Chap6

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CHAPTER 6CHAPTER 6

MARKET MARKET STRUCTURESTRUCTURE

: : MONOPOLYMONOPOLY

6.1 Characteristic

6.2 Barriers to Entry

6.3 Short-run Decision: Profit Maximization

6.4 Short-run Decision: Minimizing Loss

6.5 Long-run Profit Maximization & Misconception

6.6 Social Cost of Monopoly

6.7 Price Discrimination2

Definition:

•Existence of a single seller in the market who produces goods that have no substitutes.

•An industry with a single firm in which the entry of new firms is blocked.

•For example: Microsoft, Tenaga Nasional Berhad.

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One seller and large number of buyers: • Firm supply is equal to the whole market/industry

supply.• The monopolist is a firm as well as an industry in

itself. Product has no close substitute :

• Unique product with no competition. Price maker :

• Monopoly can influence either the market price or quantity supplied.

• Constraint by demand behavior of consumers. Barriers to entry :

• Heavy restrictions or barriers. Barrier to entry is legal or natural constraints that protect a firm from potential competitors. 4

6.1 Characteristic

Definition:• legal or natural constraints that protect a firm

from potential competitors. • The existence of monopoly in the long run is

depends on the barriers to entry.

The following are some common types of barriers: Control over raw material Patent and copyright Cost of establishing an efficient plant Government franchises

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6.2 Barriers to Entry?

Control over raw material• A monopoly status can be maintained through

control over the supply of raw materials• For example: China is the monopoly supplier of

pandas.

Patents or copyrights • A patent is an exclusive right to the production

of an innovative product.• A copyright is an exclusive right to the author,

of a book or a composer of a music or producer of a movie.

• The owner of the patent and the copyright has a monopoly over that particular product but its valid foar a limited time period only and the monopoly will expire in due course.

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Types of Barriers to Entry

Cost of establishing an efficient plant• This is the case of natural monopoly.• A natural monopoly exists when one firm can

meet the entire market demand at a lower price as compared to two or more firms.

• Example; TNB

Government franchises • The government will give an exclusive rights to

a firm to sell certain goods and services in certain area.

• Example; the government has given the right to install the satellite television system to ASTRO in Malaysia.

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Types of Barriers to Entry

The firm’s demand curve represents the industry demand curve since there is only one producer in a monopoly.

The demand curve for the output in monopoly is downward sloping.

Marginal revenue curve below the demand curve. It is twice as steep as the demand curve.

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Market Demand and Marginal Revenue

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TABLE 13.1 Marginal Revenue Facing a Monopolist

(1)QUANTITY

(2)PRICE

(3)TOTAL REVENUE

(4)MARGINAL REVENUE

0 $11 0 1 10 $10 $102 9 18 83 8 24 64 7 28 45 6 30 26 5 30 07 4 28 28 3 24 49 2 18 6

10 1 10 8

For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it.

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FIGURE 13.3 Marginal Revenue Curve Facing by Monopolist

The monopolist will fix a higher price if demand is inelastic and a lower price if demand is elastic.

When demand is elastic (Ed >1):• a decrease in price increases total revenue • marginal revenue is positive

When demand is unitary/ unit elastic (Ed = 1):• Total revenue is maximum• Marginal revenue will is zero (intersect with

quantity). When demand is inelastic (Ed < 1):

• a decrease in price reduces total revenue• marginal revenue is negative 11

Demand Curve and Elasticity of Demand

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(b) Total Revenue

$60,000

0 16 32

Total revenue

$3,750

016 32

Marginal revenue

Elastic (Ed > 1)

Inelastic (Ed < 1)

Unit elastic (Ed =1)

D = Average revenue

1-carat diamonds per day

(a) Demand and Marginal Revenue

$ p

er d

iam

on

dD

oll

ars

1-carat diamonds per day

Demand Curve and Elasticity of Demand

MR PED TR

+ve Elastic ↑

0 Unitary Elastic

Maximum

-ve Inelastic ↓

MR = MC • Profit maximizing output• No incentive to change the output.

MR < MC• it would pay for the firm to decrease output as

the saving in cost would be bigger than loss in revenue

MR > MC• additional revenue will more than additional

cost, thus it would be better off for the firm to increase output

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The monopolist is a price maker because can select the price that maximizes profit.

6.3 Short-run Decision: Profit Maximization

In the short run, a monopolist firm can earn supernormal profit, normal profit, or subnormal profit.

Supernormal profit:• Profit that earned by a firm when its (TR >

TC) or (P > ATC). Normal profit:

• Profit that earned by firm when its (TR = TC) or (P = ATC)

Subnormal profit:• Profit that earned by firm when its (TR < TC)

or (P < ATC) 14

Short-run Decision: Profit Maximization

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Supernormal Profit

Quantity

Price

PPROFIT

DD = AR MR

ATC

MC

ATC

QM

• TR > TC

• P > ATC

TR

TC

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Normal Profit

Quantity

Price

P = ATC

DD = AR MR

ATC

MC

QM

• TR = TC

• P = ATC

TR TC

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Normal Profit

Quantity

Price

P

DD = AR MR

ATCMC

QM

• TR < TC

• P < ATC

TR TC

ATC LOSS

Firm suffer losses:• Average revenue less than average total

cost. The monopolist will continue to

produce rather than shut down in the short run because price exceeds average variable cost.• Despite having market power, the

monopolist still constraint to either setting the price or output only, not both.

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6.4 Short-run Decision: Minimizing Loss

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p

Marginal cost

Average total cost

Average variable cost

Demand = Average revenue

Marginal revenue

0 Q

e

c

b

a

Loss

Quantity per period

Marginal revenue equals marginal cost at point e. At quantity Q, price p (at point b) is less than average total cost (at point a)The monopolist suffers a loss.But the monopolist will continue to produce rather than shut down in the short run because price exceeds average variable cost (at point c).

Do

llars

per

un

it

Long-run is the time period in which the firm can adjust its input used in the production.

A monopolist firm in the long-run is also in equilibrium at a point where MR = MC.

A monopolist that earns economic profit in the short-run may find that profit can be increased in the long run by adjusting the scale of the firm.

A monopoly that suffers a loss in the short run may be able to eliminate that loss in the long run by adjusting to a more efficient size

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6.5 Long Run Profit Maximization

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Misconception

Monopolist CAN earn positive economic profit in the long run.

Monopolist seek to maximize PROFIT.

Monopolist has BOTH good and bad to the market/society.

Monopolist ALWAYS earn positive economic profit in the long run.

Monopolist seek to maximize PRICE.

Monopolist ALWAYS bad to the market/society.

True Wrong

Deadweight loss• The result of not producing at price equal to

marginal cost like in perfect competitive market structure.

Price discrimination • behavior that transfer income or surplus

from consumers to the monopolist. Rent-seeking

• behavior to preserve positive profits @ action taken by household & firms to preserve positive profit.

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6.6 Social Cost of Monopoly

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Deadweight Loss

A

B C

DE

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Perfect Competitiv

e

Monopoly Changes

Consumer Surplus

Producer Surplus

Total Surplus

Try this!!

Deadweight Loss????

Definition:• Charging different prices to different buyers

for the same good or different prices for the same good on different units sold.

Conditions:• Monopoly Power:

The sellers must be a monopolist or at least must posses some ability to control output and price.

• No resale:Ability to prevent those who pay the lower price from

reselling the product to those who pay the higher price.

• Market Segregation: Identify and separate different buyers based

on different elasticity of demand. 25

6.7 Price Discrimination

Types of Price Discrimination:

• First-degree price discrimination Occurs when a firm charges different prices for each unit sold and charges each consumer the maximum price that he/she is willing to pay.

Example: Product that sold in auction antique goods, artwork, car or house.

• Second-degree price discrimination The monopolist sells at different price per unit of output, depending on how much a consumer buys.

Charges higher/lower price for fewer units sold and a lower/higher price for larger quantities purchased.

Example: Public utilities electricity charges, water charges or telephone charges.

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• Third-degree price discrimination: The monopolist sells to different group of consumer with different price but every unit of product sold to a given group is sold at same price.

The price to be charge based on the price elasticity of demand.

Refer slide 11.

Example: movie ticket, transportation, medical…

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