Download Monopoly

Monopoly

A firm is considered a monopoly if . . .
. . . it is the sole seller of its product.
. . . its product does not have close
substitutes.
. . . it has some ability to influence the
market price of its product.
Why Monopolies Arise
• The fundamental cause of monopoly is
barriers to entry.
Why Monopolies Arise
• Barriers to entry have four sources:
 Ownership of key resource
 Legal barriers by government
 Pricing and Strategic attempts
 Large economies of scale
Monopoly Resources
• Exclusive ownership of an important
resource that cannot be readily duplicated
is a potential source of monopoly.
Government-Created
Monopolies
• Patent and copyright laws are a major
source of government-created
monopolies.
Government-Created
Monopolies
• Governments also restrict entry by giving a
single firm the exclusive right to sell a
particular good in certain markets.
Natural Monopolies
• An industry is a natural monopoly when a
single firm can supply a good or service to
an entire market at a smaller cost than
could two or more firms.
Natural Monopolies
• Because of economies of scale, the
minimum efficient scale of one firm’s plant
is so large that only one firm can supply
the market efficiently.
Quick Quiz!
• What are the three reasons that a market
might have a monopoly?
Quick Quiz!
• Give two examples of monopolies and
explain the reason for each.
Monopoly versus Competition
• Monopoly
 Is the sole producer
 Is a price maker
 Has a downward-sloping demand curve
• reduces price to increase sales
Competition versus Monopoly
• Competitive Firm
 Is one of many producers
 Is a price taker
 Has a horizontal demand curve
• Sells as much or as little at same price
Monopoly’s Revenue
• Total Revenue
P x Q = TR
• Average Revenue
TR/Q = AR = P
• Marginal Revenue
DTR/DQ = MR
Monopoly’s, Total, Average, and
Marginal Revenue
Quantity
Q
0
1
2
3
4
5
6
7
8
Price
P
$11
10
9
8
7
6
5
4
3
Total Revenue Average Revenue Marginal Revenue
TR=PxQ
AR=TR/Q
MR=DTR/DQ
$0
10
18
24
28
30
30
28
24
—
$10
9
8
7
6
5
4
3
—
$10
8
6
4
2
0
–2
–4
Monopoly’s Marginal Revenue
 A monopolist’s marginal revenue is always
less than the price of its good.
 The demand curve is downward sloping.
 When a monopoly drops the price to sell one more
unit, the revenue received from previously sold units
also decreases.
Monopoly’s Marginal Revenue
 When a monopoly increases the amount it
sells, it has two effects on total revenue
(P x Q).
 The output effect—more output is sold, so Q is
higher.
 The price effect—price falls, so P is lower.
Monopoly’s Marginal Revenue
 The marginal revenue curve lies below its
demand curve.
Monopoly’s Demand and
Marginal Revenue Curves
Monopoly’s Demand and
Marginal Revenue Curves
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
1
2
3
4
5
6
7
8 Quantity of Water
Monopoly’s Demand and
Marginal Revenue Curves
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Demand
(average revenue)
1
2
3
4
5
6
7
8 Quantity of Water
Monopoly’s Demand and
Marginal Revenue Curves
Price
$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Demand
(average revenue)
Marginal
revenue
1
2
3
4
5
6
7
8 Quantity of Water
Profit Maximization of a Monopoly

A monopoly maximizes profit by producing
the quantity at which marginal revenue equals
marginal cost.

It then uses the demand curve to find the price
that will induce consumers to buy that
quantity.
Profit Maximization of a
Monopoly
Costs and
Revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
Marginal
cost
Average total cost
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
Marginal
cost
Average total cost
A
Demand
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
QMAX
Quantity
Profit Maximization of a
Monopoly
Costs and
Revenue
2. ...and then the demand
curve shows the price
consistent with this quantity.
B
Monopoly
price
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
QMAX
Quantity
Comparing Monopoly and
Competition
• For a competitive firm, price equals
marginal cost.
P = MR = MC
• For a monopoly firm, price exceeds
marginal cost.
P > MR = MC
Calculating Monopoly Profit
• Profit equals total revenue minus total
costs.
Profit = TR - TC
Profit = (TR/Q - TC/Q) x Q
Profit = (P - ATC) x Q
The Monopolist’s Profit
The Monopolist’s Profit
Costs and
Revenue
0
Quantity
The Monopolist’s Profit
Costs and
Revenue
Demand
Marginal revenue
0
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Average total cost
Demand
Marginal revenue
0
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly
price
Average total cost
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly
price
Average total cost
Average
total cost
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
Costs and
Revenue
Marginal cost
Monopoly E
price
B
Monopoly
prophat
Average
total cost D
Average total cost
C
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
• The monopolist will receive economic
profits as long as price is greater than
average total cost.
Quick Quiz!
• Explain how a monopolist chooses the
quantity of output to produce and the price
to charge.
The Welfare Cost of Monopoly

The monopolist produces less than the
socially efficient quantity of output.
The Welfare Cost of Monopoly

Because a monopoly charges a price above
marginal cost, consumers who value the good
at more than its marginal cost but less than the
monopolist’s price won’t buy it.
The Welfare Cost of Monopoly

Monopoly pricing prevents some mutually
beneficial trades from taking place.
The Welfare Cost of Monopoly

A monopoly leads to an inefficient allocation
of resources and a failure to maximize total
economic well-being.
The Deadweight Loss


Because a monopoly sets its price above
marginal cost, it places a wedge between the
consumer’s willingness to pay and the
producer’s cost.
 This wedge causes the quantity sold to
fall short of the social optimum.
The Deadweight Loss
Price
0
Quantity
The Deadweight Loss
Price
Marginal
revenue
0
Demand
Quantity
The Deadweight Loss
Price
Marginal cost
Marginal
revenue
0
Demand
Quantity
The Deadweight Loss
Price
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Demand
Quantity
The Deadweight Loss
Price
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Efficient
quantity
Demand
Quantity
The Deadweight Loss
Price
Deadweight
loss
Marginal cost
Monopoly
price
Marginal
revenue
0
Monopoly
quantity
Efficient
quantity
Demand
Quantity
Price Discrimination

Price discrimination is the practice of
selling the same good at different prices
to different customers.
Some degree of monopoly power
 Market segregation
 No resale

Price Discrimination

Three important effects of price
discrimination:
1.
2.
3.
It can reduce deadweight loss.
It can reduce consumer surplus.
It can increase the monopolist’s profits.
Welfare Without Price
Discrimination
Welfare Without Price
Discrimination
Price
0
Quantity
Welfare Without Price
Discrimination
Price
Consumer
surplus
Deadweight
loss
Monopoly
price
Profit
Marginal cost
Marginal
revenue
0
Quantity sold
Demand
Quantity
Welfare With Price
Discrimination
Price
Profit
Monopoly
price
Marginal cost
Demand = MR
0
Quantity sold
Quantity
Examples of Price Discrimination
Movie tickets
 Airline tickets
 Insurance
 Discounts (coupons)
 College Tuition
 Parking

Quick Quiz!
• Give two examples of price discrimination.
Quick Quiz!
• How does perfect price discrimination
affect consumer surplus, producer surplus,
and total surplus?
Public Policy & Monopolies
 Government responds in one of four ways.
 Making monopolized industries more
competitive.
 Regulating the behavior of monopolies.
 Turning some private monopolies into public
enterprises.
 Doing nothing at all.
Creating a Competitive Market
 Government may implement and
enforce antitrust laws to make the
industry more competitive.
Regulation
 Government may regulate the prices
that the monopoly charges.
 The allocation of resources will be
efficient if price is set to equal
marginal cost.
Regulation
 There are two practical problems with
marginal-cost pricing.
 Price may be less than average total
cost, and the firm will lose money.
 It gives the monopolist no incentive
to reduce cost.
Marginal-Cost Pricing
Marginal-Cost Pricing
Price
0
Quantity
Marginal-Cost Pricing
Price
Average total cost
Marginal cost
Demand
0
Quantity
Marginal-Cost Pricing
Price
Average total cost
Regulated
price
Marginal cost
Demand
0
Regulated
quantity
Quantity
Marginal-Cost Pricing
Price
Average
total cost
Regulated
price
Average total cost
Loss
Marginal cost
Demand
0
Regulated
quantity
Quantity
Marginal-Cost Pricing
Price
Average
total cost
Average total cost
Regulated
price
Marginal cost
Demand
0
Regulated
quantity
Quantity
Public Ownership
 Government can turn the monopolist
into a government-run enterprise.
Doing Nothing
 Government can do nothing at all if the
market failure is deemed small
compared to the imperfections of
public policies.
Quick Quiz!
• Describe the ways policymakers can
respond to the inefficiencies caused by
monopolies.
Quick Quiz!
• List a potential problem with each of these
policy responses.
Monopoly Misc

X-Inefficiency


Rent Seeking Behavior






Monopolies often operate at a higher cost than necessary
Transfer wealth at someone else’s expense.
Network Effect
Allocative Efficiency (MC=D or P)
Productive Efficiency (MC=ATC)
Fair-Return/Cost of Service/Average Cost Pricing
Marginal Cost Pricing
Marginal-Cost Pricing
Price
Average
total cost
Average total cost
Regulated
price
Marginal cost
Demand
0
Regulated
quantity
Quantity
The Prevalence of Monopoly

How prevalent are the problems of monopolies?
 Monopolies are around you…….
 Most firms have some control over their prices
because of differentiated products.
 Firms with substantial monopoly power are rare.
 Few goods are truly unique.
Conclusion

A monopoly is a firm that is the sole seller in
its market.

It faces a downward-sloping demand curve
for its product.
Conclusion

Like a competitive firm, a monopoly
maximizes profit by producing the quantity at
which marginal cost and marginal revenue are
equal.

Unlike a competitive firm, its price exceeds
its marginal revenue, so its price exceeds
marginal cost.
Conclusion

A monopolist’s profit-maximizing level of
output is below the level that maximizes the
sum of consumer and producer surplus.

A monopoly causes deadweight losses similar
to the deadweight losses caused by taxes.
Conclusion

Monopolists can raise their profits by
charging different prices to different buyers
based on their willingness to pay.

Price discrimination can raise economic
welfare and lessen deadweight losses.
Conclusion

Policymakers can try to remedy the
inefficiencies of monopolies with antitrust
laws, regulation of prices, or by turning the
monopoly into a government-run enterprise.

If the market failure is small, policymakers
may decide to do nothing at all.