Monopoly decisions


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  • Exclusive right to manufacture and sell for 17 years. A single firm can supply a good or service to the entire market at a smaller cost than two or more firms. Economies of scale over the relevant range. Controls 80% of world production of diamonds
  • Students sometimes have a difficult time understanding why the monopolist has to decrease price in order to sell an additional unit of output. Note that the monopolist will charge the highest price that consumers are willing to pay. When the price is say $5, all consumers willing to pay $5 or more will make a purchase, those willing to pay less than $5 will not buy at $5. In order to attract one more customer (sell one more unit), the monopolist must lower the price, but in doing so (given the “one price” assumption) he will have to charge this lower price to ALL buyers (including those who were happy paying $5). For this reason, if the monopolist wants to sell more units (to make more money) it must also make less per unit (lower price) on all units…the quantity sold increases but the per unit price must drop: the monopolist can not escape the law of demand. For this reason, the monopolist can not charge just any price he/she wants. The monopolist chooses the combination of price and quantity that maximizes profits. This explains why we do not have to pay $1,000 or $2,000 to buy Microsoft’s Windows software. Microsoft may have monopoly power but it must still abide by the law of demand… if you want to sell more units, you must lower the price on ALL units. Monopoly power allows Microsoft to choose the price and the number of units it wants to sell, but this choice must be made within the restrictions imposed by the the market (demand).
  • Note that total revenue is rising when marginal revenue is positive, is maximized when marginal revenue is zero, and is falling when marginal revenue is negative.
  • Monopoly decisions

    1. 1. Imperfect CompetitionOccurs when firms in a market orindustry have some control over theprice of their outputMonopoly, Oligopoly, and Monopolistic Competition ©2001Claudia Garcia-Szekely 1
    2. 2. Pure Monopoly An industry with a single firm that produces a product for which there are no close substitutes, and in which significant barriers to entry prevent other firms from entering the industry to compete for profits. ©2001Claudia Garcia-Szekely 2
    3. 3. Barriers to Entry Government franchises Patents and Copyright laws Economies of scale and other cost advantages Natural Monopoly (Water, electricity) Ownership of a scarce factor of production The De Beers Diamond Company ©2001Claudia Garcia-Szekely 3
    4. 4. Firms in a Perfectly CompetitiveMarketTake the market price as a given and decide: How much output to produce How to produce output (what combination of labor and capital to use) How much to demand in each input market (How many workers to hire) ©2001Claudia Garcia-Szekely 4
    5. 5. Monopolists must decide: How much output to produce How to produce output How much to demand in each input market What price to charge for output ©2001Claudia Garcia-Szekely 5
    6. 6. Price and Output Decisions in PureMonopoly MarketsBasic assumptions: Entry to the market is strictly blocked. Firms act to maximize profits. The monopolistic firm cannot price discriminate. Charge only ONE price. The monopoly faces a known demand curve. ©2001Claudia Garcia-Szekely 6
    7. 7. Consider this hypothetical data for amonopolist’s demand curve: Quantity Price Total Revenue Marginal Revenue 0 11 1 10 2 9 3 4 Can you 8 calculate total7 ∆TR 5 6 and marginal 6 revenue for 5 PxQ /∆Q 7 the firm? 4 8 3 9 2 10 1 ©2001Claudia Garcia-Szekely 7
    8. 8. ∆TR/∆Q In PerfectQuantity Price Price MR decreases when Total Revenue Marginal As Competition Q increases decreases, Revenue P = MR 0 TR increase, X 11 = 0 1 reach aX 10 = 10 10/1 = 10 maximum 2 X (30) and 9 = 18 8/1= 8 3 then 8 24 6/1= 6 Sell more 4 decrease 7 28 4/1= 4 5 units by 6 30 2/1= 2 reducing 6 price 5 Price > MR 30 0/1= 0 7 4 28 -2/1= - 2 8 3 24 -4/1= - 4 9 2 18 -6/1= - 6 10 1 10 -8/1= - 8 ©2001Claudia Garcia-Szekely 8
    9. 9. We can plot demand and marginal revenue as follows: 12 10 Market Demand 8 Price per unit ($) 6 4 2 0 -2 0 1 2 3 4 5 6 7 8 9 10 -4 MR<Price -6 -8Marginal Revenue ©2001Claudia Garcia-Szekely 9
    10. 10. Adding the total revenue curve: 30 25 20 TR Max MR = zero 15 10 TR 5 0 Demand -5 0 1 2 3 4 5 6 7 8 9 10 -10 MR Units of output Q ©2001Claudia Garcia-Szekely 10
    11. 11. The monopolist’s profit-maximizing output and price: The maximum price this $ monopolist can charge for QChoose Q units is P.such thatMR = MC MC P ATCGo up to thedemand curveto set the price D Q Q * MR ©2001Claudia Garcia-Szekely 11
    12. 12. The monopolist’s profit-maximizingoutput and price TC = ATC x Q Profit = TR - TC MC ATC Pm Profit ATC TR = P x Q TR TC D Q Qm MR ©2001Claudia Garcia-Szekely 12
    13. 13. Monopolist Sets Price Above MC This markup over MC $ Price > MC is the signature of a To find a firm that monopolist To find a firm that MC has market power: has market power: ATC $P for firms that Look Look for firms that charge a price that charge a price that This is the “mark-up” is higher than their is $ATChigher than their above cost resulting MC of production MC of production from monopoly’s market $MC power D Qm Q MR 13 ©2001Claudia Garcia-Szekely
    14. 14. In Monopoly...The monopolist has no supply curve; there is nounique relationship between price and quantitysupplied.Since entry is blocked, the monopolist can earneconomic profits in the long run.Monopolists can have losses in the short run ifdemand is not sufficient or if costs are too high. ©2001Claudia Garcia-Szekely 14
    15. 15. Comparison of Monopoly and Perfect Competition Sum of MC above AVC for allThese are the Price and Quantity under a Perfectly Competitive firms in Perfect Competition $ industry = Market Supply MC Pm=$4 Monopolist restricts output and charges Ppc=$2 a higher price than MR under Perfect Competition D 2000 4000 Qm Qpc Units of output, Q ©2001Claudia Garcia-Szekely 15
    16. 16. Natural Monopoly An industry where the technological advantages of large-scale production allow a single firm to produce at a lower cost than many smaller companies. ©2001Claudia Garcia-Szekely 16
    17. 17. MC S This Demand can be supplied 40 Firms selling 400,000 by many perfectly competitive units at $5/unit firms each with a small plant of ATC1 size ATC1 ONE firm selling Or Demand can be suppliedat 500,000 units by5 ONE firm with a large plant of $3/unit size ATC53 MC ATC5 D 10,000 400,000 500,000 D ©2001Claudia Garcia-Szekely 17
    18. 18. Government MonopoliesSince a large firm can supply the entire market at a lower cost, governments have two choices: Allow a private monopoly to exist under government regulation or Government ownership of the industry. Most public services are state owned monopolies in most countries. ©2001Claudia Garcia-Szekely 18
    19. 19. Regulating a Natural MonopolySeveral alternatives: The government sets the price as it would occur under perfect competition. The government sets a price ceiling equal to marginal cost, and subsidizes production. The government sets the monopoly price to cover average cost per unit. ©2001Claudia Garcia-Szekely 19
    20. 20. The government forces the perfectlycompetitive solution Pm Profit Monopoly profits P = MC Profit after regulation decrease Qm Q = 600,000 ©2001Claudia Garcia-Szekely 20
    21. 21. The government sets a price ceilingequal to marginal cost, and subsidizesproduction. Pm Subsidy Loss P = MC Q = Qm 500,000 ©2001Claudia Garcia-Szekely 21
    22. 22. The government sets a monopoly’sprice to cover average cost. Pm No Loss, No Profit. P = ATC No Subsidy Q = Qm 500,000 ©2001Claudia Garcia-Szekely 22