Pure Monopoly13McGraw-Hill/IrwinCopyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Four Market ModelsLO1

Characteristics of the Four Basic Market ModelsCharacteristicPure CompetitionMonopolistic CompetitionOligopolyMonopolyNumber of firmsA very large numberManyFewOneType of productStandardizedDifferentiatedStandardized or differentiatedUnique; no close subs.Control over priceNoneSome, but within rather narrow limitsLimited by mutual inter-dependence; considerable with collusionConsiderableConditions of entryVery easy, no obstaclesRelatively easySignificant obstaclesBlockedNonprice competitionNoneConsiderable emphasis on advertising, brand names, trademarksTypically a great deal, particularly with product differentiationMostly public relation advertisingExamplesAgricultureRetail trade, dresses, shoesSteel, auto, farm implementsLocal utilities

An Introduction to Pure MonopolySingle seller a sole producerNo close substitutes unique productPrice maker control over priceBlocked entry strong barriers to entry block potential competitionNon-price competition mostly PR or advertising the productLO1

Public utility companies Natural Gas Electric WaterNear monopolies Intel Wham-OProfessional sports teams

Barriers to EntryBarrier to entry: a factor that keeps firms from entering an industryEconomies of scaleLegal barriers: patents and licensesOwnership of essential resourcesPricingLO1

Monopoly DemandThe pure monopolist is the industryDemand curve is the market demand curveDownsloping demand curveMarginal revenue is less than priceLO1

Monopoly DemandMarginal revenue < priceMonopolist is a price makerMonopolist sets prices in elastic region of demand curveLO2

Output and Price DeterminationLO2

Steps for Graphically Determining the Profit-Maximizing Output, Profit-Maximizing Price, and Economic Profits (if Any) in Pure MonopolyStep 1Determine the profit-maximizing output by finding where MR=MC.Step 2Determine the profit-maximizing price by extending a vertical line upward from the output determined in step 1 to the pure monopolists demand curve.Step 3Determine the pure monopolists economic profit by using one of two methods:Method 1. Find profit per unit by subtracting the average total cost of the profit-maximizing output from the profit-maximizing price. Then multiply the difference by the profit-maximizing output to determine economic profit (if any).Method 2. Find total cost by multiplying the average total cost of the profit-maximizing output by that output. Find total revenue by multiplying the profit-maximizing output by the profit-maximizing price. Then subtract total cost from total revenue to determine the economic profit (if any).

Output and Price DeterminationLO20DMRATCMCMR=MCA=$94EconomicProfitPm=$122

Misconceptions of Monopoly PricingNot highest priceTotal profitPossibility of losses

LO2

Misconceptions of Monopoly PricingLO20DMRATCMCMR=MCLossAVCPmQmVA

Economic Effects of MonopolyLO3(a)Purely Competitive Market(b)Pure MonopolyDDS=MCMCP=MC=MinimumATCMRPcQcPcPmQcQmPure competition is efficientMonopoly is inefficientabcd

Economic Effects of MonopolyIncome transferCost complicationsEconomies of scaleX-InefficiencyRent seeking expendituresTechnological advanceLO3

X-InefficiencyLO3ATC2ATC1 ATCxQ1Q2AverageTotal CostXX'ATCx'

Price DiscriminationPrice discrimination Charging different buyers different prices Price differences are not based on cost differencesExamples: business travel, electric utilities, movie theaters, golf courses, railroad companies, coupons, international tradeLO4Price Discrimination

Conditions for success:Monopoly powerMarket segregationNo resale

Price DiscriminationLO4

Regulated MonopolyNatural monopoliesSocially optimal priceSet price = marginal costFair return priceSet price = ATC

LO5

Regulated MonopolyLO5MonopolyPriceFair-ReturnPriceSociallyOptimalPricePrDrfbaPfPmQmQfQrMRMCATC

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