12 Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Monopoly

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Prepared by: Fernando QuijanoPrepared by: Fernando Quijanoand Yvonn Quijanoand Yvonn Quijano

© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair

Monopoly

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2 of 43© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair

Imperfect Competition andMarket Power: Core Concepts

• An imperfectly competitive industry is an industry in which single firms have some control over the price of their output.

• Market power is the imperfectly competitive firm’s ability to raise price without losing all demand for its product.

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Pure Monopoly

• A pure monopoly is an industry

1. with a single firm that produces a product for which there are no close substitutes and

2. in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

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Defining Industry Boundaries

• If the product that the monopolist produces has many substitutes, the monopolist will have a limited market power.

• The more broader a market is, the more difficult it becomes to find substitutes.

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Barriers to Entry

• A barrier to entry is something that prevents new firms from entering and competing in imperfectly competitive industries.

1. Government franchises, or firms that become monopolies by virtue of a government directive.

2. Patents or barriers that grant the exclusive use of the patented product or process to the inventor.

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Barriers to Entry

3. Economies of scale and other cost advantages enjoyed by industries that have large capital requirements. A large initial investment, or the need to embark in an expensive advertising campaign, deter would-be entrants to the industry.

4. Ownership of a scarce factor of production: If production requires a particular input, and one firm owns the entire supply of that input, that firm will control the industry.

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Price: The Fourth Decision Variable

• Firms with market power must decide:

1. how much to produce,

2. how to produce it,

3. how much to demand in each input market, and

4. what price to charge for their output.

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Price and Output Decisionsin Pure Monopoly Markets

• To analyze monopoly behavior we assume that:

• Entry to the market is blocked

• Firms act to maximize profit

• The pure monopolist buys inputs in competitive input markets

• The monopolistic firm cannot price discriminate

• The monopoly faces a known demand curve

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• In a monopoly market, there is no distinction between the firm and the industry because the firm is the industry.

• The market demand curve is the demand curve facing the firm, and total quantity supplied in the market is what the firm decides to produce.

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• The demand curve facing a perfectly competitive firm is perfectly elastic.

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Marginal RevenueFacing a Monopolist

Marginal Revenue Facing a Monopolist

(1)QUANTITY

(2)PRICE

(3)TOTAL REVENUE

(4)MARGINAL REVENUE

0 $11 0

1 10 $10 $10

2 9 18 8

3 8 24 6

4 7 28 4

5 6 30 2

6 5 30 0

7 4 28 2

8 3 24 4

9 2 18 6

10 1 10 8

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Marginal Revenue and Market Demand

• At every level of output except one unit, a monopolist’s marginal revenue is below price.

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Marginal Revenue and Total Revenue

• The marginal revenue curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it.

• Total revenue is maximum when marginal revenue equals zero.

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The Monopolist’s Profit-Maximizing Price and Output

• The profit-maximizing level of output (Qm) occurs where MR = MC.

• Notice that the outcome is different from that of perfect competition. Here, the price ($4.00) is less than the marginal cost ($1.50), and the monopolist earns positive economic profit.

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The Absence of a Supply Curve in Monopoly

• A monopoly firm has no supply curve that is independent of the demand curve for its product.

• A monopolist sets both price and quantity, and the amount of output supplied depends on both its marginal cost curve and the demand curve that it faces.

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Monopoly in the Long and Short-Run

• It is possible for a profit-maximizing monopolist to suffer short-run losses and go out of business in the long-run.

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Perfect Competitionand Monopoly Compared

• In a perfectly competitive industry in the long-run, price will be equal to long-run average cost.

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Perfect Competitionand Monopoly Compared

• Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits.

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The Social Costs of Monopoly

• Monopoly leads to an inefficient mix of output.

• Price is above marginal cost, which means that the firm is underproducing from society’s point of view.

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The Social Costs of Monopoly

• The triangle ABC measures the net social gain of moving from 2,000 units to 4,000 units (or welfare loss from monopoly).

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Price Discrimination

• Charging different prices to different buyers is called price discrimination.

• A firm that charges the maximum amount that buyers are willing to pay for each unit is practicing perfect price discrimination.

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• A monopolist who cannot price discriminate would maximize profit by charging $4.

• There is profit and consumer surplus.

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• For a perfectly price discriminating monopolist, the demand curve is the same as marginal revenue.

• There is profit but no consumer surplus.

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Natural Monopoly

• A natural monopoly is an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

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Natural Monopoly

• With one firm producing 500,000 units, average cost is $1 per unit. With five firms each producing 100,000 units, average cost is $5 per unit.

Documents

12 Prepared by: Fernando Quijano and Yvonn Quijano © 2004 Prentice Hall Business PublishingPrinciples of Economics, 7/eKarl Case, Ray Fair Monopoly