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Chapter 12
Monopoly
Basic Definitions
• Imperfect Competition: Occurs when firms in a
market or industry have some control over the
price of their output.
– Monopoly, Oligopoly, and Monopolistic Competition
• Pure Monopoly:An industry with a single firm that
produces a product for which there are no close
substitutes, and in which significant barriers to
entry prevent other firms from entering the
industry to compete for profits.
Barriers to Entry
• Government franchises
• Patents
• Economies of scale and other cost
advantages
• Ownership of a scarce factor of production
There are now four firm decisions
that must be characterized:
• There are now four firm decisions that must
be characterized:
–
–
–
–
How much output to produce
How to produce output
How much to demand in each input market
What price to charge for output
Similarities and differences Monopoly and Competition
• Similarities:
– Both know exactly what the demand curve and
price will be
• Differences:
– Competitor has no control over price
– Monopolist has total control over price
Price and Output Decisions in
Pure Monopoly Markets
• Basic assumptions:
– Entry to the market is strictly blocked.
– Firms act to maximize profits.
– The monopolistic firm cannot price
discriminate.
– The monopoly faces a known demand curve.
Consider this hypothetical data
for a monopolist’s demand curve
Q
P
0
1
2
3
4
5
6
7
8
9
TR
11
10
9
8
7
6
5
4
3
2
MR
0
10
18
24
28
30
30
28
24
18
10
8
6
4
2
0
-2
-4
-6
Example-Demand/MR
$$$
12
10
8
6
4
P
2
MR
0
0
1
2
3
4
5
6
7
8
9
10
-2
-4
-6
-8
Quantity
Example -Demand/MR/TR
TR/MR
35
30
25
P ($)
20
P
15
TR
10
MR
5
0
-5
0
2
4
6
-10
Q
8
10
The monopolist’s profitmaximizing output and price:
$
Profit = $1*4000
= $4000
• Maximizing profit
at MR=MC
MC
ATC
Pm=$4
ATC=$3
MC=$1.5
D
4000
MR
Q
Details...
• The monopolist has no supply curve; there
is no unique relationship between price and
quantity supplied.
• Since entry is blocked, the monopolist can
earn economic profits in the long run.
• Monopolists can earn losses in the short run
if demand is not sufficient or if costs are too
high.
Comparison of monopoly and perfectly
competitive market solutions:
$
Monopoly: MC=MR
Pm=$4
Ppc=MCc=MCm=$2
MC=MR=P=ATC
D
2000
4000
MR
Q
Comparison of monopoly and perfectly
competitive market solutions:
$
Monopoly
Pm=$4
Perfectly competitive market
Ppc=MCc=MCm=$2
MC=MR=P=ATC
D
2000
4000
MR
Q
Losses from Monopoly
• LESS output is produced than would be
produced in a competitive industry.
• If we look at the diagram, we see that output
stops short of where Mgl. Benefits = Mgl.
Costs.
• Buyers must pay MORE than they would
pay in a competitive market
• Figure 13.6
The Social Costs of Monopoly
• Prices are higher when a market is monopolized
than when it is perfectly competitive.
• Output is lower when a market is monopolized
than when it is perfectly competitive.
• Some consumer surplus is reallocated to producers
when a market is monopolized.
• Some consumer surplus is lost when a market is
monopolized.
Consumer Surplus
• The difference between the market price
and what people are willing to pay for a unit
of output
Consumer Surplus
Price ($)
Price ($)
Total consumer surplus
A
$5.00
B
$5.00
C
Demand
E
$2.50
1 2 3
7
Demand
E
$2.50
1 2 3
Millions of hamburgers per month
7
Consumer surplus in a perfectly
competitive market:
Consumer surplus of PC
Monopoly
$
Pm=$4
Perfectly competitive market
Ppc=MCc=MCm=$2
MC=MR=P=ATC
D
2000
4000
MR
Q
Consumer surplus in a monopoly
market
Consumer surplus of Monopoly
Monopoly
$
Pm=$4
Perfectly competitive market
Ppc=MCc=MCm=$2
MC=MR=P=ATC
D
2000
4000
MR
Q
Consumer surplus in a monopoly
market:
Consumer surplus of Monopoly
$
CS reallocated
to producer
Pm=$4
Net loss of social welfare
Ppc=MCc=MCm=$2
MC=MR=P=ATC
D
2000
4000
MR
Q
Rent-Seeking Behavior (1)
• Rent-seeking behavior: Actions taken by
households or firms to preserve positive
profits.
• Suppose someone is in a competitive
market, but would like, somehow, to be a
monopolist and earn monopoly rents.
Rent-Seeking Behavior (2)
• Actions taken by households or firms to
acquire or preserve extra normal profits
• Lobbying gov’t officials; asking for
licensure.
• Some argue that many medical
professionals lobby for licensure in order to
earn monopolistic rents.
Natural Monopoly
• An industry that realizes such large
economies of scale in producing its product
that single-firm production of that good or
service is most efficient.
Natural Monopoly
• Economies of scale must be realized at a
scale that is close to total demand in the
market.
• Figure 13
There are several ways to
regulate natural monopoly
• The government sets a monopoly’s price
equal to marginal cost.
• The government sets a monopoly’s price to
cover average cost per unit.
Summary
• Monopolies exist when there is a single
seller of a unique product and significant
entry barriers.
• The monopolist will produce where
MR=MC and determine its price from
demand.
Review questions
• Application
– Decide the output level for monopoly
– Calculate consumer surplus
• Definitions:
– Imperfect competition
– Pure monopoly
– Natural monopoly