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Market structures We 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