Ch8 Monopoly

7/27/2019 Ch8 Monopoly

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Monopoly


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Monopoly

While a competitive firm is apricetaker, a monopoly firm is aprice

maker.


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A firm is considered amonopolyif ...

It is the sole seller of its product. Its product does not have close

substitutes.


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WHY MONOPOLIES ARISE The fundamental cause of monopoly

is barriers to entry.


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WHY MONOPOLIES ARISE Barriers to entry have three

sources:

Ownership of a key resource. The government gives a single firm the

exclusive right to produce some good.

Costs of production make a singleproducer more efficient than a largenumber of producers.


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Monopoly Resources Although exclusive ownership of a

key resource is a potential source of

monopoly, in practice monopoliesrarely arise for this reason.


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Government-Created Monopolies Governments may restrict entry by

giving a single firm the exclusive

right to sell a particular good incertain markets.


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Government-Created Monopolies Patent and copyright laws are two

important examples of how

government creates a monopoly toserve the public interest.


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Natural Monopolies An industry is a natural monopoly

when a single firm can supply a

good or service to an entire marketat a smaller cost than could two ormore firms.


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Natural Monopolies A natural monopolyarises when

there are economies of scale over

the relevant range of output.

Fi 1 E i f S l C f


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Figure 1 Economies of Scale as a Cause ofMonopoly

Copyright 2004 South-Western

Quantity of Output

Averagetotalcost

0

Cost

HOW MONOPOLIES MAKE


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HOW MONOPOLIES MAKEPRODUCTION AND PRICINGDECISIONS Monopoly versus Competition

Monopoly Is the sole producer

Faces a downward-sloping demand curve Is a price maker

Reduces price to increase sales Competitive Firm

Is one of many producers

Faces a horizontal demand curve

Is a price taker

Sells as much or as little at same price

Fi 2 D d C f C titi


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Figure 2 Demand Curves for Competitiveand Monopoly Firms


Quantity of Output

Demand

(a) A Competitive Firms Demand Curve (b) A Monopolists Demand Curve

0

Price

Quantity of Output0

Price

Demand


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A Monopolys Revenue Total Revenue

P Q = TR

Average Revenue

TR/Q = AR = P

Marginal Revenue

DTR/DQ = MR

T 1 A M T t A


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Ta e 1 A Monopo y s Tota , Average,and Marginal Revenue

Copyright2004 South-Western


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A Monopolys Revenue A Monopolys Marginal Revenue

A monopolists marginal revenue is

always less than the price of its good. The demand curve is downward sloping.

When a monopoly drops the price to sellone more unit, the revenue received from

previously sold units also decreases.


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A Monopolys Revenue A Monopolys Marginal Revenue

When a monopoly increases the

amount it sells, it has two effects ontotal revenue (PQ).

The output effectmore output is sold, soQ is higher.

The price effectprice falls, so Pis lower.

Figure 3 Demand and Marginal Revenue


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Figure 3 Demand and Marginal-RevenueCurves for a Monopoly


Quantity of Water

Price$11

109876543210

12

3

4

Demand(averagerevenue)

Marginalrevenue

1 2 3 4 5 6 7 8


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Profit Maximization A monopoly maximizes profit by

producing the quantity at which

marginal revenue equals marginalcost.

It then uses the demand curve to

find the price that will induceconsumers to buy that quantity.


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Figure 4 Profit Maximization for a Monopoly


QuantityQ Q0

Costs andRevenue

Demand

Average total cost

Marginal revenue

Marginalcost

Monopolyprice

QMAX

B

1. The intersection of themarginal-revenue curveand the marginal-costcurve determines theprofit-maximizingquantity . . .

A

2. . . . and then the demandcurve shows the priceconsistent with this quantity.


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Profit Maximization

Comparing Monopoly andCompetition For a competitive firm, price equals

marginal cost.

P = MR = MC

For a monopoly firm, price exceedsmarginal cost.

P > MR = MC


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A Monopolys Profit Profit equals total revenue minus

total costs.

Profit = TR - TC Profit = (TR/Q - TC/Q) Q

Profit = (P-ATC) Q


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Figure 5 The Monopolists Profit


Monopolyprofit

Averagetotalcost

Quantity

Monopolyprice

QMAX

0

Costs andRevenue

Demand

Marginal cost

Marginal revenue

Average total cost

B

C

E

D


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A Monopolists Profit The monopolist will receive

economic profits as long as price is

greater than average total cost.


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Figure 6 The Market for Drugs


Quantity0

Costs andRevenue

DemandMarginalrevenue

Priceduringpatent life

Monopolyquantity

Price afterpatent

expiresMarginalcost

Competitivequantity


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THE WELFARE COST OFMONOPOLY In contrast to a competitive firm, the

monopoly charges a price above themarginal cost.

From the standpoint of consumers, thishigh price makes monopoly undesirable.

However, from the standpoint of the

owners of the firm, the high price makesmonopoly very desirable.


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Figure 7 The Efficient Level of Output


Quantity0

Price

Demand(value to buyers)

Marginal cost

Value to buyersis greater thancost to seller.

Value to buyersis less thancost to seller.

Costto

monopolist

Costto

monopolistValue

tobuyers

Valueto

buyers

Efficientquantity


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The Deadweight Loss Because a monopoly sets its price

above marginal cost, it places a

wedge between the consumerswillingness to pay and theproducers cost.

This wedge causes the quantity sold tofall short of the social optimum.


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Figure 8 The Inefficiency of Monopoly


Quantity0

PriceDeadweight

loss


Marginal cost

Efficientquantity

Monopolyprice

Monopolyquantity


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The Deadweight Loss

The Inefficiency of Monopoly The monopolist produces less than the

socially efficient quantity of output.


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The Deadweight Loss The deadweight loss caused by a

monopoly is similar to the

deadweight loss caused by a tax. The difference between the two

cases is that the government gets

the revenue from a tax, whereas aprivate firm gets the monopolyprofit.


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PUBLIC POLICY TOWARDMONOPOLIES Government responds to the

problem of monopoly in one of fourways. Making monopolized industries more

competitive.

Regulating the behavior of monopolies.

Turning some private monopolies intopublic enterprises.

Doing nothing at all.


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Antitrust Laws/ MRTP Antitrust laws are a collection of statutes

aimed at curbing monopoly power.

Antitrust laws give government variousways to promote competition.

They allow government to prevent mergers.

They allow government to break up

companies. They prevent companies from performing

activities that make markets less competitive.


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Regulation Government may regulate the prices

that the monopoly charges.

The allocation of resources will beefficient if price is set to equal marginalcost.

Figure 9 Marginal-Cost Pricing for a Natural


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Figure 9 Marginal Cost Pricing for a NaturalMonopoly


Loss

Quantity0

Price

Demand

Average total costRegulated

price Marginal cost

Average totalcost


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Regulation In practice, regulators will allow

monopolists to keep some of the

benefits from lower costs in the formof higher profit, a practice thatrequires some departure frommarginal-cost pricing.


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Public Ownership Rather than regulating a natural

monopolythat is run by a private

firm, the government can run themonopoly itself (e.g. in India, thegovernment runs the Postal Service,Railways).


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Doing Nothing Government can do nothing at all if

the market failure is deemed small

compared to the imperfections ofpublic policies.


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PRICE DISCRIMINATION Price discrimination is the business

practice of selling the same good at

different prices to differentcustomers, even though the costsfor producing for the two customersare the same.


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PRICE DISCRIMINATION Price discrimination is not possible when a

good is sold in a competitive market sincethere are many firms all selling at the

market price. In order to pricediscriminate, the firm must have somemarket power.

Perfect Price Discrimination Perfect price discrimination refers to the

situation when the monopolist knows exactlythe willingness to pay of each customer andcan charge each customer a different price.


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PRICE DISCRIMINATION Two important effects of price

discrimination:

It can increase the monopolists profits. It can reduce deadweight loss.

Figure 10 Welfare with and without Price


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Figure 10 Welfare with and without PriceDiscrimination


Profit

(a) Monopolist with Single PricePrice

0 Quantity

Deadweightloss


Consumersurplus

Quantity sold

Monopolyprice

Marginal cost

Figure 10 Welfare with and without Price


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Figure 10 Welfare with and without PriceDiscrimination


Profit

(b) Monopolist with Perfect Price DiscriminationPrice

0 Quantity

DemandMarginal cost

Quantity sold


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PRICE DISCRIMINATION Examples of Price Discrimination

Movie tickets

Airline prices Discount coupons

Financial aid

Quantity discounts


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PREVALENCE OFMONOPOLY How prevalent are the problems of

monopolies?

Monopolies are common. Most firms have some control over their

prices because of differentiatedproducts.

Firms with substantial monopoly powerare rare.

Few goods are truly unique.


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Summary A monopoly is a firm that is the sole

seller in its market.

It faces a downward-sloping demandcurve for its product.

A monopolys marginal revenue is

always below the price of its good.


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Summary Like a competitive firm, a monopoly

maximizes profit by producing the

quantity at which marginal cost andmarginal revenue are equal.

Unlike a competitive firm, its price

exceeds its marginal revenue, so itsprice exceeds marginal cost.


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Summary A monopolists profit-maximizing

level of output is below the level

that maximizes the sum ofconsumer and producer surplus.

A monopoly causes deadweight

losses similar to the deadweightlosses caused by taxes.


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Summary Policymakers can respond to the

inefficiencies of monopoly behavior

with antitrust laws, regulation ofprices, or by turning the monopolyinto a government-run enterprise.

If the market failure is deemedsmall, policymakers may decide todo nothing at all.


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Summary Monopolists can raise their profits by

charging different prices to different

buyers based on their willingness topay.

Price discrimination can raise

economic welfare and lessendeadweight losses.

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Ch8 Monopoly