Copyright © 2004 South-Western Monopoly vs. Competition While a competitive firm is a price taker, a monopoly firm is a price maker. A firm is considered

Copyright © 2004 South-Western

Monopoly vs. Competition

• While a competitive firm is a price taker, a monopoly firm is a price maker.

• A firm is considered a monopoly if . . .• it is the sole seller of its product.• its product does not have close substitutes.• No competition (lollipop game).

• Monopoly power arises from barriers to entry.


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 single producer more efficient than a large number of producers.



• Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason.

• Diamonds, Oil



• Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.

• Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.



• A natural monopoly arises when a single firm can supply a good or service to an entire market at a smaller cost than many competing firms.

• A natural monopoly arises when there are economies of scale over a large range of output.

Economies of Scale as a Cause of Monopoly


Quantity of Output

Averagetotalcost

0

Cost


HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS

• Monopoly versus Competition• Monopoly

• Sole producer

• Unique product

• Price maker

• Positive Economic Profit (entry/exit)

• Competitive Firm

• Many producers

• Identical product

• Price taker

• Zero economic profit (entry/exit)


Profit Maximization

• A monopoly maximizes profit by producing the quantity at which MR = MC.

• Restrict Q below where Demand intersects MC.

• It then uses the demand curve to find the P that will induce consumers to just buy that Q.

• Market power, price maker, mark-up (P > MC).


Profit Maximization

• Profit equals total revenue minus total costs.• Profit = TR - TC

• The monopolist will receive economic profits as long as the P the market is willing to pay results in TR > TC.

• This can be a long run equilibrium (entry barrier).


THE WELFARE COST OF MONOPOLY

• A monopolist restricts Q and marks-up P.

• For consumers, this combination of low Q and high P makes monopoly undesirable.

• However, for the firm, this monopoly power is very desirable (positive economic profit).


Inefficiency of Monopoly

• Because a monopoly restricts the quantity and marks the price up above marginal cost, it places a wedge between the consumer’s willingness to pay (D) and the producer’s cost of production (MC) .

• This outcome is inefficient compared to perfect competition.

• Units not produced and consumed that could benefit society.

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

monopolist

Valueto

buyers

Valueto

buyers

Efficientquantity


Figure 10 Welfare with Single Price Monopolist


Profit

(a) Monopolist with Single Price

Price

0 Quantity

Deadweightloss

DemandMarginalrevenue

Consumersurplus

Quantity sold

Monopolyprice

Marginal cost


Monopoly: Good or Bad?

• Good – new innovative products • Prescription drugs, technology (R&D)

• Bad• Restricted output, higher prices

• Government subsidy…..higher taxes• Patents…..higher prices

• You Choose!


PRICE DISCRIMINATION

• Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.

• Perfect price discrimination occurs when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.


Figure 10 Welfare with Monopoly Price Discrimination


Profit

(b) Monopolist with Perfect Price Discrimination

Price

0 Quantity

Demand

Marginal cost

Quantity sold



• More likely lower degree of price discrimination.• Segment markets

• Prevent re-sale from low WTP to high WTP markets

• Two important effects of price discrimination:• Increase the monopolist’s profits

• Lessen inefficiency (more output)



• Examples of Price Discrimination

• Movie tickets

• Airline tickets

• Discount coupons

• Quantity (volume) discounts

• Financial aid

• Prescription drugs

• If airlines sold paint


CONCLUSION: THE PREVALENCE OF MONOPOLY

• How prevalent are monopolies?

• Monopoly power is relatively common.

• Most firms have some control over their prices because of differentiated products.

• Firms with substantial monopoly power are rare.

• Few goods are truly unique.

• The story of Cooperatives.


Summary

• A monopoly firm is the only seller in its market.

• Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal (MR = MC).

• Unlike a competitive firm, market power allows a mark-up of price above marginal cost (P > MC).


Summary

• A monopolist’s profit-maximizing output is below the level that maximizes the sum of consumer and producer surplus (where D intersects MC).

• In this respect, monopoly power is bad for consumers, but good for the monopolist.

• Welfare economics suggests monopoly power is undesirable for society.


Summary

• Monopoly power can also be considered good for society in the following ways.

• Natural monopoly results in lower price than competition, but must be regulated.

• Patents give incentive to produce goods that may otherwise never be produced, but at high prices.


Summary

• Monopoly profits can be increased by charging different prices to different buyers based on their willingness to pay.

• Price discrimination lessens inefficiency, but gives most of the gains to monopolist.

Documents

Copyright © 2004 South-Western Monopoly vs. Competition While a competitive firm is a price taker, a monopoly firm is a price maker. A firm is considered