Chapter 8: Pure Monopoly
Chapter 8: Pure Monopoly. Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin What is a Pure Monopoly? A pure monopoly.
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Chapter 8: Pure Monopoly
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
What is a Pure Monopoly?
A pure monopoly exists when a single firm is the sole producer of a product for which there are no close substitutes. Examples: local telephone company, local gas
and electric company, small town gas station
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Characteristics of Pure Monopoly
Single supplier – the firm and the industry are synonymous.
No close substitutes – the product is unique and unlike any others.
Price maker – the firm has considerable control over price since it controls the total quantity supplied.
Blocked entry – barriers to entry exist because there is no immediate competition.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Barriers to Entry
Barriers to entry are factors that prohibit firms from entering an industry. They include: Economies of scale Legal barriers to entry Ownership or control of essential
resources Pricing and other strategic barriers to entry
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Economies of Scale
If as a firm expands average total cost falls, then economies of scale exist.
Only a few large firms, or even a single firm, can achieve low average total costs, given market demand.
A natural monopoly exists because economies of scale are large and the firm can achieve minimum efficient scale.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Economies of Scale
If the market is controlled by a pure monopolist, economies of scale serve as an entry barrier. New firms face very large start up costs which
result in high average total costs. This makes it hard to compete with a monopolist that is already well established.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Legal Barriers to Entry:Patents and Licenses
Government-created barriers include patents and licenses. A patent is the exclusive right of an inventor
to use, or to allow another to use, her or his invention.
Licensing also limits the production of a product at the federal, state, or municipal level.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Ownership or Control of Essential Resources
A firm that owns or controls an essential resource can prohibit the entry or rival firms.
Private property serves as an obstacle to potential rivals.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Pricing and Other Strategic Barriers to Entry
Monopolists can bar entry into a market in other ways, including Price cutting Increase funding for advertising Exclusive contracts with distributors
The legality of such behavior may be challenged in court according to laws and regulations.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Monopoly Demand
Recall that in pure competition, a firm faces a perfectly elastic demand since it is a price taker. The market supply and demand curves determine
price, which determines the firm’s demand curve. In pure monopoly, the firm’s demand curve is
the market demand curve. The pure monopolist is the industry; therefore, the
demand curve is downward-sloping.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Demand
Pure Competition Pure MonopolyPrice Price
Quantity Quantity
Pfirm’s demand
MarketDemand
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Monopoly Marginal Revenue
Because market demand slopes downward, in order for a monopolist to increase sales it must lower its price.
Consequently, marginal revenue is less than price for every level of output except the first.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Monopoly Marginal Revenue
If the monopolist increases output by one more unit, the price charged for all units sold will fall. Each additional unit of output sold increases
total revenue by an amount equal to its own price less the sum of the price cuts that apply to all price units of output.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Monopoly Marginal Revenue
Example: An increase
in production from 2 to
3 units causes price to
fall from $46 to $44.
Total revenue rises
from $92 to $132.
Quantity Price (AR)
Total Revenue
0 $50 $0
1 48 48
2 46 92
3 44 132
For the third unit, marginal revenue = $40 < Price = $44.(MR = $44 for 3rd unit minus $2*2 for price cuts of the first two units.)
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
The Monopolist Isa Price Maker
A pure monopolist can influence market supply through its output decisions. Subsequently, it can also influence the product price. Each output is associated with a unique price;
by changing the market output, a monopolist is indirectly determining the market price.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Output and Price Determination
To determine the price-quantity combination that will maximize profit, cost data is needed.
Furthermore, a monopolist will employ the MR = MC Rule in order to maximize profit.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Determining Monopoly Price and Quantity
A monopolist produces a level of output where MR = MC. This determines the profit maximizing output, Qm.
Price is determined by the market demand curve. A vertical line is drawn from Qm to the demand
curve. Pm is the profit-maximizing price.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Finding Pm and Qm
Price
Quantity of output
Market Demand
MR
MC
Pm
Qm
MC = MR
Cost data will determinea monopolist’s profit.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
A Profitable Monopolist
Price
Quantity of output
D
MR
MCPm
Qm
ATC
EconomicProfit
Profit per unit
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Misconceptions Concerning Monopoly Pricing
Three fallacies concerning monopoly behavior include: Not Highest Price Total, Not Unit, Profit Profitability Not Assured
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Misconceptions Concerning Monopoly Pricing
Higher prices often yield smaller-than-maximum total profit. The “highest price possible” is not ideal
because it results in lower output and reduces total revenue.
The monopolist seeks to maximize total profit, not unit profit.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Misconceptions Concerning Monopoly Pricing
A monopolist suffers from weak demand, bad market conditions or resource cost increases.
Thus, profit is not always guaranteed.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Economics Effectsof Monopoly
Compared to pure competition, a monopoly lacks productive efficiency and allocative efficiency.
It is considered inefficient.
A monopolist charges a higher price and sells a smaller level of output than firms in a purely competitive industry.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Inefficiency of Pure Monopoly
Because the monopolist’s MR curve lies below demand and it produces output where MR = MC, price exceeds MC.
In pure competition, entry and exit of firms ensure that P = MC = min. ATC.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Inefficiency of Pure Monopoly
Pure Competition Pure MonopolyPrice Price
Quantity Quantity
Pc
DD
Qc
S = MC
Pc
MC
Qc
MR
Qm
Pm
P = MC = min. ATCMR = MC
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Economics Effectsof Monopoly
Monopoly increases income inequality because monopoly profits are not equally distributed. Monopolists levy a “private tax” on consumers
by transferring income from consumers to shareholders who own the monopoly.
Cost may vary in monopoly because of economies of scale, X-inefficiency, rent-seeking expenditures, and technological advance.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Cost Complications
Some firms achieve large economies of scale due to specialized inputs, the spreading of product developing costs, simultaneous consumption and network effects.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Cost Complications
Cost also vary because firms produce a level of output that is higher than the lowest ATC. This is called X-efficiency.
Rent-seeking behavior alters costs when firms gain special benefits from the government at the expense of taxpayers.
In the very long run, firms can reduce their costs through technological advances.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Price Discrimination
Price discrimination is the business practice of selling the same good at different prices to different consumers when the price differences are not justified by differences in costs.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Price Discrimination
Price discrimination is not possible when a good is sold in a purely competitive market since there are many firms all selling at the market price.
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Price Discrimination
In order to price discriminate, the firm must: have monopoly power be able to segregate the market into
difference groups be able to prevent resale of the product
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Monopoly and Antitrust Policy Monopoly is not widespread because
barriers to entry are seldom completely successful.
Governments deal with monopoly behavior through antitrust laws if the monopoly arises through anticompetitive actions or creates substantial economic inefficiencies. Otherwise, the government can do nothing.
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