Download - 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
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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
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Quantity of Output
Demand
(a) A Competitive Firms Demand Curve (b) A Monopolists Demand Curve
0
Price
Quantity of Output0
Price
Demand
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Monopolys Firms Revenue
Total Revenue
P Q = TR
Average Revenue
TR/Q = AR = P
Marginal Revenue
DTR/
DQ = MR
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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.
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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
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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
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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
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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.
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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
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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
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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
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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
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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.
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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
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Quantity0
Price
Deadweight
loss
DemandMarginalrevenue
Marginal cost
Efficient
quantity
Monopoly
Price
Monopoly
quantity
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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.
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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.
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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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Price Discrimination
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
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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
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Profit
(b) Monopolist with Perfect Price Discrimination
Price
0 Quantity
Demand
Marginal cost
Quantity sold
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Price Discrimination
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.