Chapter9 monopoly

Chapter 9

Monopoly

The Monopoly Market Structure What is a monopoly exactly?

A monopoly is a market structure characterized by: A single seller A unique product Impossible entry into the market

Under a monopoly, the consumer has only one choice. Thus, they can either buy from the producer or not consume

There are no close substitutes.

A Single Seller One single firm IS the industry.

Local monopolies are more commonly observed in the real-world than national monopolies. Examples

Unique Products Why do Monopolists have unique

products? Absence of close substitutes

Impossible Entry Barriers to Entry are high

It is different or impossible for a new firm to enter an industry due to: Ownership of Vital Resources Legal Barriers Economies of Scale

Ownership of Vital Resources

A seller can create its own barrier to entry if it owns a significant portion of a key resource required for the production of the good or service.

In practice, monopolies rarely arise for this reason. The market for most resources is national or even international, and ownership of most resources is dispersed among a large number of people and nations.

Example

Legal Barriers Legal barriers to entry are the source of most

present-day monopolies.

Entry into the market or competition within the market are restricted by the granting of a public franchise, government license, patent, or copyright.

Examples:

Economies of Scale Monopolies can emerge in time naturally

because of the relationship between average cost and the scale of the operation.

This is called “natural monopolies” Def: A natural monopoly is an industry in which

the LRAC of production declines throughout the entire market.

Natural monopoly provides an economic argument for regulated public utilities.

Economies of Scale When this happens a single firm can supply

the entire market demand at a lower cost than two or more smaller firms.

Markets characterized by economies of scale often become competitive over time because of technological advances or because of natural growth in the size of the market.

SOURCES OF MONOPOLY

10 cents a kilowatt-hour with two sellers, or . . .

Because of economies of scale, one seller can meet the market demand at a lower average cost than two or more sellers.

15 cents a kilowatt-hour with four sellers.

The cost to distribute 4 million kilowatt hours of electric power is

Economies of Scale

5 cents a kilowatt-hour with one seller in the market, or . . .

Price and Output Decisions for a Monopolist The demand curve for a monopolist differs

from the competitive firm because the monopolist is a price maker not taker. Def: A price maker is a firm that faces a downward

sloping demand curve.

More Demand and some Marginal Revenue

Demand and Marginal Revenue They are both negatively-sloped

Demand Market demand is negatively-sloped. The

monopolist faces a tradeoff between price and quantity sold.

To obtain a higher price, the monopolist must lower quantity. Or, if it wants to sell a larger quantity, it must lower price.

MONOPOLY EQUILIBRIUM

Demand and Marginal Revenue

Marginal revenue is less than price

The marginal revenue curve is negatively-sloped but lies below the demand curve at each quantity: MR<P at all Q.

Calculate the marginal revenue generated along the demand curve.

MONOPOLY EQUILIBRIUMExample: Demand and Marginal Revenue

If the price is $16, quantity demanded is 2 haircuts per hour.


If the price is $14, quantity demanded is 3 haircuts per hour.


Total revenue from two haircuts per hour decreases by $4.


Total revenue from the additional haircut is $14.


Marginal revenue from the additional haircut is $10.


The marginal revenue curve is negatively-sloped and lies below the demand curve. Marginal revenue is less than price at each quantity.



The diagram shows the monopolist’s

• marginal cost (MC),• demand (D),• and marginal revenue

(MR).

Profit Maximization by a Monopolist

• average total cost (ATC),

The monopolist maximizes profits or minimizes losses by producing the quantity at which marginal revenue equals marginal cost.

Monopoly23


The equilibrium quantity is 3 haircuts per hour where MR=MC, andthe equilibrium price is $14, shown by the demand at the quantity 3.

The ATC of 3 haircuts is $10.

Profit Maximization by a Monopolist

Because P>ATC at the equilibrium quantity, the monopolist earns a profit of $4 per haircut or $12 per hour.


Profit Maximization by a Monopolist: Numerical Example

The data in the table below verify that 3 haircuts per hour maximizes the monopolist’s profit.


Short-Run and Long-Run Equilibrium

When a monopolist incurs short-run losses

However, if a monopolist incurs economic losses in the short-run, it exits the market in the long-run. The long-run equilibrium quantity is zero.


Short-Run and Long-Run Equilibrium

When a monopolist earns short-run profits

Price Discrimination The monopolist may charge different prices to

consumers to maximize profits. Def: Price discrimination occurs when a seller

charges different prices for the same product that are not justified by cost differences.

Selling a good or service at a number of different prices where the price differences do not reflect differences in cost but instead reflect differences in consumers’ price elasticities of demand.

However, specific conditions must be met before the seller can act in this way.

Conditions for Price Discrimination The seller must be a price maker and

therefore face a downward-sloping demand curve

The seller must be able to segment the market distinguishing between consumers willing to pay different prices

It must be impossible or too costly for customers to engage in arbitrage

How can a producer price discriminate Discriminating among groups of consumers

Different prices for consumers with different elasticities. The market is segmented based on some easily distinguished characteristic of consumers—age, for example.

Discriminating among units of a good

The seller charges the same prices to all consumers but offers each consumer a lower price for a larger number of units bought—volume discounts, for example.

Price Discrimination with Two Groups of Consumers

A monopolist facing two groups of consumers with different demand elasticities may be able to practice price discrimination to increase profit or reduce loss. With marginal cost the same in both markets, the firm charges a higher price to the group in panel (a), which has a less elastic demand than group in panel (b).

D

(a)

LRAC, MC

(b)

400 Quantity per period0 500 Quantity per period0

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Is Price Discrimination Unfair

There is nothing evil or illegal about economic price discrimination. It simply means charging different prices for the same good or service unrelated to differences in cost.

Price discrimination is common in all markets other than perfectly competitive markets.

Is Price Discrimination Unfair

What are its effects: Increase seller’s profit, at least in the short run Enhance economic efficiency Conserve on scarce resources. Many buyers benefit because they are now

paying a lower price Example: Movie Theatres- senior citizen and college

students discounts

How does it increase the sellers profits

Increases seller’s profits By observing different elasticities for the

consumers the following can happen Reduce the price for buyers with elastic demand will

increase TR Increase the price for buyers with inelastic demand

will increase TR When the total quantity is not changing, then costs

are not changing, but revenues are profits are HIGHER

What about efficiency Enhances economic efficiency

We know that under a monopoly the output is under- produced. But price discrimination can fix this underproduction of the good

A price-discriminating monopolist is able to sell a larger quantity than a single-price monopolist by reducing price only on the additional units sold, not on all units sold.

Because the problem with monopoly is underproduction, increasing quantity enhances efficiency. The sum of producer and consumer surplus is higher in a monopoly market with price discrimination than in a market with a single-price monopolist.

MONOPOLY AND COMPETITION

The competitive market equilibrium is where quantity demanded equals quantity supplied.

The market demand curve is D.The market supply curve is S.

Competitive Equilibrium

The competitive equilibrium quantity is QC and the equilibrium price is PC.


The competitive market supply curve, S, is the monopolist’s marginal cost curve, MC.The monopolist’s marginal revenue curve is MR.

Monopoly Equilibrium

The monopolist’s equilibrium quantity is QM where marginal revenue equals marginal cost. The equilibrium price is PM , shown by the demand at QM.

MONOPOLY AND COMPETITION Competitive and Monopolistic Equilibrium

Monopoly quantity is lower and price is higher

A monopolist supplies a smaller quantity than a competitive market would supply at a higher price.

The higher price allows a monopolist to earn positive long-run economic profits.

MONOPOLY AND COMPETITION Economic Consequences of Monopoly

The absence of competition results in

• Inefficiency and deadweight loss

• Redistribution of wealth


The competitive equilibrium price, PC, brings consumers’ marginal benefit into equality with producers’ marginal cost. Therefore, the competitive equilibrium quantity, QC, is efficient. The sum of consumer surplus and producer surplus is maximized.

Efficiency of Competitive Equilibrium


Marginal benefit in the monopoly equilibrium (equals to the monopoly equilibrium price, PM) exceeds marginal cost.

Therefore, the monopoly equilibrium quantity, QM, is inefficient because of underproduction. Monopoly results in a deadweight loss.

Inefficiency of Monopoly


Economic Consequences of Monopoly

Redistribution of wealth


The deadweight loss of monopoly arises from a net loss in both consumer and producer surplus compared with the competitive equilibrium.

In addition to the net loss in the total surplus, monopoly also redistributes some of the remaining surplus from consumers to the monopolist.

Monopoly Redistributes Wealth

Chapter9 monopoly

Documents

sloped demand market

natural monopoly

monopoly market structure

marginal revenue demand

economies of scale monopolies

lower price

monopoly equilibrium

marginal revenue curve