the
same amount of units previously are going to
be at a lower price This is just the idea of a
supply code shifting down to the right
when more firms enter. So previously at
P0, there was this amount being supplied,
and then at P0 when it moves down
to the right, this amount is being
supplied. So more units being supplied for
the same price. And as you can
see, when it shifts down to the right,
holding demand constant, at the
new equilibrium, P1, it's below P0. so
the new marginal revenue is less than before
so this means firms economic profits are
going to be less than before and vice versa
as firms exit the industry and we move
up into the left at the same price less units
are being provided as we go from S0 and S2 and
at the new equilibrium the price is going
to be higher which means firms have a
higher marginal revenue curve they're face by
marginal revenue curve. So in the long
run we see two types of pressures
occurring. So let's start
down here actually. So if you observe
that there are a bunch of firms in this
market and they're all making economic
profits and anyone can enter this market
there are no frictions. That gives outsiders
an incentive to start a business
or start a firm to capture some of these
economic profits. So these new
companies will form. They'll enter the
market. And as we just showed, when
a firm enters the market, it pushes
the supply curve down and to the
right. So this is going to lower the
marginal revenue, decrease in the price,
and as a result, lessening the economic
profits of firms. And this process
continues until there are zero economic
profits, until we have this point where
there isn't anything being made, the average
variable cost, or the average total
cost in this case, is equal to the point
where the marginal revenue and the
marginal cost intersect. On the other hand, in the long run, if a
firm in a competitive market is sustaining
short run losses, they will actually
exit the industry since they are not covering
their opportunity costs. So if they're
finally at a point where they can reallocate
their fixed costs so they don't have to renew
the rental contract or they can repurpose
the machinery to something else, then
they're going to exit the industry. While
in the short run they're kind of
constrained in a way, their fixed costs are sunk,
in the long run they're no longer sunk so
they can reallocate. And what this means
is as these firms exit, if there are
economic losses in the market then the supply
will decrease, shift up until the left, the
price will increase until there is zero
economic losses, zero economic
profits, we're at this
equilibrium point. So profits for anyone
within the industry and outside of the
industry act as a signal of what to do.
If you see these firms making economic
profits as an outsider, this is a signal for you
to be entrepreneurial and enter the market,
try and capture some of these economic
profits, but everyone that is, you know,
everyone's incentivized to do this until it
gets to zero and vice versa with economic
losses so with economic losses as a business
you will realize that you won't be making um you
know uh counterfactually good money in the
long run so you'll close your store less
competition higher prices as a result there's
no economic profits so this is the dynamics
of it no matter where we start
theoretically we should end up with a point with
zero economic profits uh so i can't even
remember i had this clip there but Curb's
hilarious, so here we go. Sorry, a little bit
of context is needed, I forgot. So, has
anyone here seen Curb? Okay, so have you seen this season, Michael? No. Okay, so Larry
isn't someone who abides by social
norms, correct? So he has an
argument with that other coffee owner,
the one on the left, Mocha Joes,
and to spite him, he opens up
a store next door. Coffee is something
here in America, which is a perfectly
competitive market. It all tastes like
shit here. Back in Melbourne, where we have
good coffee products that differentiate a
bit here, the products are all the same so
Larry opens up this spite store and they're
essentially competing on prices with all
the other coffee stores Mocha Joe was
originally making economic profit but Larry
entered and yeah well today they both end up
sustaining short-run losses and the idea
would be that that closed down in the
long run because I had these economic losses
once I can reallocate their fixed capital
which is the store and everything in it would
be better for them to exit the market.
So in the long run, as we just said before,
as you guys both pointed out actually,
when marginal revenue equals marginal cost,
this is also the point where we have average
cost. So if you remember to find the
economic profits or losses, it's the
average total cost minus where the marginal
revenue is, so minus the price and times the
quantity, the difference here is zero so
economics profit economic profit and economic
losses is zero here and just yeah going
back to this idea of zero economic profits
so why do firms still exist in the long run
if the equilibrium case is zero economic profits
so economic profits different from
accounting profits for one key reason it takes
into account implicit costs what else could
you be doing with your time or resources
so for example something you could be doing
instead of running your business is getting
like a wage at another place. So that could
be worth $100,000. So when your economic
profits are zero, your accounting profits
could be $100,000. All it's saying is
your outside option is just as good as this
option as well. So accounting profits are
going to be positive here for firms that
remain in the market, but the economic
profits are going to be zero. So that's
the key difference. These firms are still
making money. It just takes into account
what else people could be doing with their
time and resources. so yeah in the long
run there are two conditions that hold
price which is our marginal revenue equals
marginal cost that's always our maximizing
condition and the price equals the
minimum of the average cost the minimum
of the average cost as you can see here
it just touches it all right so we're
going to get started a little bit on monopoly
today we'll do like 10-15 minutes of it
and on wednesday we'll start with a more
interactive activity putting you in the
monopoly issues so unlike a perfectly competitive
market a monopoly is a market structure
in which a single firm serves an entire
market for a good that has no close
substitutes so they're going to be a price
maker mostly a price maker that they have
a lot of power not unlimited power but a
lot of power in these markets depending on
a few certain factors so there's nothing else
like it so there are many different types
of monopolies that we'll go into. So
we'll get back to that. So being the sole seller
of good in a market gives the firm much
greater power than if it was in a perfectly
competitive market. Remember, a firm in a
perfectly competitive market can't change
prices at all. They're locked into what
everyone else is doing. However, these
firms have a choice. However, the
implication is that the market demand curve
is also the monopolist demand curve without
perfectly competitive market the demand
curve was always horizontal for each
firm for a monopolist firm it's just going
to be our demand curve and this means
a monopolist doesn't necessarily have
unlimited market power so imagine before this
imagine we had our vertical demand curve
a vertical demand curve so this implies
that demand is inelastic so you could
change prices as much as you want and
demand won't decrease. So the good example
here is Martin Shkreli, who had a
monopoly that was the only seller of
this HIV drug. And this HIV drug was
necessary to live, so demand was
perfectly inelastic. He increased price by
5,000% because this was the revenue max or
the profit maximizing decision for his
firm as a monopolist. Fortunately, not
every monopoly faces inelastic
demand curves. They face demand
curves like this. And this will change
what the monopolist does depending on the
demand curve, because if you remember, with
our linear demand curve up the top here
when prices are high, prices are inelastic, sorry, not prices, demand is inelastic,
and down here it's elastic. and
if you remember if we're at a point
with really high prices and it's
inelastic how can the firm increase
their revenue what should the firm
increase or decrease their prices when
they're in the elastic zone to increase
their revenue increase the price
or decrease the price decrease yeah we
want to decrease it remember elasticity
means a one percent change in
price will result in a more than 1%
change in the demand. So if you increase
the price by 1% when it's elastic, more
than 1% of people will flock away from
your product. You're going to lose revenue
overall. But if you decrease the price
when it's elastic, then more people
will flock to the product and you'll
make revenue. So the monopolist doesn't
have full power because they're stuck by the
laws of elasticity where if they want
to maximise their revenue, they
should decrease the price until a point
of your elasticity. That's why when you face
a perfectly inelastic demand curve, if
you remember, when you're in the inelastic
area, if you raise your price by 1%, the changing
quantity demanded while away from the
firm is less than 1%, so you should raise
your price. So the shape of the demand
curve matters a lot here. Oh, yeah. Also, I should mention,
yeah, monopolies are, like, pretty bad
for society, except there's some arguments
to be made in this patience and intellectual
property that are trade-offs of
why we want monopoly. so there are a number of
reasons why monopolies can exist so economies
of scale as we talked about once you're
at a certain point you can just produce
things much more cheaply than anyone else is
able to control of an essential resource you
control it no one else has access to it
patents and intellectual property no one else
can make what you make government licenses
and franchises where governments control
who's allowed to produce, network effects and
switching costs, and finally, strategic
predatory behaviour. So economies of
scale, which is also known as a
natural monopoly, this arises when a
single firm can supply the entire market
at a lower average cost than two or more
firms could. This occurs in industries
that have very high fixed costs and low
marginal costs. So the long-run average
cost curve is still declining at market
-level output. So it's constantly declining.
Even at market level output, there are
economies of scale. So I think a really
good example of this is electric utility
companies. So the fixed cost here is
huge. You build the power grid. That is
a huge investment. But once you
have that fixed cost, the marginal
cost of delivering one more
kilowatt is tiny. So being another
firm and setting up a new set
of power lines, having that fixed
cost doesn't make any sense. It doesn't make
any sense. you're not going to make economic
profits from them so this enormous fixed
sunk cost plays a large role so yeah usually
the utilities are a big thing here so um with
the electric utilities and electric markets
this is something i talked about in a
in a another class is actually you know this
probably applies more for the government
regulation one so i'll take that back okay
control of an essential resource so a firm
gains monopoly power by owning or controlling
a resource that is essential for production
and has no clue substitutes. Competitors
simply cannot obtain the input they need to
compete. So the key insight is the resource
must be scarce and non -replicable and this
will actually affect the example I have in
the top right corner. Ownership may be natural
so by geology you can like find it in
the ground or in the earth or it can be
acquired you can build up your own supply
or you can form like partnerships essentially
so like OPEC could be an example they say
control what like 90 % of the oil's reserves
so they always mess with the oil prices
whenever they want to hit back at um you
know certain countries etc um rare and modern
economies due to global sourcing and
substitutes so a classic example back in the
day was De Beers once controlled 85% of the
world's rough diamond supply through
ownership and mines and purchasing um you know
other companies that try to get into the
the diamond gain. And as a result, they were
able to jack up the prices and maintain
these monopoly prices. So two things about
that. I actually don't think this was
the worst monopoly in the world. So
there's this idea in economics that
things like diamonds people buy as like
luxury goods. They do it for signaling
reasons. They want to signal that they
have a lot of money. So funnily enough,
raising the prices isn't actually the worst in
the world. And there's a lot of economists
who argue for these luxury taxes. So if
you tax, say, diamond necklaces by 100%, so
the price is doubled. You might actually make
consumers better off because this increases
the signal of being wealthy enough to buy
them, and you raise a lot of money in taxes
to better off society. So that's the first
thing with luxury items, the higher price might
not be the worst. You can push back
against them if you want. However, if you look
at the market recently, 50% of diamonds today
are lab-made diamonds, so companies like
the beers no longer have control over this
monopoly because there are you know plenty
substitutes around these days due to this
increase in technology etc and I think lab
-grown diamonds are at a point where people
genuinely can't tell the difference anymore
like 30 years ago you could tell the difference
like if anyone's seen like uncut gems
or something like that you know they're looking
at the diamonds I think it's really hard
for anyone to tell anymore so there's
no longer a um uh you know an essential
resource or control over this in terms of monopoly
okay this is a really interesting one patents
and intellectual property so governments
grant patents which are kinds of copyrights
and um trade secrets that give inventors
exclusive rights to produce and sell the
innovation for a fixed period only they are
allowed to sell that product or that invention
no one else can. Has anyone watched
Shark Tank before? Yeah, Isabel? What's like the one
thing they always ask the people trying
to pitch something? And if they don't have this, I'll never buy it. Not sure? Anyone want to jump in? Yeah. If you don't have a patent, will they invest? No, because they're
like, okay, if you don't have a patent,
you've got to enter a competitive market which
will drive economic problems down to zero,
why would I invest in it? They only invest in
people that have these patents because they
want protection over the idea or whatever
the product is. That's how important they are
and I mean these are these these people all
you know billionaires for a reason they know
how to make money. So patents in the US
typically last 20 years, copyrights much
longer, this can differ in different places in
the world and there's a deliberate policy
trade-off here by the government. So as
we'll talk about on Wednesday, monopolies
are bad for consumer welfare so we don't like
monopolies but we also want to incentivize
research and development so if you know companies
and researchers know if they you know
you know gold they'll be able to make a
ton of money this incentivizes putting a
lot of money to research even if 95 percent of
it is going to go to waste or fail i
shouldn't say go to waste so good examples of
this are a lot of drug companies so pfizer's
patent on lipitor um i know what the drug is
but every drug is like this while the patent
existed it generated 125 billion dollars
in sales so this was extremely profitable
for them um every time we invent a new drug
this is really beneficial for humanity in general
like um you know what if it was like the
1400s given my health i'd be dead and no
chance i'd still be alive modern medicine
has definitely saved me but when the patent
ended in 2011 what this meant was a lot of
other companies started to enter the field and
it became a competitive market so during covid
you had all these firms trying to produce
a vaccine and while in the end like we were
quite lucky and there were tons to produce
imagine if only one firm created one they
would just jack the prices to the mood
governments would have still bought it they would
have made so much money i mean they still
all made a lot of money but being able to
get um a patent on something that is you know
needed is huge in terms of profitability yeah
so building a patent portfolio is a
strategic investment in future market power so
even if 99% of you know R&D fails that 1% would
drive a lot of profit okay next is
government licenses and franchises so this is
where the government explicitly restricts entry
by granting exclusive rights to operate in
the market this can take the form of licenses
franchises charters or outright legal
prohibitions on competition so an example that
comes to my mind is you can only bet with
certain gambling companies here so i think like
drop kings and and a couple of others you
can't just go on any other side and bet um
poly market and how she is still like not
fully legal here i believe there's a lot of
regulation stuff happening with that same thing
with things like cable tv waste management
electricity companies in every anybody from
texas i can't remember i think texas is
the only place that doesn't have this as a
complete free market. That comes with its
own issues, which I can talk about another day
for those interested, but usually there's
only one electricity provider and they've
been licensed by the government to be the
electricity provider. So this allows them to
have higher prices, etc. I think a really good
example of this, also this barrier is purely
legal. It's not due to cost or technology.
If people were allowed to enter, they would.
And this is a really great example of that.
so this is the price for taxi medallions
and the taxi medallion back in the day was
the only way you could drive passengers around
for fame so if you didn't have one of these it
was illegal to drive passengers around like
in a taxi so you have all these taxis that
would buy this license and the taxi companies
were essentially monopoly over transport
until Uber and Lyft entered the market here
they disrupted the market completely and pretty
much invalidated these medallion prices
because now anyone could just sign up as a
contractor with Uber and Lyft and drive around.
You didn't have to get these permits or
these medallions in. So this is a great example
of what was a monopoly licensed by the
government originally and then that got broken
when people found a way around the legal barriers
to entry. You can see the price pretty
much dropped to zero. Finally, I just wanted
to briefly mention network effects and
switching costs. So network effects
exist when the value of a product
increases as more people use it,
combined with high switching costs, which
is the expense or hassle of changing
to a competitor. These effects
create powerful demand-side barriers
to entry that can tip a market
towards monopoly. So I think a really
great example is social media. So in a
perfectly competitive market, there will be
hundreds of different social media apps, but
everyone congregates on the same app, and
there's these network effects. So this is
why right now TikTok is probably the most
popular one in the world, because that's
what everyone's on. I think Insta's not
as popular as I looked before, and Facebook's
now completely dead, unless you're
over 60, I guess. But back in the
day, it was Facebook that was like
the monopoly over the social
networking sites. So more users attract
more compliments. App developers
sellers. So another example of this was
in the 90s, Microsoft was a monopoly in
this sense, because all the software
developers were using Microsoft and
Microsoft programs. So as you'll see in
the next lecture, I have this ad that
Apple made in the early 2000s that
tried to get people to switch away from
Microsoft to Apple, and I talk more about
the other reasons to use Apple rather
than the program. Anyway, that's all I
have for today. We'll start off by doing a
more interactive version of Monopoly, and then
I'll tell you and show you why Monopoly
is about for consumers.