Monopoly A firm is considered a monopoly if...A firm is
considered a monopoly if... it is the sole seller of its product.
its product does not have close substitutes. While a competitive
firm is a price taker, a monopoly firm is a price maker.While a
competitive firm is a price taker, a monopoly firm is a price
maker. All this means that a monopoly has market powerAll this
means that a monopoly has market power
Slide 4
2011 Thomson South-Western WHY MONOPOLIES ARISE The fundamental
cause of monopoly is barriers to entry.The fundamental cause of
monopoly is barriers to entry.
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2011 Thomson South-Western WHY MONOPOLIES ARISE Barriers to
entry have three sources: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.
Slide 6
2011 Thomson South-Western Monopoly Resources Although
exclusive ownership of a key resource is a potential source of
monopoly, in practice monopolies rarely arise for this
reason.Although exclusive ownership of a key resource is a
potential source of monopoly, in practice monopolies rarely arise
for this reason. E.g., DeBeers owns most of the worlds diamond
minesE.g., DeBeers owns most of the worlds diamond mines
Slide 7
2011 Thomson South-Western Government-Created Monopolies
Governments may restrict entry by giving a single firm the
exclusive right to sell a particular good in certain
markets.Governments may restrict entry by giving a single firm the
exclusive right to sell a particular good in certain markets.
Patent and copyright laws are two important examples of how
government creates a monopoly to serve the public interest.Patent
and copyright laws are two important examples of how government
creates a monopoly to serve the public interest.
Slide 8
2011 Thomson South-Western 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.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. A natural monopoly arises when there are economies of
scale over the relevant range of output.A natural monopoly arises
when there are economies of scale over the relevant range of
output.
Slide 9
2011 Thomson South-Western Natural monopolies Q Cost ATC 1000
$50 Example: 1000 homes need electricity. Electricity Economies of
scale due to huge FC ATC is lower if one firm services all 1000
homes than if two firms each service 500 homes. 500 $80
Slide 10
2011 Thomson South-Western Monopoly vs.Competitive Firm Is the
sole producerIs one of many producers Is a price makerIs a price
taker Faces a downward-sloping demand curve Faces a horizontal
demand curve Reduces price to increase sales Sells as much or as
little at the same price HOW MONOPOLIES MAKE PRODUCTION AND PRICING
DECISIONS
Slide 11
2011 Thomson South-Western Monopoly vs. Competition: Demand
Curves In a competitive market, the market demand curve slopes
downward. but the demand curve for any individual firms product is
horizontal at the market price. The firm can increase Q without
lowering P, so MR = P for the competitive firm. D P Q A competitive
firms demand curve
Slide 12
2011 Thomson South-Western Monopoly vs. Competition: Demand
Curves A monopolist is the only seller, so it faces the market
demand curve. To sell a larger Q, the firm must reduce P. Thus, MR
P. D P Q A monopolists demand curve
Slide 13
2011 Thomson South-Western A C T I V E L E A R N I N G 1 : A
Monopolys revenue Moonbucks is the only seller of cappuccinos in
town. The table shows the market demand for cappuccinos. Fill in
the missing spaces of the table. What is the relation between P and
AR? Between P and MR? QPTRARMR 0$4.50 14.00 23.50 33.00 42.50 52.00
61.50 n.a.
Slide 14
2011 Thomson South-Western A C T I V E L E A R N I N G 1 :
Answers Here, P = AR, same as for a competitive firm. Here, MR <
P, whereas MR = P for a competitive firm. 1.506 2.005 2.504 3.003
3.502 1.50 2.00 2.50 3.00 3.50 $4.004.001 n.a. 9 10 9 7 4 $ 0$4.500
MRARTRPQ 1 0 1 2 3 $4
2011 Thomson South-Western A Monopolys Revenue A Monopolys
Marginal RevenueA Monopolys Marginal Revenue A monopolists marginal
revenue is always less than the price of its good.A monopolists
marginal revenue is always less than the price of its good. The
demand curve is downward sloping.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.When a
monopoly drops the price to sell one more unit, the revenue
received from previously sold units also decreases.
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2011 Thomson South-Western A Monopolys Revenue A Monopolys
Marginal RevenueA Monopolys Marginal Revenue When a monopoly
increases the amount it sells, it has two effects on total revenue
(P Q).When a monopoly increases the amount it sells, it has two
effects on total revenue (P Q). The output effect: More output is
sold, which raises revenueThe output effect: More output is sold,
which raises revenue The price effect: The price falls, which
lowers revenueThe price effect: The price falls, which lowers
revenue This happens because the monopolist is subject to the Law
of Demand.This happens because the monopolist is subject to the Law
of Demand.
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2011 Thomson South-Western A Monopolys Revenue To sell a larger
Q, the monopolist must reduce the price on all the units it
sells.To sell a larger Q, the monopolist must reduce the price on
all the units it sells. Hence, MR < PHence, MR < P MR could
even be negative if the price effect exceeds the output effect
(e.g., when Moonbucks increases Q from 5 to 6).MR could even be
negative if the price effect exceeds the output effect (e.g., when
Moonbucks increases Q from 5 to 6).
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2011 Thomson South-Western Figure 3 Demand and Marginal-Revenue
Curves for a Monopoly Quantity Price $11 10 9 8 7 6 5 4 3 2 1 0 1 2
3 4 Demand (average revenue) Marginal revenue 12345678 If a
monopoly wants to sell more, it must lower price. Price falls for
ALL units sold. This is why MR is < P.
Slide 20
2011 Thomson South-Western Profit Maximization Step 1: A
monopoly maximizes profit by producing the quantity at which MR =
MC.Step 1: A monopoly maximizes profit by producing the quantity at
which MR = MC. Step 2: It then uses the demand curve to find the
price that will induce consumers to buy that quantity.Step 2: It
then uses the demand curve to find the price that will induce
consumers to buy that quantity.
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2011 Thomson South-Western Figure 4 Profit Maximization for a
Monopoly Quantity QQ0 Costs and Revenue Demand Average total cost
Marginal revenue Marginal cost Monopoly price Q MAX 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.
Slide 22
2011 Thomson South-Western Profit Maximization Comparing
Monopoly and CompetitionComparing Monopoly and Competition For a
competitive firm, price equals marginal cost.For a competitive
firm, price equals marginal cost. P = MR = MCP = MR = MC For a
monopoly firm, price exceeds marginal cost.For a monopoly firm,
price exceeds marginal cost. P > MR = MCP > MR = MC Remember,
all profit-maximizing firms set MR = MC.Remember, all
profit-maximizing firms set MR = MC.
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2011 Thomson South-Western A Monopolys Profit Profit equals
total revenue minus total costs.Profit equals total revenue minus
total costs. Profit = TR TCProfit = TR TC Profit = (TR/Q TC/Q)
QProfit = (TR/Q TC/Q) Q Profit = (P ATC) QProfit = (P ATC) Q
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2011 Thomson South-Western Figure 5 The Monopolists Profit
Monopoly profit Average total cost Quantity Monopoly price Q MAX 0
Costs and Revenue Demand Marginal cost Marginal revenue Average
total cost B C E D
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2011 Thomson South-Western A Monopolists Profit The monopolist
will receive economic profits as long as price is greater than
average total cost.The monopolist will receive economic profits as
long as price is greater than average total cost.
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2011 Thomson South-Western A Monopoly Does Not Have an S Curve
A competitive firm takes P as giventakes P as given has a supply
curve that shows how its Q depends on Phas a supply curve that
shows how its Q depends on P A monopoly firm is a price-maker, not
a price-takeris a price-maker, not a price-taker Q does not depend
on P; rather, Q and P are jointly determined by MC, MR, and the
demand curve.Q does not depend on P; rather, Q and P are jointly
determined by MC, MR, and the demand curve. So there is no supply
curve for monopoly.
Slide 27
2011 Thomson South-Western Case Study: Monopoly vs. Generic
Drugs Patents on new drugs give a temporary monopoly to the seller.
When the patent expires, the market becomes competitive, generics
appear. MC Quantity Price D MR PMPM QMQM P C = QCQC The market for
a typical drug
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2011 Thomson South-Western THE WELFARE COST OF MONOPOLY In
contrast to a competitive firm, the monopoly charges a price above
the marginal cost.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.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.However, from
the standpoint of the owners of the firm, the high price makes
monopoly very desirable.
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2011 Thomson South-Western The Welfare Cost of Monopoly Recall:
In a competitive market equilibrium, P = MC and total surplus is
maximized.Recall: In a competitive market equilibrium, P = MC and
total surplus is maximized. In the monopoly eqm, P > MR = MCIn
the monopoly eqm, P > MR = MC The value to buyers of an
additional unit (P) exceeds the cost of the resources needed to
produce that unit (MC).The value to buyers of an additional unit
(P) exceeds the cost of the resources needed to produce that unit
(MC). The monopoly Q is too low could increase total surplus with a
larger Q.The monopoly Q is too low could increase total surplus
with a larger Q. Thus, monopoly results in a deadweight loss.Thus,
monopoly results in a deadweight loss.
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2011 Thomson South-Western Figure 7 The Efficient Level of
Output Quantity 0 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
Slide 31
2011 Thomson South-Western The Deadweight Loss Because a
monopoly sets its price above marginal cost, it places a wedge
between the consumers willingness to pay and the producers
cost.Because a monopoly sets its price above marginal cost, it
places a wedge between the consumers willingness to pay and the
producers cost. This wedge causes the quantity sold to fall short
of the social optimum.This wedge causes the quantity sold to fall
short of the social optimum.
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2011 Thomson South-Western P = MC Deadweight loss P MC The
Inefficiency of Monopoly Competitive eqm: quantity = Q E P = MC
total surplus is maximized Monopoly eqm: quantity = Q M P > MC
deadweight loss Quantity Price D MR MC QMQM QEQE
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2011 Thomson South-Western The Deadweight Loss The Inefficiency
of MonopolyThe Inefficiency of Monopoly The monopolist produces
less than the socially efficient quantity of output.The monopolist
produces less than the socially efficient quantity of output. What
about the Monopolists profit?What about the Monopolists profit?
This is not a loss to society since this adds to Producer
Surplus.This is not a loss to society since this adds to Producer
Surplus. This is similar to the example of taxes, except instead of
government revenue the surplus goes to the Monopolist.This is
similar to the example of taxes, except instead of government
revenue the surplus goes to the Monopolist.
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2011 Thomson South-Western PUBLIC POLICY TOWARD MONOPOLIES
Government responds to the problem of monopoly in one of four ways:
Making monopolized industries more competitive. Increasing
competition with Antitrust Laws.Increasing competition with
Antitrust Laws. Regulating the behavior of monopolies. Will talk a
little about thisWill talk a little about this Turning some private
monopolies into public enterprises. USPS is an exampleUSPS is an
example Doing nothing at all.
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2011 Thomson South-Western Regulation Government may regulate
the prices that the monopoly charges.Government may regulate the
prices that the monopoly charges. The allocation of resources will
be efficient if price is set to equal marginal cost.The allocation
of resources will be efficient if price is set to equal marginal
cost. For natural monopolies, MC < ATC at all Q, so marginal
cost pricing would result in losses.For natural monopolies, MC <
ATC at all Q, so marginal cost pricing would result in losses. If
so, regulators might subsidize the monopolist or set P = ATC for
zero economic profit.If so, regulators might subsidize the
monopolist or set P = ATC for zero economic profit.
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2011 Thomson South-Western Figure 9 Marginal-Cost Pricing for a
Natural Monopoly Loss Quantity 0 Price Demand Average total cost
Regulated price Marginal cost Average total cost If regulators set
P = MC, the natural monopoly will lose money.
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2011 Thomson South-Western 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.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.
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2011 Thomson South-Western PRICE DISCRIMINATION Price
discrimination is the business practice of: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.
Slide 39
2011 Thomson South-Western The Analytics of Price
Discrimination Price discrimination is not possible when a good is
sold in a competitive market;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.Since there are many firms
all selling at the market price. In order to price discriminate,
the firm must have some market power.In order to price
discriminate, the firm must have some market power.
Slide 40
2011 Thomson South-Western The Analytics of Price
Discrimination Perfect Price DiscriminationPerfect 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.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.
Slide 41
2011 Thomson South-Western The Analytics of Price
Discrimination Two important effects of price discrimination:Two
important effects of price discrimination: It can increase the
monopolists profits.It can increase the monopolists profits. It can
reduce deadweight loss.It can reduce deadweight loss.
Slide 42
2011 Thomson South-Western Figure 10 Welfare with and without
Price Discrimination Profit (a) Monopolist with Single Price Price
0 Quantity Deadweight loss Demand Marginal revenue Consumer surplus
Quantity sold Monopoly price Marginal cost
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2011 Thomson South-Western Figure 10 Welfare with and without
Price Discrimination Profit (b) Monopolist with Perfect Price
Discrimination Price 0 Quantity Demand Marginal cost Quantity sold
Consumer surplus and deadweight loss have both been converted into
profit. Every consumer gets charged a different price -- the
highest price they are willing to pay -- so in this special case,
the demand curve is also MR! Marginal revenue
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2011 Thomson South-Western Price Discrimination in the Real
World In the real world, perfect price discrimination is not
possible:In the real world, perfect price discrimination is not
possible: no firm knows every buyers WTPno firm knows every buyers
WTP buyers do not announce it to sellersbuyers do not announce it
to sellers So, firms divide customers into groups based on some
observable trait that is likely related to WTP, such as age.So,
firms divide customers into groups based on some observable trait
that is likely related to WTP, such as age.
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2011 Thomson South-Western Examples of Price Discrimination
Movie tickets Discounts for seniors, students, and people who can
attend during weekday afternoons. They are all more likely to have
lower WTP than people who pay full price on Friday night. Airline
prices Discounts for Saturday-night stayovers help distinguish
business travelers, who usually have higher WTP, from more
price-sensitive leisure travelers.
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2011 Thomson South-Western Examples of Price Discrimination
Discount coupons People who have time to clip and organize coupons
are more likely to have lower income and lower WTP than others.
Need-based financial aid Low income families have lower WTP for
their childrens college education. Schools price-discriminate by
offering need-based aid to low income families.
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2011 Thomson South-Western Examples of Price Discrimination
Quantity discounts A buyers WTP often declines with additional
units, so firms charge less per unit for large quantities than
small ones. Example: A movie theater charges $4 for a small popcorn
and $5 for a large one thats twice as big.
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2011 Thomson South-Western CONCLUSION: The Prevalence of
Monopoly In the real world, pure monopoly is rare.In the real
world, pure monopoly is rare. Yet, many firms have market power,
due toYet, many firms have market power, due to selling a unique
variety of a productselling a unique variety of a product having a
large market share and few significant competitorshaving a large
market share and few significant competitors In many such cases,
most of the results from this chapter apply, includingIn many such
cases, most of the results from this chapter apply, including
markup of price over marginal costmarkup of price over marginal
cost deadweight lossdeadweight loss