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

    Copyright 2004 South-Western

    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

    Copyright 2004 South-Western

    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

    Copyright 2004 South-Western

    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

    Copyright 2004 South-Western

    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

    Copyright 2004 South-Western

    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

    Copyright 2004 South-Western

    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

    Copyright 2004 South-Western

    Quantity0

    PriceDeadweight

    loss

    DemandMarginalrevenue

    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

    Copyright 2004 South-Western

    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 lo