Download Chapter 25 - The Citadel

Chapter 25
Monopoly
Introduction
The Ambassador Bridge separating
Detroit, Michigan from Windsor, Ontario
is owned by a private company.
Clearly, this is a firm that owns a
resource with few close substitutes.
How does a firm in this situation, known
as a monopoly, determine the price to
charge for its product?
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25-2
Learning Objectives
• Identify situations that can give rise to monopoly
• Describe the demand and marginal revenue
conditions a monopolist faces
• Discuss how a monopolist determines how much
output to produce and what price to charge
• Evaluate the profits earned by a monopolist
• Understand price discrimination
• Explain the social cost of monopolies
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25-3
Chapter Outline
• Definition of a Monopolist
• Barriers to Entry
• The Demand Curve a Monopolist Faces
• Elasticity and Monopoly
• Cost and Monopoly Profit Maximization
• Calculating Monopoly Profit
• On Making Higher Profits: Price Discrimination
• The Social Cost of Monopolies
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25-4
Did You Know That...
• A monopoly can arise whenever sellers
are given exclusive rights to distribute
a good?
• A law intended to “help New York
wineries” creates a situation
called monopoly?
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25-5
Definition of a Monopolist
• Monopolist
 A single supplier of a good or service for
which there is no close substitute
 The monopolist therefore constitutes the
entire industry.
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25-6
Barriers to Entry
• Question
 How does a firm obtain monopoly power?
• Answers
 Barriers to entry that allow the firm to make
long-run economic profits
 Barriers to entry are restrictions on who
can start as well as stay in business.
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25-7
Barriers to Entry (cont'd)
• Barriers to entry include
 Ownership of resources without
close substitutes
 Economies of scale
 Legal or governmental restrictions
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25-8
Barriers to Entry (cont'd)
• Ownership of resources without
close substitutes
 The Aluminum Company of America
(ALCOA) at one time owned most of
of the world’s bauxite.
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Barriers to Entry (cont'd)
• Economies of scale
 Low unit costs and prices drive out rivals.
 The largest firm can produce at the lowest
average total cost.
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Barriers to Entry (cont'd)
• Natural Monopoly
 A monopoly that arises from the peculiar
production characteristics in an industry
 It usually arises when there are large
economies of scale
 One firm can produce at a lower
average cost than can be achieved
by multiple firms
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25-11
Figure 25-1 The Cost Curves That
Might Lead to a Natural Monopoly
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Barriers to Entry (cont'd)
• Legal or governmental restrictions
 Licenses, franchises, and certificates
of convenience
 Examples include
 Electrical
 Radio
utilities
and television broadcasting
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25-13
International Policy Example:
Malaysia’s Drug-Labeling Monopoly
• Sellers of drugs and medical products are
required to affix holographic labels providing
information on usage.
• To obtain these labels, sellers have only one
choice. They must buy the labels from a
company called Mediharta.
• This company is the only label manufacturer
that Malaysia’s Registrar of Companies has
approved to produce holographic labels.
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25-14
Barriers to Entry (cont'd)
• Legal or governmental restrictions
 Patents
 Intellectual
property
 Tariffs
 Taxes
on imported goods
 Regulation
 Safety
and quality
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25-15
Barriers to Entry (cont'd)
• Cartels
 An association of producers in an industry
that agree to set common prices and
output quotas to prevent competition
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The Demand Curve
a Monopolist Faces
• The monopolist faces the industry
demand curve because the
monopolist is the entire industry.
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25-17
The Demand Curve
a Monopolist Faces (cont'd)
• Recall that under perfect competition
 Firm faces perfectly elastic demand curve,
it is a price taker
 The forces of supply and demand establish
the price per unit
 Marginal revenue, average revenue, and
price are all the same
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25-18
The Demand Curve
a Monopolist Faces (cont'd)
• Perfect competition versus monopoly
 The perfect competitor doesn’t have to
worry about lowering price to sell more.
 In a purely competitive situation, the firm
accounts for a small part of the market.
 It
can sell its entire output, whatever that may
be, at the same price.
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The Demand Curve
a Monopolist Faces (cont'd)
• Perfect competition versus monopoly
 The more the monopolist wants to sell, the
lower the price it has to charge on the last
unit sold.
 To sell the last unit, the monopolist has to
lower the price because it is facing a
downward sloping demand curve.
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25-20
Figure 25-2 Demand Curves for the
Perfect Competitor and the Monopolist
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25-21
The Demand Curve
a Monopolist Faces (cont'd)
Monopoly
Perfect Competition
Single seller
Many sellers
Faces entire
industry demand
Faces perfectly
elastic demand
Must lower price
to sell more
Must produce more
to sell more
Not all units sold for
same price (MR < P)
All units sold for same
price (P = MR)
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25-22
Figure 25-3 Marginal Revenue:
Always Less Than Price
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25-23
Elasticity and Monopoly
• The monopolist faces a downwardsloping demand curve, and cannot
charge any price.
 A common misconception
• Thus, depending on the price charged a
different quantity will be demanded.
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25-24
Elasticity and Monopoly (cont'd)
• Question
 If a monopoly raises price, what will
happen to quantity demanded?
• Hint
 Remember how consumers respond to a
change in price.
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25-25
Elasticity and Monopoly (cont'd)
• Recall
 Monopolist is a single seller of a
well-defined good or service with
no close substitute.
 Think
of some imperfect substitutes.
 The demand curve slopes downward
because individuals compare marginal
satisfaction to cost.
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25-26
Elasticity and Monopoly (cont'd)
• After all, consumers have limited
incomes and unlimited wants.
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Cost and Monopoly
Profit Maximization
• We assume profit maximization is the
goal of the pure monopolist, just as it is
for the prefect competitor.
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25-28
Cost and Monopoly
Profit Maximization (cont'd)
• Perfect competitor has only to decide
on the profit-maximizing output rate
because price is given.
 The perfect competitor is a price taker.
• For the pure monopolist, we must
seek a profit-maximizing price
output combination.
 The monopolist is a price searcher.
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25-29
Cost and Monopoly
Profit Maximization (cont'd)
• Price Searcher
 A firm that must determine the price-output
combination that maximizes profit because
it faces a downward-sloping demand curve
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25-30
Cost and Monopoly
Profit Maximization (cont'd)
• We can determine the profit-maximizing
price-output combination with either of
two equivalent approaches.
 By looking at total revenues and total costs
or by looking at marginal revenues and
marginal costs
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25-31
Cost and Monopoly
Profit Maximization (cont'd)
• Total revenues-total costs approach
 Maximize the positive difference between
total revenues and total costs
• Marginal revenue-marginal
cost approach
 Profit maximization will also occur where
marginal revenue equals marginal cost.
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25-32
Cost and Monopoly
Profit Maximization (cont'd)
• Question
 Why produce where marginal revenue
equals marginal cost?
• Answer
 This is where the greatest positive
difference between total revenue and
total cost occurs.
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Figure 25-4 Monopoly Costs,
Revenues, and Profits, Panel (a)
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25-34
Figure 25-4 Monopoly Costs,
Revenues, and Profits, Panels (b) and (c)
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25-35
Cost and Monopoly
Profit Maximization (cont'd)
• Producing past where MR = MC
 Incremental cost exceeds
incremental revenue
• Producing less than where MR = MC
 Monopolist not maximizing profits
here either
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25-36
Figure 25-5 Maximizing Profits
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25-37
Calculating Monopoly Profit
• Monopoly profit is given by the shaded
area, which is equal to total revenues
(P  Q) minus total costs (ATC  Q).
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Figure 25-6 Monopoly Profit
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25-39
Calculating Monopoly Profit (cont'd)
• No guarantee of profit
 The term monopoly conjures up the notion
of a greedy firm ripping off the public.
 If ATC

is everywhere above AR, or demand
No price-output combination allows the monopolist
to cover costs
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25-40
Figure 25-7
Monopolies: Not Always Profitable
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25-41
On Making Higher Profits:
Price Discrimination
• Price Discrimination
 Selling a given product at more than one
price, with the difference being unrelated
to differences in cost
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25-42
On Making Higher Profits:
Price Discrimination (cont'd)
• Price Differentiation
 Establishing different prices for similar
products to reflect differences in marginal
cost in providing those commodities to
different groups of buyers
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25-43
On Making Higher Profits:
Price Discrimination (cont'd)
• Necessary conditions for price discrimination
1. The firm must face a downward-sloping
demand curve.
2. The firm must be able to readily (and cheaply)
identify buyers or groups of buyers with
predictably different elasticities of demand.
3. The firm must be able to prevent resale of the
product or service.
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Example: Why Students Pay
Different Prices to Attend College
• Out-of-pocket tuition rates for any two college
students can differ by considerable amounts.
• The reason is that colleges offer students
diverse financial aid packages depending on
their “financial need.”
• The college determines prices that families
are most likely to pay, so that it can engage
in price discrimination.
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25-45
Figure 25-8 Toward Perfect Price
Discrimination in College Tuition Rates
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The Social Cost of Monopolies
• Comparing monopoly with
perfect competition
 Let’s assume a monopolist comes in and
buys up every single perfect competitor.
 Notice the monopolist produces a smaller
quantity and sells at a higher price.
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25-47
The Social Cost
of Monopolies (cont'd)
• Comparing monopoly with
perfect competition
 Monopolists raise the price and restrict
production compared to a perfectly
competitive situation.
 Consumers pay a price that exceeds the
marginal cost of production and resources
are misallocated in such a situation.
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25-48
Figure 25-9 The Effects
of Monopolizing an Industry
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Issues and Applications: For This
Monopoly Location is the Key
• A resource with literally few close substitutes
is the Ambassador Bridge.
• Price searching for the profit-maximizing toll
rates have boosted profits.
• Total revenues in excess of $60 million have
been generated per year.
• Estimates of the market value of the bridge
value it in excess of half a billion dollars.
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25-50
Summary Discussion
of Learning Objectives (cont'd)
• Why a monopoly can occur
 Barriers to entry
• Demand and marginal revenue
conditions faced by a monopolist
 Because the monopolist constitutes the
entire industry, it faces the entire market
demand curve.
 Marginal revenue is less than price.
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25-51
Summary Discussion
of Learning Objectives (cont'd)
• How a monopolist determines how
much output to produce and what price
to charge
 Seeks to maximize its economic profits
 Produces where marginal revenue equals
marginal cost
 Charges maximum price for the amount
of output where MR = MC
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25-52
Summary Discussion
of Learning Objectives (cont'd)
• A monopolist’s profits
 Profit earned by monopolist is equal to the
difference between the price it charges
and its average production cost times the
amount of output it produces and sells.
 Monopolist typically earns positive
economic profits.
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25-53
Summary Discussion
of Learning Objectives (cont'd)
• Price discrimination
 Selling at more than one price with the
price differences being unrelated to
differences in production costs.
 Monopolist sells some of its output at
higher prices to consumers with less
elastic demand.
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25-54
Summary Discussion
of Learning Objectives (cont'd)
• Social cost of monopolies
 Price exceeds marginal cost.
 The price is higher and output is lower for
a monopolist as compared to a perfectly
competitive industry.
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25-55
End of
Chapter 25
Monopoly