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Principles of Microeconomics: Econ102 1 of 14 Monopoly: The only seller of a good or service that does not have a close substitute. Barriers to entry may be high enough to keep out competing firms for four main reasons: 1. Government Action. 2. Control of key resources. 3. Vertical Integration. 4. Continual Innovation 5. Natural monopoly. 2 of 14 A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms. Average Total Cost Curve for a Natural Monopoly 3 of 14 A monopoly maximizes profit by producing where: MR = MC Price Maker: A situation in which the firm has the ability to set or control prices, thus exhibiting market power or, the ability to charge a price greater than marginal cost. If price makers raise their prices, they will lose some, but not all, of their customers. Therefore, they face a downward sloping demand curve. A monopoly’s demand curve is the same as the demand curve for the product. 4 of 14 A monopoly maximizes profit by producing where: MR = MC Remember that when a firm cuts the price of a product, one good thing and one bad thing happens: The good thing: It sells more units of the product. The bad thing: It receives less revenue from each unit than it would have received at the higher price. 5 of 14 Finding Profit Maximizing Price and Output for a Monopolist MARGINAL TOTAL REVENUE PRICE QUANTITY REVENUE (MR = ΔTR/ΔQ) $ $– TOTAL COST MARGINAL COST (MC = ΔTC/ΔQ) $56 $– $17 3 $16 4 63 $15 5 71 $14 6 80 $13 7 90 $12 8 101 Don’t Assume That Charging a Higher Price Is Always More Profitable For a Monopolist 6 of 14 Calculating a Monopoly’s Revenue 7 of 14 Profit-Maximizing Price and Output for a Monopoly 8 of 14 What Happens If a Perfectly Competitive Industry Becomes a Monopoly? Conclusion: A monopoly will produce less and charge a higher price than would a perfectly competitive industry producing the same good. 9 of 14 The Inefficiency of Monopoly We can summarize the effects of monopoly as follows: Monopoly causes a reduction in consumer surplus. Monopoly causes an increase in producer surplus. Monopoly causes a deadweight loss, which represents a reduction in economic efficiency. 10 of 14 11 of 14 In pure monopoly, because of the high barriers to entry, economic profits can be earned in the long-run as well. At the expense of competition Monopolies do not have as strong of an incentive to be efficient as there is no competitor who could drive them out of business. No productive efficiency in the long-run Except by coincidence, a monopoly company will produce at a higher cost per unit than would be found in a competitive company in the long-run. Allocative Ineffficiency Too little of the product is being produced from society’s point of view 12 of 14 Antitrust Laws and Antitrust Enforcement Antitrust laws: Government policies / laws that deal with monopolies and collusion. Should promote competition among firms. Collusion: An agreement among firms to charge the same price, or to otherwise not compete. 13 of 14 Antitrust Laws and Antitrust Enforcement Important U.S. Antitrust Laws LAW DATE PURPOSE Sherman Act 1890 Prohibited “restraint of trade,” including price fixing and collusion. Also outlawed monopolization. Clayton Act 1914 Prohibited firms from buying stock in competitors and from having directors serve on the boards of competing firms. Federal Trade Commission Act 1914 Established the Federal Trade Commission (FTC) to help administer antitrust laws. Robinson-Patman Act 1936 Prohibited charging buyers different prices if the result would reduce competition. Cellar-Kefauver Act 1950 Toughened restrictions on mergers by prohibiting any mergers that would reduce competition. 14 of 14