The Monopoly Market Structure What is a monopoly exactly? A monopoly is a market structure characterized by: A single seller A unique product Impossible entry into the market Under a monopoly, the consumer has only one choice. Thus, they can either buy from the producer or not consume There are no close substitutes.
A Single Seller One single firm IS the industry. Local monopolies are more commonly observed in the real-world than national monopolies. Examples
Unique Products Why do Monopolists have unique products? Absence of close substitutes
Impossible Entry Barriers to Entry are high It is different or impossible for a new firm to enter an industry due to: Ownership of Vital Resources Legal Barriers Economies of Scale
Ownership of Vital Resources A seller can create its own barrier to entry if it owns a significant portion of a key resource required for the production of the good or service. In practice, monopolies rarely arise for this reason. The market for most resources is national or even international, and ownership of most resources is dispersed among a large number of people and nations. Example
Legal Barriers Legal barriers to entry are the source of most present- day monopolies. Entry into the market or competition within the market are restricted by the granting of a public franchise, government license, patent, or copyright. Examples:
Economies of Scale Monopolies can emerge in time naturally because of the relationship between average cost and the scale of the operation. This is called “natural monopolies” Def: A natural monopoly is an industry in which the LRAC of production declines throughout the entire market. Natural monopoly provides an economic argument for regulated public utilities.
Economies of Scale When this happens a single firm can supply the entire market demand at a lower cost than two or more smaller firms. Markets characterized by economies of scale often become competitive over time because of technological advances or because of natural growth in the size of the market.
SOURCES OF MONOPOLY Economies of ScaleThe cost to distribute 4 millionkilowatt hours of electric power is5 cents a kilowatt-hour with oneseller in the market, or . . .10 cents a kilowatt-hour with twosellers, or . . .15 cents a kilowatt-hour with foursellers.Because of economies of scale, oneseller can meet the market demandat a lower average cost than two ormore sellers.
Price and Output Decisions for a Monopolist The demand curve for a monopolist differs from the competitive firm because the monopolist is a price maker not taker. Def: A price maker is a firm that faces a downward sloping demand curve.
More Demand and some Marginal Revenue Demand and Marginal Revenue They are both negatively-sloped Demand Market demand is negatively-sloped. The monopolist faces a tradeoff between price and quantity sold. To obtain a higher price, the monopolist must lower quantity. Or, if it wants to sell a larger quantity, it must lower price.
MONOPOLY EQUILIBRIUM Demand and Marginal Revenue Marginal revenue is less than price The marginal revenue curve is negatively-sloped but lies below the demand curve at each quantity: MR<P at all Q.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal RevenueCalculate the marginal revenue generated along the demand curve.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal RevenueIf the price is $16, quantity demanded is 2 haircuts per hour.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal RevenueIf the price is $14, quantity demanded is 3 haircuts per hour.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal RevenueTotal revenue from two haircuts per hour decreases by $4.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal RevenueTotal revenue from the additional haircut is $14.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal RevenueMarginal revenue from the additional haircut is $10.
MONOPOLY EQUILIBRIUMExample: Demand and Marginal RevenueThe marginal revenue curve is negatively-sloped and lies below thedemand curve. Marginal revenue is less than price at each quantity.
MONOPOLY EQUILIBRIUMProfit Maximization by aMonopolistThe diagram shows themonopolist’s• average total cost (ATC),• marginal cost (MC),• demand (D),• and marginal revenue (MR).The monopolist maximizes profitsor minimizes losses by producingthe quantity at which marginalrevenue equals marginal cost.
MONOPOLY EQUILIBRIUMProfit Maximization by aMonopolistThe equilibrium quantity is 3haircuts per hour where MR=MC,andthe equilibrium price is $14, shownby the demand at the quantity 3.The ATC of 3 haircuts is $10.Because P>ATC at the equilibriumquantity, the monopolist earns aprofit of $4 per haircut or $12 perhour. 23 Monopoly
MONOPOLY EQUILIBRIUMProfit Maximization by a Monopolist: Numerical ExampleThe data in the table below verify that 3 haircuts per hour maximizes themonopolist’s profit.
MONOPOLY EQUILIBRIUM Short-Run and Long-Run Equilibrium When a monopolist incurs short-run losses However, if a monopolist incurs economic losses in the short- run, it exits the market in the long-run. The long-run equilibrium quantity is zero.
MONOPOLY EQUILIBRIUM Short-Run and Long-Run Equilibrium When a monopolist earns short-run profits
Price Discrimination The monopolist may charge different prices to consumers to maximize profits. Def: Price discrimination occurs when a seller charges different prices for the same product that are not justified by cost differences. Selling a good or service at a number of different prices where the price differences do not reflect differences in cost but instead reflect differences in consumers’ price elasticities of demand. However, specific conditions must be met before the seller can act in this way.
Conditions for Price Discrimination The seller must be a price maker and therefore face a downward-sloping demand curve The seller must be able to segment the market distinguishing between consumers willing to pay different prices It must be impossible or too costly for customers to engage in arbitrage
How can a producer price discriminate Discriminating among groups of consumers Different prices for consumers with different elasticities. The market is segmented based on some easily distinguished characteristic of consumers—age, for example. Discriminating among units of a good The seller charges the same prices to all consumers but offers each consumer a lower price for a larger number of units bought—volume discounts, for example.
Price Discrimination with Two Groups of Consumers (a) (b)per unitDollars Dollars per unit$3.00 LRAC, MC $1.50 LRAC, MC 1.00 1.00 MR D MR’ D’ 0 400 Quantity per period 0 500 Quantity per periodA monopolist facing two groups of consumers with different demand elasticities may beable to practice price discrimination to increase profit or reduce loss. With marginal costthe same in both markets, the firm charges a higher price to the group in panel (a), whichhas a less elastic demand than group in panel (b).
Is Price Discrimination Unfair There is nothing evil or illegal about economic price discrimination. It simply means charging different prices for the same good or service unrelated to differences in cost. Price discrimination is common in all markets other than perfectly competitive markets.
Is Price Discrimination Unfair What are its effects: Increase seller’s profit, at least in the short run Enhance economic efficiency Conserve on scarce resources. Many buyers benefit because they are now paying a lower price Example: Movie Theatres- senior citizen and college students discounts
How does it increase the sellers profits Increases seller’s profits By observing different elasticities for the consumers the following can happen Reduce the price for buyers with elastic demand will increase TR Increase the price for buyers with inelastic demand will increase TR When the total quantity is not changing, then costs are not changing, but revenues are profits are HIGHER
What about efficiency Enhances economic efficiency We know that under a monopoly the output is under- produced. But price discrimination can fix this underproduction of the good A price-discriminating monopolist is able to sell a larger quantity than a single-price monopolist by reducing price only on the additional units sold, not on all units sold. Because the problem with monopoly is underproduction, increasing quantity enhances efficiency. The sum of producer and consumer surplus is higher in a monopoly market with price discrimination than in a market with a single-price monopolist.
MONOPOLY AND COMPETITIONCompetitive EquilibriumThe market demand curve is D.The market supply curve is S.The competitive marketequilibrium is where quantitydemanded equals quantity supplied.The competitive equilibriumquantity is QC and the equilibriumprice is PC.
MONOPOLY AND COMPETITIONMonopoly EquilibriumThe competitive market supplycurve, S, is the monopolist’smarginal cost curve, MC.The monopolist’s marginal revenuecurve is MR.The monopolist’s equilibriumquantity is QM where marginalrevenue equals marginal cost. Theequilibrium price is PM , shown bythe demand at QM.
MONOPOLY AND COMPETITION Competitive and Monopolistic Equilibrium Monopoly quantity is lower and price is higher Amonopolist supplies a smaller quantity than a competitive market would supply at a higher price. The higher price allows a monopolist to earn positive long-run economic profits.
MONOPOLY AND COMPETITION Economic Consequences of Monopoly The absence of competition results in • Inefficiency and deadweight loss • Redistribution of wealth
MONOPOLY AND COMPETITIONEfficiency of CompetitiveEquilibriumThe competitive equilibrium price,PC, brings consumers’ marginalbenefit into equality withproducers’ marginal cost. Therefore, the competitive equilibrium quantity, QC, is efficient. The sum of consumer surplus and producer surplus is maximized.
MONOPOLY AND COMPETITIONInefficiency of MonopolyMarginal benefit in the monopolyequilibrium (equals to themonopoly equilibrium price, PM)exceeds marginal cost.Therefore, the monopolyequilibrium quantity, QM, isinefficient because ofunderproduction. Monopoly resultsin a deadweight loss.
MONOPOLY AND COMPETITION Economic Consequences of Monopoly Redistribution of wealth
MONOPOLY AND COMPETITIONMonopoly Redistributes WealthThe deadweight loss of monopolyarises from a net loss in bothconsumer and producer surpluscompared with the competitiveequilibrium.In addition to the net loss in thetotal surplus, monopoly alsoredistributes some of the remainingsurplus from consumers to themonopolist.
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