Download Lab 13 Monopoly

Lab 13 Monopoly
1. Monopoly
1.1 Definition: A Monopoly is a firm that is the only seller of a good or service that does not have a
close substitute. Example: electric company, Microsoft
1.2 Monopoly V.S. Perfectly competitive market
Number of firms
Type of product
Easy to enter or not
Take or make price
Perfect
Competition
Many firms
Identical Product
No barrier
Price Taker
Monopoly
Only One
Unique product
Entry blocked
Price Maker
Profit-max condition
P=MC=MR
P>MR=MC
2. Why monopoly exists?
To form a monopoly in the market, the barriers to entering the market must be so high that no other
firms can enter. Usually, there are four reasons to create a monopoly:
1) Government blocks the entry of more than one firm into a market.
Usually, government blocks entry in two ways:
a) By granting a patent or copyright to an individual or firm, giving it the exclusive right to
produce a product. Ex: patent on Windows operating system, copyright on a textbook
b) By granting a firm a public franchise, making it the exclusive legal provider of a good or
service.
2) One firm has control of a key resource necessary to produce a good.
Ex: The De Beers Diamond Company can form a monopoly since it controls most of Diamond
resource in the world.
3) There are important network externalities in supplying the good or service
Network externalities mean that in the consumption of a product, the usefulness of the product
increases with the number of people who use it. Network externalities can serve as a barrier to entry
since consumers are more likely to choose products from companies in which network externalities
are already formed and new company usually find it hard to attract new consumers.
4) Economies of scale are so large that one firm has a natural monopoly
A natural monopoly occurs when economies of scale are so large that one firm can supply the entire
market at a lower average total cost than two or more firms, which means that at the point where
demand curve intersect ATC curve, ATC curve is still decreasing. See the graph on the next page.
When there is only one firm in the market, ATC for producing one kilowatt-hour is $0.04 (at point
A). When there are two firms in the market, ATC for producing one kilowatt-hour is driven to $0.06
(at point B). In this case, if one of firms expends production, it will move down the ATC curve.
With lower average cost, this firm can drive other firm out of business and become (natural)
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monopoly in the market. Natural monopoly is most likely to occur in markets where fixed costs are
very large relative to variable costs.
3. Profit maximization for monopoly firm
1) For any profit maximization firm (including monopoly firm), necessary condition is always
MR=MC
2) For a monopoly firm:
Market demand curve=Firm demand curve: DOWNWARD sloping curve
3) Marginal Revenue curve is also a downward sloping curve below demand curve
4) How to find the monopoly level of output and monopoly price?
Step 1: Find the point where MC = MR. Find the Qm
Step 2: Find the Pm on the demand curve where Q=Qm.
5) Profit for monopoly firm= (Pm -ATC)*Qm
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4. Efficiency loss from monopoly
A monopoly firm will produce less and charge a higher price than would a perfectly competitive
industry producing the same good. See the graph and table below for its welfare analysis.
D
E
F
Competitive market
Monopoly market
Consumer Surplus
A+B+D
D
Producer Surplus
C+E+F
A+E+F
Economic Surplus
A+B+C+D+E+F
A+D+E+F
Deadweight Loss
0
B+C
Efficient
Yes
No
A is consumer surplus transfer from consumer to monopoly firm
5. Government regulation toward monopoly
a) Antitrust Laws: laws aimed at eliminating monopoly or collusion and promoting competition among
firms.
b) Market Power: The ability of charging P>MC
c) Horizontal Merger: two firms are in same industry. Ex.: Exxon and Mobile
d) Vertical Merger: two firms are in different production stage.
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Exercise:
1. (3.3 Page 500) Ed Scahill has acquired a monopoly on the production of baseballs (don’t ask
how), and faces the demand and cost situation given in the following table:
a. Fill in the remaining values in the table.
Price
$20
19
18
17
16
15
Quantity (per
week)
15,000
20,000
25,000
30,000
35,000
40,000
Total
Revenue=P*Q
$300,000
380,000
450,000
510,000
560,000
600,000
Marginal
Revenue=∆𝐓𝐑/∆𝐐
$16
14
12
10
8
Total Cost
$330,000
365,000
405,000
450,000
500,000
555,000
Marginal
Cost=∆𝐓𝐂/∆𝐐
$7
8
9
10
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b. If Ed wants to maximize profits, what price should he charge and how many baseballs should he
sell? How much profit will he make?
Answer: Ed should choose price and quantity where Marginal Revenue equal to Marginal Cost. So he
should charge price= $16 and should sell quantity=35,000.
Profit= TR-TC=560,000-500,000=$60,000
c. Suppose the government imposes a tax of $50,000 per week on baseball production. Now what
price should ED charge, how many baseballs should he sell, and what will his profits be?
Answer: After the government imposes the $50,000 tax, total cost increases by $50,000 . Therefore, we
can calculate the new total costs and use it to calculate new marginal costs.
Price
$20
19
18
17
16
15
Quantity (per
week)
15,000
20,000
25,000
30,000
35,000
40,000
Total
Revenue=P*Q
$300,000
380,000
450,000
510,000
560,000
600,000
Marginal
Revenue=∆𝐓𝐑/∆𝐐
$16
14
12
10
8
New Total Cost
$380,000
415,000
455,000
500,000
550,000
605,000
New Marginal
Cost=∆𝐓𝐂/∆𝐐
$7
8
9
10
11
Since the new marginal costs are the same as before, it will not influence the optimal price and quantity
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chosen by Ed. The price =$16, quantity=35,000.
Profit= TR- new TC=560,000-550,000=$10,000
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