Chapter 15 Monopoly Objectives 1.) Learning the source of monopoly 2.) Understand how a monopolist sets price and output to maximize profits 3.) Evaluate the efficiency of monopoly 4.) Learn some of the various public policies toward a monopoly 5.) Understand how and why a monopolist would price discriminate MONOPOLY Monopoly is a market structure characterized by 1. One seller 2. Homogeneous product 3. Very much control over price(pricemaker) 4. Very great difficulty in entering or exiting the market . Monopoly A Pure Monopoly exists when a single firm is the only producer or seller of a product that has no close substitute. Why Learn About Monopolies? It is estimated that about five (5) percent of domestic output is supplied under monopoly conditions It helps to understand more common market structures such as monopolistic competition and oligopoly. Why Monopolies Arise The fundamental cause of a monopoly is Barriers to Entry. Monopoly: Barriers to Entry Ownership of Key Resource Monopoly: Barriers to Entry Ownership of Key Resource Legal Barriers By Government Monopoly: Barriers to Entry Ownership of Key Resource Legal Barriers By Government Large Economies of Scale Barrier: Monopoly Resources A single owner of an important resource that cannot be readily duplicated, as with some natural resources. Government-Created Monopolies Patentand copyright laws are a major source of government-created monopolies. – Certain new pharmaceutical drugs Governments also restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets. – Local cable television 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. – The minimum efficient scale of one firms plant is so large that only one firm can supply the market efficiently. Economies of Scale as a Cause of Monopoly Cost Average total cost 0 Quantity of Output Quick Quiz! What are the three reasons that a market might have a monopoly? Give two examples of monopolies, and explain the reason for each. Monopoly Behavior Monopoly verses Competitive Firm Monopoly Sole Producer DownwardSloping Demand Curve Price Setter Reduces Price to Increase Sales MarginalRevenue curve below demand Monopoly Behavior Competitive Firm verses Monopoly Competitive Firm One of many Horizontal Demand Curve Price Taker Sellsa lot or a little at same price Marginal Revenue curve is horizontal Demand Curves for Competitive and Monopoly Firms... (a) A Competitive Firm’s (b) A Monopolist’s Demand Curve Demand Curve Price Price Demand Demand 0 Quantity of 0 Quantity of Output Output Monopoly’s Revenue Total Revenue: Q x P = TR Average Revenue: TR ÷ Q = AR Marginal Revenue: TR ÷ Q = MR A monopolist’s Marginal Revenue is always less than the price of its good, because of the downward sloping demand curve. The Marginal-Revenue curve lies below its demand curve. $P Q $TR $MR Price 11 0 0 N/A 10 10 1 10 10 9 2 18 8 9 8 3 24 6 7 4 28 4 8 6 5 30 2 5 6 30 0 7 4 7 28 -2 3 8 24 -4 6 2 9 18 -6 1 10 10 -8 5 0 11 0 -10 4 3 Demand Marginal 2 Revenue 1 1 2 3 4 5 6 7 8 9 10 Quantity Total, Average, and Marginal Revenue for a Competitive Firm Quality Price Total Average Marginal Revenue Revenue Revenue Q P (TR=P*Q) (AR=TR/Q) (MR= TR / Q) 1gallon $6 $6 $6 $6 2 6 12 6 6 3 6 18 6 6 4 6 24 6 6 5 6 30 6 6 6 6 36 6 6 7 6 42 6 6 8 6 48 6 6 $ elastic portion inelastic portion Marginal Revenue Demand Quantity $ Total along the elastic along the inelastic Revenue portion of the portion of the demand curve, demand curve, lower prices and lower prices and greater quantities greater quantities result in rising result in declining total revenue total revenue Quantity Monopoly’s Marginal Revenue When a monopoly drops price to sell more product, the additional revenue received from previous amounts sold will decrease. Two effects on revenue when price is dropped: –The Output Effect –The Price Effect Profit Maximization of a Monopoly The monopolist’s profit-maximizing quantity of output is determined by the intersection of the Marginal-Revenue curve and the Marginal-Cost curve. Same rule of profit maximization as perfectly competitive firm MR = MC Monopoly’s Profit Maximization Price D Quantity MR Monopoly’s Profit Maximization Price MC = Supply D Quantity MR Monopoly’s Profit Maximization Price MC = Supply MR=MC D Quantity MR Profit Maximization of a Monopoly competitive markets, price equals In marginal cost. In Monopolized markets, price exceeds marginal cost. – As long as Average Total Cost is below the monopolist’s price, economic profits will be earned. Monopoly’s Profit Maximization Price Price MC = Supply D Quantity MR Monopoly’s Profit Maximization Price Price MC = Supply Price consistent PM with profit maximizing quantity D Quantity QM MR Profit Maximization of a Monopoly competitive markets, price equals In marginal cost. In Monopolized markets, price exceeds marginal cost. – As long as Average Total Cost is below the monopolist’s price, economic profits will be earned. Monopoly’s Profit Maximization Price MC = Supply Monopoly Price PM Monopoly Quantity D Quantity QM MR Monopoly’s Profit Maximization Price MC = Supply PM Monopoly Average Cost Curve D Quantity QM MR Monopoly’s Profit Maximization Price MC = Supply PM Monopoly Profit! D Quantity QM MR Comparing Monopoly and Competition Fora competitive firm, price equals marginal cost. P = MR = MC Fora monopoly firm, price exceeds marginal cost. P > MR = MC A Monopoly’s Profit Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q Quick Quiz! Explain how a monopolist chooses the quantity of output to produce and the price to charge. The Welfare Cost of Monopoly A monopoly leads to an inefficient allocation of resources, leading to a failure to maximize total economic well-being, The monopolist produces less than the socially efficient quantity of output. The Welfare Cost of Monopoly At monopoly prices, some potential consumers value the good at more than its marginal cost but less than the monopolist’s price. These consumers do not end up buying the good. Monopoly pricing prevents some mutually beneficial trades from taking place. The Welfare Cost of Monopoly: Deadweight Loss Because a monopoly sets price above MC it places a wedge, similar to a tax. The wedge causes the quantity sold to fall short of the social optimum. Monopoly’s Profit Maximization Price MC = Supply Monopoly Price PM Monopoly Quantity D Quantity QM MR Monopoly’s Profit Maximization Price MC = Supply PM Efficient Quantity! D Quantity QM MR Monopoly’s Profit Maximization Price MC = Supply PM D Quantity QM MR Monopoly’s Profit Maximization Price MC = Supply PM Monopoly Deadweight Loss D Quantity QM MR Monopolistic Deadweight Loss: Example Cable TV market. Assume: – Competitive Market Price = $15 – Monopolist Market Price = $25 – Marginal Cost = $5 Deadweight loss to society is $10: – Consumer does not value cable TV at more than its cost. Hence the consumer will not subscribe to cable TV.0 The Market for Drugs... Costs and Revenue Price during patent life Price after Marginal patent cost expires Marginal revenue Demand 0 Monopoly Competitive Quantity quantity quantity Public Policy Toward Monopoly: Government may intervene by. . . Creating a competitive market Implement/Enforce Anti-Trust Laws Regulating the behavior of monopolies Price control and regulation Public Ownership Government runs the monopoly itself Doing Nothing Marginal-Cost Pricing for a Natural Monopoly Price Average total cost Loss Regulated Marginal cost price Demand 0 Quantity Quick Quiz! Describe the ways policymakers can respond to the inefficiencies caused by monopolies. List a potential problem with each of these policy responses. Price Discrimination: Monopoly Tool The practice of selling the same good to different customers at different prices. – Not possible in a competitive market. Two Important Effects: – Can increase the monopolist’s profits – Can reduce deadweight loss A Parable About Pricing (Figure 15-10) Welfare With and Without Price Discrimination (a) Monopolist with Single Price (b) Monopolist with Perfect Price Discrimination Price Price Consumer Surplus Deadweight Loss Profit Profit Marginal cost Marginal cost Marginal Demand Demand Revenue 0 Quantity Quantity 0 Quantity sold Examples: Price Discrimination Movie Tickets, i.e., children, adult, senior Citizens Airline Tickets, i.e., first class, coach, stay over, one-way verses round-trip Discount Coupons Financial Aid Two-Part Tariff, i.e., amusement park entrance fee, and then a fee for each ride The Prevalence of Monopoly How prevalent are the problems of monopolies? Monopolies are common. Most firms have some control over their prices because of differentiated products. with substantial monopoly Firms power are rare. Few goods are truly unique. Quick Quiz! Give two examples of price discrimination. How does perfect price discrimination affect consumer surplus, producer surplus, and total surplus? The Prevalence of Monopoly Howprevalent are the problems of monopolies? – Monopolies are common. Most firms have some control over the prices because of differentiated products. Ben & Jerry’s Ice Cream vs Breyer’s – Firms with substantial monopoly power are rare. Few goods are truly unique. Summary A monopoly is a firm that is the sole seller in its market. It faces a downward-sloping demand curve for its product. A monopoly’s marginal revenue is always below the price of its good. Summary a competitive firm, a monopoly Like maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost. Summary A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. A monopoly causes deadweight losses similar to the deadweight losses caused by taxes. Summary Policymakers can respond to the inefficiencies of 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. Summary Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. Price discrimination can raise economic welfare and lessen deadweight losses.
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