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To: Bearded One who wrote (17937)	3/6/1998 3:06:00 PM
From: Bearded One	Read Replies (1) \| Respond to of 24154

Supply/Demand curves and Economies of Scales with Monopolies and 'new' technologies. Suppose we have a company A which is the sole supplier of a product such as software. Software has a high fixed cost and very low (essentially zero) variable cost. That is, the cost of to make a billion copies is not much more than the cost of making 1 copy. Some have argued that in software, monopolies are good because of these zero variable costs, thus allowing lowering of prices with increased demand. But that is a misreading of basic economics. Here's an example. This first graph shows the demand curve for a given software product, as well as the 'profit' curve for monopoly company A which sells a software product: price \| \| d d: demand curve. How many consumers will purchase \| d the software at the given price? \| d \| a d \| a d a: Profit line of company A. How many copies does A \| a d have to sell at that price to break even? \| a d \| a d \| a +--------------------------- quantity The difference between the line a and d is the profit of company A per unit sale. As company A wants to maximize profits, they choose the point such that the unit profit * # of sales is maximized. Note that they do NOT choose the lowest price/highest quantity which would be the best for the consumer. price \| \| d \| d \| d \| a d \| a d<----- price/quantity point where company \| a d maximizes profit \| a d \| a d<-- much better point for the consumer \| a a not chosen, though still profitable +--------------------------- The ability to choose where on the demand curve you want to be is a signature of a monopoly. Now suppose another company (B) comes in with a higher fixed cost than A. Look what happens: price \| b \| d b \| d b \| d \| a bd \| a b d<---- price/quantity where company A \| a b d maximizes profits \| a b d \| a b d \| a b +--------------------------- Company (B) can make money by selling at a lower price point than the current market price. Even though their costs are greater than A, A is selling at a high enough price for B to move in. So B tries to take some of market by selling at a lower price than A. A lowers its price in response. As a result, we have a lower price overall, increasing demand. Thus we wind up with this graph: price \| b \| d b \| d b \| d \| a bd \| a b d<---- price/quantity where company A \| a b d maximizes profits \| a b d<---- lower price/more quantity \| a b d as a result of A/B competition \| a b +--------------------------- The consumer benefits because of the lower price and increased quantity. Now the question is, what does this have to do with the supply/demand curves? Well, the demand curve is the same as above. In the case where just company A exists, A can supply the demand at any price point. So it LOOKS like the supply curve is inverted. As company A's variable costs are zero, basically, the supply curve for company A is just a vertical line at the company's capacity, well above the demand curve. Something like this: price \| a \| a \| a \| a<- company A \| a supply curve \| a \| a \| a \| +--------------------------------- quantity Qa Let's add in another, less efficient company with less max capacity and higher fixed costs: price \| b a \| company b a \| B's b a \| supply b a<- company A \| curve b a supply curve \| ---->b a \| a \| a \| +--------------------------------- quantity Qb Qa Now let's add a third one in, with even less max capacity and higher fixed costs: price \| c b a \| c company b a \| c B's b a \| c supply b a<- company A \| ^ curve b a supply curve \| \| ---->b a \| \| a \| +---company C's curve a \| +--------------------------------- Qc quantity Qb Qa Now, let's add them together and see what we get: price \| ... \| a+b+c \| a+b+c \| a+b+c \| a+b+c \| a+b \| a+b \| a Supply curve of companies A,B, and C \| a +--------------------------------- Qc Qb Qa Qa+Qb Qa+Qb+Qc quantity Lo and behold!! an Upwardly Sloping Supply Curve! Thus, the more companies, the more upwardly sloping the supply curve, and the lower the prices.