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Monopoly
- 2. The monopoly firm While a competitive firm is a price taker, a monopoly firm is a price maker. A firm is considered a monopoly if: it is the only seller of its product. & its product does not have close substitutes.
- 3. Why monopolies arise The main cause of monopoly is barriers to entry. Barriers to entry have 3 sources: a key resource (e.g. oil) is owned by a single firm - rare the government gives a single firm the exclusive right to produce some good (e.g. Australia Post) or due to patent & copyright laws. costs of production make a single producer more efficient than having many producers – natural monopoly.
- 4. Natural monopoly An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a cheaper than 2 or more firms could. A natural monopoly arises when there are economies of scale.
- 5. Economies of scale as cause of natural monopoly Quantity of output Average total cost 0 Cost
- 6. Monopoly production & pricing decisions Monopoly is the sole producer faces a downward-sloping demand curve is a price-maker so can reduce price to increase sales
- 7. Demand curves: competition vs. monopoly Copyright © 2004 South-Western Quantity of output Demand Competitive firm ’‘s demand curve Monopolist’s ’demand curve 0 Price Quantity of output0 Price Demand
- 8. Monopoly revenues – as usual… Total revenue P × Q = TR Average revenue TR/Q = AR = P Marginal revenue ∆TR/∆Q = MR
- 9. Monopoly water supplier’s - example Quantity of water Price Total revenue Average revenue Marginal revenue (Q) (P) (TR = P X Q) (AR = TR/Q) (MR = ΔTR/ΔQ) 0 litres $11 $ 0 — 1 10 10 $10 10 2 9 18 9 8 3 8 24 8 6 4 7 28 7 4 5 6 30 6 2 6 5 30 5 0 7 4 28 4 –2 8 3 24 3 -4
- 10. Note: A monopolist’s MR ≤ P. Because demand curve is downward-sloping. When a monopoly drops price to sell an extra unit, revenue received from previously sold units decreases. Hence, AR (demand curve) is negatively sloped
- 11. Example Suppose monopolist sells 100 units at $10.50 earning $1050 in revenue If it wishes to sell 101 units it must cut price because it faces downward-sloping demand. Suppose it cuts price to $10.45 to sell 101 units. It then earns 101*$10.45 = $1055.45 MR= $5.45 which is less than price $10.45 because in increasing output it loses 5 cents on the first 100 units.
- 12. Graphing demand & MR Copyright © 2004 South-Western Quantity of water Price $11 10 9 8 7 6 5 4 3 2 1 0 –1 –2 –3 –4 Demand MR 1 2 3 4 5 6 7 8
- 13. When a monopoly increases the amount sold it has two effects on revenue: 1. Output effect—more is sold. 2. Price effect —price falls.
- 14. Profit maximisation A monopoly maximizes profit by producing output where marginal revenue equals marginal cost. MR = MC It then uses demand curve to find the price that will induce consumers to buy that quantity.
- 15. Profit maximisation for monopoly Copyright © 2004 South-Western QuantityQ Q0 Costs and revenue Demand ATC MR MC Monopoly price QMAX B 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity ... A 2. ... and then the demand curve shows the price consistent with this quantity.
- 16. Profit maximisation Comparing monopoly & competition For a competitive firm: P = MR = MC For a monopoly: P > MR = MC.
- 17. Monopoly profits Copyright © 2004 South-Western Monopoly profit Average total cost Quantity Monopoly price QMAX0 Costs and revenue Demand Marginal cost Marginal revenue Average total cost B C E D
- 18. Monopoly – zero economic profits Copyright © 2004 South-Western Quantity Monopoly price QMAX0 Costs and revenue Demand Marginal cost Marginal revenue Average total cost BE
- 19. Monopoly losses Copyright © 2004 South-Western loss Average cost Quantity Monopoly price QMAX0 Costs and revenue Demand Marginal cost Marginal revenue Average total cost BE D C
- 20. Welfare costs of monopoly A monopoly charges P > MR=MC. For consumers, high price is undesirable. For owners of the firm, high price is desirable. But gains to owners are less than losses to consumers – so there is a deadweight loss.
- 21. Inefficiency of monopoly Copyright © 2004 South-Western Quantity0 Price Deadweight loss Demand Marginal revenue Marginal cost Efficient quantity Monopoly price Monopoly quantity
- 22. Deadweight loss The DWL caused by a monopoly is similar to that caused by a tax. The difference - government gets revenue from a tax, whereas firm owners gets monopoly profit.
- 23. Price discrimination Can a monopoly do better by charging more than one price? Answer: sometimes..... Price discrimination means either: selling the same good at different prices to different customers. selling different amounts of the same good to the same customer at different prices.
- 24. Price discrimination Examples movie tickets – prices for students airline prices – business versus tourist travel quantity discounts – electricity & water tariffs
- 25. Price discrimination Idea of charging lower movie ticket prices for students is not to be ‘kind’ to them. Students often have low incomes and low willingness- to-pay. Their demands are often very elastic. Hence charging them a low price is an attempt to maximise the extraction of profits from them.
- 26. Price discrimination Price discrimination is impossible in a competitive market since many firms all selling at same price. To price discriminate, firm must have market power.
- 27. Example: Perfect price discrimination Perfect price discrimination arises when a monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
- 28. Perfect price discrimination It can increase monopolist’s profits. It can eliminate DWL.
- 29. Welfare without price discrimination Copyright © 2004 South-Western Profit (Monopolist with single price) Price 0 Quantity Deadweight loss Demand Marginal revenue Consumer surplus Quantity sold Monopoly price Marginal cost
- 30. Welfare with perfect price discrimination Copyright © 2004 South-Western Profit (Monopolist with perfect price discrimination) Price 0 Quantity Demand Marginal cost Quantity sold
- 31. With perfect price discrimination The monopolist captures more profits. The DWL disappears.
- 32. Practical issues Often cannot perfectly price discriminate but you can guess a customer’s willingness-to-pay. e.g. a plumber charging a customer to repair some roof piping on a rainy day when customers lives in E7 and drives a Mercedes. A customer wanting to travel by air to Karachi tomorrow at 9-00 am is most likely to be a business traveller.
- 33. How prevalent are problems of monopolies? Monopolies are common. Most firms have some control over their prices because of differentiated products. Firms with substantial monopoly power are rare. (because few goods are truly unique).
- 34. Policy Policymakers can respond to inefficiencies of monopoly behavior with antitrust laws, regulation of prices, or by turning monopoly into a government-run enterprise. If the market failure is deemed small, policymakers may do nothing.
- 35. Summary A monopoly is a firm that is the sole seller in its market. It faces a downward-sloping demand for its product. A monopolist's marginal revenue is below the price of its good.
- 36. Summary Like a competitive firm, a monopoly maximises profit by producing where MC=MR. Unlike a competitive firm, a monopoly’s P > MR so its P > MC.
- 37. Summary A monopolist’s profit-maximising output is below the output level that maximises social surplus. A monopoly causes deadweight losses similar to the deadweight losses caused by taxes.
- 38. Summary Monopolists can raise profits by charging different prices for the same good to different buyers based on their willingness to pay. Price discrimination can raise economic welfare and lessen deadweight losses.