11-1Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Chapter 11

Pure monopoly

11-2Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Learning objectives• Review the nature of barriers to entry into an

industry, their form and their likely occurrence• Examine demand from a monopolist’s viewpoint• Understand how monopoly adjusts price and

output in short-run and long-run situations

11-3Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Learning objectives (cont.)• Compare the outcome of a monopoly industry

with that of one that is purely competitive. Is the allocative and productive efficiency observed in pure competition achieved by the monopolist?

• Discuss whether government can play a role in modifying monopoly behaviour

11-4Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Barriers to entry• High barriers to entry explain the existence

of monopolies• Entry barriers block all potential competitors• Economies of scale:

– Defined as the forces that reduce the average cost of producing a product as the firm expands the size of the output in the long run

– In some industries, efficient, low-cost production can only be achieved if producers are large

11-5Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Barriers to entry (cont.)• Ownership of essential raw materials

– BHP controlled all known iron deposits in Australia in the 1940s and 1950s

• Legal barriers: patents and licences• Note:

– Pure monopolies are rare– Monopolies may be desirable or undesirable

depending on what premise is used– Natural monopoly occurs in industries whose

technological and economic realities are out of the possibility of competitive markets

11-6Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Monopoly demandThree assumptions:

1. Monopolist’s position is guaranteed:– Ownership of patent or control of raw materials

2. No prospect of government intervention or regulation of the firm

3. Monopolist does not discriminate between buyers by charging different prices

11-7Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Monopoly demand (cont.)• Monopolist’s demand curve is the industry

demand curve and therefore is down-sloping• Price (P) exceeds marginal revenue (MR)• Monopolist is a ‘price maker’ since it can

influence total supply

11-8Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

MarginalRevenue

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11-9Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Monopoly demandPrice elasticity and total revenue• Marginal revenue is negative beyond the point

of unit elasticity of demand

11-10Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 QQ

Do

llars

Do

llars

200

150

200

50

750

500

250

MRMR

Elastic

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18QQ

DD

TRTR

Inelastic

Unit elasticityUnit elasticity

Demand, MR, TR: imperfectly competitive firm

11-11Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Price and output determination• Profit-seeking monopolist employs same rationale

as in a competitive industry:– MR = MC rule

• No supply curve. Why?– At any given demand and cost conditions, there is

only one profit-maximising price–output combination

11-12Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Misconceptions concerning monopoly pricing• Not highest price

– Monopolists seek to maximise profit, not necessarily price

• Total profits not unit profits– Monopolists seek to maximise total profit, not necessarily

per-unit profit

• Losses are possible– Pure monopoly does not guarantee economic profits– In the short-run, monopolist may experience losses

because of weak demand or high costs

11-13Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Profit

Q0 1 2 3 4 5 6 7 8 9 10

200

175

150

125

100

75

50

25

P

DD

MR

MCMC

ATC

$94

$122

MR = MC

Profitper unit

Competitiveprice

Profit maximisation under a pure monopoly

11-14Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Loss

Q0 1 2 3 4 5 6 7 8 9 10

200

175

150

125

100

75

50

25

P

DD

MR

MCMC

ATC

Lossper unit

AVC

Loss minimisation under monopoly

MR = MC

11-15Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Economic effects of monopoly• Productive inefficiency:

– Minimum ATC is not necessarily chosen

• Allocative inefficiency:– P price does not necessary equal MC– Monopoly will produce a smaller output and charge

a higher price than would a competitive industry

• Income distribution– Substantial economic profits of a monopolist are not

widely distributed and are often concentrated in the hands of upper income groups, contributing to inequality in the distribution of income

11-16Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Q

P

DMR

MC

Pm

Qm

MonopolistMonopolistwill sell lesswill sell less

units at aunits at ahigher pricehigher price

than inthan incompetitioncompetition

Pc

Qc

Profit maximisation under monopoly

11-17Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Economic effects of monopoly (cont.)

Cost complications• Economies of scale

– Demand may not be sufficient to support a large number of competing firms. Only a single firm can produce the output efficiently — natural monopoly

• X-inefficiency– The failure to produce any given output at the lowest

average cost possible

• Very long run may allow for technological progress

11-18Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Technological progress

• Dynamic efficiency:– Ability to develop the most efficient production

techniques over time

• Are purely competitive firms or monopolists more innovative over time?

– The competitive model — has the incentive to be efficient to reap economic profits over time

– The monopolist model — barriers to entry ensure economic profit even in the long run, and the incentive to develop new product and techniques will be weak

11-19Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Price discrimination• A situation where a given product is sold at

more than one price and the price differences are not justified by cost differences

Three required conditions are:• Monopoly power• Market segmentation• No resale

11-20Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Price discrimination (cont.)Consequences• More profits

– Price discrimination can yield additional profits for a monopolist

• More production– The discriminating monopolist will produce a larger

output than a non-discriminating monopolist

11-21Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Regulating monopolies• Historically, in Australia monopolies have been

operated or heavily regulated by the government• Socially optimal price: P = MC

– May result in severe losses

• ‘Fair-return’ price: P = AC– Normal profit is generated– Only partially resolves problem of under-allocation

11-22Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Regulated monopoly

Q

DMR

P

Pric

e an

d co

sts

MC

ATC

Monopoly price:MR = MC

Fair return price:Price = ATC

Socially optimum price:Price = MC

11-23Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIverBy Muni Perumal, University of Canberra, Australia

Next chapter:

Monopolistic competition