Monopolies and Oligopolies in Gambling

1. Monopolies and Oligopolies in Gambling Juho Lähteenmaa PolEG 14/02/2019

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3. Pure Competition • Definition: Each firm assumes that the market price is independent of its own level of output Many producers Products are homogeneous Perfect Information Free entry and exit, freedom to choose output and price Ideal, theoretical case. Does not exist in purely form.

4. Pure Competition • Every producer faces a flat demand curve. Price is same for every producer and production decision of one firm about the quantity produced does not affect in market price. • Profit maximizing firm is price taker and produces quantity y which gives • Marginal cost(y) = Price • Zero economic profits MC(Y) P D(Y) P* Y y*

5. Monopoly Effect in quantity demanded derived from price change • Price giver • Faces down curving demand. This means that monopoly’s production decisions (price, quantity or quality) affect in market price (or in quantity demanded). Or the optimum when monopoly decides the price

6. A = Consumer surplus B + C = Producer surplus D = Deadweight loss Marginal Cost A pm* Average Cost B Profit D p* C Demand Marginal Demand qm* q*

7. Price discrimination • One way to gain profits for monopoly (not necessary monopoly) is to use price discrimination. • Monopoly is able to use price discrimination only if • It has market power (= able to decide the price) • It is able to recognize differences in demand • It has the ability to prevent arbitration and resale of product

8. Price discrimination First-degree price discrimination ... or perfect price discrimination: each unit of the good is sold to the individual who values it most highly, at the maximum price that this individual is willing to pay for it. Ideal, theoretical case. Does not exist in purely form. H. Varian, 2010 Producer who is able to perfectly discriminate its customers, in other words gets every customers reservation price from every output, gets the whole consumer surplus for itself.

9. Price discrimination 2. Second-degree price discrimination ... or the case of nonlinear pricing, since it means that the price per unit of output is not constant but depends on how much (or in which quality) you buy. Because monopolist is not able to recognize the consumers’ reservation prices and even can’t classify its customers in classes where groups’ “aggregate” behaviour would be known, monopolist constructs price-quantity (or price-quality) packages so that customers would act as self selective. Business class vs. economy class

10. Price discrimination Two customer groups, High Income (N) and Low Income (K) 2. Second-degree price discrimination If monopoly tries to sell X0 with price A and X1 with price A + B + C, the High Income customer would prefer X0 Willingness to pay By decreasing the lower class quality (or quantity), the High Income customer is ready to pay A + C + D for X1 and Low Income customer pays A from X0 In the case of first-degree discrimination monopoly would get the whole consumer surplus from both types K*A + N*(A + C + D) K*A + N*(A + B + C) B … but if monopoly sells X1 with price A + C, High Income customer is indifferent between X1 andX0 B … but in this time it is not able to recognize in which customer group each customer belongs A DH C DL … but it can do better! D Q X1 X1 X0 X0

11. Price discrimination 3. Second-degree price discrimination The monopolist sells to different people at different prices, but every unit of the good sold to a given group is sold at the same price. When assumed that people from different groups are not able to resell goods, monopolist sets higher price to the group which have less elastic demand and lower price to more price sensitive group. Student discounts at the movies and senior citizens’ discounts at the drug store

12. Demand relative to minimum efficient scale (MES) What causes Monopolies? P Monopoly is unprobeable • Natural monopoly • Economies of scale: Producing higher amount of one product gives scale advantage • Economies of scope: Producing different kind of products gives production advantage • High fixed costs with low opportunity value outside the business (sank costs), density advantages etc. AC(Y) P* D(Y) Y MES P Monopoly is probable AC(Y) D(Y) P* MES Y

13. What causes Monopolies? • Government regulation/public production in areas which have significant externalities (e.g. gambling, alcohol etc.) • History (e.g. Veikkaus) • Rent-seeking = an attempt to obtain economic rent by manipulating the social or political environment in which economic activities occur, rather than by creating new wealth. • To obtain having monopoly status in market or reduce competition, producer could have an interest to pay sum up to discounted value of future’s profits (e.g. by lobbing politicians)

14. Oligopoly • Most of the markets are not monopolies or purely competitive • Analysing the oligopoly market is harder than pure monopoly or competitive market • Ways to analyse oligopoly markets are e.g. Cournot (suppliers choose level of output) and Betrand (suppliers choose prices) oligopolies.

15. Oligopoly • Market power comes from product differentiation • By differentiation producer is aiming to make demand less price elastic • Monopolistic competition: Firms are having market power (demand curve is not flat) but they are experiencing competition due to other substitutes. • Eventually, when there exists enough suppliers with similar products, market has zero profits.

16. Why there are positive profits in gambling? • Violation of competitive market assumptions • 1.Notmany producers • Economies of scale and scope • Regulated markets (point 4.)

17. Why there are positive profits in gambling? • Violation of competitive market assumptions • 2.Products are heterogeneous • Product differentiation leads to market power (gambling companies can make demand less elastic) • Location • Brand • Games

18. Why there are positive profits in gambling? • Violation of competitive market assumptions • 3.Imperfect Information • Uncertainty is a core feature in gambling • Asymmetric information (!) • Gamblers may not even know the expected utilities (von Neumann-Morgenstern utility) • Consumers are not able to compare the products

19. Why there are positive profits in gambling? • Violation of competitive market assumptions • 4. No free entry • Regulation causes rents in market • Even if there are positive profits in market there is no possibility enter in market • Even the potential competition may cause competitive behaviour of monopoly

20. Why there are positive profits in gambling? • Breaking the pure competition assumptions does not directly implicate the positive profits but explains why they are possible • Product differentiation, asymmetric information, lack of competition etc. gives market power for producers and barriers in entering the market prevents the monopolistic competition to clear the profits • Earlier described classical monopoly and price discrimination mechanisms are the reasons why monopoly (or oligopoly) is able to make profit

21. Further questions Link • Q: How many firms are needed to generate competitive market? • A: Impossible to answer straight. This is dependent on elasticities, product differentiation… Oligopoly models are not giving any unequivocal answers • Q: Is it possible to estimate the monopoly power in market? • A: Possible but not easy. Market share, level of profits or any direct key number won’t tell about the monopoly power.