More Related Content Similar to Monopoly decisions Similar to Monopoly decisions (20) 1. Imperfect Competition
Occurs when firms in a market or
industry have some control over the
price of their output
Monopoly, Oligopoly, and Monopolistic
Competition
©2001Claudia Garcia-Szekely 1
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. 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. Firms in a Perfectly Competitive
Market
Take 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. 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
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6. Price and Output Decisions in Pure
Monopoly Markets
Basic 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. Consider this hypothetical data for a
monopolist’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. ∆TR/∆Q
In Perfect
Quantity 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. 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
-8
Marginal Revenue
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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
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11. The monopolist’s profit-maximizing
output and price: The maximum price this
$ monopolist can charge for Q
Choose Q units is P.
such that
MR = MC MC
P ATC
Go up to the
demand curve
to set the price D
Q
Q *
MR
©2001Claudia Garcia-Szekely 11
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. In Monopoly...
The monopolist has no supply curve; there is no
unique relationship between price and quantity
supplied.
Since entry is blocked, the monopolist can earn
economic profits in the long run.
Monopolists can have losses in the short run if
demand is not sufficient or if costs are too high.
©2001Claudia Garcia-Szekely 14
15. Comparison of Monopoly and Perfect
Competition Sum of MC above AVC for all
These 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. 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. 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 by
5 ONE firm with a large plant of
$3/unit
size ATC5
3 MC ATC5
D
10,000 400,000 500,000 D
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18. Government Monopolies
Since 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. Regulating a Natural Monopoly
Several 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.
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20. The government forces the perfectly
competitive solution
Pm
Profit Monopoly
profits
P = MC Profit after regulation
decrease
Qm Q = 600,000
©2001Claudia Garcia-Szekely 20
21. The government sets a price ceiling
equal to marginal cost, and subsidizes
production.
Pm
Subsidy
Loss
P = MC
Q = Qm
500,000
©2001Claudia Garcia-Szekely 21
22. The government sets a monopoly’s
price to cover average cost.
Pm No Loss,
No Profit.
P = ATC No
Subsidy
Q = Qm
500,000
©2001Claudia Garcia-Szekely 22
Editor's Notes 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.
