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CHAPTER 13Monopoly
CHAPTER 13Monopoly
TM 13-2Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define monopoly and explain the conditions under which it arises.
• Distinguish between price-discriminating monopoly and single-price monopoly
• Explain how a single-price monopoly determines its price and output
TM 13-3Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit
• Compare the performance and efficiency of competition and monopoly
• Define rent seeking and explain why it arises
TM 13-4Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define monopoly and explain the conditions under which it arises.
• Distinguish between price-discriminating monopoly and single-price monopoly
• Explain how a single-price monopoly determines its price and output
TM 13-5Copyright © 1998 Addison Wesley Longman, Inc.
How Monopoly Arises
• A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.
TM 13-6Copyright © 1998 Addison Wesley Longman, Inc.
How Monopoly Arises
• No Close Substitutes
• If a good has close substitutes, it faces competition from the producer of the substitute.
• Barriers to Entry
• Barriers to entry are legal or natural constraints
that protect a firm from potential competitors.
TM 13-7Copyright © 1998 Addison Wesley Longman, Inc.
Barriers to Entry
• Legal Barriers to Entry
• In a legal monopoly competition and entry is restricted by the granting of a public franchise, government license, patent, or copyright.
TM 13-8Copyright © 1998 Addison Wesley Longman, Inc.
Barriers to Entry
• Natural Barriers to Entry
• A natural monopoly results from a situation in which one firm can supply the entire market at a lower price than two or more firms can.
• Example: Electric utility
TM 13-9Copyright © 1998 Addison Wesley Longman, Inc.
5
10
15
Natural Monopoly
0 1 2 3 4
D
Quantity (millions of kilowatt-hours)
Pri
ce (c
ents
per
kil
owat
t-ho
ur)
TM 13-10Copyright © 1998 Addison Wesley Longman, Inc.
Quantity (millions of kilowatt-hours)
5
10
15
Natural Monopoly
0 1 2 3 4
D
ATC
Pri
ce (c
ents
per
kil
owat
t-ho
ur)
TM 13-11Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define monopoly and explain the conditions under which it arises.
• Distinguish between price-discriminating monopoly and single-price monopoly
• Explain how a single-price monopoly determines its price and output
TM 13-12Copyright © 1998 Addison Wesley Longman, Inc.
Monopoly Price-Setting Strategies
• Price discrimination is the practice of selling different units of a good or service for different prices. (ex. pizza, airlines)
• A single-price monopoly is a firm that must sell each unit of its output for the same price. (ex. DeBeers)
TM 13-13Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Define monopoly and explain the conditions under which it arises.
• Distinguish between price-discriminating monopoly and single-price monopoly
• Explain how a single-price monopoly determines its price and output
TM 13-14Copyright © 1998 Addison Wesley Longman, Inc.
Single-Price Monopoly
• The firm’s demand curve is the market demand curve.
• Marginal revenue is not the same as the market price.
TM 13-15Copyright © 1998 Addison Wesley Longman, Inc.
Single-Price Monopoly
Bobbie’s Barbershop, in Cairo, Nebraska is the sole supplier of
haircuts in town.
Let’s examine the market for haircuts in Cairo.
TM 13-16Copyright © 1998 Addison Wesley Longman, Inc.
Demand and Marginal Revenue
Quantity MarginalPrice demanded Total revenue(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars perhaircut) per hour) (dollars additional haircut)
)/( QTRMR
a 20 0
b 18 1
c 16 2
d 14 3
e 12 4
f 10 5
TM 13-17Copyright © 1998 Addison Wesley Longman, Inc.
Quantity MarginalPrice demanded Total revenue(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars perhaircut) per hour) (dollars additional haircut)
)/( QTRMR
a 20 0 0
b 18 1 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
Demand and Marginal Revenue
TM 13-18Copyright © 1998 Addison Wesley Longman, Inc.
Quantity MarginalPrice demanded Total revenue(P) (Q) revenue
(dollars per (haircuts (TR=P Q) (dollars perhaircut) per hour) (dollars additional haircut)
)/( QTRMR
a 20 0 0
b 18 1 18
c 16 2 32
d 14 3 42
e 12 4 48
f 10 5 50
18
14
10
6
2
Demand and Marginal Revenue
TM 13-19Copyright © 1998 Addison Wesley Longman, Inc.
Demand and Marginal Revenue
Quantity (haircuts per hour)
Pri
ce &
mar
gin
al r
even
ue
(dol
lars
per
hai
rcut
)
TM 13-20Copyright © 1998 Addison Wesley Longman, Inc.
Demand and Marginal Revenue
Quantity (haircuts per hour)
Pri
ce &
mar
gin
al r
even
ue
(dol
lars
per
hai
rcut
)
DMR
TM 13-21Copyright © 1998 Addison Wesley Longman, Inc.
Demand and Marginal Revenue
10
20
16
14
DMR
cd
Total revenue loss $4
Total revenue gain $14
Marginal revenue $10
2 3Quantity (haircuts per hour)
Pri
ce &
mar
gin
al r
even
ue
(dol
lars
per
hai
rcut
)
TM 13-22Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
• A single-price monopoly’s marginal revenue is related to the elasticity of demand for its good.
TM 13-23Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
50
–10
10
20
10
– 20
Demand and Marginalrevenue curves
Quantity(haircutsper hour)
Pri
ce $
mar
gin
al r
even
ue
(dol
lars
per
hai
rcu
t)
TM 13-24Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
D
50
10
20
10
Demand and Marginalrevenue curves
Quantity(haircutsper hour)
Pri
ce $
mar
gin
al r
even
ue
(dol
lars
per
hai
rcu
t)
–10
– 20
TM 13-25Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
D
MR
50
10
20
10
Demand and Marginalrevenue curves
Quantity(haircutsper hour)
Pri
ce $
mar
gin
al r
even
ue
(dol
lars
per
hai
rcu
t)
–10
– 20
TM 13-26Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
D
Elastic
Unit elastic
Inelastic
MR
50
10
20
10
Demand and Marginalrevenue curves
Quantity(haircutsper hour)
Pri
ce $
mar
gin
al r
even
ue
(dol
lars
per
hai
rcu
t)
–10
– 20
TM 13-27Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
0
10
20
5 10
D
MR
Elastic
Unit elastic
Inelastic
Maximumtotal revenue
Quantity(haircutsper hour)
Demand and Marginalrevenue curves
d
f
Pri
ce $
mar
gin
al r
even
ue
(dol
lars
per
hai
rcu
t)
–10
– 20
TM 13-28Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
0 5 10
10
20
30
40
50 Total revenuecurve
Quantity(haircutsper hour)
Tot
al r
even
ue
(dol
lars
per
hou
r)
TM 13-29Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
0 5 10
10
20
30
40
50 Total revenuecurve
Quantity(haircutsper hour)
Tot
al r
even
ue
(dol
lars
per
hou
r)
TM 13-30Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
0 10
10
20
30
40
50 Total revenuecurve
TR
Zeromarginalrevenue
Quantity(haircutsper hour)
5
Tot
al r
even
ue
(dol
lars
per
hou
r)
TM 13-31Copyright © 1998 Addison Wesley Longman, Inc.
Marginal Revenue and Elasticity
• Profit maximizing monopolies will never produce at an output in the inelastic range of its demand curve.
• It could charge a higher price, produce a smaller quantity, and earn a larger profit.
TM 13-32Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price Decision
Marginal MarginalPrice Quantity Total revenue Total cost(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
)/( QTRMR )/( QTCMC
20 0
18 1
16 2
14 3
12 4
10 5
TM 13-33Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price Decision
Marginal MarginalPrice Quantity Total revenue Total cost(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
)/( QTRMR )/( QTCMC
20 0 0
18 1 18
16 2 32
14 3 42
12 4 48
10 5 50
TM 13-34Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price Decision
Marginal MarginalPrice Quantity Total revenue Total cost(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
)/( QTRMR )/( QTCMC
20 0 0
18 1 18
16 2 32
14 3 42
12 4 48
10 5 50
18
14
10
6
2
TM 13-35Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price Decision
Marginal MarginalPrice Quantity Total revenue Total cost(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
)/( QTRMR )/( QTCMC
20 0 0 20
18 1 18 21
16 2 32 24
14 3 42 30
12 4 48 40
10 5 50 55
18
14
10
6
2
TM 13-36Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price Decision
Marginal MarginalPrice Quantity Total revenue Total cost(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
)/( QTRMR )/( QTCMC
20 0 0 20
18 1 18 21
16 2 32 24
14 3 42 30
12 4 48 40
10 5 50 55
18
14
10
6
2
1
3
6
10
15
TM 13-37Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price Decision
Marginal MarginalPrice Quantity Total revenue Total cost(P) demanded revenue cost Profit
(dollars (Q) (TR = P Q) (dollars per (TC) (dollars per (TR – TC)per haircut) (haircuts/hour) (dollars) add. haircut) (dollars) add. haircut) (dollars)
)/( QTRMR )/( QTCMC
20 0 0 20 -20
18 1 18 21 -3
16 2 32 24 +8
14 3 42 30 +12
12 4 48 40 +8
10 5 50 55 -5
18
14
10
6
2
1
3
6
10
15
TM 13-38Copyright © 1998 Addison Wesley Longman, Inc.
0 1 2 3 4 5
10
20
30
40
50
Quantity (haircuts per hour)
Tot
al r
even
ue a
nd to
tal c
ost
(dol
lars
per
hou
r)
A Monopoly’s Output and Price
TM 13-39Copyright © 1998 Addison Wesley Longman, Inc.
0 1 2 3 4 5
10
20
30
40
50
Quantity (haircuts per hour)
Tot
al r
even
ue a
nd to
tal c
ost
(dol
lars
per
hou
r)
A Monopoly’s Output and Price
TR
TM 13-40Copyright © 1998 Addison Wesley Longman, Inc.
0 1 2 3 4 5
10
20
30
40
50
Tot
al r
even
ue a
nd to
tal c
ost
(dol
lars
per
hou
r)
A Monopoly’s Output and Price
TR
Quantity (haircuts per hour)
TC
TM 13-41Copyright © 1998 Addison Wesley Longman, Inc.
0 1 2 3 4 5
10
20
30
50
Tot
al r
even
ue a
nd to
tal c
ost
(dol
lars
per
hou
r)
A Monopoly’s Output and Price
TR
Quantity (haircuts per hour)
Economicprofit = $12
TC
42
TM 13-42Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price
0 1 2 3 4 5
10
14
20
Quantity (haircuts per hour)
Pri
ce a
nd
cos
t (do
llar
s pe
r ho
ur)
TM 13-43Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price
0 1 2 3 4 5
10
14
20
Quantity (haircuts per hour)
Pri
ce a
nd
cos
t (do
llar
s pe
r ho
ur)
D
MR
TM 13-44Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price
0 1 2 3 4 5
10
14
20
Quantity (haircuts per hour)
Pri
ce a
nd
cos
t (do
llar
s pe
r ho
ur)
D
MC
MR
TM 13-45Copyright © 1998 Addison Wesley Longman, Inc.
A Monopoly’s Output and Price
0 1 2 3 4 5
10
14
20
Quantity (haircuts per hour)
Pri
ce a
nd
cos
t (do
llar
s pe
r ho
ur)
D
ATC
MC
MR
Economicprofit $12
Profit = $12($4 x 3 units)
TM 13-46Copyright © 1998 Addison Wesley Longman, Inc.
Price and Output Decision
• The competitive firm is a price taker, whereas the monopoly influences its price.
• For the monopoly, price exceeds marginal revenue, thus price exceeds marginal cost.
• Profit is maximized where MC = MR
• Monopolists can earn economic profits--firms cannot enter due to barriers to entry.
TM 13-47Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit
• Compare the performance and efficiency of competition and monopoly
• Define rent seeking and explain why it arises
TM 13-48Copyright © 1998 Addison Wesley Longman, Inc.
Price Discrimination
• Price discrimination usually equals bigger profits
• Monopolists attempt to find ways of discriminating among groups
• inelastic demand = higher price
• elastic demand = lower price
How do these firms make a profit?
TM 13-49Copyright © 1998 Addison Wesley Longman, Inc.
Price Discrimination
• Consumer surplus
• Price discrimination attempts to capture the consumer surplus for the monopoly.
TM 13-50Copyright © 1998 Addison Wesley Longman, Inc.
Price Discrimination
• Discriminating Among Units of a Good
• Charging buyers different prices on each good bought (ex. bulk buying discounts)
• Discriminating Among Individuals
• Some people value additional units differently
(ex. pizza)
TM 13-51Copyright © 1998 Addison Wesley Longman, Inc.
Price Discrimination
• Discriminating Between Groups
• Charging different prices to different groups based upon their price elasticity (ex. air fares)
Let’s look at how price discrimination, when used by a monopoly, can lead
to higher profits — Global Air.
TM 13-52Copyright © 1998 Addison Wesley Longman, Inc.
$5 mil.
A Single Price of Air Travel
Quantity (thousandsof trips per year)
Pri
ce(d
olla
rs/ t
rip
)
5 10 15
Alltravelers
Businesstravelers
Vacationtravelers
500
2,000
0
1,000
1,500
2,500
Pri
ce(d
olla
rs/ t
rip
)
D
MC
MR
$2mil.
Quantity (thousandsof trips per year)
0 4 10 15
500
2,000
1,000
1,500
2,500
Dv
MC$3 mil.
Quantity (thousandsof trips per year)
0 6 10 15
Pri
ce(d
olla
rs/ t
rip
)
500
2,000
1,000
1,500
2,500
DB
MC
TM 13-53Copyright © 1998 Addison Wesley Longman, Inc.
Price Discrimination
Quantity (thous. of trips per year)
$2mil.
0 4 10
500
2,000
1,000Dv MC$3 mil.
Quantity (thous. of trips per year)
0 6 10
Pri
ce(d
olla
rs/ t
rip
)
500
2,000
1,000
1,500
2,500
MC
Pri
ce(d
olla
rs/ t
rip)
DB
Business Travelers Vacation Travelers
1,500
TM 13-54Copyright © 1998 Addison Wesley Longman, Inc.
$3.5 mil.
Price Discrimination
Quantity (thous. of trips per year)
$2.45 mil.
0 4 10
Dv MC
Quantity (thous. of trips per year)
0 6 10
Pri
ce(d
olla
rs/ t
rip
)
500
2,000
1,000
1,500
2,500
DB
MC
Pri
ce(d
olla
rs/ t
rip)
MRB
1,700
5 7
1,350
MRv
Decrease inquantitydemanded
Increase inquantitydemanded
Business Travelers Vacation Travelers
500
2,000
1,000
1,500
TM 13-55Copyright © 1998 Addison Wesley Longman, Inc.
More PerfectPrice Discrimination
• Global becomes creative
• Places restrictions on discounts further targeting the vacationers
• This lowers their fare even more
• Creates some frills and priority reservations targeting
the business travelers
• This allows them to charge more
TM 13-56Copyright © 1998 Addison Wesley Longman, Inc.
Perfect Price Discrimination
Quantity (thous. of trips per year)
0 6 10
Pri
ce(d
olla
rs/ t
rip
)
500
2,000
1,000
1,500
2,500
DB
MC
Pri
ce(d
olla
rs/ t
rip)
3
Business Travelers
0 4 10
Dv
Vacation Travelers
500
2,000
1,000
1,500
Quantity (thous. of trips per year)
MC
14
Profit from businesstravel with perfectprice discrimination
Profit from vacationtravel with perfectprice discrimination
TM 13-57Copyright © 1998 Addison Wesley Longman, Inc.
Limits to Price Discrimination
• Can only be used if the goods cannot be resold.
• The monopoly must be able to identify groups with different elasticities of demand.
TM 13-58Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit
• Compare the performance and efficiency of competition and monopoly
• Define rent seeking and explain why it arises
TM 13-59Copyright © 1998 Addison Wesley Longman, Inc.
Monopoly andCompetition Compared
Pri
ce
Quantity
PA
PM
PC
0
DMR
S,MC
QM QC
Single-pricemonopolyrestricts output,raises price
Equilibriumin competitiveindustry
TM 13-60Copyright © 1998 Addison Wesley Longman, Inc.
Inefficiency of MonopolyP
rice
Quantity
PA
0
D
QC
PC
S
PerfectCompetition
Consumersurplus
TM 13-61Copyright © 1998 Addison Wesley Longman, Inc.
Inefficiency of MonopolyP
rice
Quantity
PA
PM
0
DMR
MC
QM QC
PC
Consumersurplus
Monopoly’sgain
Deadweightloss
Monopoly
TM 13-62Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain how a price-discriminating monopoly determines its price and output and how price discrimination increases profit
• Compare the performance and efficiency of competition and monopoly
• Define rent seeking and explain why it arises
TM 13-63Copyright © 1998 Addison Wesley Longman, Inc.
Rent Seeking
• Because a monopoly creates economic profit in the long-run, people devote a lot of effort to obtain monopoly rights.
• This activity is called rent seeking.
• The firm is attempting to capture some of the consumer surplus for itself.
TM 13-64Copyright © 1998 Addison Wesley Longman, Inc.
Rent Seeking
• They attempt to do so by:
• Buying a monopoly (ex. taxis)
• does not ensure an economic profit
• Creating a monopoly (ex. lobbying)
• very costly
TM 13-65Copyright © 1998 Addison Wesley Longman, Inc.
Gains from Monopoly
• Economies of Scale and Scope
• Lowers average total cost and a greater range of goods produced
• Incentives to Innovate
• The attempt to apply knew knowledge in the production process and obtain a patent