Download ECN 104 Notes: Week of March 31 Pure Monopoly

ECN 104 Notes: Week of March 31
Chapter 10
Pure Monopoly
An industry in which only one firm is the sole seller of a product or service.
Characteristics of this market are:
1.
2.
3.
4.
Single seller
No close substitutes
High control over price
High barriers to entry
Barriers to entry include Economies of scale, Legal Barriers, Ownership, and pricing/strategy
barriers.
Economies of scale: New firms entering the market would have a hard time competing with the
older large firm because the large firm will be producing at a lower ATC position.
Legal Barriers: Patents –give exclusive rights of production to the inventor for a number of years
Liscences-government may limit entry of firms by requiring liscenses
Ownership of Resources: one firm/country may own all/most of world’s natural resource
Pricing/strategic barriers: one firm may slash prices and up advertising to make it very difficult for
a new firm to make a profit and thereby discourage entry.
How does a monopolist decide price and quantity?
First we make 3 assumtions: 1. firm is the sole producer; 2. firm is not gov’t regulated; 3. firm
charges same price to all customers.
Because the monopolist is the sole producer, its demand curve IS the market demand curve.
1. Because the market demand curve is downward sloping, the monopolist can increase sales by
decreasing price. Therefore, MR<P, unlike in perfect competition. In perfect competition, there is
one price and you can sell the quantity you want at that price. If you charge above that price, no
one will buy, so MR=0, if you charge below that price, all you will do is lower profit, so why
charge below? For a monopolist, if you lower the price, you will sell more. If you raise the price,
you will sell less. But the lower price refers to all units, not just the last unit sold, while MR refers
only to the last unit sold. As such, MR will always be lower than P for the monopolist.
2. Monopolist is price maker: by changing market supply, the monopolist determines price.
3. The monopolist will always set prices in the elastic portion of the demand curve, because it
is in this area when a price decrease will raise TR. Elsewhere, they would only be
decreasing TR.
Equilibrium: Profit Maximization is found by producing enough quantity such that MR=MC
Why? If MR>MC the firm could make more profit by producing more. If MR<MC the firm could
make more profit by producing less.
Lets look at an example. Keep in mind that Profit= TR-TC, and AR=(P*Q)/Q = P
Q
0
1
2
3
4
5
6
7
8
9
10
P
172
162
152
142
132
122
112
102
92
82
72
TR
0
162
304
426
528
610
672
714
736
738
720
MR
162
142
122
102
82
62
42
22
-2
-18
ATC
Na
190
135
113
100
94
91.67
91.43
93.75
97.78
103.33
TC
100
190
270
340
400
470
550
640
750
880
1030
MC
Profit
-100
-28
34
86
128
140
122
74
-14
-142
-310
90
80
70
60
70
80
90
110
130
150
Where should the monopolist produce? At 5 units. Then P=$122
Graphically, we can see the monopolist’s decision is at the intersection of the MC and MR curves,
and that price is determined by drawing a vertical line up from the MR=MC point. Profit is the
geometric area P*Q – ATC*Q.
$
MC
P=122
Profit
ATC
ATC
D
5
8
Quantity
MR
Myths of Monopolist Pricing:
1. Monopolists charge the highest price they can (false)
2. Monopolists want to maximize per unit profits (false)
3. Pure monopoly guarantees profit (false)
Monopolists seek to maximize total profits. This implies they likely charge a price lower than the
highest possible price. Moreover, if the demand curve is low enough, and costs are high enough,
the monopolist may not be able to make a profit no matter what price they charge.
Efficiency
Is a pure monopolist efficient?
Productive efficiency- Monopolist produces at a point where ATC> minATC. This implies that
they are not productively efficient. They find it profitable to sell smaller amounts at higher prices
than a competitive firm and thus are not at lowest ATC.
Price
S
Pm
Pc
Qm
D = MR(competitive)
MR(monopolist)
Qc
Quantity
Allocative Efficiency- since MB=P>MC then there is underallocation of resources to this product
(not enough is being produced)
Therefore Monopolies are not efficient.
It is said that Monopolists are rent seekers. Rent Seeking is action by persons, firms or unions to
gain special benefits from the government at tax payers or someone else’s expense.
However, some people argue that if a monopolist wishes to keep his/her monopoly power, he/she
is more likely than the competitive firm to stay on top of more efficient production techniques and
technological advances over time. Therefore the inefficiency of monopolies may be over stated.
In the basic model, we assumed that unit costs would be the same for a competitive firm as for a
monopolist, but this may not be so. Moreover, the value of the product may differ.
These types of complications to the basic model include:
1. Economies of Scale – when there are large economies of scale, market demand may not be
sufficient to support large numbers of competing firms.
2. Simultaneous consumption – the firm may be able to satisfy large numbers of customers at
the same time with relatively low marginal costs
3. Network effects – the more people use a product, the higher the value of the product,
including the existing ones.
4. X-inefficiency- failure to produce on the ATC curve (produce above it)
Price Discrimination
What would happen if we relaxed the assumption that a monopolist must charge the same price to
each consumer? What if the monopolist could charge a higher price to those who were willing to
pay more (those who want it more)
This behavior is called Price Discrimination – selling a product to different buyers at different
prices when the differences are not justified by differences in prices.
Ex/ airline tickets (student rates, etc)
Consequences of Price Discrimination in our model:
Because each unit is sold at a different price (the price the consumer is willing to pay) MR=D=P
1. Higher profit
2. More production (because MR=D, and production occurs where MR=MC)
We can see these effects by comparing a single price industry to an industry with Perfect price
discrimination:
Single Price:
$
MC
P1
Profits
ATC
D
MR
Quantity
Perfect Price Discrimination
Graphically:
$
MC
Profits
ATC
ATC
D
Quantity
Regulated Monopolies
Many natural monopolies have been regulated by the government. Ex. Hydro, telephone, etc. The
government usually regulates these firms by setting a maximum price which is considered ‘fair’ or
‘optimal’, and the monopolist cannot legally charge more than this price.
Fair Return Price: P=ATC
This price enables the producer to obtain a normal profit and that price is therefore equal to the
average cost of producing the good. Most regulatory agencies in Canada set this kind of price.
Socially Optimal Price: P=MC
This price results in allocative efficiency. However if this price is below the monopolists ATC,
they will not wish to continue producing in the long run, so the government would face a dilemna.
It is possible that at P=MC they might still make a normal profit, if MC>=ATC. Below we see a
graphical example where P<ATC at the socially optimal price:
Graphically:
$
MC
Pm
ATC
Pfr
Pso
D
MR
Qm Qfr
Qso
Quantity