Monopoly

Monopoly• A firm that is the sole seller of a product• No close substitutes• Many barriers to entry• Sources of market power:–Firm owns a key resource–Government gives a firm exclusive selling rights

(patents)–The costs of production make a single producer

more efficient than a larger number of producers

Natural Monopoly

• Market that run most efficiently when one large firm provides all of the output

• Firm’s costs continuously decrease with increased output when providing for entire market.

• What resources do you need for public water?

How do Monopolies Maximize Profits?

Let’s pretend that I wrote an economics book that explains the concepts of economics SO well that you

are GUARANTTEED to score a 5 on the A.P. Microeconomics exam. Also, it only takes one hour to read!!! Lastly, lets assume I was able to obtain a

patent for this amazing book.

Figure 3 Demand and Marginal-Revenue Curves for a Monopoly

Quantity of Vespernomics Textbooks

Price

$1110

9876543210

–1–2–3–4

1 2 3 4 5 6 7 8

First, lets review: What would my firm’s demand look like if the book sold in a competitive market?

In reality, do you think the demand for my book would really look like that?

P Qd TR MR

11 0

10 1

9 2

8 3

7 4

6 5

5 6

4 7

3 8

In reality, do you think the demand for my book would really look like that?

P Qd TR MR

11 0 0 -

10 1 10 10

9 2 18 8

8 3 24 6

7 4 28 4

6 5 30 2

5 6 30 0

4 7 28 -2

3 8 24 -4

Graph demand and MR for my books

Quantity of Vespernomics

Price

$1110

9876543210

–1–2–3–4

Demand(averagerevenue)

Marginalrevenue

1 2 3 4 5 6 7 8

If a monopoly wants to sell more, it must lower price.

Price falls for ALL units sold.

This is because monopolies are STILL impacted by the law of demand.

The dilemma for monopolies

• As a monopoly produces more, the price and revenue of their goods will fall

• WHY?????

So let’s go back to the main question, how do I maximize my profits!?!?

Remember profit maximization is where MR = MC

Quantity of Vespernomics

Price

$1110

9876543210

–1–2–3–4

Demand(averagerevenue)

Marginalrevenue

1 2 3 4 5 6 7 8

MC

- My profit maximization quantity is 5, where my MR = MC

- But, at that quantity, the five people who will buy the book are willing to spend $6

So, the firm would sell the good for $6

Inefficiency of Monopolies

FIRMS

BUYERS

The Deadweight Loss

• A monopoly sets a price above its MC–Price is higher than the market price–Quantity is lower than the market

quantity–This causes markets to be inefficient• Deadweight loss

Figure 8 The Inefficiency of Monopoly

Quantity0

PriceDeadweight

loss

DemandMarginalrevenue

Marginal cost

Efficientquantity

Monopolyprice

Monopolyquantity

Review: Monopoly Key Concepts • Monopoly's are able to charge a higher

price because they have high market power

• MR is below demand• The price that a monopoly sets is equal

to the demand at the profit maximizing production level (MR=MC)

• P > MC• Monopolies cause inefficient markets– Produce less and a higher price

Price Discrimination

Price Discrimination

• Selling the same good at different prices to different customers

Price Discrimination

• Selling the same good at different prices to different customers

• This can be done only if a firm:– Has market power– Can separate consumers into groups– Can prevent resale between consumers

Lets say I want to start selling the critically acclaimed book: Vespernomics

Let’s also assume that it costs me $5 to produce one book of Vespernomics

Now assume that there are two types of people who want to buy Vespernomics

• Type 1: These are the die hard readers. There are currently two type 1 people and are willing to spend $50 for the book

• Type 2: These are the, “I just want to make Mr. Vesper happy so I can pass” readers. There are currently five type 2 people and are willing to spend $10 for the book

I can sell the book for $50 and make a profit of $90. But, there would be 5 students who don’t have the book.

I can sell the book for $10 and make a profit of $25. Obviously, a much

smaller profit.

Now assume I can price discriminate

• Type 1: The die hard readers

• I can sell them the books for $50 and make a profit of $90

• Type 2: The “just want to pass” readers

• I can sell them the book for $10 and make a profit of $25

So, as a firm, I make the most profit possible of $115 AND everyone who wanted the book will be able to obtain it.

THE BIG IDEA

Contrary to popular belief, price discrimination actually makes a market

more efficient! More consumers are able to purchase the product and there

is less surplus lost (deadweight loss). The monopoly firm will just share most

of the surplus.

Final Question

If a firm can PERFECTLY price discriminate, who would obtain all of

the surplus?

Natural Monopolies

All of you used a good/service today produced by a natural monopoly…

Natural Monopoly

• A monopoly that exists because it would be most efficient for the market

• A natural monopoly provides a good/service to the entire market at a smaller cost than two or more firms– Natural monopoly is always in economies of scale– The firm’s ATC is still decreasing when it earns

normal profit (where ATC = D)

Natural Monopoly

Regulating Natural Monopolies

• The government sets the price and quantity• The regulated price is where the natural

monopoly earns normal profit– When price = ATC

Regulating Natural Monopolies

MC