Monopoly

Monopoly

is a situation in which there is a single seller of a product for which there are no good substitutes.

When a monopoly exists, there are generally high barriers to entry into the industry.

What are the reasons for these barriers?

(1) Legal Barriers

patent - grant of an exclusive right to use a specific process or produce a specific product for a period of time (17 years in the U.S.)

licenses and franchises - permission, granted by a government, to enter an industry or occupation

(2) A single firm has sole control of a resource essential to an industry.

(3) Economies of Scale

Costs per unit in an industry may be low only when a firm produces a lot of output.

Consequently, small firms will be unable to enter the industry because costs are too high.

Market Demand Curve

price

quantity

Demand

Because the monopoly firm is the only seller of a good, the market demand curve for the good is the same as the demand curve for the firm’s product.

This is not true for the monopolist.

Remember for a perfectly competitive firm: MR = P.

For a monopolist, MR < P.So the MR curve lies below the demand curve.

Quantity Price TR MR

10 20 200 ---

11 19 209 9

Drawing the MR curve when the demand curve is a straight line: MR has the same Y-intercept and is twice as steep as the demand curve .

$

quantity

DemandMR

Determining the optimal output

and price, and the maximum profit:

7 Steps

Step 1 a. Draw and label the axes.

$

quantity

Step 1 b. Draw and label the ATC and MC curves.

ATCMC

$

quantity

Step 1 c. Draw and label the D and MR curves.

ATCMC

MR D

$

quantity

Step 2: Find the profit-maximizing output where MR = MC

ATCMC

MR D

$

quantityQ*

Step 3: Determine the price from the demand curve, above Q*.

ATCMC

MR D

quantity

$

Q*

P*

Step 4: Determine the cost per unit from the ATC curve, above Q*.

ATCMC

MR D

quantity

$

Q*

P* ATC*

Step 5: Determine the TR = PQ box.

ATCMC

MR D

quantity

$

Q*

P* ATC*

Step 6: Determine the TC = ATC . Q box.

ATCMC

MR D

quantity

$

Q*

P* ATC*

Step 7: Find profit = TR - TC.

ATCMC

MR D

quantity

$

Q*

P* ATC*

profit

In the previous set of graphs, the monopolist was earning a positive economic profit.It is also possible for the monopolist to have a loss or to breakeven.Let’s look at a monopolist with a loss.

Step 1: Draw and label the axes and curves. (For a loss, the ATC curve must be entirely above D.)

ATCMC

MR D

$

quantity

AVC

Step 2: Find the profit-maximizing (or loss-minimizing) output where MR = MC

ATCMC

MR D

$

quantityQ*

AVC

Step 3: Determine the price from the demand curve, above Q*.

ATCMC

MR D

$

quantityQ*

P*

AVC

Step 4: Determine the cost per unit from the ATC curve, above Q*.

ATCMC

MR D

$

quantityQ*

ATC* P*

AVC

Step 5: Determine the TR = PQ box.

ATCMC

MR D

$

quantityQ*

ATC* P*

AVC

Step 6: Determine the TC = ATC . Q box.

ATCMC

MR D

$

quantityQ*

ATC* P*

AVC

Step 7: Find profit or loss = TR - TC.

ATCMC

MR D

$

quantityQ*

ATC* P*

lossAVC

A Monopolist Breaking Even (Zero Economic Profit)

Step 1: Draw and label the axes and curves. (To break even, D must be tangent to the ATC curve.)

ATCMC

MR D

$

quantity

Step 2: Find the profit-maximizing output where MR = MC

ATCMC

MR D

$

quantityQ*

Step 3: Determine the price from the demand curve, above Q*.

ATCMC

MR D

$

quantityQ*

P*

Step 4: Determine the cost per unit from the ATC curve, above Q*.

ATCMC

MR D

$

quantityQ*

ATC* = P*

Step 5: Determine the TR = PQ box.

ATCMC

MR D

$

quantityQ*

ATC* = P*

Step 6: Determine the TC = ATC . Q box.

ATCMC

MR D

$

quantityQ*

ATC* = P*

Step 7: Find profit = TR - TC. Since TR = TC, = 0

ATCMC

MR D

$

quantityQ*

ATC* = P*

Monopoly Possibilities

short run: positive profits, losses, or breaking even.

long run: positive profits, or breaking even.

What is bad about monopoly?

Consumer options are limited. Profits do not signal firms to enter the industry.

(They can’t get in because of the barriers to entry.)

There is allocative inefficiency. ( P > MC ) The monopolist does not produce all units that consumers value more than it costs to make them.

Allocative Inefficiency ( P* > MC* )

ATCMC

MR D

quantity

$

Q*

P* ATC*

MC*

Natural Monopoly

a situation in which ATC declines continually with increased output.

So a single firm would be the lowest cost producer of the output demanded.

ATC doesn’t turn upward until a very high output level, beyond the amounts that consumers will buy.

ATC

$

quantity

Remember: the MC curve is below the ATC curve when ATC is sloping downward.

ATCMC

$

quantity

Draw the demand and MR curves.

ATCMC

MRD

$

quantity

What can the government do about a natural monopoly?

government take over the industry let it operate freely government regulation of monopolist

Natural Monopoly: operating freely

ATCMC

MRD

$

quantityQ*

P*

Regulation

marginal cost pricing (P = MC) average cost pricing (P = ATC)

Natural Monopoly: marginal cost pricing regulation

ATCMC

MR

D$

quantity

Pm

Qm

Natural Monopoly: marginal cost pricing regulation

ATCMC

MR

D$

quantity

Pm

Qm

P < ATC Firm has a loss! So this won’t work.

Natural Monopoly: Average Cost Pricing Regulation

ATCMC

MRD

$

quantityQa

Pa

Natural Monopoly: Average Cost Pricing Regulation

ATCMC

MRD

$

quantityQa

Pa

Zero economic profits: this can work.