MicroconomicsRittenberg

Chapter 10Monopoly

What is a Monopoly?

2

A monopoly is a market structure in which there is a single supplier of a product.

The monopolist:May be small or large.Must be the ONLY supplier of the product.Sells a product for which there are NO close

substitutes. (The greater the number of close substitutes for a firm’s products, the less likely it is that the firm can exercise monopoly power.

Monopolies are fairly common: U.S. Postal Service, local utility companies, local cable providers, etc.

The Creation of Monopolies

3

Monopolies often arise as a result of barriers to entry.

Barrier to entry: anything that impedes the ability of firms to begin a new business in an industry in which existing firms are earning positive economic profits. There are three general classes of barriers to entry:Natural barriers, the most common being

economies of scaleNetwork effectsActions by firms to keep other firms outGovernment (legal) barriers

Economies of Scale

4

In some industries, the larger the scale of production, the lower the costs of production.

Entrants are not usually able to enter the market assured of or capable of a very large volume of production and sales.

This gives incumbent firms a significant advantage.

Examples are electric power companies and other similar utility providers.

Monopoly based on Economies of Scale

5

Actions by Firms

6

Entry is barred when one firm owns an essential resource.

Examples are inventions, discoveries, recipes, and specific materials.Microsoft owns Windows, and has been challenged by the U.S. Dept. of Justice as a monopolist.

Government

7

Governments often provide barriers, creating monopolies.

As incentives to innovation, governments often grant patents, providing firms with legal monopolies on their products or the use of their inventions or discoveries for a period of 17 years.

Types of Monopolies (Alt. Text)

8

Natural monopoly: A monopoly that arises from economies of scale. The economies of scale arise from natural supply and demand conditions, and not from government actions.Local monopoly: a monopoly that exists in a

limited geographic area.Regulated monopoly: a monopoly firm

whose behavior is overseen by a government entity.

Monopoly power: market power, the power to set prices.

Monopolization: an attempt by a firm to dominate a market or become a monopoly.

Kinds of Monopoly (Dolan Text) A closed monopoly is protected by

legal restrictions on competition. For example, state law in Washington prevents anyone from offering competing car ferry service to islands served by the Washington State Ferry System.

A natural monopoly is an industry in which long-run average cost is minimized when just one firm serves the entire market. Distribution of natural gas to residential customers is an example.

3. An open monopoly is a case in which a firm becomes, at least for a time, the sole supplier of a product without having the special protections against competition that is enjoyed by a closed or natural monopoly. An example is Sony’s first home video cassette recorder.

Washington State Ferry at Lopez Island

Picture by E. Dolan

Clicker: 2 pointsIf a monopoly exists because of huge

economies of scale across the whole range of demand for the product, it could be called a/an:

A.Closed MonopolyB.Competitive MonopolyC.Natural MonopolyD.Open MonopolyE.Regulated Monopoly

The Demand Curve Facing a Monopoly Firm

11

In any market, the industry demand curve is downward-sloping. This is the result of the law of demand.

In Monopoly the monopolist IS the industry because it is the sole producer.

Therefore the monopolist faces a downward-sloping demand curve. The industry demand curve is the firm’s demand curve.

Marginal Revenue

12

Marginal Revenue (MR) is:

MR is less than price for a monopoly firm.

The MR is less than price and declines as output increases because the monopolist must lower the price in order to sell more units (because the demand curve slopes downward).

QTR

MR

Demand Curve for a Monopolist

13

Q Price TR MR

1 $1,700 $ 1,700 $1,700

2 $1,650 $ 3,300 $1,600

3 $1,600 $ 4,800 $1,500

4 $1,550 $ 6,200 $1,400

5 $1,500 $ 7,500 $1,300

6 $1,450 $ 8,700 $1,200

7 $1,400 $ 9,800 $1,100

8 $1,350 $10,800 $1,000

9 $1,300 $11,700 $ 900

Average Revenue

14

Whenever MR is greater than AR, AR rises.Whenever MR is less than AR, AR falls.Average revenue is:

Note that the AR is the same as price. In fact, the AR curve is the demand curve.

With a downward-sloping demand curve, prices fall as output increases. This means that AR falls.

MR must always be less than AR.

PQQP

AR

From the text but not very useful

For A Monopolist: Marginal Revenue IS NOT Price

15

The MR Curve for a downward sloping, linear demand curve:

Is always below the demand curve

Sits half-way between the demand curve and the Y axis

In other words it is half-way between the quantity on the Demand curve and a quantity of Zero

Demand and Revenue for the

Monopolist

16

Monopoly firms NEVER chose to produce in the inelastic range of their demand curve.

Monopoly firms will always withhold product to keep their sales in the Elastic or Unit Elastic range of their demand curve.

Monopoly Profit Maximization

17

The monopolist will not set the price arbitrarily high.

For the monopolist, the profit-maximizing price still corresponds to the point where MR=MC.

The monopolist’s market power will allow the firm to achieve above-normal profits.

Unlike Perfect Competition, in Monopoly:

MR < Price & MR < Demand Curve

Profit Maximizing Monopoly

Monopoly Firms pick their profit maximizing quantity where:

MR=MC

The price is determined by the Demand Curve at that Quantity

D

Monopoly Profit Solution

Price is the intersection of the Monopoly Quantity with the Demand Curve

Cost is found at the intersection of the quantity with the firm’s Average Total Cost Curve at the selected quantity

Cost

Profit Maximization

20

Price is the intersection of the Monopoly Quantity with the Demand Curve

Cost is found at the intersection of the quantity with the firm’s Average Total Cost Curve at the selected quantity

Clicker:

D

To maximize profit this monopoly firm would produce where:A.ATC = Demand B.Demand = MCC.Demand = SupplyD.MC = PriceE.MR = MC

Clicker:

D

To maximize profit this monopoly firm would produce quantity:

A.MB.N C.QD.R E.We can’t tell

Clicker:

D

To maximize profit this monopoly firm would charge consumers Price:

A.AB.B C.CD.DE.We can’t tell

Clicker

D

This profit maximizing monopoly’s profit is shown by the area:

A.AFHCB.AFGBC.DJKCD.AFMOE.BGMO

Clicker

D

This profit maximizing monopoly’s total revenue is shown by the area:

A.AFHCB.AFGBC.DJKCD.AFMOE.BGMO

Clicker

D

This profit maximizing monopoly’s total cost is shown by the area:

A.AFHCB.AFGBC.DJKCD.AFM0E.BGMO

Price Discrimination

27

Under certain conditions, a firm with market power is able to charge different customers different prices. This is called price discrimination.

Necessary Conditions for Price Discrimination

28

For price discrimination to work, the firm must be able to set the price.The firm cannot be a price taker.

The firm must be able to “segment the market”. That is, the firm must be able to:Separate the customersPrevent resale of the product

Price Discrimination in Action

29

REAL WORLD PRICE DISCRIMINATIONMovie theaters…

AgeMatinee

RestaurantsKids menuSeniors menu/discountsEarly-bird specials (early dinner

AirlinesBusiness classAdvance bookingStaying over Saturday

Others???

New slide – not posted on Web

Price Discrimination

31

With Price discrimination the firm captures part of the “Consumer Surplus” and makes it part of “Producer Surplus.”

That adds to revenue and profit.

New slide – not posted on Web

Monopoly and Perfect Competition: Comparison

32

Clicker

D

This profit maximizing monopoly’s total cost is shown by the area:

A.AFHCB.AFGBC.DJKCD.AFM0E.BGMO