ch 22 monopoly

7/28/2019 Ch 22 Monopoly

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Copyright 2004 South-Western

Imperfect Competition

Market structures other than Pure Competition

are referred to as markets with imperfect

competition. These include:

Pure Monopoly

Monopolistic Competition

Oligopoly


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Monopoly Firm

While a competitive firm is aprice taker, a

monopoly firm is aprice maker.

A firm is considered a monopoly if . . .

it is the sole producer/seller of its product.

its product does not have close substitutes.

Entry of new firm (s) is blocked.

It is a price maker


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Why Monopolies Arise

Main cause of monopoly is barriers to entry.

Barriers to entry have three sources:

Ownership of a key resource.

Government gives a single firm the exclusive right

to produce some good.

Costs of production make a single producer more

efficient than a large number of producers.


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Monopoly Resources

Although exclusive ownership of a key

resource is a potential source of monopoly, in

practice monopolies rarely arise for this reason.


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Government-Created Monopolies

Governments may restrict entry by giving a

single firm the exclusive right to sell a

particular good in certain markets.

Patent and copyright laws are two importantexamples of how government creates a

monopoly to serve the public interest.


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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.


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Natural Monopolies

A natural monopoly arises when there are

economies of scale over the relevant range of

output.


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Figure 1 Economies of Scale as a Cause of Monopoly


Quantity of Output

Averagetotal

cost

0

Cost


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How Monopolies Make Production AndPricing Decisions

Monopoly versus Competition

Monopoly

Is the sole producer

Faces a downward-sloping demand curve Is a price maker

Reduces price to increase sales

Competitive Firm

Is one of many producers

Faces a horizontal demand curve

Is a price taker

Sells as much or as little at same price


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Figure 2 Demand Curves for Competitive and MonopolyFirms


Quantity of Output

Demand

(a) A Competitive Firms Demand Curve (b) A Monopolists Demand Curve

0

Price

Quantity of Output0

Price

Demand



Monopolys Firms Revenue

Total Revenue

P Q = TR

Average Revenue

TR/Q = AR = P

Marginal Revenue

DTR/

DQ = MR



Monopoly Firms Demand, MR, and Price

A Monopolys Marginal Revenue A monopolists marginal revenue is always less

than the price of its good.

The demand curve is downward sloping. When a monopoly reduces the price to sell one more unit,

the revenue received from previously sold units also

decreases.



Monopoly Firms Marginal Revenue

A Monopolys Marginal Revenue When a monopoly firm increases the amount it

sells, it has two effects on total revenue (PQ).

The output effectmore output is sold, so Q is higher. The price effectprice falls, soPis lower.


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Demand (AR) and MR Curves for a Monopoly Firm


Quantity of Output

Price

11

10

9

8

7

65

4

3

2

1

0

1

2

3

4

Demand

(Average

Revenue)

Marginal

Revenue

1 2 3 4 5 6 7 8



Profit Maximization by a Monopoly Firm

Two steps:

1. A monopoly firm maximizes profit by

producing the quantity at which MR = MC

2. It then uses the demand curve to find the price

that will induce consumers to buy that

quantity.


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Figure 4 Profit Maximization for a Monopoly Firm


QuantityQ Q0

Costs and

Revenue

Demand

Average total cost

Marginal revenue

Marginal

cost

Monopoly

price

QMAX

B

1. The intersection of themarginal-revenue curve

and the marginal-cost

curve determines the

profit-maximizing

quantity . . .

A

2. . . . and then the demandcurve shows the price

consistent with this quantity.



Profit Maximization

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



Monopoly Firms Profit

Profit equals total revenue minus total costs.

Profit = TRTC

Profit = (TR/Q - TC/Q) Q

Profit = (ARATC) Q

Profit = (P-ATC)

Q


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Figure 5 Monopoly Firms Profit


Monopoly

profit

Average

total

cost

Quantity

Monopoly

price

QMAX

0

Costs and

Revenue

Demand

Marginal cost

Marginal revenue

Average total cost

B

C

E

D



A Monopolists Profit

The monopolist will receive economic profitsas long as price is greater than average total

cost.

When P > ATC, firm earns economic profit

When P = ATC, firm earns no economic profit

When P < ATC, firm goes into loss



Welfare Cost of Monopoly

In contrast to a competitive firm, the monopolycharges a price above the marginal cost.

From the standpoint of consumers, this high

price makes monopoly undesirable.

However, from the standpoint of the owners of

the firm, the high price makes monopoly very

desirable.



The Deadweight Loss

Because a monopoly sets its price abovemarginal cost, it places a wedge between the

consumers willingness to pay and the

producers cost. This wedge causes the quantity sold to fall short of

the social optimum level of production.


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Figure 8 The Inefficiency of Monopoly


Quantity0

Price

Deadweight

loss

DemandMarginalrevenue

Marginal cost

Efficient

quantity

Monopoly

Price

Monopoly

quantity



Deadweight Loss

The deadweight loss caused by a monopoly issimilar to the deadweight loss caused by a tax.

The difference between the two cases is that the

government gets the revenue from a tax,whereas a private firm gets the monopoly

profit.



Public Policy toward Monopolies

Government responds to the problem ofmonopoly 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.



Increasing Competition with Antitrust Laws

Antitrust laws are a collection of statutes aimedat curbing monopoly power.

Antitrust laws give government various ways to

promote competition. They allow government to prevent mergers.

They allow government to break up companies.

They prevent companies from performing activitiesthat make markets less competitive.


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Regulation

Government may regulate the prices that themonopoly charges.

The allocation of resources will be efficient if price

is set to equal marginal cost.


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Public Ownership of Monopolies

Rather than regulating a natural monopoly that isrun by a private firm, the government can run

the monopoly itself (e.g. in the United States,

the government runs the Postal Service). Similarly, in Pakistan, the government controls

the postal services and electricity

generation/distribution company (PEPCO)


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Price Discrimination

Price discrimination is the business practice ofselling the same good at different prices to

different customers, even though the costs for

producing for the two customers are the same. In order to price discriminate, the firm must

have some market power.


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Perfect Price Discrimination

Perfect price discrimination refers to the

situation when the monopolist knows exactly

the willingness to pay of each customer and cancharge each customer a different price.


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Two important effects of price discrimination: It can increase the monopolists profits.

It can reduce deadweight loss.

f


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Figure 10 Welfare with and without Price Discrimination


Profit

(a) Monopolist with Single Price

Price

0 Quantity

Deadweight

loss

DemandMarginalrevenue

Consumer

surplus

Quantity sold

Monopoly

price

Marginal cost

Fi 10 W lf ith d ith t P i Di i i ti


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Figure 10 Welfare with and without Price Discrimination


Profit

(b) Monopolist with Perfect Price Discrimination

Price

0 Quantity

Demand

Marginal cost

Quantity sold


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Examples of Price Discrimination Movie tickets

Airline prices

Discount coupons

Financial aid

Quantity discounts

C Of


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Conclusion: The Prevalence OfMonopolies

How prevalent are the problems of monopolies? Monopolies are common.

Most firms have some control over their prices

because of differentiated products. Firms with substantial monopoly power are rare.

Few goods are truly unique.


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Summary

A monopoly is a firm that is the sole seller in itsmarket.

It faces a downward-sloping demand curve for

its product.

A monopolys marginal revenue is always

below the price of its good.


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Summary

Like a competitive firm, a monopoly maximizesprofit by producing the quantity at which

marginal cost and marginal revenue are equal.

Unlike a competitive firm, its price exceeds itsmarginal revenue, so its price exceeds marginal

cost.


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Summary

A monopolists profit-maximizing level ofoutput is below the level that maximizes the

sum of consumer and producer surplus.

A monopoly causes deadweight losses similarto the deadweight losses caused by taxes.


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Summary

Policymakers can respond to the inefficienciesof monopoly behavior with antitrust laws,

regulation of prices, or by turning the monopoly

into a government-run enterprise. If the market failure is deemed small,

policymakers may decide to do nothing at all.


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Summary

Monopolists can raise their profits by chargingdifferent prices to different buyers based on

their willingness to pay.

Price discrimination can raise economic welfareand lessen deadweight losses.

ch 22 monopoly

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