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Chapter 9 Monopoly ECONOMICS: Principles and Applications, 4e HALL & LIEBERMAN, © 2008 Thomson South-Western Monopoly • Monopoly firm - The only seller of a good or service with no close substitutes • Monopoly market – The market in which the monopoly firm operates • Barriers to entry – Economies of scale – Legal barriers – Network externalities 2 Barriers to Entry • Economies of scale – One firm can operate at lower average cost than other firms – Natural monopoly - arises when one firm • can produce for the entire market • at lower cost per unit 3 Figure 1: A Natural Monopoly • Figure 1 A Natural Monopoly Dollars $15 Three firms –each produce 100 units Each operate at C on LRATC curve Cost per unit = $15 Two firms- each produce 150 units Each firm operate at B on LRATC Cost per unit = $12 (higher) C B 12 A 5 One firm – produce 300 units Operate at A on LRATC curve Cost per unit=$5 LRATC 100 150 300 Articles of Clothing per Day 4 Barriers to Entry • Legal barriers – Protection of intellectual property • Patents - temporary grant of monopoly • Copyrights - grant of exclusive rights to sell a literary, musical, or artistic work – Government franchise • Grant of exclusive rights over a product 5 Barriers to Entry • Network Externalities –The added benefits for all users of a good or service that arise because other people are using it too –Joining a large network is more beneficial than joining a small network 6 Monopoly Behavior • Goal – Earn highest profit possible • Economic constraints – Cost – to produce any level of output • Input prices • Technology – Given market demand curve • the highest price it can charge 7 Monopoly Price or Output Decision • The output level – And the maximum price it can charge and still sell that output level • The price – And the maximum output the firm can sell at that price • The MR curve lies below the demand curve – Downward-sloping demand curve – MR<P 8 Figure 2: Demand and Marginal Revenue • Figure 2 Demand and Marginal Revenue for Patty’s Pool Dollars $13 A 10 9 B C Demand 0 -1 3 4 MR 9 The Profit-Maximizing Output Level • To maximize profit – Produce the quantity where MC = MR – MC curve crosses the MR curve from below • Price and output are not independent decisions, but different ways of expressing the same decision 10 The Profit-Maximizing Output Level • Figure 3 Monopoly Price and Output Determination Monthly $60 Price per Subscriber 40 MC E D 10,000 30,000 MR Number of Subscribers 11 Monopoly and Market Power • Market power – The ability of a seller to raise price without losing all demand for the product being sold • Price setter – A firm with market power that selects its price, rather than accepting the market price as a given 12 Profit and Loss • Profit – When P > ATC – Total profit = Profit per unit * Q – Profit per Unit = P – ATC • Loss – When P < ATC – Total loss = Loss per unit * Q – Loss per unit = ATC - P 13 Profit and Loss • Figure 4 Monopoly Profit and Loss (a) MC ATC Dollars (b) ATC MC AVC Dollars $50 E $40 40 32 E Total Loss Total Profit D D 10,000 Number of MR Subscribers 10,000 MR Number of Subscribers 14 Equilibrium in Monopoly Markets • Monopoly market – equilibrium – The monopoly is maximizing profit • Short run – Produce where MR=MC – Profit if P>ATC – Loss if P<ATC • If P>AVC – produce • If P<AVC – shut down 15 Equilibrium in Monopoly Markets • Long run – Monopolies may earn economic profit – Monopoly suffering an economic loss should always exit the industry • If regulated - the government may decide to subsidize it • If privately owned – exit the industry 16 Monopoly vs. Perfect Competition • Economic profit – Reduced to zero by entry of other firms – in perfect competition – Continue indefinitely – in monopoly • For a given technology, monopoly market – Higher price – Lower output • than a perfectly competitive market 17 Monopoly and Perfect Competition • Figure 5 Comparing Monopoly and Perfect Competition (a) Competitive Market Price per Unit (b) Competitive Firm Dollars per Unit S 2. and each firm produces 1,000 units, where P = MC. MC ATC E $10 $10 d=MR D 100,000 1. In this competitive market of 100 firms, equilibrium price is $10… Quantity of Output 1,000 3. When monopoly takes over, the old market supply curve . . . Quantity of Output 18 Monopoly and Perfect Competition • Figure 5 Comparing Monopoly and Perfect Competition (c) Monopoly Price per Unit $15 4. becomes the monopoly's MC curve. S = MC F 5. The monopoly produces where MR = MC, E 10 MR 100,000 60,000 D Quantity of Output 6. with a higher price and lower market output than under perfect competition. 19