CHAPTER 13 Monopoly. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which.

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


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


Learning Objectives





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.


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.


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.


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


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)


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)


Learning Objectives





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)


Learning Objectives





Single-Price Monopoly

• The firm’s demand curve is the market demand curve.

• Marginal revenue is not the same as the market price.


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.


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




)/( 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





)/( 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




Quantity (haircuts per hour)

Pri

ce &

mar

gin

al r

even

ue

(dol

lars

per

hai

rcut

)




Pri

ce &

mar

gin

al r

even

ue

(dol

lars

per

hai

rcut

)

DMR



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

)


Marginal Revenue and Elasticity

• A single-price monopoly’s marginal revenue is related to the elasticity of demand for its good.



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)



D

50

10

20

10



Pri

ce $

mar

gin

al r

even

ue

(dol

lars

per

hai

rcu

t)

–10

– 20



D

MR

50

10

20

10



Pri

ce $

mar

gin

al r

even

ue

(dol

lars

per

hai

rcu

t)

–10

– 20



D

Elastic

Unit elastic

Inelastic

MR

50

10

20

10



Pri

ce $

mar

gin

al r

even

ue

(dol

lars

per

hai

rcu

t)

–10

– 20



0

10

20

5 10

D

MR

Elastic

Unit elastic

Inelastic

Maximumtotal revenue



d

f

Pri

ce $

mar

gin

al r

even

ue

(dol

lars

per

hai

rcu

t)

–10

– 20



0 5 10

10

20

30

40

50 Total revenuecurve


Tot

al r

even

ue

(dol

lars

per

hou

r)



0 5 10

10

20

30

40



Tot

al r

even

ue

(dol

lars

per

hou

r)



0 10

10

20

30

40


TR

Zeromarginalrevenue


5

Tot

al r

even

ue

(dol

lars

per

hou

r)



• 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.


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





)/( QTRMR )/( QTCMC

20 0 0

18 1 18

16 2 32

14 3 42

12 4 48

10 5 50





)/( 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





)/( 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





)/( 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





)/( 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


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


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)


TR


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)


TR


TC


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)


TR


Economicprofit = $12

TC

42



0 1 2 3 4 5

10

14

20


Pri

ce a

nd

cos

t (do

llar

s pe

r ho

ur)



0 1 2 3 4 5

10

14

20


Pri

ce a

nd

cos

t (do

llar

s pe

r ho

ur)

D

MR



0 1 2 3 4 5

10

14

20


Pri

ce a

nd

cos

t (do

llar

s pe

r ho

ur)

D

MC

MR



0 1 2 3 4 5

10

14

20


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)


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.







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?



• Consumer surplus

• Price discrimination attempts to capture the consumer surplus for the monopoly.



• 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)



• 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.


$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.


0 4 10 15

500

2,000

1,000

1,500

2,500

Dv

MC$3 mil.


0 6 10 15

Pri

ce(d

olla

rs/ t

rip

)

500

2,000

1,000

1,500

2,500

DB

MC



Quantity (thous. of trips per year)

$2mil.

0 4 10

500

2,000

1,000Dv MC$3 mil.


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


$3.5 mil.



$2.45 mil.

0 4 10

Dv MC


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


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


Perfect Price Discrimination


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


MC

14

Profit from businesstravel with perfectprice discrimination

Profit from vacationtravel with perfectprice discrimination


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.







Monopoly andCompetition Compared

Pri

ce

Quantity

PA

PM

PC

0

DMR

S,MC

QM QC

Single-pricemonopolyrestricts output,raises price

Equilibriumin competitiveindustry


Inefficiency of MonopolyP

rice

Quantity

PA

0

D

QC

PC

S

PerfectCompetition

Consumersurplus


Inefficiency of MonopolyP

rice

Quantity

PA

PM

0

DMR

MC

QM QC

PC

Consumersurplus

Monopoly’sgain

Deadweightloss

Monopoly







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.


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


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

CHAPTER 13 Monopoly. TM 13-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Define monopoly and explain the conditions under which.

Documents

market price

outputmonopoly price

lower price

singleprice monopolyexplain

legal monopoly competition

entrylegal barriers

entrynatural barriers

market demand curve