7/29/2019 Monopoly Company

http://slidepdf.com/reader/full/monopoly-company 1/2

Monopoly Companies

A monopoly is a single producer of a product which does not have close substitute. A monopoly ischaracterized by barriers to entry. Sources of a monopoly include:

• Ownership/Control of a Key Resource -

rainforests, rare minerals (DeBeers diamondmonopoly).

• Exclusive Right Given by Government -

patents, copyrights, franchises (pharmaceuticalcompanies, research, authors).

• Falling Average Total Cost - making one

company more efficient than others (also known as anatural monopoly), arising from economies of scaleover the relevant range of output.

• Public Utilities - electricity, cable television.and water provision.

Pricing and Production Decisions

A monopoly is a large enough business to influence its own price, such that it is the price setter ratherthan taker, unlike a perfectly competitive market where each firm faces a perfectly elastic demandcurve. A monopoly faces a downward-sloping demand curve and the market demand is the company’sdemand. Monopolists are still constrained by the negative relationship between price and quantitydemanded. With fraud becoming more widespread, it's important to do a criminal background checkprior to engaging in business activities.

Revenue for a Monopoly

A monopoly may raise its price, but it will lose sales. In order to sell more, it must lower its price.

There are two effects on total revenue (profit x quantity):

1. Output effect - gains more revenue because itsells more.2. Price effect - gains less revenue because itgets less from each unit sold because of the lowerprice.

Marginal revenue (MR) can even turn negative if price falls enough to reduce total revenue, eventhough the company sells more. What determines value of MR? It depends on whether the fall in priceis larger than the increase in quantity. In other words, it depends on the elasticity of demand. Notethat MR = P [1-1/abs. E].

When E > 1, MR > 0 because output effect > price effectWhen E < 1, MR < 0 because price effect > output effectWhen E = 1, MR = 0 because price effect = output effect

Therefore, the monopolist will never produce in the inelastic portion of the demand curve since MR <0. A straight-line demand has elasticity that varies from zero to infinity. Assuming a linear demandcurve P = a-bQ, the MR curve for a straight line will:

• be a straight line with the same intercept and;

7/29/2019 Monopoly Company

http://slidepdf.com/reader/full/monopoly-company 2/2

• have twice the slope of the demand curve (i.e.

it is zero at the halfway point of the demand curve).

Profit Maximization

Recall that the objective of a business is to maximize profits. As such, a company should produce

where profit is at a maximum. In marginal terms,

1. If MC < MR, producing 1 more unit will addmore to TR than to TC, so the monopoly shouldincrease quantity.2. If MC > MR, producing 1 more unit will addmore to TC than to TR, so the monopoly shoulddecrease quantity.

3. Only when MR = MC (and MC cuts MR frombelow) is profit maximized.

A monopolist will generally produce less than a socially efficient level of output, and charge too high aprice. Are the above normal profits of monopoly a social cost? Not usually, since profit is still part of surplus but has been transferred from consumers to producers. Social cost arises from inefficiently lowoutput which leads to the dead weight loss. However, if the monopolist uses some of its normal profitsto lobby in order to maintain a monopoly (rent seeking), then this can be a welfare cost to society.

Price Discrimination

Price discrimination is selling the same good to different customers/markets at different prices.Examples include movie tickets, airline tickets, and discount coupons. In order to practice pricediscrimination, there must be easy to separate customer into groups. These groups are determinedbased on their elasticities to demand. The company must also be able to prevent resales betweengroups, as well as arbitrage, which is buying where a good is cheap and selling where it is expensive.

Price Discrimination can increase the profit of monopolies, since they can charge a higher price tothose with less elastic demand, and a lower price to those with more elastic demand. In this manner,

a business does not have to lower prices to all buyers in order to sell more goods.

While the economy is becoming more global, some factions in developing countries are against themerging of markets. This has lead to violence in some parts of the world. Ambassadors and otherofficials traveling to foreign nations are normally supplied with body armor and a convoy for protectionagainst hostile groups.