Monopoly - Profit-Maximization in Monopoly - Economics
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Monopoly Economics A monopoly (from Greek μόνος mónos ["alone" or "single"] and πωλεῖν pōleîn ["to sell"]) exists when a specific person or enterprise is the only supplier of a particular commodity. This contrasts with a monopsony which relates to a single entity's control of a market to purchase a good or service, and with oligopoly which consists of a few sellers dominating a market).[2] Monopolies are thus characterized by a lack of economic competition to produce the good or service, a lack of viable substitute goods, and the possibility of a high monopoly price well above the seller's marginal cost that leads to a high monopoly profit.[3] The verb monopolise or monopolize refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power to charge overly high prices.[4] Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry (or market).[4] A monopoly is distinguished from a monopsony, in which there is only one buyer of a product or service; a monopoly may also have monopsony control of a sector of a market. Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. Monopolies, monopsonies and oligopolies are all situations in which one or a few entities have market power and therefore interact with their customers (monopoly or oligopoly), or suppliers (monopsony) in ways that distort the market.[citation needed] Monopolies can be established by a government, form naturally, or form by integration. In many jurisdictions, competition laws restrict monopolies. Holding a dominant position or a monopoly in a market is often not illegal in itself, however certain categories of behavior can be considered abusive and therefore incur legal sanctions when business is dominant. A government-granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic interest group. Patents, copyrights, and trademarks are sometimes used as examples of government-granted monopolies. The government may also reserve the venture for itself, thus forming a government monopoly
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Monopoly - Profit-Maximization in Monopoly - Economics
- 2. Monopoly While a competitive firm is a price taker, a monopoly firm is a price maker.
- 3. Monopoly • A firm is considered a monopoly if . . . …it is the sole seller of its product. …its product does not have close substitutes.
- 4. Why Monopolies Arise The fundamental cause of monopoly is barriers to entry.
- 5. Why Monopolies Arise Barriers to entry have three sources: • Ownership of a key resource. • The government gives a single firm the exclusive right to produce some good. • Costs of production make a single producer more efficient than a large number of producers.
- 6. Monopoly Resources Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason.
- 7. Government-Created Monopolies Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.
- 8. Government-Created Monopolies Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.
- 9. Natural Monopolies 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. Natural Monopolies A natural monopoly arises when there are economies of scale over the relevant range of output.
- 11. Economies of Scale as a Cause of Monopoly... Average total cost Quantity of Output Cost 0
- 12. Monopoly versus Competition Monopoly Is the sole producer Has a downward-sloping demand curve Is a price maker Reduces price to increase sales
- 13. Competition versus Monopoly Competitive Firm Is one of many producers Has a horizontal demand curve Is a price taker Sells as much or as little at same price
- 14. Quantity of Output Demand (a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve 0 Price 0 Quantity of Output Price Demand Demand Curves for Competitive and Monopoly Firms...
- 15. A Monopoly’s Revenue • Total Revenue P x Q = TR • Average Revenue TR/Q = AR = P • Marginal Revenue ∆TR/∆Q = MR
- 16. A Monopoly’s Total, Average, and Marginal Revenue Quantity (Q) Price (P) Total Revenue (TR=PxQ) Average Revenue (AR=TR/Q) Marginal Revenue (MR= ) 0 $11.00 $0.00 1 $10.00 $10.00 $10.00 $10.00 2 $9.00 $18.00 $9.00 $8.00 3 $8.00 $24.00 $8.00 $6.00 4 $7.00 $28.00 $7.00 $4.00 5 $6.00 $30.00 $6.00 $2.00 6 $5.00 $30.00 $5.00 $0.00 7 $4.00 $28.00 $4.00 -$2.00 8 $3.00 $24.00 $3.00 -$4.00 QTR ∆∆ /
- 17. A Monopoly’s Marginal Revenue A monopolist’s marginal revenue is always less than the price of its good. The demand curve is downward sloping. When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.
- 18. A Monopoly’s Marginal Revenue When a monopoly increases the amount it sells, it has two effects on total revenue (P x Q). The output effect—more output is sold, so Q is higher. The price effect—price falls, so P is lower.
- 19. Demand and Marginal Revenue Curves for a Monopoly... Quantity of Water Price $11 10 9 8 7 6 5 4 3 2 1 0 -1 -2 -3 -4 1 2 3 4 5 6 7 8 Marginal revenue Demand (average revenue)
- 20. Profit Maximization of a Monopoly • A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. • It then uses the demand curve to find the price that will induce consumers to buy that quantity.
- 21. Profit-Maximization for a Monopoly... Monopoly price QuantityQMAX0 Costs and Revenue Demand Average total cost Marginal revenue Marginal cost A 1. The intersection of the marginal-revenue curve and the marginal- cost curve determines the profit-maximizing quantity... B 2. ...and then the demand curve shows the price consistent with this quantity.
- 22. Comparing Monopoly and Competition • For a competitive firm, price equals marginal cost. P = MR = MC • For a monopoly firm, price exceeds marginal cost. P > MR = MC
- 23. A Monopoly’s Profit Profit equals total revenue minus total costs. Profit = TR - TC Profit = (TR/Q - TC/Q) x Q Profit = (P - ATC) x Q
- 24. M onopol y profit The Monopolist’s Profit... Quantity0 Costs and Revenue Demand Marginal cost Marginal revenue QMAX BMonopoly price E Average total cost D Average total cost C
- 25. The Monopolist’s Profit The monopolist will receive economic profits as long as price is greater than average total cost.
- 26. The Market for Drugs... Costs and Revenue Price during patent life Price after patent expires Monopoly quantity Competitiv e quantity 0 Quantity Demand Marginal cost Marginal revenue
- 27. The Welfare Cost of Monopoly In contrast to a competitive firm, the monopoly charges a price above the marginal cost. From the standpoint of consumers, this high price makes monopoly undesirable. However, from the standpoint of the owners of the firm, the high price makes monopoly very desirable.
- 28. Price 0 Quantity Marginal cost Demand (value to buyers) Efficient quantity Cost to monopolist Value to buyers Value to buyers Cost to monopolist Value to buyers is greater than cost to seller. Value to buyers is less than cost to seller. The Efficient Level of Output...
- 29. The Deadweight Loss Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost. This wedge causes the quantity sold to fall short of the social optimum.
- 30. The Inefficiency of Monopoly... Quantity0 Demand Marginal revenue Marginal cost Monopoly price Deadweight loss Efficient quantity Monopoly quantity Price Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
- 31. The Inefficiency of Monopoly The monopolist produces less than the socially efficient quantity of output.
- 32. The Deadweight Loss The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax. The difference between the two cases is that the government gets the revenue from a tax, whereas a private firm gets the monopoly profit.
- 33. Public Policy Toward Monopolies Government responds to the problem of monopoly in one of four ways. • Making monopolized industries more competitive. • Regulating the behavior of monopolies. • Turning some private monopolies into public enterprises. • Doing nothing at all.
- 34. Increasing Competition with Antitrust Laws • Antitrust laws are a collection of statutes aimed at curbing monopoly power. • Antitrust laws give government various ways to promote competition. They allow government to prevent mergers. They allow government to break up companies. They prevent companies from performing activities which make markets less competitive.
- 35. Two Important Antitrust Laws • Sherman Antitrust Act (1890) Reduced the market power of the large and powerful “trusts” of that time period. • Clayton Act (1914) Strengthened the government’s powers and authorized private lawsuits.
- 36. Regulation Government may regulate the prices that the monopoly charges. The allocation of resources will be efficient if price is set to equal marginal cost.
- 37. Marginal-Cost Pricing for a Natural Monopoly... Regulated price Quantity0 Loss Price Demand Marginal cost Average total cost Average total cost
- 38. Regulation 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.
- 39. Public Ownership Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself. (e.g. in the U.S., the government runs the Postal Service).
- 40. Doing Nothing Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies.
- 41. Price Discrimination Price discrimination is the 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.
- 42. Price Discrimination 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.
- 43. Perfect Price Discrimination 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.
- 44. Price Discrimination • Two important effects of price discrimination: It can increase the monopolist’s profits. It can reduce deadweight loss.
- 45. Deadweight loss Consumer surplus Welfare Without Price Discrimination... Price 0 Quantity Profit Demand Marginal cost Marginal revenue Quantity sold Monopoly price (a) Monopolist with Single Price
- 46. Welfare With Price Discrimination... Price 0 Quantity Demand Marginal cost Quantity sold (b) Monopolist with Perfect Price Discrimination Profit
- 47. Examples of Price Discrimination • Movie tickets • Airline prices • Discount coupons • Financial aid • Quantity discounts
- 48. The Prevalence of Monopoly • How prevalent are the 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. Few goods are truly unique.
- 49. Summary • A monopoly is a firm that is the sole seller in its market. • It faces a downward-sloping demand curve for its product. • A monopoly’s marginal revenue is always below the price of its good.
- 50. Summary • Like a competitive firm, a monopoly maximizes profit by producing the quantity at which marginal cost and marginal revenue are equal. • Unlike a competitive firm, its price exceeds its marginal revenue, so its price exceeds marginal cost.
- 51. Summary • A monopolist’s profit-maximizing level of output is below the level that maximizes the sum of consumer and producer surplus. • A monopoly causes deadweight losses similar to the deadweight losses caused by taxes.
- 52. Summary • 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. • If the market failure is deemed small, policymakers may decide to do nothing at all.
- 53. Summary • Monopolists can raise their profits by charging different prices to different buyers based on their willingness to pay. • Price discrimination can raise economic welfare and lessen deadweight losses.
- 54. Graphical Review
- 55. Economies of Scale as a Cause of Monopoly... Average total cost Quantity of Output Cost 0
- 56. Quantity of Output Demand (a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve 0 Price 0 Quantity of Output Price Demand Demand Curves for Competitive and Monopoly Firms...
- 57. Demand and Marginal Revenue Curves for a Monopoly... Quantity of Water Price $11 10 9 8 7 6 5 4 3 2 1 0 -1 -2 -3 -4 1 2 3 4 5 6 7 8 Marginal revenue Demand (average revenue)
- 58. Profit-Maximization for a Monopoly... Monopoly price QuantityQMAX0 Costs and Revenue Demand Average total cost Marginal revenue Marginal cost A 1. The intersection of the marginal-revenue curve and the marginal- cost curve determines the profit-maximizing quantity... B 2. ...and then the demand curve shows the price consistent with this quantity.
- 59. The Monopolist’s Profit... M onopol y profit Quantity0 Costs and Revenue Demand Marginal cost Marginal revenue QMAX BMonopoly price E Average total cost D Average total cost C
- 60. The Market for Drugs... Costs and Revenue Price during patent life Price after patent expires Monopoly quantity Competitiv e quantity 0 Quantity Demand Marginal cost Marginal revenue
- 61. The Efficient Level of Output... Price 0 Quantity Marginal cost Demand (value to buyers) Efficient quantity Cost to monopolist Value to buyers Value to buyers Cost to monopolist Value to buyers is greater than cost to seller. Value to buyers is less than cost to seller.
- 62. The Inefficiency of Monopoly... Quantity0 Demand Marginal revenue Marginal cost Monopoly price Deadweight loss Efficient quantity Monopoly quantity Price
- 63. Marginal-Cost Pricing for a Natural Monopoly... Regulated price Quantity0 Loss Price Demand Marginal cost Average total cost Average total cost
- 64. Welfare Without Price Discrimination... Deadweight loss Consumer surplus Price 0 Quantity Profit Demand Marginal cost Marginal revenue Quantity sold Monopoly price (a) Monopolist with Single Price
- 65. Welfare With Price Discrimination... Price 0 Quantity Demand Marginal cost Quantity sold (b) Monopolist with Perfect Price Discrimination Profit