Download Monopoly

Imperfect
Competition
Occurs when firms in a market or
industry have some control over
the price of their output
Monopoly, Oligopoly, and
Monopolistic Competition
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Pure Monopoly
• An industry with a single firm
that produces a product for
which there are no close
substitutes, and
• where significant barriers to
entry prevent other firms from
entering the industry to compete
for profits.
2
Barriers to Entry
• Government franchises
• Patents and Copyright laws
• Economies of scale and other cost
advantages
– Natural Monopoly (Water, electricity)
• Ownership of a scarce factor of
production
– The De Beers Diamond Company
3
Firms in a Perfectly
Competitive Market
Take the market price as a given and decide:
• How much output to produce
• How to produce output (what
combination of labor and capital to
use)
• How much to demand in each input
market (How many workers to hire)
4
Monopolists must decide:
• How much output to produce
• How to produce output
• How much to demand in each
input market
• What price to charge for
output
5
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.
– Must charge only ONE price.
• The monopoly faces a known
demand curve.
6
Consider this hypothetical data
for a demand curve:
Quantity
Price
0
11
1
10
2
9
3
8
4
5
6
7
8
Can you7
calculate total
6
and marginal
5
revenue for
the firm?4
Total Revenue
Marginal
Revenue
P x Q
DTR /DQ
3
9
2
10
1
7
MR decreases when
In
Perfect
Quantity
Price
Total
Q
increases
Competition
Revenue
P = MR
0
11
0
X
1
10
10
X
2
9
18
X
As Price
3decreases,
8
24
Sell more 7
4 increase,
28
TR
units
a by
5 reach
6
30
reducing
maximum
6
5
Price
30
>
MR
price
(30) and
7 then
4
28
8decrease
3
24
9
2
18
10
1
10
=
=
=
DTR/DQ
Marginal
Revenue
10/1 = 10
8/1= 8
6/1= 6
4/1= 4
2/1= 2
0/1= 0
-2/1= - 2
-4/1= - 4
-6/1= - 6
-8/1= - 8
Price per unit ($)
We can plot demand and
marginal revenue as follows:
12
10
8
6
4
2
0
-2 0
-4
-6
-8
Market Demand
1
2
Marginal Revenue
3
4
5
6
7
8
9 10
MR<Price
Adding the total revenue
curve:
30
25
TR Max
MR = zero
20
15
10
TR
5
Demand
0
-5 0
-10
1
2
3
4
5
6
7
8
9
10
MR
Units of output Q
10
The monopolist’s profitmaximizing output and price:
Choose Q
such that
MR = MC
The maximum price this
monopolist can charge for Q
units is P.
$
MC
P
ATC
Go up to the
demand curve
to set the price
D
Q
MR
Q
11
The monopolist’s profit-maximizing
output and price
TC = ATC x Q
Profit = TR - TC
MC
ATC
Pm
Profit
TR = P x Q
ATC
TR
TC
D
Q
Qm
MR
12
Monopolist Sets Price Above
MC
This markup over MC
$
Price > MC
To find a firm that
has market power:
$P
Look for firms that
charge a price that
$ATC
is higher than their
MC of production
$MC
is the signature of a
monopolist
MC
ATC
This is the “mark-up”
above cost resulting
from monopoly’s market
power
D
Qm
MR
Q
13
In Monopoly...
• 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 have losses in the short
run if demand is not sufficient or if costs
are too high.
14
Comparison of Monopoly and
Perfect Competition
$
MC
Pm=$4
Ppc=$2
MR
These
are
theabove
Price
Sum
of
MC
Monopolist restricts
and
Quantity
under
AVC
for
all
firms
in a
output and charges
PerfectPerfectly
Competition
a higher price than
Competitive
industry
under Perfect
= Market Supply
Competition
D
2000
Qm
4000
Qpc
Units of output, Q
15
Natural Monopoly
An industry where the technological advantages
of large-scale production allow a single firm to
produce at a lower cost than many smaller
companies.
16
S
MC
ATC1
5
This Demand can be supplied
40 Firms selling 400,000
by many perfectly competitive
units at $5/unit
firms each with a small plant of
size ATC1
ONE firm selling
Or Demand can
be supplied
500,000
units atby
ONE firm with a large
plant of
$3/unit
size ATC5
3
MC ATC5
D
10,000
400,000 500,000
D
Government Monopolies
Since a large firm can supply the
entire market at a lower cost,
governments have two choices:
• Allow a private monopoly to exist
under government regulation or
• Government ownership of the
industry.
– Most public services are state owned
monopolies in most countries.
18
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.
19
Consumer surplus in a Perfectly
Competitive market:
Consumer
Surplus
MC
Ppc=$2
D
MR
4000
Qpc
Units of output, Q
20
Consumer surplus in a
monopoly market:
$
Consumer
Surplus
Pm=$4
MC
Ppc=$2
D
MR
2000
Qm
4000
Qpc
Units of output, Q
21
Producer Surplus under
Perfect Competition
MC
CS
Lost CS
Ppc=$3
PS
PS
D
2000
Qm
4000
MR Qpc
22
Producer Surplus Under
Monopoly
MC
CS
Ppc=$4
Lost CS
PS
D
2000
Qm
4000
MR Qpc
23
Perfect Competition
$
MC
CS
Ppc=$2
PS
D
MR
4000
Qpc
24
Q
Monopoly
Ppc=$4
MC
CS
Lost CS
PS
D
4000
Qpc
25
Lost Consumer Surplus
due to Monopoly
MC
CS
Pm=$4
D
2000
Qm
4000
MR Qpc
26
Q
Part of the Consumer’s Loss
becomes Producer’s Surplus
MC
CS
Ppc=$4
PS CS LOST
Lost
D
2000
Qm
4000
MR Qpc
27
Q
Part of the Producer’s
Surplus is Lost
MC
CS
Ppc=$4
Lost CS
PS
Net
Loss
PS
D
2000
Qm
4000
MR Qpc
28
Q
What would happen if the
Monopolist Price Discriminates?
MC
P1
P2
P3
P4
Lost CS
becomes PS
Lost CS
P1xQ1
D
Q1
Q2 Q3 Q4
MR
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When Monopolist Price
Discriminates
There is No Net Loss to
Society
30
Price Discrimination
• Airline Tickets
– Weekend Stay tickets cheaper
• Movie Tickets
– Senior Citizen Discount
• Groceries
– Supermarket Coupons
• Tuition
– Scholarships
• Books
– Hardcover vs. Soft cover
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