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Monopoly
1.
CopyrightĀ©2004 South-Western 1515Monopoly
2.
Copyright Ā© 2004
South-Western ā¢ While a competitive firm is a price taker, a monopoly firm is a price maker.
3.
Copyright Ā© 2004
South-Western ā¢ A firm is considered a monopoly if . . . ā¢ it is the sole seller of its product. ā¢ its product does not have close substitutes.
4.
Copyright Ā© 2004
South-Western WHY MONOPOLIES ARISE ā¢ The fundamental cause of monopoly is barriers to entry.
5.
Copyright Ā© 2004
South-Western WHY MONOPOLIES ARISE ā¢ Barriers to entry have three sources: ā¢ Ownership of a key resource. ā¢ The government gives a single firm the exclusive right to produce some good. ā¢ Costs of production make a single producer more efficient than a large number of producers.
6.
Copyright Ā© 2004
South-Western Monopoly Resources ā¢ Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason.
7.
Copyright Ā© 2004
South-Western Government-Created Monopolies ā¢ Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.
8.
Copyright Ā© 2004
South-Western Government-Created Monopolies ā¢ Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.
9.
Copyright Ā© 2004
South-Western Natural Monopolies ā¢ 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.
10.
Copyright Ā© 2004
South-Western Natural Monopolies ā¢ A natural monopoly arises when there are economies of scale over the relevant range of output.
11.
Figure 1 Economies
of Scale as a Cause of Monopoly Copyright Ā© 2004 South-Western Quantity of Output Average total cost 0 Cost
12.
Copyright Ā© 2004
South-Western HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS ā¢ Monopoly versus Competition ā¢ Monopoly ā¢ Is the sole producer ā¢ Faces a downward-sloping demand curve ā¢ Is a price maker ā¢ Reduces price to increase sales ā¢ Competitive Firm ā¢ Is one of many producers ā¢ Faces a horizontal demand curve ā¢ Is a price taker ā¢ Sells as much or as little at same price
13.
Figure 2 Demand
Curves for Competitive and Monopoly Firms Copyright Ā© 2004 South-Western Quantity of Output Demand (a) A Competitive Firmās Demand Curve (b) A Monopolistās Demand Curve 0 Price Quantity of Output0 Price Demand
14.
Copyright Ā© 2004
South-Western A Monopolyās Revenue ā¢ Total Revenue P Ć Q = TR ā¢ Average Revenue TR/Q = AR = P ā¢ Marginal Revenue āTR/āQ = MR
15.
Table 1 A
Monopolyās Total, Average, and Marginal Revenue CopyrightĀ©2004 South-Western
16.
Copyright Ā© 2004
South-Western A Monopolyās Revenue ā¢ A Monopolyās Marginal Revenue ā¢ A monopolistās marginal revenue is always less than the price of its good. ā¢ The demand curve is downward sloping. ā¢ When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.
17.
Copyright Ā© 2004
South-Western A Monopolyās Revenue ā¢ A Monopolyās Marginal Revenue ā¢ When a monopoly increases the amount it sells, it has two effects on total revenue (P Ć Q). ā¢ The output effectāmore output is sold, so Q is higher. ā¢ The price effectāprice falls, so P is lower.
18.
Figure 3 Demand
and Marginal-Revenue Curves for a Monopoly Copyright Ā© 2004 South-Western Quantity of Water Price $11 10 9 8 7 6 5 4 3 2 1 0 ā1 ā2 ā3 ā4 Demand (average revenue) Marginal revenue 1 2 3 4 5 6 7 8
19.
Copyright Ā© 2004
South-Western Profit Maximization ā¢ A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. ā¢ It then uses the demand curve to find the price that will induce consumers to buy that quantity.
20.
Figure 4 Profit
Maximization for a Monopoly Copyright Ā© 2004 South-Western QuantityQ Q0 Costs and Revenue Demand Average total cost Marginal revenue Marginal cost 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.
21.
Copyright Ā© 2004
South-Western Profit Maximization ā¢ Comparing Monopoly and Competition ā¢ For a competitive firm, price equals marginal cost. P = MR = MC ā¢ For a monopoly firm, price exceeds marginal cost. P > MR = MC
22.
Copyright Ā© 2004
South-Western A Monopolyās Profit ā¢ Profit equals total revenue minus total costs. ā¢ Profit = TR - TC ā¢ Profit = (TR/Q - TC/Q) Ć Q ā¢ Profit = (P - ATC) Ć Q
23.
Figure 5 The
Monopolistās Profit Copyright Ā© 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
24.
Copyright Ā© 2004
South-Western A Monopolistās Profit ā¢ The monopolist will receive economic profits as long as price is greater than average total cost.
25.
Figure 6 The
Market for Drugs Copyright Ā© 2004 South-Western Quantity0 Costs and Revenue DemandMarginal revenue Price during patent life Monopoly quantity Price after patent expires Marginal cost Competitive quantity
26.
Copyright Ā© 2004
South-Western THE WELFARE COST OF MONOPOLY ā¢ In contrast to a competitive firm, the monopoly charges a price above the marginal cost. ā¢ From the standpoint of consumers, this high price makes monopoly undesirable. ā¢ However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable.
27.
Figure 7 The
Efficient Level of Output Copyright Ā© 2004 South-Western Quantity0 Price Demand (value to buyers) Marginal cost Value to buyers is greater than cost to seller. Value to buyers is less than cost to seller. Cost to monopolist Cost to monopolist Value to buyers Value to buyers Efficient quantity
28.
Copyright Ā© 2004
South-Western The Deadweight Loss ā¢ Because a monopoly sets its price above marginal cost, it places a wedge between the consumerās willingness to pay and the producerās cost. ā¢ This wedge causes the quantity sold to fall short of the social optimum.
29.
Figure 8 The
Inefficiency of Monopoly Copyright Ā© 2004 South-Western Quantity0 Price Deadweight loss Demand Marginal revenue Marginal cost Efficient quantity Monopoly price Monopoly quantity
30.
Copyright Ā© 2004
South-Western The Deadweight Loss ā¢ The Inefficiency of Monopoly ā¢ The monopolist produces less than the socially efficient quantity of output.
31.
Copyright Ā© 2004
South-Western The Deadweight Loss ā¢ The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax. ā¢ The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit.
32.
Copyright Ā© 2004
South-Western PUBLIC POLICY TOWARD MONOPOLIES ā¢ Government responds to the problem of monopoly in one of four ways. ā¢ Making monopolized industries more competitive. ā¢ Regulating the behavior of monopolies. ā¢ Turning some private monopolies into public enterprises. ā¢ Doing nothing at all.
33.
Copyright Ā© 2004
South-Western Increasing Competition with Antitrust Laws ā¢ Antitrust laws are a collection of statutes aimed at curbing monopoly power. ā¢ Antitrust laws give government various ways to promote competition. ā¢ They allow government to prevent mergers. ā¢ They allow government to break up companies. ā¢ They prevent companies from performing activities that make markets less competitive.
34.
Copyright Ā© 2004
South-Western Increasing Competition with Antitrust Laws ā¢ Two Important Antitrust Laws ā¢ Sherman Antitrust Act (1890) ā¢ Reduced the market power of the large and powerful ātrustsā of that time period. ā¢ Clayton Act (1914) ā¢ Strengthened the governmentās powers and authorized private lawsuits.
35.
Copyright Ā© 2004
South-Western Regulation ā¢ Government may regulate the prices that the monopoly charges. ā¢ The allocation of resources will be efficient if price is set to equal marginal cost.
36.
Figure 9 Marginal-Cost
Pricing for a Natural Monopoly Copyright Ā© 2004 South-Western Loss Quantity0 Price Demand Average total cost Regulated price Marginal cost Average total cost
37.
Copyright Ā© 2004
South-Western Regulation ā¢ In practice, regulators will allow monopolists to keep some of the benefits from lower costs in the form of higher profit, a practice that requires some departure from marginal-cost pricing.
38.
Copyright Ā© 2004
South-Western Public Ownership ā¢ Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself (e.g. in the United States, the government runs the Postal Service).
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South-Western Doing Nothing ā¢ Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies.
40.
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South-Western PRICE DISCRIMINATION ā¢ Price discrimination is the business practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.
41.
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South-Western PRICE DISCRIMINATION ā¢ Price discrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power. ā¢ Perfect Price Discrimination ā¢ Perfect price discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
42.
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South-Western PRICE DISCRIMINATION ā¢ Two important effects of price discrimination: ā¢ It can increase the monopolistās profits. ā¢ It can reduce deadweight loss.
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Figure 10 Welfare
with and without Price Discrimination Copyright Ā© 2004 South-Western Profit (a) Monopolist with Single Price Price 0 Quantity Deadweight loss DemandMarginal revenue Consumer surplus Quantity sold Monopoly price Marginal cost
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Figure 10 Welfare
with and without Price Discrimination Copyright Ā© 2004 South-Western Profit (b) Monopolist with Perfect Price Discrimination Price 0 Quantity Demand Marginal cost Quantity sold
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South-Western PRICE DISCRIMINATION ā¢ Examples of Price Discrimination ā¢ Movie tickets ā¢ Airline prices ā¢ Discount coupons ā¢ Financial aid ā¢ Quantity discounts
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South-Western CONCLUSION: THE PREVALENCE OF MONOPOLY ā¢ How prevalent are the problems of monopolies? ā¢ Monopolies are common. ā¢ Most firms have some control over their prices because of differentiated products. ā¢ Firms with substantial monopoly power are rare. ā¢ Few goods are truly unique.
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South-Western Summary ā¢ A monopoly is a firm that is the sole seller in its market. ā¢ It faces a downward-sloping demand curve for its product. ā¢ A monopolyās marginal revenue is always below the price of its good.
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South-Western Summary ā¢ Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. ā¢ Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost.
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South-Western Summary ā¢ A monopolistās profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. ā¢ A monopoly causes deadweight losses similar to the deadweight losses caused by taxes.
50.
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South-Western Summary ā¢ 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. ā¢ If the market failure is deemed small, policymakers may decide to do nothing at all.
51.
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South-Western Summary ā¢ Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. ā¢ Price discrimination can raise economic welfare and lessen deadweight losses.
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