Transcript
BySudarshan Kadariya
JMC
What is Monopoly??
A firm is a monopoly if . . .◦ it is the only seller of its product, and◦ its product does not have close substitutes.
The fundamental cause of monopoly is the existence of barriers to entry.
Barriers to entry have three sources:◦ Ownership of a key resource.◦ The government gives a firm the exclusive right
to produce some good.◦ Costs of production make one producer more
efficient than a large number of producers (Natural Monopoly)
Although exclusive ownership of a key resource is a potential source of monopoly, in practice monopolies rarely arise for this reason. Example: Diamond
Governments may restrict entry by giving one firm the exclusive right to sell a particular goods in certain markets.
Example: Patent and copyright laws are two important examples of how governments create monopoly to serve the public interest.
An industry is a natural monopoly when one firm can supply a good or service to an entire market at a lower cost than could two or more firms.
In other words, natural monopoly is an industry in which economies of scale are so important so that only one firm can survive.
Example: delivery of electricity, phone service, tap water, etc.
A natural monopoly arises when there are economies of scale over the relevant range of output.
Quantity of Output
Averagetotalcost
0
Cost
Quantity of Output
Demand
(a) A Competitive Firm’s Demand Curve (b) A Monopolist’s Demand Curve
0
Price
Quantity of Output0
Price
Demand
Quantity of Water
Price
$1110
9876543210
–1–2–3–4
Demand(averagerevenue)
Marginalrevenue
1 2 3 4 5 6 7 8
Note that P = AR > MR at all quantities.
Unregulated natural monopoly
Regulated natural monopoly
An unregulated natural monopoly would attempt to maximize profits by producing the quantity of output where marginal revenue equals marginal cost. (MC=MR)
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׀ 0 ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ 0 10 20 30 40 50 60 70 80 90 100
PUN
$
Quantity (thousands)
D = PQUNMR
MC
ATC
Exploitation to customers Excessive profitability strengthen the
monopoly power Inequitable distribution of resources Operational inefficiency, etc
If so, How to curve????
The optimal quantity of output occurs where price equals marginal cost. (P=MC)
Thus, marginal social benefit equals marginal social cost.
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׀ 0 ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ 0 10 20 30 40 50 60 70 80 90 100
PUN
$
Quantity (thousands)
D = PQUNMR
MC
ATC
QOPT
POPT
Producing the profit-maximizing output causes a deadweight loss.
The deadweight loss is equal to the area between the demand curve and the marginal cost curve for the amount of underproduction.
Deadweight loss: The costs to society created by market inefficiency due to inefficient allocation of resources. Price ceilings, price floors, and taxation are all said to create deadweight losses. Deadweight loss occurs when supply and demand are not in equilibrium.
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׀ 0 ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ 0 10 20 30 40 50 60 70 80 90 100
PUN
POPT
$
Quantity (thousands)
D = PQUN QOPTMR
MC
ATC
DeadweightLoss
Monopolyprofit
Averagetotalcost
Quantity
Monopolyprice
QMAX0
Costs andRevenue
Demand
Marginal cost
Marginal revenue
Average total cost
B
C
E
D
Quantity0
Price
Deadweightloss
DemandMarginalrevenue
Marginal cost
Efficientquantity
Monopolyprice
Monopolyquantity
P > MC; monopoly
P = MC; optimum
The monopolist produces less than the socially efficient quantity
P = MC; Profit maximizing
If a natural monopoly is regulated to produce the optimal quantity of output, the firm will suffer an economic loss.
To keep the monopoly firm to survive would require a government subsidy to the firm to eliminate the economic loss.
Economic loss: The difference between the revenue received from the sale of an output and the opportunity cost of the inputs used.
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׀ 0 ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ 0 10 20 30 40 50 60 70 80 90 100
PUN
POPT
$
Quantity (thousands)
D = PQUN QOPTMR
MC
ATC
Subsidy
Regulated price
GOVERNMENT SUBSIDY TO FIRM
Loss/Subsidy
Quantity0
Price
Demand
Average total cost
Regulatedprice Marginal cost
Average totalcost
The ideal public policy is to force the firm to produce Qoptimal and then subsidize for its economic loss.
Qoptimal
Ideal outcome
Compromise outcome
To avoid the need for a subsidy, natural monopolies are often regulated to earn zero economic profit (a normal rate of return).
But, this leads the following problems:1. The natural monopoly lacks incentives to control costs. (price may go up as cost)2. The regulators may not be able to obtain accurate information.
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׀ 0 ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ ׀ 0 10 20 30 40 50 60 70 80 90 100
PUN
POPT
$
Quantity (thousands)
D = PQUN QOPTMR
MC
ATC
Subsidy
Compromise price
To overcome the monopoly power or the
inefficiency of monopoly firm or the inefficient
allocation of resources, government can play a
significant role to balance the social benefits
and the costs through subsidy to the firm or
determining the zero economic profit. (Profit
constraints – normal rate of return, price
ceiling, etc.
THANK YOU.
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