Download 16. Monopoly Market structures Pure Monopoly Why monopoly

Market structures
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16. Monopoly
Gene Chang
Univ. of Toledo
Pure Monopoly
Characteristics of Monopoly
– Only one supplier in the industry
– Product is unique (no close
substitutes)
– Entry is prohibited or extremely
difficult by law
Examples of Monopoly
Ownership
of a key resource. Mine
(e.g. diamond deposit of South
Africa), land, or tourist attraction.
Legal entry barrier
– U.S. Post Service
– Patent law (e.g. drug companies) or
copyright
– Franchise granted by local government
(cable, utility service, etc.)
distinguish the market structure
by examining the following
characteristics in the industry:
– Number of firms in the industry
– Nature of the products: do firms in the
industry produce identical products?
– Barriers of entry: How easy is it for new
firms to enter the market?
Why monopoly exists
Existence
of Barriers to entry:
– Ownership of a key resource.
– The government gives the firm the
exclusive right to produce some good.
– Costs of production make a single
producer more efficient than a number
of producers.
Examples of Monopoly
Costs
of production make a single
producer more efficient than a
number of producers
– Telephone
– Water supply
– Electricity
– Cable company
Natural
Monopoly
1
Natural Monopoly
The monopolist faces the industry demand curve,
which is downward sloping
monopoly arises when a
single firm can supply a good or
service to an entire market at a
smaller cost than could two or more
firms.
Economies of scale prevail in the
range of the market output.
Natural
P
D for the
monopoly’s
product
0
Q
Monopoly
The Monopolist’
Monopolist’s supply decision
Monopolist
is a price “maker”
maker”--- it
can “set”
set” the price along the demand
curve.
It chooses a point (price and
quantity combination) along the
demand curve to maximize its profit
Total
revenue = P X Q
Marginal Revenue
is the addition to the total revenue
resulting from one more unit of sale
of the product.
∆ TR
MR = -----------∆ Q
Demand and revenues for Viagra, a
monopolist product
Quantity
(10million)
Price
($)
Total Revenue
($)
Marginal
Revenue ($)
PXQ
Demand and Marginal Revenue for Viagra,
A monopolist product
16
14
Demand
Marginal revenue
12
1
15
15
2
14
28
13
3
13
39
11
4
12
48
9
$ 6
5
11
55
7
4
6
10
60
5
2
7
9
63
3
8
8
64
1
9
7
63
-1
10
6
60
-3
10
8
0
1
2
3
4
5
6
7
8
9
10
-2
-4
Quantity
2
Monopoly’
Monopoly’s production decision
Monopoly’s production decision
Profit Maximization
If
the demand curve is a downward
sloping straight line, then the
marginal revenue curve is a line
below the demand curve.
Monopoly’
Monopoly’s production decision
Quantity
(10million)
Price
($)
Marginal
Revenue ($)
Marginal
Cost
($)
1
15
2
14
13
14
7
3
13
11
2
4
12
9
1
5
11
7
1.5
6
10
5
2
7
9
3
3
8
8
1
4
9
7
-1
5
10
6
-3
6
Monopoly’s production decision
P
MR
> MC, it pays for the firm to
expand the production
If MR < MC, it pays for the firm to
reduce production.
The rule for profit maximization for
the monopolist
MC
P*
D
0
Q
Q*
MR = MC
MR
Monopoly’
Monopoly’s production decision
monopolist charges the price at
P, where Q* intersects the demand
curve.
The MarkMark-up by the monopolist
Monopoly’s production decision
The
P
MC
ATC
P*
Monopoly
profit (rent)
D
P > ATC
P > MC
0
Q
Q*
MR
3
Monopoly
Monopoly profit / Monopoly rent
Monopoly
P
ATC
P*
Monopoly
profit (rent)
Monopolist
produce at the point
where demand is elastic.
elastic.
D
0
– Reason: If inelastic, MR<0. Or, P⇑⇒
Total profit⇑
profit⇑ and the monopolist will
continue to cut the production.
Q
Q*
MR
The case against monopoly
Inefficiency of a Monopoly
Restricting the output and raise the
price
Restricting entry and keep the high
monopoly price in the long run
Not producing at the minimum ATC
Not producing at the point MU = MC
Resulting in efficiency loss or
economic welfare loss
P
AntiAnti-trust and antianti-monopoly law
Sherman Act
Efficient
scale
MC
ATC
P*
D = MU
0
Q
Q*
MR
The case against monopoly
profit exist in the long run
– See the difference between monopoly
and perfect competition
– Reason: A monopolist is protected by
high barriers of entry
MC
Natural Monopoly
Economy of scale and a downward
sloping AC curve
Only one firm can survive in the
industry
4
Regulation of natural monopoly
Natural Monopoly
P
P*
– Possible problems: May cause a
natural monopoly to suffer from loss
D
ATC
MC
0
Q*
Regulator: consumer groups,
regulation committees
Pricing options: P = MC
Pricing options: P = ATC
– Possible problems: moral hazard. the
monopolist has no incentive to cut cost
and operate efficiently
Q
MR
Is monopoly all bad ?
May encourage inventions as the
monopolist can collect all return for
its investment in its inventions.
Price discrimination
Same cost but different prices
charged on different consumers or
different markets.
Same price charged on consumers
with different costs to provide the
goods and services
Price discrimination
Airfare
Student and senior discount
Rate of utility charged to customers
with different supply costs.
Why price discrimination
The monopolist attempts to
maximize profits
Is there any merit
5