monopoly concepts on economics

8/10/2019 Monopoly Concepts On Economics

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MONOPOLY

Lecture 1


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Monopoly

Microsoft copyright for windows.

So can charge 3000 rupees forWindows.

Because it has the exclusive right tomake and sell copies of windows.

Microsoft is said to have monopoly in the

market for windows


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MonopolyMicrosofts business decisions are not welldescribed by the model of firm behaviour wedeveloped in Chapter 14.

In that chapter, we analysed competitivemarkets in which there are many firms offering

essentially identical products, so each firm haslittle influence over the price it recieves.

By contrast , a monopoly such as Microsoft

has no close competitors and, therefore, caninfluence the market price of its product.

While a competitive firm is a price taker, amonopoly firm is a price maker.


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MonopolyIn this chapter we examine the implications of thismarket power. We will see that market power altersthe relationship between a firms price and its costs.

A competitive firm takes the price of its output asgiven by the market and then chooses the quantity it

will supply so that price equals marginal cost. Bycontrast the price charged by a monopoly exceedsmarginal cost. The result is clearly true in the case ofMicrosofts windows. The MC of windows-the extra

cost that Microsoft would incur by printing one morecopy of the program into some floppy disks or a CDis only about Rs. 150. The market price of windows ismany times marginal cost.


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MonopolyIt is perhaps not surprising that monopolies chargehigh prices for their products. Customers of

monopolies might seem to have little choice but topay whatever the monopoly charges. But, if so, whydoes a copy of windows not cost Rs 20,000 orrupees 2 lakhs. The reason of course, is that if

Microsoft set the price that high, fewer people wouldbuy the product. People would buy fewer computers,switch to other operating systems, or make illegalcopies. Monopolies cannot achieve any level of profit

they want, because high prices reduce the amountthat their customers buy. Although monopolies cancontrol the prices of their goods, their profits are notunlimited


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MonopolyAs we examine the production and pricing decisionsof monopolies, we also consider the implications ofmonopoly for society as a whole. Monopoly firms, likecompetitive firms, aim to maximise profit. But thisgoal has very different ramifications for competitive

and monopoly firms. As we first saw in Chapter onConsumer surplus, self interested buyers and sellersin competitive markets are unwittingly led by aninvisible hand to promote general economic well

being. Because monopoly firms are unchecked bycompetition, the outcome in a market with amonopoly is often not in the best interest of society.


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Monopoly

One of the ten principles of economics in

Chapter 1 is that government sometimesimproves market outcomes. The analysis inthis chapter will shed more light on thisprinciple. As we examines the problems thatmonopolies raise for society we will alsodiscuss the various ways in whichpolicymakers might respond to these

problems. The US government for e.g., keepsa close eye on Microsofts business decisions.


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Monopoly

A firm is considered a monopoly if . . .it is the sole seller of its product.

its product does not have close

substitutes.


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Monopoly

Why Monopolies Arise

- The fundamental cause of monopoly isbarriers to entry.

A monopoly remains the only seller in itsmarket because other firms cannot enterthe market and compete with it.


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Monopoly

Barriers to entry have three sources: Ownership of a key resource.

The government gives a single firm the

exclusive right to produce somegood.

Costs of production make a single

producer more efficient than a largenumber of producers.


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Monopoly ResourcesThe simplest way for a monopoly to arise is

for a single firm to own a key resource. Fore.g., consider the market for water in a smalltown. If dozens of town residents have

working wells, the competitive modeldescribed in Chapter 14 describes thebehaviour of sellers. As a result, the price of agallon of water is driven to equal the marginal

cost of pumping an extra gallon.


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Monopoly Resources

But if there is only one well in town and it isimpossible to get water from anywhere

else, then the owner of the well has amonopoly on water.Not surprisingly, themonopolist has much greater marketpower than any single firm in a competitive

market.In the case of a necessity likewater, the monopolist could commandquite a high price even if the MC is low.


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Monopoly Resources

Although exclusive ownership of a key resourceis a potential source of monopoly, in practicemonopolies rarely arise for this reason. Actual

economies are large, and resources are ownedby many people. Indeed because many goodsare traded internationally, the natural scope oftheir markets is often worldwide. There are,

therefore, few examples of firms that own aresource for which there are no closesubstitutes.


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Government-Created Monopolies

Governments may restrict entry by giving a

single firm the exclusive right to sell aparticular good in certain markets.

Some data needs to be centralised andcomprehensive for e.g. a database of all.com,.net and.org addresses.

IOC had the exclusive right of selling petrol

AEC has the exclusive monopoly of sellingelectricity in Ahmedabad.

G t C t d M li


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Government-Created Monopolies

Patentand copyright lawsare two

important examples of how governmentcreates a monopoly to serve the publicinterest.Say the benefits of patents in

pharma research, or a novelist to writebetter books.

The benefits are offset to some extent

by the costs of monopoly pricing.


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a ura onopo es

An industry is a natural monopolywhen a

single firm can supply a good or service toan entire market at a smaller cost thancould two or more firms. For e.g.-distributionof water fixed costs of building a network ofpipes.


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a ura onopo es

Another e.g. excludable(toll collector) but

not rival(use by one does not diminish abilityof others to use it.) bridgeused soinfrequently, never congested FC high, MCnegligible, ATC falls as number of trips risesso economies of scale.


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a ura onopo es

In a natural monopoly less concerned about

entrants as all firms would know that if theyenter all would have a smaller piece of themarket.

As the market expands a natural monopolycan evolve into a competitive market, ieneed for more bridges as populationincreases.


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Natural MonopoliesA natural monopolyarises when thereare economies of scale over therelevant range of output. In this case a

single firm can produce any amount ofoutput at least cost. That is, for anygiven amount of output, a large

number of firms lead to less output perfirm and higher ATC.


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Economies of Scale as a Cause of

Monopoly...

Averagetotalcost

Quantity of Output

Cost

0


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Monopoly versus Competition

MonopolyIs the sole producer

Has a downward-sloping demand curve,raise price quantity falls or reduces outputprice increases

Is a price maker

Reduces price to increase sales, would preferto sell higher q at higher P but not possible.


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Competition versus Monopoly

Competitive FirmIs one of many producers, small relative to the

market

Has a horizontal demand curve, product withmany close subs, relatively elastic demandcurve.

Is a price taker

Sells as much or as little at same price


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How monopolies make productionand pricing decisions

Now that we know how monopolies arise,we can consider how a monopoly firmdecides how much of its product to make

and what price to charge for it. Theanalysis of monopoly behaviour in thissection is the starting point for evaluating

whether monopolies are desireable andwhat policies the government mightpursue in monopoly markets


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Monopoly versus competition

The key difference between a competitive firmand a monopoly is the monopolys ability to

influence the price of its output. A competitive

firm is small relative to the market in which itoperates and, therefore, takes the price of itsoutput as given by the market conditions. Bycontrast because a monopoly is the sole

producer in its market, it can alter the price of itsgood by adjusting the quantitty it supplies to themarket.


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One way to view this difference between acompetitive firm and a monopoly is toconsider the demand curve that each firm

faces. When we anlysed profitmaximisation by competitive firms in thepreceding chapter, we drew the market

price as ahorizontal line.


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Because a competitive firm can sell asmuch or as little as it wants at this price atthis price, the competitive firm faces a

horizontal demand curve as we will see inthe figure (a). In effect because thecompetitive firm sells a product with manyperfect substitutes(the product of all the

other firms in its market), the demandcurve that any one firm faces is perfectlyelastic.


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By, contrast, because a monopoly is thesole producer in its market, its demandcurve is the market demand curve. Thus,

the monopolists demand curve slopesdownward for all the usual reasons, as inpanel(b) of figure. If the monopolist raisesthe price of the good, consumer buy less

of it. Looked at another way, if themonopolist reduces the quantity of outputit sells, the price of its output increases.


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The market demand curve provides aconstraint on a monopolys ability to profit

from its market power. A monopolist would

prefer, if it were possible, to charge a highprice and sell a large quantity at that highprice.


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The market demand curve makes thatoutcome impossible. In particular, themarket demand curve describes the

combinations of price and quantity that areavailable to a monopoly firm. By adjustingthe quantity produced(or equivalently theprice charged), the monopolist can choose

any point on the demand curve but itcannot choose a point off the demandcurve.


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What point on the deamnd curve will themonopolist choose?As with competitivefirms, we assume that the monopolists

goal is to maximise profit. Because thefirms profit is total revenue minus totalcosts, our next ask in explaining monopoly

behaviour is to examine a monoplistsrevenue.


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Quantity ofOutput

Demand

(a) A Competitive FirmsDemand Curve

(b) A MonopolistsDemand Curve

0

Price

0 Quantity ofOutput

Price

Demand

Demand Curves for Competitive and

Monopoly Firms...


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A Monopolys Revenue

Total Revenue

P x Q = TR

Average RevenueTR/Q = AR = P

Marginal Revenue

DTR/DQ = MR


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A Monopolys Total, Average, and

Marginal Revenue

Quantity

(Q)

Price

(P)

Total Revenue

(TR=PxQ)

Average

Revenue

(AR=TR/Q)

Marginal Revenue

(MR= )0 $11.00 $0.00

1 $10.00 $10.00 $10.00 $10.00

2 $9.00 $18.00 $9.00 $8.00

3 $8.00 $24.00 $8.00 $6.00

4 $7.00 $28.00 $7.00 $4.00

5 $6.00 $30.00 $6.00 $2.006 $5.00 $30.00 $5.00 $0.00

7 $4.00 $28.00 $4.00 -$2.00

8 $3.00 $24.00 $3.00 -$4.00

Q

TRDD /


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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 drops the price to sell one moreunit, the revenue received from previously sold

units also decreases.To increase amount soldmonopoly must lower P.

onopo y s arg na evenue


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onopo y s arg na evenue

When a monopoly increases the

amount it sells, it has two effects ontotal revenue (P x Q).

The output effectmore output is sold,

so Q is higher.The price effectprice falls, so P is

lower. Price effect is not seen for

competitive firmWhen PE is greater than OE, MR is

negative.

Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.


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Demand and Marginal Revenue Curves

for a Monopoly...When

Quantity of Water

Price

$11

10

9

8

76

5

4

3

21

0

-1

-2

-3-4

1 2 3 4 5 6 7 8

Marginalrevenue

Demand

(average revenue)


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Profit Maximization of a Monopoly

A monopoly maximizes profit by producingthe quantity at which marginal revenueequals marginal cost.

It then uses the demand curve to find theprice that will induce consumers to buythat quantity.

Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.


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Profit-Maximization for a Monopoly...

Monopolyprice

QuantityQMAX0

Costs andRevenue

Demand

Average total cost

Marginal revenue

Marginalcost

A

1. The intersection ofthe marginal-revenuecurve and the marginal-cost curve determinesthe profit-maximizing

quantity...B

2. ...and then the demandcurve shows the priceconsistent with thisquantity.


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Comparing Monopoly andCompetition

For a competitivefirm, price equalsmarginal cost.

P = MR = MC

For a monopolyfirm, price exceedsmarginal cost.

P > MR = MC


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A Monopolys Profit

Profit equals total revenue minus total

costs.Profit = TR - TC

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

Profit = (P - ATC) x Q


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The Monopolists Profit

The monopolist will receiveeconomic profits as long as priceis greater than average total cost.

monopoly concepts on economics

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