Double Marginalization Problem
This short video covers the double marginalization problem. The problem is what happens to social welfare, prices, and profits when one monopoly sells to another
This short video covers the double marginalization problem. The problem is what happens to social welfare, prices, and profits when one monopoly sells to another monopoly. It is a classic problem with applications in industrial organization, innovation policy, and development.
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The answer to practice question #6 that seems correct to me is considered as incorrect by the system -- I wonder who is right...
Corrected. Please bear in mind that MRU Development Economics is basically just Tyler and myself. We do have some great student and technical help but sometimes errors sneak through, especially on our first run. Our motto of Learn, Teach, Share reminds everyone that this is a joint enterprise like Wikipedia so we are grateful when people spot errors.
I don't think I heard an explanation as to why the slope of the marginal revenue curve was twice that of the demand curve. Is this something I should already know?
It's not terribly important but it is easy to prove with a bit of calculus. Write an inverse linear demand curve as P=A-bQ. Note that A is the vertical intercept and b is the slope. Revenue is P*Q or PQ=AQ-bQ^2 now take the derivative to get MR=A-2bQ, i.e. a curve which begins at the same vertical intercept, A and has a slope of 2b.
I got this question wrong twice, which means I got the monkey score. But unlike any monkey, I watched the video twice. So there is clearly something I don't understand. Please help.
The question is:
5. In a standard monopoly model, a monopoly produces less than the competitive market. The difference between the monopoly output and the competitive output (the trades which do not take place as a result of monopoly distortion) is known as: *
a) dead weight loss
b) monopoly profit cost
c) monopolistic loss
The correct answer (by elimination) is a. Now this doesn't make any sense to me. I understood dwl to be the money left on the table by any retailer who doesn't lower prices. If I sell widgets at $10 per, and 100 people buy widgets at a profit of $2 per, then I make $200. On the other hand, were I to sell 500 widgets at $8 per, I'd sell a lot more widgets, but my profit would be zero. The difference in revenue (not profit) is the dwl. Is this correct?
Monopoly profit means I can sell 50 widgets at $20 and make a lot more money. But the DWL is now 450 widgets at $8 each, and you do the math--it's a big number.
Well, if so, then how can the answer to the above question be dwl?
Good question. Here is what you are missing. Dead weight loss is NOT about profits. DWL is a measure of social loss, to be precise DWL measures potential gains from trade that do not occur. The height of the demand curve at the Xth unit tells us the value that consumers place on the Xth unit of the good, the height of the MC curve at the Xth unit tells us the cost of producing that unit. Thus, whenever the demand curve is above the MC curve there is a potential gain from trade. The trouble is that a monopoly can increase profit by reducing output (for the reasons you explain in your question) even though less output means fewer gains from trade and more DWL. In other words, producing more would lower the monopolist's profit but it would increase social surplus--that is it would increase consumer surplus more than the loss in monopoly profits so society as whole would be better off.
For this to make any sense you have to assume that no bargaining is possible between the two firms. The net result is more likely to depend on each firm's outside opportunities. It also required fixed unit pricing amongst a long list of assumptions that don't seem appropriate.
Clearly the downstream producer is making far less profit when the upstream producer pushes prices upwards. All the downstream producer has to say is "fine, bugger off. I won't buy any of you stuff anymore." That threatens both of their profits and enables them to coordinate prices and quantities to maximise their combined surpluses. This maximised surplus is then shared proportionally to the outside opportunities of each firm.
I mean, aren't there a whole bunch of game theory models that show monopoly selling power is restrained by a monopoly buyer? I can think of a few off the top of my head if there is not.
I'm having a very hard time imagining any real life situation where this can apply, and not be circumvented.
Indeed, I can hardly think of a situation where some degree of monopoly power is not inherent in all stages of production. So this problem should be rife - energy, shipping, resources, property markets, etc. I'm surprised we can produce anything.
Dead-weight loss is considered to be a net social loss. The video mentions a couple of times: "the economy shrinks". But I think we miss part of the story. The thing is that when a monopoly ends up producing less than what would be produced in perfect competition, it frees up resources that can be used up in other industries, thus affecting demand and supply in those other industries in favor of more production. I think we have here some "live-weight gains" that can, at least partially, offset dead-weight losses in industries affected by lack of competition. So, can we apply this Bastiatesque reasoning here?
I'm confused by the Microsoft example. There was no web browser market at all, let alone a monopoly in one. So this doesn't address the charges of the antitrust suit, namely that MS was stifling innovation by bundling its browser with its OS.
Also: have you not noticed that even now Internet Explorer sucks? The only reason it's marginally improved since the 90s is because of the competition from other browsers. One in particular....
I agree that the bundling issue is separate from this video, but I think what Alex was really getting at is that originally Netscape Navigator was not free. When Microsoft came out with IE it was priced at zero in a sense. In response to this Navigator eventually had to also lower its price to zero as well and try to make money through indirect means like advertising/portal. Microsoft probably made a mistake as they would have dominated browsers anyways without the bundling issues.
Chrome is better than IE now, but it is also free. Most browser software is now a part of companies that produce operating system software as well. There are a few exceptions, but most importantly Microsoft lowered the price of browser software to zero.
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I understood dwl to be the money left on the table by any retailer who doesn't lower prices. If I sell widgets at - http://mruniversity.com/courses/development-economics/double-marginaliza...
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